Kontent Review

  

    What do I think of yesterday's stock-market bacchanalia?  I think it was and is an absolutely wonderful gift for people who have been dragging their feet in raising cash!  It's amazing, if not frightening, that any action of the nation's bumbling central bank can evoke such enthusiasm.
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      Introduction

    On March 20th, I issued an unequivocal sell recommendation on stocks. If you wish, you may categorize the missive at hand as an unequivocal reaffirmation of the March 20th recommendation.

    After the close yesterday, I posted the following on the GRA website:

        "Can +195 points on the DJIA be a bearish development?  I think it can, and I will do my best overnight to explain why. I was hoping to use the time to catch up on some other research material, but something like today, occurring when it did and for the stated reasons, simply cannot pass without comment. The piece will be short, and I will try to have it out before the open tomorrow."  Here goes.
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    Several months ago, I observed that two of the three US financial, markets -- debt and currency -- might very well have tougher sledding in a climate in which there was uncertainty about what the Fed was going to do on a forward basis, versus the one we've been in.  The climate we've been in has been one of relatively high certainty about the succession of rate hikes that commenced in June 2004.

    At the time, the above view was expressed in response to what was yet another attempt, albeit another premature attempt, by Wall Street bulls to promote into higher stock prices "the Fed is almost finished" mantra.  Yesterday, the bulls believe they finally got what they've been so arduously hoping for.  In the process, they may also wind up getting some fallout for which they had not been hoping nor will they especially enjoy.

   What they did want and get came in the minutes of the FOMC's March policy meeting, released yesterday afternoon.  Here's what put the Street into such an orgasmic mood:

        "In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 4.75 percent at this meeting... Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy."

    The bullish camp placed inordinate emphasis on the above passage. Inordinate in that there was plenty of other material you easily could construe as being in conflict with it.  A major portion of the minutes appears in the excerpt at the conclusion of this missive, but I implore people to read the document in its entire context, which can be done at:

    Now that the Federal Reserve has wended its way through a succession of 15 rate increases over almost the last two years, I think there is a growing list of criticisms you can lodge against how this was handled and what it has accomplished.  Start with the fact the Federal Funds Rate never should have been taken to a trough of 1% to begin with.  How that came about and what took place afterwards can be laid squarely on the shoulders of Alan Greenspan and his practice of end-justifies-means leadership.  This variety of governance has now infected and corrupted, at least on an intellectual level, most of Washington.  In my view, it poses a huge threat to the well-being of the Republic!

    And has the 375 basis points in a higher Federal Funds Rate really accomplished much more than simply making everyone's cost of money a good deal more expensive?  Using money measures M2 and M3 as guides, we have more expensive money with no serious contraction in its availability:

                   Year-Over-Year Growth
         Money     ----------------------
        Measure    2/2006  2/2005  2/2004
        ---------------------------------
           M2       4.7%    5.3%    4.5%
           M3       8.0%    5.0%    4.3%
        ---------------------------------

    Of course, in the Greenspan/Bernanke New World Order of Fed governance, we are no longer allowed to have M3.  Do you think the above numbers might have anything to do with the real reason why?  (The "official" reasons provided by the Fed were moronic nonsense!)

    M3 is the broader, far better gauge of liquidity creation.  If you were the Fed and wanted to foster long-term trendline growth of around 3.5%, give or take, in real gross domestic product, there is no way you would be permitting M3 to grow at 8%.  Unless, of course, your motives were different than the ones publicly stated.  (A fibbing Fed? -- perish the thought!)

    And something else that bothers me -- a lot -- is that a variety of Federal Reserve communications strongly suggest that a majority of the FOMC's members are making monetary policy on the basis of actually believing the government's shoddy data, the inflation data in particular.

    Expanding and amplifying on this laundry list of criticisms is a task for another time.  What I want to emphasize here is that Federal Reserve monetary policy of years standing has created such a mess that an intended result in one area presents the major risk of unintended consequences in others.  And now that the central bank clearly is signaling its desire to throttle back on rate increases, the likely unintended consequences, at least in my opinion, will be seen in the behavior of the dollar's exchange-rate value and of open-market, longer-dated interest rates.  In my view, the behavior, on balance, will be of the negative variety.  (The possible policy shift that has been signaled is not likely to hurt the rise in prices of many commodities, though.) 

    As to the dollar and bond prices, the negative behavior already has begun!  Using the Dollar Index as a proxy, it is very close to making a multi-month low.  As to long-term interest rates, between February 9th and last Friday, the yield on the Treasury 4.50s of 2/15/2036 rose from 4.53% to 5.11%, representing a loss almost 8.9% of this issue's principal value.

    On the other hand, yesterday's release of FOMC minutes certainly gave the Fed what it wanted in stock prices.  And, yes, the Fed cares very, very much about the stock market.  Despite public protestations to the contrary, it certainly seizes on appropriate opportunities to "help" the market when possible. At a time stocks were in growing trouble, yesterday was one such opportunity, with advance billing in last week's Wall Street Journal article authored by Greg Ip.  (Leaking inside information is OK if you are a Fed official?)

