Sound Bites: US insiders flee as Fed officials feud over rates

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According to FactSet, for the second quarter the blended earnings decline for the S&P 500 is -3.5% with 91% of the index companies reporting as of August 12th. That marks the first time the index has recorded five consecutive quarters of year-over-year earnings declines since the third quarter of 2009. Nevertheless, as earnings season winds down, investors are pushing broad US benchmarks to new all-time highs. Investors it seems are buying into the narrative that earnings will only get better from here.

While time will tell if the "things can only get better" scenario will play out, it is clear that investors are paying a high price to bet on that outcome. The average stock P/E as measured by INK remains at 21.6 on a 12-month trailing basis which is at the high end of historic ranges. Meanwhile, as investors are buying, insiders are not. Our US INK Indicator is now just a shade above the 30% mark, at which point there are only 3 stocks with key insider buying for every 10 with selling. It has not been this low since the end of April of last year. The nine months that followed were anything but pleasant for investors. And, just like last year, the US central bank wants to prepare the market for a rate hike.

Indeed, on Tuesday of this week, New York Fed president William Dudley was even talking about a possible rate hike in September.  The next day, however, the Federal Reserve released its minutes from its July meeting and anything but a clear picture emerged. Instead, investors were more or less treated to an open feud among monetary policymakers as to whether or not conditions were in place for a rate hike. The conflict was on full display particularly with respect to inflation. From the minutes:

With inflation continuing to run below the Committee's 2 percent objective, many judged that it was appropriate to wait for additional information that would allow them to evaluate the underlying momentum in economic activity and the labor market and whether inflation was continuing to rise gradually to 2 percent as expected. Several suggested that the Committee would likely have ample time to react if inflation rose more quickly than they currently anticipated, and they preferred to defer another increase in the federal funds rate until they were more confident that inflation was moving closer to 2 percent on a sustained basis...However, some other participants viewed recent economic developments as indicating that labor market conditions were at or close to those consistent with maximum employment and expected that the recent progress in reaching the Committee's inflation objective would continue, even with further steps to gradually remove monetary policy accommodation. Given their economic outlook, they judged that another increase in the federal funds rate was or would soon be warranted, with a couple of them advocating an increase at this meeting.

From our perspective, the notion that the Fed could even seriously contemplate a rate hike right now is odd given that its inflation gauge, the Personal Consumption Expenditure Price Index (at 0.9% year-over-year) remains far from the central bank's stated target of 2%. Even the PCE Core Index which strips out food and energy prices is struggling at 1.6%.

Incidentally, some news organizations have essentially suggested that the Fed is split 50/50 on whether to hike rates now. The passage above suggests otherwise. It is no accident that the term "many" was used to describe those wanting to wait and "a couple" was used to characterize those wanting to hike right away. At this point, it is clear that the not-now-nays comfortably have it.

In any event, while we are not great fans of targeting inflation at 2%, it nevertheless is the stated goal of the central bank. So we are puzzled about the Fed's feud over when to raise rates given that it has failed to meet its inflation objective. We are not alone as insiders are fleeing this market even as other investors ambitiously bid up asset prices.

Perhaps the Fed should spend more time either addressing the appropriateness of its 2% target with the objective of changing it, or alternatively putting forward a plan to convince investors that it will actually meet the current goal.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live broadcast, catch the replay here: http://bit.ly/2blaHb0. This post includes material from the US Market INK Report sent to INK subscribers on August 16th.

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