HAPPY NEW YEAR!!!
New Year’s Day always leads me to want to pull out the old crystal ball and try to make a stock market prediction for 2018. To make this exercise simple, and understandable for most readers, I decided to focus on what the Dow Jones Industrial Index could do in 2018.
After all, when the general population thinks about the US stock markets, they often refer to the Dow index.
Stock Market Prediction for the Dow
Right now, the Dow is very overbought on the RSI-9 graph of the monthly chart which is of concern to me. Of course, when a market is trending, the RSI can remain overbought for a very long time. RSI tells us that the overbought market is due for a correction, but it can’t really tell us WHEN that will happen.
The MACD histo bars (9,20,7) have leveled off somewhat from the spring of 2017. However, they remain steadfastly in positive territory. So there are no sell signals yet. Again, I refer to the monthly chart for this observation.
Consider the long period of expansion (endless rallies) since the last serious corrective base. The last deep base (a 20% bearish correction or more) was in the period of 2008 to 2012. So, since 2012, the Dow has been on a steady course higher. Five straight years with only minor pullbacks! To simply make a stock market prediction of more of the same would seem the easy way to forecast events in the new year. After all, trend is a powerful force in the stock market, as we have seen time and time again.
One thing in favor of the Bulls is that the last corrective base ( in 2008-2012) was a base re-set since the low of the base was lower than the previous large base (from the dot-com era). Those base re-sets can sometimes mean that the next corrective base won’t be so bad. This remains to be seen, of course, but I thought I would mention it. Another thing to consider is that the current bull market is nearly the longest in US history.
A Hawkish Fed in 2018
The US stock market has been supported by easy money policies at the Federal Reserve for several years. Now, the FED will be going through some serious quantitative tightening in 2018 with the sales of bonds held by the FED. The Fed is also expected to continue hiking interest rates. So we will have a double whammy from the FED in 2018! Can the economy withstand this double hit?
Perhaps the new tax reform which takes effect today could continue to drive the US economy forward, despite the hawkish Fed? We shall see.
There is also a great amount of political uncertainty both at home and abroad. Instability in Washington is just as worrisome to some investors as is the unrest overseas. The feud between Democrats and Republicans and even within the parties is about as bad as I can remember. Then toss in the issues we might face with North Korea or in the Middle East, and the stock market could get quite shaken up at some point.
Stock Market Prediction Timetable
My own prediction is that the Dow will take a serious hit sometime in 2018. I think the period of spring and summer might be most vulnerable for various reasons. The Dow might re-cover some by late this year once the frothiness has been removed from the market. Yet overall, I expect the Dow to finish lower by around 15% compared to the 24,719 mark as of the last day of 2017.
So, my prediction is the Dow will finish at around 20,500 to 21,000 but we could see a mid-year dip that takes the Dow as low as the top of the brief early 2016 correction which was at around 18,300 or so.
January Often Sets the Tone
I wouldn’t be surprised to see the month of January set the stage for a rougher year. I expect greater volatility and some profit-taking in the early part of the new year. Take a look at the chart down at the bottom of this blog. The Dow is about as high above the 50 day line (percentage-wise) as we have seen in a long time. The daily RSI is extended into a very long period of being overbought (above 70).
It’s often said that January sets the tone for the US markets. So if we get a rough start in January, that could lead to the negative results I expect for the year overall.
Of course, predictions a year out are not easy to make. I looked at some of my 2017 predictions in the category marked 2017 Predictions by Members on the Talking Stocks Forum . I can see I was off quite a bit on most predictions. 2017 turned out to be quite a bullish year, and quite unexpected in some ways, and with very little volatility.
I have a hard time believing that we can have two years straight of low volatility! So, I am betting on a more volatile market in 2018 and lower finish by year end.
Anyone else care to make a prediction? Please click on the reply button to make your own comments.
Dow Jones Industrials ($INDU) Daily Chart
Here’s another under-the-radar BIGGIE that a lot of people may be missing, and it could spell disaster for the economy and stocks….