    However, as it relates to the stock market and as the summary section of this missive opines, I think yesterday's rally, along with its probable follow-through into at least a portion of today if not a bit beyond, merely represents "an absolutely wonderful gift for people who have been dragging their feet in raising cash!"
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      FOMC Minutes Excerpt

        "...Meeting participants saw both upside and downside risks to their outlook for expansion around the rate of growth of the economy's potential.  In the housing market, for instance, some downshift from the rapid price increases and strong activity of recent years seemed to be underway, but the magnitude of the adjustment and its effects on household spending were hard to predict.  Some participants cited stronger growth abroad and robust nonresidential investment spending as potentially contributing more to activity than expected.  It was also noted that an abrupt rise in long-term interest rates, reflecting, for example, a reversion of currently low term premiums to more typical levels, could weigh on both household and business spending.

        "Several participants noted that the labor market had continued to strengthen, with payrolls increasing at a solid pace.  The labor market was now showing some signs of tightness, consistent with a relatively low jobless rate.  There were anecdotal reports of shortages of skilled labor in a few sectors, such as health care, technology, and finance.  Still, participants expressed uncertainty about how much slack remained.  Pressures on unit labor costs appeared contained, despite rising health-care costs, amid continued robust productivity growth and still-moderate increases in several comprehensive measures of compensation growth.

        "In their discussion of prices, participants indicated that data over the intermeeting period, including measures of inflation expectations, suggested that underlying inflation was not in the process of moving higher.  Crude oil prices, though volatile, had not risen appreciably in recent months on balance, and a flattening in energy prices was beginning to damp headline inflation.  In addition, core consumer inflation was flat or even a bit lower by some measures. Some meeting participants expressed surprise at how little of the previous rise in energy prices appeared to have passed through into core inflation measures.  However, with energy prices remaining high, and prices of some other commodities continuing to rise, the risk of at least a temporary impact on core inflation remained a concern.

        "Participants noted that there were as yet few signs that any tightness in product and labor markets was adding to inflation pressures. To date, unit labor costs were not placing pressure on inflation, and high profit margins left firms a considerable buffer to absorb cost increases.  Moreover, actual and potential competition from abroad could be restraining cost and price pressures, though participants exchanged views on the extent to which conditions in foreign markets might be constraining prices domestically.  However, participants observed that there was a risk that continuing increases in resource utilization could add to inflationary pressures. Some participants held that core inflation and inflation expectations were already toward the upper end of the range that they viewed as consistent with price stability, making them particularly vigilant about upside risks to inflation, especially given how costly it might be to bring inflation expectations back down if they were to rise.

        "In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 4.75 percent at this meeting.  The economy seemed to be on track to grow near a sustainable pace with core inflation remaining close to recent readings against a backdrop of financial conditions embodying an expectation of some tightening.  Since the available indicators showed that the economy could well be producing in the neighborhood of its sustainable potential and that aggregate demand remained strong, keeping rates unchanged would run an unacceptable risk of rising inflation.  Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy.  However, members also recognized that in current circumstances, checking upside risks to inflation was important to sustaining good economic performance. The need for further policy firming would be determined by the implications of incoming information for future activity and inflation.

        "With regard to the Committee's announcement to be released after the meeting, members expressed some difference in views about the appropriate level of detail to include in the statement.  In the end, they concurred that the statement should note that economic growth had rebounded in the current quarter but that it appeared likely to moderate to a more sustainable pace in coming quarters.  Policymakers agreed that the announcement should also highlight the favorable outlook for inflation and summarize their reasons for that assessment, but that it should reiterate that possible increases in resource utilization, along with elevated levels of commodity and energy prices, had the potential to add to inflation pressures.  Changes in the sentence on the balance of risks to the Committee's objectives were discussed.  Several members were concerned that market participants might not fully appreciate the extent to which future policy action will depend on incoming economic data, especially when an end to the tightening process seems likely to be near. Some members expressed concern that retention of the phrase 'some further policy firming may be needed to keep the risks... roughly in balance' could be misconstrued as suggesting that the Committee thought that several further tightening steps were likely to be necessary. Nonetheless, all concurred that the current risk assessment could be retained at this meeting.

        "...At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

        "'The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4.75 percent.'
The vote encompassed approval of the paragraph below for inclusion in the statement to be released shortly after the meeting:

        "'The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.  In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.'

        "Votes for this action: Messrs. Bernanke and Geithner, Ms. Bies, Messrs. Guynn, Kohn, Kroszner, Lacker, and Olson, Ms. Pianalto, Mr. Warsh, and Ms.Yellen.

        "Vote against this action: None.

        "The meeting adjourned at 12:15 p.m."