by Rasool Cunningham
Trading Editor Philadelphia, PA (DYDD)
Watching this market over the past ten days has been a blast for me. If you don’t know by now, I’ve been living under a rock for the past five and a half months, so this has been great to me. What hasn’t been great is my trading. Not that I’ve traded much, but my thinking around trading is off. My emotions are out of control. I’m too hype. I have a hammer and everything looks like nail to me. I’m looking for the dollar to a break some time this month. Even though the U.S. economy is looking strong, and the Fed has stopped QE’ing, I think that is priced in now.
The Dollar index is now pricing in a Fed rate raise, I think. But with USD/JPY at $120, EUR/USD at $1.23, and the Yuan USD exchange rate at $6.15 Yuan per Dollar, there is little macroeconomic pressure on the Fed to do so.
I did see this article by Jon Hilsenrath on research done by Fed economists saying they have models telling them to move sooner than later. They have a simulation they’ve used to tell when the optimal time would be to raise, and how fast they should raise. They used the usual metrics like the unemployment rate and inflation. Hilsenrath and the Fed says these models should be taken with “a high degree of caution.” He also mentions that Fed chair Janet Yellen has used the models in the past to say it wasn’t time to raise yet. So, maybe she uses them now to say it is? The macro pressures mentioned above could be looked at as since those things have already happened, the time to raise is now (or soon) because it won’t be as disruptive since some of the pain of these moves is already occurring.
The problem is, these “great metrics” were not brought about by real production, investment and demand. The almost five trillion dollars the Fed pumped into the market came from a computer; not from other countries buying U.S. produced stuff. Normally, that money would have come from people buying stuff we produce. It would mean that the U.S. has started producing a lot more things the world wants. The low interest rates we have would mean the world is buying U.S. debt because the future looks bright for the U.S. When demand for U.S. debt is sited remember that’s demand for the left over U.S. debt after the Fed has bought up so much of it.
To make matters worse, what the U.S. does produce it owes out. On top of that, the money lost in investments that caused the financial crisis put the world economy in a wealth creation hole. Wealth is created by saving and investing those savings in profitable endeavors. Leading up to the financial crisis the world invested in non profitable endeavors (bad debt instruments) which lead to the financial crisis.
Fast forward almost seven years, the stock market is at all time highs, Interest rates are still very low, the Dollar is running roughshod over it’s foreign counterparts; the Fed has ended it’s QE program and are expected to raise rates some time next year. If and when the Fed raises rates it will be a major sell signal, I think. It would be the same as if the QE money did come from other countries buying our stuff or investing in the U.S., not buying any more, or taking their money out of U.S. investments. Never mind the fact that rates will be higher for businesses. That will be an issue, but the raise won’t be crazy, so, that issue won’t be so pressing right away. The pressing issue will be: Who will be the greater fool?
Who will believe these “great metrics” are sustainable in a normal market atmosphere?
There’s no shortage of bears, but there are also a lot of bulls who believe this economy. If they don’t believe what they were told, they believe what they have seen, (or thought they’ve seen,) in bullish numbers/action over the past few years. The recency bias is strong.
The bias has gotten so strong it may have even drawn in the retail investors who swore off the market after the financial crisis. In true mom and pop fashion they may be getting in at the top. I’m not calling a top (but mom and pop getting in is usually a sign of a top) until the Fed raises rates. Many think they won’t do it. I think they will. How else would they lower them again in the future? Put a better way, how else will they reload the bazooka? The macroeconomic pressures to raise rates may have fallen with dollar and oil price moves, but the political pressures may be on the rise. With a real possibility of the GOP taking control of the Senate, the Fed may want to head off criticism. The Forex market sure believes it could happen. The Dollar is still strong in part because the possibility of the Fed raising rates is perceived as real.
I’m not trying to scare any one, or make a grand prediction. I’m simply saying you can’t fix a debt crisis with more debt, and that becomes very evident once monetary conditions start moving toward normalization.
So, who will be the greater fool? Will it be the the energy investors? How about the businesses that have finally started hiring more people at better wages? Will it be the Keynesian economists who are prematurely using the “recovery” word after Fridays great jobs report? Will it be the huge bond funds? How about the huge stock funds? Will it be mom and pop? Mom and pop can afford it the least. Will it be the traders? This is when we’ll see what Mohamed El-Erian means by “The New Normal.” Look for big down and up moves in the stock market. Something similar to what Japan’s markets have gone through over the past thirty years. Here’s how their market did on a yearly basis over that time span:
We can expect the same thing once the Fed starts normalizing. You see, the problem is: No one wants to be the greater fool. They’ll sell early to avoid being left holding the bag. That’s the problem with printing money to solve problems, you have to take it out of the economy almost as fast as you put it in, or face the prospect of disaster. This means someone needs to get hurt in the process because the Fed can’t come right and say: “Hey, this is going to get crazy for a bit, so, hold on.” That would scare the bejeezous out of the market making it worse than it otherwise would have been. So they have to let some market participants get hurt. It’s like what Dr. Spock always says: “The needs of the many outweigh the needs of the few.” That’s cool as long as you’re not one of the few.
The Fed is trying to take the brunt of the pain by holding a shitload of undesirable assets while all this is going on. After the fact, those assets may become more desirable, but that’s only if nothing unforeseen happens.
In closing, remember: It’s important to wait for the rate raise before you start trying to avoid being the greater fool (or heavily shorting this market). Before then, any market drop is a BTFD moment because of all the liquidity around. Once rates are moved up it will signal to liquidity it’s time to go back home. The liquidity already inside stocks will have to come out if its owners don’t want to be the greater fool. The thing is, the Fed may not raise rates until long after you’ve read this post. If you remember anything from this post remember this: Don’t be the greater fool thinking the market only goes one way. Don’t think the market can’t give back all the gains it has made over the past seven years. It can happen. Keep that in mind and you won’t be the greater fool.
