Home > Uncategorized > 2012/04/25: Waitin’ on the Fed: Highlights and Headwinds… which will win out?

2012/04/25: Waitin’ on the Fed: Highlights and Headwinds… which will win out?

© 2012 ROHR International, Inc. All International rights reserved.

The FOMC rate decision and statement, Fed staff and member forecast revisions, and Chairman Bernanke’s press conference are alleged to be a major driver for the markets later today. Forget about it. It’s going to be more of the same, even if it is a supportive factor. It will be no surprise of the net focus will be continued improvement in US growth, even if at a slower pace than the Fed would like. More blame and derision will likely be (rightfully) heaped on the ineffective US administration and Congressional response to the problems in employment and housing. That is ultimately linked to the uncertain business environment regarding taxes, regulation and a bit of protectionism: Taxulationism(1) still rules. Yet, after all that only one thing matters…

There is still a ‘Bernanke Put’ ready to be implemented if necessary. There will almost certainly be a lack of any overt commitment to further immediate QE (quantitative easing.) That will be a disappointment to the aggressive bulls who would like to see the Fed continue to juice the economy and equities market (along with other risk assets.) However, that famous a cappella group Benny and the Doves are still singing the same tune: the Fed is prepared to step in if conditions should deteriorate. Voilà… the ‘Bernanke Put.’

And in spite of those two highlights, further central bank support may indeed be necessary at some point. It was most interesting that the equities Closed lower last Thursday in spite of 18 out of 18 corporate earnings announcements beating estimates. That was due to the increasing headwinds that are appearing from many macroeconomic quarters…

(1) Taxulationism © 2010 Alan Rohrbach & Jack Bouroudjian. All international rights reserved unless explicitly waived

…including economic data turning significantly worse at the end of the first quarter, the European Sovereign Debt Crisis rearing its ugly head once again, a less robust outlook for the tech sector, and (last but not least) the outlook for China.

And given its importance as a ‘tipping point’ for a global economy balancing between a very weak Europe and resilient US economy, it is important to cover the last bit first. While it has been apparent to avid students of the Chinese economy for a while, last week’s IMF World Economic Outlook included an interesting sub-report on China.

It noted that China’s falling trade surplus was tied into a tectonic shift in its national policy toward greater consumption. While this is something that the rest of the world was keen to see implemented, it will likely be a drag on the Chinese and global economy in the near-term. This is due to the need to establish a social safety net to encourage greater consumerism from previous heavy savings. This is a step away from the significant construction and capital goods economy to a more consumerist culture. And natural headwinds will occur.

Whatever else one may assume about the successful middle class in China, we know two things for certain: they are both shrewd and frugal. However much their government or anyone else would like to see them spend more on consumer goods, their natural high savings culture is not going to change in a heartbeat. That high savings rate is there for a reason: the previous lack of any government provided social safety net whatsoever. And they are not likely to significantly loosen the purse strings until they have some confidence in the new regime taking power later this year.

Even once that occurs, it will likely take some time to convince them that the new social safety net is financially robust and guaranteed under law. With due respect for the tremendous evolution that China has engineered, that last bit is still an area of concern both domestically and internationally. As such, the Chinese evolution into a more consumerist culture is going to take time. It is literally a generational shift.

As such, there will be a transition period. And that will not necessarily meet the rest of the world’s expectations for renewed aggressive Chinese economic growth typical of previous phases. There are many folks (including many we highly respect) who have been involved in China for many years who are expecting the recent deceleration of growth and inflation to bring an easing response from the Chinese government. Classically this takes the form of a loosening of the bank reserve requirements.

And in previous cycles that was enough to foment a return to strong growth. However, if the move toward investment in the social safety net (and away from capital goods and construction) is real, there is reason to doubt as much strength will ensue in the coming cycle. In other words, China is moving from being a major rapidly developing economy toward a more stabilized model. All fine and good. Yet not necessarily experiencing the same sort of growth is previous.

