The Battle

Posted on: by .

Market pull back was significant and certainly has triggered concerns that a larger correction is looming. While I am expecting some significant pull backs in equities, I am not sure THIS is the start of a broader correction – not yet anyway. I am certainly not bullish the broad market based on strong fundamentals, my general bullishness remains that I still think there is some steam left in the Federal Reserve train and they are NOT going to start raising rates or end accommodation – not anytime soon.


The Battle

The battle is between the Federal Reserve and the laws of Supply and Demand. I will always take Supply and Demand to go the distance; it has a winning track record. However, I still think the Fed can go a few more rounds. So far – from an investor return standpoint, there is nowhere else to go; bonds pay nothing, cash has negative real returns, so what options are out there?

Lastly, there is a mid-term and a FOMC meeting coming up – any weakness that brings heightens concerns about the market and economy will be met with more Fed accommodation.

As my recent Market Previews have pointed out there are some fundamental problems, chief among them is the leveraged margin that has been keeping pace with the rise in the markets. With volume light and market forces driven on borrowed cheap money, the game eventually ends in disaster if not mitigated and reduced. When does debt hit its limit and there is no more to borrow? I am not sure, as I previously mentioned, unlike the previous bubbles, the Fed is also in this game. That means we can certainly make a larger bubble and for longer and when this one bursts it could get very ugly.


Know thy Market!

I am not adverse to investing into the bubbles and gaining as assets inflate, but one can’t also be fooled into believing it is not a bubble. If we remove the Fed’s accommodation and return to the free market interest rate environment, what happens? I think we all know the answer to that and by admitting to the results we can only come to one reasonable conclusion that a large portion of this ongoing years long rally is fueled by Fed accommodation.

So when does the battle between Keynesian Fed accommodation and the laws of Supply & Demand end? I am not sure, but I do believe we are getting close to an end game. Not because the Fed will STOP accommodation or zero interest rates, I don’t see the uber-dovish Keynesian Fed becoming hawks and raising interest rates. So what is the end, if not the Fed ending their accommodation? It comes when the forces of Supply and Demand overwhelm the powers of the Fed. A catalyst event could be the tipping point and this event may very well a re-pricing of a major of commodity out of the dollar, a global shift to a new reserve, export/import currency trade regime by the BRICs, or even perhaps an internal domestic break of faith on negative interest rates. I am not sure what it will be, but it will be something that cracks the faith in the currency.


To ignore history, is to err!

Yesterday I pointed out this happened before in 1971 when the gold standard ended. Regardless if you are for or against a gold standard, the results of coming off the standard shook the world’s faith in the new US FIAT currency, the dollar based solely on credit and faith. Inflation rocketed as the dollar was unpegged from gold at $35 an ounce, we saw oil, gold, commodities rocket as the world started dumping dollars for assets and the Fed and the US was caught in the bluff of inflation – which had been hidden by the gold standard. As I mentioned in yesterday’s preview, Volcker (Fed Chair) and the Fed was concerned that hyperinflation could hit at any moment. Inflation was moving up rapidly with no end in sight and Volcker’s ballsy response was to rocket interest rates up to 20% to HOPEFULLY garner enough buyers of dollars for the high interest rate return, in hopes to halt this massive dump of dollars. The inflation rocket that was on the launch pad to hyper-inflation. It worked, but also added decades of huge future debt to this nation. Think about the billions in government bonds issues with 15-20% interest rates. I had talked with a broker from the era and he said he could NOT even sell bonds at 15%, 16%, or 17% – investors were seeing the bond market collapse and inflation on the rise. They knew from history that tomorrow could bring 25% or perhaps 50% rates and hyperinflation – who knew where it would stop. Those that locked in 20% rates were smart or were they just lucky? Hindsight is easy, but can you imagine at the time buying a bond paying 10% thinking you got a good deal, only to watch months if not weeks later the same bond paying 15%? You would certainly feel like a chump and when markets are moving quickly and panic is setting in – people don’t make the wisest of decisions.


