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“It was something devastating — and unreal — like the beginning of the end of the world — or the end of it”

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There’s a post-Fed hangover in the market this morning and dark clouds over Wall Street.  After the market followed the recent Fed day script nearly step for step yesterday, international markets continued the downward trend overnight, and US markets are picking up right where they left off yesterday with the S&P 500 down nearly 1% and the Nasdaq down over 1%.  Not surprisingly, investor sentiment has taken another hit as the latest data from the American Association of Individual Investors (AAII) showed that bullish sentiment declined to 31.3% from 34.4% and the lowest level since late May.

Besides the Fed, there’s been a ton of other central bank activity overnight, so read all about it in today’s report.  On the economic calendar, initial jobless claims came in lower than expected falling to 201K compared to forecasts for a level of 225K.  Continuing claims also came in 30K lower than consensus forecasts.  Lastly, the Philly Fed manufacturing report dropped to -13.5 which was the lowest level since April and was well below consensus forecasts of -2.

If you told us that the above quote described an event that occurred on this same day in a prior year, 2008 would immediately come to mind, and you would think it came from someone on the former Lehman Brothers trading floor or another investment bank. Lehman had just filed for bankruptcy, and AIG, along with the rest of the financial sector, was teetering on the brink of collapse.  At least that’s the way most remember it.  What you may be surprised to hear, though, was that while the S&P 500 closed at 1,251.70 on the Friday before Lehman filed for bankruptcy, the Friday after, it closed at 1,255.08 for a gain of 0.27%.  Not much to brag about, but not bad considering the largest bankruptcy in US history.

The market always looks forward, and by the time Lehman failed, the S&P 500 had already dropped 20%. Anyone who went home that Friday after Lehman probably breathed a sigh of relief thinking the worst had passed, but the calm of “Lehman week” was only the eye of the storm.  Over the course of the next 115 trading days, the Financial Crisis would knock another 44% from the S&P 500 before finally heading out to sea.

So, when is the quote from, and who said it?  It was none other than Katherine Hepburn, and she was describing the “Long Island Express” hurricane which struck eastern Long Island on this day in 1938. Hepburn wasn’t even on Long Island at the time, but instead in Connecticut at her family’s summer home in Old Saybrook on the Long Island Sound.  Below is the entire quote.

“It was something devastating — and unreal — like the beginning of the end of the world — or the end of it” — and I slogged and sloshed, crawled through ditches and hung on to keep going somehow — got drenched and bruised and scratched — completely bedraggled — finally got to where there was a working phone and called Dad,” – Katherine Hepburn

The “Long Island Express” surprised just about everyone at the time.  Back then, there was no radar, satellites, or weather buoys, and forget about hurricane hunters.  The only way to detect a tropical storm or hurricane was if it hit land or if a ship encountered out at sea. On a side note, it’s also a reason that storms appear to be more numerous now than they did over time.  Back then, if it was out of sight, it was out of mind.

While ships out at sea had encountered the storm, forecasters were anticipating a track towards Florida, but then the storm turned, and on 9/20/1938, the AP reported that it was headed out to sea. The morning of 9/21/1938 was sunny in Long Island, and people were eager to enjoy a day outside after what had been days of rain.  The only hint of unsettled weather was a forecast from the Weather Bureau which noted that “The tropical storm will be attended by rain in New England and portions of New York and the Middle Atlantic States tonight”.  The part about rain they got right, but they completely missed the direct hit of a category 3 hurricane on Long Island and southern New England.  It was a hurricane so strong that it permanently altered the geography of the coastline it encountered.

The chart below shows the path of the 1938 hurricane which took it right over the Hamptons on Long Island, which is home to some of the most expensive real estate in the United States, and into Connecticut and Rhode Island.  There hasn’t been a direct hit of a hurricane on the coast of Long Island since 1985, and when Superstorm Sandy hit the New Jersey coast in 2012, its maximum winds were 80 mph. A category three storm like the one in 1938 packs winds in a range of 111 to 129 mph.  The financial impact of the storm totaled $620 million which translates to nearly $14 billion in today’s dollars.  That may sound like small change compared to a storm like Hurricane Katrina which caused nearly $200 billion in damage, but think about how much less the region was built up back in 1938 versus now.  Also, real estate building codes in the region aren’t nearly as strict when it comes to hurricanes as in an area like Florida or even other coastal areas in the southeast or along the Gulf Coast.  It’s been a while, but that doesn’t mean the threat is any lower, and as we all know from experience, problems tend to pop up when they’re least expected.

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“There is one kind of prison where the man is behind bars, and everything that he desires is outside; and there is another kind where the things are behind the bars, and the man is outside.” ― Upton Sinclair, The Jungle

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It’s Fed Day, and while these are always eventful days for the markets, there is basically zero chance that the Federal Reserve makes any change to rates this afternoon, so the real focus will be on the Summary of Economic Projections (SEP) and Powell’s press conference at 2:30.  Outside of the Fed announcement, there is no economic data on the calendar, but we will get earnings reports from FedEx (FDX) and KB Home (KBH) after the close.  Heading into the opening bell, equity futures are higher, while yields, the dollar, and crude are all modestly lower.

Investors are on tenterhooks this morning waiting for the latest economic projections and statement on interest rates from the Federal Reserve.  With control over the cost of credit and supply of money in the economy (and a nice marble building), the Federal Reserve is in a powerful position.  However, even the most powerful people can’t predict the future, and the ability of the men and women who make up the committee to predict where the economy is going probably falls somewhere between Jimmy the Greek’s record on Sunday NFL games in the early 1980s and Pete Rose’s betting percentage on the 1987 Reds.  Despite that reality, when the statement and economic projections hit the tape in a few hours, billions in capital will be shifted based on their contents, and traders will make and lose fortunes based on how they were positioned heading into the announcement.   Play ball!

It was just over two months ago that headline CPI for June dropped to 3.0% and investors thought some real progress had been made on inflation. With that progress, the view has increasingly been that the Fed would move to the sidelines taking a wait and see approach towards interest rate policy. Unfortunately, for fixed income investors, though, interest rates have done nothing but go up.  Since 7/13, the day after the June CPI report, yields have been higher across the curve to levels not seen in at least 15 years.  At the very short end of the curve, the 3-year yield is up just 5 basis points (bps), but two-year yields are up 34 bps, and 10-year yields have shot up 50 bps.

In terms of how those higher yields impact price, the iShares 20+ Year Treasury ETF (TLT) is down 8% and back down near its lowest levels since 2011. Talk about a lost decade!

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