Wednesday, June 19, 2016 - Don't Fight It

Don't Fight It

by Sinclair Noe

DOW – 206 = 15,112
SPX – 22 = 1628
NAS – 38 = 3443
10 YR YLD + .13 = 2.31%
OIL - .52 = 98.15
GOLD – 17.00 = 1352.30
SILV - .34 = 21.45

One of the best known adages in the financial world is “Don't fight the Fed”. Marty Zweig is credited with that sage wisdom. Zweig was a professor of finance, and a financial analyst; he went on to become a hedge fund manager and he wrote a newsletter. He famously bet that the market would go down in 1987, and by October of that year he was short the market and made a big profit while most other money managers were getting clobbered.

“Don’t fight the Fed”; that meant, according to Zweig’s theory, that if interest rates were going down, stocks would go up, and vice versa. He also claimed the way to make money was to be risk-averse, rather than taking chances on the upside. He said he was a big poker player while at Wharton, but had stopped playing when he became a money manager because he hated losing.

In addition to “Don't fight the Fed”, Zweig is credited with the adage, “Don't fight the tape”; in other words, the market will have the last word, and complaining that the market is wrong is an excellent way to lose money. Zweig had a third rule: “Never relax”.

Today the Federal Reserve concluded their Federal Open Market Committee meeting; they issued a formal statement and then they issued their quarterly economic projections and then Fed Chairman Bernanke held a press conference.

The formal statement was almost identical to the statement from the FOMC meeting in March. No real change in interest rate targets. No real change in their purchases of securities to prop up the markets. No real change in outlook. No real change in targets. No real change in anything. No talk of taper. We'll go through that statement in a moment.

The economic projections showed a very, very, very slight improvement in the economy; a tiny improvement in GDP growth, a slight improvement in unemployment, and just a hint more inflation; it was not a cause for optimism.

Then Bernanke held a press conference. Bernanke said job gains and housing markets had increased consumer confidence; most FOMC participants do not favor selling agency debt; he reiterated that thresholds aren't triggers on rates; the Fed's monetary policy will continue to support recovery; the Fed may vary it's purchases based upon economic data; the Fed may moderate the pace of purchases later this year; the Fed may stop purchases by the middle of next year; and the Fed will ease QE if the economy improves.

And then Bernanke tried to soften the blow by saying: “If you draw the conclusion that I've just said that our purchases will end in the middle of next year, you've drawn the wrong conclusion, because our purchases are tied to what happens in the economy."

And then Bernanke tried to reassure market participants that any change in the bond purchase program would “be akin to easing off the gas pedal rather than putting on the brake,” and that the Fed is able and willing to adjust its purchases back upward if its forecasts turn out to be too optimistic.

Bernanke said today that the "sharp rise in rates", was not about the Taper but "due to other factors, including optimism about the economy,” and he said he was a “little puzzled by that” and it couldn't be explained by “Monetary policy”. Well, he can believe that if he wants but if it looks like a duck, and quacks like a duck.

In his prepared remarks Bernanke referred to the newly released economic projections: "If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year."

Let's review the key points of the formal statement:

… economic activity has been expanding at a moderate pace. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline... The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.

... the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.

The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

So, we got a combination of official statement saying “no taper”, then Bernanke saying “taper”. And the bottom line here is that traders in the financial sector are terribly afraid of losing free money from the Fed; and the most obvious rationale behind the fear is that the economy is not strong enough to support valuations.

Elsewhere.

The Congressional Budget Office just released their analysis of the fiscal impact of the immigration reform legislation from the Senate and it turns out that the bill is expected to lower the budget deficit by $197 billion over the next decade. The CBOs guesstimate of the bill's impact over its second decade (2024-2033) is $690 billion in deficit reduction. 

What's going on here is that the budget agency expects immigration to generate more costs but even more revenues. Between health programs, entitlements, SNAP, etc., they expect spending to go up about $260 billion over the next ten years. But they estimate revenues to go up about $460 billion. The net difference, about $200 billion, is the projected impact on the deficit.

Deloitte Financial Advisory Services settled with New York's banking regulator over its consulting work for Standard Chartered Bank on money-laundering issues. In August, the agency said Deloitte consultants hid details from regulators about Standard Chartered Bank's transactions with Iranian clients.

Under the agreement, the consulting firm affiliate of Deloitte & Touche agreed to pay $10 million, to implement reforms designed to address conflicts of interest, and to a one-year suspension from consulting work at financial institutions regulated by New York's Department of Financial Services.

Remember the $25 billion settlement last year with the five biggest mortgage lenders? The mortgage settlement came after the housing crash led to a wave of foreclosures across the country and after widespread improprieties in mortgage lending and in the foreclosure process were uncovered. The Big Five were supposed to change their evil ways. A report has now been issued to see if the lenders are getting better and the answer is “sort of”, but four of the five have yet to meet their commitment to end the maze of frustrations that borrowers must navigate to modify their loans.

The new chair of the Securities and Exchange Commission, Mary Jo White, in an interview with the Murdoch Street Journal said the agency was no longer going to just settle all of its fraud and abuse cases by letting the accused get away without admitting or denying wrongdoing. In some cases, she said, the SEC will actually try to force some admissions of wrongdoing.

White said: "We are going to, in certain cases, be seeking admissions going forward. Public accountability in particular kinds of cases can be quite important." But she went on to say that settling is quicker and not as risky, and it gets money to investors faster, and settling without admitting guilt is still a major tool in the arsenal. White said the SEC will decide case-by-case when to seek admission, depending on "how much harm has been done to investors, how egregious is the fraud." In other words, don't hold your breath waiting for a perp walk.

Meanwhile, Britain's Commission on Banking Standards has just issued a 500 page report calling for a new criminal offense for “senior persons” who run banks in a “reckless manner”, as well as much more stringent clawback rules that could see managers being stripped of several years’ worth of pay. The Commission warned that bankers had escaped “personal responsibility” for their actions, and said that drastic reforms were the only way to restore trust in banks. The report also said the bailout of the Royal Bank of Scotland had hurt the broader economy and the bank should be broken up.