fbpx

Is the Fed Playing Chicken With the Stock Market? – Ep. 124

  • The U.S. stock market finished up its worst week since August, when everybody though a rate hike was just around the corner
  • Substantial triple-digit losses across the board
  • The Dow Jones closed down 309 points – almost 4%
  • Similar percentage decline for the S&P 500
  • The NASDAQ dropped 111 points, over 4% decline for the week
  • The media is blaming this decline on oil prices, and yes, oil prices are weighing on some stocks
  • Some stocks benefit from lower oil prices – case in point: transportation
  • Dow Transport was weaker than any other index – down more than the markets on a percentage basis
  • The truth is that oil prices and stock prices are going down for the same reason
  • The reason is a slower growing global economy, including the U.S. economy, and the fact that the Fed is threatening to slow it down further with an interest rate hike
  • Some of biggest losers are not even in the stock market, but in the bond market
  • The high-yield bond market is getting obliterated
  • A chunk of the high yield market is energy companies
  • Two things are hurting them: the fear of rising interest rates and the slowing of the U.S. economy
  • We are heading for a recession, if we are not already in one
  • This does not bode well for the high-yield bond market, because in a recession these companies will have more trouble servicing their debt
  • The Fed’s monetary policy of zero percent interest rates forced a lot of Americans into these high-yield bonds – people are hungry for yield
  • A lot of risky companies who did not have access to credit, were able to borrow all sorts of money because of this hunger for yield
  • This is the same thing that happened in the sub-prime market
  • Customers all over the world needed yield, and the mortgage market was where they got it
  • There was so much demand for mortgage debt on Wall Street it was easy for non-credit-worthy customers to get a loan
  • The same thing is happening in this high-yield market. Carl Icahn was on CNBC on Friday morning, referring to the present situation as a “power keg”
  • It is a powder keg that the Federal Reserve created and in theory they will light the match if they raise interest rates next week
  • In fact in my last podcast I mentioned that for the first time, the Fed might actually raise rates, and I received quite a few comments asking me if I was ready to admit that I was wrong
  • The Fed is trying to change the nature of a rate hike – alter the narrative away from normalization to a one-and-done scenario
  • Markets anticipate future events and they price them in, so the beginning of the tightening – “liftoff” I felt markets would look toward the eventual destination and start pricing that in.
  • None of the markets can handle that
  • So the Fed assured the markets that liftoff didn’t matter because the first hike will be small and the trajectory will be very low
  • That’s why I called it a trial balloon.  The Fed wanted to see how the markets would respond to a tiny, symbolic rate hike just to prove we can do it, and then a long period of time, before another one, if there is another one
  • Initially it looked as if the markets was buying the idea, but remember I kept saying there is time, and the markets could decline – in fact that is already happening
  • Maybe the Fed’s trial balloon is not going to go over very well
  • We had a “Black Monday” in August prior the potential September rate hike
  • We have another Black Monday coming up – the technicals on the market look awful
  • We could have a huge decline on Monday, and you’d better believe the stock market is going to be high on the Fed’s agenda
  • When the Fed called off the rate hike last time and we got a huge bounce in the stock market
  • The reason the Fed gave was weak global economic condiditons
  •  None of those problems have been solved and it can be argued that global economic conditions are weaker now than in August
  • What is worse is the U.S. economy. All of the forward-looking indicators are flashing recession
  • This is not a normal tightening situation. These are unprecedented times and what’s going to happen is also unprecedented
  • We are not going get an inverted yield curve to predict this recession because the Fed’s not going to let it happen
  • The Fed started tightening monetary conditions by first threatening to taper, then to taper, then threatening to raise rates – it’s their rhetoric which is effectively tightening monetary conditions.
  • We are not on the cusp of recession
  • The data that came out this week that most indicates recession is inventory data and wholesale sales
  • Wednesday we got a report that wholesale trade inventories were down .1%
  • On Friday, business inventories increase was zero.
  • Businesses are not building inventories because they have a backlog and sales were below expectations
  • The inventory to sales ratio is now even higher
  • Future GDP will continue to decline
  •  If interest rates go up,  credit card rates will go up, variable rate home mortgages will go up, high-yield market bond funds will collapse
  • This is why it is so important to the Fed that the market does not collapse when they raise rates
  • This is why there is a good chance, if the market decline extends until Wednesday, the Fed may not raise rates
  • This time around, there will be an excuse that has nothing to do with the U.S. economy
  • If they do not raise rates, I do not believe there will be a time in 2016 that the Fed will be able to raise rates
  • If the Fed does raise rates, there is a huge risk that the market will not recover
  • Warren Buffet said,”When the tide goes out, you can see who has been swimming naked”.
  • The tide goes out when the Fed raises rates
  • Claims that current monetary policy is working now are premature because the success is measured  by a strong economy with normalized interest rates and a reduced balance sheet
  • All data, with the exception of backward-looking jobs data, suggest we are close to recession
  • This is what scares the Fed: let’s assume that they do raise interest rates on Wednesday and then the market tanks even more. What is Yellen going to do?
  • That is why it is so dangerous for the Fed to play the game of a symbolic rate hike just to prove they can do it.
  • If the Fed decides to raise rates I do believe it will set bigger declines in motion and we’re in for a wild ride
  • Gold was positive on Friday and gold stocks were mixed, but out-performed the overall market
  • The dollar is falling against the euro and the yen, which is problematic and troubling
  • At some point, with a weaker dollar we will experience commodity shortages, and it’s going to be a brand new commodity bull market.