What Message Was Embedded In Fischer’s Entire Speech?
Human beings tend to look for data that supports their personal bias. This concept applies to interpreting information coming from the Federal Reserve. It would be easy to find portions of Vice Chairman Stanley Fischer’s remarks that support the case for raising rates as well as the case for holding rates steady for the remainder of 2016.
Fischer Says Low Rates Are Concerning
In Monday’s speech, Fischer enumerated concerns that are tied to an extended period of near-zero interest rates:
There are at least three reasons why we should be concerned about such low interest rates. First, and most worrying, is the possibility that low long-term interest rates are a signal that the economy’s long-run growth prospects are dim.
A second concern is that low interest rates make the economy more vulnerable to adverse shocks that can put it in a recession.
And the third concern is that low interest rates may also threaten financial stability as some investors reach for yield and compressed net interest margins make it harder for some financial institutions to build up capital buffers.
Does It Imply The Fed Needs To Hike Rates?
If the Fed Vice Chair comes out and says there are serious concerns about having low interest rates for an extended period of time, then it is logical to imply the Fed’s Vice Chair is in favor of hiking rates in December. However, the text of Fischer’s speech makes it clear that it is not that easy:
Now, I am sure that the reaction of many of you may be, “Well, if you and your Fed colleagues dislike low interest rates, why not just go ahead and raise them? You are the Federal Reserve, after all.” One of my goals today is to convince you that it is not that simple, and that changes in factors over which the Federal Reserve has little influence–such as technological innovation and demographics–are important factors contributing to both short- and long-term interest rates being so low at present.
Some Areas Are Outside Of The Fed’s Control
If Fischer believes successfully pushing interest rates higher is not as “simple” as the Fed hiking rates, what areas did he focus on during Monday’s speech? Excerpts from his prepared remarks provide some insight:
What might contribute to raising longer-run equilibrium interest rates?
- An improvement in animal spirits
- Expansionary fiscal policy (examples: boost government spending by 1 percent of GDP or cuts taxes by a similar amount.)
In summary, a variety of factors have been holding down interest rates and may continue to do so for some time. But economic policy can help offset the forces driving down longer-run equilibrium interest rates. Some of these policies may also help boost the economy’s growth potential.
Fed Desperately Wants Higher Rates
With rates near zero, central bankers are probably not sleeping very well given the limited ammunition they have to fight the next recession. The Fed wants to raise rates to put some bullets back in their chamber, but they don’t want to push the economy into a recession via an ill-timed rate hike. Based partly on the fear of hiking too soon, Janet Yellen’s remarks last Friday contained an easy to discern dovish tone. Fischer’s speech basically asked for fiscal help from Congress, something that has been absent for quite some time.
Stock Market Maintains Indecisive Stance
An October 12 article contained four charts outlining some key areas for the stock market. An updated version of one of the charts is shown below. Early in Tuesday’s session, the S&P 500 remained above several “we will learn something either way” levels.
Janet Yellen’s speech last Friday cast some doubt on current expectations of a December rate hike. The first sentence of her prepared remarks questions analysis based on recent economic history:
“Extreme economic events have often challenged existing views of how the economy works and exposed shortcomings in the collective knowledge of economists.”
It is possible Yellen was implying the call to raise interest rates based on the historical relationship between employment and inflation may be premature given the state of the global economy. From The Wall Street Journal:
“Her speech at a conference held by the Federal Reserve Bank of Boston offered a window into her mind-set and how policy might evolve in the months ahead. She effectively expressed sympathy for the idea of keeping short-term interest rates low to let the economy gather steam and reverse some of the long-run debilitating effects of the slow recovery, such as low labor-force participation and business investment. That implied very gradual rate increases in the months ahead.”
Are Inflation Expectations Taking Off?
If we use the ratio of inflation-protected Treasuries (TIP) to standard Treasuries as a proxy for inflation expectations, it is difficult to say they have reached alarming levels. The TIP/IEF ratio is currently lower than it was in both November 2008 and June 2015.
Other excerpts from Yellen’s prepared remarks lean toward the dovish end of the interest rate spectrum:
“If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a ‘high-pressure economy,’ with robust aggregate demand and a tight labor market.”
