How To Play The FRB Wimp-Out
Economists term the assumption that nothing changes as the naïve forecast. That’s what we had from the Federal Reserve Board throughout 2014 and it’s what we’re having now. Nobody’s jittery about overstaying the easy-money construct. Stock market operators like me so far can live with extended valuations for e-commerce and tech houses like Amazon AMZN , Alibaba BABA , Facebook, Microsoft MSFT and Apple AAPL . Let somebody else own General Motors GM and Exxon Mobil XOM for a comeback.
I’ve struggled over 60 years to outfox the FRB. You do this by projecting what will be in their heads 12 months out, not by currently voiced concerns reported on page one in the press.
The Fed is in a mode of absurd double-speak and wish fulfillment. No inflation, currently, and this is bad for the economy. What’s more, they won’t raise interest rates even after inflation ratchets back to 2%. So… all you consumers out there, spend your savings, buy first homes and shop until you drop. Treat yourself to a new car while the cost of carry hangs so low.
With 30-year Treasuries yielding 1.49%, 10-year paper at 70 basis points and the two-year notes at 20 basis points, the Fed would be first to say the market has taken away historic powers to reset interest rates, influence the economic cycle, up or down, or combat inflation and the unemployment rate.
This was not always the case. My favorite FRB chairman, Andrew Mellon, viewed most industrialists as dumb bunnies who sparked inventory and capital goods recessions by periodic overspending. His was the right call that repeated itself into the sixties.
President Franklin Roosevelt despised Mellon for his harsh response to corporate sector exuberance. Always an astute banker, Mellon inventoried a conservative loan portfolio, believing recurrent business cycles were a given every five years. FDR prompted the U.S. Treasury to sue him for tax evasion. Mellon died before the case was decided in his favor. His collection of Italian Renaissance art became the nucleus of the National Gallery of Art in our capital, endowed by Mellon, actually designed by his architects.
In our time, Federal Reserve Board chairmen like Paul Volcker, William McChesney Martin and Alan Greenspan stand out. Volcker practically bankrupted the country, pressing on 15% interest rates, but he bled out inflationary expectations then rising at a 7% to 8% clip.
Alan Greenspan proved the most energized chairman, super proactive. When Greenspan dropped the Federal Funds rate 50 basis points, January 2001, Nasdaq NDAQ rallied overnight nearly 15%. We all got busy discounting coming economic expansion.
Unfortunately, central bankers don’t trash-talk like stand-up comics, who themselves can be filled with wisdom. Not just in the U.S., but in Japan, England and Germany, central banker verbiage is interchangeable, dull and most unlikely to catch oncoming inflection points.
I’m at the far end of the investment spectrum, craving the moon, but still research based in my picks. Being fundamentally right and overweighted in Apple, Facebook, Alibaba, Amazon and Microsoft is a derivative of my belief that disinflation lasts for years and the FRB has no tools to deal with it.
If domestic interest rates snake along ground zero, the price-earnings multiplier for growth stocks holds in new-high ground. Curiously, the recent changes in the Dow Jones Industrials list put the emphasis on growth. The Dow Jones should drop “Industrials” from its name. It is no longer descriptive of this index which more and more looks like the S&P 500 Index. Who needs it?
Wisely, to remain competitive as an index, the Dow can’t count any longer on stocks like Exxon Mobil, halved by the market past five years. I regard pre-technology market leaders before 1960 as the uninvestables. Stocks like U.S. Steel, Alcoa AA , General Electric GE , even General Motors and Ford Motor F sport overleveraged balance sheets and stagnant demand for their output.
I’m a player in materials stocks like Freeport-McMoRan FCX because it got oversold. Same goes for Halliburton HAL which has tripled in a matter of three months, its high over $29, low under five bucks. I’ve bought a bunch of MLPs like Enterprise Products Partners EPD and Williams Companies, hoping their distributive cash flow holds up, that oil futures don’t tank.
My most believed-in play on the persistence of minimal interest rates is the high-yield market for corporate debentures. Here, I’m arbitraging money, as well. My cost of carry doesn’t exceed 1% on a portfolio of debentures with five-year duration, yielding over 5%. I’ll be wrong only if the country sinks into deep depression or interest rates spike several hundred basis points. At least, I’ve got the Federal Reserve Board on my side.
Over sixty years, averaging my costs on borrowed capital, I come out somewhere between 6% and 7%. FRB Chairman McChesney Martin was my nemesis in the sixties. When inflation reared its head, he’d take away the punch bowl, spiking margin requirements to 90% while money market rates shot up unmercifully. I turned to money brokers to fuel my obsession with convertible bonds like Boeing BA , United Aircraft and Eastern Air Lines which all doubled and tripled as the jet age unfolded in the world.
The shoe’s on the other foot now. Unless you believe an effective Covid-19 vaccine is around the corner (I don’t), these stocks are the untouchables, bleeding capital, day after day.
In case you’re wondering why I haven’t mentioned our present FRB chairman by name, it’s because it doesn’t register on me as yet. He’s faceless. Contrastingly, Alan Greenspan with his “Greenspeak” was embedded in our consciousness. Alan was great stepping in with a liquidity infusion day after Black Monday.
I’ve reservations on whether Alan read the nineties as well as late eighties. He completely ignored ominous fiscal drag during the Clinton Administration. Approximately 50 changes in the discount rate between Greenspan’s ascendency to his post in 1987 and his retirement in 2006. If nothing else, all this plastered Alan on the front page, periodically. Nobody then caught the variable of the public reducing its savings rate to near zero.
Greenspan once opined that you never recognize bubbles until after the fact. Our investment problem, Covid-19 induced, is the reciprocal: When to anticipate a resurging setting. My answer: Not so fast. Let Jerome Powell sleep through all this because whatever he says has no meaning for financial markets. His pronouncement that he wouldn’t raise interest rates even if inflation reached 2% adumbrates the powerless FRB, no new tools at hand.
Actually, Powell took a page out of Ben Bernanke’s book. Ben kept telling everyone who’d listen that low interest rates would rest in place for the foreseeable future, at least two years. Janet Yellen also talked this talk. Late in 2013, stock pros finally believed Bernanke meant what he said. Risk on then pervaded the air.
The country changed for the better after Paul Volcker’s lavage rapide. Labor’s givebacks started. Jimmy Hoffa’s ghost could no longer threaten paralysis for the country’s interstate commerce. Membership in the United Auto Workers peaked and then General Motors closed down their second-floor cafeteria in the General Motors building on Fifth Avenue, a profligate utilization of high-priced square footage.
Never forget, rising bond yields top out any bull market within a year or two. The reciprocal is true, too. During the nineties, the 10-year yield on Treasuries started at 7.8%, then declined to 6% until 2000. The S&P 500 Index started out at 15 times earnings, but ended the decade near 30 times. Tracking Federal Funds, I was surprised to see it as low as 25 basis points in 2015 vs. its long-term trend at 4%. Nobody sees 4% coming back. Even a rise to 2% shouldn’t panic the stock market, impacting price-earnings ratios. A 4.5% yield is the long-term norm.
Friends periodically ask me how long can the good times last. Normally, I turn it around and ask why they can’t last. Consider, every central bank in the universe is praying for an inflationary bias. Until we see wage inflation and the end to easy money, stay invested.
Sosnoff and / or his managed accounts own: Amazon, Alibaba, Facebook, Microsoft, Apple, Ford Motor bonds, Freeport-McMoRan, Halliburton, Enterprise Products Partners and Williams Companies.