Fed problems: What's past is prologue

Conventional wisdom attributes market indigestion to anticipation of Federal Reserve action, but the evidence indicates investors are finally reacting to what our central bankers have already done.

By Bill_Fleckenstein Aug 23, 2013 12:43PM

Stock market © Zurbar, age fotostockI'm going to begin on the subject of financial publication headlines, expectations and what might really be behind the recent weakness in stocks and bonds. The Financial Times recently led off with the following above-the-fold headline: "Sell-off as markets expect early Fed move."

 

The article began: "Expectations of an early move by the U.S. Federal Reserve to slow its support for the U.S. economy firmed (on Aug. 15) after the release of data showing a strengthening labour market and higher inflation." The British newspaper went on to attempt to blame the previous day's stock market decline on jobless claims.

 

I would be the first to admit that on many days the market does what it does and there really is no proximate cause or logical explanation. But I can guarantee you that the FT's explanation is not what happened, because all the other macro data were weak and there was no new news about potential early tapering.

 

They're not buying it 

In fact, in an article the day before in the same publication -- headlined, "Central banks struggle to convince investors" -- author Ralph Atkins tried to get at the real problem, although he couldn't quite put his finger on it. Atkins noted that central banks have failed to persuade markets on a case for interest rates remaining low, but asserted: “Central bankers are used to having their way.”

 

Atkins continued, "The U.S. Federal Reserve's large-scale asset purchases, or quantitative easing, delivered the desired market rallies. Mario Draghi, European Central Bank president, crushed eurozone doubters by pledging to backstop government debt markets.

 

"But the latest actions by the ECB and the Bank of England -- using 'forward guidance' to persuade investors that interest rates will remain firmly at historical lows -- have had, at best, mixed results. Market borrowing costs have actually edged higher and on some gauges investors have brought forward the expected date for hikes in official interest rates. If market scepticism builds, the two central banks may be forced into fresh measures to stimulate growth."

 

The QE and the damage done

Therein lies the dilemma. If markets don't do what the central banks want, the central planners will do more, thinking that the problem is that they haven't done -- or threatened to do -- enough. However, if the markets know that the central banks will do more if required (i.e., in the event that bond markets don't bring rates back down to where the central banks want them), then why are bond markets declining?

 

The only logical answer is that they are reacting to what the central banks have already done. That predicament is the one no financial bull wishes to contemplate, but it is at the heart of the problems we are headed toward.

 

My belief is that bond markets around the world have not backed up because of any serious fear that a massive amount of stimulus is going away, but rather because the deflationary fear trade was way overdone. Now debt markets are declining because there is no real investment demand at these levels. Yes, there are forced buyers, such as pension funds and insurance companies, but investors are not really dying to own them, as yields are absurdly low.

 

Aug. 20 saw the release of the Fed’s July Federal Open Market Committee meeting minutes, which were eagerly awaited even though they once again revealed nothing new. In the wake of the release, the bond market sold off hard, closing at a yield of 2.89% for the 10-year, a new high. Thus, our Treasury market continues to be weak, in defiance of the Fed's wishes, bolstering my contention that the Fed is no longer able to control that market as it used to.

 

In short order 

On a related note, The Wall Street Journal ran a front-page story on Aug. 20 headlined, "Rising markets batter short sellers." In it, one featured short seller stated: "'It is actually more painful now than it was in '99.'" Though I am very sympathetic to that statement, I would like to disagree with it. There is really no comparison between the lunacy of 1999 and the present day.

 

The insanity back then was not confined just to dot-com business concepts. Most stocks were ridiculously valued until the very end, when there was a group of mundane securities that weren't too expensive. Nonetheless, the environment was much better because that bubble had not yet spawned the real estate bubble or the misallocations of capital and bad policies that followed in the wake of both.

 

Thus, prices of stocks were insanely high, but there were not the massive macro problems that exist today. Thus, given the horrible fundamental backdrop, stocks are expensive and risky, but there are only a modest number (perhaps 100) of truly ridiculous valuations.

 

The same trader was later quoted as saying he believes that his short positions "will be proved right -- eventually," which brings up another point that needs to be made about short selling. Namely, that while research is essential, it alone won't get you very far. Short selling, sadly, is all about tactics, managing risk and the constant need to modulate positions, i.e., when to press and when to take positions off.

