Not Much of a Comeback

Good Evening: After three successive down days that left the major averages some 5% below their recent peak, U.S. stocks were well positioned for a nice comeback on Monday. It didn’t happen; most of the major asset classes spent much of the day simply marking time. Just why investors refused to let their risk appetites feast on last week’s decline may or may not be important, but it does beg a few questions.

After all, didn’t one of last week’s highlighted uncertainties — the status of Chairman Bernanke’s renomination before the U.S. senate — become clearer over the weekend? And hadn’t CNBC’s, Jim Cramer, instructed his viewers to “buy, buy, buy!” once Bernanke’s status was clarified? At the risk of over-reading the situation, I think it’s quite possible market participants were unmoved during today’s session because there is a split of opinion as to whether Mr. Bernanke’s likely confirmation is actually good, bad, or indifferent for the markets. I, for one, wish we had a person at the helm of the Fed who is actually experienced in the ways of markets and finance — maybe someone like GMO’s Jeremy Grantham.

The damage visited on U.S. stocks on Friday did not spread very far overnight, as equities in both Asia and Europe stabilized to varying degrees. U.S. stock index futures were pointing higher in the hope that a show of support by the Obama administration and senators on both sides of the aisle would lead to Mr. Bernanke’sconfirmation sometime this week. None of the earnings news out this morning was able to dampen this early enthusiasm, and stocks opened 0.5% higher when the bell rang. Hoping for more, investors soon received less when existing home sales data were weaker than had been expected. Down 16.7% month over month, the figures served to remind investors that recoveries from recessions can be a tad uneven.

The major averages responded to the housing data by retreating back toward the unchanged mark, with the small cap and mid cap indexes even registering small declines by mid day. Stocks then settled into a sideways range for the rest of the session before settling roughly equidistant between the day’s highs and lows. Volume was on the light side, measures of volatility fell, and the major averages themselves scratched out gains of between 0.15% (Russell 2000) and 0.5% (Dow Transports). If stocks don’t don their rally caps tomorrow, we could be in for an interesting rest of the week. Treasury investors, too, sat on their hands today. Yields across the coupon curve rose a gentle 2 bps. Likewise our nation’s currency, as the dollar eased a mere 0.1%. Maintaining their recent correlation with equities, commodities also managed a half-hearted comeback on Monday. Shadowing the precious metals for most of the session, the CRB index finished 0.4% higher.

It’s not quite apathy, but many people I’ve spoken to are either ambivalent or equivocal when it comes to their feelings about a second term for Fed Chairman, Ben S.Bernanke. During this age of indulgent parenting, it’s somewhat easy to understand why. Our current Chairman either ignored, or was an accomplice to, the initial fires that soon raged in our banking system from 2007-2009; yet, he helped douse the flames by training the hoses of liquidity on them. Goat, or hero?

His qualifications also remind one of a typical, “on the one hand…” economist: He has the benefit of both continuity and on-the-job experience in his favor, and yet he spent almost no time outside the world of academia prior to his first stint at the Fed. And by trying hard to protect the Fed’s vaunted independence, Mr. Bernanke’sinsistence of privacy in the Fed’s dealings has actually let politics seep into the relationship between our elected officials on Capitol Hill and the appointed ones in theEccles building. Mr. Bernanke is a hard man to embrace, even if the alternatives (Summers, Krugman, etc.) might be worse.

For those on both the Left and the Right, one of Mr. Bernanke’s most worrisome traits is that, in addition to not seeing the financial crisis coming, he still maintains that the Fed had almost nothing to do with inflating the credit bubble that preceded it (see below). Taken directly from his speech of January 3 of this year, the following statement is intended to help remove the Fed’s fingerprints from the scene of the housing accident:

“My objective today has been to review the evidence on the link between monetary policy in the early part of the past decade and the rapid rise in house prices that occurred at roughly the same time. The direct linkages, at least, are weak”.

Bernanke goes on to say that it was access to exotic, poorly underwritten mortgages — and not low interest rates — that led to rapid price increases in U.S. residential real estate, concluding:

“I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary.”

Well, now, Mr. Chairman…just which arm of the Federal government has a supervisory role over our nation’s largest banks? That would be the Federal Reserve, and the Fed could have stepped in at any time to say “no mas” to much of the reckless mortgage lending going on up and downWall Street. Since home prices were cresting just as Mr. Bernanke was given the keys to Mr. Greenspan’s former office, I blame the Maestro for both the low rates and the lack of mortgage lending oversight. The problem I have with Mr. Bernanke, however, is the same one that nags others and is brought into stark relief by this speech — he doesn’t get it. We need a real leader at the helm of the Fed, a man or woman of true character who will stand up to both Congress and the banks while implementing sound monetary policies.

The last person who fit the above description was Paul Volcker. Alas, he has done his time and is not available. With his deep knowledge of finance, and his unmatched appreciation for financial history and proper central banking, Jim Grant would be an ideal choice for Fed Chair. Sadly, Jim has said he would decline any nomination and would resign if somehow confirmed.

I’m sure there are others who would act responsibly as the leader of the world’s most powerful financial institution, and upon reading the latest “GMO Quarterly Letter”, I wonder if Jeremy Grantham would take the job. As you’ll see by reading the attached, Mr. Grantham knows our markets, how the different asset classes inter-relate, and has an especially keen eye for bubbles. I don’t agree with everything he says in this wandering missive about the decade just past, but his list of “lessons learned” is a very instructive read. I have no idea whether Mr.Grantham would either take the job or even be effective once confirmed. But, unlike Mr. Bernanke, Mr. Grantham saw the financial crisis coming from a mile away. He has a firm grasp of what happened and why. Best of all, his no-nonsense approach would be fascinating to watch during the next four years.

— Jack McHugh

U.S. Stocks Rise on Growing Confidence in Bernanke Confirmation

Monetary Policy and the Housing Bubble, by Ben S. Bernanke

GMO Quarterly Letter — What a Decade

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