The strange relationship between rates and the market, between policy and performance, has turned us all into double talkers.
Or triple. Sometimes quadruple.
The latest US jobs report is a perfect example. Out came the numbers, showing an OK level of August job creation but the lowest unemployment rate since the recession.
That’s good, right? Nope: markets fell, with the Dow losing 1.7% and the S&P down 1.5%.
Double talk: good news about the US economy increased the odds of a rate raise, which is bad for equities. Good means bad.
China’s stimulus announcement last week provided another good example. Beijing promised to boost infrastructure spending, further ease monetary policy, reform state-owned enterprises for faster decisions, and boost bond swaps to alleviate regional debt pressures.
The news lifted Asian markets notably, with Shanghai adding 2.3% on Wednesday and the Nikkei 225 rising 7.7%.
Easier money and more spending = good, right?
Not so quick. The S&P jumped almost a percent on the open, but then started to fall. It ended the day down 2.3%. The Dow moved similarly, as did the TSX.
That’s because stimulus is not actually a good thing. It means the Chinese economy needs help. Asian market saw cheaper money and moved up, but North American markets saw further confirmation of struggles in the world’s economic growth powerhouse and moved down.
Bad = Good but actually bad.
There have been some even more convoluted reactions. Good news being interpreted as bad but that suggests good, which is bad.
Here’s my idea: eliminate the double talk. Don’t try to interpret what a piece of news means to the markets in the short term, based on rates or stimulus or bounces. Focus on what the news actually says about global economic health.
Good = good.
Bad = bad.
For an easy, small, insignificant example, let’s take the health of US markets (…). In general, the data reveals an economy doing well, but not great. Manufacturing output has flattened and orders are well down. August’s jobs gain of 176,000 was well below trend. Inflation is weak and growth is marginal. The energy sector is shrinking.
In the markets, the biggest buyers are businesses buying their own shares. Revenue growth has turned negative. Breadth is narrower by the day, with a few select stocks (Apple, Google, Microsoft, Facebook, and the like) distorting the image of growth. Valuations are still near all-time highs.
Each of these points could be an essay on its own. Instead, here’s my simplification of the situation.
Things are still arguably good…but in context, they are heading down, not up. Things rarely go straight from Great to Bad (except in the case of serious crashes, like 2008). Generally the change from bull back to bear takes time. The market corrections of the last few months are the start of that process.
This is the simplest way to explain why I see a crash coming. I have gone through many of the details in previous letters, but you know what they say about the power of a picture.
Given this, how should we think about Yellen’s big decision?
In the most straightforward way possible.
Raising rates would be bad for the markets. It would supposedly say that the economy is doing well, but what it says matters far less than what it means. It means money costs more.
Cheap money has inarguably propelled the stock market. Share buybacks have become the most significant buying force in the market – and companies have been borrowing the funds they use to buy back their own shares.
Cheap money is the last vestige of America’s resuscitate-the-markets policy program. We had our rounds of quantitative easing, we had twisty bond buying programs, and we had cheap debt. How well it all worked will be debated for decades, but at present we know that:
- Supportive fiscal policy fueled a six-year bull market.
- The last piece of that policy is likely about to end.
- Domestic economic support is limited. The energy sector has been decimated, manufacturing is weak, volatility is way up, the duration of the bull is making investors nervous, the strength of the dollar is hurting exports, and corrections in recent months suggests markets have topped.
- Support from outside North America is just as weak. China is slowing, Europe is struggling, Japan remains buried in debt, resource-reliant countries in Southeast Asia and South America are hurting, and emerging markets are losing momentum.
Yellen may not raise rates on Thursday, but that would simply kick the can down the road. It would also damage the Fed’s cred, which matters because the entire recovery has been based in the market believing in Federal Reserve policy. And it would ensure that volatility remained the market mainstay.
I think it more likely that she does raise rates. Look back up at my fancy chart: if she doesn’t raise rates now, then when?
But if she does, the market will have to face reality.
With no QE and with rates on the rise, the market will have to actually respond to economics instead of policy postulations. Good will mean good. Bad will mean bad.
And things simply are not that good. That is why I see hurt on the horizon. It might happen suddenly following the Fed or more gradually over the fourth quarter.
In terms of the resource end of your portfolio: if you are fully invested, I would sell some. Sell the gainers, the dogs, or both. Hold onto stocks you would still want to own if they fell 15 or 20%. Resource stocks have little left to lose so will not feel the full wrath of a market correction or crash, but neither will they be spared.
If you are partly in stocks and partly cash, the choice is yours. Ask yourself the would-you-want-it-down-20% question.
If you are in cash, don’t buy now. Better opportunities await.
Details on those opportunities are pending. It is so interesting to assess what happened historically to gold and to gold miners when rates were raised, when markets corrected, when policy eased again. Stay tuned.