retail sales number changes nothing. Everybody and his no good brother-in-law now
is going to hike its
fund rate target by 50 basis points next week, right? I think so, too, but I'd be more comfortable in my opinion if I didn't have so much company. Too much company often means you're wrong -- as in football, there are penalties for piling on.
It is now taken virtually as a given that the
FOMC will intensify its campaign to stamp out excess, so investors are trying to figure out the economic/sector/earnings impact of the tightening. It was mere weeks ago that a case was argued with a straight face that high-multiple tech-sector stocks would be immune to Fed tightening because they had little or no debt. That view has now been demonstrated to have been either rationalization, wishful thinking, or sheer lunacy. Money has since fled the tech wreck to move into "safe havens" in such sectors as financials, consumer durables and energy -- i.e., into businesses that have traditionally been viewed as cyclical and/or credit-sensitive.
This strategy smacks of rotational rationalization to me. We're in a market period when investors are advised to look for value. It's a "last shall be first" moment in which money is flowing from stocks that have worked into those that haven't. There may, indeed, be plenty of cheap stocks out there to be bought, but my enthusiasm is muted by the notion that, just as expensive stocks get more expensive, so, too, might cheap stocks become a lot cheaper as the Fed adds pressure.
Cash is the ultimate diversifier, but today's facts of life in professional money management -- competitive factors, prospectus language, compliance reviews and consultant scrutiny -- mean that money isn't likely to leave the equity market for other asset classes unless the client, the beneficial owner, makes the call. That is a risk to consider as the Fed ratchets up its rate target and thereby elevates the returns available in short-term investment alternatives.
But if relentless Fed tightening is now conventional wisdom, there is more heterogeneity in the views about the results that are likely to flow from that policy. Soft landing would still prevail over hard among economic forecasters if, as pollsters put it, the vote were taken today. But the probability of a hard landing is almost surely rising, in the minds of policymakers and private sector forecasters alike. As these concerns are voiced in the weeks ahead, the pace of market rotation is likely to speed up as perceived safe havens rise and fall with the shape-shifting changes in the best-guess outlook.
During this process, keep in mind that the brakes don't always grab in the place where they are applied. Remember Mexico in 1993-94, Southeast Asia in 1997 and Russia in 1998 -- or Mexico in 1982, for that matter. Among the integrated markets of our increasingly globalized economy, the effects of Fed action are much more complex than simple teaching models have it.
A Fed tightening campaign was brought to conclusion by the collapse of Mexico in 1982; another was complicated by the "peso-ization" of the dollar in 1994. The soaring dollar led to the 1997 crisis in Asian nations that had inflexible currency links to the U.S. unit. Russian default and its fallout in 1998 forced the Fed from a tightening bias in August to outright ease in October. In a dollarized world, Fed tightening can grab anywhere that dollars change hands, wherever balance sheets are weakest.
Where might they grab this time? With loosened linkages between the dollar and those past victims, it just might be that this time our brakes actually grab us. The cheap euro may provide insulation to Euroland's economy and markets. Japan? Well, maybe. But recent U.S. equity-market trends heighten the sense that this time it might be our own economy's turn to eat home cooking as dished up by the Fed.
Household-sector debt is one area of concern, especially with the explosion in margin accounts and subprime lending. Corporate debt quality may be deteriorating, as reflected in widening spreads. Or it may be the dollar itself that becomes the pinch point. If Fed tightening causes mayhem in U.S. asset markets, or the U.S. growth outlook comes in for downward adjustment, and is then seen as a slower grower than a resurgent Europe, the dollar could become the trigger mechanism in a vicious cycle of restraint -- slowdown -- depreciation -- inflation -- restraint -- etc.
The point is, don't get blinkered like Dobbin -- scope the whole field. As
Greenspan & Co.
tighten the vise, stress will be felt in markets worldwide. This time, the strain and stress fractures may appear here first. But in case you now think that there is relatively easy money to be made in "low risk" bearish strategies -- now that the trend has turned and an unfriendly Fed has yet to get really started -- recall that pain elsewhere in the dollarized world resulted in additional legs up for the great 1990s U.S. bull market.
It's a complex jungle out there -- don't be a hero.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at