Janet, We Have A Problem...

| About: SPDR S&P (SPY)


I took a look at some charts and decided the economy doesn't look so hot.

Former Minneapolis Fed chief turned-Monday morning quarterback Narayana Kocherlakota agrees with me.

S&P PE multiples beg to differ.

Former Minneapolis Fed chief turned-Bloomberg View columnist Narayana Kocherlakota is aggravated.

Kocherlakota, after ceding his post to TARP-itect (get it?) Neel Kashkari, has taken to Monday morning quarterbacking his former colleagues. Earlier this month, he said the following on the way to contending that "there's not enough inflation":

In January 2012, the Federal Reserve promised to keep its preferred measure of inflation close to 2 percent over the longer run. More than three years later, that promise remains unfulfilled, casting doubt on the central bank's willingness to deliver.

Kocherlakota's message to the Fed is that it should be easing, not tightening. Of course there's not much more room to ease. Unless of course the FOMC intends to give negative rates a shot (something which Janet Yellen reminded Congress she had the "legal basis" to do on Tuesday).


But as I outlined previously, Kocherlakota has a solution for this problem.

Instead of the Fed raising rates, the government could simply issue more debt. That way, the long-run neutral rate would rise giving the Fed some breathing room to cut rates in the event a recession comes around again and, as an added bonus, there would be a larger universe of bonds out there for the Fed to purchase. Hell, if they decided to go the helicopter route, they could just buy the bonds directly from the Treasury and skip the whole primary dealer charade.

Now I figured "The Koch" would be pleased with St. Louis Fed Chief James Bullard's contention that the Fed should just throw in the towel on forward guidance and only cut rates one more time in two-and-a-half years. But I was wrong. Bullard's "prescription" isn't "ambitious enough," Kocherlakota said today, in his latest Bloomberg missive. Here are a few short excerpts:

Bullard's rationale focuses on productivity, the amount of goods and services that people produce for each hour worked. Productivity has grown slowly over the past decade, providing much less of a boost to overall economic growth than it has historically.

The question, then, is why Bullard wouldn't argue for lowering rates to support faster growth. His answer: the Fed has already reached its target of 2-percent annual inflation, so further stimulus would risk overshooting that goal.

His justification has two flaws. First, Bullard uses a somewhat obscure measure of inflation developed by the Dallas Fed, rather than the Fed's preferred measure, which is well below 2 percent and is expected to remain there for the next two to three years. Second, the risk of excess inflation is relatively manageable: The Fed can readily address it by raising interest rates. What's really troubling is the possibility that, say, global financial instability will require the Fed to rescue the U.S. economy at a time when its capacity to lower rates is severely limited.

His conclusion: "...the fed should be cutting, not raising, its rate target." Or, to use a legendary American film analogy:

(Film credit: The Big Lebowski)

Ok, then. This is another one of those instances where policy makers (or in this case "former" policy makers) seem completely oblivious to the fact that these policies aren't working, where working means facilitating a broad and robust recovery at home and facilitating a sustained rebound in global growth and trade.

One of two things has happened here. Either the post-crisis experience shows the limits of monetary policy, or it shows that when pushed over what one might describe as the line in the sand labeled "common sense", counter-cyclical policies are not only ineffective, they're actually counterproductive.

Here's the thing (and I've said this before): there's no such thing as a free lunch, but dammit that wouldn't stop me from eating one if it ever came along. That is, if the Fed and other DM central banks could print money to infinity without causing inflation expectations to become completely unanchored and that same money printing catalyzed a prolonged period of healthy growth and global prosperity, then I wouldn't be poking fun at central planners. I'd be enjoying the boom times just like everyone else.

That's what separates me from those increasingly annoying critics and permabears who for some perverse reason revel in pretending that Janet Yellen and Haruhiko Kuroda are actually bad people as opposed to just being economists who are confused about the fact that sometimes, econometric models are best left confined to academic journals.

The global economy isn't a guinea pig. If there's a sin here, it's gambling with people's economic fate. This isn't some grand global conspiracy to exacerbate the wealth gap and disappear the middle class. That was happening way before 2008 and would have continued to happen, Bernanke or no Bernanke. Rather, this is just a rather spectacular example of the old adage "sometimes really smart people do really dumb things." Unfortunately, central bankers have also become the living embodiment of Einsteinian insanity.

Make no mistake though, Kocherlakota has got one thing right. The US economy is sputtering and the Fed has little to no counter cyclical slack. Where he gets it wrong is thinking that cutting rates to zero or below (which he pretty clear advocates) is going to help. Just ask Japan. Or Europe.

But let's look at some charts that certainly seem to suggest that "cleanest dirty shirt" or not, the US might indeed be headed into a downturn just as the Fed contemplates how and when to hike rates.

We'll start with Barclays who, in a note out last week, warned of "an industrial contagion." It's a good note, but really, the whole thing can be summed up with one excerpt:

We have long been of the view that labor market data provide the best real-time indicator of underlying economic activity and are the best leading indicator with respect to turning points in the business cycle. Based on the recent slowing in the employment growth, we see an elevated risk of recession.

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(Chart: Barclays)

Now let's look at three graphics from Deutsche Bank which show the "interesting" divergence between employment, profits, and tracking estimates for Q2 growth:

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(Charts: Deutsche Bank)

And here's a look at Class 8 truck orders, rail freight, and seaborne trade:

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(Charts: Deutsche Bank)

Finally, have a look at productivity and wage growth:

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(Charts: Deutsche Bank)

I don't mind being crass, so I'll just put it bluntly: I don't care one way or another. Would I prefer the economy to do well and people to prosper as opposed to the opposite? Well, sure. But I'm a completely objective observer. I look at variables that I think might be relevant (which is why I included the charts on Class 8 sales and freight) and then I look at markets and see if they seem to reflect reality.

If multiples were depressed and the economic picture looked promising, then I'd be reporting that. But unfortunately, we have the economic backdrop shown above, cast against this, in terms of multiples:

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(Charts: Deutsche Bank)

I don't know about you, but it doesn't seem to me that the trajectory of the economy justifies the highest TTM S&P (NYSEARCA:SPY) multiple since 2008 and the highest forward multiple since 2002.

And just imagine what the numbers would look like if nearly 380 out of 500 companies hadn't habitually been reducing their share count with buybacks!

So place your bets. Will the Fed topple the Jenga tower with another hike this year? Or will they have a come-to-Kocherlakota moment?

Survey says...

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.