The Fed Grinch Who Stole Christmas?
The bears have embraced the final speech of the year from their best friend, Federal Reserve Chairman Jerome Powell. And that could lead to a fresh wave of selling.In my last comment, I discussed why Ron Mock, OTPP's president and CEO, is worried about tariffs and stated the following:
The former partner at The Carlyle Group strode to an altar in front of reporters on Wednesday in DC and shrugged off the stock market’s two-month plus beating, slowing global economic growth and the ongoing verbal lashing from the guy who hired him (president Trump). Mr. Market quickly showed what it thought of Powell’s performance. The Dow Jones Industrial Average tanked 352 points to its lowest level of the year.
“Regardless, markets were looking for more signals from Chair Powell that he hears their concerns. He is now in a tough spot,” said Datatrek co-founder Nicholas Colas.
SunTrust Chief Markets Strategist Keith Lerner told Yahoo Finance there is a “buyer’s strike” in the market right now. Oof.
The average investor is probably wondering how one person — albeit one powerful person — managed to send stocks into a fresh tizzy within an hour. It’s not enough to say “Powell jacked up interest rates again, the market hates higher rates.” Per the usual on Fed decision days, there is a good deal of psychology at play. A single word could upset investors, which was obviously the case on Wednesday.
Yahoo Finance compiled a checklist for the average investor to use to help understand what Powell just did and why the market responded so harshly.
Feeding recession fears: The Fed forecast two years of slowing GDP growth in its economic projection materials. GDP is expected to take a step down to 2.3% in 2019 from 3% this year. That’s a downgrade of the Fed’s September protection for 2019 of 2.5% growth. For those increasingly worried about a U.S. recession next year, the downgrade only feeds the concerns. Not helping matters is Powell saying there is a “mood of angst” amongst businesses he speaks with on the economy.
Missing inflation: The Fed forecast 1.9% inflation in 2019 as measured by their preferred personal consumption expenditure (PCE) gauge, down from 2% previously. That is also below the Fed’s long-term goal of 2%. Powell downplayed the ongoing undershoot of the target. “Well, we’re pretty close to 2%,” Powell told reporters. Bottom line: if the economy was as healthy as Powell suggests, there would be more inflation and the Fed wouldn’t have downgraded its outlook.
The psychological: The market has a long-held view the Federal Reserve closely watches the stock market and gets worried when it declines. And when they get worried, the Fed will be more inclined to be dovish with their policy. Powell stuck a fork in that view on Wednesday, which likely spooked some investors. The Fed chair downplayed the market’s slide since October and said it wasn’t much a factor in the monetary policy body’s decision.
How investors read that: The market could keep declining into 2019 and the Powell led Fed will continue to hike interest rates. Nobody on Wall Street is keen on that prospect.
The balance sheet: Powell also suggested the Fed will continue to wind down its $4 trillion balance sheet. The process, which is running at a $50 billion a month clip, is seen on Wall Street as leading to tighter financial conditions. In other words, less friendly conditions for stocks.
"I think that the runoff of the balance sheet has been smooth and has served its purpose," Powell said during the conference."I don't see us changing that."
As far as the Fed, this interview took place yesterday, a day before today's meeting where the Fed raised rates and signaled two more rate hikes for next year. Ron said if the "Fed goes or holds, it won't make much of a difference" but he added "moderation is appropriate" as the yield curve is flat and global growth is slowing.I also added this:
I couldn't agree more but it seems the Fed is on a different page, looking at lagging economic indicators.
Ron is worried about rising trade tensions and volatility. I'm more worried about three scenarios:
What about tariffs? That's what Ron Mock and Teachers' are worried about. Well, Trump's protectionist policies got us into this mess and it's up to him and his team to manage them appropriately because if trade tensions only get worse, it will impact stock markets, and he can kiss his reelection bid goodbye.
- An emerging markets crisis: As the Fed raises rates, sucking liquidity out of the global system, the odds of another crisis in emerging markets are on the rise, and so is the likelihood of a global synchronized downturn next year. This is why US long bonds (TLT) rallied today following the Fed's decision. That and everyone panicked so there was a massive flight to safety. I would say the odds of an emerging markets crisis went from 30% to 50%.
