Our central bank, once the institution that rarely spoke, now is verbose to the point that its governors don't seem to know when to shut up. Thus we now have an investment community permanently fixated on Federal Reserve policy as the key to everything.
Equity managers like to excuse valuations detached from any reality of earnings fundamentals by saying, "Don't fight the Fed." But the real message is, "Don't fight the crowd." Because the crowd slavishly follows whatever the Fed is up to.
What are the markets most thinking about (when Greece isn't back on the screen)? The next Fed move, of course. So every bit of data, large or small, tends to be seen in that light.
In mid-June, Fed Chair Janet Yellen indicated that the central bank likely would begin raising rates later this year, although the increases would be gradual. Stocks headed up in the following days.
Since the house organs of the investment world never want the cycle to end, they tend to spin things for the better, and the journalists read really cool wire-house research that similarly couches things in favorable terms.
So in 2007, stocks hit the peak of their cycle in October, thanks to a Fed rate cut, with a recession less than three months away (no, it did not start after Lehman Brothers failed in September 2008). There was plenty of economic evidence available that showed the economy was grinding to a halt, in particular the housing sector that had been at the center of the cycle. But everyone dismissed that as secondary to Fed policy.
In fairness to equities, they did begin a steady decline after the October 2007 top, once the long-awaited Fed move had become reality rather than rumor. It was in fact a double-cut, more than the market expected.
Stocks usually rally after the first rate increase. The next rate increase likely won’t occur until September, at the earliest. Then the market should be safe until at least the fourth quarter, possibly longer.
This is why the market top for this cycle is probably not in yet. That factor also helps keep some of my immediate anxiety in check about recent disturbing numbers.
Retail sales are in fact tepid this year, with year-to-date sales growth of 1.87%, the weakest since the recession. The spring is no better - even April-May of 2008 had better year-on-year growth than April-May 2015. Wholesale sales were down 3.3% for 12 months through April.
Meanwhile, business cap expenditures are hardly robust. Research firm FactSet projects that this spending will drop 3.4% this year, versus a 6% increase in 2014. One reason is a significant cap ex falloff in the energy sector, due to lower oil prices, but telecom services, utilities and materials also are cutting back.
What will matter to markets for now, though, is whatever the Fed says next
Wednesday and whatever trouble that Greece manages to get in or out of. Both events could lead to explosive (if short-lived) moves in either direction.
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M. Kevin Flynn, CFA, is the president of Avalon Asset Management Company in Lexington, Mass. Website: avalonassetmgmt.com.
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