As you probably know, EQUIFAX ( NYSE: EFX ) suffered a huge breach of its database that compromised almost every adult American’s identity, and my fear is that this could trigger a recession!
Now, here’s the interesting part from an investor’s perspective: many, many people are putting on CREDIT FREEZES to their accounts, which basically means that they are preventing any new credit lines or credit accounts from being opened in their name. Many news websites and financial advisors are telling people to do this.
The theory of the Profitskey.com is that this could slow up loan growth by several percentage points in the coming weeks and months, and slower loan growth means that money acceleration into the economy will slow and even suffer decreases! I just saw a statistic in BARRON’s ( http://www.barrons.com ) that shows that Federal Reserve created credit in the US economy had slowed to just 3.5% from 5% last year ( See the Randall Forsyth column) …and this CREDIT FREEZE pandemonium could bring credit growth to a GRINDING HALT!
Sure, if someone wants to take out a new loan or credit card account, they could call the credit bureau company (if they can figure out which one will affect their loan — there are 3 major credit bureaus to call) and ask to un-freeze their account for a short while. But my theory is a lot of people will not want to deal with that hassle…and many are scared to death to un-freeze their accounts anyway for fear of being violated by a hacker. Also, in many states, there is a charge for each time a person freezes and un-freezes their account, and so many people will not want to bother with those charges for a quick loan or credit card account. END RESULT: A significant slowdown in new auto loans, credit card accounts, and other loans like home equity.
Lest anyone is naive enough to believe that our economy’s growth doesn’t thrive and survive on CREDIT EXPANSION, this could be the perfect storm to cause a RECESSION! Look, if credit expansion slows just 3.5% from current levels, that would be enough to tip our US economy into contraction. In other words, it will not take a lot to slow down our economy into a stall speed. The velocity of money within our semi-fragile economy could go negative, and with negative velocity of money, then earnings will dry up! Earnings are “the mother’s milk of profits” in a free market economy….
And the STOCK MARKET hates a RECESSION!
Today, I bought 3 VXX Sept 20th $20 call contracts a short time ago. By all appearances, though not yet confirmed, the iPath VXX ETN appears to be at a double bottom. The current price is in the high $16’s, so I would need to see about a 25% spike in the VXX to get this one in the money. Historically, VXX has rallied as much as 100% in some significant corrections….and even on a relatively minor correction, it has shown the ability to rally about 25%, at the least.
Take a look at the VXX daily chart (shown at the bottom of this blog post)….it appears to be at a double bottom today…but of course, the double bottom is not YET confirmed. If the price breaks much below the horizontal blue-dashed line at about $16.76, then the double bottom would be a false conclusion….especially if it closes below that line.
Also, I looked at the SCTR score on VXX…it is at the absolutely lowest level on that measure at 0.1….it can’t get any worse than that! (The Stock Charts website owns the formula and patent for the SCTR measures at http://www.stockcharts.com .) So, on a relative basis to other stocks, the VXX is a screaming bargain, it seems…
Now granted, the VXX and its cousins such as UVXY and TVIX (I know there are others, I just can’t think of them right now)…are ETFs that de-grade over time, especially in a flat or rising stock market. So, in some ways, the lower SCTR score would be the norm any way….
But a SCTR at 0.1 is suggesting that at some time in the future, it’s got to get a lot better than this? At least for a spell…
By extending out to mid-September on the purchase of my call contracts, I can let these pups sit in my portfolio for many months, assuming they don’t degrade too quickly in price, which could only happen if the market keeps rising and investors get too complacent. These VXX calls can act as an anchor against some of my long trades….and, at least compared to recent history, the price on these calls are very cheap right now….and that’s when you want to own them, imho…when they are cheap!
So, they can act as cheap portfolio insurance — of course, going out to September is also taking advantage of annual cyclical moves, as the stock market often swoons in late summer and into September, which is historically the worse month for the stock market…
I may pick up a couple more of these VXX calls, should the double bottom not hold…and if it does hold, at least I have a good foothold with 3 contracts today. If somehow, the price jumps 40% from here to late August, I would stand to make about a $180 profit per contract, or close to a $550 gain on these 3 contracts. I don’t have too many long positions right now (I am actually short some specific stock names like SHLD and VRX currently), but someone with a larger long positon might consider more contracts than this.
