On CNBC’s Fast Money last night we had the pleasure of getting DoubleLine Capital’s Jeffrey Gundlach’s response to the Federal Reserve’s policy statement (or non-statement):
On Friday, I detailed some of Gundlach’s recent commentary from his firm’s quarterly investor call (here). I want to highlight, once again, his belief that the Fed wants to prove their independence. And may even do so by (what he calls) blowing themselves up and hiking into a weakening economy:
Gundlach feels the Fed is annoyed by the assumption that their hands are tied by Fed Fund futures. He is very clear that he does not think they will raise in Sept, and that if they did they would be doing so into weakening economic data. But he feels they desperately want to prove their independence from such forecasting. If only to prove that they “are not controlled by the market”. Which has been the knock on this particular group for some time.
Gundlach also made the point that the recent data (specifically the Aug ISM nearing some of the lowest levels since the start of QE in 2009) places the U.S. economy on recession watch. But Gundlach thinks the Fed may “blow themselves up” anyway.
That’s all fine and good. And it all makes sense. But I’m still pretty sure they don’t have the cajones to prove their independence before the presidential election. So for the time being, 10 year treasury yields, without the benefit of strengthening economic data, will probably remain range-bound between 1.5% and 1.9%.
Which brings me to Fed Chair Yellen’s response to a question in the presser yesterday afternoon. She was asked whether the election is playing into their decision to not raise before November, despite employment and inflation hitting previously identified targets for rate normalization, from WSJ:
“I can say, emphatically that partisan politics plays no role in our decisions about the appropriate stance of monetary policy,” she said. “We are trying to decide what the best policy is to foster price stability and maximum employment and to manage the variety of risks that we see as affecting the outlook.”
That answer is probably mostly true. After all, this is a Fed that has never missed an opportunity to miss an opportunity over the past few years, election or no election. But the fear of affecting this particular election is acting as a significant force that has most people thinking the Fed’s next move won’t be until December, at the earliest. Sure, you could argue that by not raising that is taking a side or getting involved in the election. But the FOMC’s default setting is no sudden moves (higher). There was no election last year and they arrived at the same conclusions. Fed officials must feel that a move can wait, and doing so before the election is getting involved. Staying where they are is not. This seems clear as day to me.
I’ve been consistent about this point. When Sept rate hike odds started to gain steam (more so in the financial press that the futures markets) I said time and time again that there was no way in hell that they would raise prior to the election. The only bout of downward volatility we had in the stock market since Brexit came with the ridiculous prospects of a rate increase in Sept. Those odds gyrated around 20-30% during most of that hiccup. There’s virtually no history of a surprise rate hike with odds like that.
Right now, Fed Fund Futures are pricing about a 20% chance for a Nov 2nd hike. Again, right now, that means it’s basically zero. Unless something changes drastically in the next month, the Fed is out of the way until their Dec 14th meeting. As we head into quarter end, with the S&P 500 (SPX) up 3% and the Nasdaq Composite up 9% large capital pools will likely keep stocks bid up with a little quarter end window dressing.
As we get into October, and Q3 earnings season, with expectations low and sentiment poor, (Factset estimates a 2.1% yoy decline for SPX earnings) things could be interesting. If we see results and guidance that were not as bad as expected (Intel pre-announced positively for Q3 last week), then new highs for the S&P 500 are likely. (Assuming we do not get some sort of external shock from Europe’s banking sector, or China).
And back to the election for a second. Keep an eye on the polls the next few weeks, if Hillary Clinton were to again build the sort of sizable lead that she had in August, the market will start to price in that certainty. That means overall buying with some possible sector specific under-performance based on her likely policies (e.g. drug pricing). It’s been my view that a Trump presidency could be the single most destabilizing event for our economy this year and tight polling like we’ve seen the past week could start to be reflected in some defensive selling if we have no clue how the election will turnout into Nov 6th.
So there you have it. I can see new highs with the Fed on hold, better than expected Q3 earnings, no external shocks and political certainty if HRC regains steam. This is NOT a long term prediction. I remain bearish for fundamental reasons on U.S. stocks overall. I am not suggesting committing long term capital to stocks here, I am merely mapping out how and why the SPX could breakout and possibly keep going over the next few months. But the higher we go between now and year end in this scenario, the harder we likely fall in the Near Year, as we have done the last three. (Or if there’s a “certainty into the election” bid in the market, you could see a sell the news right after that).
One last point, if the Fed persists with not raising despite hitting prior targets, and we do not get a raise in Dec, then stocks could actually explode to the upside. I feel strongly that this would be the beginning of a blow off top with really bad consequences afterwards. This is a very different road map that the sharp 5 to 10% decline which people have been accustomed to seeing and buying over the past few years. And so many would love to see again.