Xavier's Thoughts on the Fed Minutes

I like simple things and explanations.  Maybe because I do not have a rocket science mind or because I am not into the theater of the absurd. In either case here is my humble thoughts on the Fed…although you all know very well my true thoughts.

I read the Fed’s minutes yesterday like many of you - well at least all you bond lovers. Still the same old stuff. Maybe-maybe dependent on conditions. I have long said that they would not raise rates, but if they do  it will be in June because September is too close to the American elections and, independent or not, the Fed is loath to raise hackles.

So what if we get one more bump for the year? It is not going to be a earth-shattering event, of that you can be certain. The hike will be small and manageable even if it is ill advised. It may come, it may not come, but, I assert, it will be overtaken by the actions of the other major central banks and the inflow of capital into American securities where some yield is still attainable even if it is paltry.

Thoughts On China Volatility

As most of you know –tough to miss considering that all the news is discussing it- the Chinese stock market took another dive last night. As a matter of fact the CSI 300 index plunged 7% and the market closed in under 30 minutes, which means that Erich did NOT get a good night sleep.

Part of the reason is that while the Chinese government is devaluing the yuan, they still have to spend money to buy yuan to control the fall. After all, devaluation is causing dramatic capital outflows already. The funny thing is that since 2011 the government has complained about an excess of foreign exchange reserves. However, we can all be certain that they do not want a feeding frenzy and a complete collapse of the yuan. The PBOC said back in 2011 that reserves exceeded a “reasonable” level when they were just over $3 trillion. The latest figures show them at $3.3 trillion, after peaking at almost $4 trillion. So, what is “reasonable”? I suspect that something under $3 trillion is the goal. What does this mean? More devaluation, more stock market volatility. And, the Japanese – I mean Abe- must be HATING this, as their currency has risen, because many investors in Asia rush to Japan when things look bleak in China.

Who needs Star Wars when we have Currency Wars.

PS. This is all to say that in today’s world the markets ALL revolve around central government actions. 

Slow and Steady Wins the Race

With the market anticipating a 25 basis point increase by the Federal Reserve in a couple of weeks, we thought that this graph would prove insightful. At Cutler, our view is that the reasons at this point for a rate increase are tenuous, and therefore we would anticipate a a slow rate cycle. In the past, this type of environment has been a positive for equities.

Markets Begin Acting Like Markets

 

When China announced a devaluation of the Yuan, it was indicative of a sickness that has been festering in the global equity markets. Growth has been anemic for several years, but equities have generally rallied. The primary contributor has been the generally low level of interest rates around the globe. Today, the Federal Funds rate sits at 0%, with the prospect of a 25 basis point increase before year end. This, coupled with uncertainty in China, is in our view the catalyst of the current market volatility.

Cutler has been advocating that a 10% market correction could be “just around the corner” for several years. This is a normal occurrence for equity markets, but one that hasn’t happened since 2011- over four years ago. Last October, stocks had just over a 9% correction. The culprit at the time? The end of quantitative easing. The end of QE III is a similar factor (monetary tightening) as the onset of 0.25% interest rates. The market will adjust, as it is currently, and ultimately the economy will move forward under these very accommodative policies. The Fed continues to be a stimulus; even with modestly higher rates, we are in a historically low rate environment.

What should investors do? As we advocated last year, ensure that you are in a diversified portfolio. At any given time, certain asset classes may underperform and look unattractive. However, when investments shift leadership, this change can take place very quickly. Timing the market is not a sustainable approach to investing, but understanding your portfolio risk will help you remain invested during times of turmoil. Give Cutler a call if you would like to talk about your portfolio risk at any time.

China Devaluation; Time to Panic?

On Monday evening, the People’s Bank of China lowered the currency peg to the US Dollar by 1.9%. This was followed by additional weakening on Tuesday night, with the two-day move the largest Yuan fluctuation since 1994. Given that China’s currency reserves have been depleted by over US$300 billion this year defending against the rise in the Dollar, this is not entirely surprising. The devaluation immediately makes Chinese exporters more competitive and Chinese assets cheaper in Dollar terms. What does it mean for the US stock market and US multi-nationals? The market reaction has been pronounced, but not severe. The negative response is based, in our view, on two developments: 1) The USD continues to rally, decreasing the value of overseas earnings and hurting competitiveness, and 2) China’s currency movement may portend greater economic weakness in the world’s 2^nd largest economy.

We feel that the latter of these concerns is the greater risk. For much of this century, the Chinese economy was the global engine for growth. This growth, while still in excess of 6%, has abated while simultaneously the US is at the onset of a rising rate environment. We believe that investors should recognize that the Chinese government is showing its determination to maintain growth, at any cost. Such determination may ultimately be successful and greater currency flexibility will allow stimulative monetary policy. Furthermore, the devaluation of the Yuan is deflationary, meaning that if the Federal Reserve was cautious about impending rate increases, they are more so now. We believe that a September rate hike is still the more likely scenario, but the Fed Statement will likely have strong language regarding the cautiousness with which the central bank will proceed.  A Fed fueled rally may still be in the cards.

Updated Commentary

There has definitely been lots to discuss in the financial markets this Summer. Greece and China have led the way, with both having rollercoaster new cycles. We have updated our commentary at www.cutler.com with our most recent market review. Please visit to hear our thoughts and contact us anytime!

Where is the US consumer?

Economic data continues to baffle economist and the Fed. One day we get positive data and the next we get the opposite. We look for “reasons to believe’ in every data point and possible miscalculations or a fallacy in the data collection, estimation, interpretation. In the end, we all know that the US economy depends on the consumer.

1.      The energy industry remains weak, as evidenced by May’s regional survey of business conditions conducted by the FRB-Dallas. Yet, oil prices have risen from the lows, leaving the consumer a bit hesitant about spending their ‘new found’ wealth. Gas prices, at least in VA are up over 20% from the lows. Clearly the price of oil is key to a consumer led recovery. Stability, though, is extremely important.

2.      May’s Chicago PMI was released on Friday. It was relatively weak. We now have six such surveys. The average of their composite indexes fell from 0.6 during April to -2.4 during May, the lowest since July 2009. The average of the orders and employment components was also weak in May. It still looks like a soft 2Q recovery based on the averages of these surveys.
3.      The American Trucking Association’s preliminary For-Hire Truck Tonnage Index, which is seasonally adjusted, fell 3.0% during April and it increased just 1.0% yoy, which was the smallest such gain since February 2013. Neither the weather nor potholes can be blamed for this slowdown, which seems to confirm the recent weakness in consumer spending.

4.      The Association of American Railroads that US railcar traffic was down 2.7% yoy for the week ending May 23, with carloads down 9.1% and intermodal units up 4.3%. The carloads picture is less desirable for those of us rooting for the US economy to come out of its soft patch. Of the eight major categories in this segment of rail traffic, six are trending lower. Bloomberg Economist Michael McDonough found that carloads of waste and scrap, which have been particularly low in recent weeks, are highly correlated and coincident with real GDP. Maybe the recent weakness in real GDP wasn’t just a bunch of seasonal adjustment garbage.

Let’s not kid ourselves, there is no major global economy that is booming. The only thing booming is central bank debt. And, by the way, the Fed bought a ton load of mortgages last week. Who cares if they even raise rates, they have a ‘truckload’ of interest and pay downs that they are reinvesting.