Does The Fed Know What It Is Doing

The market seemed to be very confused last week as it saw almost a 400

point drop on the prospect of rising interest rates and then it went up 350

points on Friday on the strong jobs report.

We are going to have to get used to this kind of behavior by the market over

the months ahead.

So why is the market going up?

The definition of a bubble is when something is being bought simply because

it’s prices are going up. I believe the stock market is going up because stock

prices are going up. The higher they go, the more people want to buy. When

compared to the alternatives such as cash and bonds, the stock market

seems to be the only game in town. “Instead of having my money in the bank

making nothing I can put it in the market.”

There are many people who are in the stock market that have no business

being there. They just see no other alternative for their money. That is a

classic bubble scenario.

What do you think about that? Do you really believe that the fundamentals of

this economy warrant the stock market having gone up so much since the end

of the great recession?

Central banks around the world are going in different directions, and there is

not a coordinated global effort to address the global economy. Here in the

United States we seem to be about to raise interest rates. In Europe, they are

about to enact quantitative easing that drives interest rates down. The

Japanese are lowering their interest rates. The Chinese are lowering their

interest rates.

The markets are very confused by all of this and will probably be reacting to

each data point separately since it is so difficult to get a broad picture of what

is going on.

What I don’t understand is why the Federal Reserve is in such a rush to raise

interest rates. It seems they are being pushed into it because “rates have

been low for so long that this can’t go on.” This is hardly a reason to raise

rates, and I question the wisdom of doing so.

We also know that the Federal Reserve has a history of not being very good

at timing when to start raising interest rates or in detecting significant

structural issues in the economy. During the Great Depression, the Federal

Reserve raised interest rates at the wrong time and plummeted the economy

into another severe contraction.

In 1991, Alan Greenspan, then chairman of the Federal Reserve,

recommended repealing the Glass-Steagall Act that had been passed during

the Great Depression. The Act separated deposits and investments of those

deposits at banks. Without the protections that the Act had provided us for 58

years, banks started investing deposits into speculative real estate

investments just as they did leading into the Great Depression. We all saw

that we almost had another depression when the financial crisis hit in 2008.

In 1994, the Federal Reserve raised interest rates at the wrong time and

almost collapsed the bond market, which could have triggered a global

financial crisis equivalent to the one in 2008. They had to enact emergency

measures to counteract the effect of their actions.

In October 2007, Ben Bernanke testified that subprime mortgages were such

a tiny percentage of the overall mortgage market that we didn’t need to worry

about them. While he was right about the percentage of the mortgage market

that subprime represented, he was very wrong about us not needing to worry

about them. He did not see all of the clever things that people had done with

those subprime mortgages.

Today we don’t know what all those clever people have been doing with 0%

interest rates for the last six years. We’re about to find out if there is another

subprime mortgage type unintended consequence lurking. The risk this

represents could bring the market down dramatically.

In November 2007 we told our clients and I told my newsletter subscribers

and radio show listeners to get out of the market altogether. I see the same

risk today and that is why last August we told our clients and I told my

newsletter subscribers and radio show listeners to get out of the market

altogether.

If you are still in this market, I believe you are in great danger of losing

large amounts of your net worth. Please do not leave your financial

security at risk, if this turns out to be the bear market that I think it is.

The 2008 bear market wiped out 12 years of gains in just 17 months. I do not

want to see that happen to anybody. It is why I write this email, it is why our

advisory firm exists, it is why I do my radio show and why we have our

seminars. I want to help as many people as possible have peace of mind.

There are several indicators that continue to be very worrisome and point to

the US economy being unhealthy.

According to Standard & Poor’s the percentage of Junk bonds trading at

distressed levels is at the highest it has been since the end of the credit crisis.

Junk bonds are corporate bonds. This means that this is money that has been

borrowed by corporations. If these bonds are trading at distressed levels, it

means that the market is perceiving that the number of defaults might rise.

Companies default on their debt payments if they have financial difficulties.

In previous emails, I discussed that the “spread” between Treasuries and

Corporate bond interest rates were at levels that have in most periods

predicted recessions. This means that the market perceives the risk of

corporate bonds to be so high that they are demanding very high-interest

rates before they will lend money to corporations. As stated above, the wider

that spread is, the greater the likelihood that a recession is coming.

The manufacturing numbers that we saw recently showed that our

manufacturing sector is actually now in contraction. The Institute of Supply

Management Survey told us that the number had dropped below 50.

According to Citigroup, the ISM Survey crossing below 50 has produced a

recession 65% of the time since 1948. The argument today is that

manufacturing is a smaller share of the economy however it is still a perfect

predictor of our economic growth.

Seems hard to believe that it has been over three months since we sold.

Despite everything that has happened since, then I have yet to see any

behavior exhibited by the market that tells us that we are not in a bear market.

However, having said that, if the market insists on going up, it could do it for a

long period of time before it finally comes to its senses. This being the case I

do want to participate to the extent that we can. There have been many times

in history when the market went up for no reason other than that it was going

up. Those periods can last for years before the market finally comes crashing

down.

That is why we will buy if we hit our buy trigger.

I understand that it is no fun to be on the sidelines when the market is going

up. With our strategy, that is an inevitability. As I have described in previous

emails, there are bull runs within every bear market.

When people ask me “what do you do for a living?” I say, “we sell peace of

mind.” Our product is peace of mind. If our clients can feel peace of mind

during times of great market adversity like we have had over the last month,

then we have delivered our product.

There is nothing more important to us than that. It is our singular goal to keep

our clients from becoming poor. Preserving the wealth that they have built is

job number one for us. I encourage you to join the Money Matters family!

I believe that avoiding large losses is the single most important thing that we

should be concerned about as investors.

We want to help you to achieve your financial goals.

Thank you for subscribing to this newsletter. I hope it finds you and yours in

good health and spirits.

Cheers!

Ken