Vous êtes sur la page 1sur 12

VOLUME   1.10 1.

SEPTEMBER 16, 2009 

The Fed’s Dilemma:

When to Tighten?

The rally in U.S. equity markets since The essential dilemma faced by the

March 2009 has been remarkably strong and Federal Reserve is balancing weakness in U.S.

steady, particularly given that growth has been housing and employment against emerging

driven by a set of unsustainable factors: bubbles in commodities and stocks. In

restocking, fiscal stimulus and quantitative recognition of this dilemma, the Fed has

easing. Even optimists are having a hard time recently started talking up their exit strategy.

arguing that pent-up demand will cause a In our view, the Fed’s talk will not translate

return to sustainable pre-crisis growth rates in into significantly higher interest rates as the

the near future. China’s dramatic equity recovery is much more fragile than the markets

market correction last month (chart on p. 9) seem to be predicting. In particular, the

resulted from the realization that stimulus and housing market remains vulnerable. We

easy credit are not a recipe for sustained believe that montary policy will largely be

growth (see our August 11 letter entitled dictated by ongoing weakness in the housing

China’s Reflation Experiment). Conditions in market and persistently high unemployment.

U.S. equity markets are setting up for a Tightening before these two problems are

potential correction. under control would court political disaster.

currency for financing global risk assets as
people like to borrow at low rates in a weak
Prices in major cities turned up in the
currency. Consequently, as long as the Fed
2 quarter of 2009 after two and a half years
must prop up the housing market, the world
of steady decline. The geographically
will be awash in liquidity.
unconstrained Western and Sunbelt markets
are still off nearly 50% from the peak in 2006,

while the Eastern coastal markets are down a

more modest 15-20% (Chart 1). The

inventory of new homes for sale has declined

well below pre-bubble levels and improving

sales volume has brought down the inventory

of existing homes by 10% from the peak in

early 2008 (Chart 2).

The problem for the Federal Reserve is

that rising delinquency rates driven by

unemployment, negative home equity, and the

forced deleveraging of real estate speculators CHART 3

will continue for at least another year or two

(Chart 3). Meanwhile, emerging markets are

showing robust growth, commodity prices

have moved way up and global stock markets

are on a tear (See charts on p. 9-10). The U.S.

dollar is replacing the Yen as the favorite

WWW.BOECKHINVESTMENTLETTER.COM                                                                        2
The implications of this view are:

1. We continue to be in the sweet spot for


2. Commodities remain a likely beneficiary

of excess liquidity, although we are

concerned about a near-term pullback (see

Near term, we expect a substantial
correction in commodity prices. China’s
3. Given the success of policy in stabilizing
purchases for stockpiling are slowing down
the housing market and the expectation of
rapidly, as reflected in the 40% decline in the
virtually unlimited government support for
Baltic Dry Index (Chart 4), a measure of global
the sector, downside risk in the residential
demand for bulk shipping capacity. With very
sector is limited. Investors should have a
little growth in industrial demand, commodity
look at the attractive yields available in
prices are riding on a cushion of speculative
REIT’s and position for a recovery in
housing prices in 2-3 years.
While it is true that the unprecedented

Commodities scale of quantitative easing threatens to erode

Investing in commodities as an purchasing power of key currencies, the timing

inflation hedge has been a widespread theme is far from certain. Near term, rising

over the last nine months. Gold bullion unemployment and spare capacity will

recently topped U.S. $1,000 for the third time maintain deflationary pressure that will more

in a year.

WWW.BOECKHINVESTMENTLETTER.COM                                                                        3
than offset the effects of loose monetary the global slowdown. Many deals are getting

policy. done which are opening up vast new sources of

supply. In addition, technological innovation

Another key factor is that the Fed’s
and substitution always accelerate after major
relative success in stabilizing the economy
price spikes.
shows that their interventions are gaining

traction. Consequently, the likelihood of the The bottom line is that supply shortages

Fed being forced into the type of extreme are a short-term phenomenon. In the long-run,

measures that would truly ignite a dollar crisis supply can expand virtually without limit.

has greatly diminished over the last few Apart from wars, history tells us that

months. Betting on a significant pickup in commodities have only ever out-performed

inflation in the next year or two is becoming an equities for short periods; the 1970s due to

increasingly risky play. inflation, and in 2000-2008 due to the rapid

expansion of demand from emerging markets.

