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“The extreme limit of wisdom, that’s what the public calls madness.” — Jean Cocteau
The Madness of It All
San Francisco Fed President John Williams warned against slowing the trajectory of intent on tightening monetary policy in the U.S. earlier this morning from Australia. Williams said: “Raising interest rates to bring monetary policy back to normal helps us keep the economy growing at a rate that can be sustained for a long time”. He added: “If we delay too long, the economy will eventually overheat.” Williams has been hawkish and his support for the central bank’s public stance is not surprising, but economic data have been inconsistent of late, particularly data on consumer inflation. Those decision makers at the Fed obviously believe that with full employment comes headline level inflation. The FOMC in aggregate appear to believe as a group that full employment in an economy comes after the official unemployment rate drops below 5%. Maybe that’s true for job fulfillment, but job fulfillment and the full employment of an economy are two very different things. Economics 101.
Hence, the problem. That concept for the uninitiated, is what is referred to as the Phillips Curve. There are reasons why the Phillips Curve has not unfolded in reality the way that it does in the textbooks. Those reasons seem obvious to traders and investors, but somehow not to our esteemed economists at the central bank. For one, the individual in this economy is not at full employment. Due to current healthcare laws, many hourly workers are held to less than 30 hours a week. Some of those folks are then forced into part-time positions, or multiple jobs. Many of these folks are working at income levels well below where they had been earlier in their lives, due to drops in national productivity levels or technological advance. My point is not to fight about healthcare or against progress here, just to point out that John or Jane Doe might be working their tail off, but they do not feel as though they are fully employed at the individual level. They are functioning below their potential, due to external forces. That hurts morale. Without a higher level of comfort or satisfaction at the individual level, Mr. and Ms. Doe are not going to open their wallets.
Then there’s commodity prices. Seen the price of oil lately? I bet you have. Usually, in periods of low unemployment and sustained economic growth, commodity prices rise, which supports headline level consumer inflation. Commodities in general have seen their priced contract this year — oil is just the leader — heading into a bear market very publicly last week. Anyone else notice headline CPI drop from a height of 2.7% year over year to where it is now, 1.8%? That should be your focus right there, and the Fed’s too. Obviously, this is a component ignored by their Phillips curve, yet crucial to the nation’s success in getting inflation back to target, and maintaining said target. A weaker dollar would help in this regard. The clearly announced intent to wrestle the balance sheet down, while continuing to raise the target for the fed funds rate is obviously supportive of a stronger dollar, and could be the one thing, if implemented congruently, that sparks the next recession.
Last week’s trade was exciting, and at times scary. The S&P 500 bumped its head on the 2,441 level seven times between Thursday and Friday. Oil rolled off a cliff. Several truly positive earnings results strayed in from the tech space. Think Adobe Systems (ADBE) , Red Hat (RHT) , and Oracle (ORCL) . Did last week’s moves halt a rotation? Was there ever really more than some profit taking among the front runners that others took as a nod that was not there? Those are tough questions to answer for those of us that have to try to answer them.
The truth is that last week, the top two performing sectors were information technology and healthcare. The health care sector was supported by the reform bill being negotiated around the U.S. Senate. Right? Right? Well, the top two sectors over the last 90 days are … tech and healthcare. How about year to date? Tech and healthcare. Five years back? Still, tech and healthcare. You can go even further back if you want, the story does not change all that much. Even more interesting, the two worst performing sectors over one week, 90 days, year to date, and five years out? Energy and telecom, at every checkpoint. Now, there is obviously some rotation within these sectors, as different industry groups themselves are hit with innovation, and/or react to policy changes (and expectations), but performance among sector groups has been remarkably consistent over a long stretch of time.
The healthcare bill is hot on everyone’s minds.