the Fed’s dilemma


From almost my first day in the stock market, domestic macroeconomic policy has been implemented by and large by the Federal Reserve.  Two reasons:  a theoretical argument that fiscal policy is subject to long lead times–that by the time Congress acts to stimulate the economy through increased spending, circumstances will have changed enough to warrant the opposite; and ( my view), until very recently neither Democrats nor Republicans have had coherent or relevant macroeconomic platforms.

If pressed, Wall Streeters would likely say that Washington has historically represented a net drag on the country’s economic performance of, say, 1% yearly, but that it was ok with financial markets if politicians didn’t do anything crazily negative–the Smoot-Hawley tariffs of 1930, for example.

During the Volcker years (1979-87), money policy was severely restrictive because the country was struggling to control runaway inflation spawned by misguided policy decisions of the 1970s (Mr. Nixon pressuring the Fed to keep policy too loose).  Since then, the stock market has operated under the belief that the Fed’s mandate also includes mitigating stock market losses by loosening policy, the so-called Greenspan, Bernanke and Yellen “puts.”

recent past

We’ve learned that monetary policy is not the miracle cure-all that we once thought.  We could have figured this out from Japan’s experience in the 1980s.  But the message came home in spectacular fashion domestically during the financial crisis last decade.  As rates go lower and policy loosens, lots of “extra” money starts sloshing around.   Fixed income managers gravitate toward increasingly arcane and illiquid markets.  In their eagerness to not be left out of the latest fad product, they begin to take on risks they really don’t understand as  well as to forego standard protective covenants.

We could almost hear the sigh of relief from the Fed as the tax bill of 2017, which reduced payments for the ultra-rich and brought the corporate tax rate down to about the world average, passed.  Because the bill was so stimulative, it gave the Fed the chance to raise rates as an offset, meaning it could tamp down the speculative fires.


Enter the Trump tariffs.

Two preliminaries:

–tariffs are taxes.  Strictly speaking, importers, not foreign suppliers (as the president maintains (could it be he actually believes this?)) pay them to customs officials.  But the importer tries to ease his pain by asking for price reductions from suppliers and for selling price increases from customers.  How this all settles out depends on who has market power.  In this case,it looks like virtually all the cost will be borne by domestic parties.  Domestic economic growth will slow.  The relevant stock market question is how much of the pain consumers will bear and how much will be concentrated in a reduction of import business profits.

–I think Mr. Trump is correct that the US subsidy of NATO is excessive.  It represents the situation at the end of WWII, when the US left standing–or at best the time when the USSR began to disintegrate into today’s Russia (whose GDP = Pennsylvania + Ohio, or California/2).  I also think that China, with a population five times ours and an economy 1.25x as big as the US (using PPP), is a more serious economic rival than we have seen in decades.  It doesn’t have the post-WWII sense of obligation to us that we have seen elsewhere.  So we have to rethink our relationship.

Having written that, I don’t see that Mr. Trump has even the vaguest clue about how the country should proceed, given these insights.

To my mind, tariffs + retaliation mean both domestic and foreign companies will be reluctant to locate new operations in the US.  Tariffs on Chinese handicrafts may bring industries of the past back to the US, at the same time they force China to increase emphasis on industries of the future.  I don’t get how either of these moves should be a US strategic goal….

the dilemma

The question for the Fed:  should it enable the president’s spate of shoot-yourself-in-the-foot tariff policies by lowering rates?  …or should it let the economy slide into recession, hoping this will jar Congress into action?


more oil production cuts announced

the news

Over the weekend, a group of non-OPEC oil producing countries, including Russia and Mexico, announced they will pare their collective crude oil output by 500,000 daily barrels.  About 60% of the total reduction will come from Russia.

On hearing that, Saudi Arabia said it would reduce its liftings by more than its already-promised 486,000 daily barrels.  The kingdom didn’t specify an amount, however–and the wording of its statement suggests the number will be small.

Nevertheless, the combined declarations have been enough to raise the price of oil in commodity trading by about 5% today, and 10% in total.

