Comstock Partners, Inc.January 04, 2016
Difference between Past Fed Tightening and Now
A reporter asked us about the prospects of the stock market if the Fed raises the Fed Funds rate, since at the time there was a strong possibility of a rise in the rate to around 25 basis points. We explained that, in our opinion, the ending of the ZIRP (Zero Interest Rate Policy) and increase in Fed Funds will be a significant negative for the stock market. The reporter asked why this is a negative since many times when the Fed raised rates in the past, the stock market also rose. We explained that the difference between the Fed raising rates in the past and today is that raising rates now has a lot more to overcome than in the past. We then explained the difference.
Will all of these Headwinds be the Catalyst for a U.S. Recession or even a Global Recession?
The most controversial question for 2016 and 2017 is whether the U.S. will collapse into a recession ….one that could wind up as a global recession? In mid-year 2016 we will have 8 years of global expansion even though the expansion in the U.S. has been one of the weakest expansions on record. Global recessions typically occur on the average of about 8 years. This potential recession may not be due to the U.S. consumer because unemployment has improved and wages are finally starting to rise after 20 years of stagnation in real wages. Oil and food prices declined significantly, but have been somewhat offset by health care costs and apartment rentals. Also, the unemployment rate is partially distorted since the labor force participation is near a 40 year low. Even though there could be a consumer produced U.S. or global recession, the greater risk is the American export sector, which has been a larger factor in the weak recovery due to the dollar’s rise and if the dollar, as well as rates, rise in 2016 watch out for a recession.
Now that the Fed has started its tightening policy whereas almost all other parts of the world are now following the Fed’s easy money position, this will take the global economy into the awkward position of easing as the U.S. is tightening. This will probably cause interest rates and the currencies of our trading partners to decline just as they are starting to rise in the U.S. This will put pressure on the U.S. manufacturing sector and will probably drive the U.S. into a recession while our trading partners could prosper. The manufacturing sector is important to the U.S. economy because it has provided many of the skilled jobs in the U.S. This may seem fine for the global economy until the world’s largest economy pulls down the global economy as we did in 2007 and 2008 with the housing bubble bursting. Keep in mind that the bubbles of the dot coms in the late 1990s, housing in 2007, and now central banks have had an enormous negative influence abroad. We discussed this in many comments in 2006, 2007, and 2008 (just type “housing” in the archives of our comments to see how many times we warned our viewers about the housing bubble and you can do the same for the dot com bubble and central bank bubble). It was the Fed that drove us into the housing bubble and it was also the Fed that was oblivious to the U.S. having the most expensive valuations in the world during the dot com bubble. You would have to reach far and wide to find a market more expensive than the U.S. stock market (especially NASDAQ) in the late 1990s (maybe the tulip bulb mania of the 1600s).
We believe strongly that the Fed will be to blame for the central bank bubble we find ourselves immersed in presently. After all, it was the Fed (under Greenspan) that missed the dot com valuations, and it was the Fed that lowered rates to 1% in June of 2003 that brought on the housing bubble with virtually no discipline of the banks and other mortgage lenders. When the credit markets and housing markets imploded in 2007-2008, driving the U.S. into the “great recession”, the Fed resorted to whatever it took to save our economy from collapsing into another depression. As stated previously, the measures the Fed took in the “central bank bubble” and inspired other central bankers to follow our lead (like QE and dramatic increases in the balance sheet) could be worse than the dot com bubble and housing bubble combined. When this breaks there will be no shortage of business school textbooks about the inter-relationships between these three bubbles.
Another reason we are skeptical about the U.S. economy avoiding a recession in 2016 is because of the breadth being as weak as it was in 2015. The top 10 companies in the S&P 500 accounted for virtually all the gains, but were overwhelmed by the 490 stocks that accounted for the decline in the index. This is also true about the number of stocks in the S&P 500 above the 10 day, 150 day and 200 day moving averages. We are also very concerned about the unsustainable path of the entitlements in our country. We have to elect the politicians who can get us on a sustainable path for the promises we made for the Affordable Care Act, Social Security, Medicare, and Medicaid by increasing the retirement age, means testing, and adjusting for inflation properly (for the ACA we need a program that doesn’t increase the premiums while making sure we increase the participants).
In fact, we believe the Fed’s decisions over the past 20 years were instrumental in the dot com and housing bubbles. In the Fed’s mind they have done everything possible (including increasing their balance sheet from $800 bn. to $4.5tn.) to resurrect the U.S. economy. Instead, their legacy will be tarnished by the outrageous policies that were used over the past 8 years, and in our view, will not result in the salvaging of our economy, but rather what may become one of the greatest destructions of wealth in history.
We hope that we satisfied the reporter’s question about why the stock market may not do well this year. Keep in mind, every time the Fed raised rates in the past, there was never a time that the financial environment was even close to being this difficult. In fact, the only time we can remember the Fed raising rates while interest rates were very low like now, was in 1937, and that drove us into another recession on top of the great depression.