Brian Pretti CFA's Contributions

Although noble, the Fed targeting the US employment level as a rationale for further money printing is a bit disingenuous given the structural issues facing the economy. What are these issues exactly and why will they be so hard to overcome?

A steep interest rate curve is not about to magically appear any time soon, again courtesy of the Fed. So the banks are going to face the reality of meaningful reported earnings pressure.

The US fiscal cliff looms as the level of current political brinkmanship has certainly gone to new highs. Can the US goods sector save the day?

I think the “facts” make a very strong case that Bernanke will not deliver any QE goods at Jackson Hole. There will be plenty of talk about vigilance and a heightened readiness to act if need be, but we’ve heard these words over and over all year long.

In many senses, both macro economic and financial market rhythm in 2012 has been very similar to what we experienced in 2010 and 2011. In each of those years the domestic economy was perking up in trajectory as the year began, only to witness slowing into the second quarter and through both of the last two summers.

Back in 2009 and 2010 I penned a number of discussions regarding the macro economic and investment theme of the “tale of two economies”. In short, what has been so glaring in the current cycle is the divergence in fundamentals between US small businesses and their larger globally oriented business brethren.

You are probably fully aware that the largest US bank, JP Morgan, had a more than noticeable derivatives loss that was announced a few weeks back. In fact, regulators seemed so taken aback that they had JP’s CEO, Jamie Dimon, appear before the Senate Banking Committee to explain.

I personally believe the Fed will not commit to a formal QE at today’s meeting. Why? We have not yet hit a proper “tipping point”. As you’ll see below, as of the moment, the TIPS breakeven inflation rate is well above what was seen at the initiation of QE2 and Operation Twist.

As we move into the summer of 2012, we once again find ourselves in a world of heightened asset price volatility, concerns over European governments and the Euro banking system as a whole, as well as clear economic slowing in the emerging economies.

Over the course of the current economic cycle I have written numerous times about the theme of “the tale of two economies”. In short, large companies have enjoyed a vigorous recovery, record profit margins and all time high nominal profits. But their US domestic small business brethren have seen nothing of the sort.

In a little under 75% of occurrences over the last half century plus, it has not paid to get bearish between May and October of election years. Will it be so again in 2012?

In addition to the Bush tax cuts and automatic spending to expire yearend, there is yet another expiration event that is receiving little to no attention that I believe will have some impact on either the bond market or what supposedly seems to be the recovering fundamentals of the big banks. That event is the expiration of FDIC insurance for all bank deposit amounts above $250,000.

A potential loss of confidence in the Fed is not a guarantee. But likewise it is not an impossibility as per historical experience. What compels me to at least bring up this issue as a potential outcome is the fact that I see no one talking about it and/or the ramifications of such an event. We need to benchmark behavioral anecdotes as we continue through this cycle and think beyond conventional constructs.

Certainly we’ve started 2012 with a better tone to a number of economic indicators. Employment numbers have strengthened, leading economic indicator series have trended higher, and there’s even a little bit of life in housing as many former savers have now become mom and pop landlords in the effort to achieve some type of rate of return in what essentially is a Fed sponsored yield starved environment.

You may have seen that the quarterly Duke/Fuqua CFO survey was released last week. Always worthy of a quick check in based on the very simple truism that “the CFO always knows”. Who better to have a read on the true pulse of business fundamentals?

It appears that consumer confidence and small business optimism experienced key turning points right around a national average gas price of $3.50 per gallon. Currently, it is $3.72. With wages stagnant and high unemployment, will this time be any different? Not likely.

To suggest that there’s plenty to worry about in the current financial market and economic cycle is an understatement. I could spend pages of discussion space. Although scenario planning and assigning probabilities to a series of multiple outcomes is essential to the risk management process, so too is the abandonment of personal ego in being emotionally accepting of short term outcomes.

We have two rhythmic forces at work here in the current market cycle. First is the rhythm of central bank monetary interventions (money printing) and how these interventions have influenced both financial markets and the real economy. The second “force”, if you will, is the ebb and flow of investor focus in decision making between the secular issues of importance (debt and deleveraging) and the cyclical (the short term firming or softening in economic tone). These two forces have necessarily collided at times in the current cycle. Right here and right now we have a bit of a collision in that an incrementally better tone to economic stats is now occurring at the exact time the Fed Dollar Swap program and ECB LTRO program have been implemented that have acted to enhance overall market liquidity.