The stated purpose of quantitative easing was to drive down interest rates on U.S. treasury bonds.
But as U.S. News and World Reported noted last month:
By now, you’ve probably heard that the Fed is purchasing $600 billion in treasuries in hopes that it will push interest rates even lower, spur lending, and help jump-start the economy. Two years ago, the Fed set the federal funds rate (the interest rate at which banks lend to each other) to virtually zero, and this second round of quantitative easing--commonly referred to as QE2--is one of the few tools it has left to help boost economic growth. In spite of all this, a funny thing has happened. Treasury yields have actually risen since the Fed’s announcement.
The following charts from Doug Short update this trend:
Of course, rather than admit that the Fed is failing at driving down rates, rising rates are now being heralded as a sign of success. As the New York Times reported Monday:
The trouble is [rates] they have risen since it was formally announced in November, leaving many in the markets puzzled about the value of the Fed’s bond-buying program.
***
But the biggest reason for the rise in interest rates was probably that the economy was, at last, growing faster. And that’s good news.
“Rates have risen for the reasons we were hoping for: investors are more optimistic about the recovery,” said Mr. Sack. “It is a good sign.”
Last November, after it started to become apparent that rates were moving in the wrong direction, Bernanke pulled a bait-and-switch, defending quantitative easing on other grounds:
Conventional wisdom is that the Fed wants the U.S. dollar lower, so it must drop. But the dollar seems to be lacking proper obedience to the Fed’s grand commands.
Before you shout that all fiat currencies go to zero, let’s stipulate that the U.S. dollar has already proceeded 95% of the way to zero. According to the handy BLS inflation calculator, the 2010 dollar is roughly worth 4.5 cents of the 1913 dollar. Put another way, it now takes $22.10 to buy what $1 purchased in 1913.
(Interesting that the BLS inflation calculator only goes back to the birth of the Federal Reserve….)
So a 50% rise in the dollar would register as a mere blip on a 100-year chart. I mention this to put a 50% rise in perspective. It will seem like a large move in the present, but on a longer timeline it wouldn’t be that big a deal.
How could the dollar rise when the Treasury and Fed are moving Heaven and Earth to drive it down? Let’s turn to the Fed Flow of Funds for some perspective: what happened from 2007 (pre-recession) to the present?
Household Real Estate Assets: $22.7 trillion to $16.5 trillion: -$6.2 trillion
Corporate Equities: $9.6 trillion to $7.8 trillion: -$1.8 trillion
Mortgage debt: $10.53 trillion to $10.12 trillion: -$ .41 trillion
Household/non-profit Net Worth: $64.2 trillion to $54.9 trillion: -$9.3 trillion
And this is after a tremendous run-up in both bonds and stocks since early 2009. Add in whatever estimates of commercial real estate losses you reckon are semi-accurate and other impaired enterprise assets currently valued at "historical cost," i.e. marked to fantasy, and you get a number well north of $12 trillion even at conservative estimates.
The Fed has fought off this mass devaluation of assets by expanding its balance sheet by $2 trillion. First it sought to stem the collapse of the housing market by buying $1.2 trillion in impaired mortgage backed securities (taking garbage off the banks’ balance sheets) and now it is trying to suppress interest rates by buying $1 trillion in Treasury bonds (recall that QE1 already loaded the boat with T-Bills, so QE2 is simply adding another $600 billion to an already heavy cargo.)
In both cases the Fed’s campaigns are mere rear-guard actions: housing continues to slip, and the tides of higher yields and rates have started rising despite the Fed’s…
This map from the Notorious B.I.G. should give you a pretty good idea of the shape of earnings season, we’re about two weeks away from the heart of it…
In response to readers’ requests, I disclose my own amateur’s Investment Strategy for Q1 2011: cash is king, and the U.S. dollar looks good simply because almost everyone expects it to collapse.
Despite my oft-avowed amateur-market-observer status, readers often ask me for advice or opinions on where to put their capital. This is not advice (please read the HUGE GIANT BIG FAT DISCLAIMER below), it is a disclosure of my own personal opinion, what we might call "one investment strategy of many possible investment strategies" for the first quarter of 2011: cash, baby, cash all the way.
Why am I in cash? Because I don’t trust the parallel rallies, and I am extremely skeptical of the various "stories" which are driving the rallies. Why am I skeptical? Because everybody and their sister has bought into the stories, and a one-sided trade is rarely the winning one.
