Monday, August 22, 2011

Gaming the Jackson Hole Economic Summit

Last week a certain presidential candidate, speaking about Federal Reserve Chairman Ben Bernanke, said, “….printing more money to play politics at this particular time in American history is almost treacherous – or treasonous in my opinion.” I don’t know if he meant it was almost treasonous, or it was actually treasonous, but either way the notion that current and future Fed policy is treasonous is ludicrous, in my opinion. The candidate also said that Bernanke would be “treated pretty ugly down in Texas.” I don’t know about Texas, but we do tend to spend a lot of our time thinking about Wall Street, where I can assure you, a lot of thought is being given to the possible tactics of the Fed Chairman. On August 26th at 10AM E.T. the Chairman will give his annual speech about the future prospects of the economy at the Economic Symposium of the Federal Reserve Bank of Kansas City, in Jackson Hole, Wyoming. The short-term fortunes of bullish and bearish investors will have much to do with what Chairman Bernanke has to say. Last year, at the Jackson Hole Symposium, Bernanke gave his speech on August 27th and strongly hinted at a new Federal Reserve program to expand the Fed’s balance sheet by buying bonds in the open market. While the Fed called this program “quantitative easing,” for many it amounted to simply printing money. So it is no accident that money printing…whether treasonous or not…is in the news.

There is much debate in economic circles about the effectiveness of the program, called QE2. It was announced during a period of time last summer when there was great fear about the strength of European sovereigns, namely the PIIGS countries of Portugal, Italy, Ireland, Greece, and Spain. Many feared that the global economy would fall into recession. One year later many of the same fears are still with us, and critics note that commodity prices and inflation are higher, unemployment and housing prices have not improved, and consumer confidence is very low. However, from the day Chairman Bernanke gave his speech last year, the stock market put in one of the strongest rallies of the bull market that began in March of 2009. From the date of his speech in late August until February 18th, 2011, the stock market exploded higher to gain +27%. Stock market bulls are hoping for a similar program, with similar results, this year. And stock market bears are terrified that the Chairman will come up with some kind of innovative and effective program that will stop the current market correction in its tracks, with the same result as last year.

As I see it, there are several possible outcomes from Bernanke’s Jackson Hole speech. 1) No new program is announced and bulls are disappointed (bearish), 2) A new program is announced and the market is so oversold it doesn’t matter how effective the program is, the market will rally (bullish), 3) A new program is announced and investors don’t believe it will be effective (bearish). If you are bearish and think stock market prices are headed lower, Chairman Bernanke is a crafty, innovative, and brilliant adversary. He has stated on many occasions that a bull market in stocks provides a positive “wealth effect” that is good for the economy. His past actions show he is willing to break all of the rules in order to put a floor under U.S. stock prices, if he can. Unfortunately, I believe that at this point in the cycle the world’s economic problems can’t be solved by monetary policy alone, and I believe that the majority of investors agree with me. In short, if the stock market does rally on Bernanke news out of Jackson Hole, I think it is likely to be a short-lived rally. We have positioned our portfolios to defend against further declines.