Don’t concentrate on the finger!
Market crashing? Time to panic? As expected there is certainly significant volatility and even massive intra-day volatility. However, we knew or should have known to expect this. We only had to look at the end of QE1 and QE2 to see how the market fell into spastic volatility and selling pressure. We have also tested and broken down through significant supports and it’s not over. We should see more volatility, panic and confusion. However, we should be prepared and have some dry powder to take advantage of this volatility. Looking at the Russell Index (which you know I watch closely), it looks like we could be building support. However, expect volatility until the FOMC meeting.
Don’t concentrate on the finger!
We need to look at the “big picture”, the “whole enchilada”, the “1,000 foot view” in an objective manner to see and understand the why and the how. Bruce Lee said it best in the opening of the movie Enter the Dragon. He was trying to teach a pupil about “emotional content” the ability to be objective and focus to see the BIG PICTURE. He said of emotional content, “It’s like a finger pointing to the moon!” The student was looking at the finger and Bruce hit him and said, “Don’t concentrate on the finger or you will miss all that heavenly glory!” A great scene with a simple message.
All too frequently we focus on the minutia and miss the big picture, much like that pupil concentrating on the finger.
The big picture starts with the economic condition and central bank policies. We must first separate the West from the BRICs / emerging markets. To keep it simple, I will just outline the economic conditions of the West vs. BRICs.
This is a very simplified view of course, but it is generally a correct assessment. Reviewing the big picture is not about deciding which is better or worse, who to blame, or taking sides. The purpose is to look at it objectively, regardless if we like the results – we must just accept them and understand them.
The West is in obvious trouble, but rather than solve the problems it wishes to hide the symptoms with bail-outs, free money, and more entitlements.
Historically, from Ancient Rome to the modern world when civilizations face economic crisis the government intercedes. The problem when government moves into the realm of interventionism is that it can become pervasive, even with the best of intentions. Social programs, entitlements, aid, well-fare (for business and individuals) became the knee-jerk and go to response. The government, like all of us, does NOT wish for anyone to fail and wants to stop failure. However this interventionism never addresses the causes and frequently masks the fundamental problems of the current economic system. We see a rise in central planning, collectivism, socialism, even communism during these economic stressful times. People turn to the government for answers and the government is quick to respond. Democracies (even Republics) are ruled by the populist vote, so they MUST give the people answers and help – otherwise they will quickly be out of power.
Objects of our Charity
Government programs used to help the poor, the weak, the failed businesses, the old, the young, the sick, the minorities – slowly moves from best of intentions of a short-term boost to give them a leg-up and back on their own feet into long-term entitlements. We begin to breed generation after generation of people that expect them, feel that they are owed them; they have become reliant on these government entitlements. We even begin calling them the “entitled” generation. What we are actually doing is turning these peoples and failed businesses into the OBJECT of our Charity. It destroys business, keeps the poor – poor, drains public coffers, eliminates competition, and ultimately steals man’s pride, self-respect, and most importantly accountability and responsibility.
This lesson was not to deviate from today’s Market Preview about the big picture; it is to help explain the current Fed policy. The Fed is not much different in their view of interventionism and trying to help. Even our own Fed is charged with the mandate of “full employment”. The previous market preview discussed the 1930’s Keynesian view that is forming today’s fiscal and monetary policies.
So let’s look at the West collectively from their central banks interventionism.
The western central banks have pumped trillions into the system with Quantitative Easing (QE – printing money buying government bonds and assets) and artificially set interest rates at or close to zero.
What are the general results? Well certainly trillions more in debt and increased in leveraged debt. Unfortunately the job markets in the West remain exceedingly weak. Large parts of Europe have double digit unemployment rates and in the U.S. our broader measure of unemployment have remained stubbornly high. The boom in job creation has been part-time jobs as we have seen contraction in full-time jobs.
What the central bank policies have done is mask any REAL fundamental problems. It has inflated asset prices with leveraged capital from those that have access to credit and margins. This makes it SEEM better than it is, by addressing the symptoms and ignoring the fundamental problem. The artificially low rates has also hand-cuffed lenders, who are not willing to lend to higher risk borrowers (that need to borrow the most) because the interest rates do NOT properly reflect the risk to lend to these people.
The massive jump start to the economies in the West with these central banks’ interventionism has not worked and we are seeing it now as it is being threaten to be removed.
Yet the Keynesians see the problem as not spending enough. Paul Krugman (Nobel Prize Winner), NYT columnist, and considered the principal expert in Keynesian economic theory has blamed “austerity”, the “sequester”, and Republicans for the failure. He has argued we have not spent nearly enough and we need to expand the QE program and fiscal programs. He also has the ear of President Obama and is well respected by Fed Chair Janet Yellen.
