“What happened” is the question I was asking all day on Wednesday. The market was having a broad-based risk-on rally which appeared to be defying the current tightening monetary policy narrative. While the buy-the-dip crowd was out in force there appeared to be more going on. Gold bottomed yesterday and surged higher – this implies looser monetary policy not the tightening the market has been anticipating.
The narrative has been that the Federal Reserve is raising rates in December and since this diverges from the rest-of-the-world’s monetary policy the dollar should rise and put downward pressure on US corporate earnings. This gives the SP500 a tremendous headwind, yet since the October FOMC meeting the SP500 has shown strength.
While the US consumer is plodding along, the global industrial economy is in recession so the economic fundamentals will not catch up to the current high market valuations anytime soon. So what has been filling the sails of the SP500 since mid-October?
I have always said it would take a near-term reversal of monetary policy from tightening to more quantitative easing for the market to see new highs. With the Fed firmly set on raising rates in December, this reversal cannot happen until next year after further economic weakness and financial stress. By that time, it might be too late for the market to reach new highs.
So “what happened” was buried deep in the FOMC minutes from October which was released yesterday. I have not found any discussion about it in the mainstream news, not that they will admit the stock market has been fueled by QE the last few years instead of economic fundamentals. But there it was as pointed out by Goldman Sachs:
“Participants also noted that the lower long-run equilibrium rate implies that the near-zero effective lower bound could become binding more frequently. As a result, “several” participants indicated that it would be “prudent” to consider “options for providing additional monetary policy accommodation” should the economic recovery falter.”
It is the first hint of more QE along with the admission that we could continue to bounce off zero interest rates for some time. In the short term, Fed has to raise rates in December – not to signal the economy is good, but because NOT raising rates signals the economy is not strong.
With FOMC participant’s statement the markets get the message that we are getting marginal short term monetary tightening, but expect significant monetary easing at the first sign of weakness. And the markets expect global economic weakness and financial stress to continue.
I also find it interesting the SP500 extended its October rally a couple of days after the “hawkish” FOMC meeting and then again with the release of the minutes. Surely, no one leaked the contents of the minutes early to Wall Street in October. That never happens.
So now the financial markets can continue the “bad economic news is good financial market news” matra and the stock market can continue to remain elevated from fundamentals a bit longer because more market QE support is just around the corner. The market is assured the “Greenspan put” and Ben’s “dropping money from helicopters” is still firmly in place.
Please understand my view on QE is that it has become a drag on economic growth or the opposite of the Federal Reserve models imply. The Fed models only see you as a consumer who will spend more if interest rates are lower, where in reality anyone looking toward retirement sees the low current and future income on retirement assets and determines rationally they need to save more and spend less in order to reach their retirement income goals. This lack of spending becomes a drag on the economic recovery.
In an indirect way, suppressed interest rates are a virtual tax on retirement, pension and insurance funds that are being employed to fund record corporate stock buybacks, speculative global financial investments, and sub-par economic investments (mal-investments). The loss of retirement security is permanent; the QE induced global financial bubble will end like all bubbles do.
The narrative that “low interest rates will continue until the economy improves” reminds me of the saying “the floggings will continue until morale improves”.
I have posted a Special Alert for members on how this affects our investment allocation decisions.