The FOMC Is Making Those Annoying Noises Again

August 21, 2016

Late summer is usually a boring period in the market, and this year is proving to be no exception.  As seen in the Bear’s Eye View (BEV) chart below, since early July the venerable Dow has made nine new all-time highs (BEV Zeros). Moreover, the other days in the past month and a half have all closed within 1.50% of making a new all-time high. 

So when is the stock market boring after seeing the Dow Jones Index make so many new all-time highs within six weeks?   If you’re like me, who in your circle of friends and family cares about what the stock market is doing anymore?  A few people maybe.  But after March 2009, since the bottom of the credit crisis, most of the people I know have moved on with their lives.

Today is a different world from what it was twenty years ago.  All during the 1980s and 1990s, seeing the Dow Jones making new all-time highs caught everyone’s attention.  TV shows used the stock market in their plot lines, and the daily closing price of the Dow Jones was a frequent news item on the local news.

My mother lived through the Great Depression.  During her entire lifetime, buying a US Savings Bond was as risky a venture she would make, until 1999, when after seventy years she was finally ready to take the plunge into the stock market.   Mind you, nothing big.  But she, like most people during the high-tech bubble, got caught up in the excitement as the Dow Jones Index went from one new all-time high to its next. 

Seventeen years later, it’s not at all like that today.  Look at the Dow Jones’ trading volume below.  Since July 2nd it’s dropped like a rock, exactly as the Dow Jones has been making all of those new all-time highs.  It’s been like this for years.

And another thing that’s darn suspicious about the NYSE’s current bull market; all the gains seen in the stock market since Obama became president have occurred as economic demand for electrical power (EP) has stagnated.  Note Dr. Bernanke’s “Operation Twist” below, where the FOMC in January 2011 began monetizing long-term bonds as a new means to “stimulate economic growth” by lowering long term bond yields.  Just four months after its implementation, the American economy’s demand for EP began a two year, 2.5% contraction that saw the Dow Jones move from 12,400 to 15,400.  There’s just something wrong with that.

Only one new all-time high in the Dow Jones Total Market Group (DJTMG) this week: Heavy Machinery.  Last time we saw a week with less than two new all-time highs was last February; six months ago.

But the DJTMG’s Top 20 (chart below), or the number of groups within 20% of their last all-time high ended the week at 48.  Seeing the Top 20 at 48 isn’t necessarily an indication of market strength, but it certainly tells us that at the end of the week, the market wasn’t preoccupied with concerns of Mr Bear.

Next is the frequency distribution table for the DJTMG from where I derive the data for the plots seen in the two charts above.  From the declining number of all-time highs since early July (BEV-Zero column), we can conclude that even though the Dow Jones is currently making new all-time highs, upward momentum in the general market has greatly diminished.  However, with the Top 20 now at 48, its high since June of last year, the general market isn’t thinking of rolling over either. 

But this is no reason to be purchasing stocks, or even holding on to one’s position in the stock market.  The big picture as I see it is; the market is either being inflated by the “policy makers” or is being deflated by Mr Bear.  Most investors only make money when they hold on to shares as the market is being inflated.  Yes, in a down market one can make money by shorting stocks or purchasing put options, but most retail investors can’t make money during market declines.

With October approaching, the prudent thing to do in late August seems to be to get some distance between your money and the stock market.  Going into cash, or buying some gold and silver bullion isn’t unreasonable at this point in time.  I also like the precious metal miners.  If you want to buy the miners of gold and silver I won’t try to talk you out of it.

Gold (Blue Plot below) is still taking a rest, and market sentiment (Red step sum plot) in the gold market is coming around.  Like the stock market, gold and silver bullion for weeks now haven’t done much to keep their supporters entertained.  Though notably, their miners have provided much excitement to their investors since last January.

But unlike the stock market, which has been advancing for the past seven years under suspicious circumstances, gold since last December is coming off the bottom of a four year, 45% market decline.  Silver at its December bottom saw a decline of over 70% from its April 2011 top; ditto for the miners of gold and silver.

For a moment, forget about the obvious market manipulation that’s rampant in today’s financial markets.  Historically, the secret of making money in any market is buying near the bottom of a bear market, and selling near the top of a bull market.  If you can accept that as a good market strategy, then you should understand the logic of exiting the aging bull in the stock market, and moving your money into the bull market for gold, silver and the precious metal mining shares that began only months ago.   But as always, the decision is yours.

The FOMC is making those annoying noises again; that they’ll increase their Fed Funds rate next month.  I don’t believe they’ll do it, but then I didn’t believe they’d increase short-term rates last December either, and darn if I wasn’t wrong.  But they paid a price for raising rates by a pathetic twenty-five basis points eight months ago.  December was the bottom in the multi-year bear market in gold and silver bullion, with the precious metals miners bottoming a month later in January 2016.  The Federal Reserve’s last rate increase, tiny as it was, also resulted in a short, but sharp double-digit correction in the stock market.

