Like most of us, Fed officials don’t like to be ignored. A few of them crave attention.
That’s why Fed officials love giving speeches and appearing on CNBC. However, over the past year or so, investors have moved on. They seem to have lost their interest in the Fed.
That was not the case at the beginning of 2016 when two Fed officials—namely, Fed Vice Chairman Stanley Fischer and FRB-SF President John Williams—warned investors that four rate hikes were likely over the rest of the year.
They were hammering home the message of the December 15-16, 2015 meeting of the FOMC, when the committee hiked the federal funds rate for the first time during the current expansion and released a dot plot indicating four rate hikes in 2016.
The S&P 500 plunged 13.3% early last year from its high on November 3, 2015 to a low of 1829.08 on February 11, 2016 (Fig. 1). The two Fed officials realized that they were getting too much attention and backed off, toning down their market-rattling rhetoric in subsequent clarifications of what they really meant. The 25bps rate hike at the end of 2015 to 0.25%-0.50% was followed by another “one-and-done” hike in 2016 to 0.50%-0.75% at the end of 2016, a third hike on March 15 this year to 0.75%-1.00%, and a fourth to 1.00%-1.25% on June 14.
However, there were no tightening tantrums in the financial markets. Investors simply lost interest in the Fed and adopted an attitude of benign neglect, much to the consternation of attention-needy Fed officials. Consider the following:
(1) Stocks. The stock market mostly ignored all those hikes, proceeding to melt up from last year’s low by 34.1% to a record high of 2543.46 on June 19. Yesterday, It closed only 1.4% below that level on Tuesday. The forward P/Es of the S&P 500/400/600 rose from 14.8, 14.8, and 15.2 in early on February 2016 to 17.4, 18.0, and 19.2 on Tuesday (Fig. 2).
The Buffett ratio, which is the market value of US stocks traded in the US divided by GNP, rose to 1.72 during Q1, nearing its record high of 1.80 during Q1-2000 (Fig. 3). The similar ratio of the S&P 500 market capitalization divided by the composite’s revenues rose to 2.00 during Q1, matching the previous record high. A comparable weekly measure using the S&P 500 stock price index divided by forward revenues per share rose to a record 1.95 during the week of June 22 (Fig. 4).
(2) Bonds. Initially, the reaction in the bond market to the Fed’s rate hikes was also extremely benign (Fig. 5). The US Treasury 10-year bond yield plunged 93 bps from 2.30% on December 16, 2015 to a record low of 1.37% on July 8 of last year. The yield curve spread narrowed from 215 bps to 97 bps over this period (Fig. 6). Last year’s lows in both were made on July 8, a few days after the Brexit vote. Yields fell and the yield curve narrowed during the first half of last year because the economy looked weak according to the Citigroup Economic Surprise Index (CESI) (Fig. 7). In addition, inflationary expectations over the next 10 years remained subdued around 1.5% (Fig. 8).
From last year’s low, the bond yield jumped to this year’s high (so far) of 2.62% on March 13. The yield curve spread widened to 196 bps on the same day. The Brexit vote didn’t precipitate a financial crisis as was feared by many. The CESI rebounded smartly from last summer’s low of -25.4 to peak at 57.3 on March 15 of this year as the economy recovered from the energy industry’s rolling recession. Of course, much of the surge in the bond yield and the yield curve spread occurred after Election Day when Donald Trump’s ambitious and stimulative agenda of tax cuts and infrastructure spending suddenly looked possible. Animal spirits soared according to surveys of consumer and business confidence. So did stock prices.
However, the CESI, which peaked on March 15 at 57.9 proceeded to plunge to the most recent low of -78.6 on June 16. The 10-year yield was down to 2.21% on Tuesday, and the yield curve spread was 105, near Monday’s 98, which was the narrowest since right after the Brexit vote! Expected inflation over the next 10 years was 1.73% yesterday, down from the recent peak of 2.08%.
(3) Currencies & commodities. The currency markets have also mostly ignored the Fed. Despite the March and June rate hikes, the JP Morgan trade-weighted dollar peaked on January 6, and fell 17% through yesterday (Fig. 9). The FOMC’s latest Summary of Economic Projections shows that the Committee is aiming to raise the federal funds rate maybe three to four more times to achieve the median projection of 2.1% by the end of next year. Yet the dollar remains weak. Usually, a weak dollar should be bullish for commodities. Instead, the price of a barrel of Brent crude oil has fallen from a recent high of $57.10 to $47.23 yesterday (Fig. 10). Over this same period, the CRB raw industrials spot price index has stalled after rising smartly since late 2015.
