Comstock Partners, Inc.April 28, 2016
The Ending of QE
The ending of QE-3 formed a stock market top formation that presents a very strong technical resistance that will be DIFFICULT to overcome!!
The stock market swings (based on the S&P 500) have been extremely volatile since the end of QE-3 in December of 2014. In fact, ever since QE-1 ended in 2010, QE 2 ended in 2011, Operation Twist ended in 2012, the market rose slightly and then fell sharply soon afterwards. Now that the Fed ended QE-3 and have started raising rates the stock market has been very volatile and we suspect that the swings will wind up breaking down through the lows of 1812 and 1810 that took place early this year. (First Attachment—Ending QE and the Markets Reaction).
(Second Attachment—S&P 500 – Ten Market Peaks) These are the same type of stock market swings that remind us of all the other endings of QE phases. This time the S&P 500 rose into 2015 to make a record high in May of 2015 at 2135 (rounding out for simplicity). The market has not exceeded that level since then, even though it has come close numerous times over the past year. In fact, in 2015 the market rose to 2120 in February, 2115 in March, 2126 in April, 2135 in May, 2130 in June, 2133 in July, 2117 in October, 2115 in November, and 2002 in December. Also there has been a 2020 peak this April--that's 10 peaks over the past 15 months. That's a lot of peaks to break through, especially when the Fed is trying to tighten and you can see from the first attachment that the market breaks down whenever they just stop loose monetary policy.
The lows made last year were 1867 in August and 1872 in September. The second low in September was interrupted by a strong move back to 2021 also in September. The lows that were made this year (2016) were 1812 in January and 1810 in February. These two lows were also interrupted by a sharp move up to 1947 also in February and the low of 1810 was called the Jamie Dimon low on February 11th. That was because of Dimon’s purchase of his company stock, JP Morgan, that same day. The move up since the Feb 11th low has been quite impressive by rising to 2120 in April and is still pretty close to that peak now (2076 ).
The bulls have been watching the stock market rise to new highs without many corrections over the past seven years. In fact, the market has not had a significant decline since this bull market started in March of 2009. Clearly, this seven year bull market in the U.S. was due to the Fed pumping in enormous amounts of money into the financial system. Such monetary policy in the U.S. (and also worldwide) distorted the way money is typically distributed and inflated the price of stocks, bonds and anything else that trades, including commercial real estate.
This ludicrous monetary stimulation policy was not confined to the U.S. The rest of the world copied the U.S. as well as Japan, who has been doing a similar monetary policy for the past 27 years without much success. The Japanese stock market hasn’t come close to the 39,000 reached by the Nikkei in late 1989. It is now trading around 16,700. The Bank of Japan (BOJ) has been even more outrageous than our Fed since they have been buying everything imaginable to keep their economy afloat. Their present ownership of common stock ETF’s is mind boggling! Their Japanese government and the (BOJ) own over 10% of over 200 stocks of their most widely traded index, the Nikkei 225. The BOJ has just recently decided to use negative interest rates to stimulate their economy and weaken the Yen. The “unintentional consequences” hit them as the stock market fell and the Yen rose. Negative interest rates are also being used by the ECB in order to grow the European economy. As is the case with Japan, we believe their efforts will fail miserably. In China, though rates are not negative, the Public Bank of China (PBOC) has “doubled down” and added huge amounts of renminbi debt over the past seven years. In fact the government debt has grown to 243% of GDP over the last 7 years.
We have been extremely critical of all the Central Banks that have been guessing on the policies they use while hoping everything will work out without even considering the “unintended consequences” that may occur. Just by studying the first attachment chart you can see what a difficult time the Fed will have in reversing their extremely loose monetary policy. Every time they have tried to reverse it, the stock market drops, and now they are scared to death of trying to raise rates again after the decline the market took in January, not long after the first rate hike in December.
In the U.S. alone the Fed’s balance sheet grew from just over $500 bn in 2009 to $4.5 tn presently. This drove interest rates much lower and essentially forced investors (who wanted to get an adequate return on their money) into risky stock investments, risky bond investments and even commercial real estate. The Fed claimed they were saving the U.S. from going through another “Great Depression”. They could be correct in that assessment since this crisis is still called the “Great Recession”. What the Fed didn’t tell anyone about is the fact that they all have been complicit in this crisis.Comstock was one of the first institutions that came out being very, very critical of the Fed since it was so clear to us that what took place to provoke the "Great Recession" was caused by Alan Greenspan. He got it right at first during the dot com era when he stated in 1996 that the worldwide markets reflected "irrational exuberance" but then changed his mind when the stock market continued up and he thought maybe this time it would be different!! When the market finally broke in 2000 he should have realized that the U.S. market was the most overvalued market in its entire history. He didn't and instead in 2003 he lowered interest rates to 1% and kept them there for a year. This started the worst financial crisis and depression since the "Great Depression". As our readers are aware we have comment after comment on our website, Comstockfunds.com , about the Fed and central banks. In fact, we have a “special report” titled “THE CENTRAL BANK BUBBLE”.
We firmly believe that if the Fed decides to raise rates at this time, while most other central banks continue their stimulus plans, the results could be disastrous. If the Fed does move this year (which is a high probability), it will drive interest rates higher, the U.S. dollar higher, and the stock market lower. If the Fed makes more than one rate hike this year, it will just drive the rates and U.S. dollar even higher and the stock market much lower. However, if we are correct and the stock market drops sharply after the first hike, we suspect they will make the first hike the last hike for the year and maybe forever. In fact, if they really fear the market as much as we think they do, they could even go back to QE-4. But, in our opinion, if they do the investors will not continue to be the Fed’s flunkies any longer and the market will still fall sharply knowing there is no way out of this mess except to tighten.
In our opinion, once the Fed makes the next rate hike the market will not have a chance of breaking through the 10 peaks outlined in the second attachment. Those are all peak prices that should hold with such a weak economic recovery (0.5% GDP for the first quarter), earnings and revenue recessions, and a stock market with very high valuations (22 times earnings if GAAP earnings are used).