This was a busy week for economic data releases. In the manufacturing sector, January industrial production and capacity utilization were released, as were the regional manufacturing surveys from New York and Philadelphia. In the housing sector, data on housing starts, building permits, and homebuilder sentiment were released. January retail sales and inflation data also came out this week.
I could run through each of the economic releases and give you the investment implications, but I would be wasting your time. You see, this market is uninterested in economic data. It doesn’t matter that industrial production and retail sales fell short of estimates, or that inflation data exceeded estimates, or that revolts in the Middle East are spreading. Stock prices shrugged off the economic data misses and rose yet again this week. In the month of February, the S&P 500 is up 4.37%, and almost 7% for the year. This market is keyed in on one variable and one variable alone.
What is that variable you may ask? The Federal Reserve. You may be tired of hearing about Fed policy, but if you want to truly understand the current investing environment, Fed policy is the only thing that matters. The Fed is the primary driver of all asset markets today.
Just take a look at the charts below. Since Chairman Bernanke signaled the Fed would print more money, asset markets have surged. The S&P index has risen virtually uninterrupted—gaining almost 30% in less than six months. The CRB raw industrials index has gained 23%, High Yield bond spreads have compressed by 236 basis points. Investment-grade credit spreads have moved in 47 basis points. This was, of course, intended by Ben B. Despite two bubbles in ten years, Ben B. still believes inflating asset prices creates sustainable economic growth. He has the order mixed up. It is sustainable economic growth that is supposed to lead to higher asset prices.
In his own words at a recent National Press Club speech, Ben B. said the intention of quantitative easing is to “lower yields and force investors into alternative [read riskier] assets.” You should have heard the guy. He stands up on stage and boasts about how the first time the Fed engaged in quantitative easing the S&P 500 bottomed a week later.
Do you want to be forced into riskier assets? I sure don’t. Asset prices should not be used as a monetary policy tool. The financial markets serve a vital function in a capitalist economy. They provide for the efficient and effective allocation of capital. Manipulating asset prices leads to a misallocation of capital (for example a real estate bubble) and financial instability. It’s like price fixing.
To be honest, I don’t even think Ben B. yet grasps the profound implications of his actions. By openly acknowledging that the Fed is targeting asset prices he has given every hedge fund manager, every big Wall Street trading house, and every speculator a license to mint money. Stocks are indeed rising because of quantitative easing, but stock prices are likely rising even more due to the Fed’s desire to keep equity prices higher than they otherwise would be. Ben B. has confirmed that there is a Bernanke put. Any significant equity market correction is likely to be met with another round of quantitative easing. Rising stock prices are simply the market digesting the implications of the Bernanke put.
You may not care that Ben B. is artificially inflating asset prices. After all, who doesn’t like a rising stock market? It creates the sense that things are getting better, that you are getting wealthier. But if all it takes to make stock prices go up 30% is the printing of $600 billion, why not print $1 Trillion, $2 Trillion, or $3 Trillion? Your portfolio value could double in no time. Besides causing the widespread misallocation of capital, inflating asset prices by printing money leads to inflation.
We haven’t seen inflation yet, but it is coming. The full effects of quantitative easing round one have not even fully filtered through the economy, and goods and services prices are already beginning to rise. Over the last six months, inflation has risen at a 3.16% annual rate. And if you look at private sector measures of inflation such as the MIT Billion Prices Project, inflation is accelerating much faster than the CPI implies. Yet our central bank chief continues to print more money. That frightens me, as it should you. Because if there is one thing that is more powerful than the Bernanke put it is higher interest rates and inflation.
Keep a close eye on Ben B. Fed policy is the only variable that matters in the current environment.
Jeremy Jones, CFA
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