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Mark's Market Blog

9-22-13: It's all about the Fed.

By Mark Lawrence

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The Fed chickened out. Tapering is off. The vodka will continue to flow freely into the punch bowl for the foreseeable future. Yipee!!! Markets promptly shot up to new all- time highs, and kept going up from there. And they're going to keep going up until congress brings them crashing down with their latest debt ceiling fight - any week now. When will the taper begin? Not in October, that will be in the middle of the debt fight. The mid-December meeting? And crush the Christmas shopping season? Nah. Imho, we're looking at the January or March meeting to start the taper.


S&P 500 March 29 2012 to September 20 2013

The Philly Fed manufacturing index is up. Housing sales are at a 6 year high. Job creation is up a bit. Unemployment claims are down a bit. Things continue to get slowly better.

Germany had their elections today. Merkel will remain prime minister. She will have to form some sort of coalition to govern, she did not win an outright majority. Several small parties fell below the 5% rule, including her partner, so she'll have to for a government with one of the major parties, which will take some time. Germans are apparently very satisfied with her policies, especially her holding fast against bailouts of the southern countries.

Europe adopted the Euro in 2002, locking their countries into a fixed exchange rate. Eight years later Germany and the north were doing great, the south of Europe not so much: they needed to devalue, but couldn't. And we get a big crisis. Now, several years into their crisis with their central bank buying junky southern government bonds and printing money and making concessions to the south, it's all getting fixed, right? All those trillions of dollars spent on bailouts are working, right? Nah, the southern economies continue to stagger into deeper recessions with higher unemployment, the northern economies are recovering and starting to grow again. Unemployment in Spain, Greece and Portugal are growing from the mid-20s towards 30%, while unemployment in Germany is dropping below 6%. The problem, far from being fixed, is getting worse. Expect further crises in spite of French President Hollande's proclamation that "The Eurozone debt crisis is over." And expect further central bank printing, as the northern countries continue to vote against bailing out the south properly, and refuse to let the south break from the euro to fix their problems by devaluing their currency. This is like watching a marriage between a drunk and a codependent: it doesn't end, it just lurches from one drama-filled problem to the next.

We're getting quickly into the continuing resolution / debt limit debate season. House republicans have decided to send a party- line bill to the senate which raises the debt limit but cuts off funding for Obamacare for the year. It's DOA. If the republicans had nominated senate candidates last election who didn't say things like rape-induced pregnancies were part of God's plan it might not be DOA. What's plan B? I'm not aware of one. I expect this fight to get messy. But republican leadership knows very well a government shut down will play very poorly for them heading into next year's elections.

A new aspect of Obamacare has been recognized: it's a bailout of cities and states who have expensive retirement medical packages they can't afford. The pension payments are guaranteed by contract, sometimes by constitution, but the medical expenses often aren't. California and her cities, for example, could dump all the police and firemen medical policies and give retirees a fixed amount, say $125 / month, to go buy their own Obamacare policy. That will take care of them from their retirement age of 52 or so until their medicare kicks in at 65. This will save states and cities about $10,000 per retiree per year. If you're a state retiree, prepare to love Obamacare insurance exchanges. Federal taxpayers are going to pay hundreds of billions of dollars to subsidize these policies and effectively bail out California, Illinois, New York for a few more years. Don't worry: the Fed will print the money to cover this, so it will be our children who pay for this retirement medical care, not us. Ponzi Lives!

