That is essentially what Chairman Powell and his European counterpart, Mario Draghi, told investors last week. If this was not their message, that is the way it was interpreted by investors Thursday morning, as the S&P 500 (SPY) and Dow Jones Industrial Average (DIA) approached new all-time highs.
At the same time, long-term interest rates are plunging to new lows for this year, as money piles into the safe-haven of U.S. Treasury securities. This doesn’t suggest that the medicine central banks say they will provide is going to heal the patient. It doesn’t tell me that more monetary policy easing will lead to economic growth. Instead, it says the Fed is refilling a prescription for a drug designed to alleviate pain, but not for the 90% that need it.
Precious metals are also surging with gold (GLD) at a six-year high, as investors anticipate lower real interest rates. If the Fed believes it can inflate our way out of the burgeoning debt crisis, I think it is sorely mistaken. All it is doing with its program to inflate financial assets is sowing the seeds of the next financial crisis.
Bad News Is Bad News
To understand how distorted the logic is following the Fed meeting on Wednesday, investors now want to see weak economic data leading up to the July meeting, so that a cut in interest rates is guaranteed. That is INSANE. It affirms that investors are still addicted to the drug that was introduced ten-years ago to stem the deflationary spiral in financial assets. I would rather see improving economic data and corporate fundamentals that validated stock valuations that are already near historical highs.
Lowering interest rates today implies weaker rates of growth in the future, which leads to lower corporate revenues and profits. As such, corporate earnings expectations continue to deteriorate. The consensus is now calling for zero growth in the third quarter, which will follow two quarters of declining year-over-year earnings. There is a miraculous surge in earnings growth expectations to 6.8%, which is designed to achieve a modest 3% rate of growth for the year.
Bad news may be good news for the weeks leading up to the next Fed meeting in July, but I expect that it will no longer be good once investors realize that rate cuts are having no impact on economic growth or corporate profits. Rate cuts near the end of the previous two business cycles, which followed a period of tightening, were signals to sell stocks. I see it as no different this time.
A False Premise
Chairman Powell said on Wednesday that “they will act appropriately to sustain the expansion.”
I would like to know exactly how cutting short-term interest rates will accomplish this goal. The problem is that further inflating financial assets with lower interest rates is not going to help the half of the U.S. population that can’t come up with $400 in the case of an emergency. It won’t lead to higher wages for the 90% of American households that need it. It won’t put the down payments required to buy new homes in the pockets of a new generation of potential homeowners. It won’t resurrect the manufacturing sector.
Lowering interest rates will encourage consumers, corporations and the government to take on even more debt than already exists today. How well has that worked over the past decade? It will create more wealth and income disparity, which will lead to more uncertainty and political instability. It will encourage more speculation and has resulted in valuations for newly public companies reminiscent of the year 1999.
The End Game
Bernanke, Yellen and now Chairman Powell tell us that the Fed was largely responsible for saving the U.S economy from a depression. They say that their actions led to what will soon be the longest expansion on record. I would argue that the Fed did just the opposite. It distorted our economy and markets in ways that have laid the foundation for the next financial crisis. Fed policies created unprecedented wealth for a few and transferred wealth from savers to investors and speculators. In doing so it slowed the rate of consumer and capital spending growth. The economy and markets would have recovered on their own without the Fed’s intervention.
If the Fed achieves its objective of sustainable higher rates of inflation, that will lead to a rise in long-term interest rates, which will devastate our overleveraged economy. If they don’t achieve their objective, and the rate of growth and inflation continue to slow, the Fed will have created another stock market bubble that is bound to burst. They are damned if they do, and damned if they don’t, and it is a quagmire off their own making.
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Disclosure: I am/we are long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.