Black Swans and the Federal Reserve: Is There Really a Difference?

“The black swans are circling like vultures now. Dark economic events seem to be flying in out of nowhere for those who have vision to see them. Even dovish New York Fed President William Dudley says that he is less confident about the economy than he was when he and his Feddish partners voted to raise interest rates last December …

There is practically a parade of black swans lined up for action.

Look at how many poked their heads up in just the past week — all just waiting their turn to have a go at the market.

Will it be bankruptcies in shipping, oil drilling, auto loans and student loans that pile up into a big enough heap to implode a couple of major banks, or will it be the Chinese flush turning into a whirlpool that sucks all industry down, or will US economy manage to hold on until the next housing collapse when the next wave of adjustable-rate mortgage failures hits people who only put 3% down so that banks lose a bundle in foreclosures during a market of falling prices?

Or will it simply be that recession is already here as a sinking tide that lowers all boats?

My point has always been that with so much bad economic news building up in the world and such monstrous overhangs of national, corporate and personal debt — mostly worse than the last timearound — the odds are strongly stacked on the side of major trouble. If you’re wise you’ll prepare for that in reasonable and prudent ways.” – Michael Pento

That was an ominous piece of literature. The basic question is – what’s next?

The black swans (unpredictable economic events) are swarming. The economy is faltering, and the fault in it lies in the hands of the Federal Reserve.

Jim Cramer of Mad Money (the first and hopefully the last time I will ever quote him) had a bit to say on the Fed:

“I almost wonder if they live in a vacuum. Who are they talking to? Don’t they at least have some buddies who are concerned about a recession? Don’t they know some people are pulling back from investing…? When you look beyond the market’s tight linkage to the price of oil, the idea that we could be headed into a recession has become a powerful theme, a whispered undercurrent in this environment that surfaces whenever oil takes a dive.”

Jim isn’t wrong (this time).

The Fed does live in a vacuum. They throw around free money in the market to create predictable gains that make almost every bet a winner. They groom black swans into flight.

There’s a whisper in the back of everyone’s minds at this point. We are 3 years overdue for a correction. Every time the stocks dip, analysts say things like “It could be a situation where the price is getting a little bit ahead of what the opportunity might be” (Eric Schoenstein) and “Investors need to exercise caution as markets enter a different phase with less central bank support than has been the case over the past decade.” (David Simner).

But when the stocks rise, that bearish undertone is completely covered by a bullish war cry. “Listening to companies on their earnings calls, I think the general trend is still looking pretty positive… we’re looking through the one-time hits and still expecting robust growth into 2018” (Jeremy Bryan) and “Valuations across the board may be frothy, but I think there are plenty of companies who can justify their valuations” (John Mackay).

That back and forth, constantly changing sentiment is confusing, for consumers and analysts alike. What is actually happening? Are stocks actually overvalued or are they justified by earnings? When will the black swans land? Are things actually okay?

There are a couple of key signs that point to no, things are not okay.

One of the most concerning aspects is how our current Fed Chairwoman feels about financial collapse:

“Would I say there will never ever be another financial crisis? No. Probably that would be going a little too far, but I do think that we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be.” CNBC

She also believes that there is not “anything concrete to react to” with regards to the too big to fail status of the banks. The funny thing is, the banks that failed in the previous downturn have grown even more since then. One would have to be completely jaded to not be able to see anything there.

if_the_biggest_banks_were_too_big_to_fail_aligned

Image courtesy of WeLearnToday.com

(And that’s only to 2012)

The whole situation sounds similar to when Ben Bernanke said that the subprime mortgage market was contained“. Contained enough to result in the worst economic downturn since the Great Depression. Contained enough to result in a near collapse of our financial institutions. Contained enough to wipe the savings of millions of Americans.

That doesn’t seem very contained, Mr. Bernanke.

Yellen has a similar rosy-hued outlook on the economy. With regards to the bubbles that are starting to pop up over the economy, she had this to say: “Valuation pressures across a range of assets and several indicators of investor risk appetite have increased further since mid-February.” 

stock-market-valuation-2017-704x500

Image courtesy of SeekingAlpha.com

But Janet forgot to mention something very important. The Federal Reserve “front-ran” the US stock market recovery and created an asset bubble. They promised overnight profits on bonds to member banks, and encouraged those banks to invest those profits into stocks. Central banks purchased $3 trillion in annualized assets in 2017 alone, according to Marketwatch.com.

