The yield on the 10-year US Treasury note fell to 1.39% on July 24, and it has risen since to 1.8%. That’s a difference of about $40 per bond. Oil has increased about $17.50 per barrel since June, and Gold is up $90 an ounce. The Dow Jones Industrial Average is up more than 10%, or 1,200 points, since June 4th. And the Federal Reserve is running out of time and options.
The Federal Open Market Committee has 3 ½ more meetings this year: Jackson Hole later this month (that’s the ½ because it’s not an official meeting), September, late October and December. This Jackson Hole conference has wrought consistent market moving comments for the past few years, and we expect this one will follow true to form. The closer we get to the November election, the more political any action by the Fed appears.
Our guess is that there will be dovish language (dovish means more stimulus) from Jackson Hole along with some optimism over recent improvements in economic data. No later than the September FOMC meeting, we would expect to hear that the Fed will leave the Fed Funds rate near zero through the end of 2015. This should be a very worrisome indication of how the economic recovery looks to the nation’s central bankers. Not that we expect they will get it right, but it gives us insight into their true economic feelings.
Recent positive data give the Fed room to delay further Quantitative Easing. We believe that we will see additional Fed easing but not until after the election. And the market numbers bear that out. The increase in yields suggest that there is little anticipation of impending bond purchases by the Fed, but increasing oil and gold prices indicate that inflation fears are still alive and well. Sometimes rising commodity prices signal economic expansion and increased demand. With China’s expansion slowing, this is probably not the case this time.
Stock investors are clearly expecting something more from the Central Bank, and we worry they will be disappointed. Investors long to believe in magic. In spite of unpleasant realities, there is a penchant to ignore the bummers and hope for Team Bernanke to wave their wands.
This is an exceptionally difficult investment environment. The economy is clearly growing, but the pace of growth is anemic by the standards of historical economic recoveries. Investors are frustrated by very low yields, and they are bored in some cases over having to remain conservative. They are wooed by the quick bursts of risk-on trades stimulated by promises of more government money, yet they have even less tolerance to endure losses as data deteriorate.
We have opined for some time that while this recovery is clearly underway, it is not without peril. Caution is still warranted and will be for some time. We believe that large, blue-chip companies with solid balance sheets and organic earnings growth make most sense for portfolios under our management.
A line from a favorite poem that hangs above my desk reads, “And whether or not it is clear to you, no doubt the universe is unfolding as it should.” The over-leveraged economic expansion took time and so will this recovery, but we will recover. America will prevail.
Hang in there.