Friday, March 21, 2014

The Waiting Wall

From our friends at the Wall Street Journal:

"Is this a recipe for another period of financial excess or runaway inflation? Not necessarily. Real short-term borrowing rates also were negative for most of the 1940s. Some analysts say World War II jolted the U.S. out of Depression. That might be the case, but cheap credit also helped.
This little history sums up Fed Chairwoman Janet Yellen’s challenge. The Fed is effectively betting it’s replaying a financial history that looks more like the 1940s than the 1970s or 2000s. If officials are wrong in that diagnosis, the consequences could be rather unpleasant."


As much as it makes us uncomfortable sharing a picnic bench with the Fed, from our perspective (see Here & Here) they're looking at the right parallel. To that point, we recognize that it is this visceral and underlying cynicism/disdain of the Fed's quite visible hand which will likely provide the counterintuitive market dynamics we described in our previous notes on the 40's.    
Another Fed meeting, another taper - and another wail with dramatic pause from the participant and pundit peanut gallery. Our general take is that despite the immediate reaction by the market and extrapolation of near-term rate hikes on the horizon, the truth is the sentiment picture towards and drawn by the Fed will likely change swiftly when the ebullient character in our own domestic markets turn down. From our perspective that seems increasingly likely as the Fed pivots further away from their extraordinary monetary support.  

You'll notice that although the Fed helped smooth the business and market cycle during the 1940's, by the time the Fed started walking back its purchases at the beginning of 1947, the bloom had already come off the rose in the equity markets. It was during this time period that the zeitgeist saw a return to the economic hardships of the Great Depression, which bolstered Treasuries despite the fact that inflation was beginning to find traction in the system. 

Although the timeframes are different (4/42-4/46 & 3/09-3/14) between the two SPX series, when you factor in the pauses the Fed made in their LSAPs this time around the block, the comparison is much closer.

While the performance of long-term Treasuries and equities since the initial taper have been similar, our outlook continues to be more favorable for Treasuries going forward.