Perspectives

Are You Following the Herd?

In her September 2015 FOMC announcement, Janet Yellen spooked the herd with talk of economic concerns.  Past messages about delaying raising interest rates were typically met with market rallies, so she and analyst, including myself, were a bit surprised when the market instead declined. While I go into detail about this effect in my December Current Situation report and what it means going forward, the point I want to make here is that her “worries” about the economy were what the market reacted to.

 

An odd but apt analogy

I do not know how I learned this or why I remember it, but this odd analogy seems to fit.  I remember passing the same stockyard a few times in my twenties and always wondered why in the middle of the stockyard filled with cattle there was a small man-made dirt hill that always had one cow standing above the rest.  I think it was a friend who grew up on a farm that informed me that the hill was there to keep the herd from getting spooked and stampeding.

Without the “lookout” the cattle in the stockyard could only see the cattle around them.  If a semi-truck released pressure in its brakes, the sound would cause fear to race through the herd.  If the only thing the cattle could see was the fear of the cattle around them then fear would elevate quickly and a stampede could follow with much injury.

But with a “lookout” all the cattle could raise their heads and see how it was reacting.  If the “lookout” was calm and not worried, then there was nothing to worry about and everything settled down.

One of the market’s lookouts is the Federal Reserve Chair.  When she forgot her role as a “lookout” and showed signs of economic worry in her September announcement, the herd got spooked and fear started to spread – the market declined.  Having quickly realized her mistake, she back-pedaled rapidly on her stated concerns.  Her latest narrative is about “how much confidence” she has in the economy.

But the analogy is not finished.  My view is the ranch foreman is simply trying to keep the herd calm as they load the cattle onto the semi-truck.  And we all know where the semi ends up.  The other ranch hands are working hard too. My personal favorite headline is Credit Markets Scream Recession, But Goldman Says Not to Worry.

Why does Goldman say not to worry?   Because their “forecast” for global growth is supportive for credit. Thanks Goldman, but the markets lead the real economy and they do not lead your forecasts.  Of course, Goldman Sachs knows this.

 

Optimistic Forecasts are for the Herd

Janet had such a large flip flop in such a short time it makes you wonder what she really thinks.  Would the Fed actually tell us one thing when they think another?  Do they use overly optimist economic forecasts as a policy tool – a cheerleading tool to manage expectations to encourage growth?

In July, the Fed inadvertently published staff forecast for the 2015 rate hike and Reuters had this to say about the accidentally leaked information:

“The staff views were less optimistic about the economy than several key policymaker forecasts…The Fed’s staff also took a dimmer view of long-run economic growth, expecting gross domestic product to expand 1.73 percent in the year through the fourth quarter of 2020.”

Make sure you should read my post about Forecasting Optimism to understand my opinion on forecasts.

 

On the markets

As an investor I do not care about what the economy did last month or is even doing presently.  The stock market and the credit markets are leading indicators for the economy.  What I focus on are the leading indicators for the stock market.

And guess what?  The credit markets lead the stock market and they are one of my best indicators.  And if the credit markets are screaming economic recession, what does that mean for the stock market that leads the economy after the seasonally strong month of December is behind us.

 

I just posted our December Current Situation Report for members.   Leave the herd behind and join us at TSP & Vanguard Smart Investor where we don’t rely on over optimist guesses; we focus on the real data.