Fed Returns to Boost Market - Will We Ever Have Reality Again?

Stocks staged a massive rally this week with the S&P 500 rallying more than 300 points or 12.2% from the previous week.  Of special notes, REITS (real estate investment trusts) rallied the sharpest, rising 24%.  Midcap stocks which have been underperforming for quite a while also turned in stellar weeks, with the Midcap (MDY) and Russell 2000 (IWM) rising 18%.

From an industry perspective, all sectors of the market rallied.

 
Basic Materials, a sector that failed to make new highs in the latest market bull thrust, performed best, rising 20.6%.

Closely following was the financial sector, rising sharply on the Federal Reserve Bank’s latest stimulus announcement
Federal Reserve Stimulus - CNN article

I had been paying close attention to a number of exchange-traded funds to gauge the health of the US economy.  It appeared to me that low interest debt had enabled businesses that might have failed in 2008-2009 to remain.  These had often been referred to as Zombie Corporations.  As interest rates continued to fall, businesses were able to issue more and more debt to stay afloat.  Eventually, some event would trigger this debt to default.  It was my thought that when these ETFs started to drop in price, it would be an indication of an impending recession.

One of my proxies for this lower quality debt was an instrument with the ticker symbol JNK.  As the symbol implies, the debt held in this ETF is just that, junk.  You can see that this ETF price fell off a cliff.  There was a real possibility that heavily debt-ridden companies would go bankrupt.  But that reality quickly came to an end as the Fed announced that they would bail out not only quality corporations, but shaky corporations as well as states, counties and likely foreign banks and governments as well.  Soon the Fed will own the entire world.


Other ETFs that the Fed may now be buying include:

If the Federal Reserve Bank can buy these ETFs, and the Fed can’t lose money, then if could be foolish to try to fight the trend.  Or so it seems.

What's Next?

In a normal world, the rally to the 50% retracement level is by no means extraordinary.  While many oohh and ahh over the remarkable rally, the Fibonacci retracement levels automatically include a 50% retracement along with the real Fibs of .328 and .618.  In some theories, prices failing at the 50% retracement level can be expected to fall to the -.23 level.  This would suggest S&P prices falling to the 1900 level.

It's hard to imagine this to happen though.  Despite 16 million people filing for unemployment and businesses across the world being shut down, liquidity has always seemed to reign supreme, despite any fundamental support.

Once again, markets have no correlation with reality.



Money Supply Spikes

As the chart of the M1 money supply illustrates, money supply has been surging to dizzying heights, now backed not only by government treasuries but also a wide range of corporate bonds.  Some can interpret this as the Federal Reserve Bank and the US Treasury taking control over US corporations.


The increase in the money supply is said to be temporary and will be pulled back when things normalize.  But as we've seen post-2009, things never normalized.  Any attempt to decrease the money supply was met with swift negative market reactions.  This is the new reality, 0% interest rates, increasing Federal Reserve stimulus actions to keep the financial structure afloat; many suggesting that it won't be long until the Federal Reserve starts buying stocks.  Again, does it make any sense to fight the Fed?  It does appear to be inevitable.  But ultimately, must it fail?

I thought it might but after 11 years of the Fed-controlled market, I do not expect to see a normalization in my lifetime.  As such, I choose to stay out of stocks, except for special situations such as some gold and silver mining stocks.

I continue see gold still as a safe haven.  In times of loss of confidence in fiat currencies, gold stands out as one asset that can provide purchasing power.

Gold futures rallied to new recent highs but still are a few hundred off of the lifetime highs.  One can expect gold to continue rallying and perhaps even silver following.

Two Schools of Thought

Inflations:  Gold and real estate are often said to be good hedges against inflation.  The sharp move in REITs this week along with gold making new highs supports this view.

Deflation:  How quickly will the economy recover?  Some suggest that things won't start getting back to normal in July, the President is pushing to get things moving as quickly as possible.  A slowing economy might present a deflation scenario.  Holding US dollars is often recommended to ride out this storm.

I suggest holding both.

Rates Will Never Go Up Again!

Rates are breaking lower, dropping below 2.85% on the ten-year basis. As the chart above shows, the recent levels were holding but a break through now shows that we can expect the 10-year rates to test the 2.0% level.

The stock market continues to remain at relatively high levels even though interest rates, another barometer of the economy, languishes at lows, continually making new lows.

As long as the Fed keeps rates down to zero, the bank arbitrage between the cost of money 0% and guaranteed income Treasuries will continue. It now becomes a no-brainer that rates will continue to fall and we will drift into the dreaded DEFLATION!!!!