So, what could cause a stock market correction? Seemingly any number of things! We have the FED meeting coming up in the next two days, and how will they word future interest rate increases? And the debt ceiling debate is starting to come into focus, and the Republican Party seems to be quite fractious when it comes to this subject, so don’t expect an easy push to raise the limit, in my opinion. Then there is the high valuation of the current stock market, and perhaps too much optimism by investors as to how quickly Trump can get things moving?
Also, there is much divisiveness in the communities of our country– it seems about as divided as it was in the pre-Civil War days, but only the haves versus the have-nots (rather than the North vs. the South). But even if one believes the market can look past all of these threats, then one should still respect that our current market valuations seem to be pricing in perfection. Just one big “slip up” is all it takes to send stocks tumbling, in my humble opinion.
I am not a registered financial advisor, and so these are only one person’s opinions. You should always consult a licensed RIA or licensed stock broker before investing or acting on any trades.
VXX daily chart
The real center of the financial storm is with Europe’s banks and financial institutions…and the very center of this storm lies in Frankfurt, Germany, home to Duetsche Bank (NYSE: DB) which is said to have a large book of derivatives that dwarfs the size of the bank’s assets. I have read from at least two sources that the total notional value of the derivatives book of Deutsche Bank is quite large–very large and possibly unmanageable in a crisis.
But first, let’s digress a moment to the Brexit event that happened last Friday morning. From what I am reading in Barron’s (www.barrons.com) and other financial news sites this weekend, it seems that with Prime Minister Cameron resigning under pressure, that a new coalition government will form in the coming weeks that will represent the new will of the people.
In the Parliamentary system, change can happen much faster than it does here with our Congressional and Executive government system….
So, I think it’s unlikely that Parliament will refuse to carry out the wishes of their electorate….unless the economy gets so bad and the citizens ask for another vote….but things will have to get bad first, in my humble opinion.
As for the markets tumbling, that has more to do with the Euro countries and with the banking system in Europe. In other words, it’s not the UK’s exit that has investors on pins and needles, but it’s the EU that is at the center of the crisis.
With the UK vote in favor of exit, this will de-stabilize Europe and so we are likely to learn that countries like Spain, Greece and Italy will also want to exit so they can escape the onerous rules that the EU has imposed on their growth due to high debt problems…
In other words, should this crisis get out of hand, then DB may not be able to honor its derivatives trades–just as AIG could not honor its derivatives trades back in 2008 and only when the US government bailed out AIG, was the world saved from a calamity!
Now, DB is said to be in a similar tight spot as was AIG, except that the trigger event has not yet happened for DB, but it’s much closer today than it was last Thursday before the Brexit results were known. There is no known crisis yet (and so I don’t want to sound alarmist), but the worry is that this could get out of hand before DB or other banks can safely unwind their derivatives positions.
So, if DB runs into deep trouble, will the EU central bank come to the rescue? What about other large banks with large derivatives positions?
I don’t think the EU has enough assets to pull off a meaningful bailout….the FED doesn’t have the fire power either, nor would it attempt a rescue of a foreign bank for political reasons….the only possible savior would be the IMF and the World Bank, which is the only world bank that still has a pristine balance sheet. But how much damage might occur before the emergency response is acted upon?
AND what happens to the current two top reserve currencies, the dollar and the Euro, should the IMF have to bail out the European banking system?
Will the counter-parties to DB and CS’s derivatives also collapse?….after all, JPM, Citi and BAC, GS and MS (all US based banks)hold many of the counter-party trades to those swaps, options and futures held in Europe. Could the US dollar also collapse in such a scenario? If so, would the IMF make the SDR the new global currency?
I don’t claim to know the answer to that one (yet), but I do think owning some gold can soften the blow, should this selloff escalate faster than many experts are predicting!
The Department of Labor’s (DOL) jobs number was a big miss! So much so, that it led me to think that it might have been “a fix.” The reactions of many ranged from dis-belief to comments of the markets being nothing more than “a casino” as one trader remarked on the Talking Stocks Forum message board.
