Not So Easy Does It?

The good news is that risk assets of all flavors have posted gains for the year to date. The bad news is that said gains in the financial markets have been a tad on the lean side. The Dow Jones Industrial Average, for example, which ended the quarter within a whisker’s width of an all-time record high, posted a price gain of 1.5% (before dividend reinvestment) for the first half of 2014. This was bested by a 1.7% price gain for the ten-year Treasury note futures contract despite earlier widespread concern that interest rates would rise this year.

 Commodity prices, moreover, were the big winners with crude oil leading the pack with a 31% gain for the first half. Gold posted a 7.2% return while industrial metal prices were mixed. The really smart money, however, was in contemporary art, a sector that experienced record auction prices for objects that purport to be, well, art. Who wouldn’t prefer owning one of Jeff Koons’s inflatable this, that, or t’others to a mundane scrap of paper representing fractional ownership of a corporation?

 The economy bounced back from the stunning 2.9% drop in GDP of the first quarter, although the data reported thus far do not suggest that it was an outsized bounce. The purchasing managers’ survey showed improvement even though the industrial production reports for April and May were a wash with the former down 0.6% and the latter up by the same amount. Unemployment claims, while bouncing around a bit per usual, were essentially flat at a level that implies continued moderate (but below trend) growth in employment. Housing starts improved somewhat, but, here as well, results have been relatively flat going back to last year. All in all, the sub-par expansion appears to be moving along at a somewhat disappointing pace that is unlikely to accelerate without a more rapid rate of job creation.

 The inflation indicators, which had spent quite some time well below the Fed’s 2% target rate, have recently bounced up to meet said target. Kudos to the central bankers for avoiding deflation. If they are equally successful at avoiding excessive inflationary pressures down the road, we will be pleasantly surprised (no, make that stunned).

 In other news, we note that the Japanese have proposed a new national holiday to be dubbed, “Mountain Day.” If instituted said holiday would be the nation’s sixteenth such celebration. Why so many? Japan’s white collar workers have long refused to take their allotted vacation days for fear of getting behind and losing face. Hence, the government must force them to take time off lest the number of stress-related deaths grow even larger.

 There are reports that the French national railway system (SNCF) has spent billions to purchase new rolling stock for passenger trains. Alas, it turns out that the new cars are too tall for the existing station platforms. The answer, of course, is to throw even more money at the problem by lowering said platforms. In America we prefer direct injections of money into the economy, about which we shall have more to say anon.

 In the sporting news, Wrigley Field turned 100 in April. To celebrate the occasion as only the Cubs could do it, the team blew a three-run lead and lost to the Diamondbacks, a squad that this season appears to be worse than even the woeful Cubbies. It could not have gone more true to form if it had been scripted.

 Considering all of the abuse hurled in the direction of various Vanderbilt athletic teams in these pages over the years, we feel compelled to note that this year’s baseball team won the College World Series, thereby securing the school’s first national championship in a revenue sport…ever. A certain curmudgeon was in the stands in Omaha with tears of disbelief in his hoary eyes as he watched the Commodores emerge victorious. They might not have been the best team (Virginia gets our nod on that score) but they were definitely the grittiest.

 We have an abiding interest in economic and market cycles and in various indicators that are designed to give one a leg up in divining the ebbs and flows thereof. We have a special affinity for some of the more esoteric indicators that, while not of rigorous analytical origin, are nonetheless interesting by their very nature. Among these is a measure of animal spirits known as the Hemline Indicator. The idea here is that rising hemlines are indicative of rising expectations that, in turn, produce higher stock prices. When hemlines plunge, or so the thinking goes, stock prices follow suit.

 Ever vigilant for insights to aid our readership, we recently visited a mall to do some window shopping in the name of research. Of course, we totally dismissed ogling the displays in the windows of Victoria’s Secret as we did not wish to appear “creepy” to our fellow mall walkers. (Well, okay, we did take just a quick peak.) What we saw in the more mainline retailers’ windows, moreover, was rather astonishing. Next to a mannequin sporting hot pants (Buy! Buy!) was another outfitted with an ankle-length skirt that featured a slit up to the hip (Sell! No, wait! Buy! No, uh…).

 As disconcerting as those observations were, the worst was yet to come. We have seen hot pants and slit skirts before and have even commented upon same in these pages. In the very same window, however, was something we have never encountered – a mannequin wearing a skirt that was scooped to mid-thigh in front and dropped to mid-calf in back. Good grief, what is one to make of THAT?

 Completely disillusioned by the esoteric, we decided to return to the mainstream and take a gander at the City Hall Indicator. This is based on the hoary adage, “You can’t fight City Hall.” In the economic and financial arenas, City Hall is the Federal Reserve and going against the grain of their current policy is usually unproductive at best. Easy money typically leads to higher risk asset prices and tight money usually produces bear markets in same.

 We have noted in recent missives that our central bankers, in their tireless efforts to take away the punch bowl before the party gets going too good, decided late last year to begin tapering the monthly purchases of government and mortgage bonds that had been swelling the Fed’s balance sheet. Said swelling had kept downward pressure on interest rates and injected excess liquidity into the financial system for quite some time. No doubt the positive returns in risk asset prices since the lows in the spring of 2009 have resulted from the Fed’s largesse.

 A look at our chart of M1 and M2 growth suggests that the word tapering was carefully chosen. There was little apparent change in the growth rate of the monetary aggregates earlier in the year, but, as the process has continued to unfold in recent months, there has been a noticeable, albeit not drastic, slowing of money growth.

 If expanding reserves were good for risk asset prices, logic suggests that slowing reserve growth would take at least some of the steam out of the markets. One must be aware, however, that changes in monetary policy tend to work with a lag, sometimes a rather long one. It is also important to note that the majority of the Fed’s key decision makers still appear to be more concerned with the risk of deflation than inflation, although the balance of power may be shifting toward the latter. Hence, the continuation of the tapering program is not writ in stone.

 We advise enjoying your summer but keeping an eye on the Fed and, perhaps, a finger on the trigger. And, if you are of a mind to do so, pray for the Cubs. Only Divine Intervention can save them at this point.

 Weaver C. Barksdale, CFA