Where Exactly is There? And Do We Really Want To Go?
Well we know where we're goin'
But we don't know where we've been
And we know what we're knowin'
But we can't say what we've seen
And we're not little children
And we know what we want
And the future is certain
Give us time to work it out
Talking Heads, Road to Nowhere
If you were fortunate enough to be on safari without an internet connection and are just now checking your accounts, you might think that this was just another sleepy week on Wall Street. But as everyone by now knows, it was anything but, with some extreme moves in stock markets both here in the U.S. and abroad. Last week’s Millers Market Musings detailed the reasons for the upcoming volatility of the past week and the mechanism through which a slowing Chinese economy can reverberate through emerging markets and into our markets here, even for companies with absolutely no exposure to China. The feedback loops and VAR models I discussed immediately reared their ugly heads on Monday and Tuesday. The stock market was following its usual pattern in a de-risking selloff on Wednesday when a wishy-washy statement from NY Federal Reserve head Bill Dudley sent markets higher on the hope that the Fed will push back its expected September rate hike. While some people applauded the market’s recovery, I was left wondering - is that really where we want to go? To a place where simply pushing back a tiny rate increase is enough to launch a recovery? Because what that really means is that we’re in a pretty bad neighborhood already, we just don’t know it yet.
Think about it – what is lurking out there that is so scary that the Fed is afraid to move up its target Fed Funds rate by – wait for it – 0.25%? What do they know that we don’t? Are we never going to have normal rates, because every time they get close, emerging markets throw a hissy fit? Isn’t not raising rates in September just kicking the can down the road, for, oh, I don’t know, forever? Because the issues that keep sending emerging markets, including China, into spasms every time the Dollar strengthens aren’t going away any time soon. These are deep seated, long term problems, and those emerging markets aren’t going to suddenly be de-linked in October, or December, or any time soon. So let’s figure out where we are going and get there already.
Put another way, for all of the good news here in the U.S. (second quarter GDP here was revised up to 3.7% on Friday), a little 25 basis points shouldn’t knock us off the rails. So why are the folks at the Fed so worried? When you watch their interviews, they are clearly taking great pains not to upset anyone – so…who or what are they worried about?
It can’t be large, public companies here in the U.S. Corporate America has been and still is able to borrow at extremely low rates for long durations. They’re set for the foreseeable future. They don’t need low rates anymore.
I’m going to go on a rant here for a second: unfortunately, lower rates have not helped the real driver of our economy, small businesses, because an onerous regulatory environment for community banks makes it extremely difficult for them to lend. Loans are not getting to those that need them, because the FDIC has been on a witch-hunt since 2009 to bring down community banking. That may sound extreme, but I’m not joking. My background is as a bank analyst for KBW, and I still invest a large portion of my fund in regional banks. I speak to well over a hundred bank CFOs and CEOs a year – and their life is a nightmare. Banks that had nothing to do with making subprime loans and selling them to Merrill to be repackaged into CDOs are feeling the brunt of our new bureaucratic and regulatory regime, and it is ugly. Shelia Bair and her ilk have done more to destroy community banking in this country than anything else in the past 20 years. And when you destroy community banking, you destroy the heart and soul of our economy. That is the legacy Bair left us, and it is the reason why our recovery is so weak.
But I digress. Higher Fed Funds rates will have absolutely no impact whatsoever on our economy, because large corporations have all the debt they need and small businesses can’t get money at any price. You see, it’s not the price of money that is the issue –it’s the availability. Real companies don’t make investment decisions based on 25, or 50, or even 200 basis point differentials in borrowing costs. If a project you are considering borrowing a significant sum of money to finance is make or break based on whether or not your loan rate is 4% or 6%, you have a problem. You shouldn’t do that project. Real people running real businesses get this. Academics who have never held a job outside of a university or a Federal Reserve bank don’t. They’ve never had to make payroll. They’ve never had to finance a new piece of equipment, or even go and sell a product to a customer. They don’t know how business works. To them, it’s all just numbers in a model. And in their model higher rates drive down economic activity. I’d argue the opposite. Higher rates will make banks more willing to lend because they will finally be paid to take on that risk. Right now, they are holding securities until rates rise. Let banks get paid for their credit risk and you’ll see them lending more money, will which drive our economy forward. It’s not the cost of money that determines whether or not a business will borrow – it’s the access.
So, put another way – does the Fed think our economy is really so shaky, our recovery so fragile, that a tiny move higher in Fed Funds will derail it and send us careening back into a recession? I can’t imagine that, if they have any common sense left, they do. So what is lurking out there that is keeping the Fed from acting? It has to be a fear of a repeat of 1997 and 1998, when emerging market currency problems morphed into the Russian debt crisis and Long Term Capital blowing up, necessitating a rescue orchestrated by the Fed. In other words, maybe they are worried about, or should be anyway, the “unknown unknowns” as Defense Secretary Donald Rumsfeld once said.
Maybe you wonder where you are
I don't care
Here is where time is on our side
Talking Heads, Road to Nowhere
But what if, instead, they really do know about the linkages that are lurking in the system, but can’t really say so, for fear of setting off the exact problem they are hoping to avoid? Our markets, and theirs, are apparently locked in a dance, where quant funds that trade across markets are going to have to de-risk, and quickly, and the Fed is hoping that time will solve the issue. We’ve been down this road before. Once fragile markets are over-leveraged and linked together, there is no turning back. You can slow down, but eventually, you’re going to get there. And “there” isn’t a place you really want to be.
And it's very far away
But it's growing day by day
And it's all right, baby, it's all right
Talking Heads, Road to Nowhere
This week’s Trading Rules:
S&P 500 (SPY) Support and Resistance Levels:
Last week’s top support of 197 and bottom support band of 182 seemed to be the right levels. This week’s are:
Support: 195/196, 188/189, then 183.50/184. Below that, buckle up.
Resistance: A lot at 199/200. 204.5/205, 208, then 210.
Positions: Long and short U.S. stocks, long SPY puts.
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Miller’s Market Musings is a free weekly market commentary written by Jeffrey Miller, who has been managing money through various market environments for over 20 years. You can subscribe here. If you no longer wish to receive this letter, simply hit reply and put “Remove” in the subject line. Prior posts (from pre-2012 can be found at www.millersmusings.com).