With the Fed’s third rate hike this week in the post-financial crisis era, let’s take a look at how market rates have reponded.
Here’s a chart of the U.S. 10 year government bond yield.
On December 16, 2015, the Fed moved for the first time. The 10-year traded up to 2.33% that day and didn’t see that level again for 11-months. Despite the fact that the Fed forecasted four hikes over the next twelve months, the bond market wasn’t buying it. A month later, the fall in oil prices turned into a crash. And the 10 year yield printed a new record low at 1.32%, just under the crisis lows.
On December 14, 2016, the Fed made the second move. This was after they had spent the better part of the last nine months walking back on what they thought would be their 2016 hiking campaign. The difference? Trump was elected the new President and he was already fueling confidence from talk of big, bold fiscal stimulus. The Fed’s big hiking campaign was placed back on the table. The high in yields the day the Fed made hike #2 was 2.58%. The next day it put in a top at 2.64% that we have not seen since.
And, of course, this past week, we’ve had hike #3. The 10 year yield traded up to 2.60% that day (Wednesday) and we haven’t seen it since, despite the fact that the Fed has continued to tell us another couple of hikes this year, and that the economy is doing well, expect about three hikes a year through 2018. Yields go out at 2.50% today.
So why aren’t market rates screaming? The 10 year yield should be 3.5%+ by now. And consumer rates should be surging. Is it the Bank of Japan, the European Central Bank and China buying our Treasuries, keeping a cap on yields? Is it that the market doesn’t believe it and thus the yield curve is flattening (which would project recession)? Probably a bit of both. The important point is that the Fed absolutely cannot do what they are doing if they think they will push the 10 year yield up to 3.5%+, and fast.
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Following the Fed yesterday, we heard from the Bank of Japan overnight, and the Bank of England this morning. As for Europe, we heard from the ECB last week.
Coming into this week we’ve had this ongoing dynamic, for quite some time, of the Fed going one way on rates (up) and everyone else going the other way (cutting rates, QE, etc.).
That’s been good for the dollar, as global capital tends to flow toward areas with rising interest rates and better growth prospects. That combination tends to mean a rising currency and rising investment values. What really determines those flows though, is the perception of how that policy spread, between countries, may change. Most recently, that perceived change in the spread has been in favor of it growing, i.e. Fed policy tighter or at least stable, while other spots of the world considering even easier on monetary policy.
That divergence in policy has been bad for currencies like the euro, the pound and the yen. But that hit to the currency is part of the recipe. It promotes higher asset prices, better exports and growth. And as Bernanke says, QE tends to make stocks go up, which helps.
Still, those stocks have lagged the strength in U.S. stocks. With that, over the past six months or so, I’ve talked about the opportunities in European and Japanese stocks for a catch up trade.
While U.S. stocks have continued to set new record highs, stocks in Europe and Japan have yet to regain the highs of 2015 — when the global economy was knocked off course, first by slowing China and a surprise currency devaluation, and later by a crash in oil prices.
With that, if you think Trumponomics marked the end of the decade long deleveraging period (post-financial crisis), and that the Fed is signaling that by ending emergency level monetary policy, then the rest of the world should follow. That means the next move in Europe, Japan, the UK will be toward normalization, not toward more emergency policies.
That means the expectations on the policy gap narrows. With that, we may have seen the bottom in the euro. If negative interest rates and an election cycle that has parties that are outright promising to destroy the euro can’t push it to parity, what can? If it can’t go lower, it will go higher.
And if the euro has bottomed and the next move for the central bank in Europe is tapering, the first step toward ending emergency policies, then this stock market in Europe looks the most intriguing for a big catch up trade – still about 20% off of the 2015 highs and well below the pre-crisis all time highs.
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As we head into the Fed tomorrow, stocks have fallen back a bit today.
Yesterday we looked at the nice 45 degree climb in stocks since Election Day. And the big trendline that looked vulnerable to any disruption in the optimism that has led to that climb. That line gave way today, as you can see.
