As a sort of calm returns to equity it is becoming increasingly clear that the talk of ‘regime change’ is premature if not unfounded. The regime in question is ‘low volatility in equity prices and low interest rates’ courtesy of a kindly ‘put’ supplied by the Fed. The alleged change is that inflation may take off at any moment, mainly in the US but elsewhere in due course (UK does not count in this context even though it has ‘above target’ inflation), and that a zealous FOMC will embark on even more interest rate hikes than the three it has already signaled for 2018. To add to the fears, the new Fed Chair, Jay (Jerome) Powell is deemed to be something of a dark horse while the balance of FOMC members has swung in favour of ‘hawks’. Last week I was interviewed by Jenny Hammond of AssetTV (link https://investor.asset.tv/video/who-exactly-jay-powell) who posed a number of highly relevant questions that help deconstruct the ‘regime change’ talk, not least on Mr Powell’s likely approach to monetary policy:
- Inflation seems far from out of control in the US. Last week, as I suggested, the CPI did edge higher thanks to oil prices and the weaker dollar may well keep it above 2% for a while. However, Figure 1 presents a different perspective on price changes, especially on wages when compared to the January 2018 figures that caused so much panic earlier this month. In any case, the FOMC’s preferred measure of inflation is the PCE (Personal Consumption Expenditure) Price Index which has not exceeded 2% per annum since 2012. Moreover, the FOMC will be all too aware that the sharp rises in hospital and other medical care is having a depressing effect on consumption on other items.
- It is true that the FOMC is eager to raise interest rates but its aim is normalising rather than tightening monetary policy. The Bank of International Settlements (the central banks’ trade association) has been calling for a move away from negative and zero rate policies because they encourage excessive investment risk-taking and undermine prudent borrowing and lending. The FOMC under Janet Yellen has for at least the last two years been carefully and consistently guiding the market to expect a series of gradual incremental hikes. Some investors may have chosen not to listen but the intention has been clear: raise interest rates but without frightening the children. This is not a new development.
- Mr Powell has never dissented from the majority FOMC decisions (i.e. the policies of Ben Bernanke and Janet Yellen) since becoming a member in 2012. Intriguingly, not only is he not a distinguished economist, he is not an economist at all. He is a lawyer and a successful investment banker, rich enough perhaps to impress the plutocratic Mr Trump as friendly to Wall Street. However, as a Fed Governor he was responsible for bank regulation and adopted a pragmatic rather than partisan approach. It is likely, at least initially, that he will have a similarly pragmatic approach to monetary policy, relying on the expertise of Fed staffers while also being prepared to respond benignly to market crises. The Fed ‘put’ has never been explicitly acknowledged but there is every reason to believe that Mr Powell will want discreetly to maintain belief that it exists. We may discover more about Mr Powell in two weeks’ time, albeit perversely, as he tries to follow precedent in dodging questions in his testimony in Congress. By that time the PCE Price Index for January will have been published and analysed to destruction.
This is not to say that investors should or will stop fretting and another correction in 2018 is still perfectly possible. The VIX has fallen back but not yet completely and possibly only because so many of those previously shorting it have been blown away. Nevertheless, it seems time to start looking for stocks that offer opportunities at least in the short-term and in this week’s edition we cover a wide range of interesting small companies, a mid-cap and a blue chip multinational.