VOL. 128 | NO. 138 | Wednesday, July 17, 2013
The Worldly Investor
Two Acts Remain in Bernanke’s Screenplay
By David Waddell
After weeks of volatility, driven by complex Fed speculation after a chorus of mixed messages, Chairman Bernanke re-focused marketplace attention on the Fed’s core purpose. As per Congress, The Federal Reserve Act directs: “the Federal Reserve...shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential…to promote the goals of maximum employment, stable prices and moderate long-term interest rates.”
The Fed must, by directive, utilize its full arsenal to accomplish its congressional mandate. Period. Therefore, the nuanced guesswork around tapering stimulus programs and the timing of interest rate hikes based upon the Fed governors’ tastes and preferences is largely irrelevant. Until the Fed unequivocally perceives that the economy is encroaching on its long run potential and therefore on a glide path to maximum employment, it is mandated to stimulate.
Reading the Fed’s Playbill
The Fed has performed three acts of strength and daring since 2008. Two acts remain.
Act I: Financial System Preservation – The Fed preserved the global financial system by utilizing enhanced powers granted by Congress.
Act II: Deflation Evasion – The Fed prevented the onset of deflation through swift and massive policy easing.
Act III: Wealth Restoration – The Fed boosted housing and asset prices through continuously expanded quantitative easing programs.
Act IV: Employment Restoration – The Fed must ensure that the U.S. economy regains enough sustainable internal momentum to embolden hiring and reduce the unemployment rate.
Act V: Inflation Containment – The Fed will ultimately need to taper and tighten to reduce pent-up inflationary pressures.
In summary, Bernanke has reassured markets that the Fed will not skip Act IV. Until the economy shows the intestinal fortitude to encourage hiring at a higher and more consistent pace, the Fed is mandated to maintain stimulus. Once full employment appears within range, the Fed will transition to Act IV … but not before.
Don’t Fight the Fed
With the Fed’s sights clearly set on full employment, its quantitative easing policy transitions from being an asset price insurance policy to being an economic insurance policy. While the asset price insurance policy benefited stock market multiples, the economic insurance policy will benefit corporate earnings. Therefore, the Fed has committed itself to the pursuit of higher corporate earnings! Investors looking at the current quarter will see little evidence of this. Revenues will come in flat and earnings growth will register in the low single digits. But who cares? What has markets rallying is not past realities, but future expectations. With the Fed targeting corporate earnings, estimates for 2014 have up-ticked. Current estimates for 2014 S&P 500 earnings are $124.44, 25 percent higher than the earnings generated over the last 12 months.
Investment strategists must decide whether the Fed will be capable of meeting its full employment mandate. If you believe in Bernanke, you believe in stocks. If you do not believe, buy bonds. But know that to date he has successfully completed Acts I, II, and III. Will Act IV be a hit? We are betting that it will.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.