On the supply side, the specter of
With the arguments for inflation hedging
looming shortages that drove the spike in
waning, weak industrial demand and new
commodities in mid-2008 has faded. Many
sources of supply opening up, commodities
previously closed emerging markets have
should provide relatively poor returns over the
begun to open up to foreign resource company
next few years.
development as their revenue declined due to

WWW.BOECKHINVESTMENTLETTER.COM                                                                        4

WWW.BOECKHINVESTMENTLETTER.COM                                                                        5
Investment Conclusions CHART 6

Financial conditions remain positive for

North American equities. The yield curve (the

spread between 10-year Treasuries and the T-

bill rate, see chart on p. 12) remains close to a

record high. Having narrowed dramatically,

credit spreads are stable. However, longer

spite of clear evidence of economic recovery.
maturities still have some way to go before
As discussed earlier, the initial recovery may
reaching normal levels; business loans in the
be robust but longer term prospects are not
banking system are still being liquidated at a
likely to be. Financial fragility prevails, the
prodigious 25% annual rate (see Chart 6). Core
world remains very deflationary and the U.S.
inflation is still declining gently and will
housing market, like motherhood, is sacred.
continue to do so.
Obama would surely be a one-term President if

Federal Reserve talk of an exit strategy the Fed knocked the underpinnings out of the

is jargon for raising interest rates. It is nascent housing recovery.

primarily designed to calm bond and stock

The stock market is still in the bullish
markets and particularly foreign holders of
zone of rapid liquidity expansion and falling
dollars who fear that U.S. monetary profligacy
inflation combined with expectations of
and massive fiscal deficits will ultimately lead
economic recovery. However, we must keep in
to a dollar crisis.
mind that the S&P 500 is up 50% from its

Investors should view Fed talking as panic lows in March. Consolidation or even a

just that. Raising interest rates is premature in good correction could easily develop in the

WWW.BOECKHINVESTMENTLETTER.COM                                                                        6
September-November period, a time which has The U.S. dollar has continued to slide

seen more than its fair share of pullbacks. in recent weeks but still remains well above its

However, the trend is up; we are in a new bull pre-Lehman level. We expect only a gradual

market. Fears of over-valuation are deterioration of the dollar, as central banks will

exaggerated. The rapid resurgence of M&A step in to limit the fall. In a deflationary world,

activity (e.g: Kraft/Cadbury Schweppes, Rio no one wants their currency to go up against

Tinto/Chinalco, Pfitzer/Wyeth, Oracle/Sun) at the dollar. Countries like China will hold their

significant premiums at this early stage of nose and continue to buy dollars.

market recovery signifies that insiders with Commodity currencies like the
deep pockets are not afraid to put big money Canadian and Australian dollars have
into assets they see as cheap and strategically experienced sharp increases against the U.S.
attractive. This is not the sort of reckless M&A and this is making their governments quite
activity we normally see at the top of the nervous. The Bank of Canada has already
market driven by bankers with money to burn. stepped in to cool the rise; another example of

We continue to favor corporate bonds. countries trying to resist the U.S. dollar

There is unlikely to be any significant rise in decline.

treasury yields, hence credit spreads which are As reasoned above, commodity prices
still too high should narrow with corporate are vulnerable to a correction. The rise from
yields falling. Those with expertise and some the March lows has been underpinned in large
degree of bravery should reach out a bit in part by financial demand and that could easily
terms of risk. High-yield bond spreads at close go into reverse.
to 900 basis points are attractive relative to the
Gold’s rise is an example of investment
driven demand. No one can predict how far

WWW.BOECKHINVESTMENTLETTER.COM                                                                        7
such demand could take it in the short term,

but it is not the same as demand coming from

end use, mainly jewelry. That demand has been

depressed and scrap sales have been high.

Investors have been doing all the lifting. In a

world of falling inflation, high unemployment,

a stable U.S. dollar (for awhile) and a possible

commodity correction ahead, gold is by no

means a safe bet. A significant break above

$1,000 per ounce would no doubt trigger an

orgy of buying, but the sustainability of a big

rise would be quite another thing.

Tony & Rob Boeckh

September 16, 2009

*All charts from IHS/Global Insights, and may

not be reproduced without written consent.

WWW.BOECKHINVESTMENTLETTER.COM                                                                        8

WWW.BOECKHINVESTMENTLETTER.COM                                                                        9

WWW.BOECKHINVESTMENTLETTER.COM                                                                        10

WWW.BOECKHINVESTMENTLETTER.COM                                                                        11

WWW.BOECKHINVESTMENTLETTER.COM                                                                        12