I reviewed my notes from 4 years ago and the economy was weak, unemployment was rising and interest rates were falling. We were coming off of 5% on the 10-year. What a bond market rally! It is the mother of all bubbles. I guess you've got to be long the bond market. There is little hope for our economy at this point, not until we have a new administration.

Will we get to the point when the dollar is so devalued that interest rates will have to rise? On no, at that point, the Federal Reserve will step in and buy the Treasuries.

One thing for sure, if the interest rates ever do rise, it will probably cause another economic disaster for the banks as well as countries that continue to pour into Treasuries at miniscule rates. When are we ever going to get our economy together? Is there any hope???

The S&P 500 and other major indices have been crossing the 200-day moving average. Will this be the catalyst for increased buying? Or are we just completing a head and shoulders topping formation with an ominous descending neckline?

There can be no doubt that corporate earnings have been impressive. Even a perma-bear such as myself has restrained myself from adding shorts so far on this move. In fact, a month or so ago, I even purchased a bunch of C at $3.67. It felt right at the time and wasn't really based on any technical studies. It's just that I've been following the markets since the 70s and markets have rhythms, which after awhile, you just feel.

I'd like to short the stocks now but I want to see if some extra upside might kick in. Lots of news coming this week including GDP and Durable Goods on top of earnings. Perhaps finally we will stop being a derivative play of Europe and start acting on our own.

One thing that troubles me still though is rates. If rates and the SPX were acting as they should be, that is, being correlated, we would also see rates breaking above 3.5% but no, they are languishing at the 3% mark, and threatening to drop to 2.50% on the next wave down.

A strong pop for stocks might start pulling some money out of the treasuries and into stocks. With the little volume in stocks, it's evident that only the institutions are pushing stocks around, as evidenced by the 1,000 point collapse in early May. I certainly wouldn't recommend stocks for anyone after that event. It shows that any wealth in the market could be wiped out in seconds. I was short the market then and was watching it, tick by tick from my home in Mexico. But instead of jumping for joy at making a killing, I was spooked! It was as if the machines had taken over Wall Street. I've seen this Terminator movie many times in the past. It was even proposed in a Tom Clancy book, I believe it was Executive Decision, when a computer code got placed into the market system and when activated, collapsed the US financial system.

Anyway, I heard one proposal that as long as short term rates remain near 0%, all of the other rates will continue to be arbitraged down and that is one reason for the continuing decline in longer term rates. Or perhaps there is just no belief in the US stock market while President Obama is in power. Will we have to wait until November elections to see some pop in interest rates? Or are they really reflecting a new reality? DEFLATION.

WHAT IF??? The Safety Trade Doesn't Work???

"What can they be thinking?' I keep asking myself as the Federal Reserve and US Treasury Department vow that they have a strong dollar policy. Even as the US Dollar continues to collapse, no doubt due to current monetary policies, our money leaders assure us that they are supportive of the strong dollar. Even as Japan and other countries shiver as the dollar reaches new lows and they vow to begin buying dollars, our leaders tell us one thing but enact policies that clearly show that they are shooting for different results.

This is not the time or place to discuss political issues so in defense of our leaders, I can only surmise that they truly understand the global financial situation AND KNOW, the in the event of a financial meltdown, the world will flock to the US Dollar in search of safety. Such is what happened this morning as news of a possible Dubai meltdown spread through the markets. Gold was down some $40 early, the Euro dropped significantly and the dollar rallied above the 75 level. As the dollar rallied, markets collapsed but then the attitude changed. Still enjoying my holiday, I paid scant attention to the talking heads commenting how a Dubai meltdown might actually be good for the US economy. Well, again, I sure didn't catch the jist of this comment but in the end, the dollar again began drifing down and markets recovered.

And now I ask, what happens if the dollar isn't the safe haven that it once was. What happens if foreign government and institutional investors refuse to buy into negative interest rates? Will the US really ever pay back all of the debt they are accumulating? What happens to the US Dollar and the economy if we have yet another banking system meltdown (a sure thing in my mind) and yet the dollar remains weak? Arggghhh! The US will have to devalue, default on debt payments much like our neighbors in the Gulf, interest rates will soar, fiat currencies will become worthless.

WHERE CAN YOU PUT YOUR MONEY????

