The Fed Put May Be Over

The big announcement on interest rates last week from the Federal Reserve’s Open Market Committee was a big nothing. That’s right, after all the talk about rate hikes in June and definitely in September, it didn’t come. With just Jeffery Lacker dissenting, the FOMC voted to leave rates at near zero. This worried markets because investors know that the Fed wants to raise rates and that they didn’t means that economic conditions must be worse than originally thought.

Stocks sold off on Friday and are off more this week. With employment rising, what could have the Fed so spooked? Could it be the lack of inflation in the U.S.? Could it be the concerns about the fragility of global markets? Perhaps both of these reasons played a part. However, I read three headlines on CNBC.com that grabbed my attention: Renters, Get Ready to Take It on the Chin; How Much Do You Really Need for Retirement?; and Chase Mortgage CEO Red Flags FHA Loans. They caught my attention because each represents growing headwinds for the consumer and thereby impedes economic growth. Two-thirds of US GDP is driven by the consumer. If the consumer is weak, so is economic growth.

The article on retirement argues whether $1million or, as Legg Mason suggested earlier this year, $2.5million is the right amount for retirement. In 2008 Hachette Books published my first book: A Million Is Not Enough. Needless to say, my math suggests the higher Legg Mason number. The real rub is not in what retirement will require but in how far most Americans are from these sorts of savings. Households between ages 55-64 have an average of $104,000 in retirement savings while households 65-74 average $148,000. Either amount requires the owner to save aggressively and work longer. The days of company sponsored defined benefit pensions funding worker retirements are largely a thing of the past. Workers have to depend on their own savings and increased savings rates mean lower spending.

JP Morgan Chase Mortgage is backing away from FHA loans. The FHA requires a FICO Credit score of just 520 and a 3.5% down payment. Chase says this is sub-prime quality and that they are not sub-prime lenders. If banks back away from this market, no matter the reason, first-time homebuyers will have a tougher time purchasing a home.

Almost twelve million households spend 50% of their income on rent. No food, clothing, or gasoline for the tank – just rent. That group is expected to increase by more than an additional million households over the next ten years. This means more people with less money to spend on non-housing stuff.

Thinking about some of the data the Fed may have considered, readers can reach similar conclusions after a brief perusal of CNBC.com. With lackluster prospects for economic growth, the risk-trade (the shift to much higher risk investments in lieu of safer less volatile shares) seems ill-advised.

As long as the Federal Reserve has been ready to respond to every market downturn and reflexively rush to the fore with more monetary stimulus, downturns have been avoided, and losses have been quite limited. The current dialogue toward tightening makes it clear that this backstop or Fed Put may be a thing of the past. As risk appears to matter again, it is critical that investors understand what they own and why. Balance sheets, earnings, prices, cash-flows, and management teams matter a lot when times get tougher. Please make sure you have a seat when the music stops!

Peace,

Michael