The run up, of course, was on the optimism about a pro-growth government, coming in after a decade of underwhelming growth. The dead top in stocks took place the day after President Trump’s first speech before the joint sessions of Congress. There is a phenomenon in markets where things can run up as people “buy the rumor/news” and then sell-off as people “sell the fact.”
It’s a reflection of investors pricing new information in anticipation of an event, and then selling into the event on the notion that the market has already valued the new information. It looks like that phenomenon may be transpiring in stocks here, especially given that the timeline of tax reform and infrastructure spending looks, now, to be a longer timeline than was anticipated early on.
And as we discussed yesterday, it happens to come at a time where some disruptive events are lining up this week: from a Fed rate hike, to Dutch elections, to Brexit, to G20 protectionist rhetoric.
Stocks are up 6% year-to-date, still in the first quarter. That’s an aggressive run for the broad stock market, and we’re now probably seeing the early days of the first dip, on the first spell of profit taking.
What about oil? Oil and stocks traded tick for tick for the better part of last year, first when oil crashed to the mid-$20s, and then when oil proceeded to double from the mid-$20s. Over the past few days, oil has fallen out of it’s roughly $50-$55 range of the Trump era. Is it a drag on stocks and another potential disrupter? I don’t think so. Oil became a risk to stocks and the global economy last year because it was beginning to trigger bankruptcies in the American shale industry, and was on pace to spread to banks, oil producing countries and the global financial system. We now have an OPEC production cut under the belt and a highly influential oil man, Tillerson, running the State Department. With that, oil has been very stable in recent months, relative to the past three years. It should stay that way – until demand effects of fiscal policy start to show up, which should be very bullish for oil.
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This week will be a huge week for markets. Stocks continue to hover around record highs. Rates (the 10 year yield) sit at the highest level in three years.
This snapshot alone suggests a world that continues to believe that pro-growth policies “trump” all of the risks ahead. At the very least, it’s pricing in a world without disruptions. But disruptions look likely.
Here’s a look at stocks as we enter the week. Still in a 45 degree uptrend since the election.
But if we take a longer term look, this trendline looks pretty vulnerable to any surprise.
Let’s take a look at the disruptions risks:
There was a chance that the official execution of Brexit may have come as soon as tomorrow — the UK leaving the European Union by triggering Article 50 of the Treaty of Lisbon. That looks unlikely now, but could come in the coming weeks. To this point the Bank of England has done a good job of responding and promoting stability which has led to financial markets pricing in an optimistic outcome.
We have the Fed on Wednesday. They will hike for the third time in the post-financial crisis era. We don’t know at what point higher interest rates, in this environment, might choke off growth that is coming from the fiscal side.
This next chart looks like rates might run to 3% on the 10-year. That would do a number on housing, IF tax reform and an infrastructure spend out of the White House come later than originally anticipated (which is the way it looks).
We also have the Bank of Japan and Bank of England meeting on rates this week. Let’s hope they have a very boring, staying the path, message. That would mean extremely stimulative policies for the foreseeable future 1) in the case of Japan, to continue to promote global liquidity and anchor global yields, and 2) in the case of the UK, to continue to promote stability in the face of uncertainty surrounding Brexit.
Keep this in mind: The Bank of Japan’s big QE launch in 2013 is a huge reason the Fed was able to end QE in the first place, and start its path of normalization. The BOJ launched in April of 2013. Bernanke telegraphed “tapering” a month later. The Fed officially ended tapering on October 29, 2014. Stocks fell 10% into that official ending of Fed QE. On October 31, 2014 (two days later), the BOJ surprised the world with bigger, bolder QE (a QE2). Stocks rallied.
Finally, to end the week, we have a G-20 finance ministers meeting. This is where all of the trade and dollar rhetoric from the new administration will be front and center. So the news/event outlook looks like some waves should be ahead. But any dip in stocks would be a great buying opportunity.
