The conventional investment wisdom for the last six years has been “Don’t Fight The Fed.” In hindsight those with blind faith in the Fed outperformed those who viewed the unprecedented monetary policy with a dose of skepticism. Those that tried to be a bit clever anticipating the possible end of asset purchases, allowing our economy to walk on its on two feet, found themselves playing catch up time and time again since 2009. You can see the lock-step action of the expansion of the U.S. Monetary Base with that of the expansion in the S&P500, per Bloomberg:
Now with the U.S. done with QE, and the BOJ and the ECB having grabbed the baton, the question you have to ask yourself is whether or not global QE efforts are enough to keep the S&P 500 chugging along despite the severe headwinds for U.S. multinationals caused by weakening global currencies. It has been my view that the epic decline in the Euro and the Yen in the last six months could more than offset the lower input costs of cheaper oil and industrial commodities. Especially for U.S. companies that get at least half their sales from overseas. Sales growth, or the lack thereof seems to be one of the missing ingredients of U.S. stocks near all time highs at this stage of the recovery.
This week, the FOMC will meet and I suspect their commentary continues to be dovish with little changes from the minutes we just received from the December meeting. There is no FOMC meeting in February, but in between the Jan meeting and the March 18th FOMC meeting we will get the Jan and Feb jobs reports and I suspect that the slightest bit of wage inflation could turn the conversation towards sooner than expected rate increases. Why would that be given the sluggishness of the global economy? I think the continued strength in U.S. Treasuries tells the whole story. If the U.S. economy continues to de-couple from that of the globe, and the Fed keeps ZIRP in place they risk the potential of an epic risk asset bubble as U.S. investors will see little reason to invest anywhere else in the world and the stock and real estate bubble that would ensue could make 1999 and the mid aughts look like child’s play.
I have to assume the Fed feels pretty good about themselves at this point, avoiding the total annihilation of the financial system, and a subsequent depression with our economy out-performing that of almost every other major in the world, having reduced unemployment by almost half from the 2010 peak and contemplating rate increases. And they should.
But if the Fed were to signal rate increases sooner than the market is pricing, could we see an unwind of the bond trade (recently expressed this view in the TLT, read here)? But at this point, with U.S. Treasuries rallying on almost every negative headline around the world, I suspect it does not pay to be to clever at this point. The rate differential between UST and that of Europe seems too dramatic, and our bonds remain the safe haven asset of choice when geopolitical fears pop up in places like Ukraine or the potential for Greece to leave the Eurozone. So despite higher rates in the U.S. being practical as the FED should be wary of creating a REAL asset bubble, to take the opposing view is just you trying to be clever, and how’s that working out for you?