And now that the Fed is easing off, the market is being to show cracks beneath the surface.

Richard Fisher, the former president and CEO of Federal Reserve Bank of Dallas was the “whistleblower” in this situation. He had a lot of good points to make:

  1. “What the Fed did — and I was part of that group — is we front-loaded a tremendous market rally, starting in 2009.”
  2. “I’m not surprised that almost every index you can look at … was down significantly.” [Referring to the results in the stock market after the Fed raised rates in December.]
  3. “We front-loaded at the Federal Reserve an enormous rally in order to accomplish a wealth effect.”
  4. “The values are very richly priced here, so I could see significant downside.”
  5. “I wouldn’t blame [what is happening in the market’s now] on China. We’re always looking for excuses.”
  6. “You have to be careful here and frank about what drove the markets…. It was, the Fed, the Fed, the Fed, the European Central Bank, the Japanese Central bank … all quantitatively driven by central bank activity. That’s not the way markets should be working…. They were juiced up by central banks, including the Federal Reserve…. So, I think you have to acknowledge reality.”

And finally…

The Federal Reserve is a giant weapon that has no ammunition left.”

Straight from the horses mouth. You can watch the whole confession here.

We are exiting the longest period of central bank stimulus in history. So when the market does correct (crash) again, the tools that the bank has to fix things are more limited. They’ve used every tool in the toolbox, to the point where it is rusted out and nearly useless.

A good example of what has been going can be compared to holding shock defibrillators to a patient’s chest. If you continually hold the shock, it will be ineffective. You need to take it off, allow it to recharge, and hit it quickly and suddenly to revive that dying heart.

The Fed held the defibrillator to the chest for far too long.

And now the defibrillator is dead. There’s no charge left.

This market was built on Fed free money and now that that money is being taken away, the market will flatline.

This rally has been steep and drawn out.

DJIA-Decade-Graph-Irrational-Exuberance-768x452

Image courtesy of The Great Recession Blog

The graph above compares the dot-com bubble to the Global Financial Crisis to the current rally.

As you can see, the sharpest incline has been recently, and we are just beginning the flattening out process.

And what happens after we flatten out, as history shows us so concisely?

A crash. It doesn’t happen immediately. It rounds off, eases down the edge of the cliff, trickling downward, until eventually it completely drops off.

This an irrational and an exuberant rally.

We can see the exuberance in the steepness of the incline. We can see the irrationality in the fact that the entire rally is based on free money and false promises.

Auto sales are tanking. Home prices are beginning to decline, and massively bubbling in some areas (Nashville, for example). Commodity prices are falling, despite the monopolies best efforts to keep them up. Student loans are piling up. Fed is taking money out of the market.

images

Image Courtesy of ZeroHedge.com

As much as I disagree with the Fed and the measures they’ve taken, it’s fact that the money they’ve injected into the market is what has kept us afloat.

Stephen Lewis, the chief economist at ADM, presents a “scathing critique of capital markets, modern economists, central bankers, and everything else that is broken in today’s society” in the following article Stephen Lewis

I’ll highlight some key points that he made.

  1. What stands out is the failure of economics, as an intellectual discipline, to come to grips with the real world.
  2. After all, whether an item of expenditure is to be classed as consumption or investment is, to an unsettling degree, a matter of convention. [read my article on CPI measurement for more about this]
  3. Virtually all central banks now subscribe to the frankly weird view that economies cannot grow satisfactorily unless they maintain a 2% rate of arbitrarily- defined consumer price inflation.

Basically, everything stems back to a misuse of power by those in charge of our money. $4.5 trillion was pumped into the markets. There is going to be a $14 trillion unwinding between the Fed, ECB, and Japan.

That’s $14 trillion in bonds to be sold.

They are going to have to have exorbitant yields in order to entice buyers to buy them.

This Unwinding couldn’t be happening at a worse time. The stock market is faltering, the retail sector is failing, and the auto market is posed to crash.

Basically, the market is set up for a heart attack. The rally has been steep and long, but the pulse of the economy is beginning to falter and flatline.

The tools that we relied on before to bring the economy back to life are gone. The Fed’s defibrillator has a dead battery. There is nothing left that they can do. The black swans are circling.

Money will have to be put back in the hands of the people. And the entire market ideology that we have is going to have to shift. Only sound economic policy and a market built on true, sound money can save us now.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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