The market came under pressure yesterday, but continues to remain in this range. We are certainly stuck in a conundrum, as I pointed out yesterday. This morning the futures seem to be rebounding off the lows from yesterday, but I have yet to see anything to determine if we see a break-out rally or a slight correction. It’s as if the market is in stall mode and has yet to make its mind up. The FOMC meeting left more questions than answers, the Ukraine situation remains elevated, China’s economic data looks a little weaker than expected, and Europe remains in bailout and can-kicking mode. I haven’t even mentioned our own economic fits and starts situations.
I firmly believe the market rally’s most significant contribution continues to come from the Federal Reserve’s monetary policy. As I have previously pointed out the two biggest financial instruments in the world are the US equity markets and US treasury markets. Nations around the world HAD bought US treasuries to protect themselves from inflation and also because Oil was priced (globally) in dollars, petrodollars. If you are a small nation and need to buy oil, but are concerned about your currency and inflation, you buy US treasuries to hedge against inflation and lock in oil purchases based on dollars. This single factor is the largest contributor to making the US dollar the world reserve currency and also making US treasuries one of the most sought after financial vehicles.
Courtesy of Cliff Kule
Additionally, in the US pension fund holders, conservative investors, retirees, and those looking for interest on their money have also relied on US treasuries, further fueling the demand for Treasuries. However, all that changed with the credit crisis and the Fed’s “extraordinary measures” by lowering interest rates to zero, printing trillions, and funding government deficit spending. We saw a radical halt in US treasury purchases by foreign nations, in fact the largest purchaser (China) had announced a few years ago (after ZERO interest rates)) they would not INCREASE their US treasury holdings, other nations followed. This halt and slow of large foreign nations buying US treasuries was a significant contributor that forced the Fed to start the QE program. For if the US government needed to deficit spend $1 trillion dollars, thus they US government needed to borrow it, but all the big buyers stopped buying (mainly because they paid zero to little interest), the Fed had no alternative BUT to step-up and start printing money and buying. It wasn’t just foreign nations that stopped buying; we saw a huge decline in new investor money into treasuries after yields declined.
The Fed’s monetary policy of Zero interest rates and now having to become the largest single buyer of gross treasury issuance forced investors and foreign nations to look elsewhere. In essence their policy turned off the demand for treasuries, significantly. In fact the Fed has even argued this point, they WANT money driven into the equity markets to create a “Wealth Effect”. The Fed was right, money flowed into equities and the flow into treasuries shrunk considerably. This is the predominate reason why I still believe the equity market’s rally largest contribution has been Fed policy, not fundamentals, not earnings, not sales growth, not economic growth.
Government Economy vs. Real Economy
The Fed’s monetary policy has also decoupled any real connection between the market value and the economy. Many analysts and talking heads would disagree with my assessment and state the market has rallied because the economy has improved. However, I would counter with two realities; first is that the Fed remains the single largest buyer of US treasuries and has held rates at ZERO remove the Fed’s buying and rate fixing, forcing investors into equities. What would happen to the bonds and equity market if the Fed STOPPED QE and RAISE rates? They know the answer – market will fall sharply?
Second, the economic data is not nearly as rosy as they would like to believe; the U6 total unemployment rate is still over 12% (levels we haven’t seen since the early 1990s), the U3 rate largest contributor to its drop is the radical decline in the participation rate at 63% (not seen since the 1970s), GDP growth remains sub 3% (even after the radical adjustments), real inflation rates (pre-1990s models) remain above 5%, top-line domestic revenue growth has been in the sub 1% levels, over 40 million on food stamps, more ever on Medicaid, more government welfare expansion .
Yet the most simple refutable evidence that the economy is not nearly as strong as we are led to believe is that the Fed continues to keep rates at ZERO, continues to be the single largest purchase of US treasuries, and single largest purchaser of MBSs. If everything was so great, how come they haven’t raised rates or halt QE all together?
Courtesy of shadowstats.com
I think one could effectively argue that the vast majority of government measured economic improvement has come from the government’s intervention and NOT from domestic private sector strength. The simple reality is that we have become NUMB to this government intervention; we look at government headlines and want to see improvements, but don’t ask HOW or WHY? We are so tired and burned out on economic stagnation, the blame game, government political battles, threats of shutdowns, debt ceilings, fiscal cliffs, austerity, sequester, and the litany of government intervention. The government has just worn us down and we are just becoming addicted to an extent of blind faith in the headline numbers and that everything is improving.
