Comstock Partners, Inc.November 02, 2016
The CB's have to Learn You Can't Go To "Cold Turkey" from "Wild Turkey"
The Central Bankers Continue to Guess on What to do
We have been discussing (in the most critical way possible) the Central Banks all over the world for the past 16 years. In fact, a journalist called us this past January and asked what we thought of the stock market? We responded that we expected the stock market to decline sharply during the year 2016 as the Fed raised rates. The journalist countered that every time the Fed raised rates in the past the stock market still did quite well. So far the journalist has been correct and we have been wrong. We believe this will change again within the next few months since the Fed will be forced to finally reverse the damage done over the past 8 years.
We tried to explain to the journalist that we are presently in a completely different situation than we were in the past, when the stock market rose as the Fed raised rates because the economy was doing well and/or there were inflationary risks. Now we have gone through QE1, QE2, QE3, and “Operation-Twist” where we drove rates down to zero (ZIRP), or close to it for the past 8 years. This time the Fed has grown its balance sheet from about $800 bn. to over $4.5 tn. This enormous amount of money has to be eventually wound down. This injection of money printed by the Fed has not driven us into an inflationary bubble because there is very little “velocity” (the pick-up of transactions). The injection of money does not lead to inflation since the money printed by the government or Fed does not get the public to spend the money and they save it instead. This is called a “liquidity trap”, which is what Japan went through for the past 27 years. The high debt that we have generated, as well as Japan, has caused a deflationary environment, which neither one of us seems able to achieve any type of “escape velocity”.
This time is also different from the past rate hikes since now our Fed is about to raise Fed Funds right into the face of a manufacturing recession (down for over 6 quarters in a row). We also are threatening to raise rates right into the face of virtually every other central bank that is still in the loosening phase of printing more money and lowering interest rates. All this while we are about to tighten by increasing rates and raising the value of the US dollar. And because of the US dollars rise and continued rise as we raise rates, it will be more difficult to compete with our trading partners and lower our exports. Most of our trading partners are participating in a race to the bottom, as they do whatever they can to lower their currency in order to sell more goods and services to the US.
We have given this journalist at least 4 more reasons why we believe the increase in rates will lead to a bear market for US stocks. Right now, we would have to admit it looks like the journalist was right this past January. At first, we looked like geniuses as the US stock market dropped sharply in January. However, we still think we will win the prediction contest with the journalist (but maybe a little later this year or early next year). The reason we haven’t been accurate is because there were no interest rate increases since we essentially made the challenge to whether the US market would rise or fall with the interest rate hike that was expected. Remember, in December of 2015 Stanley Fischer predicted that there would be at least four interest rate hikes in 2016. So far, there were frequent predictions by voting members of the Fed that they would be voting for increases. In fact, at the latest meeting there were 3 dissenters who voted against passing up the increase in rates. We do believe there will be enough votes to raise rates this December, and that is when we will reverse our losing ways with the journalist. This past month 3 Fed officials stated that we should hike the rates because they are worried about already keeping the rates far too low for too long. They were all worried about the risk of financial instability. We will have to see how it works out, and will let you know as we continue to believe we will win the so called “bet” with the journalist as soon as we start tightening, while every other central bank is driving rates lower or even into negative territory. As we stated before, we believe all the central banks are guessing at the new made up remedies, that have never been tried before, and will result in “unintended consequences” that could be disastrous.
Our debt (helped by the central banks), as well as Japan and the rest of the world, will eventually drive us into a global deflationary debacle. We would put the probability of inflating our way out of this mess at about 30 % and continuing to fall into a deflationary global bear market at about 70%. Please keep in mind the debt is not just our national debt of $20 tn. but the total debt of over $100 tn. if you include the promises made by the government of Social Security, Medicare, Medicaid, and the promises of pensions to Federal employees.
Our Fed and other Central Bankers have been propping up financial markets all over the world. But now that there are record outflows of equity mutual funds, all bond funds, and other actively managed funds, there will be nobody (including the Central Banks) remaining to buy the financial assets as the money is going into ETF’s, savings accounts, and under their mattresses. There is no one left to buy as the selling increases and there are record low amounts of insider buying and corporate borrowing to buy shares to increase earnings per share by lowering the number of shares outstanding. This could turn out to be a bear market worse than 2000-2001 and 2007-2008.