- Trump gets impeached in 2019: There is increasing chatter that President Trump gets impeached next year but some think the Mueller probe could turn out to be a disaster — for the Democrats. So, I would say the odds of a Trump impeachment are 30% right now going into the new year but truth be told, the stock market is acting like it's a done deal.
- Trump fires Fed Chairman Powell: After today, I would place the odds of Trump firing Powell and replacing him with Treasury Secretary Steven Mnuchin or Larry Kudlow or some other dove at roughly 60%. Trump follows the stock market very closely, he tweets about it and for him, it's a direct measure of the success of his presidency. He wants to be reelected and there's no way he will allow Jerome Powell or any other Fed Chairman to engineer a recession going into 2020. He has the power to fire and replace him and while the stock market will sell off hard on the news, it will recover and rally if a far more dovish Fed Chair takes over.
Trump is ruthless, he has proven it time and time again. He has made many mistakes but he will do whatever it takes to win another election, including firing Powell and backing off on tariffs if that's what it takes.
If he wins a second term, the Chinese will have to start negotiating harder on trade and concede something significant.
I'm getting way ahead of myself here but stay tuned, volatility isn't over, not by a long shot.
The only good news I can tell you is large global pensions, sovereign wealth funds, and institutional leveraged players need to rebalance their portfolio come the end of the month, away from bonds and back into stocks. So we may get a bit of a breather as we approach the end of the year and start a fresh new year.
Maybe. That all remains to be seen. These markets are insane, scaring off retail investors and hurting a lot of institutional investors as well.
No wonder everyone is looking to increase their allocation to private markets, the high-frequency algos and short-sellers shorting with no uptick rule have ruined public markets, for good in my opinion.
The FOMC could ignore Trump but it should listen to Druckenmiller, Gundlach and others who are more forward-looking. And it should read Francis Scotland's analysis on why the balance sheet matters and stop stating nonsense that the balance sheet reduction program will continue to proceed as planned. That's just foolish and dangerous.
In his post-Fed meeting observations, Martin Roberge of Canaccord Genuity shared these thoughts today:
Missing expectations: Contrary to our expectations and that of many investors, the Federal Reserve did not strike a dovish tone yesterday. Jerome Powell simply stuck to the dot-plot message projecting two rather than three Fed hikes. Unfortunately, fewer rate hikes had become the consensus among investors. More was needed to reverse the ongoing bearish mentality. We believe investors would have welcomed some guidance as to when or under which conditions these two rate hikes would be implemented. In other words, the Fed had to go one step beyond the data dependency narrative and mention, for example, that “the two rate hikes projected by FOMC members are to be conditional to a halt in US/global economic momentum and/or a renewed increase in inflation expectations”. This would have sent a clear message that the two Fed hikes would likely be a H2 story and this would have been just fine we believe. Rather, investors are left to guess and the next hike could be as soon as March, June…Bears are in full control of the market, no thanks to Chairman Powell and the FOMC. They gave them a green light to keep shorting the market.
The Fed/FOMC’s domestic bias. We understand the crowd saluting the Fed decision and seeing it as a pre-emptive strike against future asset bubbles. The problem is that asset inflation also works the other way around and with investors all-in in equities, the stock market has become intertwined with the business cycle through the financial conditions channel. The same stock market generates about half of its sales/earnings into foreign markets. These foreign markets account for 85% of the global economy and the latter has been slowing down at a very fast pace and leading economic indicators point to further downside. This is where we part ways with the Fed, its members and several pundits supporting the Fed decision based on relatively strong US growth conditions. Figure 1 will come as a shock to these people as it reminds us that every time the OECD LEI diffusion index has fallen near/below 20%, the US ISM manufacturing survey dipped below the 50 boom-bust line. The last reading is 12%! In our view, history will show that Jerome Powell’s error will have been his failure to drop his domestic bias and account for the global economy when it comes to running the Fed’s monetary policy.
Too little too late? Obviously, the bond market cheered the Fed decision by rallying a full point. Bond investors, likely informed by their equity counterparts, knew that the stock market setup going into the Fed meeting was the January 2016 playbook. As such, they remembered that the Yellen pause was followed by a ~100bp decline in US T-bond yields in less than 6 months. We like to remind investors that in December 2015, the Fed dot-plot projected four hikes in 2016. We ended up having only one hike in December. Our point is that the Fed comments through the press conference likely compounded a curve flattening that should not have occurred. The risk is that flatter curves, lower equities and wider credit spreads tighten financial conditions even more which will force the Fed to surrender and pause when it will likely be too late to raise the odds of a soft landing as the ISM drifts to 50 in H1 (see scary Figure 1).
