Will Fed Meeting Be a Turning Point for Stocks?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The Fed has its August meeting today and stocks sold off in the morning despite media attempts to put a positive spin on the outcome. The latest phase of the rally that started in early July took place after Ben Bernanke admitted to congress that the U.S. economy was troubled. Stocks shouldn't have rallied on this news, but they did.

The stock market is supposed to be a leading indicator of the economy and should react to changes approximately six months in advance. This only works in a free market however. The more the authorities are fiddling with the financial system behind the scenes, the less stock prices will act as an early warning system. The bull market peaked in October 2007 for instance, but a recession began only two months later.

This time, U.S. stocks peaked on April 26th. May and June were bad months for the market. While stocks have not gotten back to their highs, they have been rallying since the beginning of July, when problems in the eurozone calmed down (thanks to a commitment of an almost trillion dollar bailout for the currency). The rally entered a second phase after Ben Bernanke testified before congress about the bleak prospects for the U.S. economy. The market sold off that day, but then mounted a rally on the bad news, which was supported by numerous economic reports showing the economy was turning down.

Why would anyone buy stocks when the economy was facing a possible recession? While this behavior doesn't make sense, a better question is: Who was buying stocks after this news came out? Based on the trading volume, not many market participants were entusiastic. With the exception of a few days of selling, the entire rally since early July has taken place on below average volume - a technical negative.

The 50-day moving average for volume has also been declining as well since early July. This is part of a greater trend that started in March 2009, when the bigger rally began. Volume peaked on the Dow Industrials when the market hit bottom and back then there were days when over 600 million shares were traded. More than a year later, a day when over 200 million shares traded would be considered good volume.

The market seems to be rallying on the hopes of Fed easing. With fed funds rates at zero, the traditional forms of easing are obviously no longer available. The Fed would have to engage in quantitative easing (a form of money printing), which would involve the purchase of treasury bonds and this would lower their interest rates. According to mainstream media reports, consumers and businesses would supposedly borrow and spend more money as a result. This is wishful thinking at best.

Even though the Fed has lowered interest rates to nothing and has effectively provided the big banks with free money, this has not been passed on to the consumer. Interest rates on credit cards were 14.55% in 2005 and in May 2010 they were 14.48% (see: http://www.federalreserve.gov/releases/g19/Current). Banks have not lowered their interest rates in response to the Fed's recent actions, but have pocketed the difference. This has been the major reason that they have been reporting such huge profits. It is naive to think that they are going to change their behavior.

Disconnects between markets and the underlying economy have happened many times. They don't last forever however. The two eventually have to meet. Either the economy improves to justify market pricing or market prices decline to meet the economy. The tech bubble at the end of the 1990s and the more recent real estate bubble were good excellent examples of this. Pricing that is too high will come back down to earth and the correction can last for years. Government attempts to try to hold up the market, as has happened with real estate prices, don't prevent the inevitable, they merely delay it. The current disconnect with stock prices and the economy will also self-correct and may do so suddenly. The only question is when it will occur.


Disclosure: No Positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

IMF Selling Gold to Dampen Rally

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Like clockwork, the IMF gold sale has reared its ugly head again as has occurred during a number of previous gold rallies since 2007. This time the IMF is actually selling the gold. It only threatened to do so the previous six times or so. It says it is looking for a central bank buyer. For some time, rumors have claimed that the central bank buyer will be China and these resurfaced again last week before the IMF announcement. China is playing coy however and says it wants the gold at a discount to the current $1000 price. Other possible buyers include Russia, the Gulf Oil States, Japan and India, all of whom have relatively low gold holdings and too many U.S. dollars.

The IMF is selling one-eight of its claimed gold holdings (the IMF is not audited, nor will it answer questions about whether its gold is held in individual contributing countries and being double counted as part of their gold reserves) or 403 metric tons. While this sounds like a lot, its is less than $13 billion at current prices. China alone has approximately 2000 billion dollars in reserves held in foreign currencies, almost half of which are in U.S. dollars. China's current gold holdings are 1054 metric tons, up from 400 metric tons in 2003. So it has less than $33 billion in gold versus almost 1000 billion in U.S. dollars. It is thought that the gold sale is being used as a way to let China get rid of some its U.S. dollars without dumping them on the open market.

There is also a two-day Fed meeting this week on Tuesday and Wednesday and a G20 meeting this Thursday. Since the Credit Crisis began two years ago, the U.S. dollar has rallied from just before the Fed meeting to just after (gold falls in response). This has happened no matter how much the Fed has announced it is debasing the currency. No one in their right mind would buy dollars under such circumstances, which leads to the obvious conclusion that global monetary authorities are acting in concert at these times to hold the dollar up. Expect this again this week. As mentioned in this blog on Friday, the dollar is too extended from its 50-day moving average and will try to rally back to that point.

Gold has traded as low as $996 this morning and the trade-weight dollar is at 76.97 at the moment (still below its 78.33 break down level). Expect general weakness in gold and the other precious metals and strength in the dollar until Thursday. A reversal for both after that is highly likely. Keep an eye out for buying opportunities, particularly in the mining stocks.

NEXT: Manipulation Fails, Gold Rallies Back

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.