Yes, it’s my contrarian nature: when everyone is a believer in a "story" that is too good to be true, then I become skeptical. This often gets me in trouble. When everyone was buying GM at $50, I was shorting it. When everyone was buying Fannie Mae at $60, I was shorting it (via puts). Both GM and FNM were obviously, painfully insolvent, but it took practically forever for reality to intrude on the fantasy/narrative that each firm was a "solid blue chip" investment with numerous analyst recommendations. In the meantime, I lost money treading water for quarter after quarter.
So even though the market is clearly top-heavy, the short-side trade may yet be ground down by the Fed’s prop-job and the Wall Street/Central State partnership’s desperate desire to use a rising stock market as a propaganda proxy for the "recovery."
(Hey, just borrow and squander roughly 13% of GDP, year after year after year (roughly 45% of the entire Federal budget), and you might stimulate a modest "recovery," too.)
So let’s examine each of the "stories" driving the rallies.
1. The global recovery is solid, and Central State stimulus and quantitative easing will keep growth rising and interest rates low. This narrative drives capital into "risk assets," i.e. stock markets, commodities, FX carry trades, Chinese real estate, junk bonds, etc.
Oh boy is 2011 going to be an exciting year! Some things that I think might happen:
-Volatility is going up across the board. If you have the stomach for the swings that are coming across all markets there is a ton of money to be made; balls and timing are all that are necessary. The markets will create dozens of opportunities to make and lose.
-There will be 50 days with a swing in the S&P greater than 1%. There will be 10 days where gold swings $50. There will be two days with a drop greater than 100 bucks. Most of the big moves will be down moves. Bonds will not be spared the volatility.
-Gold will be higher a year from now but off its peak. At some time in the fall, gold will be near 1,800 and the New York Times will do a front-page story that gold is on its way to 2,000. That will be the high point of the year.
-Copper will continue to rise. This metal will benefit as the poor man’s gold. Why buy an ounce of something for $1,600 when you can have a whole pound of something else for only $5? The logic is compelling only because there is no logic. Increasingly, it will become understood that money does not hold value. Copper will do a better job of storing value then a Treasury Bond.
-The US bond market is in for a heck of a year. The 30-year will trade at BOTH 3% and 5%. Higher rates will come early in the year, then the deflation trade will come back into vogue.
-Spain will be the next sovereign debtor that falls prey to the market. This will happen before the end of the 1st Q. The package to bail them out will exceed $500b. This will exhaust the EU resources. There will be very high expectations that contagion will then move to Italy. That will not happen in 2011 (2012?) The European Central Bank will step up to the table (finally) and support the market for Italy. Sometime between March and June Italian bonds will be a great buy.
-The IMF will contribute $125b to the Spanish bailout. The US portion
William Black of UMKC believes the Euro could unravel in the coming 3-4 years as the political tension continues to increase and ultimately creates a divide between the core and periphery. Black says the economies on the periphery are likely to remain very weak and will lead to civil unrest and political overhaul. In the end the strains will be too much for the region to overcome.
Black also discusses the imbalances in China and why the Chinese are likely to experience their own crisis in the coming years. (Video here.)
There are few indicators more prescient than the yield curve. Over the years the curve has successfully predicted all but two post WW2 recessions. In the last 40 years it is 7 for 7 in predicting recessions. A negative yield curve is generally consistent with a Federal Reserve that is attempting to cool the economy. Clearly, they have a tendency to overshoot.
The current curve, however, is quite steep and tends to be consistent with a Federal Reserve that is attempting to stimulate the economy (something they also have a tendency of overshooting). Based on past readings the Cleveland Fed says the current environment is consistent with 1% growth in real GDP:
“Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.0 percent rate over the next year, the same projection as in October and September. Although the time horizons do not match exactly, this comes in on the more pessimistic side of other forecasts, although, like them, it does show moderate growth for the year.”
But meager growth is better than no growth. At current levels the probability of recession is virtually 0%. Unfortunately, low growth means this is going to continue feeling like a recession for a large portion of the country. And in a balance sheet recession the usual Fed toolbox of altering interest rates is unlikely to have the usual stimulative impact.
Sabres were rattling on the Korean Penninsula today while Europe’s troubles percolated on the back burner and U.S. markets meandered in lighter than average pre-Christmas volume.
South Korea conducted its drills in spite of dire North Korean warnings but the ripples of the conflict spread across the region as the Shanghai Composite (SSEC) dropped -1.4%, bringing its decline from early November perilously close to the -10% marker for an official “correction.”
On the other side of the world, Europe continued struggling with its debt problems as Moody’s downgraded Anglo Irish Bank to junk status and Portugal and Greece continue attracting the negative attention of the ratings agencies. In France, the cost of insuring debt rose to record highs while the Euro declined over concerns of the ongoing banking stress in the Union.