Now, at putting myself at risk of sounding like another “conspiracy theorist crackpot,” let me explain my rationale on this idea. Of course, readers should decide for themselves, but I only ask that readers consider the evidence.
First, keep in mind that the ADP payroll report showed 100,000 more private payroll jobs just the day before the DOL release. ADP is a very large payroll processing firm, and they have direct access to the payroll systems of many private employers. So, it stands to reason that ADP can see first hand if private employers are adding to or subtracting from their payrolls.
In the recent past, many popular media and government pundits have attempted to diminish the ADP numbers as being less reliable than the DOL’s numbers, but this attempt at slighting ADP’s results seems to be more of a miss direct attempt to inflate the value of the government report versus the actual payroll results of a top vendor in the payroll services sector.
The government report uses many adjustments including seasonality factors and a birth-death model for businesses that many experts question. The ADP number on the other hand, at least as it relates to private payrolls, is pretty much an un-doctored number.
So, if one assumes that the ADP monthly jobs report is is closer to reality (at least with private payroll figures), then let’s move on to some reasons that would be motivations for the Fed to hold interest rates steady (and keep bond interest rates low).
The first reason is the monthly Treasury bond auctions which occur this week in the U.S. As I have noticed time and time again, bond yields tend to fall in the week of each re-funding. However, there has to be some sort of fear of bad news in the air to drive down interest rates, and this bad news often seems to arrive in the week of each month when the Fed holds its largest bond auctions.
With our large sovereign debt ($19 trillion), it makes sense to try to auction off new treasury notes and bonds at as low of an interest rate as the markets will accept. As it is now, the US can only cover its interest rate payments, and that is at a stretch without sacrificing other areas of the bloated budget.
So, from the federal government’s position, it makes sense to try and auction off new treasury notes and bonds at the lowest possible interest rates. During times of fear, investor money typically rotates into US treasuries as they are perceived to be both liquid and safe investments. Bond prices tend to rise (and interest rate yields fall) during times of fear, due to the safety perception of this investment.
Yet, the Federal Reserve had been preparing us for another rate hike either in June or July, which is contradictory to the directions that yields take during times of worry. A rate increase seemed to be increasingly likely, and the short end of the yield curve was rising in anticipation of it. Rising interest rates create a problem of interest rate coverage– a financial concept that says that net tax receipts have to at least cover the interest rate payments on the treasury notes and bonds.
So, if the Treasury can auction off those debt instruments at lower interest rates, then those low rates remain intact to maturity some ten to thirty years out. Since interest rates are at near historic lows, and the amount of US debt is very large, it only makes sense for the government to try to auction off their paper at the lowest possible rates.
Now, back to the Fed. The US central bank had one caveat to its forecasts, and that was that an interest rate hike would be “data dependent.” On Friday, that data came in weak. So, the stunning low jobs number did “the dirty work” for the auctions by driving bond yields down and delaying a threatened Fed hike in June.
The low jobs number also helps several other concerns as far as keeping interest rates low:
Those examples include “Brexit,” China, and Europe. In the case of Brexit, the Fed can now avoid a mistake of raising rates right before the Brexit vote in the UK. A vote to leave the European Union could un-glue markets worldwide, and so keeping the US interest rates on hold (and thus keeping the US dollar soft) lessens the chance of large capital outflows from Europe and the UK, which could trigger a financial crisis.
And the lack of a Fed rate hike also keeps China from doing a devaluation of the yuan. The last major yuan devaluation occurred on August 24th of last year, and so take a look at your stock charts to see what happened last year on that date and you will understand why it is important for the Fed not to raise rates while China’s economy is weak!
China’s currency is weak but still pegged to the US dollar, so with the greenback now conveniently weakened, that takes pressure off China having to de-value its currency. A weaker dollar is in essence, a de facto devaluation of the Chinese currency relative to other currencies around the world. Yet, since China does not have to officially de-value its currency, the world financial markets remain calm.
