September 17 - some great stuff via John Hussman's weekly market comment:
… Meanwhile, it is probably worth marking down September 13, 12:30 PM Eastern, S&P 500 1438 as the point when the Fed finally went all-in, much to our relief - allowing the market to presume unlimited QE, and removing the constant anticipation that the Fed would draw the last arrow from its quiver to kill off every prudent element of our economic system. As Bernanke noted at his press conference, the Fed has been down to two main tools given that interest rates are effectively zero: "balance sheet action, and of course, we can restructure those - change those in various ways. The other type of tool is communication tools. And we could - we continue to work on how to best communicate with the public." So the Fed has now left itself with nothing but talk.
We continue to view QE as being of no real economic benefit, and though it has clearly affected financial markets, QE has typically boosted the stock market by little more than the amount it has lost over the prior 6 month period. That's another way of saying that I doubt the Fed's actions will be of much durable effect here at all. As I noted in July, the probable upside benefit to QE3 was likely to be limited to the upper Bollinger band of the S&P 500 on weekly and monthly resolutions. And here we are.
The S&P 500 now sits atop its upper Bollinger bands (two standard deviations above its 20-period moving average) at daily, weekly and monthly resolutions. Further progress requires the market to sustain these strenuously overbought conditions. Investment advisors are now bullish by a margin of greater than two-to-one, and the pace of selling by corporate insiders has tripled since July to a rate of six shares sold for every share purchased.
You can see the extreme positioning of the S&P and the U.S. dollar in the two bollinger band charts below:
Now some folks have said, in the aftermath of last week's craziness, that anyone who thought the Fed would fall short on Thursday should essentially feel shamed / embarrassed by their bad analysis.
To which we reply, really? Ben Bernanke basically went insane on Thursday. Are you really supposed to discount a guy going insane?
By "insane" we mean that the Fed has instituted a policy akin to pushing its entire stack of chips into the center of the table. Once you go "infinite" what have you got left? Zimbabwe-style bricks of cash shipped out via Amazon (AMZN) prime? Liquidity shot in people's faces with water cannons?
The following from Gavyn Davies at the Financial Times, Why Did Ben Bernanke change his mind, also sheds light on the surprisingly weak rationalizations for the Fed's lunacy:
Why has [Bernanke] done this? It is not because the expected path for unemployment has worsened since January. Surprisingly, the path for unemployment in the FOMC's September projections is almost exactly identical to that published in January, if not a little lower …
Nor has there been any drop in the FOMC's inflation projections, which might have given the Fed more scope to ease policy, relative to what was indicated earlier in 2012. It therefore follows that the only thing which can have changed is the FOMC's interpretation of the seriousness of the unemployment problem. It now sees the weakness in the labour market as requiring much more urgent action than it thought as recently as a few months ago …
To which again we say, hmm. Really? The Fed has decided to basically use everything it's got … leaving nothing in reserve from a psychological perspective … because it is so suddenly worried about unemployment that all of a sudden, oh my gosh, ALL OF THE CHIPS go in the middle right now?
It is a real possibility, one supposes. It is possible that Bernanke is a true drinker of his own Kool-Aid, which would make him the monetary policy equivalent of cult leader Jim Jones.
It is also possible that Bernanke and the FOMC can be counted among the worst traders ever, with a sense of risk management so nonexistent, so awful, that they happily accelerate screamingly overbought trends (in stocks) and oversold trends (in the dollar) at the same time, ahead of a pending Greece-related Europe flare-up, just because they are immensely dense like that.
Such a course would be on par with pointlessly canceling one's hurricane insurance even as the storm bears down on the beach house, but no matter. It is at least theoretically possible the Fed is that stupid … but why give credit to such unlikely dumbness, when a plausible alternative explanation is readily available.
We think the Fed pushed all in, e.g. "went infinite," with specific political motivation prior to the November elections. But regardless of whether you believe that, the game has now shifted significantly because a series of open questions has been put on the table:
- What happens after infinity?
- What happens when you hit the problem with all you've got and it still doesn't work?
One can imagine an exchange going like this:
Mr. Chairman, what will you do if "infinite" QE fails to work as advertised and does not bring down unemployment?
Bernanke: Well, then we will just print more.
But what about inflationary concerns?
Bernanke: Inflationary concerns are worth the risk. We are attempting to create inflation.
But what if no amount of juice solves the problem? What if your created inflation makes unemployment worse, by forcing savers to save even more as a bulwark against rising food and energy costs, lowering consumer spending further?
Does an "off" switch even exist? To what ends will you pursue "infinity?" Will you recreate Argentina or Venezuela, where unofficial inflation numbers run higher than twenty percent a month? Would Evans and Rosengren and your number one Keynesian superfan Krugman be satisfied then?
At the end of the day we are traders, not economists or prognosticators. But this stuff matters from a trading perspective because at some point the market is going to clue in to the fact that even "infinite" QE will not work … and will likely even cause more harm than good. When that happens, it is going to be very, very ugly.
It is also entirely possible that the Fed's infinite QE actually worsens the consumer spending picture through the mechanism as described in our hypothetical dialogue. If strapped middle class consumers, who are already paying a form of "stealth inflation" tax in rising food and energy prices, are forced to save and retrench FURTHER because of QE's inflationary impact, consumer spending could actually DROP. Wealth effect? For the 1% maybe, or just possibly the upper 30%. For the 70% that comprises most of the country, a wealth effect in reverse …
And such could occur at a time when corporate profit margins were long overdue for a drop already, via finally seeing the backside of multi-year cost-cutting and fat-trimming gains (which can only go so far) and a post-2008 global stimulus bounce that has now all but run its course …
All told, we actually find it a less frightening notion to see the Federal Reserve as epically corrupt versus epically stupid or epically in thrall to their own "bet the farm" Jim Jones Kool-Aid notions. An organization that is corrupt but intelligent can at least be counted on to consider the merits of pulling itself back from the brink. An organization run by out-to-lunch academic Kool-Aid drinkers is a threat to blow up both itself and the world for the sake of institutionalized idiocy. What the Federal Reserve is doing has been properly labeled the greatest mad science monetary experiment of all time, and the risks of blowing up the laboratory have just increased dramatically.
Whether Bernanke is a maniac at the poker table or a deviant calculated risk taker playing an insider's game in which the real fate of the average American be damned, the net result is the same: The Fed's approach to monetary policy makes LTCM (Long-Term Capital Management) look like they were playing with a third grader's milk money and the markets will feel the consequences.
In terms of positioning, we continue to look for short opportunities in a market that is extremely, insanely overbought, via companies that have ample exposure to ongoing global slowdown (which QE3 does not change) and which showed their weakness via lackluster response to the Fed run-up. We also continue to see the dollar as a prospect for violent snap-back given its extreme oversold state and the increasing likelihood of a market rethink once the euphoria of infinity wears off.
We are not opposed to going long into Soros style false trends but only from reasonable pockets of consolidation with evidence that a meaningful period of intermediate term upside is sustainable or at least plausible - such certainly does not seem the case here.