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How Bernanke Takes His Porridge

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BEN BERNANKE
AP

The noted American philosopher and psychologist William James once said "the art of being wise is the art of knowing what to overlook." This is often the case with investing -- one must sometimes ignore issues that may be important in the long run in order to focus on what could have impact today. In fact, we need to look no further than Ben Bernanke for evidence of this strategy. As Chairman of the Fed, Bernanke is tasked with the dual mandate of controlling inflation while maintaining employment. But given the deep recession this country is emerging from and the scars it has inflicted upon the American workforce, Bernanke seems to be "overlooking" his inflation mandate in order to focus on restoring employment. At his most recent testimony to the Senate, he said "currently, the cost pressures from higher commodity prices are also being offset by the stability in unit labor costs. Thus, the most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in US consumer price inflation." According to market strategist David Rosenburg, unit labor costs fell at a 0.6% annualized rate in Q4, which made for a negative figure in five out of the last six quarters. Because of this persistent drag of wage costs, Bernanke is choosing to not be concerned about the acceleration of commodity prices.

However, the rest of the world doesn't necessarily share his views. A quote from the boutique research firm GaveKal sums it up perfectly: "when the Fed worries about something, I start to worry about something else." We may be in a position where the overall Consumer Price Index isn't changing dramatically, but that doesn't mean that individual components aren't shifting. The weakness in labor costs continues to mask the upward moves in other areas. To take advantage of these shifts, I have positioned my clients with an overweight in energy and an underweight in consumer discretionary sectors. Rising energy costs will obviously benefit their producers, while they will tighten the purse strings of consumers for non-essential spending.

And while Bernanke may not be ready to face inflation head on right now, it is only a matter of time before he has to deal with it. Therefore I think it is wise to shorten duration ahead of what are inevitable moves up in interest rates. BCA Research points out that "even policy hawks would agree that tightening in the face of a geopolitical/oil shock would be madness." Because of the tenuous situation in the Middle East, policymakers have to cool their jets at least for the time being. Prior to these events, the 'DO NOT WALK' sign was already flashing when it came to buying bonds. In the last 200 years, US treasury 10 year yields have only been below their current level from the late 1930s to the early 1950s, during which time we were suffering through a depression and WWII. So it's unlikely that without the distortive effects of the QE programs we would stay at these levels for much longer. But the global unrest and fear of undoing any recovery is giving investors a few more precious moments to 'cross the street' so to speak from bonds to equities, and unload their duration risk before the developed economies start hiking rates.

Once we start discussing rising interest rates, many get concerned that equities are destined for difficult times as well. But actually, the investment research firm Strategas finds that the average S&P 500 performance 6 months following the first hike in interest rates is about 8%. I am still willing to put money to work with those types of potential returns. The only danger is that the economy is recovering at a healthy enough clip to encourage money to move out of financial assets and invest in the 'real' economy (ie building businesses and making capital expenditures). While a stronger GDP print would spell good news for politicians, because of this potential investment shift, it doesn't necessarily imply that the stock market will move up in tandem. In fact, Ed Easterling of Crestmont Research has found that in the last century, secular bear markets have experienced higher nominal GDP growth than secular bull markets. Recently we have seen the Citi Economic Surprise Index, which measures actual macro data versus consensus estimates, registering new highs. Things are recovering faster than people would expect. Strategists often hope for the Goldilocks Scenario, where the ideal economy is neither too cold to cause a recession, nor too hot to cause inflation, but just right. Bernanke still thinks it is too cold. I think we are just right for the time being, but the porridge seems to be heating up.


Rosenau/Paul is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC & HighTower Advisors, LLC, a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.

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