Sunday, 22 July 2018

On NFPs and broken battle plans

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Anthony Peters sees markets trading around obstacles at their peril.

Anthony Peters

Anthony Peters SwissInvest strategist

On Thursday I took a look at equity markets and the pretty high levels to which they seem to be trading. On that day they took a bit of a bath which many wrote off as nerves ahead of Friday’s US Labor Department releases and fear of a strong Nonfarm Payroll.

The Labor Department duly obliged with a staggeringly strong report, way ahead of what anyone had expected and then, totally against all rationale, stocks went on a mission not south but north. Two days on, the how and why remains something of a mystery.

Explaining the unexplainable in markets is terribly easy, although those simple explanations tend to come out of the bottom drawer of analytics (more buyers than sellers) and they add little to our understanding of the underlying. Fund flows are normally a better way of tracking demand and supply of capital invested in financial instruments but even these have not been consistent of late.

Transparency is all fine and dandy but the economy is a dynamic creature which does not stick to the beaten path.

So how can it happen that after an event as significant as an October NFP of 204k and an upward revision of the September figure from 148k to 163k that equities are poking around at new all-time highs? The answer must be that they either have discounted a December tapering move or that they now, more sensibly, believe that tapering does not in itself spell Armageddon. A strong figure was, on the back of the big Advanced Q3 GDP forecast, supposed to push the probability of first Fed tapering steps in December from 20% to between 40% and 50%.

Bubble formation

One hedge fund manager wrote to me on Thursday, wondering whether equities might not look a bit toppy and whether it mightn’t be time to lighten up a bit. What might make him think that I know more about it than he does escapes me; I’m not the one who runs a hedge fund. I do, however, agree with him that if a market can trade its way around all these obstacles as if they weren’t there, irrespective of wind and waves, then one has to be at risk of being in some stage of a bubble formation.

The worst thing about bubbles is that it is so hard not to get sucked in. Watching a market race away while not being on board does not lend itself to easy sleeping and, far more to the point, to easy communication with the bosses or the trustees.

I have suggested before, and I shall repeat, that I do not believe that the obsession with transparency makes the life of a central banker any easier than it does for that of an investor. The latter is obliged to plant his guesses around what he does know rather than what he doesn’t know and the former is tied down by the expectations of the latter. Forward guidance is, in my view, proving to be useless to both the monetary authorities and to markets and I recall the world really being a safer place before it became the “done thing”.

Transparency is all fine and dandy but the economy is a dynamic creature which does not stick to the beaten path. Pinning future monetary policy to any single measure is a dangerous game. Arthur Wellesley, the 1st Duke of Wellington, is supposed to have once said that if he thought his hair knew what his head was thinking, he’d have it shaved off. As a military man, he knew the principle that any plan of battle becomes invalid the moment the first shot is fired.

The Fed is living with the self-imposed policy millstone of 6.5% unemployment. In fact it rose in October from 7.2% to 7.3% despite the strong jobs growth. After the Q3 GDP release and especially it’s implicit deflator at 1.9%, the last thing the Fed needs is to find its hands tied by the stubborn unemployment rate, not least of all because employment is the lagging indicator of all lagging indicators. Being tied to tracking that is the fool-proof recipe for falling behind the curve. It might sound good to Joe Sixpack and make good copy in the press but it is fraught with problems. FOMC members might be advised to read up on General Dan Sickles and his role in the Battle of Gettysburg.

Meanwhile, US bond markets were closed yesterday for Veterans’ Day and equities marched on the spot. Issuance was light to non-existent over here in Europe and my decision to be elsewhere seems not to have been entirely without merit.

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