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With today marking eight years from the bottom in the stock market, let’s talk about why it bottomed. And then take look at the run up in stocks since 2008.
First, why did stocks (the S&P 500) turn at 666 on March 9th, 2009?
Policymakers were scrambling to stop the bleeding in banks, trying to unfreeze global credit, and stop the dominos from continuing to fall.
The Fed had already launched a program a few months earlier to buy up mortgage back securities, to push down mortgage rates and stop the implosion in housing. Global central banks had already slashed interest rates in attempt to stimulate the economy. The U.S. had announced a $787 fiscal stimulus package a few weeks earlier. And then finance ministers and central bankers from the top 20 countries in the world met in London on March 14.
Here’s what they said in the opening of their communique: “We have taken decisive, coordinated and comprehensive action to boost demand and jobs, and are prepared to take whatever action is necessary until growth is restored.”
The key words here are “coordinated” and “whatever action is necessary.”
The Fed met four days later and rolled out bigger purchases of mortgages, and for the first time announced they would be buying government debt. This was full bore QE. And it was with the full support of global counterparts, which later followed that lead.
What wasn’t known to that point, was to what extent policymakers were willing to intervene to avert disaster. This statement by G20 finance heads and the action by the Fed let it be known that all options are on the table (devaluation, monetization, etc) — and they were all-in and all together in the fight to stave off an apocalypse. With that, the asset reflation period started. And it started with QE.
With that said, let’s take a look at the chart on stocks and the impact QE has had along the way.
The baton has now been passed to fiscal stimulus in the U.S. But we have the benefit of QE still full bore in Europe and Japan. The question is, can that continue to anchor interest rates in the U.S. and keep that variable from stifling the impact of growth policies.
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One of the best investors on the planet, David Tepper, was on CNBC this morning. Let’s talk about how he sees the world and how he is positioned.
What I appreciate about Tepper: He’s a common sense guy.
And his common sense view of the world happens to be in alignment with the view and themes we discuss here every day. So he agrees with me – another thing I appreciate about him.
As you know, Wall Street and the media are always good at overcomplicating the investment environment with their day-to-day hyper analysis. Because of that, they tend to forge a path that moves further and further away from the simple realities of the big picture. That’s actually good. Because it creates opportunity for those that can avoid those distractions.
Right now, as we’ve discussed, the big picture is straight forward. We have a President that wants deregulation, tax cuts and a big infrastructure spend. And we have a Congress in place that can approve it. And this all comes at a time when the world has been in a decade long economic slog following the global financial crisis – in desperate need of growth. With that, we have a Fed that still has rates at very, very low levels. And the ECB and BOJ are still priming the pump with QE.
This is precisely Tepper’s view. He says the bowl is still full, i.e. the stimulus from the monetary policy side is still full, and now we get stimulus coming in from the fiscal side. What more could you ask for (my words) to pump up growth and asset prices, which will likely spill over into a pop in global growth. Still, people are underestimating it. And as he says, the Fed is underestimating it.
Are there risks? Yes. But the probability of growth, with the above in mind, well outweighs the probable downside scenarios. What about execution risk? Even if tax reform and infrastructure are slow to come, Tepper says deregulation is a done deal. It drives earnings and “animal spirits.”
He likes stocks. He likes European stocks. And I think he really likes Japanese stocks, but he stopped short of talking about it (my deduction).
Among the risks: Inflation picking up too fast, which would require the Fed to move faster, which could choke off growth (undo or neutralize fiscal stimulus).
This is why, among other reasons, Tepper’s favorite trade is short bonds. – i.e. higher interest rates. If he’s right and economic growth has a big pop, he wins. If the risk of hotter inflation materializes and rates move faster, he wins.
