BUBBLE, BUBBLE, TOIL AND TROUBLE?

With the Iran crisis continuing to bubble, oil prices mounting another run at $70 a barrel, and renewed anxiety on Wall Street about corporate earnings, you might think that the odds were fading for another round of Fed-induced interest-rate hikes. But the members of the National Association for Business Economics (NABE) think otherwise. The January NABE Industry Survey, released today, reflects expectations of “solid growth in the economy,” said Gene Huang, NABE member who in his day job is chief economist, FedEx Corporation, in a
press release.

Reviewing a copy of the entire survey obtained by CS reveals that the 142 NABE-member economists polled generally observe that industry demand for goods and services is rising. In fact, NABE’s net rising index–which measures the percent of respondents reporting rising demand minus the percent reporting falling demand– increased to 54 percent, the highest reading since the second quarter of 1997. No wonder then that the NABE survey finds that three out of five respondents predict inflation-adjusted gross domestic product will grow at an annual rate of three to four percent in the first half of 2006.
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Source: NABE


The question is whether the Fed is drinking from the same batch of dismal science Kool-Aid? Judging by current trading in Fed funds futures, the answer comes back a clear “yes.” The April ’06 Fed funds contract is priced for a yield of roughly 4.6%, a sizable premium over the 4.25% that now prevails as official policy at the central bank.
In simpler times, when there was just one telecom stock and state-of-the-art money management was run with a pencil and a legal pad, such a positive outlook for continued economic growth would cheer Wall Street. Alas, nothing’s quite so simple in 2006. Equity traders are as nervous as a cat in a room of rocking chairs, as witnessed by the S&P 500’s sharp fall of nearly 2% on Friday, a pullback that nearly wiped out the January rally that formerly graced the venerable stock-market index. Still, some are scratching their heads over what’s weighing on stocks at a time when economic growth is thought by many to be in no danger of evaporating any time soon. But worry not: as usual, there are plenty of gremlins lurking in the shadows to explain what ails confidence.
As noted above, the Iranian situation extends no shortage of potential for anxiety, largely as a geopolitical event that, in the worst-case scenario pushes oil prices into stratosphere, thereby taking the expected toll on corporate earnings. But a reading of the insular world of studying bull and bear markets also offers some excuses for staying cautious as well, according to analysis published on Friday by the money management shop of Comstock Partners:

A study of past bull and bear cycles indicates that cyclical peaks and troughs exhibit repetitive and consistent behavior that helps determine whether the stock market is closer to a top or a bottom. Market bottoms typically are accompanied by low valuations, highly negative investor sentiment and an easing monetary policy. By way of contrast, market peaks usually exhibit high valuations, positive investor sentiment and tightening monetary policy. In addition, by definition market peaks occur following substantial gains while bottoms occur after significant declines. In our view the current status of these factors strongly indicate that current market conditions are much more typical of a top than a bottom. Valuations are high, investor sentiment is positive, the Fed is tightening, and the market has risen significantly over the last three years.

Donald Luskin of TrendMacrolytics is also “uncomfortable” with the rally that formerly defined January trading before Friday’s selloff. Writing on January 20 in a note to clients, Luskin invoked a contrarian strain of thought by lamenting the fact that investor sentiment was recently quite strong. “In 77 years, there have been only a dozen in which the first four days of January performed better than this year — a fact that animated much non-fact in the media about the “January Indicator,” he observes.
Luskin’s “most disturbed,” however, by “the fact that more than all the gains year-to-date were made during those celebrated first four trading sessions. Those days coincided with a surge of confidence that the Fed would conclude its rate-hiking cycle with the January 31 FOMC meeting.” Yet in Luskin’s opinion, which seems to be gaining ground on the Street, the Fed’s tightening won’t conclude at the end of the month, a prediction supported by the renewed rise in oil prices, to name one smoking gun altering perceptions on monetary affairs at the moment.
If you’re looking for consistency, the best locale remains the worldview of bonds, where the 10-year Treasury yield continues to provide a counterpoint to predictions of higher rates on the short end of the yield curve. The 10-year’s 4.38%, as we write, is about the same level from late-December–or October, or the summer of 2004, for that matter. The message here is unchanged: economic slowdown and/or deflationary winds are coming.
The equity market may be swirling, the geopolitical scene reeling, and oil prices running. But at least you can still find consistency in the 10 year.