So the EU laid down the law last week: Greece had to prove that it was serious about austerity measures. It had to get all political parties who might win in elections this year to agree to maintain the austerity measures, and they did. It had to pass a bill detailing the austerity measures through parliament, and it did. The government and the major political parties went further, and sacked anyone who voted against the measure – displaying a fairly hair-raising resolve to ditch democracy if that was necessary to make a buck. And it had to find a few more hundred million in austerity measures, which it was working on.
Then a group of Euro finance ministers was to meet on Wednesday, sign off on the deal, and move the process forward so that the March bond payment would be covered (assuming a few other things, like the IIF agreement, moved forward as well).
Well, that meeting has been canceled. It is being replaced with a conference call. Jean-Claude Juncker said that they had not received “assurances” from Greek leaders about the cuts. You may read between the lines here with some ease: it is hard to imagine how greater assurances could have been given than sacking all of the dissenters and passing a law despite protestors outside threatening to burn the ancient city down.
The Euro ministers may have been surprised by the report that Greece’s economy contracted by 7% (annualized) in the latest quarter, but although that was larger-than-expected it wasn’t so different that it should completely change the EU’s perspective. To me, Juncker’s downgrading of the meeting looks like a fairly clear indication that the EU is not at all united about whether Greece should be saved, allowed to default while remaining in the EZ, or kicked summarily out of the EZ (or even the EU). It sounds like an excuse. It is hard to see how Greece could have done more than they did this weekend. I don’t believe Greece can be prevented from defaulting, and I have said that now for a very long time. I think that enough in the EU have come to the same conclusion that the default is going to happen, probably in March – and the way the EU has gone about it, frankly, is going to cause bad blood in Athens for a generation.
Meanwhile, in Japan the Bank of Japan overnight added ¥10 trillion (about $130bln) to their version of QE, and declared that it now has an inflation target of 1%. The BoJ didn’t state over what period inflation is to return to 1%. I will say that it’s about time – the country that has had the most need of QE, the most reason to weaken its currency, has for the last couple of decades refused to apply meaningful monetary stimulus to its deflation problem. I’m fond of saying that the BoJ correctly diagnosed the disease (deflation) and correctly prescribed the treatment (more money) but completely blew the dosage. “The body economic has cancer: radiation is prescribed. Here is a prescription for one hour in a tanning bed.” With this action, they are finally starting to increase the dosage.
I showed a couple weeks ago that core inflation in Japan, just as in Europe, the UK, and the US, has been rising (in Japan’s case, rather fitfully) for several years. But that is mainly from global factors – the rising money tide raises all prices, no matter its source. The quickest way for Japan to increase its own inflation is for it to intentionally weaken its currency. That they’ve never done this is hard to understand, and must be tied to a sense of national honor and pride in the currency. A weaker Yen would help growth and raise inflation. It boggles why a more-aggressive monetary policy hasn’t been pursued before now.
If Japan is serious, then currency-hedged Nikkei is going to finally be an interesting investment. Since 1989, the only way you wouldn’t get smoked being long the Nikkei was because you were usually buying Japanese stocks with cheaper yen than when you went to sell. While the Nikkei in Yen terms has lost about 77% over the last quarter-century, in dollar terms it has only lost about 57%, thanks to the ever-appreciating currency. If the BoJ is really going to print, and has the guts to outprint the U.S., then the Nikkei may appreciate while the currency actually weakens.
The economic news in the U.S. continues to be okay, but not great. Today’s Retail Sales report was better-than-expected as core Retail Sales was +0.7% versus expectations for +0.5%, but December’s numbers were revised lower and essentially offset the weakness. These are not depression numbers, but they aren’t also robust expansion numbers. We continue to stumble forward economically…but at least we’re stumbling forward.