For context, this is the guy that literally changed global investing sentiment in late 2010 when he sat in front of a camera on CNBC, in a rare high profile TV interview (maybe first), when investing sentiment was all but destroyed by the global financial crisis and the various landmines that kept popping up. Tepper said in a very confident voice that the Fed, by telegraphing a second round of QE, had just given us all a free put on stocks (i.e. the Fed is protected the downside, it’s a greenlight to buy stocks). For all of the market jockeys that were constantly focusing on the many problems in the world, that commentary from Tepper, for some reason, woke them up.
For perspective on Tepper: Here’s a guy that is probably the best investor in the modern era. He’s returned between 35%-40% annualized (before fees) for more than 20 years. He made $7.5 billion in 2009 betting on financial stocks that most people thought were going bankrupt. And he was telling everyone that what the Fed is doing will make ‘everything’ go up. It sparked, in 2010, what is known as the “Tepper rally” in stocks.
When Tepper speaks it’s often smart to listen. And he likes the Trump effect!
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Since going public last week, Snap has had a valuation north of $30 billion. It’s been getting hammered from the highs over the past couple of days. A big component to the rise of Internet 2.0 was the election of Barack Obama. With a change in administration as a catalyst, the question is: Is this chapter of the boom in Silicon Valley over? And is Snap the first sign?
Without question, the Obama administration was very friendly to the new emerging technology industry. One of the cofounders of Facebook became the manager of Obama’s online campaign in early 2007, before Obama announced his run for president, and just as Facebook was taking off after moving to and raising money in Silicon Valley (with ten million users). Facebook was an app for college students and had just been opened up to high school students in the months prior to Obama’s run and the hiring of the former Facebook cofounder. There was already a more successful version of Facebook at the time called MySpace. But clearly the election catapulted Facebook over MySpace with a very influential Facebook insider at work. And Facebook continued to get heavy endorsements throughout the administration’s eight years.
In 2008, the DNC convention in Denver gave birth to Airbnb. There was nothing new about advertising rentals online. But four years later, after the 2008 Obama win, Airbnb was a company with a $1 billion private market valuation, through funding from Silicon Valley venture capitalists. CNN called it the billion dollar startup born out of the DNC.
Where did the money come from that flowed so heavily into Silicon Valley? By 2009, the nearly $800 billion stimulus package included $100 billion worth of funding and grants for the “the discovery, development and implementation of various technologies.” In June 2009, the government loaned Tesla $465 million to build the model S.
When institutional investors see that kind of money flowing somewhere, they chase it. And valuations start exploding from there as there becomes insatiable demand for these new “could be” unicorns (i.e. billion dollar startups).
Who would throw money at a startup business that was intended to take down the deeply entrenched, highly regulated and defended taxi business? You only invest when you know you have an administration behind it. That’s the only way you put cars on the street in NYC to compete with the cab mafia and expect to win when the fight breaks out. And they did. In 2014, Uber hired David Plouffe, a senior advisor to President Obama and his former campaign manager to fight regulation. Uber is valued at $60 billion. That’s more than three times the size of Avis, Hertz and Enterprise combined.
Will money keep chasing these companies without the wind any longer at their backs? The favor in the new administration looks more likely to go toward industrials and energy. That would leave the pumped up valuations in some of these internet businesses, that operate with no real plan on how to make money, with a long way to fall.
In our Billionaire’s Portfolio, we’re positioned in a portfolio of deep value stocks that all have the potential to do multiples of what broader stocks do — all stocks owned and influenced by the world’s smartest and most powerful billionaire investors. Join us today and we’ll send you our recently recorded portfolio review that steps through every stock in our portfolio, and the opportunities in each.
It’s jobs week. Thanks to 1) Trump’s reminder to the country in his address to Congress last week that big economic stimulus was coming, and 2) Yellen’s remarks last week that all but promised a rate hike this month, the market is about as close to fully pricing in a rate hike as possible for March 15.
The last data point for everyone to obsess about going into next week’s Fed meeting will be this Friday’s jobs report.
But as I’ve said for quite a while, the jobs data has been good enough in the Fed’s eyes for quite some time. Nonetheless, they’ve had many, many balks along the path of normalizing rates over the past couple of years. Here’s a look at a chart of the benchmark payrolls data we’ll be seeing Friday.
