Will the Fed succeed in engineering a 1970's investment environment?

I think that this is what the Fed is aiming for. It wold reduce the US federal debt burden to a manageable level. Below is a comment from Frank Holmes essay today on what worked then. (Remember, these are nominal numbers; inflation averaged over 8%/annum during the decade. Thus, the real value of the initial stock of government debt was reduced by over 50%; sorry, bondholders.)

"A Rerun of That ‘70s Show?

Looking ahead, if the economy starts to experience runaway inflation, history shows it makes sense to hold real assets. A decade ago, Investment Advisers Stephen Leeb and Donna Leeb wrote a very informative book on how to profit from the “Turbulent Post-Technology Market Boom.” The book, Defying the Market, discussed how to protect against deflationary and inflationary scares, comparing investment ideas that were likely novel to many people in their day, including energy, food, gold, and small-cap stocks.

Will Commodity Investors See
a Rerun of That ’70s Show?

	Nominal Annualized Returns
Gold/Silver	33.10%
Gold Stocks	28.00%
Oil	26.40%
Oil stocks	14.20%
Equity REITs	12.10%
Commodities	11.00%
Real Estate	10.10%
S&P 500 Index	8.40%
CPI	8.10%
T-Bills	6.80%
Government Bonds	3.90%
Source: Defying the Market, Stephen Leeb and Donna Leeb, Leeb Investment Advisors

One table listed the performance of these investments during an earlier era when Americans faced high inflation—the 1970s.

In that decade, gold, silver and oil outperformed many other areas of the market. Gold stocks rose 28 percent on an annualized basis and oil companies grew 14 percent. The S&P 500 Index, on the other hand, grew 8.4 percent on a nominal basis. After factoring in sky-high inflation of 8.10 percent, gold and oil still added significant real returns. The real return of the overall stock market, on the other hand, was nearly zero.

“Stocks leveraged to growth, such as the oils and oil drillers, did splendidly. But the big-cap stocks [i.e. the general market] … were complete duds,” wrote the Leebs."

The shift to equities from bonds is underway in Japan

Japan’s public pension fund, the world’s biggest manager of retirement savings, said it will reduce its holdings of local bonds and buy more shares.  The bond allocation is being reduced to 60% from 67%.

http://www.businessweek.com/news/2013-06-07/japan-s-pension-fund-cutting-local-bond-holdings-to-buy-equities

I suspect that the equity markets have further to go, at least until central banks start tightening.

Asians taking US jobs!

And it's not just Asians in Asia; it's also Asians in the USA. Is this a 5th column? Women, also, show some troubling signs of over-achievement. Lincoln

From today's US Bureau of Labor Statistics press release:

"Among the major worker groups, the unemployment rate for adult women (6.7 percent) declined in April, while the rates for adult men (7.1 percent), teenagers (24.1 percent), whites (6.7 percent), blacks (13.2 percent), and Hispanics (9.0 percent) showed little or no change. The jobless rate for Asians was 5.1 percent (not seasonally adjusted), little changed from a year earlier. (See tables A-1, A-2, and A-3.)

Puzzling failure of household sector in OECD to reduce debt after crisis

Only households in Germany and Japan are less indebted than in 2000. (see attached) This is interesting in light of Martin Feldstein's comments on NPR yesterday, when he pointed out that the household savings rate is now below 3% in the US and so consumption will consequently be very constrained in the next few years.

A small increase in interest may, in the absence of inflation should that be the case, trigger a shift from consumption to saving.

Consumers rewarded for defaulting on mortgages

Eleven banks, including Bank of America, Citi, and Morgan, have begun sending checks to "victims" of the robo-signing scandal, by which banks foreclosed on mortgage defaulters without observing proper procedures.  The cost to the industry, and therefore their shareholders and depositors is $9.3 billion.  Of the $9.3 billion settlement, $3.6 will be distributed to the victims in the form of cash payments. There are 4.2 million of these victims; a case-by-case review has found that only 53 of the 4.2 million were not actually in default.  (Yes, the number is 53.)  So the others (4.2 million minus 53) were in default.  This is why they are being compensated.

It's a little sad that people who actually paid their mortgages are not being compensated.  But such is the way of the world.

"Frustrated central banks move into riskier assets"

This is the title of an article on page 2 of today's Financial Times. Central Bank Publications and RBS have surveyed 60 central banks and these banks expressed dissatisfaction with artificially low interest rates on reserves currencies and fear for the consequences of unbridled monetary expansion as practiced by the Fed and others.  These banks hold $10.9 trillion dollars, most of which reserves are in Asia and the Middle East.  They have been diversifying into non-traditional currencies like the Canadian and Australian dollars, the Chinese renminbi, and the Scandinavia currencies.  Here is a quote: "The response to the crisis by these monetary authorities has had a profound effect, the poll found: more than four-fifths of the respondents said the aggressive monetary easing of the US Federal Reserve and the European Central Bank had altered their behaviour."

