In a classic scene from the classic movie, Caddyshack, Bill Murray's character, Carl Spackler, recounts for a young caddie at the point of a pitchfork the time he carried the Dalai Lama's golf bag (big hitter, the Lama).
Carl notes how chagrined he was when, at the end of the round, the Dalai Lama did not tip him. He said, "Hey, Lama, hey, how about a little something, you know, for the effort, you know?" According to Carl, the Dalai Lama replied, "Oh, uh, there won't be any money, but when you die, on your deathbed, you will receive total consciousness." Looking at the fearful caddie forced to listen to the story, Carl quips, "So I got that goin' for me… which is nice."
As we fondly remember that scene, we see a strong connection to the equity market, to which we would assign the role of Carl, and Ben Bernanke, to whom we would assign the role of the Dalai Lama.
In his speech at Jackson Hole today, Ben Bernanke basically said, "there won't be any tip today, but on your deathbed, you will receive total consciousness."
In more specific market parlance, the takeaway from the speech is that QE3 is not a certainty, but if economic conditions warrant additional accommodation, the Fed stands ready to provide it… which the market thinks is nice.
All kidding aside, the highly anticipated speech from Jackson Hole was mostly an academic exercise. The Fed chairman focused on the history of monetary policy since late 2007 and called attention to various studies that have addressed the Fed's unconventional policy actions.
The conclusion, which was not absolute, was that "…a balanced reading of the evidence supports the conclusion that central bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks."
The equity market suffered a knee-jerk sell-off as headlines from the speech hit the wires. The quick-strike interpretation by many was that the market was disappointed there was not a clear cut signal that QE3 is on the way soon. Those same people were left scrambling to explain the rally that ensued only minutes later and carried the market to new highs for the day.
Reading between the lines of the intraday action in a thinly traded market is futile, particularly as we take into account too that it is the last day of the month before a three-day weekend, that Spain announced a "bad bank" plan, and that the ECB will hold court next week.
What we learned from the 2012 Jackson Hole speech was more of the same:
- The Federal Reserve, weighing the respective costs and benefits of unconventional policy tools, will employ those tools if it feels the benefits outweigh the costs.
- The hurdle for using nontraditional policies should be higher than for traditional policies given their uncertain costs.
- There are limitations to monetary policy support as it cannot achieve by itself what a broader and more balanced set of economic policies might achieve (i.e. the chairman said it cannot neutralize the fiscal and financial risks that the country faces, as it cannot fine-tune economic outcomes).
- With stable inflation expectations, employment trends remain the primary guidepost for the Federal Reserve as it assesses its progress in meeting its dual mandate.
- The Federal Reserve is confident in its ability to manage an exit strategy from its unconventional monetary policy.
- The Federal Reserve would like fiscal policymakers to get a credible plan in place that sets the federal budget on a sustainable trajectory in the medium and longer runs, while taking care to avoid a sharp near-term fiscal contraction that could endanger the recovery.
Saying the same thing over and over again gets the message across, yet that does not guarantee the message being communicated will be effective.
In 2009, the message that unconventional policy tools were being employed was impactful because those tools were new and innovative. In 2012, with the U.S. economy not even growing 2.0%, the message that the same unconventional policy tools can still be used does not have nearly the same impact.
That is partly owed to the fact that the unconventional tools are now thought of as being conventional. In this regard, the speech from Jackson Hole failed to offer any real accommodative impact in our judgment because there was nothing for the market to think of as being new and innovative. References to unconventional policy approaches revolved around asset purchases and communication policy. Been there, done that.
As discussed in our note, "The Irrelevance of QE3," monetary policy will help preserve the status woe of subpar economic growth, but it will not be the catalyst for sustained economic growth above potential. The past three years have proven as much, and we are concerned the equity market is putting too much faith in monetary policy alone as a growth driver.
There is a growing risk that the equity market's faith in the Federal Reserve and other central banks as market saviors will be lost. This is a risk that should not go unappreciated as economies around the globe slow and both revenue and earnings growth decelerate.
Something else market participants should consider is that the September 12-13 FOMC meeting comes and goes without a QE3 announcement. To be sure, it is not a done deal as many pundits were suggesting only a short time ago. That does not mean the equity market will unravel. Today's speech at least offered the tip that the Fed will do more if necessary. That could be enough of a tease that puts a floor of support under equity prices during consolidation phases.
No one knows for certain what the future will bring -- not even the Dalai Lama. There will be some interesting days ahead in the near term with the ECB meeting (Sept. 6), Germany's high court ruling on the constitutionality of the ESM (Sept. 12), the US presidential election (Nov. 6), and the task of dealing with the fiscal cliff (TBD).
In the face of those unknowns and weakening earnings trends, our tip is to remain defensive.