by Rasool Cunningham
Philadelphia, PA (DYDD)
Recently, I expressed my confusion on these markets in a twitter thought train that I won’t dig up now only to say the same thing later in this post. This is an attempt to clear up some of that confusion by organizing some thoughts.
But first, the markets: The efficient market hypothesis has been proven wrong on the margins. Sometimes everything isn’t reflected in the market’s price at any given time. Sometimes the markets are distorted by outside forces. Realizing when these forces are at work, and what part of the process you are in at any given time is an edge for the studious market participant.
Currently we have QE. It has inflated asset prices to record levels. Not businesses or consumers around the world buying a record level of things, but a flooding of bank reserves that banks use to make loans and create money. Yes, banks create money when they make loans. U.S. stock margin debt is at $500 billion because banks create money.
Not because people have been so successful in their endeavors, accumulated lots of money, put it in banks; swelling bank reserves leading them to make more loans. But by The Fed creating reserves through buying bonds from banks. This means you can’t believe anything you see right now.
It’s all distorted. It’s like the Shanghai composite on June 3rd 2015. On the way to new highs no one should have believed:
We need to see what managers can do in a normal setting. Normal interest rates, normal competition for capital, normal market dynamics. What the Fed means by “Normalization.”
Who can run their businesses (their ship) when the waters get rough?
This is what we need to know before we can make any determination as to what the future looks like for these public companies that make up the market of stocks. (Saw that in a headline the other day. “it’s a market of stocks, not a stock market.” smh.) There are about ten or eleven public companies that you must buy if you see blood in streets. Outside of them, we really need to see who’s a good manager. Who’s innovating enough to withstand the down turns that must happen in any business or industry?
The oil managers are being tested now. The best of them will thrive in this environment. Money will flow to those companies. Seeing who can still produce profits when market conditions aren’t at their most favorable is part of evaluating whether a company is a great investment or not.
The best leaders relish these moments. They know these are really just opportunities to win again. Market share is up for grabs, whole companies are up for grabs. I saw a tweet that relates to this:
It’s cliche, but true. Good leaders feel this way. These are the companies we want to own. Until we get back to a normal monetary world we won’t get the answers to these questions. This is where some of the confusion comes from. Some people are bearish because they can’t answer this question, not because they hate stocks or the markets. Others can’t understand why anyone would be bearish on a market that’s up 300% over the past six years. You get different perspectives clashing in the markets. The other part of the confusion is the mixed messages coming out of the Fed, BoE, ECB, BoJ and all the other alphabet central planners. This is leading to mixed messages going into / coming out of markets.
The Fed meant to be more transparent when it started writing longer more detailed FOMC statements. They’ve only become more opaque. Secrecy is key to monetary policy because people will front run you. The Dollar is up before the Fed has hiked. Now we’re getting the price action and market effect we would have gotten if the Fed had hiked; everywhere except the stock market.
The drop in gold would signal a major change in the way the Fed has been conducting monetary policy. It says the Fed is hiking already. There are more Dollars in the world than ever before and all of them are strong. So the Fed has a dilemma: How do you reach your inflation targets with most prices dropping? How do you hike rates with the dollar surging? How do you not hike rates with job growth as high as it’s been in modern times? If you don’t hike rates soon, how will the reversal of a strong dollar play out?
I can go on and on with these. The Fed is dammed if it does and damned if she doesn’t. For all the reasons mentioned above: the Fed must get the market back to normal. Think of it like a patient under anesthesia for too long. The effects can be deadly. If that Dollar fall is triggered by bad U.S. econ data the Fed could be faced with a situation where they can’t raise rates whether their inflation target is hit or not. Central bankers don’t like that type of shit. Rigidity of monetary policy is not a good thing.
One can’t really know what the Fed is watching right now. Best guesses say they’re watching inflation. But if that’s the case, why haven’t they openly said they wouldn’t be hiking interest rates this year at all because commodity prices have gone to shit in a hammock? Why keep saying you think the data will be good enough to warrant a rate hike this year? Even as the whole world sees prices falling? This is where the Fed induced confusion comes in. Half the market doesn’t believe the Fed can raise rates.
Technology has lots to do with the price dynamics of global commodities. Even gold has Bitcoin to compete with. The Dollar rise also has a lot to do with those dynamics. The Fed keeps wording their statements to reflect a rate hike this year because they can’t be seen as rigid in their policy.
That’s a bad way to make your monetary policy, though. Even if it seems necessary, it’s not good to make these types of decisions based on how it will look. If the market loses faith in the Fed’s ability to hike, the reversal in the Dollar could be strong enough to push inflation up enough to hit the Fed’s target right at the exact time that U.S. econ data starts turning down. Fed Chair Yellen testified to Congress that she wouldn’t hike rates if she thought it would tip us into recession. But what if that’s her only choice?
What if by being so transparent the Fed has given itself only two options: Low rates or recession? The market knows transitioning from zero interest rates is a tricky, so, once that process begins the market (and business managers) need to salvage as much cash in realized gains as possible; wait out the transition, and have better chances at catching good deals on good companies. Companies that have proven they provide products and services people need, not just want.
There’s been lots of debate about bubbles here or there. Now we have to add another asset to the bubble talk: Is the Dollar now in a bubble?
We won’t know what’s in a bubble until the Fed normalizes (or doesn’t normalize) interest rates. But if the Fed depends on good econ data and doesn’t get it, it can’t hike. This means the Dollar is too strong. That should be good for the U.S economy, but the lag between when the Dollar falls and when its fall has a positive effect on the U.S. economy is long enough to give a central banker vertigo. They will be out of step in the beginning. They would truly be out of ammunition. Regular ammunition that is, they could go nuclear. Qe5 would be nuclear. It would also be to the detriment of Japan and Europe, and for different reasons, the U.K.. The IMF has asked the Fed not to hike this year, wonder what they would think of another Qe?
I’m still confused on the markets. I still can’t see a reason to buy or sell stocks here. The Bull case is: The Fed can’t hike, so the punch bowl is still full. That’s a bad reason to buy stocks. The bearish case is: none of this is real, and it will end badly. That’s a bad reason to sell stocks. Even if we know it will end badly, we can’t be sure when it will end. So for now: I’m still neutral on stocks. As for the Dollar I’m leaning towards neutral there also. Looking for chop in the Dollar index. Each major Dollar Forex pair is a blog post of its own, and this post is already too long. So…
I’ll end it with thanks for reading, I hope it helps, and good luck this week traders!