So, regardless of whether you buy into my thesis that the weak jobs number was contrived, there is no denying that the result plays right into the hands of what the global elite were secretly hoping for.
So, welcome to the casino! The house welcomes you to pull up a chair, and place your bets on the next roll of the roulette wheel. The markets continue to gyrate without any consistent direction because the global elites (who control the financial institutions) are trying to keep a weak and sensitive financial system from falling out of balance.
So, we lurch from one crisis point to the next. While the Fed and other central banks talk about a controlled economic recovery, what they really seem to be doing is trying to keep currency crosses moving in a narrow channel so as to avoid a sudden spiral of financial conditions.
NOW, if all of what I have speculated on seems to make no sense, then I ask that you at least consider that the US dollar daily chart shows the buck was hitting the late January down-trend resistance line. That line is also very close to the down-trending 50 day line. So, when the greenback hit that yellow-dotted line on my chart, that was a natural resistance point where a reversal could take place….and it sure did!
Take a look….
So, was the Jobs number a fix? Whether or not you accept the theory of a contrived report, then perhaps we can agree on this: the US dollar chart was set up to reverse, and it was conveniently right for it to do so as far as “the house” was concerned! The Fed saves face because it cannot raise rates in the wake of weak data, and the day of reckoning in the financial markets is delayed yet again.
The Plunge Protection Team or PPT for short, is a theory that many experienced traders will talk about from time to time. This theory got its start after the single biggest one day trouncing of the US stock market back in October 1987 when stocks lost 23% of their value in a single day. From the very next day, the stock market began a quick recovery and within only a few weeks, the devastating crash was quickly forgotten. The theory was that the US central bank (the Federal Reserve) intervened in the markets using their close ties to well established Wall Street investment firms to prop up stocks.
Since that time, there have been other calamities such as the 1997 Emerging Market crisis and the 1998 Long Term Capital Management crisis, as well as the after effects of the 2000 Tech Wreck and the 2008 Financial Crisis. After each of these events, and other lesser known ones in between, the assumption among many traders was that the Federal Reserve (“the Fed”) had intervened in some way to support the markets when buyers disappeared.
Recently, someone raised the question on the Ace Talking Stocks forum (simply google “Talking Stocks” to find it) if there was any evidence to suggest that the PPT is still in existence?
I responded that I believe that the Plunge Protection Team has gone global. By that, I mean that the global elites of the largest economies work together to coordinate PPT activities as needed around the world (those being the US, China, Japan and Europe). It is not just a US phenomenon any more, but a truly coordinated, global effort. The vehicle they use to implement PPT policies is mostly in manipulation of currencies.
For example, China was on the verge of breakdown back in early February with its high debt, and its currency on the brink of a large devaluation…. and the global elites got together and decided they would let the Yen and Euro go higher and let the US dollar fall, because the Yuan is pegged to the dollar. By letting the $ fall, it would also allow the Yuan to devalue against most currencies without actually doing an official devaluation.
In other words, a sleight-of-hand was pulled off by the global elites. With a falling dollar, the commodities have come roaring back, the Yuan has stabilized, and bond prices in high yield debt have stabilized. My guess is that the global elites will do a reversal in June when the Brexit issue comes to the fore. Then, they will let the Euro drop and the US $ will climb again–at least gradually–so that they don’t de-stabilize the recovery in China.
Actually, this isn’t my theory; I got the idea from a video by economist Jim Rickards, whose circle of friends includes many of the global elites. He put forth the idea that the G-7 and G-20 countries under the leadership of IMF Director Christine Lagarde are working together to re-direct the currency wars into currency cooperation in order to keep the global economy stable. All I have done really is to suggest that this coordinated effort is an extension of the PPT theory to one of a global scale effort.
That’s the grand plan, at least. Yet, I would also argue that the Elites don’t have full control of the situation due to all the calamities that are going on. How long can they keep moving to put out one fire when that starts a new fire somewhere else? The situation in Japan is growing more worrisome with their large debt and a strong Yen…even the US is not immune with its slowing economy. How many fires can they put out when the problem is out of control debt in nearly every corner of the globe? Like several small fires in a large forest that at some point become too difficult to control, the fires can come together to form one large conflagration that destroys all of the forest.
