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

  • Markets
  • Analysis
  • The Fed and the Economy
  • Selling Fear


Markets


How are markets doing year-to-date? Overall, US equities (stocks) are slightly positive (less than 1%), ahead of international stocks, which are also slightly positive, except for emerging market stocks, which are slightly negative. Growth stocks are still edging out value stocks, and small company stocks are beating out large company stocks (mega-sized stocks are negative thus far). Commodities (corn, copper, soybeans, etc.), are up about 5%, with crude oil going from $60 to $70 per barrel so far this year (up 17%). Gold is slightly positive (<1%) year-to-date. Within bonds,short-term municipal bonds are slightly positive, while bonds of lower quality are negative, and those with considerable interest rate risk, like long-term corporate bonds and long-term US treasury bonds, are down over -5 %. $1.19 buys a euro, which makes the dollar about flat (but strengthening) for the year thus far. Ten-year Treasury yields have risen to 2.95%.


Analysis


Trade and interest rates! I still pore over 80 page analyst reports, but I no longer write them. Simple is better, and I think global trade angst is the simple reason for large, more globally-oriented stocks underperforming small. It also explains the underperformance of international indices, as these countries tend to more trade-oriented. As for value versus growth, value stocks tend to return more cash to shareholders via dividends (i.e yield), versus growth stocks, which reinvest their cash, rewarding investors through capital gains (i.e. price appreciation). The combination of price gains plus dividends results in shareholder total returns. Since interest rates have risen sharply this year, that would explain the underperformance of more yield oriented value stocks, and indeed dividend yields - and hence interest rate sensitivity - for value stock indices are more than double those of growth stock indices. So that makes sense as well. And commodities seem to be bouncing off of cyclical lows (for this expansion) from the first quarter of 2016.


The Fed and the Economy


Fed thoughts: In the US, the April payroll report of 164,000 was deemed "good enough" by markets, with second quarter GDP growth estimates in the 2%-3% range. That, coupled with inflation measures touching 2%, should ensure two to three additional rate hikes this year. I’ve shared in the past a little insight from my years with a macroeconomic forecasting firm over two decades ago, namely, that the economy tends to accelerate during Fed rate hike regimes. That’s probably due to market participants’ (individuals and firms) moving forward discretionary purchases in anticipation of higher rates in the future. “Making hay while the sun shines” is how my old boss Dave Ranson (a Chicago Ph.D) used to put it, or more formally, intertemporal output migration. He described it once in the Wall Street Journal in a piece titled, “GDP Always Outwits Monetary Policy.” Since some of this activity is merely GDP being “rescheduled” from the future towards the present, it leads to a boom in the present, followed by a bust down the road. Statistically, this relationship has waned over the ensuing decades, probably because so much credit activity has moved to large global banks and is less sensitive to or less under the purview of the central bank. But the key takeaway is that the maximum negative impact of Fed rate hikes on the economy occurs about a year or a year and a half after the last hike. That would put the possibility of a Fed-induced recession occurring at least a year and half from now.


Selling Fear


Most of you know that Wall Street is often characterized as “selling fear and greed,” while the financial press has a particular fondness for fear. This goes back at least to the early part of the last century, when satirist H.L. Mencken famously stated that “the best client is a scared millionaire.” Studies have shown that newsstand magazine sales increase by roughly 30 percent when the cover is negative rather than positive. Kee Points readers also know that I hold Wharton Professor Jon Scott Armstrong in high regard when it comes to peer-reviewed research on what actually works in marketing. He looks at everything from the color of type to the appeal of celebrity endorsements. When it comes to “fear appeals,” Armstrong, in a piece titled, “How to use fear to persuade: New evidence,” finds that strong fear is more persuasive than mild fear: He said, “I have cited 98 experimental and non-experimental studies confirming that strong fear is more effective.” More importantly he added, “To the extent that emphasis is placed on a possible fearful outcome, people tend to ignore the probability of such an event.” This an important insight for investors, as there is usually a pretty wide gap between fearful stories of what could happen, on the one hand, and what will happen, on the other.