It is the end of 2015 and we have been in for a wild ride, driven by Fed interventionism and uncertainty. The Fed raised rates to the upper end of their 0 – .25 years long ZERO rate policy. However, the 25bps raise had little effect on bonds or the market in general, yet it did quiet the media who has been myopically focused on whether or not the Fed would raise rates this year. For the most part nothing has really changed, the Fed continues to inflate the money supply, continues to buy bonds, continues to buy mortgage back securities, and rates now floored at 25 bps, is not really that much of a change.
So what should we expect for 2016?
Predictions next year come down to whether or not the Fed continues to drive market headlines as to whether or not they will change policy. No doubt the Fed continues to be the buyer of last resort, supporting bonds and inflate asset prices. I don’t see the Fed exiting in 2016 and I also don’t see any significant change (hike) in rates.
All year commodities have been under pressure, regardless if it is oil, corn, gold, or soybeans all commodities have headed significantly lower. The primary driver for this has been the strong dollar. Remember at the beginning of 2015 the headline story that drove the dollar all year was the end of QE and the Fed was going to hike rates. Meanwhile Japan, Europe, and China have been taking an easy monetary approach, by cutting rates and increasing their own versions of QE. That drove foreign currencies lower against the dollar. This drove the dollar higher and commodity prices lower.
Commodity prices have become far more attractive. Yet the hypocrisy abounds as I heard one person said gold is a bad buy at these levels, but then later was excited how cheap gas was. I am not sure if they made the connection that all commodities are driven lower by the stronger dollar. We are certainly pleased to buy cheaper gas, but to be critical of other commodity prices that are low is rather short-sighted.
I believe there is still some room to see the dollar spike higher at the beginning of the year, but not much longer. Perhaps see the DXY (dollar index) break above 100 again. However, unless the Fed takes a Signiant hawkish position we could see the dollar begin to collapse. 94 is the support through 2015 and if that can’t hold, we could see it fall into high 80s before support is found. A drop in the dollar into the 80s means we should see commodities make a significant rally.
A drop in the dollar, means this could be the year of the beginning of the commodity rally and that also translates into inflation.
courtesy of FRED
We have been in what seems to be a disinflationary (a contraction of inflation) environment if we measure it by the PCE, CPI, or PPI (all inflationary measure indices), we can confirm that disinflationary pressure by looking at the decline in the commodity markets. However, we must ask WHY we are experiencing disinflation. The Fed’s easy monetary policy is trying to spur inflation, by pushing bond prices higher, lowering rates, buying bonds, and increasing the money supply. Some would say the Fed policy, which is expected to create inflation, has failed.
courtesy of FRED
The reality is that outside forces are the primary cause for the disinflation we are experiencing. We live in a global trade and consumption environment. The Keynesian theories were developed in the 1930s, when nations were self-reliant and global trade was related only to a few agriculture items (coffee, tea, etc.). The U.S. was self-reliant, it had oil, steel, manufacturing, and thus the nation could implement nationalist and protectionist policies (rightly or wrongly). The Keynesian theory was created under this self-reliant paradigm, we printed our own money, we created our own goods, and we had our own commodities. There was belief the government could intervene and help the economy when needed.
Today is radically different, the majority of our goods are imported. We import durable goods, finished goods, commodities, agriculture, pretty much everything. We have a trade deficit as we consume far more than we export. Keynesian theories based on the self-reliant economies over 70 years ago (pre-World War II) are not working today. Proof is that after printing trillions of dollars, buying trillions of bonds, and keeping rates at zero – we are not seeing any inflation, actually the opposite.
Global trade has made us become more reliant on our trading partners and therefore more reliant on the value of their currencies (trade weighted dollars). If our trading partners change THEIR own monetary policies to make their currency stronger or weaker, it directly impacts our purchasing power of their goods.
Currently all our trading partners are devaluing and weakening their currencies, by cutting rates and increasing their stimulus (QE type policies), while the US in 2015 has begun to strengthen their currency. The irony is that we have done little to strengthen the currency other than a paltry 25bps rate hike, but the perception is driving theirs and sometimes perception is everything.
The silly “Unicorn” moniker for these extremely over valued companies harkens back to the dot.com era. They are the first to stall and get burned and I think we will see more consolidation and also fewer IPOs in this category.
Apple closed down on the year and I think that is a surprised to everyone. Google on the other hand had a solid year. The tech sector will continue to be mixed and I think strength will continue to come from disruptors as well as the Asian tech sector, who will be the next Samsung?
Environmental disrupting companies will also gain traction. The world has latched onto the global warming story and that is driving nations to change environment policies and consumers are becoming more conscious in their purchases. Tesla seems to be the harbinger and we could see more battery, green, and other environmental conscious companies rise up. These could be take-over targets by oil companies and companies like GE that are trying to expand into this growing space.
The general market I think will have a more difficult year, much like 2015. Investors will need to be selective in creating their portfolios, as picking broad based index ETFs or index tracking mutual funds will most likely under perform a more sector driven economy and market.
The dollar rally which is driving disinflation can quickly become deflation. It is deflation that is the greatest fear of the Fed. The Fed certainly painted themselves into a corner and has been forced to raise rates in December, I am sure they hope they don’t have to again and thus further drive the dollar higher. Hopefully the rate hike has quieted the media and they can now turn back to their easy money policies and curb the dollar rally.
Support & Resistance
INDU 17,400 – 17,800
The last day of the year and I would not expect much. I think we will be hard pressed to push above 17,800. I would look for a visit to 17,400 and if that does not hold, watch the 17,200 area.
NDX 4600 – 4700
The tech heavy index has held up well, despite some volatility. I think a drop to 4600 is in the cards and we need to see if it can hold that level. The beginning of the year could bring volatility with a test of 4500.
SPX 2040 – 2080
Push above 2080 could happen to close the year out, but I suspect selling pressure and we could see 2060, then 2040, and eventually 2020 before a support is found. I don’t see a strong rally in the near term.
RUT 1140 – 1180
The Russell finished the year very weak. Since the Summer the Russell could never rally back. We hit a low in late September, but unlike the rest of the indices it had no steam to keep going and we stalled and fell again. The Russell is the key indicator of order flow and now it is showing weakness. If we can see the Russell move higher into the new year to 1180 and move higher it might spell a good rally for the other indices. However, if we can break above 1160 and we see a decline to 1140 and then 1120 – it doesn’t bode well for the general market. 1120 is a key support if we need to pay attention to if we decline in the New Year to that level.
In conclusion I think the big story that will not get much attention, but will drive the markets (commodity, stocks, bonds,) will be the dollar. If the dollar index can hold in the 95 – 100 range through 2016 it will be a nonstory. However, I don’t think it will stay there and if we crack below 94 we could see a spike in inflation, that drive commodities higher. The Fed’s wish of inflation could come fast and too much, which would be unwelcomed.
The coiled spring of inflation is under considerable pressure as the Fed has poured trillions into the system and continues to support bonds, while keeping its foot on the throat of interest rates. The velocity of money continues to decline as the money continues to pile up higher behind the dam.
courtesy of FRED
courtesy of FRED
When will inflation come? That will be based on what happens with the dollar index and the velocity of money – those two will be the prime indicators. The question is not whether it comes, but how fast does it come.
Courtesy of www.publicdomainpictures.net