When Stock Markets Trump the Economy

Life in a centrally-managed stock market continues today as the Fed tries to influence market expectations. Overnight, it was ‘influential’ Fed board member William Dudley’s turn to tell markets to expect a rate rise in June. From Reuters:

The U.S. economy could be strong enough to warrant an interest rate increase in June or July, New York Federal Reserve President William Dudley said on Thursday, cementing Wall Street’s view that the Fed will tighten policy soon.

“We are on track to satisfy a lot of the conditions” for a rate increase, Dudley said. He added, though, that a key factor arguing for the Fed biding its time a little was the potential for market turmoil around Britain’s vote in late June about whether to leave the European Union.

There’s always an out, isn’t there? A weak piece of data, concerns about China…and now, the potential for Britain to leave the European Union!

It wasn’t that long ago that Dudley sang from a very different song sheet. Here’s a cnbc.com report from 1 March:

An influential Federal Reserve official on Tuesday said he sees downside risks to his U.S. economic outlook, an assessment that could flag a longer pause before the Fed’s next interest-rate hike than he and his colleagues had earlier signaled.

“At this moment, I judge that the balance of risks to my growth and inflation outlooks may be starting to tilt slightly to the downside,” New York Federal Reserve President William Dudley said in remarks prepared for delivery at a conference in Hangzhou, China sponsored jointly by the People’s Bank of China and the New York Fed.

So the US economy is getting stronger is it?

Then why in April did the ISM manufacturing index fall to its lowest level since 2009? During the first quarter, US economic growth was just 0.5%, the slowest growth rate in two years.

Since then, data has improved somewhat, so you’ll likely see an improvement on the first quarter, but it’s hardly a sign of strength. It’s just more evidence that the US economy is in a slow/low growth environment with no real prospect of a sustainable improvement towards higher growth.

Which brings us back to Dudley’s comments. My guess is that he is more interested in managing the stock market than the economy.

The S&P 500 was in the process of bouncing off the lows when Dudley spoke on 1 March. It opened that day at 1937 points. His dovish comments on interest rates saw the index soar 2.1% on the same day.

But the S&P 500 is around 2050 points now, up more than 13% from the lows of February. Much of that rally was due to the Fed pulling back on its interest rate increase rhetoric.

The Fed knows the market’s reaction is down to their communication, so they’re now trying to massage things back the other way.

The truth is that the Fed has no idea whether it will raise rates in June. They’re simply drip feeding information into the market to see how it will react. If the market falls too much on the expectation of a cut, it won’t happen.

It used to be that the economy drove financial markets…or that financial markets anticipated the direction of the economy. These days, you could argue strongly that the financial market drives the economy.

This is why the Fed is so intent on managing the stock market now. The economy is a secondary concern.

As pathetic as that sounds, it’s the reality we are in.

US markets reacted to Dudley’s comments overnight by falling about 0.5%. European stocks fared worse, while commodities were relatively stable. The Aussie market is holding up OK.

Gold stock, however, took a big hit yesterday. Many fell by more than 5% on the fear of another US rate rise. Or was it just profit taking after a stellar rent run?

The subject of gold is always a touchy one. People either love it or hate it. As a group, most analysts here at Port Phillip Publishing like gold. But it is not a company view. There is no company view.

I bring this up because I’ve had a few questions lately on the differing views between me and Jason Stevenson, editor of Resource Speculator, who writes for our sister publication, Money Morning.

Jason is bearish on gold. He reckons you’ll see new lows in the metal and in gold stocks. I’m bullish. I think the lows for this cycle are in.

Some people struggle with that. They question why we have opposing views at the same company.

The simple answer is that we have differing opinions. This is what makes a market. Our parent organisation is called Agora. Agora is an ancient Greek word for meeting place, or marketplace.

Our business is simply a marketplace for ideas. There is no line to push. We simply say what we believe in.

Who knows who is right or wrong? While the aim is to make profitable recommendations for our customers, the best way to do that is to think independently and not be influenced by the crowd. Your job is to judge each argument on its merits and decide what works for you.

So I applaud Jason for his bearish view on gold…even though I think he is wrong!

But I don’t know for certain that gold is going higher. Speaking of ancient Greeks, I’ll borrow Socrates’ philosophy. That is, the only thing I know is that I don’t know.

So I look to the market for instruction instead. In the case of gold, I look at the index of US gold stocks, known as the HUI. You can see the performance of the HUI over the past five years or so below:

Source: Market Analyst

[click to open in new window]

Here’s the important thing to consider. Over the course of the 2011–2016 bear market, gold stocks fell nearly 85%. This is on par with the fall in the Dow Jones index during the Great Depression. From 1929 to 1932, stocks fell 89%.

In other words, it doesn’t get much worse than the 2011–2016 gold stock bear market. Since bottoming in January this year, gold stocks rallied 137%! That’s a massive rally in a small timeframe.

It’s a powerful sign that the bottom is in. But you simply must get a correction after such a strong run.

I think that’s where we are in the cycle now. This is a correction at the start of a new upward cycle, not the start of a decline to new lows.

But hey, that’s just my opinion. I’ll take the Socratic escape route and admit that I don’t know. Let’s see what happens…


Greg Canavan,

For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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