Conundrum

Posted on: by .

We were not able to hold at support levels and did break down lower, but it was not in a panic fashion, rather it was a controlled sell off and a slow liquidation. It wasn’t driven by fear or an event, but rather seemed like investors wanted to take some risk off the table, lock in some gains, and avoid some possible volatility as we come into the Fed’s December meeting and the possibility of taper.


Conundrum

There seems to be a conundrum of sorts. We are told and see government data that shows some strength in the recovery and then we see the rally in the equity market this year and believe that is proof that the economy is improving. However, correlation is not causation. Yeah, it is hard to get over that hurdle for many and too frequently no one asks the all-important question, WHY?

There are several factors that impact the market that have nothing to do with domestic economic conditions.

First: Overseas Revenue
Over 50% of revenue and sales (which is also growing) come from the international market. In fact, the growth in the S&P 500 top line revenue and sales is predominantly coming from emerging markets, not the U.S.

Second: Zero Interest Rates
The borrowing costs for money have never been so low. The Federal Reserve has set their target interest rates to ZERO and expect it to remain at zero until at least 2016. This has allowed companies to borrow huge sums of money to invest, do share buy-backs (which increases their earnings), and pay down debt. Japan used to be the source of cheap money, but in the last few years that has changed and the U.S. has become the source.

Third: QE
The Federal Reserve’s ultra-stimulative monetary policy has served two purposes. First, it has lowered the yield on treasuries to very unattractive rates, thus making equity investments the only reasonable alternative. Second, the Fed is now absorbing the vast majority of mortgage backed securities (MBS) and thus is limiting and reducing the liabilities of lending institutions, effectively shifting the risk from the private to public sector.

Forth: Leveraged Debt
Leveraged debt has been allowed to increase. Those businesses, investors, and institutions that have access to credit have been allowed to leverage up their debt rapidly. The NYSE margin rate has broken through all-time highs and it doesn’t look like it is stopping any time soon. There is over $400 billion (quickly closing on $500 billion) in margin and this is only one sector of the market.


Courtesy of advisor perspectives

It is primarily these four issues that are driving equities higher, NOT the improvement in the domestic economy. Remove the Federal Reserve’s QE policies, raise interest rates to normal levels, and limit leveraged debt and this market quickly stalls. Certainly there remains exciting and strong growth in the emerging markets and many companies are prospering, but remember this is also off-setting stagnation and contraction in the domestic economy and the West (namely Japan, Europe, and UK).


Have vs. Have-Not’s!

There is another issue that is becoming more apparent and that is the spending and access of credit between the HAVE’s and the HAVE-NOT’s. Political pundits like to create labels to delineate this difference; “99%”, “1%”, “Rich”, “Poor”, etc. However, it is not as simple as that, it has far more to do with debt and the ability cover the debt costs. Recently a report showed millionaires and billionaires that suffered the same problems that the rest of the 99% suffered: the inability to manage and cover the costs of their debt. Famous movie stars (Nicolas Cage blows through $150 million), athletes, singers, and even business leaders have fallen in the great recession. At the other end of the scale, there are those in the lower and middle income, the “99%”, which are doing just fine because they had savings and were not over extended.

However, this group of low debt to savings ratio, whether they are part of the “1%” or “99%” are the minority. If we look at holiday sales we see that they are able to spend, but they are too small a group to lift all boats. It is the majority that is under considerable debt and is not able to serve that debt effectively that continue to show stagnation in their spending.

Walmart, Target, and other domestic retailers (no luxury) have announced steep discounts, crushing margins, and low top-line sales. According to the National Retail Federation there was a 2.9% drop on the Black-Friday weekend sales on a year-over-year basis. Retailers need to move inventories in this short holiday season to cover costs and are willing to take step discounts.

Credit Card Tombstone


Economic Survey

This morning CNBC’s “All-American Economic Survey” expects a sharp 9.4% drop in holiday spending this year, compared to actual sales reported by the National Retail Federation a year ago. What was more alarming was that there was also a sharp spending falloff in the higher income levels. Those with over $100,000 of annual income plan to spend $300 dollars less this year, on average, according to their survey. 83% of those surveyed felt the economy was in fair to poor condition, with 15% believing it was good and improving (declining below the mid 20% range we have seen in recent years).

There was one other interesting statistic they measured, those with more than $100,000 annual incomes and more than $50,000 in the market thought the stock market would continue to rally in 2014 by an overwhelming majority (7-to-2 margin).

It is surely convoluted when you think about it; 83% think the economy is fair or poor, over 70% think the market will continue to rally, and the wealthy on average are spending $300 dollars less this year on the holidays. Have we become accustomed and numb to the Federal Reserve’s monetary policy propping up the bond and equity prices, keeping rates low for cheap money, while we all realize the economy pretty much stinks? That seems to be the consensus.

Clearly the market is not rallying because the economy is improving and thus, as is usually the case, correlation is not causation.


Support & Resistance

INDU 15,600
We snapped lower and it looks like the next support consolidation level is around the 15,600 level. I think we could get there prior to the Federal Reserve’s taper announcement on Dec 17-18th.

NDX 3450
The NDX seems to be holding up fairly well compared to the other indices. I would look at 3450 as a short-term support consolidation area, with 3400 as a low support.

SPX 1770
It seems like the top area of a possible support area is 1770 with the low range of 1750. This is pretty sloppy area and I wouldn’t pick any spot in this 20 range as the exact top or bottom, but rather a range in which we could see some intra-day move. The VIX is still above 15, but not spiking higher and is pricing in expectations of volatility.

RUT 1100
The broader area of support is 1100 and we continue to hold around this area, if we break I would look at 1080 and then 1060 below. Do we hold in this area until Dec 17-18th and the Fed meeting?


Taper… not going to happen!

You know my position, they will NOT taper, if Yellen has anything to do with it. Bernanke is mentally struggling with it for sure. This is his last meeting and will certainly set in stone his legacy. If the Taper doesn’t happen we could be setting up for a rally off these lows.

He was the man that gave birth to the radically unprecedented monetary policies; ZERO interest rates, printing TRILLIONS of dollars, buying mortgages, and funding government deficit spending. He knows how radical it has been and he certainly would like to be remembered as the man that saved the economy with extraordinary measures, but also the one that began winding down those measures as the economy has now improved and he was able to hand-off a growing economy to the next Chairman.

Frankly, this entire Federal Reserve monetary policy exercise is as mind boggling as it is absurd. There is no economist or anyone with any basic understanding of the Federal Reserve that would have considered that our own Federal Reserve would have taken such radical actions if you asked them back in 2007 or even 2008. If you told someone that Fed would take rates to zero, print trillions, and buy government bonds and mortgages they would tell you to take off that tinfoil hat. However, here we are and now we are numb to it, it has been years and looks to be on going for years to come. It will certainly be looked back upon in history, decades from now, as the beginning of the endgame. At this point, even Federal Reserve members, like Fisher, don’t know how to turn it off, or even if they can without causing major disruptions that no one is willing to be held accountable for.

There are two types of people at the Federal Reserve now, those like Fisher that want to stop it and who are scares they might not be able to. Then there are those that don’t see it as a problem at all and measure the market and economy as if correlation is causation. In fact, they believe that they should ramp up the money printing. It is those that don’t see a problem that are now in charge and Bernanke knows that when he is gone Yellen has no plans to wind it down.

Comments are closed.