Rates under Volcker (1975-1979 NY Fed President / 1979-1987 Fed Chair)


Keynesian’s Disingenuous History Lesson

The fact is most people don’t realize how close this nation came to a dollar collapse and hyperinflation in the 1970s and how WE failed the gold standard. The gold standard didn’t failed, the government failed in their responsibility and accountability of maintaining the standard and the world called our bluff. We lost and faced a possible collapse. Of course you will not learn about this in school or even in college economics, because we are still taught Keynesian economic theory in school and they would never admit the failures of economic policies they theories help create – it is usually blamed on others, as they don’t want to admit or challenge their economic theoretical beliefs. Bretton woods collapse, London Gold Pool, Two-Tier Gold Scheme, 1970s Inflation, and the rest in many cases are not even mentioned in College or High School history or economic text books and if it is – it is skimmed over or blamed on others. We have been taught to believe and it has been well marketed that the problems with the 1970s was an Oil Crisis and blamed on the Middle East – but that was a RESULT of the economic demise of the dollar and the introduction of the Fiat currency, not the cause. It all comes back to the dollar. The 1960s-1970s is a massive economic embarrassment for Keynesians and US economic policies, much like the Vietnam War that accompanied the time. However, you can’t hide the Vietnam War from the public – it was on TV and our men were coming home in body bags. However, hiding and blaming economic woes and math on far off places is far easier – because it is not tangible and most people don’t understand it.


Courtesy of www.kitco.com


Currency Devaluation War!

Today the dollar has been rallying, not because of any Federal Reserve Policy. In fact the Fed policy has been TRYING with all their might to WEAKEN the dollar and create inflation. Remember the Fed target rate of inflation (using the CPI) is 2% – they are printing money and have pushed rates to ZERO in a scheme to INFLATE the nation out of debt and kick start the domestic economy. The dollar rally is the EXACT opposite result of what they are trying to do.

The Fed is getting its ass handed to them by Japan and now Europe. Japan had blasted a massive broadside of YEN printing and pushing rates negative that sent the Yen collapsing against the dollar at the end of 2012. While painful for our exports and trade gap, it has not caused too much concern. Japan is no longer the world player in the consumer or even producer market, China has already taken that lead, coupled with South Korea as well as a growing South East Asia market. Latin and South America are also strong growth sectors. So our Fed looks at Japan as also-ran of the big West Economic Players, they are at the end game after two lost decades, with nowhere to go but full on devaluation and eventually economic failure – the clock is ticking. Yet at the same time we are following their lead in Keynesian monetary policy, because it is always about TODAY and never about Tomorrow.

Remember Lord Maynard Keynes famous conclusion about his economic policy, “In the long run we are all dead!” This rather absurd and stupid justification for debt creation and over-stimulation today is why we WILL fail in the long run. People care about today and not tomorrow and one of my biggest issues with Keynesian economic thought.


Krugman – Courtesy of wikipedia

Even Paul Krugman makes this argument that debt doesn’t matter we just need to spend MORE today, tomorrow will work itself out. This interview with him in England just makes him sound like an idiot and yet not only is he the leading authority and the King of Keynesian, but our government – along with the Western Central Banks (Japan, England, Europe, and the U.S.) are the practitioners and blind believers in it.

Japan is the “canary in the coal-mine” for Keynesian economic outcomes. Just like I mentioned in 2008 that we should study their policy and effects because we will duplicate it – which we have, we should watch their demise – because it is the results of a policy that we have duplicated and continue to do so.

Now we have Europe (ECB) blasting euros at us from across the Atlantic, which is plunging the euro against the dollar. This dual blast from the Pacific and Atlantic in the currency devaluation war is sending the dollar higher. Yellen can ignore it for only so long, the corporate lobbyist will soon march down from K-street to tell the Fed and Congress to do something. Additionally a strong dollar is creating what may “seem” like deflation and that is a bad word to Keynesians. She will – soon – put a stop to the dollar rally and will have to blast back at Japan and Europe. This is setting up for some opportunities as well as a full out currency devaluation war.


