“New Normal” Means Central Banks Won’t Soon Exit

Good Evening: U.S. stocks rose for a third straight session, recouping almost all of last week’s losses in the process. That these gains were recorded in spite of dour employment figures, a massive drop in consumer credit, and a fresh round of warnings from folks like Nouriel Roubini, Mohamed El-Erian, and Bill Gross is at once both impressive and confusing. The central bankers of the G-20 nations are also quite aware of the headwinds facing Western economies, and they will likely be loath to remove stimulative monetary policies any time soon. The balance of 2009, therefore, looks to be a continued and volatile battle between under-nourished economic fundamentals and gluttonous policy responses. Successful investing in such a climate will not be a simple matter of being “bullish” or “bearish”; it will require an open mind.

Friday’s employment statistics were definitely on the weak side, as the number of jobs lost, hours worked, and the unemployment rate itself were all worse than consensus expectations. Only a rise in average hourly earnings posted an upside surprise, though the federally mandated increase in the minimum wage seems to have played a large role in the uptick. Tuesday’s economic calendar was light, but it was weighed down by a consumer credit report that had analysts rubbing their eyes in disbelief. BAC-MER covers the details in its report below, but it suffices to say that, even with “cash-for-clunkers”, U.S. consumers seem to be less willing to spend than they are to repair tattered balance sheets. I thought Bloomberg’s analysis of the consumer credit data was spot on: “The markets may ignore this report but policy makers won’t as it works directly against their efforts to stimulate spending.” (Source: Bloomberg.com)

Stocks overnight were quite firm, as the rest of the world greeted Wall Street’s positive response to Friday’s jobs numbers with some thumbs up of their own. Risk appetites were on the march, with the dollar heading lower, commodity prices heading higher, and U.S. stock index futures indicating early gains of 1% or so. Some activity on the M&A front was also an early upside catalyst, and Tuesday’s headline-grabbing deal was Kraft’s offer to buy Cadbury. Since other players may join the fray, the offer caused investors to imagine what their favorite names might fetch when the investment bankers start hitting the phones instead of the beaches. And don’t look now, but even the IPO market might be starting to awake after a long slumber.

The major averages opened 1% higher, gave back just about half those gains, and then traded sideways. Helped by a faltering greenback, commodity-related equities then led a charge into the closing bell that left the averages near their best levels of the session. Tuesday’s gains ranged from 0.1% for the Dow Transports to 1% for the Russell 2000. Treasurys declined, but only grudgingly so. Yields rose 1 to 5 bps in a steeping curve environment, but the damage certainly could have been worse. The sagging U.S. dollar index ended the day down 1% and set a new low for the year while doing so. Commodity traders took full advantage of the greenback’s weakness by ramping up positions in the energy and agricultural sectors. Base metals performed well, but gold and silver came in for some profit taking after the yellow metal couldn’t hold above $1000/oz. Still, the net of today’s fiat currency-inspired rally left the CRB index 2% higher at Tuesday’s close.

After reading the latest Investment Outlook by PIMCO’s Bill Gross, it would be understandable if the average investor came to the conclusion that the U.S. economy will be slow for some time, that the rallying bond market has it right, and that the rallying stock market has lost its marbles (see below). Mr. Gross reinforces his 2009 stance that U.S. investors face a “new normal” of subpar GDP growth and subpar equity returns. Due to his DDR formula (Deleveraging, Deglobalization, and Reregulation) and its affect on our economy, it makes more sense to seek income – “shaking hands” with the government, if necessary – than it does to seek the capital gains of yesteryear. He makes a good case, one not too dissimilar from the ones made by David Rosenberg, Nouriel Roubini, and others in recent months. Mr. Market has had numerous chances to see, hear, and act on these arguments, and, yet, after a stutter step or two, the old gentleman looks set to continue on his merry journey to higher prices. Is the old codger blind, deaf, or just plain dumb?

It’s confusing, especially when one listens to the type of bullish case so glibly offered by guests on CNBC. “Don’t fight the tape”…”Don’t fight the Fed”…”Warren Buffett’s bullish; that’s good enough for me”…etcetera, etcetera. Even the analysts inside the same banks display a marked disagreement about earnings (see below). So what’s a reasonably thoughtful investor supposed to do? More than trying to serve as an accurate investment weathervane, these commentaries are meant to be food for thought while analyzing where the potential risks to all forecasts might lie. I am a natural skeptic, but the primary risk to remaining steadfastly bearish on common stocks in this environment is the printing press. The Fed has one, has been using it, and will likely not relent in using it until it sees the whites of the eyes of inflation – if then. The G-20 nations have all but promised to do the same (see below).

Mr. Bernanke has based most of his career on studying the Great Depression and the Fed’s mistakes in combating the dragon of deflation during the 1930s. He has publicly vowed to slay the dragon this time around, even if it means risking some inflation down the road. Bernanke and his central banking brethren the world over seem to think they have all the tools they need to clean up an inflationary mess, should one spill forth. I seem to recall the Maestro, Alan Greenspan, having a similar confidence in the Fed’s ability to mop up after bubbles have burst. The parallels in hubris are striking. But how can one profit from Mr. Bernanke’s promises?

It’s not easy. History teaches us not to buy the first big rally after a broken bubble in an asset class, and I could easily see how the U.S. economy could go comatose once Mr. El-Erian’s “sugar high” of stimulus and inventory rebuilding runs its course. Then again, the policy responses to the Great Recession have no fiscal or monetary precedent. And, should the economy slip a gear, you can count on yet another stimulus package and yet another round of quantitative easing. It is even a long shot possibility that market participants so thoroughly believe everything will be all right that they bid up stock prices all the way into the end of 2009. If so, Treasurys cannot long retain their pigmy-sized yields. The key for investors will be to stay nimble and try to focus on investments which could benefit from either outcome. I have long favored precious metals and their related equities because I see how they could do well no matter what happens to the economy.

If a strong recovery somehow takes hold, then rising inflation expectations should help the metals and be an even bigger tonic for mining shares. If the economy slips back into a funk, then a new round of policy responses (that we cannot afford) will gush forth, harming the dollar and thus helping the metals. The only way precious metals could really get hurt is for Bernanke and his central banking colleagues around the world to guide the global economy to a perfect, soft, noninflationary landing. If you think Bernanke and his buddies can usher in a painless return to the Goldilocks era, then avoid precious metals. Stocks, bonds, commodities, and the precious metals can all – in the short run – benefit from the liquidity provided by overly easy monetary policies. The recent positive correlations among these asset classes may be sending just such a message. Eventually, however, the asset classes will have to part ways. I think the central bankers will find a way to overstay their welcome, leaving the only monetary asset they can’t print as the asset of choice.

— Jack McHugh

Dollar Falls to Lowest Versus Euro in 2009 as Stocks Rally
Unprecedented drop in consumer credit
Stocks Show Why Analysts Dismiss Economists on Growth
Stocks, Bonds in ‘Sweet Spot’ as G-20 Avoids Exit
On the “Course” to a new normal by Bill Gross, PIMCO

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