Bidirectional U.S. Stocks, Spanish Bonds and the ECB

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 new mantra for the U.S. markets appears to be "if it's Tuesday, it must be bidirectional market day".  Once again the Dow went up strongly, while the Nasdaq was trading in negative territory. Events in Spain seem to be connected with this unusual and bearish market action.

At one point during the trading day, the Dow Industrials were up 123 points. Nasdaq on the other hand was down by 20 points at its worse. The S&P was caught in the middle. The same strange behavior took place last week. Spanish bonds and the euro rallied both times and money pumping from the ECB (with perhaps some dollar swap activity from the Fed) explains these seemingly unrelated events.

The yield on the 10-year Spanish government bonds exceeded the dangerous 6% level last week and suddenly heavy buying came in and drove yields back down to around the 5.86% level. Today, the yield on the Spanish 10-year reached 6.049% and suddenly buying came in and drove the yields down to 5.86%. The Euro rallied both times. As measured by the ETF FXE, it rose to 131.19 today. There is no reason investors should be buying either one. Spain is at risk of developing a full-blown debt crisis just like Greece and the Dutch government fell and the French election went badly over the weekend.

Money pumping causes markets to rally. It is directly being aimed at the Spanish bond market and the euro however. It spills over into other markets though. Since the Dow consists only of very liquid big cap stocks it will be impacted the easiest. The rest of the U.S. market has serious problems though. Tech stocks have led it up and now they are struggling. The ECB money pumping isn't enough to counteract the forces driving them down.

Money pumping can't go on forever and every time there has been a pause, stock prices have suffered. Problems in Spain are merely part of a much larger ongoing debt crisis in Europe. The balance sheet for the ECB has already been increased by much more than has been the case in the U.S. and the chart line is going straight up. A pause will eventually take place and when it does stocks will weaken globally -- and this includes the Dow.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

The Twisted Logic of the Fed's New Policy Move

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.

At the end of its September two-day meeting, the Federal Reserve announced it latest attempt to revive  the U.S. economy -- Operation Twist. This Fed launched its first program to stimulate the economy four years ago at its September 2007 meeting and the economy is still in the doldrums. While the Fed hasn't yet begun QE III, the Bank of England looks like it is about to return to this form of money printing.

The Operation Twist announcement didn't come as a surprise to the markets. It was obviously leaked to the press days ago and articles about it were common in mainstream news outlets earlier this week.  The name comes from a dance popularized by Chubby Checker in the early 1960s -- the last time the Fed engaged in a similar policy move. The rotund Mr. Checker is an appropriate symbol for the bloated U.S. national debt,  the bloated U.S. budget deficit and the bloated Federal Reserve balance sheet, which has been swollen by huge amounts of money printing. The Twist itself involves expending lots of energy going back and forth, but getting nowhere -- the very picture of the 2011 Fed.

In the current Operation Twist, the Fed is planning on selling $400 billion of short-term debt and buying treasuries with 6 to 30 year maturities. The idea is to drive down longer-term interest rates in order to stimulate the economy. Many mortgage and credit card interest rates are set based on the yield of the 10-year U.S. government bond. The 10-year interest rate is already at a record low after falling below the low of 1.95% established 70 years ago in 1941. Real U.S. interest rates (those adjusted for inflation) have been negative for some time. Thirty-year and 15-year fixed mortgage  were already at their lowest historical rates earlier this month. There is no evidence that interest rates are holding back consumers from making purchases. Lack of jobs and income are the problem and the Fed's latest move isn't likely to improve either.

Across the pond, the Bank of England looks like it will start another round of QE (quantitative easing) later this fall. The BOE already printed 200 billion British pounds in 2009 and 2010 for its initial program. This is small compared to the $2 trillion increase in the U.S. Fed balance sheet.  It is universally acknowledged that the UK economy is weakening and the BOE is willing to take this risky inflationary approach even though British consumer prices have increased by 4.5% in the last year. Real interest rates are negative there as well.

The Fed is probably anxious to start its next round of QE as well, but political pressure is holding it back.  Republican leaders in congress sent a letter to Ben Bernanke to "resist further extraordinary interventions in the U.S. economy". Apparently, they are worried that money printing and negative real interest rates will lead to serious inflation -- just as they always have throughout history. The anemic Operation Twist certainly isn't in the category of extraordinary. If anything, it's sub-ordinary. Apparently the stock market thought so with the Dow Industrials falling 284 points or 2.5%, the S&P 500 down 35 points or 2.9% and Nasdaq closing 52 points or 2.0% lower.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.