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Mixed Data and the "All In" Fed

01/26/2012

On the morning of Thursday, January 26, some mixed economic data was released domestically. None of the data points should discourage investors that the recent improvement in economic conditions is reversing. We now await tomorrow’s Q4 GDP, which is expected to come in at +3.1% after last quarter’s +1.8%.
 
A look at the data…
 
•  Initial Jobless Claims rose from 356,000 to 377,000, an unfavorable rise above Street estimates of 370,000
•  Leading Indicators rose 0.4% above last month’s revised lower 0.2% but below Street estimates of 0.7%
•  New Home Sales fell 2.2% month on month vs. last month’s revised higher 2.3% gain
•  Durable Goods Orders rose 3.0% vs. last month’s revised higher 4.3% but better than Street estimates for only a 2.0% rise
•  Durables Ex-Transportation rose 2.1% vs. last month’s revised higher 0.5% -- better than Street estimates for a 0.9% rise
•  Capital Goods Orders Non-Defense Ex-Air rose 2.9% vs. last month’s 1.2% decline
 
What has changed in the past 24 hours is the surprise Federal Reserve announcement that extends low levels of interest rates from mid-2013 to late 2014. Since early 2009 until January 25, 2012, I have fully agreed with Chairman Bernanke’s monetary policies. However, I believe yesterday’s FOMC action was misplaced. In fact I believe Chairman Bernanke can be accused of “over trading.”
 
What he has now risked in this new paradigm of transparency is the sanctity of the Fed. He placed the Fed in a box. If the need to raise rate arises – and I expect there will be that need – how will he react? Raising rates and defying yesterday’s late 2014 target will place the institution in a position where they lose credibility with investors for many years. Never can a central bank lose its credibility; that is a cardinal investing sin.
 
I stand by continuing with a defensive allocation strategy. Be invested in risk assets but do it defensively. Focus on large, big balance sheet companies with a strong dividend yield and proven revenue growth rate; corporate and municipal bonds in an investment world chasing yield. The selloff in utilities is an opportunity.
 
Finally, when QE1 was announced in March 2009, the spot price of oil was in the mid $40’s. The second round of QE telegraphed to the markets in late August 2010 at Jackson Hole found spot oil at the mid $70’s and lifted it above $90 over three months. Mr. Bernanke and the FOMC have presented further easing; spot oil is now $100… A mistake has been made!
                                                
 
Figure 1.1 QE1 March 2009 – Spot Oil

Source: Bloomberg
 
Figure 1.2 QE2 August 2010 – Spot Oil

Source: Bloomberg
 
Figure 1.3 Further Easing January 2012 – Spot Oil

Source: Bloomberg

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