Dow down at 16,350… S&P 500 up at 1,895… Nasdaq up at 4,293. “Markets are suddenly prey to [a] disturbing thought,” explained The Telegraph’s Ambrose Evans-Pritchard in a column last Wednesday.
Like a midget’s parents at that moment of realization, traders grimaced at the obvious last week. Their six-year-old economic recovery is getting older… but is no longer able to grow.
The story progresses this week as the QE4 option is laid on the policy table. More on that and what it means for you in a second...
“For at least three years,” explained Evans-Pritchard, “a liquidity bonanza has fueled asset booms despite a weak global economy... The assumption was that the world economy would eventually catch up with stock markets and the frothiest of assets.”
Turns out that was a very bad assumption to make. Economic growth hasn’t caught up to stock market growth at all.
Economic growth hasn’t caught up to stock market growth at all.
Making assumptions is messy work. Like fashioning an explosive or a Bundt cake. One slip-up and you’ve got a real catastrophe on your hands.
For example, you might assume the elevator ride from the mezzanine to the first floor takes 10 seconds. Only after you wait three hours for the firemen to pry you free do you realize you should’ve hit the head after all.
Your poor assumption led to a fiasco. Investment preconceptions are no different.
A “rosy” job number here… and an earnings “beat” there… a confident word from Janet Yellen somewhere else. Each sanguine sound bite gave a reassuring slap on traders’ backs until their eyes were knocked from their heads.
Once their eyes were knocked out, they used their ears to make assumptions. They heard equities were only headed higher… and assumed it was true.
What evidence did they have? None, as far as we can tell.
Only last week did they realize that they made a very poor assumption.
According to our friend Steve Forbes, stocks were fully priced when 2014 started. It seems the traders agreed with him. U.S. stock returns are now negative for the year -- down 6% after last week’s tumble.
It’s not a correction, but now that stocks go down too, at least things are more interesting.
Technically, it’s not a correction, but now that stocks go down too, at least things are more interesting.
The VIX -- or fear index -- spiked above 25 last week for the first time since 2012. That means traders expect the S&P 500 to move up or down by 2% within the next 30 days.
They could be dead wrong. Or if their expectations influence people to sell, they could be right.
But what changed over the last few weeks? Who or what is to blame for investors’ concern?
Truthfully, the question is unimportant -- we spent all of last week reckoning about ignoring your own emotions, not checking stock prices and tuning out the news.
Still, the question of cause nags us.
We have our niggling suspicions whodunnit. But it’s not our beat to point fingers...
Besides, everyone knows it’s the Fed’s fault.
By now, you’ve probably seen some iteration of the chart above. It illustrates the market’s driver. When the Fed prints, stocks go up. When it doesn't, stocks go down.
And the Fed is set to end its QE program at the end of this month. Unless we’re making a poor assumption, stocks should soon fall further. And to pile assumption on guesswork, QE4 should start soon after that.
In January, the day after New Year’s, our own Jim Rickards explained the Fed was “tapering into weakness.” Due to weak growth, the Fed, Jim posited, would have to reverse course and reopen the money spigots.
To boot, readers of Jim’s newsletter Strategic Intelligence learned in their debut issue last Friday that the economy’s on the knife edge of runaway inflation and destructive deflation.
Either force could win out… except for the fact that the Fed will pay any cost to avoid deflation. Even dropping money out of helicopters, as Milton Friedman analogized.
The way to make QE4 effective, you cut taxes -- probably the payroll tax.
For that reason, Jim’s forecasting QE4 in 2015. It was officially signaled last Tuesday by the San Francisco Fed President, John Williams. Depending on the circumstances, Williams said, QE4 would “be something we should seriously consider.”
“The way to make QE4 effective,” Rickards explained on Fox Business last Thursday, “you cut taxes -- probably the payroll tax. It puts money in your pocket and my pocket and everybody’s pocket. That increases the deficit, the federal government issues Treasury bonds to cover the deficit and the Fed buys the bonds.
“So the buying the bond part is the QE4, but now you take the banking system out of it and you put money right in people’s pockets.
“It’s also going to fail,” Jim assumed, “because people don’t want to spend…”
Judging by the last time the payroll tax was cut -- in 2011 -- that seems like a safe assumption. Americans salted the extra money away, instead of buying more.
You’re sure to find out. If past is prologue, fear of failure won’t keep the Fed from screwing up. If anything, the extreme fear of deflation will motivate it to further botch capital markets with QE4.
In fact, the Fed recently crossed the “oh sh*t” line. The very line that Jonas Elmerraji at our trading desk says predicated QE1, QE2, the so-called Operation Twist and QE3.
“The Fed’s five-year forward inflation rate,” Jonas told me this morning, “has fallen below that 2.2% line for the first time since Operation Twist in 2011. Not only is this the lowest it’s been since Janet Yellen’s tenure as Fed chief started, and not only is it the lowest we’ve seen forward inflation drop since Operation Twist -- so far, it’s actually the only time post-2008 that the Federal Reserve has allowed that inflation gauge to drop below 2.2% without announcing a massive quantitative easing program.”
Poster Comment:
One of those Presidents of the FED said recently that QE was dead. What's up with this? ;)