12/05/12   ZIRP Until 6.5% Unemployment

Editor’s Corner

Ron Rowland

To no one’s surprise, the Fed left interest rates unchanged today at near zero levels, commonly referred to as ZIRP or Zero Interest Rate Policy.  What did come as a surprise was the quantification placed on earlier statements that said rates would remain low as long as the jobless rate remains elevated.  Today, that was clarified to mean rates will stay low as long as the unemployment rate is above 6.5%, and Mr. Bernanke believes that level won’t be reached for another two-and-a-half years.  The new policy also includes a condition of inflation remaining below 2.5%.

Operation Twist, which consists of the Fed buying $45 billion of long-term Treasury securities each month while selling an equal amount of short-term securities, is expiring.  The Fed said it will begin a new program of purchasing $45 billion of long-term Treasury securities each month, which is presumably not accompanied by the offset of any selling.

While it’s great to have some additional clarity, and the Fed can always change directions, the two criteria of unemployment and inflation are not without their own controversies.  You probably recall the September employment report where the unemployment rate dropped from 8.1% to 7.9% at the same time businesses were reporting sluggish job growth.  The November report, released last week, was also somewhat bewildering.  The number of citizens with jobs actually declined by 350,000 yet the unemployment rate improved from 7.9% to 7.7%.  This mathematical puzzle was explained by a whopping 542,000 people leaving the workforce.

The official CPI inflation rate is also prone to disbelief, especially when people compare it to the increases they are facing in health care costs and tuition payments.  There are actually two CPI measures used by the government today.  CPI-W is used to calculate cost of living adjustments (“COLA”) for Social Security and federal pension benefits.  CPI-U is used for inflation-indexed tax parameters.  Part of the fiscal cliff negotiations include changing the calculation methodology to what is known as “chained CPI.”  The chain-weighted approach would have the effect of lowering the reported inflation rate, which in turn reduces future COLAs and future government expenditures.  If this new inflation measure is adopted by the Fed, then it also has the potential to delay the end of ZIRP.

Investor Heat Map: 12/5/12


Industrials moved up and grabbed the number one spot on strength in the transportation and industrial equipment segments.  Health Care jumped two spots to take over second place.  The feat took place during relatively strong market conditions, proving the Health Care sector is more than just a defensive play.  Consumer Discretionary, which was on top of the list a week ago, has dropped to third as retailers and homebuilders take a rest.  Meanwhile, the Financials sector turned in one of the best performances of the week, climbed a few positions, and positioned itself to move ahead of Consumer Discretionary. 

Consumer Staples couldn’t keep pace with the broader market and fell two spots to fifth.  Materials is acting like it wants to make a powerful move, but it actually slipped from fifth to sixth this week.  Energy climbed two positions in an attempt to reverse its recent weakness.  Telecom remains among the laggards, although it managed to flip its color from red to green.  Technology was buoyed for many months by strength in Apple (AAPL) and is now being pulled down by weakness in the same stock.  Utilities brings up the rear again.  It is the weakest of the 32 equity categories in our Edge Charts.


The top five Style categories are unchanged from a week ago, although they are all registering higher momentum readings now.  Mid Cap Value is providing the leadership.  It has cleared its October and November peaks and is set to challenge its September multi-year high.  Since early January, all excursions below the 200-day moving average for Mid Cap Valuehave been held to three days or less.  Mid Caps have a clear edge at the present time with all three ranked among the top four Style categories.  Small Cap Value is also part of this upper echelon.  Additionally, Large Cap Value climbed a couple of spots, making Value stronger than Growth at all capitalization levels.  Mega Cap remains on the bottom of the list, but it managed to flip over to positive momentum and eliminated its status as the only negative Style category.  The Mega Cap group is still about 4% below its recent peak.


A week ago, China had fallen to fourth place.  At that time, we said “we view this as a short-term relative strength surge for the top three categories as opposed to being weakness for China.”  We thought it would take much longer to prove or disprove our theory, but here we are just a week later with China back on top.  That leap pushed Europe and Pacific ex-Japan, last week’s top two, each down a notch.  EAFE, the former third place occupant, fell two places to fifth.  The reshuffling allowed Emerging Markets to move up a couple of positions to land in fourth.  This is the first time in many months that the Emerging Markets benchmark has been ranked ahead of EAFE, the international developed markets benchmark.

The U.K. slipped to sixth, as World Equity and Japan traded places.  Japan started an upward climb in the rankings a few weeks ago, but that effort encountered a setback this week with the yen declining in value.  The Western Hemisphere trio of Canada, U.S., and Latin America are in a near three-way tie for last place.  Latin America has been the laggard for many weeks but is now poised to move ahead of its northern neighbors.  Despite recent strength here at home, the U.S. could soon find itself in the unenviable position of last place in our Global rankings.



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.


“It is possible that asset purchases could have unintended consequences.”

Ben Bernanke, Federal Reserve Chairman


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