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While true fundamental stock analysts and value investors often refer to technical analysis as the ‘voodoo of stock markets’, we like to look at both fundamental and technical analysis. Stock market behavior is often described as ‘a manifestation of crowd psychology’ and technical analysis does a good job of identifying the recurring trends that are driven by this psychology.
Like everyone else, we have no idea when exactly the U.S. Federal Reserve will begin their long-anticipated change in policy and start raising interest rates. However, the press release following their most recent meeting this week suggests that the Fed sees economic conditions as no longer being in need of the ‘crisis level’ that they have been for the past six years. An upgrade to the U.S. jobs outlook is a clear signal the Fed has not abandoned the possibility of a September rate hike. The Federal Reserve upgraded their assessment of the U.S. economy at several points, including this important upgrade of the jobs situation: “The labor market continued to improve, with solid job gains and declining unemployment.” ‘Solid’ is an unusually aggressive word for the Fed to use. The Fed also said that housing has shown “additional” improvement, and that labor slack ‘has diminished’ since early this year. The Fed said it would raise rates when it has seen “some” further improvement in the labor market, a word it did not have in prior statements. All in, unless the U.S. economy turns down dramatically in the next month or there is some other global economic crisis, we should expect the Fed to start the process of ‘normalizing’ interest rates at their September meeting! But I have to add that, if economists, professional portfolio managers, average investors and journalists are puzzled about the stagnant productivity in the U.S. economy, they would do well to consider how much of our time is wasted in anticipating, reading and analyzing Federal Reserve policy decisions!
Our point continues to be the longer-term policy of the Federal Open Market Committee – now internationalized – of encouraging higher stock prices so that the resulting wealth effect can help the economy. This policy has been a clear failure in our view as the enormous debts put in place to fund these policies have not resulted in better growth. The only real beneficiaries have been the financial markets. This has led to long, drawn-out 6-8 year bull markets, interrupted with short bear markets. Investors have been emboldened to take a higher degree of risk, which has lead to the record valuations in the growth and ‘concept’ areas of the market. It has also been supported by aggressive stock buybacks and a ‘stock option culture’. Investors know that the Fed’s policy is on their side: Stumble and the Fed (and the Treasury, if necessary) will immediately help out – interest rate declines in early 2000 and 2008 and the giant 2008-09 bailouts are great examples – but succeed and they will not interfere, even in the midst of the most extreme housing or tech bubble.
This near-perfect synergy between Fed policy and the stock option culture has, not surprisingly, resulted in most of the corporate cash flow of public companies being used for stock buybacks – a record $700 billion annualized rate this year at the expense of corporate investments in expansion. Therefore, well into the seventh year of economic expansion, we have uniquely had no hint of a surge in capital spending, which remains well below average. Why take the risk to build new factories or other expansion in a world where things can go wrong? It’s much safer just to buy your own stock which will push prices higher, thus increasing option values (making it easier for CEOs to go from earning 40 times the average worker in 1965 to over 300 times today) and enlarging the Fed’s wealth effect at the same time! But the downside is less corporate expansion; less GDP growth; lower job creation, and hence lower wages. “Pretty soon, Mr. Ford, there will be no one to buy your cars.” The economy becomes persistently disappointing for yet one more reason. Until we see some more logical longer-term policies, it’s hard to see financial markets being in anything other than a bubble. We are investing accordingly!