posted on 25 September 2016
by Lance Roberts, Clarity Financial
As I noted on Thursday, the Fed non-announcement gave the bulls a reason to charge back into the markets as"accommodative monetary policy" is once again extended through the end of the year.
It is not surprising the Fed once again failed to take action as their expectations for economic growth were once again lowered. In fact, as I have noted previously, the Federal Reserve are the worst economic forecasters on the planet.
As shown in the table/chart below, not only are the expectations for economic growth now the lowest on record, the Fed has given up on 2% growth for the economy with the long-run economic projections now at just 1.9%.
This should surprise no one. The Federal Reserve has continued to hope for the last several years that extremely"accommodative" monetary policy, near zero interest rates, would spark stronger levels of economic activity leading to a rise in broad-based inflationary pressures. Unfortunately, this has yet to be the case.
More on that last point in a moment.
With the Fed holding still on hiking rates, with a promise to now hike in December (**cough****bullshit****cough), traders came rushing back into the market pushing prices right back into the trading range of the last month.
Consequently, the volatility index was also smashed back to its recent lows as "fear" has been completed eliminated for now.
Basically, if you strip out the past week of volatility, nothing really changed.
For the bulls, there is some good news here.
The recent breakdown in the market, has so far, completed a successful retest of the "breakout" that occurred earlier this year. This pullback to support does confirm the "bullish trend" from February is still intact. However, given the long consolidation of prices this summer, a breakout to new highs is needed to confirm a bullish advance higher.
The breakout to new highs will also be needed to reverse the initial sell signal that has currently been registered. Such a reversal will also confirm the bullish trend remains intact. The problem is the sell signal is occurring at very high levels which suggest that any potential upside remains extremely limited for now.
For the bears, there are also points to be made.
First, the market never resolved much of its overbought condition that existed previously. This overbought condition, combined with the lower sell signal, limits upside to the markets currently. This is why I continue to recommend caution currently.
Also, it will be important for the markets to regain their footing and continue to move higher. The yellow highlights are suggesting a more important topping process may be in play, a "head and shoulder" pattern, which again suggest downside risk may be more prevalent.
While the bulls and bears can fight over who is potentially going to be correct, I am going to keep portfolio models steady into the next week.
This caution is also due to the fact Federal Reserve liquidity will likely fade starting next week. As you will see in the chart below, the changes to the Fed balance sheet have a very steady rhythm. The spike last week, needed to keep the markets from breaking the bullish trend line has temporarily been exhausted. Look for the markets to fade as liquidity dries up.
So, for now, we are exactly back to where we started from.
I will update this analysis in Tuesday's "Technically Speaking" post at the website. Make sure you are registered at the site for e-delivery.
2-Types Of Inflation
I stated above that I would discuss the Fed's inflation problem a bit more in depth. I have addressed the flaw in Yellen's current monetary policy approach as a phenomenon known as a "liquidity trap" which is described as follows:
The problem for the Federal Reserve is that getting caught in a liquidity trap was not an unforeseen outcome of monetary policy, but rather an inevitable conclusion. As shown in the chart below the more active the Fed has become with monetary policy, the lower the eventual rates of GDP, inflation, and interest rates has become. As stated, the current low levels of inflation, interest rates, and economic growth are the result of more than 30-years of misguided monetary policies that have led to a continued misallocation of capital.
Importantly, notice in the chart above, that prior to 1980 inflation was indeed rising BUT so was economic growth AND interest rates.
During the 50's, 60's and 70's, America was hard at working rebuilding Europe, Japan and the rest of the WWII destroyed landscape, entering the "space race" to put the first man on the moon, and fight the Korean and Vietnam wars. Increased manufacturing and production, rising wages and an expanding economy led to a demand for credit and pushed prices higher creating inflation. Even during the oil embargo, economic growth touched annualized rates of nearly 14%.
It was feared that high inflation and interest rates would create an economic catastrophe. So in the late 70's, the Federal Reserve jumped into action to break the back of these pressures. Those actions, and the subsequent and ongoing monetary interventions by the Federal Reserve, led to the long slow decline of American prosperity.
Today, the Fed can only dream of the type of productivity growth, rising wage and economic pressures we once faced. Today, the lack of productive inflationary pressures (inflation caused by rising wages and increased economic activity that leads to higher prices) has been a construct of the underlying structural dynamics of the economy. Home ownership rates have plunged, technological advances and productivity increases have fostered wage suppression, and high levels of uncounted unemployed (54% of the 16-54 aged labor force) drag on economic strength. This is not to mention a massive group of aging "baby boomers" heading into retirement with little more than one-years worth of living expenses in the bank.
As I stated above, inflation driven by rising healthcare, insurance, and rent IS NOT THE SAME as inflation arising from rising wages, rising prices, and increased economic activity. The former acts as a cancer reducing levels of household liquidity and consumptive capacity.
The difference in inflation types was a point made by Dr. Ed Yardeni last week:
Bingo, Dr. Yardeni.
Importantly, while there have been, once again, the annual call for higher interest rates, the reality is the economic constructs to support higher interest rates simply does not exist. While interest rates and inflation may bounce up and down in the short-term, the long-term dynamics that are currently in play suggest that we, much like Japan, will continue to experience a long road of deflationary pressures and low interest rates.
Yellen Uses Code For Stock Market Bubble
Is the stock market overvalued? Yes!
However, Ms. Yellen & Co. are not worried about such things. Or, are they?
It was interesting that Janet Yellen mentioned "commercial real estate values" in her latest comments to the press. To wit:
DO NOT misunderstand the gravity in her statement. Commercial Real Estate (CRE) valuations are a direct function of the economic cycle. The tenants of CRE buildings are companies that are affected by the ebb and flow of the economy. The reason that valuations are high relative to rent is due to the fact we are at a peak of an economic cycle. CRE values FALL during an economic recession as tenants give back space and vacate buildings.
What Janet Yellen said, without saying it, is that stock market valuations are high as stock prices have been bid up by investors just as with CRE. When CRE valuations fall, so will asset prices. Markets, and by extension prices, do not exist in a vacuum. They are all ultimately tied to the business cycle.
For the moment, none of this matters. Global Central Banks continue to push liquidity and suppress interest rates forcing investors to shove precious capital in the markets for the coordinated and ongoing "chase for yield."
However, it is worth repeating that nothing last forever, but it can, and often does, last longer than you can imagine.
Unfortunately, so does the reversion to the mean.
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