You can see in this chart, the twelve-month moving average is 195k. The three-month moving average is 182k. The six-month moving average is 182k. This is all fairly consistent with historical/pre-crisis levels.
So the numbers have been solid for quite some time, even meeting and exceeding the Fed’s targets, especially when it comes to the unemployment rate (4.7% last). However, when the Fed’s targets have been met, the Fed has moved the goal posts. When those goal posts were then exceeded, the Fed found new excuses to justify their decisions to avoid the path of aggressive hikes/normalization of rates that they had guided.
Among those excuses: When jobs were trending at 200k and unemployment breached 5%, the Fed started to acknowledge underemployment. Then the lack of wage growth became the focus. Then it was macro issues. To name a few: It’s been soft Chinese economic data, a Chinese currency move, Russian geopolitical tensions, collapsing oil prices, Brexit and weak productivity.
And just prior to the election last year, the Fed became, confusingly, less optimistic about the U.S. economic outlook, which was the justification to ratchet down the aggressive projected path for rates.
I suspected last year, when they did this that they were making a strategic pivot, to set expectations for a much easier path for rates, in hopes to keep people spending, borrowing and investing — instead of promoting a tighter path, which proved for the better part of two years (prior to the election) to create the opposite effect.
Remember, Bernanke (the former Fed Chair) even wrote a public piece on this last August, criticizing the Fed for being too optimistic in its projections for the path of interest rates. By showing the market/the world an expectation that rates will be dramatically higher in the coming months, quarters and years, Bernanke argued in his post that this “guidance” has had the opposite of the desired effect – it’s softened the economy.
A month later, in September, in Yellen’s post-FOMC press conference, she said this in response to why they didn’t raise rates: “the decision not to raise rates today and to wait for some further evidence that we’re continuing on this course is largely based on the judgment that we’re not seeing evidence that the economy is overheating.” Safe to argue, the economy isn’t overheating, still.
Again, as I said on Friday, the only difference between now and then, is the prospects of major fiscal stimulus, which is precisely what the Fed claims to be ignoring/leaving out of their forecasts – a believe it when I see it approach, allegedly.
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We closed last Friday with another new weekly record high on the Dow. But we closed with an all-time record low in the German 2-year bund. That development in Europe, weighed on U.S. yields, pulling yields down here from 2.5 to 2.31%.
So we had this divergence between what was happening in stocks and what the bond market was communicating. The bond market was telling us there was growing concern about danger to European economic stability, and therefore global economic stability, in the upcoming French elections. Stocks were telling us, growth is king – the ultimate problem solver, and growth is coming.
With that, Trump’s address to Congress on Tuesday night became a major sentiment gauge/the arbiter on which would win out, based on the perception of whether or not the Trump administration could execute on its economic plans.
The vote was “affirmative” for the growth story. Stocks gapped higher to new record highs (closing this week at another weekly record high). And the bond market turned on a dime, following Trump on Tuesday night, and have been climbing since. German yields have bounced. And U.S. yields have bounced. That leads us up to today’s speech from Janet Yellen.
There has been a tremendous shift in the past week in the expectations for a March rate hike. It’s gone from a 27% chance of a March 15 rate hike being priced in last Friday. By Wednesday morning, after Trump’s speech, it was 70%! And we close out the week with an 80% chance of a hike this month.
That additional bump came today on a speech and Q&A session from Janet Yellen today. Here’s the expectations bar she chose to set: She said the Fed would likely be moving faster than it had in 2015 and 2016. It should be said that they only hiked once in 2015 and 2016 because their forecasts proved grossly overly optimistic and they had to adjust on the fly. So they’ve already told us, back in December, that they think it will be three times this year. That’s faster than one. And today she reiterated that today.
And today she also said that if the data continued to improve as they forecast, they can hike this month.
