Thursday, October 29, 2015



The connection between monetary stimulus and the stock market is a tenuous one that runs, ultimately, through corporate profits and therefore, to some degree, economic growth. In the past, monetary stimulus – rate cuts – was associated with weak stock market performance because it was applied when the economy was weakening and there was a presumed lag between a change in policy and its ultimate effect. Monetary policy works with long and variable lags as the economists put it. So, monetary stimulus was good for stocks but not right now; more stimulus was a sign of failure, that previous cuts weren't sufficient, in the judgment of the central bank, to revive growth.

In the 2000 recession and bear market, the Fed cut the Fed Funds rate from 6.5% to 1% over a period of roughly three years and the stock market fell for almost the entire time. In the last recession and bear market the Fed cut the Fed Funds rate from 5.25% to the current 0 – 0.25% range starting in July 2007. The stock market fell, again, almost the entire time rates were being cut. In both cases, the economy eventually turned the corner, earnings improved and stock prices followed. Whether that was due to monetary policy or in spite of it is hard, maybe impossible, to determine.

QE supposedly works differently, through the portfolio balance channel, a mixture of wealth effect and forced risk taking. QE removes high quality bonds from the market and forces investors to move out on the risk scale to replace the Treasuries they sell to the Fed. The effect is to reduce corporate borrowing costs in the hope that the borrowers will find something productive to do with the extra cash. Further, because QE forces more buyers into the private sector bond markets it raises the price of those assets. The owners of those assets feel wealthier and will presumably spend more, further stimulating economic growth. The European version is slightly different but looks to accomplish the same thing – force capital into the private sector. That's the basic theory anyway. THE HOPE, THE PRESUMPTION, THE OH MY GOD, WE HAVE NO OTHER SOLUTION SO THIS BETTER WORK, WE WILL MAKE IT WORK, WE WILL ALL GO DOWN TRYING TO MAKE IT WORK. HOPE AND OPTIMISM ARE NOT SOLUTIONS!

That it hasn't really worked that way is apparently no impediment to those unconcerned with correlation and causation. The fact that stock prices have risen during periods of QE is not sufficient to prove that QE caused higher stock prices. It may have been something else that caused stock prices to rise and if so, it would seem pretty important to figure that out before acting – buying – on promises of more stimulus. One might also consider why Draghi and the ECB believe more stimulus is needed and whether policy really does work with long and variable lags.  GREED AND CONFIDENCE IN THE FED 

Stock prices are ultimately about earnings and the discount rate one applies to them. Monetary policy can have an impact on the discount rate directly but its influence over earnings is much less. There are many things that affect profit margins and earnings per share, most of them having little to do with interest rates or even economic growth for that matter. And since rates have been at this depressed level since 2008 one would think that stocks are no longer moving on expectations of a lower discount rate. That leaves earnings as the primary driver of stock prices and for anyone buying on the ECB QE and China rate cut news that might present a serious 

The immediate effect, besides pushing up stock prices, was a rise in the value of the dollar versus the Euro and the Yen. It seems to have been forgotten in the hoopla, the conditioned response to more monetary cowbell, but it was only a couple of months ago that the world's stock markets were reacting pretty negatively to a strong and steadily rising dollar. And for good reason if recent earnings reports are any indication. If stocks follow earnings – and ultimately they do – a rapidly rising dollar isn't going to be a positive development for US multinational companies. It also isn't good news – still – for countries trying to stem capital outflows.

Neither is it necessarily a positive development for the rest of the global economy. I have always been mystified that a strategy that drives capital away is considered stimulus. A more logical strategy would be to enact policies that attract capital not repel it. In fact, a cheaper currency doesn't solve any problem; it is merely an acknowledgment of past economic mistakes. A cheaper currency doesn't make a country poorer; it is a revelation of its true worth. It is the country's other economic policies that made it poor, a falling currency and the policy that produces it being merely the market's expression of that failure.

Central banks have been in the past year holding on for dear life, which is where obscurity has been their benefit. In the end, however, it will bring about their own downfall as it only serves to make matters worse. Yellen wants the central bank to be viewed as almost godlike, but they continually reveal themselves weak, deceptive and ineffectual; eschewing all long run sustainability in order to just make it through one day at a time.

Investors are now facing the second most extreme episode of equity market overvaluation in U.S. history (current valuations on similar measures already exceed those of 1929). The belief that zero interest rates offer no alternative but to accept risk in stocks is valid only if one believes that stocks cannot experience profoundly negative returns. We know precisely how similar valuation extremes have worked out for investors over the completion of the market cycle, and those outcomes have never been deferred indefinitely. The only question at present is how many grains are left in the hourglass.

The employment situation continues to deteriorate on a daily basis as Challenger, Grey & Christmas has reported layoff announcements by major corporations in 2015 that already exceed the total announcements in 2014.

Every manufacturing and services survey flash recession warning. Despite propaganda from the NAR, government and the MSM, the housing market is dead in the water.

The global economic situation has gotten so bad, central bankers have again come to the rescue by promising to prop stock markets up like they've been doing for the last six years.

U.S. economic data unequivocally indicates a recessionary environment on par with 2001 and 2008. 

The pessimism overriding the markets from August through October was warranted, based on reality, facts and historically accurate valuation methods. The 1,600 point reversal has been based solely on hope and faith in central bankers who have failed miserably in spurring economic recovery with their monetary machinations. 

The coming crash, will not be avoided through further central bank intervention.

Denial and putting trust in Ivy League educated academics who are terminally wrong in their predictions, policies, and solutions is not a logical plan. It's a recipe for disaster and another 50% haircut.

We are about to be transported back to the wonderful days of 1929. Time is growing short as the grains of sand in the hourglass run out.

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