If Krugman’s outspoken criticism and suggestions echo the general view of the Fed and the administration, we should expect MORE accommodation and low rates for a long time. The Fed’ minutes have indicated similar concerns and seem to align with Krugman’s general belief. However the central banks can’t do it alone, they need government help.
The West had first hoped that the central banks massive money printing and zero rates would spur economic activity; borrowing, lending, spending that would create jobs and get the economy going again. Unfortunately after almost 7 years it has NOT worked and Krugman blames we didn’t do enough. How much is enough, when does debt become too much? That is an answer he will NOT give.
We have already seen a large step forward in government intervention in the wake of failed monetary interventionism. In the U.S. we have bills, legislation and even new laws that expand entitlement programs, extend unemployment benefits, Obamacare, lowering student loan rates, student loan forgiveness, re-birth of the GSEs (Freddie and Fannie) and I would expect MORE government programs.
In Europe we have seen the election of the first openly Socialist President in France, who raised taxes on the rich, lowered the work week hours, lowered the retirement age, and expanded social and entitlement programs. That resulted in the largest exodus of businesses and wealth in France’s history, the nation’s unemployment has gone higher, their debt mounts and just last week S&P lowered France’s credit rating to negative.
French Socialist Party – courtesy of wikipedia
Greece’s saw a huge rise in several Socialist parties and has an actual Communist party that has gain seats in their government. They too are following similar social programs, while at the same time blaming Germany and other nations for not giving more.
The market is rightly seeing selling pressure and if we fully remove central bank and government interventionism I think this market should see a correction, rates rise, commodities rise, and a reduction in margins. We are in an inflated asset market, thanks to the Fed interventionism. That is what is happening right now as the market expects, for some odd reason, the Fed is going to, all of a sudden, become more Hawkish, and raise rates, end accommodation and begin unwinding their balance sheet.
The bond market however is pricing something completely different. It is pricing in low rates are here to stay. The 10-year yield has fallen to 2% and I think we could see 1.6 – 1.8%. If the Fed was actually going to raise rates, end accommodation, and unwind their balance sheet the bond market would sell off and we should see rates in the 10-year rise above 3%.
Remember all those economists and analyst that said we should see the Fed end their QE and raise rates at the end of this year or early next year? They coupled their Fed forecasts with 3 – 3.5% 10-year yields by the end of 2014. That WOULD be the correct assessment if they were correct about the Fed, but that is not happening – why?
The market has become addicted to the free money, the zero interest rates, and the Fed accommodation. The Fed has remained quiet and the expectations are they are going to end their programs and raise rates, just like at the end of QE1 and QE2. This has forced an unwind in risk asset, investors are exiting before rates go higher and moving to the side line.
While I agree the market is inflated and you know my long-term concerns, I think it is pre-mature to think the Fed is going to switch course and I think we are experiencing a similar QE1 and QE2 end game scenario.
I believe the Fed will ride to the rescue and we will see a rally at the end of October and into the Mid-term elections. Not that I support the such action or even believe in this massive Fed policy, I don’t. However, we can’t fight the Fed and I believe the market still has enough faith in the Fed that more QE and zero interest rates can keep this going longer, a little longer – before the REAL bubble bursts.
This is a traders market, not an investors. Investors should have hedged their positions when premiums were cheap (VIX in the 10-12 range).
Don’t fight the Fed – even though they are wrong.
There is the “Right Way”, “Wrong Way”, and the “Fed Way”.
Support & Resistance
I hate trying to look at any supports at this point because we are seeing massive intra-day volatility. This makes for great trading, but a night-mare for investors. I think we should expect more volatility before the Fed meeting. This is a narrow index, look towards the Russell for questions about support.
I have traded this index and was a market maker in securities that made up this index and I can tell you it is a beast and can move like nothing else. Expect volatility and it will only clam down when the Fed speaks in 10 days.
The VIX is shooting higher and rightly so. I think we could be finding some support and sloppy trading in the 1800 – 1900 range in the next 10 days before the FOMC meeting.
The best indicator and the reason I am not panicking is the broader based indices has found a support range and is consolidating. It has been up the last three trading days while the rest of the market is falling apart. I think, just like the 10-year yield, the RUT is pricing in a Dovish FOMC meeting and showing that we are now in a support range.
The market is rebelling, it has become part of the “entitlement” generation, and it feels it is OWED zero rates and QE. The market has turned into the object of charity. What was intended to be a short-term jump start has now become an entitlement.
Once you give away free stuff, you can’t simply take it back. Be it Farm subsidies, corporate welfare, social security, welfare, phones, food-stamps, free housing, Obamacare, or even Zero Rates and QE. The people have come to expect the free stuff and actually more free stuff.
ZIRP is nothing more than market welfare and taking it away, even the threat, is going to send panic into the market.
BTW: The Ebola story is concerning – the following website is a good Ebola FAQ site. I am not sure if this is under control at this point and could bring further volatility to the market, even after the FOMC meeting.