Is the Fed making another huge policy mistake?
So, now we know. The Fed really means it when they say they want to crash the economy to kill inflation. But I have one little question: They have a long history of being behind the curve of moving on policy rates and thus they were very late to acknowledge the surge in consumer and producer prices last year. Remember, inflation was supposed to be ‘transitory’?
Now the penny has dropped – so are they fighting the last war again? It has happened before in the period prior to the Volcker era of 1979 – 1987. I well remember the surge in price inflation at the time. The Fed raised interest rates to engineer recessions, crashed shares but did eventually bring inflation down (that was falling anyway).
Treasury Bond yields reached 15% and higher but from that peak started the great yield compression that ended only in January 2020 at a little over 1% – the great 30-year bull market in bonds as inflation died.
So imagine: If energies do start falling and the US grains do likewise, the Fed will be raising rates into a dropping inflation rate. And that, my friends, is a recipe for mayhem in the financial markets.
And all the while interest and inflation rates had been falling, their inflation mandate of 2% that was supposed to be written in stone was regularly missed. And that was because when interest rates were at the zero bound during QE, they had run out of ammo to boost demand and QE dollars went into Wall Street instead.
The result? A huge surge in the money supply (QE) with rampant speculation in assets to levels unimagined previously (see Bitcoin as the poster child of this era to an astoni9shing $70k). But now with rates zooming up, chickens are coming home to roost and the bubbles are popping.
Incidentally, I have shown many times before that the Fed follows the market — it never leads it. On Wednesday with another hike of 75 bps to 3% – 3.5% it moved up to where short term market rates were already trading. Top Tip – to accurately guess what the Fed will do in their monthly reports, check on the market rates.
Stocks are continuing their long march south with sentiment growing more depressed. One measure of how low social sentiment has reached is the vigorous rattling of the nuclear sabre by Mr Putin (again). All of a sudden, people ate starting to talk about that possibility. With the ‘cost of living crisis adding to woes, can a house price ‘correction’ be far away?
I was fortunate to identify the historic ATHs in the major US indexes in November – January period. I said then that these levels would not be reached in a very long time and I have no reason to change my view. It was where many of the US tech giants were said to be Never Sells – they were permanent money machines, or so the story went.
Of course, when the herd start believing that certain shares never go down and FOMO reigns supreme, that is precisely when they do. Here is a famous member of the FAANG Gang – Netflix – to prove the point
It lost 80% to the June low. So much for a Never Sell share! Last year, it could do no wrong with great reviews for its productions which seemed in endless supply. But then the hungry streaming competitors arrived with much dosh in their pockets after the pandemic was winding down and subscribers started to leave Netflix for the first time. It had reached maximum growth and the shares ceased being a growth story.
But note the five down on a mom div. That strongly suggests it will gradually ease in the medium term upwards to relieve the selling pressure before falling once again. Basically, this is not a share to Buy and Hold.
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So where are we on the Dow?
The decline off the January ATH is in the form of a quite rare Leading Diagonal which is a very complex pattern. I was aided in my accurate analysis of the waves by the use of Fibs as many of the waves bore a Fib relationship to the previous one.
And so my outlook is the same – hard down (with occasional brief but possibly sharp bounces) towards my first main target of 26,000 region.
When will the Ukraine-Russia war end?
One possible catalyst for a much more substantial reversal up could come from the Ukraine-Russia war. It appears the war will grind into a lengthy stalemate into the harsh winter and the pressure for a negotiated settlement would greatly increase by both sides (and the West). Fighting would cease and Russia would claim the territory where it is currently holding its ‘referendum’ and absorb it into the Federation.
Ukraine would then have free rein to export its grains and Russia’s sanctions would be lifted, allowing it to sell its oil into world markets, thus depressing energy prices. The West would greatly welcome that as it would lower inflation which the Fed is furiously fighting. Some reparations towards Ukraine could come from Russia’s oil sales levy of some sort.
While this scenario seems utter fantasy as I write tis morning with Putin still at the helm, it is undeniable that the war is getting too costly to maintain for both sides. Russia is hurting badly from the sanctions and its pariah status and Ukraine’s infrastructure is being destroyed with huge re-building costs. Not to mention the human costs.
The largest demonstrations in Russia about the new conscription laws shows how unpopular this war is, although its Soviet history has demonstrated unpopular regimes can last a very long time in that bedevilled country.
If I was to take a wild guess, I would say that such rumblings might start to emerge when the Dow has hit my first major target around 26,000. That is my best guess for the first major correction to the bear market. Until then, it is pretty much straight down.