| AFR: What happens when the US jobless rate has a 3-handle?
From AFR Contributing Editor Christopher Joye |
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In The Australian Financial Review today I consider the history of the US business cycle and the relationship between recessions, changes in the jobless rate, and inflation (click on that link to read outside the paywall via Twitter or AFR subs can use the direct link here). This is crucial because the Fed has for the first time admitted what we long suspected: Yellen is hell-bent on driving the US jobless rate, which is currently only 5.1% (cf. Australia at 6.2%), well below the 4.9% threshold that she considers to be the so-called "non-accelerating inflation rate of unemployment" (NAIRU) beyond which price pressures have historically begun to emerge. In fact, I reckon we are only 15 months away from seeking a US jobless rate with a 3-handle. Of course the Fed is playing a dangerous game whereby it is actively seeking to accelerate the return of US core inflation back towards its 2% target on the basis that there are structural deflationary pressures (eg, output gaps, heavy debt loads, technological change, supply-side damage, etc) that make a wage-price spiral unlikely. The problems with this approach are mutli-fold:
- first, nobody knows where the real NAIRU is and the relationship between inflation and unemployment is constantly evolving (there are indeed reasons to think that the US NAIRU might be materially below say 4.5% given a higher proportion of part-time workers, a cyclically low participation rate, and some elevated long-term unemployment);
- second, as central banks prioritise "nominal growth targeting" (aka business cycle smoothing) over inflation-targeting, the risk is that public (not bond market) expectations for consumer price movements become unanchored and the hard won inflation-fighting credibility of central banks is quickly eroded; and, finally,
- by debasing the price of money to the lowest levels in human history and suppressing long-term risk-free rates through ongoing asset purchases (ie, hugely important Fed reinvestments, and ECB and BoJ quantitative easing), central banks are heavily distorting savings and investment decisions towards leveraged asset-classes that benefit from low interest rates and the associated surge in asset price inflation. They are also concurrently preventing productivity-enhancing creative destruction by not allowing markets to properly "clear" (cf. China’s recent bout of equities-orientated QE). A further risk is that now we have let the controversial QE cat out of the bag, policymakers are tempted to use these "extraordinary" measures much more frequently in an effort to dull the sharp blade of freely functioning markets.
I believe that keeping an eye on the US jobless rate is crucial for long-horizon portfolio investors. One of the most frequently dismissed yet important systemic risks is US economic data (specifically, wages inflation) gradually limiting the Fed’s decision-making optionality and compelling a much steeper yield curve. Click on this link to read outside the paywall or AFR subs can click on the direct link here.
Separately in my AFR column over the weekend, I evaluated the performance of our preferred portfolio posture in 2015, which is a bar-belled strategy split between cash and alpha-focussed long-short and market neutral hedge funds with minimal beta (click on that link to read outside the paywall via Twitter or AFR subs can use the direct link here). Given extreme market volatility, abysmal equity market returns, and never-ending shocks, this approach has proven to be very successful. In this context, I also revisit the returns generated by products I have previously highlighted, including VGI Partner’s long-short global equities solution, Perpetual’s market-neutral Pure Alpha fund, and NWQ’s mutli-manager strategy, amongst others. I conclude with some analysis of so-called "alternative beta", which is an interesting opportunity asset-allocators should consider. Click on this link to read outside the paywall or AFR subs can click on the direct link here.
"CFM has publicly disclosed its six biggest sources of alternative beta: "momentum" in equity returns; the famous Fama and French (1992) anomaly whereby cheap "value" stocks outperform expensive "growth" stocks; a "quality" variable deriving from underlying earnings and cash flows that has predictive capacity regarding future returns; long-term positive or negative "trend-following" strategies across equities, bonds, currencies and commodities confirmed by 200 years of data; "carry trades" that profit from interest rate differentials between high- and low-yielding currencies at the cost of exchange rate risk; and, finally, capturing "volatility premia" by selling expensive options (much like insurance) that capitalise on the fact that people feel more pain from losses than happiness from gains."
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