 

Also, anyone who has survived this long on the short side should realize that it is nearly impossible to win when the Fed is doing what it is doing. The amount of money (about two weeks' worth of QE) that blew the top off the stock market in 1999 is literally a rounding error compared with the QE we have seen since 2009. Thus, it will be difficult for the shorts to win until either the bond market reacts more violently or we get closer to the time when bond traders take the printing press away from the Fed. And then they will win big.


109Comments
Aug 23, 2013 9:47PM
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lets try and understand what is going on.

1. the fed is printing 1 trillion per year and buying debt with printed money.

2. the budget deficit is 1 trillion per year

3. that means the fed is buying all of the deficit because no one else will at these rates

4. rates are going up even though there essentially is no new debt coming to market.

5. the critcal mass occured at 10 trillion which is the  debt that is actually borrowed, the other 7 trillion is on the fed balance sheet or fed home loan bank.

6. all future deficits will be paid for with printed money

7. if rates rise the deficit will rise also, with the increased need for printed money to pay it

8. when monetized debt exceeds borrowed debt its game over, give or take three years

9. the dow will break below 2750

10. the dollar will then be revalued

Aug 24, 2013 2:21PM
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The Federal Reserve:
1) Is A Privately Owned Banking Cartel
2) Is A Perpetual Debt Machine
3) Has Destroyed More Than 96% Of The Value Of The U.S. Dollar
4) Can Bail Out Whoever It Wants To Without Accountability
5) Uses Member Banks To Selectively Lend To Hold Us In Suppression
6) Creates Artificial Economic Bubbles To Compromise Economies
7) Is Dominated By The Big Wall Street Banks and Corrupt Banksters
8) System & Personal Income Tax Both Came To Be In 1913 without our vote.
9) Chairman, Ben Bernanke Has A Nightmarish Track Record Of Incompetence
10) Defies Democracy By Its Very Existence.
Aug 23, 2013 3:46PM
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Lots of words that come down to this... we are where we are (and that's not a good place) because we are piled high on bandwagons without a working economy and compromised commerce arena. There cannot be this many people with their hand in the honey jar because there simply isn't enough honey. Making honey certificates hasn't worked either. The globe's governments and financial sectors have us positioned for a cataclysmic failure. I'd rather own a small shop with an inventory of things people want and a reputation for good service, then all the business platforms on Earth. To be invested in them is a surefire way to get broken... and you will. Get a REAL job. Forget about how much it pays, just who will be willing to pay something when there's nothing. The ship sank already, you're just kidding yourselves about breathing underwater. It's called- drowning and you have.
Aug 24, 2013 3:43PM
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Of all the commentators on MSN money, I think Bill Fleckenstein "gets it",  and has an excellent understanding of what is really going on. 
Aug 24, 2013 9:05AM
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The inevitable crash is the ultimate manifestation of Urkel's "redistribution."  He is traveling around the country jackin'-his-jaw at colleges and universities to convince those brain-dead dim voters that they are better off without  jobs, living with their parents, etc.  He's got them pretty well handled/ manipulated.  What is amusing to me is to think that when the producers are 'busted' how he plans to continue to support the welfare queens.  There will be no more blood in the stone to suck out and "redistribute." 

Aug 24, 2013 12:08PM
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The odds are strongly in favor of Obama nominating Janet Yellen, the current San Francisco Federal Reserve Regional Bank President, to succeed Benji when his term ends next spring. Janet Yellen is noted to be a bigger "dove" than Benji when it comes to Quantitative Easing policies and hence will most probably be pushing for the even greater amounts of such that Bill predicts in his commentary this week. This escalation of QE will most probably speed up the time frame for the decimation of the US Dollar that appears to be inevitable thanks to the Federal Reserve's financial chicanery put in place after the 2008 financial meltdown caused by Wall Street. 

 

In an ominous parallel, San Francisco, which is arguably the most liberal Congressional district in the country and has already given us the fanatically liberal and polarizing Nancy Pelosi, will be giving us a new Federal Reserve Chairman in a liberal monitary policy "dove" named Janet Yellen.

 

At the risk of sounding fatalistic, it's hard to envision a scenario where this does not end very badly, especially if Obama (with powerful support from his allies in the main stream media) is successful in getting Democrats to keep control of the Senate and regain control of the House in the 2014 elections with Pelosi regaining Speaker status.