“For example, hysteresis would seem to make it even more important for policymakers to act quickly and aggressively in response to a recession, because doing so would help to reduce the depth and persistence of the downturn, thereby limiting the supply-side damage that might otherwise ensue. In addition, if strong economic conditions can partially reverse supply-side damage after it has occurred, then policymakers may want to aim at being more accommodative during recoveries than would be called for under the traditional view that supply is largely independent of demand.”
Stocks: Pullback Or New Bear Market?
This week’s stock market video puts numerous present day charts in historical context, allowing us to better understand the risks of a Fed-induced correction relative to the risk of a new long-term bear market.
Market Expectations Did Not Change
Yellen’s remarks did not significantly impact market odds for a December rate hike, meaning the market’s initial reaction did not change perceptions about the probable short-term path of interest rates. Given numerous Fed governors have made the case for a December rate increase, the market remains skeptical relative to the shorter-term message in Yellen’s remarks.
Fischer’s Follow-Up Message
Fed Vice Chair Stanley Fischer spoke to the Economic Club of New York Monday. He said low rates had negative consequences, but raising them was not as simple as it may appear. From MarketWatch:
“I am sure that the reaction of many of you may be, ‘Well, if you and your Fed colleagues dislike low interest rates, why not just go ahead and raise them? You are the Federal Reserve, after all.” One of my goals today is to convince you that it is not that simple, and that changes in factors over which the Federal Reserve has little influence–such as technological innovation and demographics–are important factors contributing to both short- and long-term interest rates being so low at present,” Fischer said.
Easy To Get Discouraged
Earlier this week the broad NYSE Composite Stock Index was sitting roughly 7% below its 2015 highs. Therefore, it is rational to get discouraged, especially given the wild central-bank-induced swings over the past couple of years. Thus, it may be helpful look at some facts.
Is The S&P 500’s Pullback Abnormal?
The chart below shows the post-Brexit rally push from point A to point B. A normal retracement would take the S&P 500 back to 2116, 2092, or 2068. After the Fed minutes, the S&P 500 was still holding above all three levels.
Does It Look Like A New Bear Market?
A September 2 analysis used the 50-day and 200-day moving averages to compare a bear market look to a bull market look. The present day S&P 500 chart has not yet morphed into an early bear market look. It may, but it has not yet.
Have Key Weekly Levels Been Given Back?
The weekly chart below shows several levels that acted as resistance in 2015 and earlier in 2016. Thus far, the S&P 500 has not seen a weekly close below the levels shown.
Have The Weekly Charts Flipped Bearish?
An August 2016 analysis looked at a rare turn in weekly stock market trends. After the Fed minutes on October 12, the S&P 500 was still holding onto the favorable long-term probability look.
Could The Facts Flip Bearish?
The answer to the question above is absolutely, positively, yes. However, none of the charts above have flipped yet, which helps us keep an open mind about better than expected outcomes. Bearish probabilities will increase if the charts above break down or give back their recently acquired and favorable looks. Time will tell. More recent comments and charts can be found here.
Rare Occurrence On S&P 500’s Weekly Chart
The S&P 500’s weekly chart did something recently that indicates investor confusion and indecisiveness. From CNBC:
The S&P 500 just experienced two “inside weeks” in a row for the first time since February 2008, an indication that the market may be in for a major breakdown or breakout in the weeks ahead. Inside weeks are unusual, but two inside weeks in a row is rare indeed. The last time the market created such a Russian-doll-like trading pattern was in February 2008; the two prior occurrences were in June 2007 and January 2000, according to Ryan Detrick, a technical analyst with LPL Financial.
June 2007 Example
From a longer-term perspective, did the S&P 500 immediately start a clearly-defined downtrend after the two inside weeks that occurred in June 2007?
The two inside weeks are shown via the orange arrows in the chart below. The S&P looked like it was initially breaking out to the upside with the move to point A. However, that move proved to be a false breakout since price then plunged toward point B. No clear direction was evident yet as price then rallied sharply back to point C. The push to a new weekly high did not come with a bullish follow-through, instead the S&P 500 dropped to point D. Following the two consecutive inside weeks, it took another 28 weeks for the market to begin the first discernible and lasting leg down in the 2007-2008 bear market.
February 2008 Example
In the wake of the consecutive inside weeks in early 2008, the S&P 500 appeared to break down in a bearish manner as it dropped to point A. However, that proved to be a false breakdown as the S&P 500 rallied to point B. The move to point B also proved to be short-lived as stocks reversed hard and dropped to point C. From point C, one more multiple-week rally to point D occurred before a more discernible downtrend began following point E. After the inside weeks, the longer-term downtrend did not begin for 27 weeks.
