The U.S. economy, propped up in recent years
by multiple rounds of quantitative easing by the Federal Reserve, is
not even close to being robust. So asserts Stephanie Pomboy, an
economist who has been quite gloomy about the economic outlook—often
ahead of the curve. Prior to the great recession, she correctly
predicted there was trouble ahead. However, Pomboy acknowledges that,
more recently, she missed the huge run-up in risk assets, including
equities. These days, Pomboy, who founded the New York firm MacroMavens
in 2002, is especially worried that the U.S. doesn't have enough
strength for sustainable growth without another boost from the Fed. And,
she says, too many investors have a false sense of security about the
economic fundamentals. Two of her main investing
recommendations—Treasuries and gold—reflect her caution.
Barron's: Let's begin with your macro view.
Pomboy:
The No. 1 th
ing is that investors generally have underestimated the
impact that QE [quantitative easing] has had on the economy and the
degree to which it has supported growth. As a consequence, they have
underestimated the cost the tapering [of monthly Treasury bond purchases
by the Fed] would have, and that is starting to come into focus. People
will realize that the economy really has not achieved any
self-sustaining momentum and that it requires continued stimulus. I
liken it to a car on a flat road that has no momentum. When you take
your foot off the gas, the car just stops moving. That's essentially
what the Fed is doing.
Eventually,
people will start to connect the dots and say, "Hey, wait a second. We
had five years of unprecedented monetary and fiscal policy, and the Fed
did succeed in reinflating asset prices. Household net worth increased
$25 trillion from the lows of the financial crisis, and yet we haven't
generated a sustainable wealth effect." Maybe this is a dark place to
go, but where would we be if the Fed hadn't succeeded in inflating
household balance sheets to that degree? It is scary to imagine, because
if you look at a chart of nominal consumer spending, which is 70% of
GDP [gross domestic product], it has continued to decelerate, even in
this period of unprecedented monetary accommodation and rampant
financial-asset inflation.
Where do the equity markets fit into your thesis?
What
happens if stock prices just stop going up at this pace, much less go
down? We don't even have to talk about the latter scenario. But if stock
prices just stop inflating at the rate they had been in the past couple
of years, what are the odds that consumer spending grows any faster
than it has? And yet, that's the expectation—that the economy can
withstand the taper, growth has its own momentum, spending is going to
accelerate, and employment is going to accelerate.
What kind of U.S. economic growth do you expect?
I
see growth generally doing what it has done, which is to continue to
gradually slow. We've had a steady decline in nominal growth, basically
since 2000. So I can see the U.S. economy continuing to grow at a slower
pace. If GDP growth is currently 3.7%, I could see it slowing to 3% or
2%, with nominal Treasury yields coming down along with it. And over the
longer term, there is no material upside risk to Treasury yields,
contrary to the popular perception that rates are going to the moon.
Where is the yield on the 10-year Treasury, currently around 2.6%, heading?
I
expect to see Treasury yields trading in a range from 2% to 3%,
basically how it's been for the past several years. You want to sell at
2% and buy at 3%. I wouldn't be surprised to see rates fall below 2%, as
investor perceptions about the economy meet with reality and they
realize that the Fed still has a lot of work to do. In the past, the
prospect of the Fed pausing the taper would have been a recipe for
running to risk assets. But this time, there would be such
disappointment that the economy really isn't up to snuff. We will have
had QE1, QE2, and QE3. So how many times is the Fed going to get it
wrong before people start to say, "These guys don't know any better than
the rest of us what's going on, and they certainly don't have the
solution because they've done QE three times and it hasn't helped?"
Where does the housing market fit into all of this?
To
me, that's really the key piece, because the impact that QE had on real
estate is arguably the most effective part of this whole policy. I
share a lot of the cynicism about the effectiveness of QE and whether it
just expanded the wedge between the haves and the have-nots. But it
clearly helped generate this recovery in real estate prices, which did
lift 5.5 million households out of negative equity. That had a
legitimate cash-flow impact, as these people could either sell their
homes and relocate to find a job or refinance their mortgage, because
suddenly their homes weren't underwater. So it had a legitimate,
positive economic impact that you can quantify, to say nothing of the
benefit to the financial sector. But all of that came to an end when
[former Fed Chairman] Ben Bernanke just talked about the possibility of
tapering last May. So a full year has gone by, and the housing market
has yet to recover its footing from just the threat of tapering.
Fixed-mortgage rates have come down a little bit on the back of this
recent rally in U.S. Treasuries, but rates for 30-year fixed mortgages
are up 70 basis points, or 0.70%, versus a year ago.
On
top of that, home prices have gone up, putting affordability further
and further out of reach for many people. So what we need to sustain
housing from here, if anything, is lower rates, not a taper.
What else concerns you about economic growth?
One
chart that really summarizes my entire view compares net worth with
consumer spending. Of the $25 trillion expansion in household net worth
since March 2009, $21 trillion was financial assets, and $3 trillion was
real estate. So the $21 trillion helps a very small segment of the
population, while the $3 trillion has a much broader impact. But it is a
massively disproportionate benefit for the high end. Even though people
in that group are the marginal drivers of the economy because they
spend a lot more, overall consumer-spending growth has continued to
slow. In the past 50 years, we have never seen household net worth
increase this much without spending growth accelerating materially as
well. This time, though, spending growth has decelerated, and each year
it takes another step down. With asset prices still not girding
spending, we need income gains. And unfortunately, employment isn't
ready to take the handoff. While the latest employment figures have
fueled the hope that things are returning to normal, the numbers are
skewed by people holding more than one job. Jobs have increased, but
hours have not. This is reflected in the gap between the household
survey—where they ask if you are employed—versus the payroll survey,
which adds up each payroll.