Aug 25, 2013 11:49AM
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a few of comments:

 

1) Ten years ago, I don't think anyone could have/would have predicted that the Federal Reserve would take the actions it has over the last 6 years. As a U.S. citizen, I would like to know what the Federal Reserve can not/ will not do. It's not clear to me.

2) The most interesting financial scenario that could play out over the next few years is to see one of the Big Central Banks lose the bubble (lose control) on interest rates. There is a decent chance one of the big three BOJ, ECB, FED will re-learn the power of the bond market, which has been quiescent for many years now.

3) A crash is not a certainty in any given time frame, but it is certain that as long as there are people and economies, there will be recessions and crashes. It is part of the human condition. I am not certain Barack and his troop of smart little boys and girls know this. I am certain that Barack and his little buddies don't really know how the economy works. I still have no idea what a Community Organizer is or how it creates any value. 

4) I am still dumbfounded and amazed (I know I should be over it by now) that our purportedly free press hasn't ever gotten around to figuring out that policies developed and implemented by Washington were at the root of US housing crisis. If you want an object lesson on how the real world works consider this. Barney Frank and Chris Dodd got their names on the key piece of legislation coming out of the US financial crisis (I challenge you to even figure out what is in this legislation), but they were also present and contributed to the very policies that put is in the predicament in the first place. The key takeaway from all this is, "in this life, you want to be in a position to make the rules, not in a position where the rules apply to you."  If anybody should be in lockup after all this, it should be our buddies Chris and Barney.

5) Rambling ends...

Aug 23, 2013 10:08PM
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Hey 1CL,

I think the dollar will be revalued all right. DOWN!!! And I'm betting anywhere between 50 and 95%. A lot of it depends on what the foreign countries that hold part of our debt will do, but a BIG devaluation is coming, and when it does, it's going to happen FAST, with VERY little warning. Also I think we're in for a HUGE increase in prices in this country [on the order of 300-400%].

Aug 23, 2013 7:55PM
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every country in south America experienced this QE in the past everywhere ended the same with high inflation diminishing working class purchasing power,poverty devaluation of currency low investment and foreign creditors loosing almost all their loans to these countries.It may happen here too at some point countries that hold us debt may get rid of it and invest that money in research and development to expand their economies like china and japan or  for other developing  countries  prepay their debt that has 3% more yield that us treasury 
Aug 24, 2013 2:09PM
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OK, so the fed is buying mortgage backed securities (MBS), thus adding liquidity to the mortgage market and lowering interest rates. Investors who do not have to buy MBS won't because the return is so low. This tells me that the fed is fighting the laws of economics. Now, eventually the fed will see inflation rearing its ugly head and they will stop buying MBS. The effect of this will be to remove liquidity from the mortgage market and substantially higher mortgage rates will ensue. If we are lucky, this will attract normal investors into the mortgage market, but probably not enough to drive the rates substantially lower. The increased interest rates will drive the principal values of real estate and bonds down, resulting in another burst RE bubble and market crash. The burst RE bubble will cause the economy to continue to stagnate with inflation...stagflation was the word we heard a lot of back in the Carter days...For those kids out there who were not alive back then, get ready. I was happy to get a 16.75% mortgage during the Carter years.
Aug 24, 2013 10:47AM
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Right on as always Bill.

The markets are forming a top right now but to short anything in these markets one has to rely heavily on technical analysis for clues.
Parabolic tops like the Nikkei formed like 4 months ago are great signals to short after the bounce because it takes all the buyers out of said market and sellers imbalance into a vacuum creating bigger drops.
I'm waiting for a clear signal like when the GLD ETF had a very violent drop in one day after hitting 1800$ top.
It has to be a vicious body blow to knock the lights out of the bulls (like a 700 point drop) and turn them into sellers once the bounce is tepid and the smart money enters short .
Shorting into normally up trending markets, you will lose 90% of the time.

Aug 24, 2013 10:41AM
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Bill is right, Ben has telegraphed his moves months in advance so when rates rise there will be no surprise. The market is pre-adjusting to what they know is going to happen and the easy money isn't stopping, just slowing a little, so keep your panties on, the rides not over yet.
Aug 26, 2013 10:41AM
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In essence the national economy of the US and Europe is paying bills with the Visa and then paying the Visa payment with the Master Card.  It is really not much more complicated than that.
Aug 25, 2013 9:24PM
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Bill

 

No argument here.

