Tuesday, February 4, 2014

Did Zero Hedge just turn bullish?

You have to love the tone of the writing at Zero Hedge. I can generally count on them to point out that not only is the glass half full, it's actually leaking. In a recent post, ZH may have inadvertently turned bullish on the stock market.

Consider the post entitled Fed's Lacker Slams Permabulls, Pours Cold Water On The US "Growth Story". The post details Richmond Fed President Lacker's comments on the economy. I won't go through all the details, but the main point was the skepticism that Lacker expressed about the robustness of the US economy's growth rebound [emphasis added]:
Economists' hopes have been bolstered of late by a recent string of data releases indicating that 2013 ended on a positive note. Second-half growth in real GDP — our broadest measure of overall economic activity — was stronger than we've seen in quite some time. While that figure was boosted significantly by inventory accumulation that is unlikely to persist, there was some evidence of momentum that might carry forward.
In effect, Lacker said that he had seen these growth spurts before:
Although consumption grew rapidly at the end of last year, we have seen similar surges since the last recession, only to see spending return to a more moderate trend. Consumer spending trends are likely to depend on whether the dramatic events of the last few years are only a temporary disturbance to household sentiment or if they instead represent a more persistent shift in attitudes about borrowing and saving. At this point, I am inclined toward the latter view.
If growth was so robust, then where's the hiring and the capex?
Businesses also appear to be quite reticent to hire and invest. A widely followed index of small business optimism fell sharply during the recession and has only partially recovered since then. Interestingly, when small business owners were asked in the latest survey about the single most important problem they face, 20 percent answered "government regulations and red tape." This observation accords with reports we've been hearing from many business contacts for several years now. They've seen a substantial increase in the pace of regulatory change and a substantial increase in uncertainty about the shape of new regulations. Both are said to discourage new hiring and investment commitments.
Lacker is known to tilt to the hawkish camp (see this Business Insider review of the hawk-dove spectrum) and his speech concluded with a summary of his skeptical view that the current bout of so-called growth acceleration is real:
The pickup in growth late last year is certainly a welcome development, and it may well be a harbinger of stronger growth ahead. But experience with similar growth spurts in the recent past suggests that it is too soon to make that call. My suspicion is that we will see growth subside this year to closer to 2 percent, about the rate we've seen since the Great Recession.

Is bad news good news?
I pointed out before that too much growth could actually be bad news because it would push the Fed towards a tightening bias that would spook the markets (see The risk of catastrophic success). In that sense, a growth deceleration towards the 2% level as postulated by Lacker could actually be a good thing for financial markets, as long as the economy doesn't slow into recessionary territory.

Tim Duy recently made the point that the bond market is pricing in slower growth and an easier Fed by highlighting Jon Hilsenrath's recent WSJ article:
The market, in short, is now pricing in a much easier Fed, not a tighter Fed. Movements in 10-year Treasury notes are telling the same story. Last summer, 10-year yields were rising because investors saw a tighter Fed. Now they’re falling. Investors seem to be reading a string of soft economic data – weaker car sales, a manufacturing slowdown, disappointing job growth – and concluding the economic coast is not as clear as it appeared just a few weeks ago.
Duy went on to suggest that the market is expecting a more accommodative Fed:
I would suggest that the decline in rates indicates the Fed is too tight, not too easy. Indeed, we would hope that they would only be tapering in the context of a rising interest rate environment as it would suggest that market participants were anticipating higher growth and inflation. But the Fed doesn't see it that way. They see lower rates as a signal that policy is easier. And hence are not inclined to react to ease policy further by stopping the taper.
Indeed, the 10-year yield has been falling for most of 2014:

The current round of stock market weakness has been attributed to two causes: the possibility of a US growth slowdown and the rising risk of an emerging market crisis because of Fed tapering. Now consider the following:

Falling bond yields? An easier Fed? Shouldn't that be music to the ears of the US stock investors as they get over this "growth scare". Similarly, won't this be good news for emerging market investors as well, because tapering would be replaced by other forms of accommodation. When will Mr. Market take the view that an easier Fed is good news (as long as the economy doesn't keel over into recession)?

Regardless of whether Lacker is right about a reversion to a 2% growth rate, it seems to me that a 2-3% growth rate for the US economy represents the sweet spot (not too hot, not too cold) for risky assets.

This brings up an interesting question. Does that mean that when ZH tried to talk down the growth rate, it actually (inadvertently) turned bullish?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

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