Issue 69 - April 05, 2011


Implications – A Bevy & A Wedge

From the ground and the air, a series of “Black Swan” events arrived in succession during this first quarter. Beginning in a fashion reminiscent of Sarajevo 97 years ago, an uprising in Tunisia ignited a sequence of uprisings and governmental changes across Northern Africa and into the Middle East. Oil prices jumped sharply resulting in a 20% increase in spot and near dated futures. Japan was next as it found itself reeling from the multiple impacts of an earthquake, tsunami, and nuclear reactor incident. These events have conspired to now impact our “just in time” global supply chains across a broad array of industries including car parts and computer chips. The Euro Area crisis, which we expected to be the dominant macro economic development, did play its role. Both Ireland and Portugal saw a change in their governments and were moving towards a nationalization of their banks as their sovereign bonds moved into the unsustainable double digit yield territory along with Greece. Here on the domestic front, the data presented a story of a continuing fragile recovery with persistently high un/under employment and a housing market which is at best case just flat out stuck. In spite of all of these factors, US equities put in a solid performance and US Treasury rates were for all practical purposes little changed. Wow! It would certainly be reasonable to think that oil prices above $100 would have some slowing impact on the rise in equity prices, let alone the combination of these events. Well, maybe they did. Maybe equities would have been up even more had it not been for these events? But this thinking begs the question of what is continuing to drive investor’s appetite for domestic equities in the face of remarkable macro economic forces?

Implications - Quantitative Easing 2.0

The Federal Reserve continued the policy of a zero percent benchmark rate and announced a purchase plan of $600BB of various US Treasuries that is scheduled to be completed by the end of June. For those who might doubt the impact of such a policy consider that US equities are up approximately 30% since the Federal Reserve hinted at their intentions in Jackson Hole last August.

Trying to assign the attribution of this rally to either the improving economic activity or the incentives of QE2 is impossible; which is not to say that it is not important. Several current and voting board members of the Federal Reserve have not been in favor of this round of QE and are not going to be a party to another round of what they believe to be a relatively reckless policy. If we don’t have sufficient organic economic strength, we are going to feel it in stock prices which have enjoyed an 87% correlation to the expansion of the Fed’s balance sheet since the spring of 2009. Now this could be a case of “Fooled by Randomness” but the current Federal Reserve appears to be quite comfortable taking credit for the rise in equity prices. On January 25, 2011 Bernanke was shown on CNBC stating the following:

“The policies have contributed to a strong stock market just as they did in March 2009, when we did the last iteration of this. The S&P 500 is up 20% plus and the Russell 2000, which is about small stocks, is up 30% plus.”

The winding down of this policy potentially coupled by rising rates in the Euro Zone might just get the attention of risk seeking investors.

Implications – Rules Rules Rules

To put the new Dodd-Frank Wall Street Reform and Consumer Protection Act and its potential impacts on markets and financial institutions into context, we turn to a relatively simple rules based game – golf. Golf is a game of few rules which results in a fairly lengthy list of “decisions”. For round numbers, a golf rule book that you might find in any bag has typically 34 listed topics. The quadrennial publication of the “Decisions on the Rules of Golf” however runs several hundred pages.

It is estimated that this new Dodd-Frank legislation will require some 240 plus new rules and thousands of pages of decisions. Meanwhile, Basel III is yet another set of global based requirements coming down at the same time. These guidelines look to create a consistent set of policies pertaining to bank capital adequacy and liquidity across all markets.

The main trouble with this entire sausage making exercise beyond the obvious impossibility of implementation is that many of these policies are not going to encourage the hoped for outcomes.

The US based legislation speaks as the name implies primarily to a set of policies intended to protect the consumer. The first skirmishes of this are currently playing out surrounding the “swipe” fees that banks charge for Debit Card transactions. The legislation calls for a cap of 12 cents versus the current standard of 44 cents. The banks, rightly or wrongly, claim that at 12 cents, these transactions are not profitable and therefore they won’t offer the cards at all for transactions under $100. The banks have also responded to this legislation with a call for $5 atm fees. At a time when many individuals and households are running at razor thin monthly margins; these actions could drive more consumers out of the traditional banking system and into the arms of under regulated pay day lenders and their like.

Basel III, with its calls for increased capital requirements, would potentially stifle credit expansion and could within reason deem that many of the largest global banks are by this new reckoning, insolvent. Neither outcome is exactly what is needed at this time.

Catching up with the Can

For the better part of three years now, global bankers and legislators have worked at a variety of policies to stem the liquidity crisis of 2008 and to encourage economic growth through an episode of global deleveraging which continues to this day. We knew going in that this would be difficult. A policy of forbearance or kicking the can down the road almost inevitably catches up with the can. The hope is that the underlying conditions have recovered sufficiently to absorb the recognition of losses when that happens.