A quick history of the crash of 2008. The Fed prints money like mad starting in about 2000, and this forms a huge bubble in real estate. Add in congress pushing for unrealistic levels of home ownership, and pretty soon mortgages are written for a total of a couple trillion dollars that everyone knows will never be repaid. It all comes crashing down and we look right into the abyss. Is this the end of Capitalism? Nope. The Fed, who got us into this by printing money, prints more money to get things working again - they have a new name for this, "Quantitative Easing." After about a year that ends, and the markets start acting like they'll all come crashing down again. So the Fed goes back to printing, now it's "QE2," which, unfortunately, is not a really big luxury ship, it's another really big money printing scheme. QE2 ends, and the markets again start acting like they're all going to come crashing down again. So the Fed goes back to the only thing they know - when all you have is a hammer, the whole world looks like a nail. They print money again, "QE3." They talk - just talk - not about ending QE3, but just about slowing it down a bit, they call this "tapering." Bond interest rates climb from 1.7% to 3% and the markets act like they're going to crash again. So, no tapering. That brings us up to this week. As soon as tapering is trash-canned (Wednesday), markets shot up, the dollar went down, interest rates went down, gold shot up. What's next? We're all addicts now, we all need our daily shot into the arteries, and the Fed is our pusher. We all know how addictions end - rehab if you're rich and lucky, the gutter otherwise. The Fed tells us that QE3 will run, if necessary, to infinity and beyond. Bernanke said this week that the country will not be ready for a 4% interest rate until 2015 or 2016. One day the bond market will turn on the Fed - the Fed will be printing money like mad, buying bonds like mad, but bond prices will collapse anyway, interest rates will skyrocket. That's when the Fed has officially run out of heroin, that's when the drug has stopped getting us high, and that's when all hell breaks loose. Some say that's the day to buy gold. I'm not so sure - gold is only good if one day there's someone somewhere you're willing to sell it to, someone who has a currency you're willing to take for your gold. Jim Rogers, my favorite talking head, is now saying, "Bernanke is going to go down in history as an absolute disaster." I agree. I don't see when the end to this comes, but it will not end well.

James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, said today in an interview with Bloomberg that the Fed shouldn't raise short-term interest rates if inflation is below 1.5%, and that a 1.5% inflation floor would "reassure markets" that have been swept up in turmoil as participants begin to anticipate a tightening of monetary policy. Bullard also said that he would recommend increasing the size of the central bank's quantitative easing program if inflation were to fall below 1%, a scenario he said would have him "pretty concerned." The Fed currently offers forward guidance on the future path of its main policy rate based on the "Evans Rule," named for Chicago Fed president Charles Evans. The rule, adopted by the Fed at the conclusion of its December 2012 meeting, dictates that the Fed won't consider raising short-term rates "at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." The Fed is terrified that we'll repeat 1937, when we fell back into the depression and wound up in WWII, or that we'll have a couple decades of deflation like Japan since 1990.

Mike O'Rourke at JonesTrading sums up what a lot of traders are feeling right now about the Fed (still easing), the stock market (making new highs) and the economy (seemingly weakening a bit) in one paragraph. "Right now, the FOMC has “a tiger by its tail” - it has lost control of monetary policy. The Fed can't stop buying assets because interest rates will rise and choke the recovery. In short, today's decision not to taper was driven by unimpressive economic data, the fear of a 3% yield on the 10 year Treasury, and gridlock in Washington. If the economy cannot handle a 3% yield on the 10 year, then the S&P 500 should not be north of 1700. It is remarkable that the equity market continued to buy into easy money over economic growth. QE3 has been ongoing for nearly a year and the economy is not strong enough to ease off the accelerator (forget about applying the brake). Simultaneously, the S&P 500 is up 21% year to date and the average share gain in the index is over 25%. Maybe today’s action will turn out to be short covering, but if it was not then paying continually higher prices for equities in a potentially weakening economy is a very dangerous proposition."

Apple released the iPhone 5s, which has a nifty little fingerprint scanner you can use to unlock the phone instead of a password. Cute, huh? Here's a cute observation: the 5th amendment prevents law enforcement from requiring you to give them your password, allowing them to search your phone for incriminating evidence. It's not obvious that the 5th amendment prevents them from making you press your finger against the phone, giving them access. Or maybe they get your finger print off something you touched and transfer a copy to your phone. Are biometrics protected? Do you have a right to privacy with regard to your finger prints or retinal images? Expect a Supreme Court case in several years, after a few Federal Appeals courts have spoken.

Last week I wrote about how California's minimum wage hike was mostly going to go into the pockets of illegals. I was frankly outraged when I learned this. I've since calmed down, and I see things differently now. The more we pay illegals, the fewer qualify for welfare. In fact, I want to take this further: I think we should pass a federal minimum wage for illegals and make it $20 per hour. Furthermore, the law should say any illegal who makes less than $20 can sue his employer for back pay and attorney's fees. Let's make illegals so expensive that no one hires them for unskilled labor. That's what I think now.

A new study published in the British medical journal attempts to quantify the harm done by various drugs. Their results were, imho, pretty predictable: the single worst drug is alcohol. Or as many like to say, "no one every smoked a joint then beat up their wife."

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