What are some of your key concerns about consumers?
The
increase in spending—punk as it is—is almost entirely due to higher
prices—not higher demand or unit sales. Fully 90% of the increase in
discretionary spending from the precrisis level is explained by
inflation. In other words, people aren't spending more because they want
to. They are spending more because the price of all the stuff they buy
has gone up—hardly a sign of consumer strength.
Haven't you been too gloomy at times over the years?
At
every turn, expectations for the economy have proved to be far too
sanguine, and my seemingly pessimistic view has been vindicated. The Fed
has repeatedly had to lower its assessments for growth, and renew QE.
So my feeling is that I've nailed the economic forecast and that, as a
consequence, I was right on interest rates. What I missed was the flight
to risk against a backdrop of weakening growth, and I admittedly
worshipped at the altar of the fundamentals. Liquidity can only take you
so far, and at some point, the fundamentals win out, as they did
ultimately in 2008. You could have asked me that question in 2006 or
2007, and I would have said, "Look at what all the economic data are
telling you–people are defaulting on their mortgages, etc., and the hit
is coming." And, eventually, it did. At some point, the fundamentals
will be undeniable, especially at a time when the Fed is taking away
liquidity by tapering.
And the Fed
can't continue to taper Treasury purchases, considering that foreign
purchases of Treasuries have collapsed in the past several years. We
used to rely on foreign financiers to fund our borrowing, but those days
are long gone. They are buying Treasuries at a rate not much above $100
billion a year, down from $800 billion 3½ years ago.
What's the implication of this?
Foreigners
are buying about $10 billion a month of Treasuries. This compares with
deficit financing needs for the U.S. government of roughly $40 billion a
month, based on this year's deficit. So the Fed needs to pick up
roughly $30 billion a month in slack. When the Fed slashed its buying to
$25 billion, effective this month, it for the first time opened up a
demand deficit for Treasuries. If they continue to taper, that gap will
expand, and things could get bumpy in the Treasury market. Rates won't
go up five basis points before the Fed would start talking about more
QE.
Who is going to buy a 10-year
Treasury yielding 2% when inflation in the U.S. is 2%? No
profit-oriented domestic investor is going to do that. We were able to
rely on foreign central banks to buy our Treasuries, because they were
trying to debase their currencies to manage their exports. But that's
not the case anymore. The upshot is that we are out of natural buyers of
Treasuries, and that's where the Fed has been so critical. So
unbeknownst to many, the reason why Treasury yields are 2.6% is in part
due to the economy, but it is largely due to the fact the Fed has just
been sopping up all of the surplus supply that foreigners are leaving
behind.
So, what kind of investing makes sense now?
Given
my thesis that the Fed is going to have to taper the taper, so to
speak, it will become clear that the economy can't handle a reduction of
stimulus. As a result, Treasuries should continue to rally, in part
because buying long-dated Treasuries is the mechanism by which the Fed
will continue the stimulus. Second, the dollar should take a hit. There
is a feeling that the U.S. is the furthest along in the recovery as it
unwinds its stimulus, while the central banks in Japan and Europe are
just getting started.
OK, then what assets are attractive?
The
easiest way to play the idea that the dollar is going to take a hit in
terms of global psychology is being long gold. This brings me back to
the trades that I have recommended throughout this entire postcrisis
stretch: Be long Treasuries and gold, as the twin beneficiaries of
continued monetary accommodation.
Could you summarize a few other investment themes?
In
the U.S., the consumer discretionary sector is the most vulnerable, and
those stocks have come under pressure recently, along with the retail
stocks. I'd probably want to be overweight the large-cap multinational
companies versus the small-caps, because when you have a slowdown in
growth, you want to stay with the companies that have the economies of
scale. And in this environment, it would be good to have access to
global consumers, rather than having all your eggs in the U.S. consumer
basket. Looking more globally, I really do think that Russia and China
are interesting plays. Yes, growth has slowed in the emerging economies,
but they are still expanding faster than all the developed economies
are. They are unencumbered by debt, and they have a much better
demographic situation than many of the developed countries do.
Thanks, Stephanie.
At the Economic Club of New York, New York, New York
October 15, 2007
The Recent Financial Turmoil and its Economic and Policy Consequences
http://www.federalreserve.gov/newsevents/speech/bernanke20071015a.htm
It does seem that, together with our earlier actions to enhance liquidity, the September policy action has served to reduce some of the pressure in financial markets, although considerable strains remain. From the perspective of the near-term economic outlook, the improved functioning of financial markets is a positive development in that it increases the likelihood of achieving moderate growth with price stability.
However, in such situations, one must also take seriously the possibility that policy actions that have the effect of reducing stress in financial markets may also promote excessive risk-taking and thus increase the probability of future crises. As I indicated in earlier remarks, it is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In particular, as I have emphasized, the Federal Reserve has a mandate from the Congress to promote maximum employment and stable prices, and its monetary policy actions will be chosen so as to best meet that mandate.