The Fed's Invisible Hand
I have not been a huge advocate of the Federal Reserve's QE programs for the simple reason that outside of inflating asset prices, it has done nothing for the broad swath of the American economy. This is something I addressed recently stating:
"While the ongoing interventions by the Federal Reserve have certainly boosted asset prices higher, the only real accomplishment has been a widening of the wealth gap between the top 10% of individuals that have dollars invested in the financial markets and everyone else. What monetary interventions have failed to accomplish is an increase in production to foster higher levels of economic activity."
However, the issue of the perpetual interventions into the financial markets is that it has created a sense of "invincibility" by market participants that no matter what happens the Federal Reserve will step in. This is a point that Fed President Jeffrey Lacker recently penned in an op-ed for the WallStreet Journal:.
"Moreover, Federal Reserve actions in the recent crisis bore little resemblance to the historical concept of a lender of last resort. While these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility. Ambiguous boundaries around Fed credit-market intervention create expectations of intervention in future crises, dampening incentives for the private sector to monitor risk-taking and seek out stable funding arrangements.
Central bank operational independence is a unique institutional privilege. While such independence is vitally important to preserving monetary stability, it is likely to prove unstable—both politically and economically—without clear boundaries. Central bank actions that alter the allocation of credit blur those boundaries and endanger the stability the Fed was designed to ensure."
The dependence on the Federal Reserve for support is dangerous and will, if not already, lead to another financial market and ensuing crisis. The question is not "if," only of"when?"
Markets Hold Critical Support After Fed Minutes Confirm Dovish Stance
Over the last couple of weeks, I have pointed to the very critical support levels for the S&P 500 stating:
"As shown in the chart below, the market has held onto its critical moving average since December, 2012 when the Fed initiated its latest liquidity intervention program (QE3)."
Yesterday, the Federal Reserve released their meeting minutes from the last FOMC meeting which revealed a rather "dovish" tone noting the threat of global economic weakness.
"'Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector,' according to the minutes, which were released by the Fed with the traditional three-week lag. 'Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk.'
These worries about global growth and the economic impacts of a strong dollar represent a new twist in the Fed's running debate about when to raise short-term interest rates. Officials spent much of the summer discussing the timing and mechanics of rate increases. Many officials expect the first rate increase by mid-2015. An improving U.S. job market led some officials to press for earlier increases.
The minutes showed more clearly than before that concerns about global growth and the disinflationary impact of a strong currency are giving officials additional pause about moving quickly on rates."
As I wrote yesterday:
"I would most likely bet on the latter as the deflationary pressures that are rising in Japan and the Eurozone flow back into the domestic economy over the next couple of quarters. The chart below shows the breakeven 10 and 5-year inflation rates as compared to real economic growth."
"While the ongoing mainstream mantra remains that economic growth in the U.S. is set to improve in the months ahead, the deflationary feedback loop suggests the opposite. Furthermore, the downturn in current breakeven inflation, along with a sharp drop in U.S. Treasury rates, suggests that the U.S. economy is already being impacted.
Why is this important? Because the Federal Reserve is suggesting that they will look to start raising interest rates in 2015. However, the inflationary data is suggesting that this will likely not be the case."
The Fed's concern over deteriorating economic growth confirms my suspicions that that the Federal Reserve is likely caught in a "liquidity trap" from which they will find extremely difficult to escape. The problem for the Federal Reserve is being stuck at the zero bound of interest rates. Should the already weak economy be dragged into a recession by global deflation, the Fed has lost one of its primary tools to counter it.
Doug Kass - We're Heading For A Bear Market
"I have long worried about the bull market in complacency that has seems to have fermented with the sharp rise in valuations in 2013 in which the S&P 500 rose by more than 30% while earnings climbed by only about 8%.
Since early August I have highlighted numerous technical divergences (in the weakness of the Russell Index, new highs, the cumulative advance/decline lines, etc.), the schmeissing of the high-yield market (often seen as a precursor to stock vulnerability) coupled with growing evidence of weakening global economic growth (posing a threat to consensus corporate profit forecasts) and other factors (including valuation, sentiment and geopolitics) suggesting that a downward trend and (potential) bear market might be in the early state of developing.
History also shows that rising volatility in foreign exchange markets may be consistent with bear markets."
Doug is correct. As I have been writing about for the last several week's in the newsletter(subscribe for free weekly delivery) the internal deterioration of the markets has been on the rise. Furthermore, the breadth of the market has become extremely narrow as small, mid, international and emerging market indicies have all broken major support levels and are in more formal corrections.
Historically speaking, it is not likely that large capitalization stocks will be able to withstand the downside drag indefinitely. Either the vast majority of other stocks will find a base and begin to rebuild, or a large correction will ensue for the major markets.
However, with that said, the "bull market" for the S&P 500 remains intact for now. But it is important to understand that incrementally the legs of the "bullish" thesis are systematically being removed. Like a game of "Jenga" the question is simply which "pull"will bring the whole structure down.
Lance Roberts
Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of “The Lance Roberts Show," Chief editor of the X-Factor Investment Newsletter and the Streettalklive daily blog.
