Stocks continue to trade sideways on light volume as investors await Bernanke’s speech, which is scheduled for Friday morning from the Fed’s annual summit in Jackson Hole. As we mentioned in our Market Commentary a couple of weeks ago, this summit has been closely watched over the past couple of years. Two years ago, Bernanke used the summit not to announce any new policies, but to signal a strong proclivity for additional bond purchases. What is now commonly referred to as “QE2″ was formally announced a couple months later on November 3, 2010 (immediately following the mid-term elections). At last year’s meeting, Bernanke also failed to unveil any specific easing programs. However, he announced that the Fed’s scheduled meeting the following month would be extended for an additional day so that the committee could debate the plan for additional action. “Operation Twist” was announced at that September meeting, and Jackson Hole was solidified as the Fed’s telegraphing forum.
We are two years removed from that first market-moving Jackson Hole summit and we find our selves in the same predicament – economic growth remains weak and job creation is not what it needs to be. So is the market wrong to expect big things from Jackson Hole again? If history is any guide, investors might actually be justified in expecting more market gains. Following the 2010 Jackson Hole summit, the S&P 500 rose 30% through late April, 2011. And stocks rose over 20% following the August, 2011 summit (through early April, 2012). If you were sure that Bernanke & Company were preparing further action, it would seem like a pretty good bet to allocate a little more money to stocks, wouldn’t it?
For my part, I’m not so sure that the Fed has yet decided on further action. I continue to believe that additional quantitative easing, if it indeed comes, will be announced following the elections. (And incidentally, the bond market seems to agree with me with the yield on the 10-year Treasury having risen over 0.25% in recent weeks). Bernanke has done a very effective job of talking stocks higher without actually committing to further action, but we think there are too many arguments in favor of a wait-and-see approach at this point. It’s likely that the most we can hope for before the elections may be an extension of the pledge to keep the Fed Funds rate low (perhaps through 2015). Consider the following arguments against further QE prior to the elections:
-Perhaps most importantly, aggressive Fed action so close to the election may be construed as a political move.
-Our strong suspicion for several years now has been that the Fed is most worried about the housing market. To the extent that recent data have been supportive of a recovery in housing (home sales, home prices), more Fed members may be less inclined to assume the risks of further easing.
-Recent economic data, including Retail Sales and July Non-farm Payrolls, have been promising. While it is true that this data was for only one month (following several months of weak data), we think the Fed will at least want to see if a new trend is developing, and the first data point in this process is next Friday’s August employment report.
-The situation in Europe has stabilized a bit (for now), with yields on sovereign debt falling in recent weeks.
-The Fed wants to keep as much dry powder as it can in the event that Congress is unable to address the fallout from the fiscal cliff.
Obviously, there are many solid counterarguments in support of further Fed action at this time. The strongest among these, in my opinion, are the recent increase in gas prices, the unresolved European debt crisis, the slowdown in China, and the impending fiscal cliff. But at least these things don’t seem to be getting any worse right now (with the exception of gas prices). After all, the Fed was not established to proactively address each and every possible risk factor in the economy. And as we ourselves have written about rather exhaustively, the Fed’s actions carry risks and will eventually have repercussions. Given the disapproval in many camps (Rep. Darrell Issa and Sen. Bob Corker, to name two) with the Fed’s monetary policy to date, combined with the close proximity of the presidential elections, it makes most sense that the Fed will punt for now.
If I’m right and the Fed delays action for now, it would seem that aggressively allocating new money to stocks at this time in the hopes of a favorable Jackson Hole announcement might be a little risky. After all, the S&P 500 has already risen 10% over the past three months in anticipation of additional Fed action. Several Fed members have come out in support of more action, and Bill Gross has gone so far as to say that additional Fed action is a foregone conclusion. At this point, the market is likely expecting the Fed to at least provide some sort of commitment to some future action. And while we agree that a commitment to future action may support stocks through the election (similar to 2010), will this be enough to drive stocks higher in the interim given all the other risks? Our preference is to remain invested but remain defensive during these uncertain times.