Bernanke: Inflation Is Our Friend
We have good news: the recession is over. Or at least a recession is over. Specifically, the downturn that began in 2007 came to a conclusion as of June 2009. We are learning this only now because the National Bureau of Economic Research, the semi-official recession scorekeeper, must examine the data for months before making such decisions. Of course another recession may have begun at some point between mid-2009 and now, and we just don’t know it yet. The dreaded “double dip” could be over before we even knew it began.
The current recovery – since that is what we are now in according to the experts – has been a strange one. Not only has unemployment remained at record levels, the number of jobless has actually grown since the recession ended. This supports our argument, made in this space many times, that the employment problem is structural rather than cyclical. Large numbers of people simply do not possess the skills that are now in demand. Re-educating them will be a slow process.
The other big news this week came from the Federal Reserve, which decided on Tuesday that what we really need is more inflation. The Fed is mandated by its charter to seek “maximum employment, stable prices, and moderate long-term interest rates.” It is arguably failing on all three counts. Tuesday’s statement admitted as much on the “stable prices” part. To the Fed, “stable” means long-run inflation rates in the range of 1.7% to 2%. Right now CPI is below that zone, running around 1.5%, suggesting that deflation is actually the bigger risk at present. Under normal circumstances producing more inflation is a fairly easy task of just printing more currency. It hasn’t been working as well as expected lately, so the Fed seems to be signaling it will do more of the same. Some form of additional monetary easing now seems almost certain.
Stock traders were not especially pleased by this news. The S&P 500, which had attempted a breakout earlier in the week, turned down on the Fed news before recovering somewhat from today’s low. Reaction was even more apparent in the currency, bond and gold markets. The prospect of an inflation-seeking Fed sent the U.S. Dollar down hard against other currencies. Government bond yields dropped sharply, though at today’s 2.55% close the ten-year Treasury rate is above the late-August trough. Inflation-protected securities (TIPS) had their biggest one-day gain in sixteen months. Gold jumped to an all-time high for the fifth straight session today, and the $1,300 barrier seems destined for a breakthrough soon. All this is a sign that markets listen to the Fed but don’t necessarily agree that its policies will work.
Telecommunications edged ahead of Materials to take the top spot in the sector momentum rankings this week. Consumer Discretionary stayed in third place as retailers showed continued strength. Industrials improved, possibly due to proposed tax incentives for additional business capital spending. Technology was the week’s biggest mover, vaulting from last place to fifth on the list. We are skeptical this momentum can be sustained. The defensive trio of Health Care, Consumer Staples, and Utilities have all slipped into the bottom half of the chart. Energy is in last place with Financials not very far ahead.
Growth has moved ahead of Value at all capitalization levels. The largest divergence is in the Small Caps where Small Growth climbed to the #2 spot, while Small Value is all the way down at #9. The previously-clear Mid/Large/Small stratification is now all jumbled up, with Mid Caps having a slight edge at the moment. The capitalization extremes of Mega Cap and Micro Cap both remain at the bottom of the list.
Pacific ex-Japan widened its lead over other global regions. The U.K. and Emerging Markets swapped places but remain neck-and-neck just behind the leader. A currency intervention in Japan had a dramatic one-day effect, but now the Yen is starting to creep up again, taking the luster away from a Japanese stock rally. As a result Japan fell to the bottom of the rankings and boosted the U.S. out of last place.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.
FOMC statement 9/21/10
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