On Wednesday, the pace picks up a little further. In addition to finding out what comes out of the conference call of the EU ministers, the February Empire Manufacturing report (Consensus: 15.00 from 13.48), January Industrial Production (Consensus: +0.7%) and Capacity Utilization (Consensus: 78.6% vs 78.1%), and the minutes of the latest FOMC meeting will be released. This last will be carefully scrutinized for details about how to interpret the new communications from the Fed, but I actually don’t expect we will learn much new: the FOMC went out of its way to tell us exactly what they wanted us to understand from the new approach.
Although it didn’t happen until after the U.S. market had closed – funny how that happens – there is yet another delay in the Greece-Euro deal. The Greek leaders, who were discussing the austerity measures, “agreed on all the points of the program with the exception of one which requires further elaboration and discussion” with the Troika. The ‘discussion’ seems to be brought about because Greece was told it needs to cut pensions, and the socialist party said they won’t agree to such a thing. I wonder how they’ll discuss that thing out.
Equities managed another small gain before that news came out, on still-ephemeral volume. After the close, stocks slipped, but not terribly. We will see what the morning brings.
I have been ‘bullish’ on equities for a few weeks. I put the word in quotes because although I believe stocks have a better chance to rise than to fall while the Fed and ECB (and everyone else) are pumping away, I recognize that equities are still richly valued and I am not completely sure that being long is worth the risk. I must say that for all the consistency of the advance in the S&P since mid-December (see Bloomberg chart below), the steady step higher on tiny volume scares me. It scares me because of the old market maxim that “the stock market goes up on the staircase and down on the escalator.”
I am also frightened by comments today from Blackrock Chairman and CEO Larry Fink. He suggested that investors should have 100% in equities. According to Mr. Fink, “I don’t have a view that the world is going to fall apart, so you need to take on more risk. You need to overcome all this noise. When you look at dividend returns on equities vs. bond yields, to me it’s a pretty easy decision to be heavily in equities.” It doesn’t scare me because it’s a unique thought: the talking heads on CNBC often advocate ridiculous concentrations to equities and don’t care about the price. It doesn’t scare me because he’s wrong to look at relative valuations of dividend yields versus bond yields when making a call on future performance of either asset class – the absolute level of both of them augurs poorly for future returns. Although the Chairman of a firm that supposedly has quant DNA should know better than to say something that wrong, in his role he’s really chief marketing officer and he’s trying to sell product. No, what scares me (perhaps “saddens me” is more accurate) is that anyone in a position of authority who might be listened to would actually be so cavalier as to advocate a 100% investment in anything, especially given the huge list of global risks, and especially in a market that isn’t exactly priced with a margin of safety. By contrast, Enduring Investments’ asset-allocation model currently has 3-4% in equities.
But all of that aside, the stock market isn’t going up because of heavy buying. It is going up because there is rotten liquidity and so any buying pressure pushes prices higher, and there are plenty of people who see the money spigots open and reflexively buy real assets. I don’t mind that for a trade, and I admit to being long some stocks myself just in case I am wrong and Fink is right. And I suppose that is the point. I feel I need to protect against the possibility that I am wrong. Fink doesn’t feel the same need.
One thing I am not worried about is the price of gasoline. This is not to say that I am excited about the fact that gasoline futures are right about at $3 and retail unleaded gas is nearing $3.50. If this is a demand-side phenomenon, then it could actually be good news. However, as far as I can tell, domestic gasoline demand is actually down, not up, according to the Department of Energy (see Chart below, source Bloomberg).
Demand in Europe can’t be strong right now, and the large emerging economies are struggling as well. This is all bad news, because collectively it takes away the demand-side explanation. But the answer isn’t necessarily supply-side (that is, peak oil, Hormuz fear, or low inventory levels). I think at least some of the answer is monetary-policy side. The chart below (source: Bloomberg) shows retail gasoline versus the stock market for the last five years. Some of the correlation, for example in 2008, is clearly demand-related. But the equity run-up into and through QE2, from mid-2010 into early-2011, I think we all know was mostly inspired by cheap money. Gasoline responded in the same way at that time, as did of course most commodities.
