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Posts Tagged ‘Federal Reserve Board’

Who am I to say that Ben Bernanke is wrong? After all, Bernanke went to Harvard and graduated with honors and his economics PHD from MIT. Then of course he has all of the political appointments and now is the Federal Reserve Chairman. There was someone else who had a list a mile long of credentials. In fact, he was the former Federal Reserve Chairman – Alan Greenspan. It is documented with a list a mile long of critical mistakes that were made in his part in blowing up one of the greatest debt bubbles of all time.

So, don’t let the credentials fool you. In short, Ben Bernanke wants to save the planet by purchasing billions of dollars of US Treasuries or said in another way, lend billions of dollars to the US to keep US debt a float. Buying a Us Treasury Bond is the equivalent of lending money to the United States. His logic? The Fed buys billions of dollars of US Treasuries, then mortgage rates will go down and interest rates on loans will do down further encouraging businesses and consumers to borrow and spend. This in turn might invigorate the economy and ease unemployment.

Let’s take a look at the main reason why this is a dangerous bet. I have many more. The problem is limited space.

Have you ever seen a kid blow a bubble as big as it will go? The child keeps blowing and blowing and the bubble gets bigger and bigger. The eyes of the child show the disbelief that the bubble hasn’t popped yet as more air is forced into the gum. Our bond market is one big juicy fruit bubble already. Let’s blow some more air into that bubble and see what happens.

By pouring billions of dollars into Tresuary bonds, prices of bonds (in theory) will continue to go up and interest rates fall. Common sense will tell you that prices of bonds are going up for no good reason. Thus they turn into the equivalent of worthless internet stocks that went up in price based on nothing material. This has the makings of a massive bubble. Riddle me this – what happens when that bubble bursts? Interest rates sky rocket. Isn’t that what he is trying to prevent in the first place?

There is also the notion that people are going to spend, spend, and spend because of low rates. If that were the case, people and companies would have already been doing it. Let’s face it, you need confidence to borrow money. I will just say two words why that isn’t going to happen – OBAMA ADMINISTRATION.

Further, how did that first round of 100’s of billions of dollars do for us? I don’t think that I need to answer that question.

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What is that sound that investors heard on Friday? It is kind of faint. Oh it is the Federal Reserve Board Chairman Ben Bernanke screaming as loud as he can between that rock and a hard place. I am starting to find that this is all one big joke…that is this thing called investing.

Let’s back track for a moment. Things were as bad a few weeks ago as they are today when Ben Bernanke had his chance to rescue the market by stating the Federal Reserve Board would intervene following the Federal Reserve Board meeting. He should have known that his silence would be deafening and the market would react negatively. Well, guess what, the market did react quite negatively.

The market or drug addict was upset at not receiving assurance that the dealer was going to come through with some more stimulus or drugs. Then Bernanke sees what a tough time the market is having and at his speech at Jackson Hole last Friday he states that he has a lot of actions that they can pull out of the bag to help the economy.

In other words, he didn’t say the right things then so now he is telling the market what it wants to hear. Wall Street, who really wants to drink the kool-aid, puts in an impressive rally on Friday because Big Ben says he is going to save the day. “Don’t worry (wink, wink) I got this one,” says the Fed Chief.

Let’s take a look at what is really going on here. Further actions taken by the Federal Reserve Board will result in one of two scenarios. They wll either add another band-aid to the festering wound they call the economy or they will fix the economy.

For all of those who are bullish on Bernanke, you might want to consider something. They have already pulled out all of the stops and it didn’t work. Further, since the normal routine chemo didn’t kill the cancer we call the debt crisis, then they are just left to try experimental drugs.

The probabilities of them fixing the problem are so very low. This is a sign of desperation. Bernanke is like everyone else in Washington. Just tell them what they want to hear and keep back pedalling and hope that no one realizes that there are no good options with the exception of one.

Let the economy fix itself. Let bad investments go bad. Take it off life support and let it fight through the pain and recover on its own. As we can continue to push that reality off into the future, we are just making the problem worse.

Market Outlook

On the one hand, the contrarian in me doesn’t like the fact that everyone is so negative at the same time. That is typically a contrarian indicator. When everyone thinks that everything is either good or bad, things are about to change and go the other way. That is typically how it goes. On the other hand, maybe things are just this bad and it has never been so obvious. Monitor risk because I believe the probability is high that we did indeed start part III of the bear market back in April.

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It isn’t hard to put a list together outlining the challenges that this country faces. Probably my top 3 on a list would be unemployment and the government’s inability to do anything about it, the trillions of dollars worth of debt not just here but all over the world, and then the foreclosure crisis.

