Strong Enough?

"All that is gold does not glitter, Not all those who wander are lost;
The old that is strong does not wither, Deep roots are not reached by the frost." - J.R. R. Tolkien

There is a lot of debate going on at present about whether the Federal Reserve considers the United States economy strong enough to handle a second interest rate increase.  The number out today seem to indicate that the economy is more robust than was previous thought as Q4 GDP was revised up to 1.0% from 0.7%.  While this is a significant increase 1.0% is hardly robust.  Both consumer income and spending ticked higher in January pushing inflation higher than expected.  All of these data points are positive and should give teh Federal Reserve some much needed credibility for raising rates last year however are they strong enough to force their hand in increasing rates next month or even alter this year?

Were the global economy in a stronger position I would have anticipated an increase in the near future but the issue is that the United States is rapidly becoming the only shining star providing light for a gloomy global economy.  Since the announcement of the data points the dollar resumed its ascent and this will continue to erode not only emerging markets with debts tied to the dollar but exporters in the United States.  While this may not be a catalyst to cause a recession in the United States it may have the impact of taking the growth of the rest of the world lower.

I have to say that I am relatively surprised at the continued success of the United States economy and am hopeful that it can continue.  Certainly I do not see a deep drawn out recession on the horizon but I also do not see robust growth either.  I expect that the Federal Reserve will leave interest rates alone at the next meeting and unless there is a dramatic improvement in the global growth story or inflation in the United States starts to really take hold I doubt that there will be more than one more 1/4% increase in rates this year.

As far as the stock market goes then it may end up being a market full of gyrations and little upward or downward movement, sort of a barking dog situation.  This would not be a bad outcome when you consider such an extended bull market.  During this time it will be interesting to see how the Federal reserve acts and whether companies can somehow stem the slowdown in earnings however this will become harder and harder the higher the dollar climbs. For this reason I continue to expect weakness in the stock market but the damage may be limited to less than a bear market but that will be determined by the direction of the Federal Reserve as while the economy may be able to weather another rate hike I do not think the stock market has the backbone.

Range Bound

"Home, home on the range.  Where the deer and the antelope play.  Where seldom is heard a discouraging word and the skies are not cloudy all day." - A Scout Song

After the recent market draw down it appears that the market is now range bound and waiting for more stimulus from a central banker to break out higher or more poor economic data points to dive lower.  In the chart below I have drawn in blue lines showing the range.  As you can see from the chart there is real resistance against moving a lot higher and I would expect any upward move to be short lived and a selling opportunity.

The recent rally was created by the ECB when Mario Draghi hinted that further stimulus was on its way in the form of negative interest rates and more cash infusions.  This is all in an attempt to stave off deflation in Europe.  With the added stimulus the dollar continued on its path of strength and the 10-year yield fell to one of its lowest on record and is now around 1.7%.  While low this is still a big number compared to the rest of the developed world so I could see rates going lower from here.

In contrast to Europe in the United States the CPI (inflation) numbers for January were recently released and they are showing upward pricing pressure.  Total CPI was up 1.4% while core CPI was up 2.2% year over year.  This is far higher than the numbers expected particularly when you factor in a continued slide in the price of oil.  The two largest contributors were apparel and medical services but I have to say that outside of these two components I have been witnessing bumps in prices across the board from Starbucks to Rubios.  It will be interesting to see whether this upward trend is signalling an economic expansion or desperation of companies to maintain profits in the face of a weakening economy but what it will do is keep the Federal Reserve from lowering interest rates in the near term.

This means to me that the market will mark time and bounce around within its range until a clearer indication of the state of the global economy comes to light.  One thing that is not helping all of this confusion is that there is no clear indication of who will take over the White House.  I have to say that once again it looks like the candidates are less than optimal to deal with the economic crisis that they will face at home and abroad and this lack of leadership will not help the markets.  So for now sit tight and let everyone else fight over these meaningless gyrations in the market.

Hard Boiled?

When I was a student there was a ridiculous game that we used to play with eggs.  In a box of 6 eggs one was raw and the rest were hard boiled.  It was effectively a game of Russian roulette as you had to choose an egg and smash it on your head.  The loser was the unlucky person that selected the raw egg as it would break spattering egg all over them.  Typical students, anything to entertain ourselves rather than study!

