As poor economic news continued to pour in last week, punctuated by Friday’s dismal Non Farm Payrolls report, the chatter regarding “QE2” or “QE Lite,” some sort of additional quantitative easing by the Fed, rose to nearly hysterical levels by the close of business Friday.
We’ll talk in a moment about how terrible last week’s data really were, however, it’s important to look ahead to Tuesday’s FOMC meeting and why it’s “D-Day” for U.S. and global markets. The rumblings from various Fed members, including Dr. Bernanke himself, seem obviously geared towards preparing the markets for some level of additional intervention by the Federal Reserve; it also seems obvious that the market has managed to avoid a severe downdraft by hoping and planning for that action to take place next week.
The big questions of course are will they do it, when will they do it and will it work?
Considering “will they do it,” in my opinion, I think there is no doubt that Dr. Bernanke and his colleagues will do everything and anything they can to restart this economy and particularly avoid deflation.
Regarding when they do it, major market players seem to be betting that it will be this Tuesday but I would suggest that isn’t a foregone conclusion based on Dr. Bernanke’s comments in a recent speech and the fact that it’s August and nobody is really paying attention. He might be better off saving these last bullets for September or October when it might have a greater impact on social sentiment and optimism going into the election.
Will it work is a tougher question and the answer holds the most important ramifications for the economy and markets going forward. Since the crisis started in late 2007 with the sub-prime meltdown, the Federal government has dumped more money into this rat hole than the combined total of major events like World War I, the New Deal, World War II, and the Korean, Vietnam and Iraqi wars.
And what have we gotten for our money? Unemployment has barely budged. The economy has mounted a weak recovery, at best, and now appears in danger of slowing down as the stimulus wears off, while the stock market, home market and commercial real estate market are nowhere near their old levels of health.
To understand if it will work, one has to consider what bullets the Fed still has left. Much talk about QE2 revolves around the Fed not paying banks interest on money they park with the Fed, the buying of more Treasuries or mortgage backed securities as old ones mature or some sort of universal refinance/forgiveness plan for government backed mortgages that are underwater.
There appears to be no appetite for taking on more government debt or even extending the “Bush Tax Cuts” and so, in reality, Dr. Bernanke has a couple of small caliber hand guns left in his arsenal compared to the bazookas he has already fired. Simply put, he’s warming up the last couple of helicopters remaining in his fleet of “money dumpers,” and it’s easy to conclude that QE2 won’t make much of a significant difference long run - and that we have a long, hard road ahead of us as individuals and as a nation.
Looking at My Screens
Markets remain overbought on a short term basis and subject to a quick and dirty correction. As I’ve stated recently, we’re setting up for a rather harsh trip south but there could easily be another “up” leg here, particularly if Dr. Bernanke starts shooting from the hip this week.
chart courtesy of StockCharts.com
Looking at the chart of the S&P 500 above, we see several interesting things. First off, the red horizontal line marks significant resistance at the 1120-1130 level on a pattern basis as well as the 100 Day Moving Average sitting at 1126.
Also you’ll notice the similarities in the chart pattern within the boxes, as prices bunched up around the 1120 level and just above the 200 Day Moving Average in mid June and again Friday. The mid June congestion was resolved by the nearly 10% correction that took place during the last half of June.
And finally, the red descending line in the bottom graph represents the decline in volume over the last three weeks, even as prices have shot upwards. Volume has been low on a relative basis for quite some time now as many retail investors have left the building, but still we’ve seen heavy volume on down days and light volume on up days over the past several months. This indicates lack of commitment into this rally and fragility in its continuation.
Another particularly bearish situation is found in the action of the bond market compared to the stock market. In recent days, the stock and bond markets have been rallying simultaneously which is very atypical behavior since bond prices usually move opposite to stock prices.
At some point these two markets will return to “normal” behavior, as divergences always do, and that means that the stock market must come down or that interest rates must rise.
We remain in the “Yellow Flag” mode, expecting choppy prices ahead. If the S&P 500 is unable to break above 1130 and sustain that level, I believe that the current stalemate could very likely be resolved with a substantial move lower. I think this resolution could begin as early as this week or next unless Dr. Bernanke refills the punch bowl of easy money at Tuesday’s FOMC meeting.
The View from 35,000 Feet
The economic news was mostly tilted to the negative side last week as personal income and spending in the U.S. remained stagnant while record low pending home sales were reported for June. Factory orders were down -1.2%, twice as deep as forecast, Durable Goods Orders were down, new unemployment claims were up and the real shocker was the huge miss in the Non Farm Payroll report on Friday.
On the upside, the ISM report remained above the all important 50 level, indicating continued expansion while the Economic Cycle Research Institute’s annual index turned positive, indicating an improvement in the rate of economic slowdown.
The elephant in the room was the Non Farm Payrolls report on Friday which showed job losses of -131,000 compared to a -65,000 forecast, or a huge, serious miss, while private payrolls rose just 71,000 compared to a forecast 90,000, another gaping shortfall. To make matters worse, last month’s readings were revised downward from a -125,000 jobs lost to -220,000 which indicates almost unbelievable weakness in the employment market at this stage of a “recovery.”
With 70% of the U.S. economy being driven by the consumer, these numbers can only be described as truly terrifying, particularly when you consider that it takes 100,000 new jobs per month just to stay even and 200,000 or more new jobs per month to actually reduce unemployment. No matter how you spin this, we have a long, long way to go to get out of this hole and return to some level of “normal” employment and the corollary consumer spending.
What It All Means
What it all means is that we’re in deep trouble when it comes to our economic future. A historic bailout and stimulative monetary policy has done virtually nothing to jumpstart the real estate or employment market and deflation is coming to be a household term with ugly ramifications. When you add this all up, we very likely have more difficult days ahead in both the stock market and the U.S. economy and that more punch in the punchbowl might not do the trick this time around.
The Week Ahead
As we discussed earlier, Tuesday is “D-Day” but there are other important reports later in the week, focusing on retail sales, the ongoing employment watch and consumer sentiment.
0830: Q2 Productivity, Q2 Unit Labor Costs
1000: June Wholesale Inventories
1415: FOMC Rate Decision
0830: June Trade Balance
1400: July Treasury Budget
0830: Initial Unemployment Claims, Continuing Unemployment Claims
0830: July Consumer Price Index, July Retail Sales
0955: August University of Michigan Consumer Sentiment
1000: June Business Inventories
Leaders: France, Agriculture, Germany
Laggards: VIX, U.S. Dollar
My second son wants to be a Navy pilot and this weekend took a huge step in that direction with his first solo flight on the way to his private pilot’s license. The whole family was at the Bend airport watching him “fly around the patch” by himself and then we dunked him with the traditional bucket of water. My wife cried, and it took me back to 1968 and the day of my first solo, 42 years ago. Like then, first solo remains a red letter day in every aviator’s life.