The Fed's Conundrum (by Bob K.)
By now we are all painfully aware of the direct and now not so secret support the equity markets are enjoying from the Federal and their Broker Dealer proxies. From their point of view what they are doing makes perfect sense and is moral, in their eyes. Let’s review why they are doing this.
- Bank valuations must be at attractive levels to allow for follow-on Secondary offerings to recapitalize their balance sheets. An additional knock-on effect is the ability for the banks to mark as profits any rise in their portfolios due to equity valuation gains.
- Large Insurance companies also are incredibly undercapitalized, and any rise in the equity market releases strain in future insurance rate increases and requirements to sell more equity, plus they also get to remark their assets.
- The banks are holding a lot of commercial real estate debt and REIT debt, as equities rise they get to refinance or sell equity to buy time, also supporting the banks balance sheets.
- Pension funds, this in my view the new big monster, reports are out this week that show State Public Pension funds are undercapitalized by over 2 Trillion dollars. Only three ways to solve it, collect more, disburse less, and/or have a higher rate of return. Number one is political suicide right now, number two, is a nonstarter as the unions won’t cooperate, thus leaving number three.
- Here is one nobody talks about, Tax receipts. When is the only time in the last 50 years we ran a budget surplus? Yup, during the last stock market bubble. What propelled it? You guessed it, cap gains taxes. When you have a tax regime that is so progressive, you can only generate sufficient tax revenues by letting the wealthy generate capital gains.
OK, you can see from their point of view the upside is a no brainer. But, beside from the sheer illegality and moral aspect of this, how will it help us bears. We have been ramming our heads against support lines, negative divergences, poor fundamentals, etc. But we are up against free and unlimited money, so what do we look for?
In my view, the FED and the political elite only fear three things. Unacceptable increases in food and energy costs, an alternate reserve currency, and/or a loss of control of interest rates.
With 20% of the population un or underemployed, any additional rise in gasoline prices will bring a howl of protest from the people who see that the banks are bailed out, getting bonuses, and the rich having a strong stock market. The cost of energy is being driven by the price of the dollar, and in my view has reached its tipping point. I believe this will knock the carry trade fuel from the market.
Interest rates over 4% will prove to be a strong competitor to the stock and Reit markets, we have now reached this level. Only strong fear of loss in the equity market will scare people into bonds and lower the rates. Our government will sacrifice the stock market on the alter of the bond market.
Thirdly, the FED under no circumstance will allow our reserve currency to be supplanted by commodities based alternatives, without a huge fight. We are seeing some of that exposed through disclosures of the massive short positions in the currency metals by the Primary brokers. Silver is not backing down in price, as gold has done, and gold usually follows silver.
Bottom-line, we are close to the tipping point, I think all future moves will now have other consequences.
I always maintain a long gold position and every time Oil gets to the $80 level I short it. I manage my positions by hedges with options. I am also watching TBT above 50 as a signal that the bond market is in protest. Good trading.
