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What Now?

Here’s our quick take on what just happened with the Fed and what we might expect looking forward including the market’s reaction so far.

Foreign Aid “Act”

I no longer have confidence in the current Federal Reserve to make hard choices, at least under Janet Yellen.  Wall Street is now massively confused to say the least with their decision to not only leave rates at zero but made matters worse through commentary that sounded like we should expect a global depression!  I think most of Wall Street underestimated the US Federal Reserve’s stake in the foreign aid business because clearly this decision was not made based on US numbers.  Employment cost numbers have been on the rise since 2010, we are at full employment in all developed countries and they suggest we will not see any wage inflation for the next THREE YEARS? Job openings at all time highs with no available labor is a near perfect recipe for higher wage growth (aka inflation). 

No, their choice and their commentary was more likely a response to some strong arming by the World Bank and several emerging market trading partners in an effort to keep those economies on their roads to recovery (Europe) or off of death row (for Emerging market economies).   On top of that, they are watching China pull nearly $85B out of treasuries in the last month to cover their own falling reserves.  A move to raise rates would have, could have, created more unwanted selling pressure.  Nod to that reality.  But to sell their decision as they did seems wildly disingenuous.  By the end of the year, all of this talk of global slow down with no signs of inflation will seem like a mistake.  But I suspect they know that already.  Count on a December rate hike based on a “surprising” recovery in economic activity and some new and “unforeseen” wage inflation.

Market Reaction

It’s a little tough to tell today given the quadruple witching day (options expirations) on Wall Street, but it seems obvious that the treasury bond market and interest sensitive sectors will get another breath of life at least for the next few months.  The banking and financial services sectors are under heavy selling pressure now that rates are stuck at the bottom again.  Stocks in general and the markets should do OK, although we wouldn’t recommend changing net exposure beyond levels established in July/August just yet.  The Fed is back in the monetary support mode now taking some of the scare out of the system.  Commodities are probably in trouble in the short term but may still be just working to carve out a long term low around these levels.  We were hopeful that commodities, materials, industrials and oil services stocks would come into play now with a rate hike but Yellen and company just put that opportunity on hold in the short term.   Freeport -McMoRan down -11% as I write.

The long-term trend of the rising US dollar has certainly been a driver of returns for the last couple years (for better or for worse).  Now, with the new Federal Reserve foreign aid “act”, we might see the US dollar continue to correct, possibly angle a bit lower in the coming months giving support for emerging markets and other international holdings.  Do not count on the end of the rising US dollar trend, however.  Currency moves are regularly 7-9 years long.  We are barely 2 years into the rising US dollar trend and it ain’t over by a long shot.  Gold may sucker a few investors in during this short cycle but it should be another trap on the way to lower prices ultimately.  All in, the Federal Reserve had an opportunity to do something great, to get capital engaged in productive investment rather than engineering earnings.  But instead, they opted to inflate the debt bubble even more and to push off the hard work and timeline for real fiscal responsibility. 

The silver lining for investors in all of this is that we could be in store for a healthy fourth quarter now.  But not before we see more bottoming action in stocks for the remainder of September with a possible retest of the lows – Thanks Janet!

Today we sold our small banking position for a small loss, cut back on financials and bought a well run diversified income fund.  That’s it.  We’re already sitting on a pile of cash and intend to stay that way in the short term. Mid October is now looking quite nice for the launching pad to a healthy run higher in stock prices.   We’re making our shopping list now and finding some very juicy looking opportunities.  Who knows, maybe a rising stock market will give the Fed reason enough to do what should have done yesterday.

Have a great weekend!

Sam Jones