Comstock Partners, Inc.February 05, 2016
More Fed Criticism
We Are In Good Company
Last month’s commentary (which we also made a “special report”) was essentially a response to a financial reporter who asked us why we were so negative on the stock market in 2016 just because the Fed, more than likely, was going to raise rates. He stated that the stock market almost always rose during the previous rate increases. We explained the difference between the Fed tightening now, with enormous headwinds to overcome, relative to the times when the Fed raised rates in the past. We went on to also explain why the same headwinds to the Fed tightening would probably also cause a U.S. recession (and maybe even a global recession).
The prior comment was written in late December just after the Fed had raised the Fed Funds rate by 25 basis points. Before this past commentary very few people were warning about a recession, here or globally. However, now we are reading a lot about criticism of the Fed, and virtually everyone that appears on the financial networks seems to have a strong opinion about the probability of a U.S. or global recession. We have been critical of the Fed since the Greenspan days but seldom heard of anyone else criticizing the Fed or complaining about the ineptitude of the Fed. Now, however, after the stock market declined sharply in January, we seem to hear about these two areas of concern almost every day.
One well-reasoned recent criticism was a Wall Street Journal op-ed article by Martin Feldstein regarding the Fed on January 14th 2016. The title of the article was, “A Federal Reserve Oblivious to its Effect on Financial Markets”. We were struck at how closely this article mirrored everything we have been talking about for years. The synopsis of the article was in the second paragraph, “The overpriced share values are a direct result of the Federal Reserve’s quantitative easing (QE) policy. Beginning in November 2008 and running through October 2014, the Fed combined massive bond purchases with a commitment to keep short-term interest rates low as a way to hold down long-term interest rates. Chairman Ben Bernanke explained on several occasions that the Fed’s actions were intended to drive up asset prices, thereby increasing household wealth and consumer spending.“ The Federal Open Market Committee last month didn’t even mention the risk from persistent low rates. You can well deduce from the title of the article that Feldstein does not have much confidence in the Fed and FOMC in extricating the U.S. from the mess the Fed has put us in over the past 7 years.
Also, Bill Gross asked a sarcastic question of the central banks in his written piece for his clients yesterday. He asked, “How’s it Working for Ya?” central bankers. He then went on to criticize virtually every country that has been under the thumb of their central bank. We were happy to see that Bill Gross is on the same page as us.
Just recently, Rand Paul also criticized the Fed and the entire way our governmental system works. He stated that the U.S. spends over $600 bn. on the military in this country which compares to the top 10 countries spending on their military (including Russia, China, and the other top eight countries spending on the military). The right wing governmental forces want to spend more than $1 tn. more on the pentagon while the left wing wants to spend much more on the domestic side of our economy. Both get their way, and the taxpayers get stuck with the bill as we borrow $1 million a minute to support this and other spending. As we stated in our last comment, the total debt of the county exceeds $100 tn. if you include unfunded liabilities and promised entitlements. This debt is enormous relative to our $18 tn. economy. These numbers are the main reason our economy is growing so anemically.
We recently heard a radio interview with economist Lacy Hunt, whose point of view we very much agree with. The common theme here keeps coming back to what the Fed has done to the financial markets by essentially controlling the price of money rather than have the free market determine it. It has forced savers to chase return, which cannot be done without increased risk. And investors are not the only ones farther out on the risk curve than ever before. We see announcements almost every day about companies buying back their own stock, often with borrowed money. As Mr. Hunt pointed out in his interview, corporations are making financial investments in their own stock at very inflated levels instead of making capital investments in their businesses. This phenomenon does not bode well for future economic growth or for future stock market returns.We have been talking about the Fed and government deficit spending over the past 15 years. The Fed cannot expect to control the price of money and not have the economy and markets suffer adverse consequences. Continuing the rate increases risks further weakening of an already weak economy recovering at the slowest rate in history from the last recession. While a cessation or reversal of the rate rise has, on its own, potential to cause a panic as the markets realize that the economy is weak and not likely to recover before there is a bursting of what we and others have termed the “Central Bank Bubble”.