The Day Ahead: The Cold Water Has Been Thrown

 | Jan 15, 2013 | 8:30 AM EST  | Comments
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Well, it looks as though the fogies at the Federal Reserve have returned as impediments to a roaring bull market -- one that was supposed to have strong and sturdy legs and super attractive valuations. But wait, weren't the comments from Chairman Ben Bernanke and Mega Dove Charlie Evans (Chicago Fed president) actually welcome news? After all, they seemed to support aggressive monetary stimulus for as far as the eye could see. That's the message the white-collar-rocking finance dudes are selling. I, on the other hand, have summarized their comments as such:

economic slack + economic slack + fiscal drag = no goodie for steroid-filled market expectations.

Specifically, this is how I went about cracking the code of otherwise cryptic Fedspeak. I feel Bernanke's messages, in particular, conveyed a sense of reality to the market -- a reality the market was not prepared to hear:

Bernanke, Summarized:

Fiscal policy has two big issues -- long-run debt sustainability and a fragile economy.

A fiscal-cliff plummet had threatened to trigger another recession; the challenge is to achieve long-run sustainability without hampering recovery.

Many more fiscal problems lie ahead. Among them is the budget sequestration and debt-ceiling debate, and Bernanke expects a lot of activity on these issues in the coming months.

Estimates: 2013 fiscal drag of 1% to 1.5%

The pace of economic improvement has been slow

Fed has dual mandate -- stable inflation and full employment. The employment mandate motivates and justifies aggressive monetary policy.

Evans at a Glance:

"Given more explicit conditionality, markets can be more confident that we will provide the monetary accommodation necessary to close the large resource gaps that currently exist."

What to care about here: First, dove or not, this puts the kibosh on this ridiculous viewpoint -- which had arisen after the latest Fed minutes -- that policy tightening of any kind will begin later this year. Second, the mention of "large resource gaps" reinforces my opinion that the economy remains weaker than what's been depicted in the data. It also supports what former Fed chief Alan Greenspan has been saying for some time now about businesses' low post-recession capital investment.

When Evans issued his growth forecasts late last year he noted that, so far, the effects of fiscal policy on U.S. growth were about what he had expected.

What to care about here: The fiscal adjustment has not technically begun, and it continues to be a major source of downside risk to the economy in the first half of 2013 (which is hinted at in Bernanke's commentary).

Should the economy create 1 million jobs over six months, that would be a "substantive" improvement.

What to care about here: Finally a number has been assigned to "substantive" regarding the improvement needed before the Fed begins considering policy-tightening. I think this target is well out of reach for the first half, so it should help temper market concerns on policy-tightening.

On the Topic of Earnings Season

While the brunt of the seasonal storm hasn't yet commenced, I have detected incremental caution on the total outcome of the reporting season. Also, there a couple of data points worth mentioning.

1. Based on the early S&P 500 announcers, this earnings season is on track to logging its lowest surprise score for 2012. The market, in my view, wanted modest earnings-per-share upside on weak revenue, and respectable first takes at 2013 guidance. Now people are quietly questioning that expectation.

2. The ratio of positive to negative pre-earnings announcements has run above the seven-year average.

So doubts are creeping into the perceived sustainability of anything companies convey. However, my suggested plan of attack remains: I think folks should continue to book profits and wait until the market offers that next "tell" on the potential next march higher -- into a host of negatives, as neatly laid out by the cold-water-throwing Ben Bernanke.

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