President Obama’s Asia trip started out on a relatively positive note in India where he managed to get Prime Minister Singh to sign onto the Fed’s new money printing venture known as QE II. That was the sum total of the good news and by the end of the week and the G20 meeting the trip had turned into a kind of international economic intervention with Germany, Brazil and every other member of the group trying to convince the US that it had to give up its twin addictions to deficit spending and easy money. No sooner had the President gotten back to the US with nothing but a T Shirt that says “President Obama went to Asia and all America got was this lousy T shirt” than his own deficit reduction commission hit him with their own version of tough love in the form of a plan to reduce the deficit that managed to tick off both Republicans and Democrats which is how you know it might be worthy of consideration.
As if that weren’t enough, by the end of the week, the Fed’s plan to save the world by making people feel richer by actually making them poorer was running into some glitches. Bonds of all varieties, from corporates to munis, sold off on the week with the hardest selling coming Friday even as the Fed completed the first purchases of the new QE program. In short the bond market is not cooperating with the Fed’s plans assuming those plans included lower bond yields. Of course, I’ve pointed out before that a plan to raise inflation expectations while also reducing bond yields was, at best, contradictory and at worst, just plain stupid.
In addition to the seemingly universal rejection of the Fed’s QE program - by both markets and countries - last week also saw the return of the sovereign debt contagion fears with Ireland being urged to accept some kind of EU bailout over the weekend. The dollar finally found a bottom for all the wrong reasons and risk assets limped out of the week still running in lock step but now in the opposite direction than they have since the Fed started it’s public campaign in late August for more inflation in the things it wants to inflate. Just as a few weeks ago it was hard to find any negative news, last week news of a positive variety was in definite short supply. Germany’s economy appears to be slowing as the Euro rally puts a crimp in exports which surged earlier this year after the Euro fell during the Great Greece Fire. A volatile Euro means volatile growth for a Europe dependent on German exports to the rest of the world.
China’s inflation report last week highlighted the problems the Fed’s easy policies are causing there even before QE II gets underway. It seems highly likely the Chinese will have to raise rates again which just goes to illustrate the downside of an inflationary boom which can only last as long as the inflation that caused it. That should and did cause concern for other emerging markets. Latin American economies that benefit from higher commodity demand from Asia - and the higher commodity prices associated with that demand - are vulnerable if China has to slow their boom. And since we’re on the subject of the downside of more Fed easing, I should mention that those higher commodity prices have negative consequences here in the US as well. If companies can’t pass along the higher prices to consumers it will hit their bottom lines (which would not seem to bode well for hiring) and if they can pass it along, John Q. Public will be buying less stuff for the same number of dollars (which also would not seem to bode well for hiring).
In addition to these macro concerns, Cisco reported earnings and reduced their outlook on weak demand from among others, state governments. If the municipal bond market is right, that segment won’t be getting any better any time soon. Munis of all sorts have sold off since the election as Republicans are seen as less sympathetic to state and local budget problems than Democrats. Whether that proves true in a pinch is yet to be seen but muni buyers weren’t waiting around to find out last week. High yield munis from CA, IL and NY took the election news particularly hard.
The economic data was fairly sparse last week but what there was actually turned out to be pretty good. Considering the economic forecasting track record of Bernanke & Co., it would just figure if the US economy is rebounding just as the Fed pours more monetary fuel on the fire. It would also be terribly ironic and painful if the Fed ends up causing the very relapse QE II is intended to prevent. The retail sales reports last week sure didn’t show a lack of shoppers. The Goldman report showed a week to week gain in sales of 1.3% and year over year gains of 3.4%. As I’ve pointed out repeatedly, this recession has almost nothing to do with a lack of consumption no matter how many times the pundits say that it is.
Mortgage applications are rising again for both purchases and refinancings. I don’t know how much longer the housing market will take to clear out the inventory but I do know that there is one thing that works like a charm to speed the process - lower prices. For God’s sake, just let the market clear so we can get this over with. The trade deficit improved a bit last month. Exports improved slightly and imports fell but I can’t help pointing out that the prices of both are rising fairly rapidly. Export prices were up 5.8% and import prices by 3.6% over the last year which might not be hyper-inflation but sure as hell isn’t deflation either.In the best news of the week, jobless claims fell back to 435k. It still isn’t low enough but it is again moving in the right direction and let’s hope it keeps going to under the 400k level.
As I noted above, markets of almost all stripes took a bit of a hit last week but in the context of the recent rallies, it wasn’t that big of a deal. I suspect there is more to go though and I did some selling last week. Our cash levels are now up to about 11% and I am having a very difficult time not just selling everything and taking the rest of the year off. And if I’m thinking that, surely there must be others doing the same. A couple of weeks ago, a lot of people were thinking the market would have to go higher into year end as portfolio managers played catch up, but now we might be in the opposite situation. We’re up double digits this year and that isn’t a bad year for ten months work. Performance anxiety by portfolio managers works both ways and what that might mean is just more volatility in coming weeks.
My main concern over the last few weeks has been sentiment which continues to be way too optimistic in my opinion. Bulls are now up to 57.6% of the AAII poll respondents and anything over 50% makes the hair on the back of my neck stand up. Alright, I don’t have any hair on the back of my neck but if I did it would surely be twitching right now. In thinking through things I can find plenty of reasons to be cautious and damn few to be bullish except that the Fed’s new dollars have to go somewhere and I’d really like to get there ahead of them. That’s a game for speculators, not investors and I’m inclined to watch from the sidelines.
Disclosure: No positions