Getting right to the point, I believe it will be very important in the year ahead that investors keep “time frames” in mind. This applies both to the real economy and the financial markets. Short-term, prospects for headline US GDP growth at least over the first half of 2011 are looking pretty solid. I expect GDP numbers in the 3%+ range. That’s not bad, is it? But longer term, the US and many other areas of the global economy face very meaningful “unfinished business” which will ultimately be attended to either proactively or via the market mechanism.
From late August until mid December, we know that additional money printed by the Fed totals approximately $200 billion (POMO + QE). We can expect another roughly $500 billion in new Fed sponsored money creation over the next six months. As you know, since late summer the stock market has been in a virtually uninterrupted rise, gaining close to 20% since the Fed restarted its money printing exercises and making up all of the price ground lost since the Fed first stopped printing money in April of last year.
Additionally, the Administration, Congress and the Senate formally blessed the extensions of the Bush tax cuts in late December. Inside the final bill were over 2,000 spending “earmarks” that on a net basis add roughly $350 billion in new stimulus funds (that will be borrowed). The $350 billion in new spending is equivalent to a little over 2% of existing US GDP. So looking at new government spending and Fed money printing collectively, we’re talking about another close $1 trillion in additional funds heading toward the US economy and financial system directly in front of us. Additionally, we have some odds and ends funding coming in 2011 from the original 2009 stimulus package. Without question this will have a discernable and positive impact on reported US GDP, just as did the first stimulus package and quantitative easing program. As such, over the next six months at least, look for healthy corporate profit reports, real GDP growth in the 3%+ range, and a very modest pickup in employment as well as capital spending by corporations. All short term positives. Expect it because it’s coming.
But beyond the short term, very meaningful unfinished business remains outstanding. Certainly these items are more than well known. In my book, unfinished business highlights include:
1) US households have only begun the very much-needed deleveraging process resulting from multiple decades of debt build up and debt driven consumption. Fed money printing is not going to change this, only jobs and wage acceleration will help (both of which are in short supply).
2) I’ve seen a few pundits suggest US housing is entering a double dip. I promise there will be no double dip as there was never a recovery in the first place. We can keep on pretending the shadow inventory does not exist, but the markets never forget.
3) Without question, bank balance sheets are far from clean. Why? Although lack of market-to-market obscure any real analysis of risk, year over year bank lending remains close to nonexistent in terms of growth. Isn’t that the ultimate statement of balance sheet confidence?
4) Over the 2011-2013 time frame, $1 trillion in commercial RE mortgages comes due. Extend and pretend from the 2007-2009 period caused the spike that lies ahead. Can we extend and pretend one more time, or will we actually allow the system to clear?
5) What is happening in the Eurozone needs no commentary. Paper band-aids disintegrate when blood continues to flow. Expect many more band aids and plenty of blood.
Short term we know additional borrowed stimulus funds and Fed money printing will go a long way toward supporting headline GDP results. Longer term the issues of unfinished business loom large. It’s all in the ebb and flow of investor perceptions and emphasis at any point in time as to which drive investor behavior.
You know, as does everyone else, that we are heading directly into the wonderful third year of the presidential cycle. To be honest, the history of the second year of the presidential cycle over the last sixty years was dead on in terms of macro equity market directional rhythm in 2010. This is the top clip of the chart below. Will it be so again in 2011? I’ve learned that when it comes to politics to be surprised at absolutely nothing. The “rhythm” of the presidential cycle looking into 2011 tells us the first six months or so may be strong for equities, likewise in rhythm with the “sell in May and go away” lore. As a final note when you look at the chart, please remember that it’s rhythm and direction that are important, not the average return levels of the last six decades. Lastly, is this some type of guarantee? Of course not. But very importantly, this would coincide perfectly with a US Fed intent on serving up another $500 billion in new money over the first six months of the New Year.
And just how might the Fed impact short-term time frame investment outcomes? Again, past being prologue is never a guarantee, but we do need to remember that ALL of the equity market gains since the lows of March of 2009 have come when the QE switch has been turned to “on”, as is now the case. The chart below documents the turning points of the S&P around the rhythm of QE so far in our current little journey.
By the way, I’ve also included in the chart above the consumer confidence “present conditions” component of the headline survey. Remember, in the Washington Post op-ed words of the Chairman himself, “Higher stock prices will boost consumer wealth and help increase confidence, which can spur spending”. At least for now, that “confidence” thing is on shaky ground, no? Complete divergence in the current cycle relative to historical experience. Short term, equities are entranced with “free money”. Longer term, consumer confidence will only turn with jobs and income.
To be honest, much of what I’ve discussed above is well known. One would think there may be a natural contrary here since it’s all so well known. One might have thought the same in 2009 when QE 1 was underway, or in late summer when Bernanke “telegraphed” from Jackson Hole the “whatever it takes” secret code words. As we think about time frames, we simply need to remember that the computers controlled by the HFT crowd are by and large not programmed to act in a contrary manner. They are programmed as relatively linear heat seeking missiles, chock full of historical cycle data such as the presidential cycle, the sell in may and go away cycle, the decennial cycle, etc. As such, I believe we need to realize they can and do reinforce trends. They can exaggerate trend movement. This is neither good nor bad, but simply the reality of the moment. So we act accordingly.
It’s time to think in terms of time frames as we move into the New Year. The Fed and Administration will impact the short term – both the reality of the economy and the financial markets. But longer term Mother Nature and Father time will mandate unfinished business be addressed. Longer term, global governments and central banks can choose to proactively address unfinished business, or Mother Nature and Father Time via the financial markets will to it for them. I’d like to hope it’s the former, but the track record so far argues otherwise.
All the best to you and your families for the New Year. I wish you Health, Happiness and Prosperity in abundance.