That was not just our impression upon reviewing reports of the IMF analysis. There was a very good China Challenge segment on CNBC earlier this week with Council on Foreign Relations president Richard Haass. He was joined by veteran China participant and observer (ex-US presidential candidate and Chinese ambassador) John Huntsman. They agreed with the conclusions we had already come to appreciate. Anecdotally, major heavy equipment supplier Caterpillar Inc. has noted that their lower first-quarter turnover in China was likely to become lower volumes there for the entire year.

European Sovereign Debt Crisis

And just when everyone thought the ECB’s Long Term Refinancing Operation (LTRO) was such a success as recently as a month ago, here we go again with ‘different’ problems in Europe. And this time it’s political, which over arches the financial side of the equation: it’s about the commitment to see any of the reform programs through.

And it’s not just about the French election results minor percentage victory for the Socialists under M. Hollande. As a client of ours quipped, “It’s more so about Holland than Hollande” referring to the Dutch government resignation over the inability to agree upon the amount of austerity rather than its necessity. That is indeed particularly troubling. It’s one thing for the profligates to exhibit continued aversion to reduced spending. But in this case is about one of the most fiscally responsible governments now needing months of additional time for an election before they complete their next round of otherwise readily achievable reforms.

That said, the immediate shock to the markets on Monday was equally about the degree to which a French move to the Left might signal the end of European fiscal and labor reforms. Not so fast. As we noted immediately on Monday, in light of the striking success of the Far Right in garnering close to 20% of the vote, the final decision remains a very fraught affair. However, that very factor is more likely than not to work to Nicolas Sarkozy’s benefit.

We know for certain that the folks who supported the National Front are most certainly not going to vote for Monsieur Hollande. The post-election polling already shows that somewhere around 50-60% of the right wing voters will grudgingly support President Sarkozy in the runoff. They are basically committed to preventing a Socialist victory even if not enthusiastic supporters of the center. As such, for all the talk of abandoning reforms and returning to profligate spending,

France is still far more likely to end up maintaining its commitment to the current crisis mitigation programs. However, it is yet to be seen if they can square the circle between the obvious need for fiscal reform, and austerity weighing upon the need for growth.

That is apparent again this week with the troubling news from Greece, and even the shift in sentiment from ECB head Draghi. As reported in a Financial Times article today the Bank of Greece has just announced that the economy will shrink for the fifth consecutive year by 5.0 % this year. That is against a previous estimate of 4.5% lower growth, and includes a rise in unemployment to 19.0% from 17.7% in 2011. However, many consider those relatively optimistic forecasts. Various private think tanks point out that even that rather abysmal outlook relies upon the economy being assisted by structural reforms; and in the context of a weakening global economy there is no guarantee that will occur.

And it is not just Greece that has a problem with austerity seeming to turn into a ‘debt trap’ of sorts. Consider the way that feeds into weakness throughout a Europe where the economic indicators have suddenly weakened even for previously resilient Germany and France. That doesn’t even begin to consider what might be happening and weak sisters Spain and Portugal. And most telling of all for the pan-European picture, even the previously confident Signore Draghi has dropped upbeat language in his most recent presentation to the European Parliament. According to another report in today’s Financial Times by the estimable Ralph Atkins, the ECB head cited “prevailing uncertainty” as opposed to his previous references to a gradual recovery this year.

All of this rejection of the “German model” of austerity first and foremost is not necessarily a surprise. Among quite a few other analysts, we had noted that extreme austerity into already very weak economies was likely to depress economic turnover. And that was going to be counterproductive to achieving the fiscal rebalancing that was its ostensible goal. As folks see the impact on Greece and other economies, it is not hard to imagine why they are rejecting extreme austerity as a singular plan.

However, there is one significant drawback to this renewed demand for a growth component to any reform program: nobody has figured out a mechanism to restore ‘growth’ while still respecting fiscal and monetary guidelines to restore ‘confidence’. It does not take a lot of imagination to consider what might happen if either fiscal tightening or employment reforms go by the wayside. The ensuing lack of confidence in the government bonds of those countries will push their yields up to levels that will de facto enforce economic restraint.

