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"Michael, the Federal Reserve is doing a great job. It's made my job a lot easier by making the markets easy to predict," a trader friend of mine told me late last week.
"Here's how it works," he tells me…
"When we hear quantitative easing will continue in the U.S. economy, all you have to do is buy stocks, buy bonds, and sell the U.S. dollar. On the other hand, if we hear the Federal Reserve hint at tapering off its asset purchases, we sell stocks, sell bonds, and buy the U.S. dollar. It doesn't matter about the fundamentals. It's that simple."
I can see his point. My bet is that many traders and speculators are playing the game my friend described above. But is that what quantitative easing has become? A trade for speculators and traders to profit from with no real benefit to the average American Joe?
As I have written extensively, quantitative easing was needed in the U.S. economy at the height of the credit crisis in 2008, when it seemed our financial system was on the verge of collapse. But I'm in the camp that believes money printing has gone on for too long.
At the very core, quantitative easing portrays the U.S. economy has improved as the stock market rises and real estate prices come back. But the economic fundamentals remain anemic.
The jobs market is in a rut, real wages are declining, consumers are struggling, and businesses are staying away from spending, opting to hoard cash or buying back their own shares.
Last we heard, the Federal Reserve will continue on with its quantitative easing program—creating $85.0 billion a month in new money out of thin air to buy government bonds and mortgage-backed securities (MBS). No firm date has been provided as to when the "money-out-of-thin-air" program will end.
But we have been told by the Fed that quantitative easing will continue until the unemployment in the U.S. economy reaches 6.5% and the inflation outlook two years out is 2.5%. (Source: Federal Reserve, July 31, 2013.) In other words, quantitative easing will go on for some time still.
Until the Fed pulls back on quantitative easing, key stock indices in the U.S. economy may just continue to make new highs in the immediate term. But my readers know where I stand: the higher the markets go because of quantitative easing, the bigger the drop will be—and there is no doubt in my mind that this market will fall hard once the money printing plug is put into place.
As I have been saying for months now, the "bear" has done a masterful job at luring investors back into the stock market. And the icing on the cake? Quantitative easing has prolonged the bear market rally in stocks and is setting up key stock indices in the U.S. economy for a massive drop.
Michael's Personal Notes:
The Chinese economy, the second-biggest economy in the world, is witnessing a significant decline in manufacturing. The HSBC China Manufacturing Purchasing Managers' Index (PMI), compiled by financial information company Markit, fell to 47.7 in July from 48.2 in June. (Source: Markit, August 1, 2013.) Remember: any reading below 50 represents contraction in the manufacturing sector.
In July, the manufacturers in China reported a contraction in new orders—the sharpest drop in eleven months.
Manufacturing accounts for a very significant portion of the Chinese economy. According to the World Bank, it accounted for 30% of China's gross domestic product (GDP) in 2011. (Source: World Bank web site, last accessed August 1, 2013.)
What's happening with China's manufacturing leads me to believe that the estimates of growth we have seen for the Chinese economy this year and next are just too optimistic.
The Chinese economy grew at an annual pace of 7.5% in the second quarter of this year. It wouldn't surprise me if this growth rate declined further. And let's not forget that this growth rate of 7.5% for the Chinese economy is notably lower than its historical average of 10%.
I keep pounding this on the table: U.S. stock markets will suffer as the Chinese economy contracts.
Here's what the CEO of The Coca-Cola Company (NYSE/KO), Muhtar Kent, said on the company's second-quarter earnings conference call: "As is well publicized, China's economy has been slowing and this is now being felt in consumer spending. [Our] China first half retail sales were the slowest in 10 years… As a result, our volume performance in China remained soft and was even for the quarter, cycling 7% growth from the prior year."
This is just one example of a large American company seeing softer demand because of the economic slowdown in the Chinese economy. It's a major risk that shouldn't go unnoticed.
Originally posted at Profit Confidential
© Michael Lombardi, MBA