Even Fed Half Pointers Won’t Be Enough

I can’t come up with Chairman Powell’s first name. Maybe the country gets what it deserves: An unaggressive FRB with a President who flexes his muscles, daily. 

Remember, this is the President who struck out in the gaming business because his eyes were too big. His Atlantic City casino couldn’t cover overhead and melted down.  

As a player with over 60 years of buys and sells, I grew to fear FRB chairmen and then hated them when they flexed muscles and tightened credit irrepressibly.

My rogue’s gallery of Fed Chairmen is pretty extensive, going back 60-odd years into the late fifties when I commanded about $10,000 in equity capital. 

Consider:  Early sixties, utilities sold at 30 times earnings. A 9 figure portfolio with under 10% in utilities was unthinkable. Analysts carried long slide rules and felt secure. Yet, step by step, paper values got cut in half over 10 years. Utilities rapidly lost bond ratings. Interest rates surged from 4% to 9%, even for Big Telephone in 1970. 

Nobody remembers much about this disjointed period. Arthur Schlesinger once said after he left the White House that one of the sidelights was that he could never again believe everything he read in the newspaper. 

During 1973-’74 the conceptual framework for the market was torn apart. Earnings power had collapsed. No FRB action could counter the deep recession. Note valuation destruction for prime growthies over 12 months in 1973-’74. Polaroid ended at 12 times earnings, down from 78. McDonalds was destroyed, along with Coca-Cola and Xerox. Could we see a repeat? 

How many economists work at the FRB? We are not talking a handful, but well into the hundreds. Endless committees explore countless economic variables. 

Imagine chairman Powell taking interest rates up to 12% or even higher, if the country was out of control on expectations of inflation. In other words, the 1980s period repeats itself. Our President propels inflationary forces by government spending and runs huge budget deficits. 

Everyone’s scared. 

Decades ago, when Martin Feldstein, chairman of the Council of Economic Advisors, pointed to the national debt, he was told to shut up by Treasury Secretary Regan or be right somewhere else. The country wrestled with  rising wholesale prices for more than a decade. It could happen again. 

Nobody but economists talk about the burden of interest rates on the national debt. It's bound to go up relative to GDP and become a deflationary force for the country. 

Trump in short is the Trojan Horse bound to depress our country. Politics invariably leads economics. 

The impact on price-earnings ratios or yields on long term Treasuries is written into our financial history. With long term Treasuries yielding 4.92% presently, we are talking about a price-earnings ratio of about 15 for the S&P 500 Index. 

Viscerally, after digesting all the numbers, I feel mid-teens is as high as the market should sell at. Admittedly, the U.S. isn’t out of control like in the 1980s. Then, Fed Funds rates stuck over 10% for a couple of years. 

My conclusion is the S&P 500 Index, alone, is no longer or able to capture what’s going on with equities. The Index is pricey and conceptually should be easy to beat, but it's not happening. Clients should demand more from 

their money managers in performance measurement to include a percentage weighting in the NASDAQ 100 or at least the NASDAQ Composite Index. A 25% weighting seems appropriate, maybe more. 

Such an addition would compel money managers to carry more aggressive stock weightings, up or down, and react faster to changes in information at the margin. We could see all this next decade. 

Linear extrapolation, what economists do leads to the worst kind of forecasting. It never catches turning points. Anticipating changes at the margin is part of the art of money management. The International Monetary Fund found its forecasting errors were so great as to make them practically useless for suggesting new policy initiatives. Staff economists blamed a world rich in geopolitical and economic upheaval. Sort of what we’ve got today. Missing GDP growth by 1% on a 3% base is a 33% miss, not a 1 percent miss. 

Everyone flubbed the call on the 1982 recession which proved deep and harsh. Fed chairmen like Paul Volcker were determined to rid the country of its inflationary expectations. Volcker took interest rates up to 13% and won the battle. I was borrowing deal money at 9% and finally threw in the towel. If a FRB chairman wants a recession, he’ll make it happen. You can’t beat him when he holds the cards. 

Looking at FRB policy emphasis today. I have to say that chairman Powell would prefer to sit with his hands in his pockets. Not about to do anything earthshaking. If he’s dealing with quarter and half point easements, the market shouldn’t react because such action won’t really impact the economic setting.

Am I the only one who remembers in 2009, the U.S. Treasury and FRB saved Citigroup. The market touched down at book value, yielded 5%, selling at 14 times depressed earnings power. Nobody blew a whistle then and said “BUY”.