Fed’s Next Move

As discussed in a previous article (Don’t Fight the Fed…) the Federal Reserve is all powerful when it comes to determining the imminent stock market direction [because of their manipulation of interest rates].

What’s worth considering is what happens when the Fed runs its course.  When interest rates have been kept artificially low for too long- then there’s nothing left to cut when the next recession rears its ugly head. 

Such a scenario may be brewing now.  The Fed has artificially kept interest rates low for over five years and continues schemes to inflate the currency by injecting Quantitative Easing (QE).

The problem is that QE is now in its third rendition and the Fed’s balance sheet has expanded to over $3 trillion dollars.  The Fed is purchasing about 80% of US debt.  QE may have reached a state of diminishing returns- the only thing that’s inflating is the stock market and housing prices.

Growth is anemic.  GDP struggles to exceed 2%.  Corporate profits are up but the rate of growth has slowed.  Top line sales are mostly flat.  So what’s the Fed achieving by dumping $85 billion per month into the economy?  Not much:   2013 combined money printing of $1.66 trillion (QE3 + Deficit) has resulted in GDP growth of $386 billion (2.3%).  Would you “invest” $4 to make $1?

The “experts” clearly would, as long as it’s not their personal money.  Pundits are now predicting that the Fed won’t start easing QE until at least March 2014.  These are the same prognosticators that claimed the Fed would start tapering in October 2013.  Many are claiming that the newly appointed chair Janet Yellen is so loose with money that she won’t taper until 2015 or beyond.

Easing or tapering of QE is a serious matter.  At some point it has to come to an end, but there lies the conundrum.  If QE is cut, equity markets will pull back at the same time that bonds decline in value.  Clearly a lose-lose.  Commodities probably won’t fare any better (even precious metals- remember that gold plunged in the Fall of 2008 just like all other asset classes).

The question on my mind is why is Chairman Bernanke departing before the ship is back on course?  His predecessor Alan Greenspan served 20 years and didn’t retire until the age of 80. [Conveniently just before the housing bubble burst.]  Bernanke is only 60, apparently in good health.  We’re told he’s a scholar of the Great Depression and his QE policies have been implemented to avoid another depression.  So why leave after only 8 years when clearly the economy hasn’t recovered?

Perhaps Bernanke is following the lead of Greenspan and plans to exit before the equity bubble bursts. 

Or perhaps his role is to play the fall guy and cut QE before he departs, so the markets will correct and Yellen can start with a clean slate. 

Alternatively, maybe Yellen’s role is to play the tough guy.  Let Yellen cut QE at the start of her administration- better for markets to crash early in her tenure and hope thing work out in four years when she’s up for reappointment.  She can always blame it on Bernanke.

What will happen?  I have no idea.  We live in interesting times.  The prudent investor is patient.  He waits to enter a market when there is a clear sign that a trend is emerging.

By the way, I don’t feel embarrassed admitting I have no idea when the Fed will end QE, or what direction the market will take tomorrow.  I’m in good company.  Recently Alan Greenspan admitted that he was “surprised” that Fed models didn’t predict the housing bubble.  Isn’t that reassuring?

Don’t fight the Fed…until just before the collapse

Today the Federal Reserve announced that they would continue QE3, injecting up to $85 billion into the economy each month.  This should not come as a surprise to anyone.  Chairman Bernanke plainly stated July 10, 2013 “Highly accommodative monetary policy for the foreseeable future is what’s needed.”

Still, the markets were rattled this summer over the threat of “tapering”.  Substantial reductions were never viable.  At most, projections were that the Fed would only tapered a paltry $10 billion per month.

Quantitative Easing (QE) hasn’t produced a recovery and that’s precisely why they can’t get rid of it.  GDP growth occurred at the fastest rate the year preceding QE’s initial introduction November 25, 2008.  Five years into the “recovery” it’s only stimulating equities and real estate. 

Consider the impact of QE3 and federal deficit spending in 2013.  The combined money printing of $1.66 trillion (QE3 + Deficit) only resulted in GDP growth of $386 billion (2.3%).  Clearly, this is not sustainable.

So what’s an investor to do?  Follow the most reliable Wall Street adage ever uttered: “Don’t fight the Fed!”

QE won’t help the ailing economy but that doesn’t mean that it won’t keep Wall Street and real estate prices inflated artificially high.  The trick, as always, is to get out before the bubble bursts. 