At home, all was quiet on the Western Front as the dollar (UUP) gained, the long bond(TLT) declined and the Dow (DIA) slipped into the red while the S&P 500 (SPY) remaisn near two year highs.
On the technical side of market analysis, we remain in a sideways consolidation, unable to break higher while finding solid support just below current levels. Momentum continues to wane and the action in China could have bearish implications as the Shanghai Composite is being seen by more and more analysts as a leading indicator as that country’s global economic clout continues to grow.
At Wall Street Sector Selector, we remain in the “Yellow Flag” mode, expecting choppy to lower prices ahead.
Disclosure: Wall Street Sector Selector trades a wide variety of widely traded exchange traded funds and positions can change at any time.
Paul Volcker is worried about the future of the dollar and for good reason. The Fed has initiated a program (Quantitative Easing) that presages an end to Bretton Woods 2 and replaces it with different system altogether. Naturally, that’s made trading partners pretty nervous. Despite the unfairness of the present system--where export-dependent countries recycle capital to US markets to sustain demand—most nations would rather stick with the "devil they know", then venture into the unknown. But US allies weren’t consulted on the matter. The Fed unilaterally decided that the only way to fight deflation and high unemployment in the US, was by weakening the dollar and making US exports more competitive. Hence QE2.
But that means that the US will be battling for the same export market as everyone else, which will inevitably shrink global demand for goods and services. This is a major change in the Fed’s policy and there’s a good chance it will backfire. Here’s the deal: If US markets no longer provide sufficient demand for foreign exports, then there will be less incentive to trade in dollars. Thus, QE poses a real threat to the dollar’s position as the world’s reserve currency.
Here’s what Volcker said: “The growing sense around much of the world is that we have lost both relative economic strength and more important, we have lost a coherent successful governing model to be emulated by the rest of the world. Instead, we’re faced with broken financial markets, underperformance of our economy and a fractious political climate…..The question is whether the exceptional role of the dollar can be maintained."
This is a good summary of the problems facing the dollar. Notice that Volcker did not invoke the doomsday scenario that one hears so often on the Internet, that China, which has more than $1 trillion in US Treasuries and dollar-backed assets, will one day pull the plug on the USA and send the dollar plunging. While that’s technically possible, it’s not going to happen. China has no intention of crashing the dollar and thrusting its own economy into a long-term slump. In fact, China has…
Here’s the REAL DEAL NO BS Situation with Europe (Warning What Follows is EXTREMELY BAD).
The media is rife with misrepresentations and analysis of the EU. Here’s the real deal.
The ECB is tapped out. Having provided over €1 trillion in funding via LTRO 1 and LTRO 2, taking on over €700 billion in PIIGS debt putting its own solvency at risk, it simply cannot launch another LTRO scheme for th...
"It is no exaggeration to say that since the 1980s, much of the global financial sector has become criminalised, creating an industry culture that tolerates or even encourages systematic fraud. The behaviour that caused the mortgage bubble and financial crisis of 2008 was a natural outcome and continuation of this pattern, rather than some kind of economic accident...And yet none of this conduct has been punished in any significant way."
~ Charles Ferguson, Inside Job
"I know that my retirement will make no difference in its [my newspaper's] ca...
The S&P 500 got off to weak start and, after retracing a modest morning rally, spent most of the day in the shallow red with an intraday low of 0.63%. But in the last seven minutes of trading, the index recovered enough to a make a small gain of 0.14%. This is the fourth advance, the first was Monday's 1.60 surge, but the last three have ranged from 0.05% to 0.17% with today's close near the high of the miserly three-day series.
The index is now up 5.02% for 2012, which is 6.93% off the interim closing high.
From an intermediate perspective, the S&P 500 is 95.2% above the March 2009 closing low and 15.6% below the nominal all-time high of October 2007.
Below are two charts of the index, with and without the 50 and 200-day moving averages.
TIF - Tiffany & Co., Inc. – A surprise earnings miss and a reduced full-year profit and sales forecast from luxury jewelry retailer, Tiffany & Co., took some of the luster out of its shares today, with the stock trading down 8.5% at $56.55 as of 11:50 a.m. in New York. Options activity on Tiffany this morning suggests mixed sentiment on the st...