The chance of a dollar crisis is rising, but it is hard to see where central banks will go.

Chairman Ben and the lost boys (and girls) in Neverland

Each year, when it releases its full transcripts of the Federal Open Market Committee (FOMC) from five years ago, the Fed invites us to cast our minds back to a place long ago and far away. The conversation around the conference table at the Fed's Washington headquarters on January 30 and 31, 2007¹ seemed to take place in Neverland rather than on the verge of the worst financial crisis since the Great Depression.

Housing starts had fallen steeply from almost 2 million (annual rate) in early 2006 to about 1.1 million at year end, just before the FOMC met. The Feds were not worried however (there are few worries in Neverland) because their model predicted that the rate would soon rebound to a normal 1.3 million level. Problem solved! (But in fact, starts fell to 400 thousand by the end of 2008.) The FOMC did fret pleasantly about inflation, however.

In fact, only a relatively few paragraphs of the 200+-page transcript were devoted to the housing crisis. Here is a sampling. Moskow of the Chicago Fed said that that “the economy is clearly showing more underlying strength than we thought in December.” Lacker of Richmond commented that “each batch of housing data has bolstered my confidence in the trajectory we sketched out last fall – namely, that a drag from housing will mostly disappear by midyear with spillover having been relatively limited.” Gov. Bies said, “we feel very good about overall credit quality.” Gov. Mishkin commented, “we're not seeing anything out of the ordinary or a persistent pattern, and that gives me more confidence that nothing bad is going to happen here.” (Mishkin had co-authored a study proving that nothing bad could happen in Iceland either.) Bernanke summarized: “The general view was that housing would cease to subtract from growth later this year.” Yellen of San Francisco agreed: “Housing remains a concern, but I think the prospects for a really serious housing collapse that spreads to consumer spending have diminished substantially. . . To me the upside risk to inflation seems palpable, especially because labor markets have tightened.” (Yellen is the reputed front-runner to succeed Bernanke, assuring a continuation of .. . ah . . continuity; the magical Veil of Nescience that Dr. Greenspan bequeathed to Chairman Bernanke seems to sit well on her brow.)

The Fed GDP forecast at the meeting was a cheery 2.2% rate in the first half of 2007, 2.4% in the second, and 2.5% for 2008, not the 2% for 2007, 0% in 2008, and -4% in 2009 that actually befell the world outside of Neverland. Back on planet earth alarm bells were ringing non-stop.² Barrons had suggested in August 2006 that housing prices could drop 30%. At the Davos conference just before the Fed meeting, Nouriel Rubini made dire predictions, and the Bank for International Settlements warned of a deepening crisis. Despite these warnings, the Fed stuck to its rosy scenario because in Neverland every time someone says “I don't believe in fairies” a fairy dies.

Even Euromoney seems to have got it right! In the January 2007 cover story, “The world on the cusp,” which was well-illustrated by a drawing of a world on a cusp, Clive Harwood introduced a series of articles that presented “the view that the state of global imbalance must come to an end soon, and with painful consequences.” Charles Dumas predicted “a hard landing followed by poor recovery,” that would “likely cause severe deflation.” Brian Reading followed by stating that “the world is suffering unprecedented financial imbalances” and that “their inevitable reduction . . . will dominate global growth prospects. . .”

But even in Neverland where all stories have happy endings, drama exists. Think of Hook and the crocodile. At the Fed meeting, drama came in the form of the interim president of the Atlanta Fed, Mr. Pat Barron, a practical, energetic, and brilliant man who rose from auto mechanic at Buckhead Chrysler Plymouth to COO of the Atlanta Fed. He is a practitioner not of mathematical economics, like Dr. Ben, but of “descriptive economics,” which is now derided in academe and defined as explaining “economic phenomena as they are without making any statements about how they ought to be.” He expressed a “contrarian view” that the housing market was in deepening crisis. The Lost Boys (and Girls) listened politely to this real world Wendy and moved on.³

History suggests that investors should assign a correlation of -1 to the forecasts of certain central bankers. Ben says the exit from QE will be orderly. Where is he leading us? “Second star to the right and straight on till morning.” That's where you'll find Neverland.

1http://www.federalreserve.gov/monetarypolicy/fomchistorical2007.htm

2See Tee,Gillian, Fool's Gold, Free Press, New York, 2009, especially chapter 10: “Tremors.”

3 According to Tett's book, Geithner was also worried, but ever the good subordinate, he kept his peace.