Federal Reserve Chairman Benjamin Bernanke delivered an important speech Friday. It was highly anticipated and critically important in the minds of market soothsayers. In the end, Bernanke did not really have much to say with regard to an imminent employment of quantitative easing measures. However, what he did have to say about the current state of economic affairs and the view he and the Fed have of the future troubled me greatly.
Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.
Fed Chairman Bernanke and Treasury Secretary Geithner reintroduced uncertainty into the market equation Friday. A slew of economic data hit the wire Friday morning, including a planned address by the Fed Chairman on the prospect of quantitative easing. However, the Chairman's speech seemed to work more towards preparing the market for what it already expects, than it did toward giving it what it wants.
Retail sales data for September proved stronger than expected, and inflation remained tame, so stocks sprinted into the open. However, it feels as though the delay in Treasury Secretary Geithner's report on our foreign trading partners, especially China, has kept fear alive in the hearts of traders. Geithner's delay certainly implies a harsh but true description of China's foreign currency manipulation could be due, though it is clearly not preferred by the government. The potential repercussions of this possibility has traders and investors of all sorts uncertain, and uncertainty acts as a weight on stocks.
The Chairman's speech did not offer the rescue ship the investment community was counting on, but he said it was in nearby port if need be. He began by reassuring the community that the economy is still on pace for growth, with the "preconditions for it in place." He voiced expectations for moderate growth as time progressed.
The speech itself was intended to target the topic of monetary policy in a low inflation environment, and so the Chairman discussed the many nuances and difficulties in his current work. Indeed, while lowering the Fed's target rate to spur the economy, he would like to also see the bond market avoid disaster and equity values find further supports. While the Fed's mandate does not target stocks nor bonds, the economic play of the two is of course still important for consideration. And so, a little bit of inflation is now regarded a desirable spice for the economic gourmet. Bang!
What got me fired up to write this critical review of the Fed and Bernanke's economic vision is the deluded view the economic minders seem to have. The Fed has been one of the poorest forecasters of economic developments in recent times. After all, it failed to see the housing bubble it was building with its low rate policy. However, when cornered, Alan Greenspan will point to crooked mortgage brokers and greedy banks as the culprits. In more recent times, the latest Fed Chairman publicly stated that the mortgage and real estate crisis would be contained within the industry it served. That was a troubling failure of vision, and the disaster spread into a global financial crisis of fathomable (not by the Fed though) proportions. Or perhaps, US government advisors asked the Chairman to refrain from yelling "fire" in the theater… though flames were spreading at the time.
Once again, the Fed seems to have its blinders on, as the Chairman's speech was full of deluded impressions of the current economic environment. Hey, I'm not apologizing for telling the truth. This type of writing is why I have a following. It is because of our willingness to tell the story that bank and other institutionally paid economists and strategists are too afraid to tell. That's because it might lead you to take your capital out of the hands of their portfolio management team, and cost them their jobs.
Bernanke said that household spending should benefit from stronger household finances, further easing of credit conditions, and pent-up demand for consumer durable goods. I have issue with this statement.
The unemployment benefit compensation and emergency part-time work 17% of Americans find themselves surviving on now, are not likely strengthening their household finances. In fact, overleveraged Americans would be lucky if their income resources were even enough to stop the bleeding of their money. Under the illusion of continual employment and eventual prosperity, we have purchased homes, automobiles and all sorts of things we thought we needed with credit, and those payments likely now exceed the income generated by government supports and through the bussing of tables. Thus, can we really say household finances have strengthened? It's more like American families are facing a harsher reality day by day.
Unsteady Housing & Assets
Home prices look about ready to slip again, and without economic growth, equities might not even hold their ground, let alone appreciate further. So, with the wealth effect reversed, can we say household finances have strengthened, or that even the perception of household wealth has improved?
Bernanke also stated that further easing of credit conditions were an aid to the consumer. So, why then does consumer credit contract almost each and every month it is reported? Credit has not eased, or else record low mortgage rates would be spurring the real estate market. Instead, underwater mortgages that near or exceed the value of the properties they stand against, and poorly rated credit risks (people), cannot even refinance their current loans, let alone buy a new one or purchase one for junior. Furthermore, banks have come under high scrutiny and broad regulation, so find me a banker these days who will go out on a limb now. I think they are as scarce as the pheasant are in my Pennsylvania hunting grounds.
Thirdly, Bernanke talks about pent-up demand for household durables. You know, I think poor folk just call that wishing, and go on washing their clothes the old fashioned way. If the washing machine is broke, but Joey is still sitting idle, well than Susan will be washing the clothes in the bathtub. That is not pent-up demand; that's surviving, and nothing is going to lead a family without means to buy that new machine except a new job. Even then, the machine won't come until the refrigerator is full, the bills are caught up and some savings put in place. Pent-up demand? I call that wishing, because without a job, there will be no release of demand.
Greed is Good in the Corporate HQ
Bernanke says that similarly business investment in equipment and software should be driven rapidly by rising sales, the need to replace old equipment, strong balance sheets and low financing costs. In the case where the equipment is necessary for the generation of sales, it will be replaced and upgraded. But, you can count on corporate masters, those being you and me the shareholders, to demand EPS and dividends before new desks for the cubicle impaired. This is capitalism, where stocks are rewarded for making higher profits, not for making employees feel like human beings. Face it! That's the way you like it, so stop turning your eye from it. And don't be so surprised when you hear about some loose cannon doing in all his supervisors one angry afternoon. That said, I would still rather be working in a cubicle in Jersey City than in a sweat shot in Bangalore.