Let’s have a short review of the history of “monetary policy”; the manipulation of short-term rates above and below long-term rates for the past seven decades in the chart below. 

Let’s first look at the chart insert for the growth in Currency in Circulation (CinC) since 1920.  When interest rates peaked in October 1981, CinC had expanded by a factor of 30.  Interest rates then began a four decade decline as CinC continued increasing.  Now in August 2016; the growth of paper money in circulation has increased by a factor of 327 since January 1920, with interest rates near their lows of the past half century.

It appears that inflation in the supply of paper money circulating in the economy has little to do with interest rates, but that isn’t true.  Interest rates increased from 1954 to 1981 because CinC inflation was flowing into consumer prices.  In response to the rising cost of living, the bond market demanded an inflation premium to compensate bond buyers for the dollar’s loss of purchasing power.  After bond yields and interest rates peaked in October 1981, monetary inflation stopped flowing into consumer prices and began flowing into the financial markets, inflating the value of stocks and bonds, and lowering bond and dividend yields.

But what’s most notable in the chart below is the interplay between short term interest rates (Blue Plot) above and below the US Treasury’s long-bond yield (Red Plot), as the “policy makers” manipulate the economy into a frenzy of bi-polar behavior. 

Up to when interest rates (and CPI inflation) peaked in October 1981, the FOMC’s “policy makers” were fearless in raising short-term rates far above the yield in the long bond.  These yield inversions, as they are called, resulted in sharp economic recessions that professors of economics told everyone would check rising CPI inflation.  Well that wasn’t so, as the late 1970s and the early 1980s were infamous for CPI inflation rates of well over 10%.

However, after October 1981, when monetary inflation began inflating market values (aka Bull Markets), the “policy makers” became fearless in lowering their Fed Funds rate far below the long-bond yield.  In box #1 (above), the “policy makers” reckless “monetary policy” ignited the NASDAQ High-Tech bubble.  An inflationary market bubble that didn’t deflate until the Fed Funds Rate once again increased above the long-bond yield in the late 1990s.

As the NASDAQ High Tech bubble deflated (box #2: 2000-02), once again the “policy makers” dropped their Fed-Funds Rate far below the yield for the long bond, igniting a bubble in real estate that lasted until short-term rates once again invert above the long-bond yield: 2007.

In the aftermath of the sub-prime mortgage / credit crisis, the “policy makers” plunged the Fed-Funds Rate to an effective zero for the past eight years, box #3.  In the history of the Federal Reserve this is something that has never happened before.  Obviously something is wrong, something that talking heads in the media expect the “policy makers” to correct sometime in the future by increasing their Fed-Funds Rate back to historical norms; whatever those historical norms may be.

But the “policy makers” have a problem.  They are fully aware how since 1954 (chart below), every time they’ve increased their Fed-Funds Rate above the yield for the long bond (positive values above Red Line) the economy goes into a recession.  They also know that after interest rates peaked in 1981, driving the economy into a recession is always accompanied by a deflationary bear market somewhere in the economy.

It’s not just the “policy makers” who are aware of the consequences of inverting short-term rates above long-bond yields.  For months now, we continue hearing stories of notable billionaires and big-time money managers warning the public of a pending market disaster, even as the yield spread above is still 189 basis points (1.89%) from becoming inverted.  What’s with that?

My guess is that the Federal Reserve and the other central banks have kept their short-term rates so low for so long, that in August 2016 their banking systems financial integrity have become totally corrupted from the tsunami of cheap money flowing into them, money that can never be paid back. 

Somewhere in Europe, Asia or North America, there’s a large national bank standing on the cusp of the precipice.  And Janet Yellen, exactly like every other central banker in the world, doesn’t want to be held responsible for pushing their banking system over the cliff by raising interest rates.

- No they don’t!  -

So we’ll continue hearing those annoying noises coming from members of the FOMC, calling for interest rates increases, when actually everyone at the Fed is willing to do nothing more than to wait for their banking systems to collapse on its own. 

In the resulting deflation, bond yields will enthusiastically reverse to the upside in the charts above, allowing the Yellen Fed to raise their Fed-Funds Rate without fear of inverting the yield curve.  This course of action would also allow the FOMC to deflect their responsibility for the crash, as the inevitable rate increase was a reaction to the deflating market, rather than its cause. 

But then I could be wrong that the “policy makers” would use a market crash as an excuse to raise their Fed Funds Rate.  Since 1981, as every bubble they’ve inflated in the financial markets began to deflate, they have always lowered rates, not raised them.  Will they do something different in the next bear market?  Time will tell the tale.

Mark J. Lundeen

USA has the world’s largest holdings of gold: 8,134 - representing 77% of its Total Foreign Reserves.

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