What isn’t getting much attention is the problem that is lurking under the surface. It is also the one issue we want to keep under control. So far, the government had been able to manipulate interest rates to the point where they have been kept under control.

The picture above shows the 10 year treasury interest rate between 1962 and today. You can see how rates went real high during the 60’s and 70’s. Then in 1980, interest rates started to fall. For 30 years interest rates have fallen. In 2008, they hit the lowest level. As of late, it looks like rates could be heading back down to those levels. Currently, we are 20% above those low interest rate levels in 2008. Since April 10th of this year, the 10 year treasury rate has fallen -32%.

Remember that interest rates and the prices of bonds move in opposite directions. While interest rates are falling, bond prices are rising.

As I wrote in this article, my concern is that we have a huge bond bubble forming. A bubble occurs when everyone invests into some sort of investment because collectively they think that this is the best place to be. In this type of environment, investors just cannot get enough. They do it in such a large way that the price of the investment gets way out of line with its true value. At some point, the bubble bursts and prices come back down to their real value. Just think about what has happened to the prices of real estate after the real estate bubble popped.

Here are a few bubble facts for you:

Last year, 375 billion dollars was invested in bond funds. Between 1998 and 2008, 425 billion was invested in bond funds. In one year investors poured almost as much money in bond funds as they did the prior 10 years.

Last Friday, the Wall Street Journal reported that companies are on pace to have a record year in issuing junk bonds. Investors are flocking to the riskiest bonds issued because they can get higher interest rates or yields.

It looks like we are experiencing bond fever on Wall Street. The problem is that if the bubble bursts, then that means interest rates will soar. Soaring interest rates is the last thing that we need in a world plagued with debt. The Federal Reserve Board knows that and because of that fact have done everything humanly possible to manipulate the prices of government bonds. Let’s just hope that this grand experiment works.

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This has been an interesting debate to watch.  Until about a few months ago, inflation was the “in” thing.  The notion has been that since the Government has been printing money and flooding the economy with stimulus inflation would be created. 

My stance has been all along that we will not see inflation for a long time for a few important reasons.  First deflation is often the result of too much debt in the system.  Second, the government can print all the money it wants and not create inflation because the money that is printed is going to absorb losses in the system.  The key is that money is not circulating. 

If you introduce money into the economy and that money circulates through buying and selling of goods and services and is being lent out, you can definitely create inflation.  That is not happening.  That circulation of money is measured by the velocity of money.  If money is circulating at a high rate, we have expanding velocity.  Today we have been watching velocity contract instead of expand.  As the losses on debt continue to mount, it will be tough to expand the velocity of money.  We are on the toxic path of debt.

All of the sudden, it is as if economists are starting to recognize deflation.  Now the “in” word is deflation and not inflation.

Consider the definition of deflation.  Deflation is a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. (Source: Wikipedia)

This is pretty much what we are seeing.   Ironically, during a period of deflation, the dollar is actually strong and gold weakens.  We are also seeing that trend. 

The Federal Reserve Board is now acknowledging we might have a deflationary problem.  Ben Bernanke is regarded as an expert on deflation.  Expert or not, it is happening on his watch. Inflation is something the Federal Reserve Board can tackle head on.  Think of deflation as aggressive cancer whose only cure is experimental medicine. 

This last Federal Reserve Board meeting illustrates how they are shooting in the dark.  In fact, some economists fear that these new steps they are taking could actually backfire and make the situation worse.

Even more amazing is that we could pump 100’s of billions of dollars into the system and almost 2 years later have the same problems on a much larger scale.  As I have said many times before, the politicians and the Federal Reserve Board are useless in this scenario. 

The only solution to our economic mess is letting the system detoxify on its own allowing consumers and businesses to work through it.  In that process you stop creating more debt and allow the losses to occur.  You support small business in an attempt to rebuild what has been destroyed. 

Unfortunately, we are getting the exact opposite out of Washington.

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Did you ever wonder why mortgage rates have been so low this year?  Well, let me take you on a journey.  Mortgage rates are influenced by government bond interest rates.  Government bond interest rates are influenced by the price of Government bonds.  If bond prices go up, then interest rates go down.  In order to raise the money to pay for all of the irresponsible spending of the Government, the Treasury sells Government Bonds.  Institutions, other countries, investment firms, etc. buy the bonds from the Government.  That money then goes to work to pay for all of the spending created by the Government.