Not the time to overreact to the Fed. Yesterday was the last “liquid” day to de-risk. Tax-loss selling certainly compounded the sell-off. Today and Friday, however, are key days. In our view, the market must and should bounce back very hard given the deep oversold conditions. Otherwise, we think it will confirm an important break in psychology, the bear market thesis and reinforce the sell-on-strength mentality. For now, we believe the bears are in firm control of this market. While we could be right on an oversold bounce, the Fed’s rate strategy has likely capped the upside to the 200-dma ~2,750. We believe the Fed has performed an uncommon policy mistake due to a domestic bias that is failing to account for global growth considerations, hence contagion risk. We believe that the Fed has hiked for the last time in this business cycle. As such, our December 7 incubator suggests the maintenance of a defensive sectoral posture for now.
On LinkedIn, Chen Zhao, Chief Global Strategist at Alpine Macro, shared this following the Fed's decision to raise rates (click on image):
If you cannot read it, let me go over what Chen stated below:
Fed Chairman J. Powell had a chance to reverse the falling stock market today, but he chose to ignore market signals. By projecting a hawkish stance, the Fed is playing a game of chicken with financial markets. This is potentially dangerous because falling stock prices and weakening business confidence could become self-enforcing, driving the U.S. economy into uncharted territory. Today’s rate hike is a mistake, and the key questions are: What does the Fed’s hawkish stance mean for global financial markets and how should investors position themselves? We will address all these questions and much more in our 2019 Global Investment Outlook, to be released early in the New Year. Stay tuned.I totally agree, I think the Fed failed miserably yesterday, they blew it big time and the market is going to teach Chairman Powell and the folks at the Fed following silly econometric models a very expensive lesson.
Today, Chen put out an Investment Alert titled “Brinkmanship” in response to the Fed’s decision to raise rates yesterday and explained why the Fed’s hawkish stance is a mistake.
In addition, Alpine Macro published a Special Report titled “Volatility Candidates For 2019”. It pinpoints three major areas that could heighten financial market volatility in 2019: the rapid surge in leveraged loans and collateralized lending obligations (CLOs), an oil-induced nominal slump and a repeat of the tech mania in the 90s’.
My readers can contact the folks over at Alpine Macro to read their insights, all great stuff.
So what does the Fed's decision to raise rates by 25 basis points, continue with two more rate hikes next year, and leave the balance sheet reduction program intact mean for investors?
According to hedge fund guru David Tepper, it means the Fed is done supporting stock prices, so cash is ‘not so bad’ as an investment now:
Hedge fund titan David Tepper said Thursday the Federal Reserve is sending the market a message, and it’s not a good one.So, is Tepper right? Is cash king? It sure looks like it the day after the Fed's big bomb. Here is a market snaphot at the close on Thursday (click on image):
A day after the Fed raised interest rates for the fourth time this year, the influential investor made the following points in an email to Joe Kernen and CNBC’s Squawk Box:
The Dow Jones Industrial Average dropped by 350 points to a new low for the year on Wednesday after the Fed hiked its benchmark rate, the ninth such increase since 2015. Fed Chairman Jerome Powell indicated the the central bank would stay the course with hiking at least two times in 2019 and that it would continue to shrink its balance sheet at the same pace, another monetary tightening action.
- "Powell basically told you the Fed put is dead.
- Everyone is tight. Chinese money growth plummeting. ECB cutting the last of QE. And Fed still in tightening mode.
- The net biggest issuance of Treasuries and worldwide fixed income is coming next year. Something is going to get crowded out. Bonds stocks etc.
- Oh and there is this trade war question. I think we should be having a fight with China on different issues. But it is not conducive to confidence. Freezing some worldwide activity.
- Cash is not so bad. ”
“The Fed doesn’t care about the stock market within 400 SPX (S&P 500) points,” Tepper added in the email. “It’s the real economy stupid."
