"Kee" Points with Jim Kee, Ph.D.

Markets were slightly higher last week, as positives in the US outweighed the negatives of ongoing Greek debt-default concerns. In the US, The Conference Board Leading Economic Index (LEI) increased in May, which provided­­­ needed confidence (following a negative first quarter GDP growth number) of an improving US economy. In the words of The Conference Board, “The US LEI increased sharply again in May, confirming the outlook for more economic expansion in the second half of the year after what looks to be a much weaker first half.” Again, the LEI, which is comprised of ten components, has been one of the more reliable indicators during this expansion, which began in the summer of 2009 (almost six years ago!). The ten components are listed at the bottom of today’s Kee Points.

 

Another positive last week was the Federal Reserve Open Markets Committee (FOMC) meeting (there are eight regularly scheduled meetings per year), in which Fed Chair Janet Yellen reiterated what markets took to be a “dovish” stance (i.e. continued preference for loose rather than tight monetary policy). Ms. Yellen basically reiterated that neither the growth numbers in the US nor the inflation numbers were putting any particular pressure on the Fed to raise rates immediately, but that the Fed would like to start moving away from the 0-25 basis point bound as soon as possible. She also reiterated that when the Fed does raise rates, it will be slow and gradual rather than fast and aggressive. The following press Q&A, which tried to further dissect Yellen’s statement on the timing of the rate hike as though she had never spoken at all, was one of the more inane things I’ve witnessed from the financial press in recent years.

 

There are really two questions with regard to potential Fed rate hikes: The first is, “What will be the impact on markets as the Fed moves away from a federal funds rate target of basically zero that has been in place since the end of 2008?” The only valid is, “nobody knows.” A little nuance to that answer might be that both markets in general and the Fed’s own explicit verbiage in particular have recognized or acknowledged the inevitability of higher rates for some time, so it is hard to say it would be too disruptive a shock. The second question is, “What typically happens to markets when the Fed raises rates?” Here the answer might seem a little more obvious, as every Wall Street firm and research firm in the world runs the same data to see which asset classes do best in the periods leading up to and going beyond Fed rate hikes, based upon past rate hike episodes. The results suggest things like stocks outperforming bonds, sectors like Financials outperforming bond-like sectors such as Utilities, and international stocks outperforming domestic stocks. Of course, investing is never that easy because asset class performance also depends upon things like underlying growth and inflation-expectations, both of which vary from one prior rate hike episode to the next. Perhaps more importantly, you have to know “what’s priced in?,” that is, what is the market (and various asset class subcomponents) already expecting and pricing in?


As for Greece, concerns over a Greek debt default put downward pressure on markets last week, just as optimism over a possible compromise is putting upward pressure on markets today. Global risk measures aren’t in panic mode, although any disorderly debt default would surely roil markets in the short-term. Many have argued that a Greek exit from the Eurozone (not expected) would be a negative because it might lead to other countries exiting. But recall what economist Robert Mundell (whose work influenced the development of the Euro) said a few years ago when the issue first came up, and that is that any monetary union would actually be stronger if its weakest member left.

 

Finally, concerns over Europe remind me of the most interesting thing I saw last week: The Federal Reserve Bank of St. Louis released a study, “Regional vs. Global,” that looked at the correlations among business cycles (really expansions and contractions, which is a different thing) between the global economy, different regions or groups of countries, and individual countries. Looking at research that used data spanning from 1960 to 1990 and was released in 2003, the authors found that global shocks – and local shocks explained most of the cyclical movements in economies, with regional factors having the least influence. Looking at more recent data, the influence of regional factors increased dramatically. That makes sense because of profound developments in each region, like the creation of the euro in Europe, the North America Free Trade Alliance (NAFTA) in North America (US, Canada, Mexico), and the dramatic rise of China in Asia (and China’s entering the World Trade Organization in 2001).

 

Addendum


The ten components of The Conference Board Leading Economic Index®:


[note: The Conference Board is a “global, independent business membership and research association working in the public interest”]

 

•  Average weekly hours, manufacturing

•  Average weekly initial claims for unemployment insurance

•  Manufacturers’ new orders, consumer goods and materials

•  ISM® Index of New Orders

•  Manufacturers' new orders, nondefense capital goods excluding aircraft orders

•  Building permits, new private housing units

•  Stock prices, 500 common stocks

•  Leading Credit Index™

•  Interest rate spread, 10-year Treasury bonds less federal funds

•  Average consumer expectations for business conditions