Is it any wonder that Gold and Silver are on the rise again? These two metals seem to be re-asserting themselves as alternative currencies. Unlike the fiat currencies which the global Elites attempt to manipulate, the precious metals are becoming more immune from their control as investors flock to these alternative currencies of gold, silver and platinum.
Decision on trading options in Retirement Accounts is expected any day now…possibly on April 6th
I have mentioned this a few times over on the Nasdaq board about the Labor Department considering a ban on options trading within retirement accounts (IRAs and 401ks)….their rationale is that most retirement accounts are taking on too much risk with options trading, and that most retirement accounts are owned by older, retired or semi-retired individuals who can ill afford additional risk.
Of course, many traders use options to hedge their bets, or use options to reduce risk by using less capital in any single investment–this idea is being completely ignored by the Labor Department. In reality, the real reason, I think, is that the Labor Department is acting on behalf of the Obama administration to try and collect tax revenue on each options trade. Their idea might be that some traders will choose to convert their IRAs and 401K accounts to taxable accounts or put future savings into taxable broker accounts where options trades can then be taxed by the federal government.
Wall Street has been fighting this possible ban by sending their lobbyists to Washington to provide numerous reasons as to why Options Trading should be allowed in retirement accounts, but my fear is that this liberal Labor Department (which incidentally is not the SEC, the organization that oversees most stock and options trading) and is led by an Obama appointee named Tom Perez is determined to eliminate options trading from retirement accounts.
So, what effect will this move have (assuming they announce it)? Will it drive most traders using retirement accounts to TAKE ON MORE RISK by trading the 3x levered ETF products? Or, will retirement account traders move to trading more PENNY STOCKS in order to re-gain their lost leverage?
By so doing, will many of these traders risk increased losses because they are un-familiar with concepts like levered ETF decay and with greater volatility/ low liquidity found in many Penny Stocks? In other words, once again, Washington’s attempts at controlling how individual investors choose to trade and invest, could back-fire and create greater risk taking by those with retirement accounts?
A few days ago on the Ace Talking Stocks Forum on December 10th, I put forth a hypothesis that we could witness a reversal in gold’s fortunes ( or more precisely its misfortunes) once the US Federal Reserve (“the Fed”) likely raises interest rates on December 16th. I realized at that time that such a view was definitely not mainstream. Then, this weekend, I read in Barron’s Streetwise column by Ben Levisohn that he believes there is the chance that the US dollar will have peaked once the Fed begins hiking rates. In other words, a dollar reversal may have already begun.
I am sure that many would consider such a reaction to be illogical, but perhaps not really when one considers that dollar and gold traders have been selling the rumor of a rate hike the past few weeks…so why wouldn’t these same traders buy the news of a rate hike once that is confirmed?
From a fundamentals point of view, the dollar bears and gold bulls might find a bid once traders see that the equity markets and the economy may not be able to sustain themselves in the wake of even one Fed rate hike. Of course, as many traders realize, the pundits and the financial news media keep talking about how they believe the Fed will hike rates 2 or 3 times in 2016….they come up with these assumptions based on the Fed’s dot plot chart which forecasts rising rates for the next few years. In past rate hiking cycles, it was not uncommon to see a cycle of rate increases happen over a few years time.
But what if that one tiny rate hike next week is all it takes to put the economy and equity markets into a downward spiral? My contention is that REAL interest rates are at zero or below and raising rates will choke off an already fragile economy. Then toss in the growing panic in the junk bond market (which I have successfully traded several shorts on the I-shares I-Boxx Corporate Bond High Yield Fund ETF/ NYSE: HYG) in recent months, and this situation puts pressure on both bond and equities markets as we witnessed in the past week.
If these pressures are greater than the Fed perceives, then this blows holes into the Fed’s dot plot dreams! This in turn, would put more pressure on the dollar and give gold and silver a huge boost because some investors and economists would be pushing for the Fed to reverse the rate hike and maybe even bring back some more Quantitative Easing (“QE”) to save the economy.