Now I don’t want to sound all bleak and that our situation is dire, in fact my personal opinion is the exact opposite in specific areas. I remain bullish on the emerging markets, some areas in the tech sector (Cloud Computing, Big Data, new technology). I remain bullish in the commodity markets this year. I also think the economy is improving, just not nearly as great as we are lead to believe.
My issue, my criticism, my skepticism, is solely aimed at the government’s intervention that has made it difficult for anyone to accurately measure REAL economic improvement from the private sector. What is the REAL health of the economy, what is the REAL unemployment rate, what is the REAL inflation rate, where are the REAL signs of economic improvement? It is harder and harder to ascertain as the government has made any measure murky.
Our own equity market has been skewed, not just by the Fed’s monetary policy (which is the largest factor), but also from government bailouts, TALF, TARP, and nationalization. Freddie, Fannie, General Motors, AIG, and a host of other companies are slowly emerging from under the invisible hand of the government, but are they really and are they able to stand on their own feet.
Courtesy of cristyli
Government Motors, sorry I mean General Motors, is now again (possibly) on the brink of failure with this massive recall and most likely one of the largest class action lawsuits in the history of the automotive industry. The irony is the government is investigating them and will most likely fine them 100s of millions if not billions, yet it was the government that gave them billions and bailed them out. This story is not unique to GM, it happened to Bank of American, Citibank, AIG and others. The government spends billions of tax payers’ money to bail them out, only later to punish them and fine them billions of dollars, which the government will most likely have to bail them out again. Is anyone else seeing the absurdity in this?
Dovish or Hawkish?
The latest monkey wrench of uncertainty is whether or not the Fed will take a Dovish (zero interest rates and more QE) or Hawkish (raise interest rates and stop QE) approach? If you have been following the Market Preview you know my opinion. President Obama has stacked the board of governor’s bench with like-minded Keynesians and has appointed the most Dovish Keynesian Left-Leaning Fed Chair in the history of the Fed. The Fed did change their FOMC statement and certainly increased its Dovish tone, yet it continued with the Bernanke taper and Yellen (IMHO) made a rookie gaff in the Q&A session. The market is certainly confused by this and thus will need to wait and see. I still lean towards the Dovish side, unless Yellen has a “come to Jesus” moment.
Of course the Fed just gave themselves their own “stress test” and of course they passed with flying colors.
So we remain in this pivotal point, will the equity markets continue to rally as it did in 2013 based on the biggest Fed Monetary injection in history and the party continues? Or does the Fed actually end QE and any types of monetary stimulus and start raising rates? Lastly, how much of the economic improvement is really the private sector, which too is unknown and almost unmeasurable if we are solely reliant on government economic data?
I think the market wants to rally, it wants to remain optimistic, it wants to keep the party going, it wants to continue to expand on margin. How much longer can it and will the Fed end it sooner, rather than later?
Courtesy of Telegraph
Support & Resistance
INDU 16,000 – 16,500
We can certainly push up towards 16,500, we will see resistance there, but can we break-through and close above? I would look at the 16,000 – 16,100 range as support.
This is a critical support area that many are watching. We broke down below it yesterday and rallied into the close to TRY to get above it. This morning the futures are looking like we are going to open right in that 3650 area. Was yesterday’s action “filling the gap” from the 3600 to 3650 area, it seemed like it washed out the sellers, we will have to see if this is the second bottom forming before the next rally up to 3750. Watch the 3650 area and look for support in there to form a double bottom.
SPX 1840 – 1880
We are still in this sloppy pivotal area, waiting to go higher or lower. We will certainly see buyers down at 1840 and sellers up at 1880. The VIX is holding in the 14-15 range, reflecting that options premiums don’t know HOW to price the market. It is not pricing a correction and it is not pricing a rally.
RUT 1180 – 1210
Did the RUT fill the gap and test the low yesterday, perhaps, we had a rally into the close after we saw the sellers wash-out. Now look for some support in the 1180 area to build the second bottom and lull in buyers to rally this up to 1200-1210 range.
I think right now we remain in a trader’s market. The investors are not driving into the equities market in force and we are also not seeing an outflow to cash. The investors wait and the intraday volatility is driven by traders and liquidity.
The investors need confidence and as we get closer to the resistance area. If we close at or above it with strength, it could drive more investor flow into the equities creating a break-out rally, and rocket higher with short-covering.
I think we still have a possibility of another strong leg higher, short-squeeze, and parabolic move before we see any correction. The VIX is pricing in uncertainty and no conviction at this point. I would probably be far more bearish in the near-term if the VIX was at 10-11 range and we saw the skew flatten as well as contraction in short-open interest. Those stars are NOT aligning just yet.