Strategy II: Fed Raid. Fed officials may be coming around to believe that further rate hikes may be a mistake given the weakness in the CESI, the drop in bond yields, the flattening of the yield curve, and the decline in expected inflation. However, they may be increasingly concerned that if they signal a halt to rate hikes, stock prices might continue to melt up. Their congressional mandate is to aim for full employment with price stability. Their third, though unofficial, mandate is to maintain financial stability. This would explain the recent spate of comments by Fed officials on this subject. They are clearly trying to get our attention. Consider the following:
(1) Williams. “The stock market seems to be running pretty much on fumes,” FRB-SF President John Williams said in an interview in Sydney, as Reuters discussed on Tuesday. “It’s something that clearly is a risk to the U.S. economy, some correction there—it's something we have to be prepared for to respond to if it does happen,” he said. On the one hand, the bank president said that he is concerned about the “complacency in the market,” citing low measures of market volatility. On the other hand, Williams doesn’t foresee a major crash coming because the market is underpinned by a fundamentally sound US economy, in his opinion.
For Williams, the bottom line seems to be that the course of reducing monetary stimulus will continue to be slow and steady. That would be in keeping with his concerns about the market and remarks he made in a speech in Sydney on Tuesday that the US economic expansion will be sustained, but slow. During his speech, Williams focused on long-term demographic drivers weighing on growth, productivity, and inflation. Prior to his speech, Williams told reporters that just three rate hikes this year and three to four hikes next year would be fine. Williams gets to participate in FOMC meetings this year, but he doesn’t get a vote.
(2) Fischer. FRB Vice Chairman Stanley Fischer has more weight than Williams because he gets a permanent vote on the Committee given his position on the Fed’s Board of Governors. Fischer too warned against market complacency in a 6/27 speech. Fischer’s broad assessment is that leverage and liquidity risk in the financial markets is “relatively low.” However, Fischer seemed to be most worried about the market’s nonplussed attitude toward perceived risks inherent in elevated asset valuations.
Fischer concluded: “Prices of risky assets have increased in most major asset markets in recent months even as risk-free rates also rose. In equity markets, price-to-earnings ratios now stand in the top quintiles of their historical distributions, while corporate bond spreads are near their post-crisis lows. Prices of commercial real estate (CRE) have grown faster than rents for some time … The general rise in valuation pressures may be partly explained by a generally brighter economic outlook, but there are signs that risk appetite increased as well. For example, estimates of equity and bond risk premiums are at the lower end of their historical distributions, and, relative to some non-price-based measures of uncertainty, the implied volatility index VIX is particularly subdued.”
For what it’s worth, as of April, Fischer seemed to be in the three-rate-hikes-this-year camp along with Williams. During mid-June, Fischer spoke about his concerns over assets prices, specifically global housing, but made no mention of the path of rate hikes. Fischer’s most recent speech didn’t mention his thoughts on the course of rate hikes either.
(3) Yellen. Of course, Fed Chair Janet Yellen carries the most weight in the FOMC. Like Fischer, she too spoke on Tuesday, describing asset valuations as “somewhat rich if you use some traditional metrics like price earnings ratios,” according to Bloomberg. She said so when answering audience questions at an event in London. The good news is that she doesn’t foresee another financial crisis “in our lifetime,” reported CNBC. She is a bit older than me, but much older than Melissa.
Fed: The Great Unwinding. Besides rates, several Fed officials have taken a position on what Melissa and I have referred to as the inevitable “great unwinding” of the Fed’s $ 4.4 trillion in assets on the balance sheet. Last month, for example, Williams indicated that the balance sheet will be “much smaller” in about five years than it is today. Tempering the possibility of a repeat 2013 “taper tantrum” when global markets panicked at the mere mention of a possible tapering of asset purchases, Williams said that the Fed will start with a “baby step” likely later this year and be quite “boring” and in the “background.”
FRB-SL Fed President James Bullard, not a voter this year, also said that he has been an advocate for getting started on balance-sheet reduction, in a 6/22 interview with the WSJ. “We’re going to do it in a very controlled and passive way that I think will be easy for markets to digest, and so I’m not expecting anything too dramatic. But I think it is important to create some policy space for the future,” he said.
Melissa and I think that the Fed will probably commence the great unwinding this year, or at least outline a plan for doing so. That insight is based not only on recent comments from Fed officials, but also the latest Statement on Monetary Policy. Depending on the Fed’s approach to the great unwinding, the pace of rate hikes could slow even further, because the Fed will want to avoid a “great unravelling” of markets should the great unwinding unnerve otherwise complacent investors.
Consumer Discretionary I: Furniture Is Flying. Overlooked amid all the gloom and doom in retail is the boom going on in the home furnishings category. It reflects positive trends in housing and the economy, in general, and parallels the favorable fundamentals of the home improvement category. And so far, home furnishings has continued to defy even the Great Disruptor that is Amazon. Fundamentals are expected to stay strong for the industry for the foreseeable future on expectations for higher household formations, increasing home sales, and continued low unemployment. Consider the following:
(1) Sales. US furniture and home furnishings sales have risen every year since 2010 (Fig. 11). During April, they totaled a record $193 billion (saar), with furniture at $110 billion and furnishings at $83 billion. The inflation-adjusted total rose to a record $1,965 (saar) on a per household basis, doubling since November 1999 (Fig. 12).