The Government has a lot riding on those government bond sales or auctions.  If they go well, the Government sells the bonds and gets the money, bond prices go up, and interest rates stay low.  Since most people don’t want to lend the US money because we are in so much debt as it is, someone had to step in and help buy those bonds.  Yes, the Federal Reserve Board has been buying bonds all year creating more debt and keeping bond prices higher and interest rates lower.  I will not even go into how incredibly irresponsible it is for the US to buy its own bonds.  That goes without saying – the problem is that program is coming to a grinding halt at the end of this week following the largest bond auction on record this week – 123 billion dollars worth of government bonds to be issued.  The Fed will get out of the way and the bond markets will be allowed to function freely again.  That might not be so good.

Interest rates started going up today and are at a 2 month high.  What happens when you suppress something that should be going up and then stop?  It is like compressing a spring.  If you let go of the spring, it takes off.  I think that the same thing could happen with interest rates.  If this happens it could disrupt the credit markets, consumer interest rates will go up, businesses will have even more trouble borrowing money, and homeowners will now have trouble getting low cost mortgages. 

The stock market would have a tough time with raising rates.  However, the rising interest rates should help the dollar. If the dollar is going up, the price of gold should take a hit.  Welcome to Deflation!  The economy might start the debt detox process that should have started when this crisis started. 

If you are looking for a catalyst, this could be it.  Interest rate risk is not something that the stock market is ready to face.  However, China and others would certainly like to see the value of our dollar go back up.

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In 2006, I was writing to my clients in my private client letter about what I felt was occurring in the financial markets.  I described what I felt was coming as a Category 5 hurricane.  I think that I even named it Hurricane Greenspan at the time.  Although he is a distant memory, he had a lot to do with the problems that we are facing today.

It feels like we were hit with a category 5 hurricane last year.  Unfortunately, I think that another one is brewing and might even be getting very close to shore.

Every Friday it seems another bank fails.  Last Friday we saw a sizable bank fail.  The Failure of Colonial Bank marks the 6th largest bank failure in U.S History.  It is a bank of $25 billion and 346 branches in 5 states.  Besides the troubling nature of this story and the fact that the Government cannot bail all of them out, the FDIC insurance pot takes another big hit.  It looks like the 13 billion dollar fund will lose another $2.8 billion because of this bank failure. That insurance fund designed to protect you and me is quickly dwindling.

Another hurricane indication would be the Government’s sale of Government Bonds. The Treasury Department sells bonds to raise money for Government spending.  It is the way the Government borrows money.  Last week the Treasury Department sold 75 billion dollars in bonds.  Do you really think that China and other countries are lining up to lend us money?  No, you would be correct.

So, who is buying these treasury securities and lending money to the United States?  Ok, if you have high blood pressure or a weak heart, please stop reading.

Our own Federal Reserve Board is buying many of those securities and lending money to the US. For a great expose on this, read this article.  I don’t need to tell you how desperate that is and how much trouble we are in considering that is occurring.

I hate to say it but this is going to end badly.  All of this is going on at the same time we are facing an unemployment crisis and a whole list of problems in this country.  Once again, I advise you to watch your risk and don’t fall for the notion that this is just a normal cycle.  In other words, don’t drink the kool-aid.

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One of the most important aspects of determining risk in the stock market is watching price levels.  A price level is where the stock market closes at the end of the day.  If the S&P 500 ends the day at 895, that is the price level that we want to analyze.  Think of price levels as road markers.  If you are making progress and passing up important road markers, then you are making progress.  If you are not able to pass up important road markers, then you are losing ground. 

899 on the S&P 500 is an important price level.  The stock market fell below that price level yesterday, which is a warning sign.  You don’t want to stay below that level.  Now, the stock market will struggle to end a day back over that price level.  If it fails to do so in the near future, we might be looking at a significant decline.  The longer we stay below that price level, the greater the risk that the stock market rally that started in March is over.  As I have written since that rally started, we are always trying to answer one question.  Is this a pause in the bear market or is the worst behind us?  I still feel that this is a pause.

The next days will give us some clues.  Today is somewhat of a waste because the Federal Reserve Board is giving their Fed statement.  The market behaves very erratically on Fed Day.  Tomorrow’s reaction to the events of today will probably be more telling.

For those of you that follow technical analysis, there are two different moving averages – the simple and the exponential.  The price level of 899 represents the 200 day simple moving average.  The EXP 200 day moving average is 941.  The S&P 500 failed miserably at trying to close above that level.  While traders where cheering that the S&P 500 rose above the simple 200 day MVA, I think that many missed that the 200 day EXP MVA was a failure and a huge warning sign.  

Incidentally, the 200 EXP MVA gave its first warning November 7, 2007, when the S&P 500 was over 1500.  These moving averages are great indicators of bear and bull markets.

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