The Jackson Hole Fed Conference will find attention later this
week. Media leaks indicate that the title of the conference
this year is
Global Dimensions of Unconventional Monetary Policy
. The meeting comes in the wake of a report from the San
Francisco Fed which indicated that $600 bln in large scale asset
purchases (QE) contributed only 0.13% to GDP growth and 0.03% to
inflation. At the same time, Fed research is suggesting
that the signal on interest rates has more impactful on economic
The Fed is trying hard to bolster growth:
The Fed is giving its best effort to try to help the economy,
but it seems to realize that its tool kit is limited and there
are risks to its policy. The recent surge in home prices
and historically low level of 10 year treasury yields are
examples of policy impact which can lead to imbalance and
distortions. The title of the Jackson Hole Conference further
illustrates the Fed is operating in an unusual time and is
pushing the limits of policy.
The Fed is probably trying to exit QE
The Fed seems like it is looking for a graceful way to exit it
current QE program. The recent round of QE, QE3, started in
September 2012. The Fed has run with the program for about
one year without a material change in economic activity or
inflation. The Fed probably sees the risk or cost of
continued balance sheet expansion outweighing the benefits.
The table above highlights the change in a number of key
economic indicators from the end of September 2012 to the present
time. Without a doubt, the biggest beneficiary of QE has
been the equity market. The S&P 500 has been up over
200 points or close to 14.8%. The flat level of single
family housing starts is the most surprising indicator in the
table. Other points include:
Personal income growth was down in real terms. The Fed
did little to bolster the incomes of the average American. Blame
Spending levels did not change materially in real terms.
The growth rates of real personal expenditures and
inflation adjusted retail sales were marginally lower.
Employment conditions improved. Payroll changes were
faster and unemployment claims fell. The unemployment
rate also declined. However, weak wage and income growth question
the strength of the expansion and dampen the Fed's victory.
Treasury yields rose, but expectations play a big role in
shaping the prices. The markets get ahead of the Fed's actual
policy. Likewise, the rise in the trade weighted dollar
was a bit surprising. A more dovish ECB and weak emerging
market conditions may have played a role in the dollar's
Durable good orders, excluding defense and transport, have
risen sharply. This base is easy for growth but the
direction is a positive.
Housing was mixed to improved. The weak growth is single
family starts is a disappointment, but the existing home sales
did rise sharply and total starts increased.
Existing home prices surged and increased at a pace much
quicker than income growth.
There are probably enough signs of economic strength in the
labor data and housing numbers for the Fed to claim some type of
success with its QE efforts and exit. The Fed's balance
sheet has expanded nearly $770 bln since late September
2012. This is a lot of liquidity and activism for a
marginal increase in employment growth and little change in
In light of this, there may be pressure within the Fed to
start tapering and exit the program. Don't be shocked by a $15 or
$20 bln reduction at the September FOMC meeting. This is
probably the expectation and priced.
Get fiscal policy involved:
The table indicates that fiscal policy through changes in
taxes, spending, and regulation needs to play a bigger role in
bolstering growth. However, to this point Washington has
done a poor job formulating and executing fiscal policy. Blame
both parties. Given an adjusted to higher taxes, which
began at the start of the year, the Fed may believe it can
back off on stimulus. This may put some pressure on the
politicians to act and take leadership, but don't hold your
The capital markets are in the process of pricing the end of
Fed QE. The process has come a long way over the past
six weeks, but could continue into the FOMC meeting September 17
and 18. The treasury market is the best indicator of QE
My model suggests that the 10 year treasury yield fair value
is around 3.25% ex-Fed intervention. At this level,
the 10 year treasury will have about 300 bps of carry - premium
to the overnight rate. The graphic shows the weekly 10 year
yield. The 2003 low around 3.20% is a natural level of
yield resistance beyond the channel and the April 2009 high just
Equities will still look attractive to the10 year treasury in
the 3.50%+ area assuming the economy does not dramatically slow.
Earnings yields are still high compared to corporate and
Stocks will need to see signs of economic growth, a favorable
flow of corporate news, or stability in the treasury market to
restart the rally. The Fed story, which has been a positive, is
fading to the background. Another reason to invest needs to
surface. Equity valuation is not stretched, but is a
It might be worth looking at stocks which are not highly tied
to interest rates and have strong upward earnings
revisions. Two suggestions rest in the biotech space.
Beta is hard to remove from your portfolio without a market
hedge, but biotech should be less sensitive to interest rates and
less vulnerable to the ups and downs of economic growth.
Here are the ideas:
First, Gilead Sciences (
), Zacks Rank #1 (Strong Buy). This company is sporting a
PEG ratio of 0.80 against a 10 year average of 1.01.
Second, Biogen Idec (
), Zacks Rank #1 (Strong Buy). It has a PEG ratio of 0.93
verses its 10 year average of 1.38.
Both stocks look cheap on the basis of historical growth and
are priced less than their expected growth rates.
BIOGEN IDEC INC (BIIB): Free Stock Analysis
SPDR-DJ IND AVG (DIA): ETF Research Reports
GILEAD SCIENCES (GILD): Free Stock Analysis
ISHARS-7-10YTB (IEF): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
ISHARS-20+YTB (TLT): ETF Research Reports
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