Stay Objective!

All this seemingly doom and gloom is nothing more that objective reasoning, based on history, math, and logic – devoid of ideology bias. I don’t want there to be doom and gloom and would rather have long-term prosperity. However, that will not happen until we get off the Fed teat and get back to a free market economy and allow failure when it is warranted.

Keynesian economic engine buys prosperity today, by borrowing from our future. The math is simple – and will end, but perhaps not today.

As I come full circle as to why I don’t think we will correct or crash today, is that there is still lots of steam left in the Fed engine and with the mid-terms around the corner and a fully appointed Obama board of governors – they will not LET today’s purchased prosperity bought with debt end. They will continue until they can’t.

Japan was successful in this game for two decades, but they are about to implode – as their debt ratio has hit parabolic trajectory. We are not yet at parabolic trajectory, not even on the NYSE margin index, while high – does have some room. Perhaps like Japan, our Fed will follow suit and start buying S&P futures, like they do bonds. That too will help keep the market moving higher.

Today we continue to bet on the Fed and their money printing machine and zero rates. Don’t bet against the Fed in the short-term, but the long-term looks bleak if we don’t stop.


Support & Resistance

INDU 17,000
We cracked below the 17,000 level but I think we will put a consolidation in here and get a bounce. Perhaps form head-and-shoulders into the mid-terms, before a large drop.

NDX 4000 – 4100
We will hold up in this range for now, I am not looking for a break-down yet.

SPX 1970-1980
Could be a broader consolidation area. I mentioned 1960 as the first support on a drop and a 1940 lower bound. However, I think if we have a little consolidation we could get a bounce in here and start forming the second shoulder into the mid-terms. VIX is still in the 15 range and I suspect it will stay in here as we consolidate in this twitchy market.

RUT 1110 – 1120
If we can consolidate in here then we could see another bounce. On the longer term (weekly and monthly graph) you might get a little sick looking at it and I believe they are reflecting a rather broader drop. However, I think in the short term we could get a consolidation and bounce back up to 1150 in the short-term into the mid-terms. Much like we have been seeing a weaker RUT on order flow, but stronger narrower indices on bounces. The Fed still has another FOMC meeting in October – which they could help, bring some optimism back to the equity markets.


What you WANT to hear?

GDP 2nd quarter estimates were raised to 4.6% as the Commerce Department said that all measured categories looked strong, except consumer spending. You can’t help buy chuckle at the absurdity of these optics as anyone with even a rudimentary education in economics at the high school level knows that 2/3rds of economic activity comes from the consumer. So consumer spending remains weak and unchanged, but they just revised their estimates higher?

I think our school text books will have to change to start reflecting the growing government expansionism that is now making up a larger portion of economic activity. We also can NOT forget the GDP model recently changed adding 100s of billions of non-tangible assets into the mix, so who knows what the real economy is doing. What we do know is that this recent growth did NOT come from consumers, even the Commerce Department has admitted that much.

GDP 5%, Unemployment 6%, CPI 1.5% = these are reaching the levels of fantasy, but remain the primary economic data points the drive political spin. It’s optics and for those that actually DO the math beneath the headlines quickly find this is smoke and not remotely realistic to actual GDP, unemployment or inflation.

The problem with believing in these numbers is that when the shit hits the fan, and it will, everyone that believes in these numbers will act surprised and say – “No one saw that coming!” Just like these headline blind ideologues did during the housing crisis and the dot.com crisis before. Remember the Fed never saw the Dot.com or housing crisis come, even Bernanke said, “It seems to be just a sub-prime problem!” until it wasn’t.

2 Responses to “The Battle”

  1. McRocket says:

    Thanks for this.

    Have a good weekend.

  2. Rich says:

    Very insightful., appreciated your excellent presentation Wedensday night. I don’t think the Fed will bend until after the 2016 execution. By then who knows how much debt the Fed has acquired. Wonder what they will call the next round of ……

    Thank you