RealNetworks, Inc. (NASDAQ: RNWK) today announced that it has reached an agreement with the Washington State Attorney General over discontinued e-commerce practices. In accordance with the settlement agreement, RealNetworks has committed to:
Discontinuing the use of pre-checked boxes for purchases of RealNetworks subscription products; Spelling out more clearly the material terms of RealNetworks product offerings; Offering online cancellation of subscription offerings; Enhancing RealNetworks customer support guidelines regarding cancellation. Statement from Thomas Nielsen, President & CEO of RealNetworks:
"About two years ago, the Washington State Attorney General's Office contacted us regarding concerns they had with some of our e-commerce practices.
To learn more, sign up for David's free newsletter and receive the free report from All About Trends - "How To Outperform 90% Of Wall Street With Just $500 A Week." Tell David PSW sent you. - Ilene...
First we'll go to the technicals. Back in mid April I had opined a 'bear flag' formation was being created. [Apr 17, 2012: Potential Bear Flag Forming] But the market being the difficult beast it is, head faked everyone and rather than a break down from said flag it first went UP and nearly touched yearly highs. This caused everyone to think the bear flag had failed…. only to lead to a horrid May in the market. Generally a bear flag will resolve relatively quickly but the longer...
Despite the fact that U.S. equities are well-positioned and well-supported to go up, once again it is the headlines out of Europe—especially Greece—that are scaring off investors. Some are saying that it is now likely (and even desirable) that Greece will default on all its sovereign debt, withdraw from the euro, and severely devalue its domestic currency (Drachma?). This will allow them to operate a balanced budget while pumping cash into growth initiatives, rather than suffer the ravages of Germany-mandated austerity.
Some say, so what? Greece makes up only about 2% of the Eurozone’s overall economy. Nevertheless, you might say that t...
Markets died and then rallied to flat again as European leaders “prepared contingencies” for a possible Grexit
Markets died hard and fast earlier today as major indexes registered as much as 1.5% of losses after news that Euro zone officials were unofficially “preparing contingencies” for a Greek exit from the Euro. Unofficial statements were not enough to keep markets down however, as major indexes rallied back to flat levels by the end of the day.
So the world continues to wait on Europe, as the SPDR S&P 500 ETF (NYSEACA:SPY) gained .05%, the SPDR Dow Jones Industrial Average ETF (NYSEARCA:...
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This post is for all our live virtual trade ideas and daily comments. Please click on "comments" below to follow our live discussion. All of our current trades are listed in the spreadsheet below, with entry price (1/2 in and All in), and exit prices (1/3 out, 2/3 out, and All out).
We also indicate our stop, which is most of the time the "5 day moving average". All trades, unless indicated, are front-month ATM options.
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In this article, please revisit an article written two years ago titled, "The Calm Before the Storm." This article focused on the patent cliff that was looming in the pharmaceutical industry, that was later picked up by the New York Times and several other bloggers! Subsequent articles were written about big pharma company's revenue streams, and the pros and cons of of their later stage pipelines. Other articles have also attempted to identify smaller biotechs with the potential to reap big reward...
My last weekend update is dated from January 30 so after a long hiatus, here is an update of our virtual portfolio. Since the last update, we have closed the AA Money portfolio due to a lack of enthusiasm (and activity) and I have stopped tracking the FAS strangle as the low VIX makes it hard to get rewarded for the risk! But we have added a small $5KP virtual portfolio which does not use any margin.
FAS Money
We have had to recover from a big move up by FAS and a low VIX which keeps option prices low. But the portfolio has gaine about 10% since the last update.
Last update P&L - $5499.00
IWM Money
Not a lot of activity in this portfolio where the main focus is on the large IWM BCS. But the portfolio has grown over 20% since the last update.
Last update P&L - $1998.00
$5KP Portfolio
This is the virtual portfolio that replaced the AA Money portfolio. It does not use margin and we will keep holdings under $5K.
AAPL $50K P...
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Conventional wisdom is that the Fed wants the U.S. dollar lower, so it must drop. But the dollar seems to be lacking proper obedience to the Fed’s grand commands.
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Paul Volcker is worried about the future of the dollar and for good reason. The Fed has initiated a program (Quantitative Easing) that presages an end to Bretton Woods 2 and replaces it with different system altogether. Naturally, that’s made trading partners pretty nervous. Despite the unfairness of the present system--where export-dependent countries recycle capital to US markets to sustain demand—most nations would rather stick with the "devil they know", then venture into the unknown. But US allies weren’t consulted on the matter. The Fed unilaterally decided that the only way to fight deflation and high unemployment in the US, was by weakening the dollar and making US exports more competitive. Hence QE2.
German
Spanish
French
Italian
Portuguese
Japanese
Korean
Russian
Chinese
Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
(