The more I think about it, the more I sense that a Fed hike could cause a dollar reversal, and hence, gold could take off higher once the reality sinks in that there will be no more rate hikes to come after next week’s hike. Barron’s columnist Ben Levisohn points out that of the last 11 initial Fed rate hikes over the last few decades, 5 of them led to a weaker dollar within days or weeks of the Fed’s hike.
He also points out that 5 major economies (Europe. China, Japan, Australia and the UK) have all attempted to raise interest rates since the 2008 financial panic, and in all 5 cases, those central banks had to take back their rate increases and some are now into new QE programs. So, what makes the US Fed think that this time it might be different?
The Fed says a rate hike is justified under its “dual mandate” from Congress that it should raise rates when 1) prices are stable or rising and 2) employment is rising. The pressure has been on the Fed to raise rates because many seers perceive that both legs of the dual mandate are being met. Additionally, many of these observers believe that recent strong jobs growth should generate greater wage inflation and pump more money into the economy.
However, this observer believes that the Fed is attempting to raise rates to relieve political pressure from the financial news media and the many Wall Street titans who believe the Fed must end emergency measures. They point to the dual mandate as satisfying that requirement. However, it seems to this observer that the Fed has forgotten the first tenet of a modern central bank, and that its real mandate is to control inflation and keep the economy afloat with liquidity when financial markets are shaky. Right now, both of these unanswered “natural mandates ” are telling us that the Fed would be wise not to raise interest rates–at least not at this time.
The Fed looks mostly at the core inflation rate and gives less emphasis to the full inflation rate. For many years, the Fed’s economists have insisted that the core inflation rate is a better arbiter of inflation in the economy because food and energy (which are excluded components of the core rate) are cyclical and volatile and can unduly influence the true path of inflation. Before the 2008 Financial Crisis, there was some evidence that following the core rate made sense, since for many years, inflation was exerting a strong pressure on the cyclical elements of the American economy. By excluding volatile food and energy prices, the Fed could be more patient and methodical in raising or lowering rates by looking at the more stable influence of the core inflation rate.
The Fed tends to use a rate published as the “PCE deflator” to measure the core rate of inflation. A year ago, this rate was at 1.6% inflation. Since the Fed has repeatedly said that it will work to keep inflation at 2% or below, this 1.6% reading was getting close to the high side of its range. Moreover, the perception among many mainstream economists is that a 2% inflation rate is a most natural rate that allows an economy to grow without over-heating.
Now, even the PCE deflator has slowed dramatically to a recent 0.3% annual rate. That is hardly any measure of inflation, even by the Fed’s own definition. Past Fed chairs would have felt no pressure to raise rates with such an anemic rate, but somehow, Janet Yellen seems to believe she must act. Looking at the official US inflation rate of the last 12 months (through October 2015), we see that the rate is a very low 0.2%. That’s the official rate, which is measured by a series of rules and tests set up by the Bureau of Labor Statistics (BLS). Right now, both measures of inflation tell us that inflation is almost non-existent.
More importantly, the low 0.25% annual rate of inflation (using an average of the two official rates) is a full 1-and- 3/4% below the so-called natural rate of inflation in a healthy economy. In other words, the Fed would be wise to consider a rate hike if the rate of inflation was near or greater than the natural rate of inflation. But the current situation reflects an actual disinflation rate in the economy. To hike interest rates in such an environment is the equivalent of putting brakes on an already slow moving economy.
As I pointed out, the Fed is focused (perhaps mistakenly to some extent) on increasing jobs, but let’s consider that most of the new jobs are lower wage ones and the workers in these jobs are just trying to pay the rent and don’t have much disposable income. These new jobs do not suffer from wage inflation simply because they are paid out at lower wages.
In this observer’s opinion, the Fed should be more focused on the real inflation in the economy–of which there is very little. To raise rates in such an environment–when the dollar is already strong and choking off exports– reminds me that the Fed may be ready to commit the same sin that it did in 1937 when it choked off the struggling economy with a rate hike. At any rate, the free markets will soon be telling us if the Fed is on the right track or not. To see how the markets react, keep an eye on the US dollar and Gold charts.
