This is a pickle wrapped in a conundrum surrounded by a puzzle, or something like that. The Fed declined to hike rates, which everyone thought was bullish, and then stocks got on the vomit comet. Theyíve been going down on an elevator ever since.
I think whatís interesting here is how shamefully far behind the Fed is on this. Dudley is out there still talking rate hikes. Like, just the other day. He has gone right out of his tree. Itís almost as if he lost his B-Unit and canít log into Bloomberg.
It was like this in the financial crisis, too. The Fed was very slow to act. It is a known fact that the Fed has never forecasted a recession (in spite of employing hundreds of nerd economists whose job it is to do precisely that). They donít even react to them very well. Iím not certain weíll get a recession, but the Magic 8 Ball says, ďIt is decidedly so.Ē
Like junk bonds, for example.
Credit spreads tend to be the best capital markets indicator of bad juju. The underlying bonds are even worse than the ETF. There are bonds that are gapping 10 points lower at a time. There is no dealer participation. We are going to get hung bridge loans. Some of the larger deals are troubled. It is a mess.
My guess is that over the course of the next few weeks, the Fed is going to change their minds on rate hikes. Maybe they have already. Itís been my view that they wonít hike until 2017. I still believe that to be the case. I think you and I know what the Fed is going to do better than the Fed itself.
There are some people who think weíre FUBAR, that the Fed is out of ammo and we just have to get run over by the Mack truck because we canít hike rates anymore, and what good is QE going to do, anyway?
Well, the one thing QE did was to raise asset prices, which happens to be the thing that currently ails us.
But remember, the Fed has all kinds of tools that havenít even been explored yet.
- They can lower reserve requirements
- They can lower IOER (interest rate on excess reserves)
- They can do some magic stuff with the repo market that I donít understand
- Helicopter money
The latter refers to when the central bank prints money and doesnít buy bonds with itÖ it just mails out checks to everybody.
If I were a gold bear, Iíd be nervous.
Let the Dollar Drop
The only way the Fed can get out of this is if they somehow manage to get the dollar to go the other way. To sell off.
Thatís going to be hard. The strong dollar trade is the most relentless trend around.
This is the dollar over two years:
This is the dollar over a much longer timeframe:
Any technician would tell you that the dollar is consolidating, and the next move is higher.
But a move higher in the dollar would be brutal for global markets. EM is falling apart as it is.
If the Fed wants the dollar lower, it has to do one or more of those things in the itemized list.
An Austrian economist would say, screw it, let it go. There will be an adjustment period. And everything will be fine.
Even I am old enough to remember a time when the Fed didnít feel compelled to intervene every time stocks went down 10%.
What People Are Saying
Pretty much every hedge fund guy I talk to is 100% bearish, this is the end of the world, etc. These are the guys responsible for the five-figure orders in HYG puts.
I would say the real money crowd is a little more sanguine. They are looking for value here.
The hedge fund guys are supposedly the smart money, but they tend to move as a pack. And they all tend to be wrong at the same time.
Itís getting ugly, but this isnít the financial crisis and itís not the dot-com bust. Stocks were overvalued, but not egregiously. Carl Icahn said there was a bubble in high yield, but thereís historical precedent for spreads to be this tightóthey were tight throughout the duration of the Great Depression.
Biotech has sold off almost 30%, and big-cap biotech is trading with single-digit P/Es. Things can get worseóthatís what markets doóbut this isnít the end of the world.
I think the bigger danger is not how far the market goes down but how long it stays down. It will take a long time to reclaim the highs.
This is no-manís land. If youíre thinking of selling here, youíre probably too late. If youíre thinking of buying, itís probably too early.
I realize this is probably no help. Trust me, if I had conviction here, I would let you know.
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