I think the gasoline and equity rallies right now are occurring for the same reason. It wouldn’t be my first guess – my first guess would be demand-side, but that argument is clearly flat. I think loose monetary policy is at least part of the story here.
And speaking of loose monetary policy, I must share the following exchange with you. Bloomberg published a provocatively-titled article (“Bernanke Economy Proves Critics Clueless on Fed”) that was so lopsided the article is either a plant or the author’s kids just broke Chairman Bernanke’s window and she’s trying to make it up to him. Quoting John Lonski (Moody’s…how have they done with forecasting?) and Mark Gertler, the article bashes a number of fairly successful forecasters (such as Paul Kasriel of Northern Trust, who is consistently one of the nation’s top forecasters) by essentially saying that the failure of inflation to immediately surge following aggressive Fed easing meant that all of those forecasters were “clueless.”
One of those economists, Stephen Stanley of Pierpont Securities, took umbrage at being called “clueless” and fired back a broadside that is fantastic in that it points out clearly many of the weaknesses in the reasoning of the “I heart Bernanke” lobby (readers of this column will be familiar with many of these arguments). I have not always agreed with Stanley’s perspective on the economy – no honest economist always agrees with anyone – but he hits the nail on the head here and I will quote a large part of his response. He first points out that the article attacks a straw man because no reputable economist forecast a huge immediate surge in inflation just because of a surge in bank reserves. He then notes:
… And keep in mind that the inflation rate accelerated in 2011 by roughly a full percentage point for both headline and core. That is in fact a pretty “rapid” pickup in inflation that would get us into trouble if it persisted.
Importantly, this acceleration in inflation in 2011 was absolutely not predicted by the Fed or its apologists. The Phillips Curve model that dominates the FOMC’s thinking (and evidently Lonski’s and Gertler’s) does not even allow for the acceleration in inflation seen in 2011. In fact, the Fed models are unambiguous that inflation should be falling substantially now (because there is a lot of slack in labor markets), which is a main reason that Fed officials had such unwarranted concerns about deflation in recent years and why they now so confidently predict that inflation will decelerate from here, even as growth improves and “slack” diminishes. And herein lies the problem. We have a central bank that apparently believes that inflation is driven by wages which are in turn driven by the degree of slack in labor markets (i.e. the unemployment rate). I had thought that this dusty old Phillips Curve framework was thrown in the dustbin of history after the disaster of the 1970s, but clearly (like some bad 1950s horror film) a new generation of academic economists has dug it out of the trash, cleaned it off, and attempted to dress it in new clothes and sell it as the unquestioned consensus of the economics community. When the central bank does not allow for an important role of money in the determination of inflation, an acceleration in prices is a clear and present danger.
… The problem with the Fed is not so much that inflation is currently way too high, it is that the reaction function from economic and inflation data to policy is radically easier than it has been at any time in the Fed’s history. I do not disagree that policy should be accommodative, but there is no credible framework to defend the notion that it needs to be as or more accommodative in late 2014 than it is now. This is a train wreck waiting to happen, but it is a train wreck that will play out over years, not minutes. Happily, this means that much of the damage is preventable/reversible if the proper course correction is taken soon enough. If not, the latter part of this decade may look a lot like the 1970s.
As I say, he makes some powerful points that you have read in this space before. Economists who say we don’t need to worry about inflation because of slack growth (the Phillips Curve argument) need to explain away several data points that don’t fit that model. For example, the 1970s. They also need to explain why prices haven’t fallen over the last few years (outside of energy) despite immense slack in the economy. And he absolutely nails the vulnerability now, which is less that the transactional money supply is growing at a steady 10% rate (although it is) and more that there is no reason at all to expect that the Fed is about to take drastic actions to trim its balance sheet and begin to restrain the money supply. Indeed, quite the opposite is true.
We will get money supply tomorrow, and next week CPI. But no matter what those numbers say, some of us will still be called clueless. I guess I don’t mind being clueless, as long as I’m right.