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Federal Reserve Bedeviled By Naïve Forecasting

This article is more than 9 years old.

Economists term the assumption that nothing changes as the naïve forecast, but it's what we have from the Federal Reserve Board currently. Invariably, when the market flirts near new high ground, death doctors surface and spout the good times can't possibly last.

A bunch of market letter writers, traders and gold bugs expected the sequester syndrome to crunch GDP during 2012. Now the bears play the China card, but GDP there still ticks above 7%. For 2013, nobody dared publish a forecast that the S&P 500 Index would take out its old highs set in 2000 and 2007. But, the year ended with a burst of animal spirits, the fifth best out of 50. The W formation finally, was breached.

Meantime, the Fed seems visibly uneasy about overstaying their easy money construct, but first needs more confirmation of a reaccelerating economic setting. Employment numbers aren't good enough and GDP was beaten up by the frigid winter of 2013 – ‘14.

The FRB prays daily for inflation, reflation – anything but deflation which they believe inhibits spending by consumers and industry. I'm not so sure. Paul Volcker and McChesney Martin saw inflation under every rock and punished the financial world unmercifully with double-digit interest rates and high margin settings. The Fed always wins. It has more money than you and me.

Many academic economists expected consumers to tap out in 2014, but did they weigh the surge in family net worth, now exceeding its pre-meltdown peak? Spring car sales are buoyant, confirming consumers are ready to take on debt for big ticket purchases at low interest rates. This is what Bernanke wanted to see along with the recovery in housing. Janet Yellen talks the talk as well.

What's missing from GDP is capital goods spending and a resurging home construction sector. Both are overdue in a low interest rate environment. Could this be the big surprise for the Fed and financial markets?

Meanwhile, the bond market scrutinizes every last comma in the Open Market Committee's notes. Nobody's ready to discount the end of easy money. Scarcely noted, high yield bonds and preferred stocks go gangbusters, this sector up over 7% year-to-date.

Chances are the Fed is going to be wrong again and miss the inflection point in the economy. I see it coming sooner rather than later. I may have to eat these words because the world surely is combustible everywhere you look. All hemispheres contain tinder boxes.

The consumer carries the wherewithal to power GDP, with personal consumption expenditures at 70% of GDP and the savings rate headed towards zero. Brokerage houses catering to the public, Charles Schwab and TD Ameritrade, note a pronounced pickup in trading activity. The public finally is back, reducing money market commitments which earned zilch for so long.

Deal activity finally has surfaced after a long sleep. $100 billion overtures like Pfizer's and the hostile play for Allergan , as well as American Telephone’s interest in DirecTV are bunched together, signifying headmen at major corporations want to do more than buy back their own stock.

In my construct Fed Funds rise earlier than the Fed’s explicit timetable of mid-2015. I see money market rates getting to 2% earlier, but this is no tragedy. Not enough necessarily to queer the bond crowd or roil the Big Board.

If 10-year Treasuries reset at 3.5% and 30-year paper at 4.5%, within the context of the country’s financial history, these rates would be bargains. The S&P 500's mid-teens price-earnings ratio won't be shaded. Robert Shiller’s rearview mirror methodology of valuing the market won’t work next couple of years.

When Jerry Goodman (Adam Smith) was interviewing Alan Greenspan decades ago, he asked Greenspan if what he did was fun. Jerry, forever devilish and insouciant in his probing of big wigs had blindsided our oracle of mumbo-jumbo. Greenspan seemed nonplussed, kept his cool and responded "Well, fun is not exactly how I’d describe it."

Alas, central bankers don't talk like standup comics eviscerating politicians. In Euroland, Japan and at home their obtuse seriousness puts me to sleep. Honchos in Japan waxed too conservative for decades and nobody called them on the carpet. Euroland’s bankers long confronted with zero to 1% GDP momentum, still peer for inflation under every rock.

No major country has the gumption to implement serious infrastructure spending, and that includes us. It's what our country needs to put everyone back to work. Meantime, the FRB plays blind man and the elephant. Nobody’s sure what the economy is going to look like 12 months out.

The stock market turned wiser than the FRB. It sensed earnings momentum coming from prolonged high operating margins for major corporations, plus deal proliferation and a public with a fistful of Ben Franklins looking for action.

My thumb is down only to high priced Internet and cloud computer operators selling at sky high multiples of revenues and EBITDA. I'm allergic to stocks where the disparity between GAAP and non-GAAP earnings is wider than 10%. Analysts blithely pass this issue by, but nobody can give me a credible answer why except it’s good for investment banking business.

The intraday volatility of the Big Board is a mystery to me. Stocks like Gilead Sciences and Facebook can undulate 5%, Twitter over 10%. Meanwhile, the Fed’s biggest worry is deflation leads to stagnation. There's something wrong with this disparate picture.

I don’t recall a Federal Reserve Board that tried so hard to signal its intentions to the Street, thereby precluding a bond crowd mini-panic where interest rates rapidly reset. Right now, Fed watching is a boring waste of time.

Things are never what they seem to be on the surface. Our maximum leader, George Washington, normally is viewed mounted on his white horse. But one mount, Blueskin, was closer to grey and he was rubbed down at night with white paste to keep up appearances.

During the seventies, I remember Henry Kaufman, a Salomon Brothers partner, published his annual white paper on the supply and demand for funds, then bedrock research for projecting interest rates over the next 12 months. In those days, the Fed didn't telescope intentions so studiously. You did your own homework, anticipating what would be on their minds 12 months ahead.

Sadly, politics today leads economics.  There’s no consensus for serious infrastructure spending even though the budget deficit has shrunk markedly and is no longer a policy issue.

We’re in a good working market and I’m using up my open-to-buy.

Sosnoff owns personally and / or Atalanta Sosnoff Capital, LLC owns for clients the following investments cited in this commentary: Charles Schwab, TD Ameritrade, Pfizer, Gilead Sciences and Facebook.

mts@atalantasosnoff.com

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