Has the Fed Already Gone Too Far?
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
It is crucial for investors to understand that the Federal Reserve has not yet turned dovish and the Fed “Put” it not yet in place. Wall Street sometimes hears what it desperately needs, but that does not make it fact. While Jerome Powell has moved incrementally towards the dovish side of the ledger in the past few weeks, the Fed is still firmly in hawkish territory. If, however, Mr. Powell was actively reducing the Fed Funds Rate (FFR) and expanding the balance sheet, then we would have a dovish Fed. However, by just indicating that the FOMC might be close to finishing its rate hiking campaign, while still selling nearly $50 billion of bonds every month from its balance sheet, the Fed is still tightening monetary policy--and in a big way.
However, “The Fed is now dovish, so it’s a good time to buy stocks” mantra from Wall Street is a dangerous one indeed. This argument is false on two fronts. First, as already mentioned, Jerome Powell is still tightening monetary policy through its reverse QE process. Second, the fact that the Fed may be cutting rates soon doesn’t mean the stock market automatically goes up. The Fed began cutting rates in September of 2007 and reached 0% by December of 2008. Was it a good time to buy stocks during that time? No, it was a very dumb idea that cost you half of your investable assets. The market actually peaked around the same time the Fed began cutting rates and didn’t bottom until March 2009, three months after interest rates hit 0%.
Wall Street is gladly overlooking the current global economic crashâ€”not slow downâ€”and that means EPS for the S&P 500 going forward will be well short of the 7% currently predicted. In fact, we are most likely undergoing an earnings recession worse than what occurred during 2014-2016; especially when you factor in the fall in oil prices that will hurt the earnings of energy companies. Only, this time around there won’t be another once-in-a-generation tax cut to bail out stocks and the economy. Just the end of QE on a global basis pushing the financial world over a cliff.
Here’s another salient point. The Fed pushed the economy over the edge in 2008 when it raised rates 17 times from 2004-2006, taking the FFR from 1%-5.25%. In this current rate hiking cycle, the Fed has raised rates 9 times but also has already sold off about a half trillion dollars from its balance sheet. A reduction of this size in the balance sheet, which is a gigantic destruction of liquidity from the financial system, is something never before done or even attempted. And, the Fed continues to burn cash even though the business cycle has clearly rolled over. Add to this the fact that total non-financial debt in the US has surged from $33.3T (231% of GDP) at the start of the Great Recession in December of 2007, to $51.3T (249% of GDP) as of Q3 2018 and you can understand why this economy cannot handle higher ratesâ€¦not with an extra $18 trillion it has to service on top of what it could not bear a decade ago.
The GDP level of today is the most unstable and fragile ever. This is because today's GDP is more reliant on asset bubbles and free money than at any other time in history. Now that rates have risen, liquidity has been removed, and the stock market is rolling over, GDP should begin to fall.
My 20-point Inflation/Deflation and Economic Cycle model predicts the Fed has already tightened enough to bring on a recession; and history has proven that is where stocks can lose 50% or more of their value. Eventually, Jerome Powell will come to grips that these massive and unprecedented debt levels cannot sustain higher rates and QT at the same time. He will then start cutting rates and return to QE, but that is when most of the damage to the market occurs.
My model will monitor the incoming data to see if I’m correct in the preceding assumptions. And if so, there will be perhaps the best shorting opportunity yet coming up very soon. This is because the perma-bulls and shills on financial TV have caused the majority of investors to already price in a favorable conclusion to the trade war.Â And, have also convinced them that the Fed put is back in place. But the trade war has become a red herring, and the Fed's damage to the economy has most likely already been done. In reality, the destruction caused by central banks occurred a long time ago when they eviscerated markets in favor of perpetual bubbles. Yes, central banks have indeed already gone way too far!