Comstock Partners, Inc.May 05, 2011
The Tipping Point Has Arrived
As we pointed out from the get-go Bernanke's QE2 policy was a gamble from its inception, and its consequences are now coming to the fore with the collapse of the commodities bubble. Throughout financial history parabolic market moves have inevitably collapsed, and there is no reason to think that this one will be an exception. Although there will undoubtedly be some attempts to buy the dips, once bubbles burst they don't come back for a very long time. The chances are therefore high that this is a real tipping point for both stocks and commodities with a major downturn more likely than a mere correction.
The initiation of QE2 was a desperate move to begin with. QE1 most likely saved the world from a financial collapse and induced the start of a sub-par recovery along with a strong rally in equities. However, when QE1 ended in the spring of 2010, economic growth began to lag once again and the stock market dropped about 17%. With further stimulation from fiscal policy politically off the table, it was left to the Fed to do the heavy lifting even though the fed funds rate was already near zero, and obviously could not be reduced any further. The intention to start QE2 was announced late in August 2010, and implemented in November.
The original intention of QE2 was for the Fed to buy $600 billion of Treasuries by June 30, 2011 in order to lower medium to long-term rates, help increase home buying, weaken the dollar to aid exports and jump-start stock prices. The hope was that the resulting increase in assets including stocks and houses would spread to the real economy. Since this type of monetary easing had never been tried before on such a grand scale, it was an experiment fraught with danger and the potential of serious side effects that we pointed out at the time.
Although QE2 has helped some segments of the economy and jump-started the stock market, it has had important negative consequences as well. Since that time commodity prices have soared while long-term interest rates have climbed and the dollar has weakened. The rise in food and energy prices has caused top-line inflation to increase faster than wages, resulting in declining real income. In addition it has resulted in higher inflation in emerging nation as well as the EU, causing them to raise interest rates at the risk of slowing down global growth. Some nations have also initiated capital controls to prevent too many dollars from flooding their financial system.
Now the bubble (the third in 11 years) is finally in the process of bursting and reversing the market trends that have persisted for the past eight months when the dollar was down and everything else was up. Consumers in the U.S. are being squeezed by stagnant wages, higher commodity prices, continued weakness in housing, and high unemployment that is more than offsetting whatever benefits accrue from a weaker dollar. At the same time emerging nations and the EU are all tightening monetary policy and reducing fiscal stimulus.
Today the markets came as close as they ever do to ringing the proverbial bell that signifies things have changed. Suddenly commodities are collapsing, equities are declining, the dollar is rising and high quality long rates are dropping. In our view this constitutes a new trend that will persist for some time to come.