Who said anything about easing? That's what folks heard a week ago, or wanted to hear or expect to h...
Who said anything about easing? That's what folks heard a week ago, or wanted to hear or expect to hear in the near future, sending stocks and bonds soaring following the US's weak employment report for May.
No one disputes the fact that interest-rate sensitive sectors are slowing. But private-sector employers don't turn on a dime, hiring an average 257,000 folks a month in January through April and then dumping 116,000 of them in May. Considering the difficulty finding and retaining qualified help, it is nothing short of amazing that educated folks were willing to hang their hats on that one report.
"Jobs typically vanish at May's pace only during recessions," said Susan Hering, chief economist at Carr Futures in Chicago.
With the broad Wilshire 5000 down less than 1% year-to-date on the heels of heady gains in the previous five years - an average annual appreciation of 25% from 1995 through 1999 - "last week's rally sterilised May's 50 basis-point rate increase", says Jim Glassman, senior economist at Chase Securities.
Jumping the gun
Most economists presented a sober assessment in their weekly missives, pointing out the glaring disconnect between the May employment report and reality. A few, however, jumped in with both feet, proclaiming the end of Fed tightening and the dawn of a new bull market.
Bruce Steinberg, chief economist at Merrill Lynch, gave the Federal Reserve a long, summer break. "I think the Fed is done," Steinberg told clients in Hong Kong recently. Steinberg made a bullish prognostication on the stock market too, telling CNN's Moneyline last week that stocks have rallied on average 22% in years after the Fed stopped raising rates.
There was something wrong with Steinberg's assessment; an error of omission actually. While the end of a tightening cycle is a positive in the sense that it removes a big negative, what really gets stocks going is the stimulation of lower interest rates.
Night and day
In the last four cycles, easing has followed tightening within six months, according to Tim Hayes, global equity strategist at Ned Davis Research in Venice, Florida. That's because the Fed had to tighten aggressively to wring inflation out of the system.
In the extended tightening cycle that began in early 1987 and ended in February 1989, with a short interruption following the October 1987 stock market crash, the Fed started lowering interest rates in June of 1989. Similarly, the Fed instituted the last in a series of seven rate increases in February 1995, only to lower rates in July of that year.
One year after the 6 July rate cut, the Dow Jones Industrial average was up 40%. Similarly, one year after the last rate increase in February 1989, the Dow was up 14%.
The end of tightening must be good, right? History suggests there is nothing bullish per se about the end of a tightening cycle. It's the rate cuts that juice the stock market, Hayes says. Hays identified nine major tightening cycles going back to 1953. "In only two of them was there more than a year between end of tightening and start of easing," he says.
In 1953, the gap was less than 13 months while in 1969, it was 17 months. It was this latter example that produced the worst results for the stock market, with the Dow down 15% one year after the Fed called a halt in November 1970. "You need to have two rate cuts before stocks really take off," Hayes says.
It makes sense. The market needs to "count on more liquidity before it is driven higher," says Joe Liro, an economist at Stone & McCarthy Research Associates in Princeton, New Jersey. It is true that certain sectors, such as financial stocks, tend to lead the charge "with one or two tightenings left to go", Liro says.
The stock market's ebullience a week ago, with the Dow up 4.0% and the Nasdaq Composite Index up 19%, suggests investors think an economic slowdown comes without any effect to the bottom line. Profits and productivity tend to be procyclical - when the economy weakens, they do too.
Untapped cost savings?
Liro says that business executives are convinced they can maintain profits from the cost side. "They believe they have an infinite capacity to ring out costs," Liro reports.
Strange. Why aren't they doing it now? True profit-maximising companies are supposed to do just that, delivering bigger returns to shareholders in the process. The notion that executives can come up with productivity enhancements any time costs threaten to shrink their profit margins implies they aren't performing their fiduciary duty in general.
Right now, the suggestion of the end of Fed tightening is enough reason to rejoice, even though Steinberg's contention of its relevance to stock prices doesn't hold up.
This cycle has got to see its last rate increase. And as for any stimulation from rate cuts, short of an unforeseen event, it ain't happening this year.
Caroline Baum is a Bloomberg reporter
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