The End of Free Markets: A Great Reason to Buy Stocks

by: Balance Junkie

Advice to children crossing the street: damn the lights. Watch the cars. The lights ain’t never killed nobody.

~Moms Mabley

As adults, we often remind our children to watch the traffic lights when crossing the street. That seems like good advice, but it won’t necessarily guarantee that our kids will be safe. If the drivers on the road don’t pay attention to the signals, if they make a mistake, or if the signals malfunction, crossing on a green light or “walk” signal will be of no help whatsoever. In the end, we need to actually look at the reality on the street. You don’t walk into oncoming traffic – no matter what the lights say.

If you’ve been reading Balance Junkie for a while, you’ve likely become accustomed to my bearish leaning on the markets and the economy. I have consistently remained cautious on both due to the huge amount of debt floating around the financial system. I have been hesitant to buy stocks for fear of that unwinding very quickly, pressuring economic activity and taking all asset classes lower.

I’ve also been hesitant to take a substantial short position because I have serious doubts about the integrity of the financial markets due to the continuous tinkering of global central banks and a general lack of transparency on the part of governments, central banks, and financial institutions. Having said that, I do own a small position in an inverse ETF that will rise if the TSX falls. I’ll likely be liquidating some of that position soon as I think that stocks and commodities have the potential to rise – perhaps by a lot – in the coming months. Since the TSX has a heavy weighting in commodities, I could get clobbered on my inverse position.

Why So Bullish?

So you’re probably wondering what has led to my change of heart. Do I believe that corporate profits will be ramping up in the near future? Will the global debt problem simply vaporize? Have I suffered a head injury and/or taken leave of my senses? It’s none of the above.

Put simply, I think the traffic signals are messed up, so I’m staying off the road. The consensus view has now become that the Federal Reserve will enter the market with further quantitative easing, perhaps as early as November 3rd. That may cause a significant rally in stocks, bonds and commodities, especially gold.

That’s right. We could see a very large momentum-driven move to the upside based on nothing more than the Federal Reserve buying bonds from the U.S. Treasury. The U.S. dollar will fall, sending dollar-denominated assets higher. Other countries will not be happy as they do not want to see their currencies appreciate against the greenback. They may respond, as Japan has already, by intervening in the currency markets to devalue their own currencies.

Not only will traders be reciting the “Don’t fight the Fed” mantra every day, they will be doing everything in their power to make an extra buck by front-running the Fed. If they believe the Fed will be buying treasuries at a certain point on the curve, that’s where they’ll be buying. If they believe that the fall of the U.S. dollar will erode confidence in all fiat currencies, they will be buying miners, ETFs and physical gold with both hands.

Any news reflecting the economic reality will be ignored. There are still major problems with sovereign debt and banking in Europe. There are news stories about this every day, but none of them seems to make the top stories, even on business news networks. Last Friday evening, the U.S. bailed out 3 wholesale credit unions. Perhaps the timing of the announcement explains why this was so sparsely reported. See the zerohedge version for a no-holds-barred take on this.

Isn’t all of this great? Won’t our lives be a lot better with a rising stock market and falling interest rates? Sure. Until the Wile E. Coyote moment when we realize that our momentum has carried us past the point where the land ends and there is nothing below our feet.

Free Market Capitalism Is Extinct

So it looks like stocks may rise and interest rates that haven’t yet hit zero will make a run for the big egg as well. Do you have money in a savings account? Sorry to hear that. That’s probably going to yield zero soon too. Perhaps you grudgingly locked in a few GICs or CDs for 5 years at 3%. That might actually look like a high yield in the near future.

Will QE lower the unemployment rate or improve the economic reality of the average citizen? Will the rise in the stock market reflect economic prosperity in any way, shape or form? Absolutely not. It will simply be the result of the Federal Reserve manipulating the market. That is not free market capitalism.

I’m not an economist, banker, or lawyer. But I read the definition of market integrity. Can anyone who is a lawyer please explain to me why the Fed’s actions do not constitute securities fraud?

Faulty Signals Will Lead to a Crash

Having read the descriptions of many analysts on how this whole QE thing might play out, I have to say that the path is far from clear. Here are some of the ideas I’ve heard:

  • QE will lead to a devaluation of the U.S. dollar, which will initially cause asset prices to rise, but will eventually cause a currency crisis/collapse and hyperinflation.
  • Once the jig is really up, all of the “Don’t fight the Fed” trades will reverse. Asset prices will fall and interest rates will rise, perhaps very quickly. What’s the plan if this should occur?
  • There’s a decent chance that QE won’t work. It may inflate asset prices for a while, but fail to produce any meaningful inflation in the real economy.
  • What if the QE trade is already priced into the market such that it reverses if and when the Fed actually pulls the trigger?
  • No one, including the Fed governors, knows precisely how QE will affect global markets or economies.

We are now living in a world where Truth is bound, gagged and drugged in a back room somewhere and reality is simply irrelevant. Some will time all of this perfectly and make a fortune. Others will play the ostrich and lose it all.

I understand the “Don’t fight the Fed” meme. I do think that being short this market could be painful, but I would submit an old margarine slogan for your consideration: “It’s not nice to fool Mother Nature.” No one can dodge reality forever, and no one is bigger than the market.

So what do you do when you’re walking the streets and some rogue messes with the traffic signals? Best to go home and wait it out. The light may be green, but that doesn’t mean you won’t get hit by a semi.

Are you watching the traffic lights or the vehicles on the road?