(2) Orders. New orders in the home furnishings market have been strengthening since August 2016, and a recent survey by accounting and consulting firm Smith Leonard shows that new orders in March were up by 12% y/y, a significant advance from February’s 4% y/y gain.
(3) Online. While online furniture sales—from the likes of Wayfair (W) and Amazon (AMZN) and Williams-Sonoma’s (WSM) West Elm units—still represents only about 10% of total U.S. furniture sales, it’s a swiftly growing segment.
A 5/12 WSJ article quoted a CEO whose trucking company makes large e-commerce deliveries saying “Just in the last year, furniture has taken off.” Furniture is his company's number-one business-to-consumer shipment item, recently usurping TVs.
(4) Hot stuff. What’s flying off stores’ floors? Demand for sofas and bedding is high, in particular, while outdoor furniture and vintage furniture are also popular. The vintage trend is new and noteworthy: Vintage Ikea furniture is fetching big bucks at auctions, and virtually all furniture websites now feature a vintage selection.
(5) Amazing Amazon. Amazon has been turning more attention to its online furniture business. “Furniture is one of the fastest-growing retail categories here at Amazon,” furniture general manager Veenu Taneja told the WSJ in the article cited above. He said the company is expanding its furniture-related offerings, adding custom-furniture design services as well as Ashley Furniture sofas to its lineup. Amazon also has been speeding up delivery to one or two days in some cities.
One well-known furniture retailer has decided that joining forces with Amazon is a better strategy than trying to beat the world’s biggest retailer at its own game: Ethan Allen Interiors (ETH) announced in April that it will launch the Ethan Allen Design Studio on Amazon to sell its furniture.
(6) Good performance. The strong showing hasn’t gone completely unnoticed by investors: Through Tuesday’s close, the S&P 500 Home Furnishings industry, representing manufacturers, is up 16.9% ytd and 26.9% y/y. That’s in line with the performance of the S&P 500 Home Improvement Retail industry (home- and garden-related stores), up 11.8% ytd and 15.4% y/y. In contrast, the S&P 500 Homefurnishing Retail industry (which has home furnishing retailer Bed Bath & Beyond as its sole member) hasn’t fared as well: It’s down 24.4% ytd and 26.6% y/y.
Consumer Discretionary II: Lots of Shoppers. News from many of the publicly traded furniture retailers bears out the positive top-down trends. To furnish some details:
(1) Big Lots (BIG) posted record earnings in its Q1, its sixth straight quarter of positive earnings, and gave an upbeat forecast for the year. It has been expanding its furniture offerings this summer. Company executives recently said that customers are buying higher-quality and higher-priced goods in bed and bath, and the store is selling out items at prices that are higher than it ever carried before, e.g., a $1,000 patio set. As a result, Big Lots is expanding certain departments, including furniture. A newly remodeled Columbus, OH store will feature a new “Store of the Future” format emphasizing its strongest categories—furniture, soft home goods, and décor.
(2) Bassett Furniture (BSET) saw Q1 sales rise 4% y/y, on the strength of products made domestically. Domestically made or finished and assembled products represented 71% of its wholesale shipments. US-made furniture is increasingly perceived as better made and available for faster delivery, a critical feature in an increasingly Amazon Prime-driven one-day shipping world.
(3) TJX Companies (TJX)—parent of off-price retailers TJ MAXX and Marshall’s and one of the few retailers to navigate successfully the wrenching changes in retail—plans to expand its Home Goods chain and launch a related concept called “HomeSense,” which already operates in Canada and Europe but will have a different format in the US.
(4) RH (RH), formerly known as “Restoration Hardware,” is pursuing an “un-Amazonable” strategy and totally redefining its approach to selling furniture. While it posted a 23% Q1 revenue gain, its stock plunged recently on the negative earnings impact from liquidating merchandise and adding restaurants to some of its stores.
(5) Bed Bath & Beyond (BBBY), one of the retailers included in Bespoke Investment Group’s “Death by Amazon” index, bought online furniture seller One King’s Lane last fall as a way to deflect the Amazon threat: The younger shoppers attracted to One King’s Lane tend to shop less at Amazon. It plans to open a pop-up seasonal shop in Southampton, NY this summer, the first brick-and-mortar presence for One King’s Lane, and in a former library no less. Take that, Amazon!
(6) Wayfair (W), the only pure-play online furniture seller, is benefiting doubly from both hot demand for furniture and the online channel’s increasing popularity as a furniture outlet. Furniture is one of the fastest-growing segments of US online retail, growing 18% in 2015, second only to groceries, according to Barclays. Wayfair’s direct retail revenues popped more than 32% in Q1. The S&P 500 Internet and Direct Marketing Retail industry has been a sweet spot, rising 45.9% y/y through Tuesday.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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