There are many pundits who view the current pace of economic activity as proof positive of a recovery that is well entrenched and underway. It would be nice to think so. The recovery has been fueled by enormously easy monetary terms, low rates and concurrent quantitative easing. Despite these best efforts, it is paramount to know the context in which we find ourselves. Consider employment.

As this graph so clearly shows, yes, we are improving but we have an awfully long way to go. What of housing and the recent weakness we have seen nationally on that front? This is no small matter when it comes to discussions of interest rate policy. Lower rates may not be the answer to that market which sorely needs equity first and foremost, but higher rates will certainly retard any nascent recovery.

The picture we continue to see is one of a long term recovery that will almost certainly have series of ebbs and flows. Our point regarding the market’s apparent indifference to Black Swans and a coming regulatory bonanza is to highlight the immediate importance of the current QE policy. A market that seemingly is impervious to outside risk factors runs the risk of becoming complacent to such inconveniences. That is until it isn’t.

Risk and liquidity adjusted returns never really go out of style. Income and quality have been incredibly valuable throughout the past three years. We wrote back in 2006 that not caring about risk was not the same thing as not having it and those words ring true again today.

Markets which have become reliant on the marginal dollars provided by the Federal Reserve’s policies will have to have a period of adjustment when those policies change. This does not mean that we can not invest, but that we should do so with our eyes wide open to what we have endured and what lies ahead.

Best Wishes –

Jen & Patsy



In this Edition

  • Implications – A Bevy & A Wedge
  • Implications - Quantitative Easing 2.0
  • Implications – Rules Rules Rules
  • Catching up with the Can

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

68 - 03.03.11
What Ever Happened to Housing?/ Where Do Loans Come From?/
Where Do Loans Go?/ The Last Straw/ The Path Forward/ Equity/ Clearing Mechanism/ Restart Your Securitization Engines.

67 - 01.10.11
Curiosity of the Federal Reserve/ Complacency & Fragility

66 - 11.12.10
Phew/ Taxes and Employment/ Quantitative Easing Returns/ Incentives & Unintended Consequences/ Dear Mr. President

65 - 09.28.10
Progress in the Absence of Milestones/ Changing Nature/ Correlations & Valuations/ Synthetic Securities

64 - 08.18.10
A Tricky Diagnosis/ Traditional Treatment/ Bad Medicine/ New Age Medicine/ Homeowners/ The Banks/ Pension Plans/ Bull Flattening

63 - 06.17.10
Hip & Groovy/ The Trouble with Zombies

62 - 05.24.10
Next Sequel/ 2012

61 - 05.04.10
Intensity/ Principles versus Rules

60 - 04.01.10
Grand Isle to Lincoln
/ Mile Post 312/ Mile Post 353/ Mile Post 399/ P.I.G.S. are a Problem

59 - 02.17.10
Surprise, Surprise, Surprise/ P.I.G.S. Matter/ Leverage vs. Debt/ Going Forward

58 - 12.29.09
2009-The Year in Review/ 2010 - The Year of "The Exit"/ Deflation or Inflation?/ 4 Cylinder Economy/ Rates and Returns

57 - 11.04.09
Banks-Back to the Future/ Navigating the Tsunami/ TARP 3.0/ Implications

56 - 09.15.09
Are We There Yet?/ The Beginning? The Present/ The Journey is the Destination

55 - 08.04.09
A Transformation is not a Recovery/Not All Economic Data is Created Equal/
Smallest, Lowest, "Shortest"

54 - 06.24.09
Aftershocks/ Fragility/
Inflation and the Fed

53 - 05.29.09
A Brave New Road to Recovery/ Vehicle Choice/ Speed Limits

52 - 04.07.09
The Things We Know/The Things We Don't Know/Savings and Sensibility

51 - 03.25.09
The Correct Problem/ The Need for Speed/ No Good Deed Goes Unpunished

50 - 03.05.09
Rebuilding Credit/ Under Repair/Problems Persist/Big Chore

49 - 01.12.09
The Year in Review/ The Path Forward/ 2009


More Past Issues
can be found in our

Newsletter Archive


Market Highlights



12/31/10 12/31/09 12/31/08 12/31/07 12/29/06 12/30/05 12/31/04
11,578 10,428
S&P 500 US


1,258 1,115


Nasdaq US
2,653 2,269
EAFE Int'l Equity
1,658 1,581


5 Yr Treasury 2.30 2.02 2.71
5 Yr AAA Muni 1.77 1.75


10 Yr Treasury
3.38 3.92
10 Yr AAA Muni
3.44 3.26
30 Yr Treasury 4.50 4.325
30 Yr AAA Muni 4.82 4.9
EUR Currency 1.41 1.34
JPY Currency 82.87 81.32


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