All Eyes on Jackson Hole
“It’s like deja vu all over again.” — Yogi Berra
Let’s take a look at some economic bullet points, shall we?
* The stock market, after peaking in April, is in the midst of a summer swoon.
* The sovereign debt crisis in Europe is getting progressively worse.
* Unemployment remains stubbornly high and the housing market remains stagnant.
* Gold continues to climb as investors speculate that safe haven currencies like the USD, Euro and Yen will see continued pressure as debt levels mount.
*Quantitative easing from the Federal Reserve has recently expired and Government Stimulus money has run dry.
*Investors wait with baited breath as Fed chairman Ben Bernanke is due to give a highly anticipated speech at the annual Jackson Hole economic summit.
Sound like a good encapsulation of where the financial markets are today? Perhaps, but I’m actually describing where things stood last summer on the eve of the Jackson Hole summit. While a lot has certainly changed in the past twelve months, many of the problems facing the global economy remain the same.
And so here we are, almost exactly a year later, and the markets are waiting/hoping/praying that tomorrow Ben Bernanke can pull a rabbit out of his hat in his Jackson Hole address like he did last August, when it looked as if the stock market rally was sure to falter.
So how did things play out last summer?
As we wrote in our last quarterly letter:
“When Ben Bernanke announced the QE2 plan on August 27th, 2010 the S&P 500 was trading at 1,064 (mired in a summer slump after peaking at 1,217 on April 23rd). Once the QE2 announcement was made, equity markets promptly rallied for the next 8 months, peaking at 1,370 in April 2011 on the belief that the Fed’s policies would provide the necessary support and impetus to boost economic growth.”
Many stock market bulls believe that a third round of quantitative easing will deliver similar results. While we concede that another round of QE will likely give the stock market a short term boost, we don’t believe it will cure any of the underlying ills that the economy suffers from (high unemployment, anemic housing market, low consumer confidence etc).
But never mind all that negativity, a stock enthusiast might say, will there be a QE3?
It’s hard to predict. The Fed’s dual mandate is to provide economic growth and boost employment. While it can be argued that the last two rounds of quantitative easing helped the US economy avert a depression, the main beneficiaries of these market interventions, particularly the last round, seems to have been stock holders — not exactly the constituency most in need of the Fed’s support. And to compound the problem, two byproducts of these policies have been rising commodity prices and a weakening dollar, which creates a whole host of other issues for consumers.
Given that the Fed’s fiscal policies have come under increasing criticism from all corners of the financial and political world, including from some of the Fed’s own Board of Governors, it seems to us that another QE round would be enacted only as a policy last resort. It’s also entirely possible that the next fiscal action from the Fed would not be a QE package, per se, but rather something resembling Operation Twist, which was an approach used in the 1960’s.
But if the financial markets continue their move further south, the question becomes: what other entity could possibly intervene to provide support? Congress has demonstrated, through the debt ceiling fiasco and the rise of Tea Party influence over the Republican party, that a stimulus bill would almost certainly be dead in the water. And as we get closer to the 2012 elections, it becomes increasingly difficult for our elected leaders (namely Obama) to institute major economic policy decisions without being accused of playing politics, particularly in the toxic partisan environment of Washington.
So, really, that leaves the Fed as perhaps the only game in town when it comes to market intervention. If things get worse, then there may be increased pressure on the Fed to act since they have the mandate and resources to step in — whether that means tomorrow or at a future date remains to be seen (and regardless what your views are on the Fed’s policies, at least they can reach a decision and act on it in a timely manner — unlike our distinguished members of Congress).
So, has this summer sell-off and rampant speculation of potential Fed action hanged our investments thesis? Not really. We remain cautious and reiterate what we said in our last quarterly letter, in July, before the stock sell-off began:
“We are a bit skeptical that equity markets can rally further without this backstop and recommend clients remain defensive until it becomes clearer that the economy can stand on its own two feet absent the crutch of Federal Reserve support.”