Now, they have a post-FOMC meeting press conference scheduled FOUR more times this year (March, June, September and December). Despite what they suggest, that they could hike at any meeting and just call an impromptu press conference, they would be crazy to introduce such a surprise in markets. Stability and confidence work in their favor. Surprises threaten stability and confidence.
So if they indeed hike three times, they have a narrow window. And if they think they need to hike faster, because perhaps fiscal policy accelerates growth and inflation, they may need to keep the December meeting open for a fourth hike.
But, Yellen and company have recently gone out of their way to tell us that they are not even factoring in fiscal stimulus and deregulation (growth policies) into their view on the economy. They’ll believe when they see it and take that information as it comes, which puts them in an even more vulnerable position to needing more tightening this year, if you take them at their word and trust their forecasting abilities.
So with that in mind, why has the Fed become so bulled up on interest rate picture since December? Is it because the inflation and jobs data has gotten that much better? The unemployment rate has been below 6% (the Fed’s original target) since September of 2014 and below 5% for the past year. And the core inflation rate has been above 2% since November of 2015, which includes all year last year, when the Fed was reversing course on its promises for a big tightening year. That’s near normal employment in the Fed’s eyes and above its target for inflation – a clear signal to normalize interest rates. But they’ve barely budged.
Why? Because last year the global economy looked vulnerable. With that, they threw every other guiding data point out the window and went back to playing defense. And as recent as August of last year, the Fed messaging was quite dovish. What’s the biggest difference between now and then? The prospects of major fiscal stimulus – precisely what they say they are leaving out of their forecasts for now.
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As we discussed last week, the Presidential address to the joint sessions of Congress last night was a big market event. And as I discussed yesterday, growth and fiscal stimulus needed to be moved to the front burner of the daily narrative. The President delivered last night.
After he began speaking, one of the early headlines on my Reuters feed last night: TRUMP SAYS HE WILL BE ASKING CONGRESS TO APPROVE LEGISLATION THAT PRODUCES $1 TRILLION INVESTING IN INFRASTRUCTURE FINANCED THROUGH BOTH PUBLIC AND PRIVATE CAPITAL.
Bingo! There’s a lot of talk about the inspiration of the speech, but growth is king in this environment, after 10 years of malaise and no improvement in sight. And the focus has shifted to growth. Stocks have had a huge day. Meanwhile, yields have been up but relatively tame. Gold has been down, but relatively tame. And the dollar has been up, but relatively tame.
German 2 year yields, which have been the sour spot, as they’ve slipped toward -1% in the past week, were up bouncing nicely today.
It’s not uncommon to see big global market participants ignore all else in key market moments, and just focus on one spot. That has been the case. And that spot is the stock market. The U.S. stock market is where the impact of a trillion dollar infrastructure spend, a massive tax cut, and broad deregulation can be most directly influenced and, as importantly, stocks are capable to absorbing large, large amounts of capital.
Now, it’s time to revisit some great catch up trades I’ve discussed for a while: German and Japanese stocks. A better U.S. is better for everyone, make no mistake. Hotter growth here, will mean hotter global growth, and it gives Europe and Japan a shot at recovery, especially with their central banks priming the pump with big QE, still.
On that note, let’s take a look at the charts …
So you can see the same period here for U.S., German and Japanese stocks, dating back to 2012, when the European Central Bank stepped in with intervention in the European sovereign bond market (at least promised to do so), that turned global economic sentiment and then then Japan came in months later with promises of a huge stimulus program. All stocks went up.
But you can see, stocks in Europe and Japan have yet to regain highs of 2015, after the oil price crash induced correction.
These stock markets look like a big catch up trade is coming, and it may be quick, following the catalyst of last nights U.S. Presidential address.
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It’s jobs week. Thanks to 1) Trump’s reminder to the country in his address to Congress last week that big economic stimulus was coming, and 2) Yellen’s remarks last week that all but promised a rate hike this month, the market is about as close to fully pricing in a rate hike as possible for March 15.
