The Case Against Financial Armageddon!

Interest-Rate-SP500-061713

In MOST market drops, interest rates (money markets and bonds) provided a respectable safe haven- risk off rest period. Trading is a zero sum game- for every winner there is a loser- same for investment classes (especially Mutual Funds that must stay invested), money from one class MUST flow to another. If you were a manager who averaged 6% a year for the last few years (more on why later) are you happy to move large funds into a bonds for a 2% return? The net effect of moving these funds further erodes your yields, as you buy into the market (remember bond yields are inverse to bond prices) you drive up prices. I know there are a million comparisons featuring rates vs. corrections or up down trends- and the theory is what moves what (chicken or the egg) but with no where to go with interest rates- whats a manager to do?-Answer: stay put and move more capital to the stock market. So immediately you call your investors sitting on cash and say “Hey, the market is on sale, time to buy”, I know, because I got that very call!.

Every previous correction- there was a value to moving to bond (a decent return- and hedging for the fear of losing capital, hopefully principle erodes slower then equities) – but liquidating actually accelerates the inevitable decline of stock prices.  Today that value is just not there- and with the FED teetering on a .25% increase in interest rates?? Still not enough of a reason to call the trading floor and liquidate stock positions. The CNBC talking heads are always saying the same thing- If the S&P is up 30- it’s buy time- If the S&P is down 30 it’s buy time??? How is that a strategy- it’s a song! Some may call the last week a counter trend rally (counter to previous 2 week down trend)- a correction- based on the 6 bear bull run (which they constantly remind us is healthy)- or a sign of impending doom. The impending doom crowd looks to several things:

1) Historically high P/E ratios- While earning are dropping, and prices are (or were) rising, P/E’s have risen- but they can stay over inflated for a Long Long time- (much like technical oscillators- which can stay overbought or oversold for months if not years). Again not much a reason to flee to the safety of bonds. Conclusion– although many market drops have coincided with historically high P/E ratios- we have had many periods were P/E ratios have been over inflated yet stay that way for a long period of time. Conclusion- Inconclusive.

2) Huge mountain of debt- Doomsday sayers have pointed to the huge amount of debt the FED has undertaken on their balance sheets under the operation called Quantitative Easing. The Fed has acquired 4.5 Trillion of assets during the QE period since 2008 thru September 2013, where 700 – 800 billion had been the previous amount the Fed was willing to carry. So some may say the FED, which we all know needs to UNWIND it’s operations and zero interest rate program, might be unwilling to carry more debt- But Why? The same could have been said when the Fed’s assets reached 1 trillion or 1.4 trillion or 2 trillion or 3 trillion??? Once this thing has started when does it end….. the answer- who knows and who truly knows what level of debt the FED is comfortable with?? Who’s to say the FED isn’t willing to go 7, 8 or 12 billion??? The same people that warn of the FED’s 4.5 trillion- were warning us about 2 trillion- 3 trillion and 3.5 trillion!! Warnings can stay in the red stage for years (as have the FED debt fear mongers). The Fed uses 2 metrics to clue them into a market that may be overheating from too much QE and they are unemployment (employment) and price inflation. If you believe the latest unemployment figures- the job market is approaching FULL employment (a figure the Fed says is about 4%- Do you see the problem with figuring out the FED- 4% Unemployment = 100% employment  (about the only time 4% will ever equal 100%.)) And inflation- the wealthy economists that are often quoted probably never shop for themselves (the maids and other servants do that for them!) The Fed talks about 1% inflation, if you buy groceries you know it’s more then that, but whatevs- Conclusion- Inconclusive

3) The Economy-

“It’s the economy, stupid” James Carville

vs.

It’s the stupid economy!” Occams Razor Trader- 

From Wikipedia Quantitative easing (QE) is a type of monetary policy used by central banks in the purported attempt to stimulate the economy when standard monetary policy has become ineffective.” the traditional ways in which a central bank manipulates (you may hate that word, I do, but it is what it is) the economy is through the money supply and the discount rate. The discount rate is the rate at which a bank can borrow funds from the central bank to loan to consumers. It stands to reason that if the banks can borrow lower they will loan the money out lower, and this has a stimulatory effect on the economy. The Federal Reserve tried that and it it didn’t have enough of the the response that they were seeking. The second way to stimulate the economy is through money printing- when the Fed prints money they increase the money supply, as the theory holds if people can borrow money and put it to use- increasing the supply makes more money available to put to use and again causes a stimulatory effect on the economy, again limited effect was noted  – so they got creative. By  buying assets on the open market, they are adding capital funds to the money supply in the effort to have more funds available to be put to use to help the economy grow. The money supposedly hits the broader market as the wholesalers employ more the money multiplier effect comes into play which should stimulate. Former Federal Reserve Chairman Alan Greenspan calculated that as of July 2012, there was “very little impact on the economy”[ due to the QE policy. What it would seem was the money never really hit the broader market- and the loans the banks took were used for internal trading and business decisions rather then broad market loans. That’s why the FED points to very limited inflation (as of this writing oil supplies are a glut- and fuel prices are the lowest since the nasty oilman Bush was in office). Never before in the history of economics have we increased the money supply without inflation. The very definition of inflation “too much money chasing too few goods” is an axiom which forms one of the basic tenants of economics. Apparently the money the FED used to bolster the economy never really “hit the streets”. How would you like to be the middle man scalping a few basis points on the 4.5 billion open market purchases- the Fed was making with good ole Uncle Sam’s hard earned tax revenue?

We will never know how much the FED decides is a comfortable level to type into the computers and prop up the ahem economy, there has been talk of Buzz Light Year QE!

That means Quantitative Easing To Infinity and Beyond! The Fed can always recoup those funds from the taxes people will pay from the money they earn from being employed by the “stimulated” economy, all 32 of them.

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