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What's the True Cost of Federal Reserve Market Manipulations ?

|Includes: GLD, SPDR S&P 500 Trust ETF (SPY), TLT

What’s the cost of admission ?
In today’s marketplace it’s all about the cost of admission, whether we are talking about jobs, real estate, or capital market opportunity. In the past 25 years we have all confused the price of admission with the ease of entry. Real Estate purchasers found it far too easy to enter the fantasy realm of wealthy property baron without really assessing the true cost of their actions. In contrast, job seekers are finding that the cost of admission to continued employment is higher than they may be able to afford as education, training, and skills are priced at a premium. We find the capital markets present us with quite a conundrum these days. While the Wall Street financiers can access virtually unlimited capital making their entry into the markets easy, I again wonder if we are missing the true cost of admission and sowing the seeds of disaster. The FED has announced the details of their QE2 (Quantitative Easing) program, designed to further suppress the cost of capital. Since short term rates are already near 0%, the FED has said they will be focusing on medium term (5 to 7 year) notes when they begin their $600 billion dollar program this month. The objective is to drive capital out of medium term bonds and into riskier assets. For banks this means making more loans to businesses and consumers, for consumers it is supposed to force them to stop saving and start spending money and boosting the economy. The problem I see with all of this is the effect the devaluation of our currency already has had on asset prices. Oil is rising again, agricultural commodities are soaring and Wall Street is up to it’s old tricks, namely borrowing from the taxpayer and investing the money overseas in faster growing markets. The rise in consumer prices is troubling and may give the FED pause before too long.

In last month’s issue of my newsletter we were looking for an early November target on the SP-500 of 1223 (Page 2 Chart October Issue). On 11/5 we closed at 1225.85 and it looks like we have begun a correction. Having met our target price for the bullish cycle we face something of a quandary as our target was calculated without knowing whether the FED would actually commit to further easing. The next few weeks will be critical in determining whether this may be our top or alternatively all that money printing is going to propel risk assets higher. There are two scenarios that we need to assess: (1) the market has seen its top for 2010 and any action from this point on will be grinding lower with sell-offs and subsequent recoveries never getting past 1225.85, or (2) the market may correct a bit here (1150 ?) and then resume it’s upward bias, taking out 1225.85 and hurtle towards 1380. The wild card is whether the FED gets cold feet and let’s rising consumer prices dampen their monetary easing efforts or raises the bar even higher and commits more than $600 billion when it sees the economy not responding in the manner it intended. There is some anecdotal evidence in that Goldman Sachs and Pimco, 2 firms that have access to retired FED officials who in turn have access to current FED officials, have hinted that the FED may be prepared to inject far more than $600 billion into the economy if necessary. As we don’t have access to insider information let’s wait and see.

The Fixed Income markets are responding in a choppy fashion after the FED detailed its plan. Prior to the details being announced, the 10 year treasury note gained some traction and the yield declined from 2.7 % to under 2.5%. However, after market participants assessed the potential that rising consumer prices may indicate nascent inflation they began selling and yields are once again rising. Part of the problem in our markets this year has been volatility. The FED’s actions have the potential to further de-stabilize the fixed income markets and create bubble like conditions in commodity and equity markets, defeating the purpose of stimulating economic growth. Out of instability comes fear and fear always trumps economic potential when investors get confused. I believe we will see more selling in the 10 year note in the short term, but a good entry point may be approaching as yields rise to near 3%.

The election is over, the FED is still manipulating markets, and investors are still confused. While there is still little clarity, we are getting closer to determining what the trend may be over the next 6 to 12 months. A little more patience and analysis and we’ll soon know what we need to do.

Disclosure: Disclosure: No Positions