Foolish Fed “Facts”
As I write this, Erin Burnett is leading a CNBC discussion about the possible strength of tomorrow’s employment report, especially given the strong forecast released yesterday by ADP. If it is a strong report, everyone will speculate about the likely implications for the next Fed meeting. We’ll probably see something like the following discussion of whether 25 basis points is enough of an increase:
"Why does this matter? Why do we focus on this? Because, once again, about 50% of the stocks in the S&P 500
will do worse with a rapid hike in the federal funds rate. Another 50%
— meaning all stocks — will be affected if the Fed panics and says
that we have an inflation problem. And if the Fed takes rates up huge,
you can have all of that Dow Chemical
dividend you want, I will take cash. In
other words, it matters tremendously. And that’s why, if we get a 50
beep increase off this number, then you can say that the earnings
estimates — the lifeblood of the market — are too high for 50% of the
market. Twenty-five? And we can make it up with good
business. I find myself constantly trying to explain why we talk about
these numbers so much. But the simple answer is that equities trade off
of rates and growth of earnings. When rates go too high, we don’t care
about the darned growth of earnings."
This comment represents how many people are thinking as the Fed ponders whether to take rates higher, and by how much. There is just one problem.
It was written two years ago.
That was before the current tightening cycle even started. When I first saw this, in June of 2004) written by one of the most visible and influential commentators, I could hardly believe my eyes. The Fed funds rate was at one percent. The Fed was about to embark on a long series of gradual increases until they reached "neutral" as they defined it. The effects of monetary policy changes lag by six to nine months. How could it possibly matter whether the first hike was 25 or 50 bps?
At about the same time CNBC interviewed a big fund manager (nearly $1 billion AUM) who was also asked about the size of the Fed move. He answered that they should try 50 bp because "they could take a look for a few weeks and cut it back if necessary." Once again I wondered, "What planet is he on?"
If these were isolated examples from random blogsters or something, it would not matter. The quoted authorities are both big-time, Harvard-educated, experienced fund managers, who get heavy TV exposure and speak with real authority. The average person takes it at face value.
And it is typical of much of the "research" during this time. I have correspondence from the research head of a financial service saying that there is a "nearly perfect correlation" between stock market returns and the direction of interest rates. I’d like to see that study.
There is a way to get good information about the Fed. I’ll explain in Part II of this Fed Series.