UPDATE ON THE MARKET CORRECTION The roller coaster ride of the seven sessions since Wednesday of last week is disconcerting but it is important to bear in mind that these wild swings have taken place within a narrow range of only 2.4%, and the “double bottom” (now “triple bottom”) is still providing support only 4.7% below the all-time peak S&P500 of Sept 19. So while the audience is growing restless, the “fat lady” has not yet sung. This morning’s open was not surprising, a mild decline in the first 30 minutes which was to be expected after yesterday’s torrid advance, followed by an attempted rally that quickly stalled and then a second attempt into Europe’s closing hour. A few minutes after 11 AM, with the market down about 0.5%, reports on Draghi’s talk at Brookings began coming in and the market nosedived on heavy volume in the next hour dropping an additional 1.0%. There were several attempted rallies in the afternoon but none gained traction and the S&P500 ended the day down 2.1%, only a hair’s breadth above the “double bottom” lows of yesterday and last Thursday. The Nasdaq fared slightly better dropping 2.0% but ending the day about 0.5% above yesterday’s low. Volume was heavy again today, similar to yesterday. Important to realize that we are seeing a vast divergence between different sectors of the market. The consumer staples sector represented by XLP actually made an all-time high this morning before dropping back 1%, but the energy sector has been devastated. The price of oil is now in free fall, U.S. WTI oil dropping 2.7% today to $85.22/bbl, and Brent slipping below $90. With Saudi Arabia cutting its price instead of cutting production, there is a real possibility of oil dropping below $80 which would force many of the shale frackers to curtail their drilling. Most of these exploration and production companies are carrying a lot of debt. We have already seen one driller sell themselves to a larger firm, and others have sold off acreage to bolster their financial positions. The entire energy sector as represented by XLE has dropped 15% since early September. Other basic material producers represented by XLB are down 7% in the last two weeks alone. Since oil and other commodities are traded internationally in dollars, the 6% rise in the dollar index over the last 12 weeks has been an important factor depressing prices, together of course with booming domestic oil production and lagging global demand. It’s no wonder the Fed is concerned that the strong dollar and falling commodity prices could dampen growth and prevent inflation from reaching its 2% target. Draghi’s remarks at Brookings were negatively received because while he promised to avoid deflation he also acknowledged that there was little he could do to increase growth which depended on governments loosening their purse strings and implementing labor market and other reforms. He complained about weaknesses in the banking system that denied smaller enterprises access to credit and called for measures to develop capital markets. (Fifty-five years ago, I wrote a report for the Treasury published by the Joint Economic Committee of Congress pointing out the need for Continental Europe to develop its capital markets!) German Finance Minister Schaeuble, sitting next to Draghi, grimaced throughout the presentation and later denied that Germany was going into recession or needed to do anything different. Both Draghi and Schaeuble are in Washington for the annual meetings of the IMF and World Bank which begin tomorrow. It will be interesting to see how Schaeuble responds to the avalanche of criticism that will be leveled against Germany in the meetings. After chastising other EU countries for fiscal imbalances, Germany is now responsible for the biggest imbalance of all threatening to plunge Europe into recession, a current account balance of payments surplus equal to 8% of GDP. Europe, slowing global growth and the dollar, however, are not at the crux of the problem vexing markets. Fundamentally the markets are having a hard time adjusting to the reality of slow domestic growth in an economy hobbled by underemployment and stagnant wages and threatened by deflationary tendencies, which gives rise to the prospect of accommodative monetary policies and abnormally low interest rates stretching indefinitely into the future. This is a situation that the controlling wealthy elites cannot accept, but are powerless to do anything about, because the ideology they live by cannot contemplate progressive policies and a more active role for government in the economy. The extremely wealthy live off financial capital. They desire above all safe high-yielding investments, so they must have a “normalization” of markets as soon as possible, which means tighter monetary policy and higher interest rates. So what did they do? They fed us a fairy tale about a booming economy about to grow at 4% to 5% like Mit Romney promised. They said: “Look how the unemployment rate has dropped, the 10 year Treasury will be over 3.25% by year end (it dropped to 2.3% instead) and will reach a more normal 6% in a couple of years. Inflation is on the way (inflation fell instead), the Fed now has to raise interest rates, the sooner the better to head off inflation”. They completely ignored the disastrous Q1 drop in the economy (it snowed), the much vaunted housing recovery that never happened, the huge number of part-time workers and labor force dropouts, the stagnant wages and hard pressed consumers over-burdened with student loans and rising health care costs, who managed to replace their worn out cars thanks to the 8 year and sub-prime loans doled out by auto manufacturers, but now even that is coming to an end. They were so sure that the Fed was getting ready to raise interest rates at a fast clip, egged on by the 3 or 4 interest hawks on the Fed Board who make frequent public statements in support of their views. Imagine the consternation when they learned from the minutes of the September Fed FOMC meeting released last Wednesday, that the Fed was no longer discussing QE exit plans as they had been doing since last Spring, but instead were now focused upon global economic weakness and the deflationary effects of a strong dollar. And now, this morning, we have Bill Gross, the King of fixed income investing who abandoned his $2 trillion bond fund, telling clients in an interview: “Say bye-bye to double digit returns. With the Fed controlling markets 3% to 4% is the best return you can expect”, and then advising in a letter to investors: ************************************** “That may not be enough for your retirement or your kid’s college education. It certainly isn’t for many private and public pension funds that still have a fairy tale belief in an average 7% to 8% return for the next 10 to 20 years! What do you do? Well the obvious advice on a personal level: Retire later, save more, accept a revised standard of living. But the financial advice varies with your age and willingness to take risk. Younger investors with a Texas Hold’em “all in” attitude could push all of their chips onto the equity table. Boomers nearing retirement probably cannot afford to. A lengthy bear market could force them permanently out of the game. So, one size does not fit all here. It never has.” *************************************** That’s not what the wealthy elites, their money managers and financial advisers were waiting to hear. They aren’t interested in going “all in” and “pushing their chips onto the equity table”, but it certainly looks like that’s what they will have to come to terms with, the game they will have to play after a few more wild roller coaster rides like those of the past few days, because there is simply nowhere else to go. That’s what is basically going on in this market, IMHO. Looks like it’s going to take a bit longer to sort this out than I had thought. I’m thinking it will require 3 to 4 weeks of earnings reports to alter the sentiment enough to rise decisively above the 50 day moving average barriers. So fasten your seat belts and take it one day at a time. THE RED FLAG is out again suspending all market activity.
Posted on: Fri, 10 Oct 2014 02:35:44 +0000
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