There is likely no amount of money the governments can spend to offset their cost of funds spiraling out of control. In fact, any sign that they will capriciously abandoned commitments to fiscal reform will most certainly encourage a spike in their borrowing costs. And having committed and subsequently abandoned such a program means it will be very hard to get the higher yield Genie back into the bottle. So while we agree that some measures to encourage more growth are constructive to the fiscal rebalancing effort, they must be finely tuned to respect the fiscal reform constraints.

Lower tech sector expectations

This is simple: after an intense round of competition for subscribers, the cellular phone networks have decided to tighten up the standards for upgrades to new phones. It’s all about degree to which Apple and its cohorts are going to benefit less from the carriers underwriting phone purchases. Of course, that’s most interesting in light of the totally over-the-top Apple earnings reported yesterday. Good for them; and they are likely to still be a cash generation machine on one level or another.

However, as it regards cellular phones and other Personal Digital Assistants that are used as promotional items by the various networks, growth in turnover is about to slow significantly. That is because those carriers are going to attempt to boost their profitability by extending the phone upgrade options back to a classical 18 months to 24 months from what had been a very competitive 12 month horizon. And that seems to be true across the full spectrum of carriers.

As such, look for lower new phone authorization rates for all cell phone manufacturers; and that relates back to demand for chips and other materials from the technical materials providers. Adding to this concern on the software side is what appears to be another convoluted rollout from Microsoft. They want to focus on their enterprise software for the next Windows operating system. So they are not just going to roll it out all at once for all devices (which will include PDAs as well as computers and tablets.) Here we go with another confusing, consumer unfriendly rollout from Microsoft. Never a good thing for hardware sales.

Economic data is deteriorating rapidly

In spite of the expectations raised by the excellent corporate earnings announcements for the first quarter, these are after all ‘rearview mirror’ indications. And even as it reflects on the end of the quarter, the recent releases for March are pretty abysmal. And that is not just for Europe that everyone expects to be suffering, but also for the US.

Weekly Initial Jobless Claims are climbing toward 400,000 once again after many were hoping they would drop below 350,000. US housing continues to be a significant problem, with weaker than expected figures for both Existing Home Sales and New Home Sales within the last week. And prices continue to slip as well, even if the degree seems to be moderating. Of course, the Advance European Purchasing Managers Indices were roundly abysmal at the top of this week.

Even if some weakness was expected, it was a shock to see the degree of slippage below 50.0 in German manufacturing. And various other indications everywhere from China right through Europe into Canada and the US are telling a different tale than the equities bulls would like to hear. That culminated in this morning’s US Durable Goods Orders. While some weakness was expected in the headline number due to lower turnover at aircraft giant Boeing, even the Ex-Transportation number was off by over 1.0% (versus a flat to slightly higher estimate.)

And that is what is so significant about the remaining important data into tomorrow and especially Friday. In the context of all this cheery earnings news yet abysmal economic data, we consider the FOMC decision and likely well-scripted Bernanke press conference today fairly nominal factors for the market trend into the end of the week. Especially Friday’s Bank of Japan interest rate decision statement, and economic data that spans everywhere from the Far East across Europe into the first look at US Q1 Gross Domestic Product are likely more important.


So against the multiple potential headwinds we have better-than-expected Q1 earnings and the ‘Bernanke Put’. It creates two significant problems for the aggressive equities bulls. The first is that the latter of those two will only be implemented once the economic situation and equity markets have deteriorated significantly.

The second is that the better-than-expected Q1 earnings are indeed impressive. Against estimates that were supposed to see only one percent growth in S&P 500 earnings overall, the reality is often between 4.0% and 5.0%. However, those are ‘rearview mirror’ indications from what was admittedly a strong quarter, yet that might have borrowed economic turnover from succeeding quarters due to the extremely mild winter in the US. On current form the economic data would tend to confirm that things were deteriorating again even as early as the end of Q1. We shall see.

General Market Observations and EXTENDED TREND IMPLICATIONS will be updated at length after today’s FOMC meeting and press conference to prepare for the further significant economic data and other news into the end of the week; especially Friday’s significant economic data from all around the world (see the Calendar section for more on that.) In the meantime, the technical projections remain much the same as previous, and can also still be readily accessed via the Current Rohr Technical Projections – Key Levels & Select Comments link near the top of the right-hand column.

Thanks for your interest.

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