The reason for my story is that the Federal Reserve has used five of their 6 eggs and all were hard boiled.  So we all know that the next step is to smash a raw egg on their heads and get it all over themselves.  Of course I am referring to Janet Yellen's testimony where she said that using negative interest rates to stimulate the economy was now not off the table.  Hold on a second, she is now talking about lowering rates to negative less than two months after the momentous increase in rates of 1/4%!  So it is looking as if the rate increase will not only be reversed but will be pushed into negative territory.  The United States will then be joining the rest of the developed world with negative rates.  Talk about egg on your face!

These negative rates are going to make earning any kind of a return on savings next to impossible.  Prudent savers and retirees will be hurt as the stimulus is targeting risk and higher returns at the expense of safety.  Furthermore I would expect that they will kick start the stimulus of pouring more money into a system already awash with money.  If this is not a recipe for inflation then nothing will be and the price of gold is starting to reflect this.  After years of languishing the metal has broken to the upside and seems to be on track to recoup its losses of the previous years.

Now while I expect inflation to show up it may not be for a while.  Oil continues to fall and with the poor earnings from Wall Street will come layoffs, taking the heat off the tightish labor market. That said personal inflation rates are far higher than the Federal Reserve numbers even with the benefit of lower gasoline prices.  In fact when you look at the price of gasoline while down to around $2.50 a gallon it is still significantly higher than the sub $1.00 a gallon that it was the last time oil was down at these levels.  Inflation is here and although not reflected in their numbers is causing problems for a consumer that has not received any form of a meaningful pay increase in a decade.  This will impact consumer spending so don't expect a resurgence in the economy even if they do try to "stimulate" again.  That said it may put a floor under an already overheated market but that is another story.

While I still do not expect much of a move from the Federal Reserve in the next month or so they are certainly not going to raise rates any time soon and if the market enters a formal bear market they will once again step into the fray and "save" the market.  Unfortunately their methods of saving are not helping but are in fact going to hurt even worse in the future so my advice is to take your chances on the gold front as that, in my mind, is the only place to turn.

A Blended Return

"But with a rate of return of 1.6% or less, or a negative rate, our children and our grandchildren, if we do not make changes, will in fact not have a secure retirement.  Indeed they will not have the funds when they go to retire to even minimally get by." - John Shadegg

One of the biggest conundrums facing investors today is a blended rate of return.  Since the Federal Reserve raised rates, rates have fallen to their lowest levels since April 2015 which at the time was one of the lowest levels on record.  Furthermore the stock market is clearly in correction mode and appears to be heading for a bear market (down 20% from its highs).  Typically in a bear market the rates of return on fixed income investments are higher as the Federal Reserve raises rates to cool an economy however this time around interest rates are at historic lows and the market is rolling over so the blended rate of return for stock / bond style investors is dismal.

Reading over my blogs of the past few years I have been warning investors of this problem and now it is a reality.  Those of you who have not heeded my warnings are now facing a problem particularly if you are only invested in those two assets.  Those of you who have learned from this blog should have divested into alternative assets that are taking advantage of this market but for the rest of you I believe time is against you.  It appears that low interest rates are here to stay, at least for the foreseeable future, and the stock market with the lack of support from the Federal Reserve will not provide the kinds of return of the past seven years.

This is not only causing a problem for investors but pension funds and endowments are really feeling it.  Consider that they have factored in a blended rate of return of 6% to 8% and those returns have been achieved only because of the stock market movement.  Removing that arrow and in fact coupling low interest rates with a bear market will result in massively underfunded pensions plans.  The result will be that companies will have to fund the shortfall with rapidly eroding income which will lead to losses.  Poor earnings will drag the market lower and around we go.

So at some point, and I do not expect it to be much later than the middle of this year, the Federal Reserve will have to kick in some more quantitative easing (which as we know will not do anything other than kick the can down the road).  This might take the heat off the stock market temporarily but by then I would expect the markets to have fallen by at least another 20%.  Regardless of whether I am right or not it looks like a rocky road ahead and investors should still be looking at alternatives to stocks and bonds not only for the present but for the long haul as it is my prognosis that these two investments will not serve investors well for a number of years to come.

Heaven help us if inflation rears its head but unless oil makes a sudden resurgence or unemployment strengthens considerably it should not remain much of a factor and this should provide some solace for the beleaguered investor however that said your best bet is to look for alternatives.