January 2000 Example
How long did it take for the market make up its mind regarding a longer-term trend following the two inside weeks that occurred in January 2000? Following the inside weeks, the S&P 500 bounced around like a lottery ping pong ball before deciding on a more discernible trend 42 weeks later.
Moral Of The Story
The inside weeks did occur in calendar years that were marked by longer-term trend changes. However in the 2000, 2007, and 2008 examples above, it would have been very difficult to use the rare occurrence in a meaningful way since stocks bounced around for an average of 32 weeks before deciding on the direction of the longer-term trend.
Game Plan Remains Unchanged
Based on the facts in hand, we eliminated the weakest position from our portfolios Tuesday. With three Fed-related events coming Wednesday, we will proceed in a manner similar to the approach described on October 6.
You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.
Energy Stocks Above Prior Resistance
When investors are more confident about economic and market outcomes, they typically prefer to own growth-oriented sectors, such as energy, over more defensive-oriented bonds. The chart of energy stocks (XLE) relative to long-term Treasury bonds (TLT) is trying to hold above an important point of prior resistance. The longer XLE can hold the breakout relative to TLT, the more meaningful it becomes.
Deterioration In Numerous Asset Classes
Many interest rate sensitive assets, including gold, bonds, and REITS, sold off last week. This week’s video looks at the deterioration in the context of risk management. Updated longer-term charts are also covered for the S&P 500 and broad NYSE Composite Index.
Stocks vs. Bonds
The chart of stocks (SPY) relative to bonds (TLT) is sending similar messages to those seen in the energy/bonds ratio. The SPY/TLT ratio was rejected at the thick blue trendline three times in 2015 (see orange arrows) and again in September 2016. The longer SPY can hold the breakout relative to TLT, the more meaningful it becomes.
Tech Trying To Clear A Long-Term Box
The chart below shows the performance of technology stocks relative to intermediate Treasury bonds (IEF). The ratio entered the long-term orange consolidation box in December 2013 (almost three years ago). The ratio was near the lower end of the box as recently as June 2016. The breakout sends signals about the economy and interest rate expectations.
Rate Hike Odds
On October 4 following some strong economic data, asset class behavior started to signal two things: (1) the odds for a Fed rate hike in December were increasing, and (2) the economy and markets might be able to withstand the hike this time. Obviously, with quite a bit of time between now and the Fed’s December meeting, 1 and 2 above fall into the TBD category.
Similar Messages From High Beta
The High Beta ETF (SPHB) has higher weightings in materials (XLB), energy (XLE), and financials (XLF) relative to the S&P 500’s weightings (SPY). As shown in the chart below, this economically-sensitive investment is trying to hold the recent break above an area that has acted as resistance for a year. As recently as June 28 (point A below), SPHB looked to be on the ropes. Since then, SPHB has made a higher low (point B) and a higher high above point C.
The longer SPHB can hold above point C, the more meaningful it becomes.
Video should be fully processed and ready for viewing after 7:45 pm ET
As clients know, hard data is used to make both buy and sell decisions. Since many of the model’s inputs come from weekly charts, we check all our positions versus the hard data at the end of each week.
Last week our two weakest positions printed scores of 74 and 79. A score of 74 tells us that 74% of the data was saying “bullish” at the end of last week. It is quite common for a score to drop into the 70s during a bullish “leave it alone” uptrend. Said another way, it is common for scores to drop into the 70s during normal pullbacks (a countertrend move).
Why do we check scores at the end of each week?
Last week, every position’s hard data said “hold the position”. This Friday, we will once again check all of our positions versus a full week of data, just as we did last week.
Can the model ever make a move during the week? Yes, under certain circumstances incremental shifts can be made between Monday and Friday. For example, based on the deterioration in the data since last Friday, we made incremental reductions to some positions this week in select accounts (not all accounts).
We have what the market considers to be the most important economic report coming Friday morning, which means the data we have today may look significantly different Friday at 4:00 pm ET. The data may look better or it may look worse.
One of the weaker asset classes in our portfolios scored favorably on 81% of the questions relative to hard data last Friday. Today, the number is lower. If the facts require action at the end of the week, we will take action. No one knows what the weekly charts will look like after the payroll report. More information can be found on the CCM Twitter Feed.