Beer Goggles and Down January’s
Posted on Saturday, January 25th, 2014
On the 14th of this month Dallas Federal Reserve Governor Richard Fisher made a speech titled Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes. We love reading what Mr. Fisher has to say on monetary policy because he is not an academic and is one of the few, and perhaps only, member of the FOMC to have real world investing experience. You will find the link to his full speech below. It is well worth the read.
Fisher notes that markets have a way of overshooting at times and correcting. This may or may not affect the economy. It is his (and my) hope that it will not. In fact we will go on to outline how this retrenchment in the stock market may actually help the economy. Here is more from Fisher below and how he plans to use his vote on the FOMC this year.
…markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations.
This need not threaten the real economy. The “slow correction” of 1962 comes to mind as an example: A stock market correction took place, and yet the economy continued to fare well.
“…QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good…”
Here is the point as to the market’s beer goggles. Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.
http://www.dallasfed.org/news/speeches/fisher/2014/fs140114.cfm
How could this move lower in the market actually help the economy? Think of it this way. US corporations are forced to manage earnings higher in a rising stock market according to Wall Street’s expectations. After all we, as an investing community, have screamed for years that executive pay should be tied to performance. What better performance to attach it to than corporate stock performance? US corporations are borrowing to buy huge amounts of their own stock back thereby raising earnings per share. Earnings have been rising but revenues have not kept pace. If stock prices begin to fall executives may feel less pressure to manage to Wall Street’s expectations and may begin investing more in the business side of things thereby helping the economy and begin to expand business, increase employment and focus on raising revenue.
This week saw pressure in emerging markets due to weakness in China and further tapering of QE. As Warren Buffett says when the tide goes out you find out who has been swimming naked. It appears that Turkey and Argentina may have been. The market suffered on Friday because of this. Friday’s are typically a day when traders wrap up positions, cover shorts and typically have an upside bias. Not this week. Turkey, Argentina, and Venezuela are all prospects for a devaluation of their currency. Governments make such moves typically over a weekend as banks are closed. Governments and expectations of government moves are back distorting markets.
The S&P 500 is down 3.14% for January.
January Barometer: As January goes, so goes the year
Does the January Barometer work? Based on S&P 500 data going back to 1928, January is a good predictor of the year. When January is down, the year is up only 42% of the time and the S&P 500 has an average decline of 2.3%. This compares to positive annual returns 66% of the time and an average return of 7.5% for the S&P 500 going back to 1928. – Stephen Suttmeier BofAML
Down Januarys Serve as a Warning – According to the Stock Trader’s Almanac, every down January for the S&P 500 since 1950, without exception, preceded a new or extended bear market, flat market, or a 10% correction. 12 bear markets began, and ten continued into second years with poor Januarys. When the first month of the year has been down, the rest of the year followed with an average loss of 13.9%. In most years, these declines later provided excellent buying opportunities. – JC PARETS All Star Charts StockTwits
(Note the first research from Stephen Suttmeier is from 1928 until 2013 while JCParets is only since 1950.)
They say that Fed chairmen always tested early on in their terms. Could this be Yellen’s test?
The length of time without a correction in the market has created instability. Risks were poured on as there is now a perception that markets only go up. There is a lack of tolerance for any loss at all in markets. Recently, feedback from trading desks on the Street is that there has been much consternation over any move lower in markets bordering on sheer panic as to finding a reason why the market has moved incrementally lower. A somewhat fragile emotional state. Pull backs and corrections are normal for markets. Investors seem to have lost that concept over the last 2 years. We are due and it is healthy. Remind yourself that a 3% move lower is not the end of the world. We do believe that while the end of the world trade was on the table in 2008 it has been shown by governments that they will not let that happen. Rest assured, governments have the most to lose in that scenario and will change the rules again to make sure that the end of day’s trade does not occur. A selloff of some magnitude would make the market cheaper on valuations than it has been in years with US corporate balance sheets been made much healthier since the financial crisis. The question remains, will the FOMC have the courage to continue to taper in the face of investor consternation and Emerging Market volatility?
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.