To put these figures into perspective, world crude production is around 98 million barrels per day.  So we’re talking about less than a 2% reduction in total output.

for oil producing countries

In one sense, the agreements have already been a financial success for the countries involved.  For most, they’ll reduce future output by, say, 2% and are already receiving 10% more for the 98% they are still selling.  That combination brings in 8% more dollars.

On the other hand, a $50+ price per barrel gives new life to shale oil producers in the US.  All to that that a fracking-friendly administration in Washington and the likelihood is that crude oil output from the US will begin to rise rapidly next year, offsetting at least some of the near-term output reductions now being achieved.

for investors

For us the situation is not so clear.

–Oil exploration and development companies in the US have already risen substantially on the original OPEC cutback announcement

–We’re also only about six weeks away from the beginning of the seasonally weakest part of the year for oil.  Crude oil bought in late January can’t be refined into heating oil and delivered to retail customers before the winter is over.  The driving season doesn’t begin in earnest until April.  So demand for the two principal refined products will be at a low ebb from January – March.  Soft demand usually translates into weaker crude prices.

–At some point, we’ll begin to see US crude output pickup

–The promised output cuts won’t take effect until the new year, so it’s impossible to find countries cheating on their output reduction pledges today.  The history of all commodity cartels tells us, however, that cheating will happen.  And if past is prologue, evidence of cheating will trigger a substantial price decline.

So we can reasonably expect a substantial bump in the crude-can-only-go-up-from-here road shortly.

Although I’m not doing anything at the moment, my reaction to all this is that I’m closer to being a seller of oil exploration firms than a buyer.  If I had a relatively large position (I don’t.  I only own one e&p stock), I’d be trimming it today, with an eye to possibly buying back in late January.





Brexit, sterling and the case for London stocks

the UK stock market

I started to learn about the UK stock market in 1986, a scarily long time ago, when I took over management of a failing global fund.  I realized pretty quickly, though, that despite similarity with the US in language and accounting standards, London stocks trade on complex signals that are far different in kind from those I was familiar with in New York.  I ultimately decided that the large effort required to become proficient would pay too small a reward to justify making it.  So I remain more or less an innocent (read:  the dumb money) in that market to this day.

12% cheaper

Nevertheless, the large drop (about 12%) in the value of the pound against the dollar suggests to me that there will ultimately be a big post-Leave-vote equity investing opportunity in the UK.  If the government follows through on its plans to cut the corporate tax rate from the current 20% to 15% (something the EU would have opposed) and lowers interest rates as well, the potential would be substantially larger.

Two reasons:


–Weak currencies most often mean strong stock markets.  The most striking example I can think of is Mexico in the 1980s.  Over that period, the peso lost 98% of its value against the US$.  Still, Mexican stocks were, in US$ terms, just about the best-performing in the world–outdoing the US stock market by a mile.

Three causes:  supportive economic policies by the Mexican government; currency decline gave Mexican exporters a powerful price advantage; and the currency collapse created substantial inflation, which prompted local investors to strongly prefer equities as a way of preserving the real value of their savings.

Yes, Mexico is an extreme, but stocks in the UK are now 12% cheaper in US dollars than they were a couple of weeks ago.  And the government appears to be preparing to implement significant economic stimulus.  So earnings prospects for many firms are substantially better.

currency markets lead the way

–currency fall typically comes in advance of stock market rise.  The lag may be months.  This is partly because the currency markets always seem to act far ahead of stocks and bonds.  It’s also because equity investors, particularly in Europe, want to see some evidence of earnings improvement–either actual results or management confirmation that the numbers are looking surprisingly good–before they are willing to act.


The big question, I think, is not whether London stocks, especially multinationals or exporters, will do well.  It’s when the fallout from the Brexit vote will have fully played itself out in financial markets.  Given that European investors typically take the month of August off, and that the start of this annual vacation period is only a few weeks away, my guess is that this won’t be until close to Labor Day.