 

Sometime or another push will come to shove. "The invisible hand will step up and take control.

 

Adam Smith.

 

And Obozo's history will be in the comic books.

Aug 26, 2013 11:14AM
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If everyone knew the FED had the power ten years ago to Buy this Quantity of assets, everyone wouldn't be shocked that it has now happened, considering the Global Debt Levels. What the FEDS are doing is a bit more complex than what we have been stating and so are their future options. Until the Global Economies actually collapse, this robbing Peter to pay Paul will continue for quite some time to come. After all we have been doing it for DECADES.

For any poster to continually state that DC aka the Government was ground ZERO for the financial crisis aka Mortgages means some posters don't really understand what actually happened. Corporations control the Government, not the other way around. Seems some folks have never heard of those who lobby and or Billion Dollar SuperPacs.

Big Banks in their never ending GREED, used the housing Boom as a Opportunity to expand on their GREED. Instead of using it as a chance to right any wrongs, the Big Banks used rising prices to cook new inventive SCAMS called Derivatives. They leveraged up those scam products and then sold them across the Globe, including to Fannie and Freddie. By the way, Fannie and Freddie exposure to SubPrime was less than $300 Billion. By the way, Fannie and Freddie have almost paid back the entire amount borrowed from taxpayers. At the current rate of payback, that will take less than a year.

Some posters will always use the financial crisis to push  political agenda instead addressing the actual problem. That problem was and is the Big Banks who created 500-700 Trillion in fake derivatives assets. The entire home Mortages outstanding are a FRACTION of that amount, do the math, some will be shocked, others, not so much. Some folks ramble on, but rarely check the MATH. Maybe it's high time they did.

Aug 26, 2013 4:38AM
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The problem with this article, and with shorting in general, is timing.  Because shorting is betting against the long-term trend, if you get the timing wrong you get wiped out.  And timing the market is notoriously difficult.

 

Fleck has been right for 5 years now - yes, eventually the bond market will probably take the printing press away.  But it hasn't happened yet - anyone acting on that advice these past 5 years to short has been destroyed.

 

Maybe now is the time it's finally happening.  The more money we print, the more likely it becomes.  But proceed with caution.

Aug 24, 2013 9:28AM
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,,,,and then Obamaville reduced the number of food stamps that it distributed to the masses....

 

mmm, mmm, mmm!

Aug 26, 2013 6:09PM
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response to K asking if qe has helpful or harmful.

 

"it was totally useless.  the abyss was avoided with bush' tarp program, and the bailouts, and the stimulus programs, and the interest rates set to zero.

 

the qe simply enriched the wealthy by creating another asset bubble.  worse, it created HUGE moral hazard with not only the banks but with congress - the banks will be bailed out yet again and congress has listed over into the interminable party of no - no real fiscal policy has been enacted in years.  related massive damage was incurred as the world as encouraged (no choice) to follow along with the fed and devalue their currencies as well.

 

make up your mind k - are you going to be part of the solution or go along with being part of the problem?  you can't have it both ways."

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Bill is normally on target.  We will have a bout of Deflation with hugh inflation in the next year if what I am reading (not just by Bill) is correct.  But what to do with the stocks we have?  If we sell and sit on the sidelines, delfation will help those with cash in purchaing lower priced goods. 

 

If inflation hits, your cash is worth less than it is now in purchasing power.   It you have it in stocks that don't move much in any type of scenairo, you can't grow your stash. 

 

If you have it in dividend stocks you have to have it in stocks that have increased dividends over the years and have increasing profits to allow the increases in Dividends.  If you have it in small caps, you may need to put in a limit order to sell at a certain price on the way down. 

 

Shorts are not making anything at this time, but there are a lot of shorting going on also at this time.  

 

I think there will always be two sides of the coin and continuing with good Dividend stocks and good small caps would be the best choice for many.  Just be able to protect what you have by limiting your losses.   Your stock broker can help with setting that up.

Aug 26, 2013 4:32PM
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I would like to see an article (by Bill Fleckenstein) about what "should" be done by the Feds, Banks and Government to fix the economy and the debt problem.
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ABOUT BILL FLECKENSTEIN

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This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.

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