Are you a Counting Crows fan?
Karen and I saw the band years ago at Red Rocks, our fabled foothills venue. Front man Adam Duritz lived, he said, in Denver as a child. One great song goes, “It’s a long December and there’s reason to believe that this year might be better than the last.”
On this last day of November I’m thinking back. On November 30, 2015, marketwide short volume – daily trading on borrowed shares – was about 43%, a low number versus trailing standards. By January 2016 it had risen to 52%. At Nov 28 this year its 43%, the same as last year.
The dollar then as measured by the DXY Index was the strongest in a decade, at 100.5. It’s at 101.0 now, a fourteen-year high.
Let’s pause. What’s a strong dollar mean? Using an analogy, a football field is one hundred yards long. Suppose your team is way behind, down 30-0. So the referees shorten the field to 60 yards to give you a chance to catch up.
A strong dollar is a long field. A weak dollar is a short field. Weak dollars shorten play by making prices rise, earnings from abroad converted back to dollars appear stronger, and borrowing cheaper.
From 2009-14, the USA played on a short field, thanks to the Federal Reserve. We were down 30-0. By latter 2014 we trailed about 30-14. I use that score because by historical measures – housing starts, GDP growth, discretionary income, retail sales (excluding autos), industrial output, productivity and more – we are half what we were.
But we’re catching up, so the Fed is getting set to stretch the field again (Aside: We should never shorten the field. If you’re used to running 60 yards in practice but the games play at 100, your training is all wrong. A steady dollar is what we need.).
Getting back to our December comparisons, in 2015 the Fed inched the cost of overnight borrowing called the Fed Funds Rate up to 0.25%-0.50% (it settles sort of in the middle), the first hike in ten years. This December it’s widely expected the Fed will mosey the rate up another 25-50 basis points. Simpatico again.
In December 2015, the bond market was weak, with interest rates on the 10-year US Treasury at 2.33%, up from 1.7% in January, a 39% increase (prices and rates move inversely, so when people sell bonds, rates rise and when they buy them, rates fall). As November 2016 ends, the 10-year Treasury is 2.32%, from 1.4% in July (68% rise).
And the S&P 500 is about 5% higher now. (Speaking of stocks, don’t miss our NIRI webinar tomorrow called Hide and Seek: The Incredible But True Story of How Big Institutions Buy and Sell Your Shares.)
There is one major difference between then and now. Using our long-field/short-field analogy in a different way, when the Fed’s balance sheet has big bank reserves, that’s a short field. Low bank reserves, long field. Between early December 2015 and early January 2016, the Fed took $500 billion out of bank reserves, pushing the playing field to the full hundred yards as it tightened rates.
The whole globe rocked.
Stocks imploded and money screamed into bonds, driving rates down. For awhile at the end of January it seemed downside for the market was bottomless.
By pushing the entire $500 billion back into reserves and chopping the playing field to 60 yards, the Fed got stocks to reverse and soar all the way to the Brexit (they overdid it).
This time they’re starting December where they began January, with a long field and low reserves. They believe they can hike rates December 14 and hack the playing field down to 60 yards by boosting bank reserves, and thus next year will be better than the last.
They might be right.
I’ll tell you the risk should they get it wrong and what would set it off: If the economy lurches sharply down – despite headlines this week there’s a real chance of a recession next year looking at trends – then the Trump Rally will be a big belly well out over the Fed’s skis as winter hits. If that happens this current year will be better than the next.
I’m hoping for a short December.