April 2016 – Monthly Commentary
Central Bankers continue to confound markets with their contradictory statements and unconventional monetary policies. The European Central Bank recently decided to pay banks to borrow Euros and use that cash to lend to borrowers. ECB Chairman Draghi vows to do whatever it takes to propel the European economy to growth, and that includes printing 80 billion Euro’s a month to buy government and corporate bonds in the open market. On the other side of the globe, the Bank of Japan moved to a negative interest rate policy earlier this year despite signaling that they were against such a policy just the week prior. Presumably, their intention was to weaken the Yen, but the reversal had the opposite effect, sending the yen higher in value versus most currencies and frustrating Prime Minister Abe’s plans to stimulate growth. The Federal Reserve was not expected to change policy at the April meeting, and they held true to expectations. However, the post-meeting statement was ambiguous indicating that they will continue to watch data and adjust rates accordingly, which doesn’t do much to help investor’s divine direction and value.
The conflicting messages wreaked havoc on the markets in April, resulting in wild, counterintuitive price moves. The Euro was relatively stable versus the dollar for the month, despite expectation that the ECB would drive interest rates further into negative territory. The Yen, on the other hand, rallied 5.3% versus the dollar when the BOJ failed to meet expectations. Despite no expected rate hike from the Fed, long bonds fell nearly 2% in price, while the S&P 500 barely budged, up 0.38% for the month. The stock market tranquility was especially perplexing given that we’re in the early days of earnings season and forecasters are expecting earning to decline both year-over-year and sequentially. Looking to the commodity markets, the price movements were equally befuddling. Gold, the universally accepted inflation hedge was up 4%, while silver, also considered an inflation hedge, rallied 14.5% for the period. We think much of the price action was attributable to “crowded” trades, investment themes that are shared by many. When crowded trades reverse, they often cause extreme market movement. The price action of the Euro last fall versus the dollar is an example of such an outcome. As investors prepared for the Fed’s first rate hike, the dollar was widely expected to appreciate to the point that it would trade at parity with the Euro. In a case of “buy the rumor, sell the fact,” just prior to the hike the trend reversed and at the time of the writing, one Euro buys $1.15 delivering an enormous blow to the competitive advantage of the Euro.
We’ve written on several occasions about the illogical way the Commerce Department presents economic data and the equally illogical willingness of investors to accept that data as fact. Such an example crossed the tape last month with the release of Housing Starts data for March. The annualized number of new homes started was reported to have declined by a seasonally adjusted 91,000 units, a 7.7% decline. The media touted the news as “disastrous” coming just as building activity should be accelerating. However, seasonally adjusting economic data can distort it in such a way that positive data is twisted into negative as was the case for housing starts. We believe a better measure is to compare unadjusted economic activity on a month-over-month, and year-over-year basis. In doing so, the government “fudge” factor is eliminated. The unadjusted housing starts rate of growth, month-over-month gain was 16.5% and the year-over-year gain was 7.8%. That’s undeniably a robust outcome.