I tend to agree that we are in the down part of the K-Wave or long term cycle and that all forms of assets will devalue. With this in mind, the concensus is that the safety of the dollar is the place to be. But look at the hourly chart of the dollar today. In the end, the dollar gave up the rally and headed back down.

REMEMBER LONG TERM CAPITAL???

This hedge fund, featuring Nobel Prize winning economists as model developers amassed billions in investments. The assumptions that they built in appeared to be flawless UNTIL!!!! In the end, economic assumptions are just that. Assumptions that will change over time and sometimes in a heartbeat, without warning. Yet the Federal Reserve and Treasury continue to act apparently with total confidence that their assumptions will hold true into the future. We can print as much money as we wish and borrow as much as we wish and the world will continue to beat a path to our doorsteps. The Government and Federal Reserve has made investments that no rational person would undertake. Has it been a blatant give-a-way? Are politicians and theoretical people so niave?

THE BEST BET, BE LIKE THE GOVERNMENT

In my mind, the best bet for individuals is to act just like the government. They know that all of the debt they amass now will eventually be worthless. Either they have no intention of ever paying it back or if they do, it will be in dramatically deflated dollars. Consult with your adviser to see if such a strategy makes sense for you. If you have nothing to lose these days, take it to the limits. As deflation pervades the economy, all of your assets will deflate in value. If all you have is debt, then that will also deflate. What do you think? Not the conventional line of thinking...but what is the government thinking? Shouldn't our leaders be setting the example??? Perhaps they are.

The Real Economic Truth

What is the real Economic Truth?

Granted, one data point does not reflect the state of the world or a trend. But today's GDP number, coming in negative, should affirm that the fear of deflation is real. Many talk about it but they are currently in the minority. We can see it in the price of gold. Is this a sign of deflation? Of course not. There are strong voices on both sides. Some say gold will hit $2,000 an ounce while others feel that we are in deflationary times and the asset rallies are nothing more than Fed engineered bubbles.

Have you Ever Heard About the Kondrotieff Wave?

Odes to poor Nikolai Kodratiev, a soviet economist in the early 1920s who postulated that economies move in long waves. Poor guy got executed for his capitalistic beliefs but the theory is still out there. These cycles last about 60 years and in agrarian times, I suppose that the cycle worked. Having been looking for this downturn in the economy - and not just the economy - but real deflation, back in the late 80s and early 90s, over time, I began to dismiss the theory, believing that perhaps it worked in agrarian times but no longer.

Perhaps, a good question to pose to Alan Greenspan or Ben Bernanke is "are you aware of the long waves and have you been actively trying to fend them off?" There is no doubt that the Fed and the government have been trying to manipulate the economy and eliminate natural business cycles. But it can't be done. And perhaps we are starting to see the beginning of the end. Well, it shouldn't be the end as these cycles have persisted for centuries. There are those who are attuned to them. One is Bob Prechter of the Elliot Wave Theorist. As far as I know, he is the only one who is proclaiming the deflation story. I'm sure there are others. Dear reader, inform me. The world can read these blogs. I invite you to contribute your thoughts and ideas.

Just days ago, I spoke of the TBT on the verge of a breakout. The TBT (as I call it) is an ETF that moves inversely to interest rates at 2Xs. Since the near break out, the TBT has fallen 5%. Bond yields have fallen swiftly. Yet even though the economy appears to be extremely weak, stocks continue to rise. We are again in this land of irrationality where everything is going up. Again, FED POLICY is the culprit. Is it not evident that they are out to destroy us? And yet many fight for the independence of the Fed, the President wants Ben B. to continue at the helm and no one looks at how the Fed and it's owners are scarfing up all of the US mortgages and federal debt. We worry some about China, but what about the owners of the Federal Reserve????

DEFLATION WILL KILL THEM!!!

For sure, inflation is the key to success for the bankers. As long as inflation persists, their scam can continue forever. But what happens when deflation hits? The bankers cannot allow this but in the realm of the infinite, they cannot prevent the inevitable cycles from occurring. For years they have done their best to continue to inflate the economy. How many times now have they brought interest rates down to nothing???? And what economic catastrophes has it brought upon us? But they can't continue to keep playing this game. They can't continue to inflate the economy any longer. It has run out of steam.

TIME FOR A REASSESSMENT

I can't deny that I was one focusing hard on TBT and rising interest rates. I AM NOT GOING TO ABANDON SHIP! But over the short term, I wonder if I shouldn't be long bonds, short gold and pretty much SHORT THE WORLD?

WHAT DO YOU THINK?

Do you have an opinion? Let me hear it!