Monday, July 14, 2014

Playing devil's advocate...

As you might suspect, I read lots of other professionals' commentaries on the state of the economy and the financial markets. On occasion I find myself inspired to add my two cents in the comment section. For today's message, I thought I'd simply share my thoughts regarding today's economic/investment environment by sharing my comments on three recent articles:

My comment on an article where the author makes the case that when rates rise from very low levels, history suggests stock prices are likely to rise with them:
Hmm... There's a lot of confidence, or optimism, or wishful thinking, there. Looking at the ISMs, etc., clearly input prices are rising, and the prospects for employment are looking up. Wage growth, while being talked down, has been rising a bit as well (4.9% annualized based on last month's reading), productivity's been flat, at best, and consumer sentiment is up. I'm thinking we should take inflation potential a bit more seriously here.

Right, the Fed's in no hurry to raise interest rates, but of course we know that the bond market doesn't have to play along. A pickup in the economy, and inflation, can scare investors out of that 2.6% (10 year treasury) faster than you can say Alan Greenspan --- then the Fed's forced to play catchup, which is where recessions/bear markets come from.

My comment on an article featuring an interview with a well-known economist who does her darnedest to pour cold water on recent economic data:
The economist is a frequent CNBC TV contributor. Clearly, she has a free-market/libertarian bias (which I'm strongly sympathetic to). However, biases can cloud one's perception. And I think that's the case with Piegza. She has consistently bemoaned QE and other interventions (as have I) and, sadly, has modeled her near-term forecasts after the potential long-term ills of such measures---although, per this article, she doesn't come out and say as such. So that would be my opinion as to why she remains basically glum on the economy going forward.

I'm guessing she's wrong on many fronts. I expect employment will pick up more measurably than she anticipates. I expect overall global growth to accelerate as well --- which is contrary not only to her forecast, but to that of the IMF as well, per this morning's headlines suggesting it is about to lower its global GDP forecast.

Yes, the year has to come in lower than pre-year estimates, but that's due to Q1's terrible number. My concern is the pace of growth going forward, not where the 2014 end number comes in.

This doesn't, however, make me a raging stock market bull. In that I suspect that all this will indeed --- contrary to Piegza's opinion --- move up the time-frame for Fed tightening. Even if it doesn't, I believe there's substantial risk that the bond market will begin selling off as the economy ramps up and inflation begins outpacing expectations.

My comment on an article where the author advises investors to tune out the noise regarding the Fed's timing regarding interest rate increases, and makes the case that Fed tightening cycles (raising interest rates) are actually bullish for stocks.
I'm thinking the author is a little too sanguine on the potential stock market impact of the Fed beginning to tighten. While I cringe when I hear myself utter "it's different this time", I don't believe the Fed has ever become the bond market like it has these past few years. Bonds, in my view, from here, possess minimal upside and substantial downside risk. Just do the math and project what a 2.6% ten year looks like in a 4% environment. Will, then, the great rotation (bond sellers becoming stock buyers) finally occur? Or will the economic headwind of higher interest rates scare everyone to cash? I'm bullish on the economy near-term, therefore, bearish on fixed income, and cautious on stocks (the economy has to grow from here just to validate last year's gains). Long-term, I'm very bullish on equities, but that's a no-brainer...

I hope you can see that this is as much me playing devil's advocate (which I do with myself [my own assertions] all the time) with these authors as it is my concerns over the ultimate effects of the bond market one day reverting to the mean.

I've stated a number of times lately that the economy will need to improve to support last year's run up in stocks, and that earnings are going to have to accelerate from here to keep/bring valuations in line. On the economic front, clearly, the U.S. is improving. The rest of the developed world, not so much. On the earnings front---on balance---so far so good (although we're very early in Q2 earnings reporting season). Hence today's nice move for the major stock averages.

Stay tuned... Or tune out, and think long-term... Saner to do the latter...

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