Hint: as I look at the daily Gold chart, I see rising a Chaikin Money Flow (CMF) and Accumulation indicators which are a sign that some (“smart money”) investors are taking positions of late in the precious metal. We will soon find out how smart they really are.
Strange markets indeed!
I clearly understood why there was a big selloff on Friday morning thanks to the poor jobs number and downward revisions to previous months (referring to the monthly BLS Jobs Report). What doesn’t seem to make sense is why the market rallied back so fast, if we are to believe what almost every pundit and market commentator told us, (since the Fed decided to hold rates at the zero-bound at their mid-September meeting), and that is that the markets were disappointed that the Fed failed to raise rates.
On Friday, we witnessed a capitulation. The Dow went from over 200 points down to finish higher by 200 points. What would change sentiment so quickly when the Jobs Report was so awful?
It was like that Jobs Report never existed Friday morning except to cause some traders a quick loss on their trades. Lol!
What is clear to the profitskey.com is that this is more entertaining than a 3-ring circus! The news media must look like fools for telling us that global depression is at hand as of 8:30 on Friday morning, but only 6 hours later, everything was “hunky-dory!”
This rally looks to me to be a true RELIEF rally! Notice that I bold-print and put in caps the word “relief.” This rally on Friday afternoon was a relief rally because there are many equity traders who are happy to keep 0% interest rates for a lot longer. Yep, that’s right! And if I am right, then this blows holes in the theory that the markets were wanting a rate hike!
Even before the Fed’s September 17th decision not to raise rates, I had noticed that the equity markets were still doing what they had done the past several years. That is, the equity markets fell when the US dollar rose and/or interest rates on the 2 year and 10 year US Treasury notes were rising. This was indicative of a market that continued to equate the Fed rate hike threat as bad news. So, I was firmly in the camp that still believed that a Fed rate hike would be bad news for the stock markets.
But in the days following the Fed no-rate-hike decision, the equity markets were plunging and under great volatility. Sure enough, the most popular market pundits were going on the financial news channels like CNBC, Bloomberg and others touting that the markets were in a tailspin because the Fed failed to raise interest rates. Some of these “experts” literally begged the Fed to re-consider and act quickly to raise rates at the October meeting. I must admit, I was questioning my own belief system–had I misinterpreted the markets actions in the days leading up to the Fed no decision?
I was of the belief that the markets would not take kindly to any rate increase at this time with China in a near recession and emerging markets and commodity producers falling into depressions. Perhaps I had been wrong?
Then, the amazing capitulation in the US equity markets occurred on Friday. The markets rallied 400 points from trough to peak. Suddenly, some people began to say the unthinkable: the markets seem to like that the Fed will likely not raise rates any time soon. My belief system was redeemed! My read of the market tea leaves was correct…and it was all of these pundits who might have been wrong….again!
After all, I have been saying for the past few years on this blog that I don’t believe the Fed will raise rates at all before 2016…you can go back and read my past blogs to find the reasons. All of these highly popular pundits have been getting it wrong the past few years, and I have been right on the money up to now. And keep in mind, I am not even sure the Fed will raise rates in 2016, but I leave that as an open issue to be debated for now.
So, why did the markets collapse after the Fed no decision? I think the pundits misinterpreted the causes of the market selloff. What the markets were reacting to was that China was spinning into a possible recession, and the world’s second largest economy has a great influence on markets these days. That cannot be ignored any more. The fact that the Fed did not raise rates was official recognition of how important China is to world markets. The reaction was related directly to what was going on overseas and not to the Fed’s decision to leave rates alone.
On Monday and Tuesday, we will have to watch for follow-through by the Bulls to see if this reversal is real. Once again, this reminds me of an adage I sometimes state on the Ace “Talking Stocks Forum”: “You can choose to believe what the market pundits say, or you can choose to follow a fact-based (technical analysis) strategy like we do at www.AceStockTrader.com . ”
In a free market, it’s your choice.