The so-called Fed put Tepper refers to is the notion that the central bank would take action to support stock prices in times of volatility, without explicitly saying it was doing so. A put is an option that pays off when a security’s price falls below a certain level.
The S&P 500 is now down 6 percent this year, battered by the ongoing trade battle with China and fears of what the Fed increases are doing to the economy. The benchmark is down more than 14 percent from its record high reached in late September. The U.S. budget deficit could hit almost $1 trillion next year, Nomura Instinet estimates, which will cause the Treasury to increase the supply of debt it auctions. That, in turn, could weigh on the prices of bonds and other assets, Tepper speculates.
Tepper is the founder of Appaloosa Management, which has $14 billion under management. His calls have moved the market in the past like when he predicted in September 2010 that the stock market would surge as the Fed sought to inject the market with more liquidity. The S&P 500 is up 164 percent since that call, known as the “Tepper Rally,” in part because of additional stimulus from the Fed in the form of quantitative easing. That’s now being reversed with the Fed’s balance-sheet reduction.
Tepper, who also owns the Carolina Panthers, told CNBC in September that the bull market was in the late innings and he was selling some holdings.
But I also have to warn you, you need to be careful with David Tepper and all these hedge fund gurus coming on television spreading fear as markets get clobbered. The Fed put is dead? Want to bet on that? Let's see markets crash and you will see the Fed cutting rates back down to zero and engaging in QE infinity faster than you can possibly imagine.
And don't forget, I track David Tepper's stock portfolio very closely every quarter when I go over top funds' activity, and he's getting killed on his top long stock picks like many other gurus (he hedges and has other strategies), so he could be saying one thing on CNBC but come February 15, 2019, I'd like to see what exactly he bought and sold in Q4.
Notice how quiet Warren Buffett has been? He too is getting killed on his top stock picks this year but if I were betting on it, I'm pretty sure he's adding to many of his positions, like Goldman Sachs (GS) which has gotten killed and is now at very interesting levels for long-term investors like Buffett (click on image):
But as I've been telling my readers, ignore Buffett and the bond king's ominous warnings about US long bonds, in this environment, US long bonds (TLT) are the ultimate diversifier and will save your portfolio from getting decimated (click on image):
Will long bond prices make a new high (yields a new low)? Well, if my forecast of a synchronized global downturn in 2019 materializes, you bet they will.
Still, I caution my readers, nothing goes up in a straight line and nothing goes down in a straight line. Don't let your emotions get the best of you as you watch stocks sink lower and lower.
At the end of the month, there is going to be major rebalancing going on away from bonds and into stocks. You might not see it next week in time for Christmas but it's coming, that much I guarantee you.
In fact, I am already seeing it at the end of the day today and will watch for more rebalancing tomorrow and next week.
It was also worth noting that emerging markets stocks (EEM) ended the day up on huge volume, so there is likely some rebalancing going on there away from US stocks to international ones that got clobbered this year (click on images):
In times like these, you can't let emotions get the best of you but admittedly, it's easier said than done when watching the Dow plunge 500+ points every day with no end in sight.
You can thank Jerome Powell for the latest selloff, he and the rest of the FOMC really bungled it up yesterday, that's why he's the Fed Grinch who stole Christmas this year and possibly next year too if a full-blown bear market develops.
Below, Jim Bianco, Bianco Research president, explains why the market is worried about two more rate hikes next year. And CNBC's Jim Cramer gives his take on the Fed Chairman Powell's announcement to tighten monetary policy.
Third, global macro legend Stanley Druckenmiller discusses the outlook for the US economy, his investment strategy for stocks and bonds, President Donald Trump's attempts to sway Federal Reserve policy and the prospects for a solution to the US-China trade dispute. He talks with Bloomberg's Erik Schatzker. Any interview with Mr. Druckenmiller is always a treat.
Lastly, watch Fed Chair Jerome Powell's conference following the Fed's decision to raise rates. You can read the FOMC statement here.
Don't let the Fed Grinch and markets get you down, enjoy your holidays, I'll be back sometime next week to discuss markets and a quick recap of the year.
I remind all of you reading this blog to please contribute to it on the right-hand side, under my picture, using PayPal options. I thank all of my supporters and wish you a Merry Christmas, Happy Holidays and a Happy & Healthy New Year.
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