This is a good time to watch for upward trends in the market, as has been the past three weeks.  Take advantage of short term moves created by the unending stimulus.  This is not a time for greed, take your profits often and early.

Muddy Market

I had a mentor that would sometimes tell me that my explanations were “clear as mud.”

We’re currently in a “muddy market.”

I forecast using charts.  The attached chart is an illustration of one of the charting methods I use.  This is a year-to-date chart of the S&P500 SPY exchange traded fund superimposed with trend lines representing three forecasted periods. (Marked 1,2,3)

Period 1:  mid-February to end of April forecast based on January/February data

Period 2:  first two weeks of May forecast based on February/April data

Period 3:  mid-May to end of June forecast based on April/May data

The market performed very bullish during Periods 1 & 2, always trading above the neutral zone (blue horizontal lines).  The market changed personality during Period 3, trading above, in, and then below the neutral zone.  But always within the upper and lower boundaries (red horizontal lines).

Now the SPY looks like it has bounced off support at $156 and is headed up.  But there are concerns.  Trading volume is weak, possibly indicating the lack of institutional investor conviction.  Even more concerning is the circular reasoning used to explain market advances.  Positive news is interpreted as the economy is in recovery…negative news is viewed as assurance the Federal Reserve won’t stop Quantitative Easing (QE).  Investors seem to be ignoring persistent recession in Europe and slowing growth in China. The market only fears the end of QE.

I have no idea which way the market will turn.  Price patterns seem to indicate that it will stagnate sideways or trend down this summer.  It’s clear as mud.

S&P500 Muddy Market 160626

The market doesn’t care what you think…even when you’re right

Some people didn’t like the previous article.  Those on the Left thought I was too hard on Obama and Hillary.  The Right thought I was taking cheap shots at Bush and Palin.  Not surprisingly, no one defended McCain.

The point I’d like to make in this article is that the market doesn’t care what you think.  The market doesn’t care what your cost basis is.  The market doesn’t care if you’re long or short.  The market doesn’t care if you’re up or down for the year.  The market doesn’t care about your ideology.

The market is driven by the interaction of billions of individuals.  These individuals may not be acting rational, they might be ignorant of economics, they may be ignoring reality.  No matter how WRONG the actions of these individuals are, the market will respond based upon the law of supply and demand.  Panic selling will drive prices down; euphoric buying will drive prices up.

On December 5, 1996 Federal Reserve Chairman Alan Greenspan warned of NASDAQ investor “irrational exuberance” (see chart).  He was correct, there was a Dot-com bubble forming.  However, if you had taken his advice and stayed out of the market, you would have missed a 13 quarter rally that increased 288% before peaking on March 9, 2000.

Greenspan was right in the long run, but the market didn’t care in the short run (three year bull market).  I would rather quadruple my money than be academically correct.  Don’t try to argue with the market, buy and hedge.

NASDAQ Dot com bubble

The way we were…post-Obama

EDITOR’s NOTE:  This is a very long post but essential reading for investors interested in market dynamics.

Recently a statist tried to convince me that the stock market has rallied under President Obama.

  • January 20, 2009  S&P500 @ ~831.95
  • June 3, 2013 S&P500 @ 1640.42

Voila, under this regime the market is up 97%.

Don’t let anyone pull that trick on you.  Markets move in anticipation of earnings. PERIOD.

The two major factors effecting corporate earns are energy costs and government interference (war, tax, regulation).  [The third factor is employee wages.]

A perfect storm was on the horizon in 2008, with origins that started in 2006.  Low interest rates and over consumption spurred by the Bush administration’s policies caused inflation which was evident in sky rocketing energy costs (among other things, e.g. gold, housing and wages).  West Texas Intermediate (WTI) hit an all time high in July 2008 at $143.68.  Raw material costs were soaring and a shock way hit businesses as wholesale prices tried to keep pace.  Add to the mix increased government intervention and the expectations for profits were dismal…the market crashed.  [The collapse of the housing market was a symptom, not the cause.]

Why was there a perceived threat of government intervention?  Barack Obama, the most liberal politician ever within reach of the oval office was about to be elected President; his efforts to transform the country would be facilitated by a leftist Democrat controlled House and Senate.  Linked with already historic energy costs this was the perfect storm to redistribute and destroy profits.