Companies will Acquire One Another
So I say don't look for "rapid" spending from corporations, except in the acquisition of each other. There will be more of that use of the over-cashed balance sheets than there will be of the addition of Windows 8 and the new desk machine with the paper thin monitor. Oh, and after these companies acquire one another, they go about the business of creating synergies, which usually includes the laying off of redundant responsibilities and the poor saps who fill them. Thus, that would seem to weigh against economic growth, and certainly against employment in the near-term. The long-term might offer another sunny story, but don't look for companies to place spending above higher profits, because this ain't heaven.
Also, low financing also goes a long way toward paying out dividends. It has been figured out long ago that a good bit of leverage adds value to an organization, when it is manageable. A low cost of capital, certainly creates economic value; but how will that economic value be distributed? So who gets richer? That's right, the rich. That is especially true now that the little guy has been near permanently scared out of the stock market. Hey, but it's a good thing right? After all, without the rich building companies, the little guys would not have work. I'm being cynical, in case you’re blind. Trickle down should not translate into look down, or beat down. History shows us that mindfulness of the peasants plays smartly too, since the masses are made of them (read us). In case you haven't noticed, we're growing restless. Meanwhile, bank managers paid back the government at the cost of equity holders so that they could pay themselves bonuses. Hey, Fed-provided liquid capital markets and solvency served them well.
Public Sector Farce
The Chairman says that the public sector is improving as well. He says tax receipts in state and local governments have started to recover, which should allow their spending to rise gradually. He says the contribution of federal stimulus to overall growth should decline at a pace that does not derail economic activity. Woe there horsey!
Since when have tax receipts improved? In New York City, we are seeing more crime in unattended subway stops, fires burning longer due to greater distances for scarcer firemen to travel, and even less charitable contributions to the stubbornly needy who refuse to leave Utopia like the mayor might prefer. Yet, major extraordinary projects like the second avenue subway and the new tunnel from Jersey somehow survive these tough times? Oh well, I guess that's thanks to poor Benjamin, who gives an arm each day to the MTA in order to travel into the city to make some money serving people. Hogwash Bernanke! Hogwash! You should have been with me the other night sitting with a hobo, once a handyman, in a coffee shop until two in the morning, so they would not kick him out into the rain, where nobody would find him until he had been long dead, since those jobs have been shed too.
As far as the government stilts being slowly taken away as to avoid derailing the economy:
Well, the Chairman must bed early, because he seems to be missing the political campaign that clutters the airwaves. It harps on wasteful spending and fiscal prudence, and it scares even those bold enough to consider change from changing the tax code for the rich. The wealthy are not putting those costly (to us) dollars back to work in the economy, as one might hope. That's because they don't need another yacht as badly as we need another loaf of bread. Democrats need to drum up one more ounce of courage before their party ends, and allow the Bush tax cuts to expire on income earned above $250K. At least address the higher end, with consideration for small businessmen. Why can't we let them expire on the super-wealthy, and pass a new bill at the same time, giving tax breaks to small businessmen earning up to a million? Why hasn't a compromise come about!!!? It's because politicians care more about their seats in DC than they do about you and me.
I also believe the Chairman must have missed the fact that housing is about to double-dip in the absence of the homebuyers' tax credit. Cash-for-Clunkers was a hit too, but I don't see car sales running near 14 million today with it gone. And some of these government aids were corrupted along the way, and so efforts to keep people from devastating foreclosure instead allowed predators to misguide and steal from the needy.
Foreign Trade Supports?
Doesn't Bernanke hang out with Geithner anymore, since the G-man moved on to head the Treasury? Otherwise, why would the Chairman include continued support from our foreign trading partners as a catalyst for growth, given Geithner's engagement of China on the yuan. There's no guarantee when it comes to the Chinese; there's a reason we've been so cautious to begin with.
A Hint of an Idea
Finally some sobriety, as the Chairman addressed the modest economic growth he sees, and the jobless recovery it entails. And so, further monetary stimulus remains under consideration. He did not say much more than before, in repeating that the Fed is considering expanding its stake in long-term securities. Did you note though, that the Chairman used the qualifier "if warranted?" This suggested that QE2 is by no means a done deal. Lest we remind you that the market thinks it is, and that a letdown seems in store in one way or another.
A Shotgun of a Tool to Use
Empirical evidence suggests QE2 should act as effective economic stimulus, we agree. But Bernanke warned that we have little experience in this means of action, and so we translate to read, we might overshoot. The risk of this is that our conservative Fed might err greatly with its new weapon and unleash an uncontainable virus upon us all by charging the economy up and inflation out of control. This is why many Fed members are openly talking about a careful ratcheting up of quantitative easing. While this makes sense, it also seems to offer the risk of adding less than enough boost to the economic engine.
Either way, we see volatility increasing and uncertainty overwhelming the market, which is bad news for stocks. Only the economic life we pursue can rescue us, and perhaps this can only come naturally and with time, or by means of further creative thinking. Maybe quantitative easing will work, and maybe it will not. One thing is certain, that man will go on making monsters and monstrous mistakes. It's all we can do to try. I've been critical of the Fed today, but I've also been supportive of it in the past. We call it like we see it.
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