Depending on your political ideology, you may not agree with this narrative.  But the fact that millions of people might have held these views is indisputable.  Remember, markets move in anticipation of future events.  Perception effects the market before reality sets in.  [You may think the fears of these Neanderthal racist bigot investors was unfounded, but that’s irrelevant because they still liquidated their stock portfolios en masse.]

Viewing the chart, you can see the performance of the S&P500 along with key political event of 2006-2013.  Point 1 on the chart shows a rising market and the Democrat takeover of Congress in November 2006- the market may have been anticipating needed constraints on the Bush regime’s profligate spending and multiple Middle East wars.

Point 2 Romney drops out of the race making McCain the de facto Republican nominee.  Neither of these men were liked by the conservative right.  Early in 2008 it looked like the choice for President was between tweedle dum right-leaning-statist McCain or tweedle dee left-leaning-statist Hillary.  The crony capitalist could probably tolerate either one.  [Remember this is late January/early February 2008, Obama is raising more money and he’s won some primaries but he’s not yet the phenomenon that he’ll become.  He and Hillary brutally fight out the primary until early June.]

Point 3 Obama becomes the Democrat de facto nominee and in July the price of oil tops $143.68 (WTI).  The whirlwind forces converged to form the perfect storm.  Markets drops to a two year low.

Point 4 the market is up from lows, the McCain campaign receives its only breath of life when Palin is selected as a running mate.  You may not like Palin but remember this was the only positive bump the McCain campaign received.  The only thing that could have energized the conservatives more than Palin, would have been McCain’s sudden death.

Point 5 Palin implodes during Couric CBS interviews.  At this point everyone knew that Obama would be the 44th President of the United States.  The market goes into freefall in October 2008 and doesn’t hit bottom until March 2009 with the S&P500 closing at $676.53.  The market collapse was the steepest since the 1929 Great Depression.

Don’t try to argue that it was Lehman Brothers bankruptcy or the failure of the House to pass the first version of the $700 billion dollar stimulus package.  The market was up after Lehman and then fell the Monday after the Palin interview, surpassing the Lehman low by a full one percent.  If the drop was only because Congress rejected the stimulus on that Monday, then why did it keep falling and never recover even after Bush signed the stimulus into law later that week?

The fact of the matter is that the markets were petrified at the thought of a leftist dream team consisting of Obama, Reid, Pelosi, and Frank.  It’s self-evident.  The left’s stated agenda was- national health care, union card check, cap and trade, carbon tax, living wage, wealth redistribution…to name just a few.  All the while, two extremely expensive wars were nowhere near ending. [As of this writing, Guantanamo is still open and waterboarding has been replaced with ongoing drone strikes.]

So how did the market get back to where it was pre-Obama (minus inflation)?  Two things, quantitative easing (QE) and the fact that Obama’s America didn’t result in Armageddon (not yet anyway).  QE has resulted in the Fed’s balance sheet increasing to approximately 20% of GDP and the national debt over 100% of GDP.  The trillions of stimulus and QE dollars that have been pumped into the economy correlate to the rise in equity markets.  As to Obama’s agenda, much of it has failed or is in the process of failing.

Republicans took back the House in 2010.  Obamacare is law but its critical parts are being dismantled as the consequences are felt.  Federal agencies have restrained growth but Obama’s other initiatives have all failed to pass the House.  The second term has quickly moved from a lame duck to a cooked goose.  Over 80% of Bush’s tax cuts are now permanent; the Sequester antics made Obama look like Chicken Little; now the scandals are emerging: Benghazi (again), IRS political enemies list, Justice pressuring the Associated Press (no one cares about FOX).

Consider how bad things are in the second term- After the slaughter of 20 children at Sandy Hook Obama couldn’t even reinstate Bill Clinton’s “assault rifle” ban, couldn’t expanded background checks, and couldn’t even limit high capacity magazines. Even with the help of effeminate RINOs he couldn’t muster the votes.  Bush (both of them), McCain and Romney would have all buckled under the reactionary nanny state calls to “do something”.  Second Amendment proponents were lucky to have Sandy Hook occur under Obama’s watch.

The great hope for Obama’s second term was a Democrat take back of the House in 2014.  I haven’t checked InTrade lately but I’ll bet the odds aren’t looking real good about now.

So we’re “the way we were” minus inflation and plus trillions in debt.  Time for another crash?

S&P500 vs Obama regime 1