Market Analysis

Animal Farm

Animal Farm“In a way, the world-view of the party imposed itself most successfully on people incapable of understanding it. They could be made to accept the most flagrant violation, because they never fully grasped the enormity of what was demanded of them, and were not sufficiently interested in public events to notice what was happening. By lack of understanding they remained sane. They simply swallowed everything and what they swallowed did them no harm because it left no residue behind, just as a grain of corn will pass undigested through the body of a bird.”
― George Orwell, Animal Farm

Yellen InflationIn a performance worthy of inclusion in a George Orwell book Janet Yellen made a mockery of the concept of credibility this week. If there were ever any doubts as to what Janet Yellen was all about those doubts were surely laid to rest. It was clear from the questions Yellen received from the journalists present that the crowd was stunned by what they heard. No inflation evident she says, calling the previous day’s hot CPI number “noise” despite climbing oil prices, record prices in key food items and a barrage of increasing costs seen by pretty much everyone that doesn’t choose to be blind to it. It is no accident that the BOE has been very vocal about warning about rate increases coming sooner than expected. It is no coincidence that Canada’s core CPI came in hot as well. None of this bothers Janet. She sees nothing of the sort she claims.

CPIShe also doesn’t see any excess in leverage or debt or bubbles despite evidence to the contrary all around us with record debt levels and expansion of credit oozing through all the data pipes. No matter. She doesn’t see any of it. She’s unbothered and unconcerned.

Valuations are fine she says, nothing to be concerned about. Right. Sure, whatever Janet. Don’t let the facts bother you.

She may not see any of these things, but here’s what she did see in March: 2.8%-3.0% GDP growth. Wrong. This week, just 3 months later she took the forecast down by 25% to 2.1%-2.3%. What’s a 25% miss among friends? And is it really 25%? Fact is in 2012 the Fed projected 4% for 2014. A 45% miss and growing. The Fed missed by half. And so the goal post keeps being moved.

The plain reality is the FOMC continues to miss the boat on forecasts and Janet Yellen is the leading dove of the pack either willfully ignorant of the facts or purposefully misleading or just plain incompetent.

Janet Yellen continues to be the perfect technocrat as she has always been in her long career towing the line and never dissenting once from the consensus. Not the first choice to be Fed Chair she has shown a frighteningly lack of capacity to judge any sort of excess. In her own words about the housing bubble she sounded as convinced then as she does now:

If the bubble were to deflate on its own, would the effect on the economy be exceedingly large? ….My answer: “no”……In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock.

yoBrilliant. I’m clearly with the minority here as I see the notion of a Fed chair displaying such ignorance to reality as a negative. Janet Yellen had several options this week as the data clearly gave her an excuse to start rightsizing the market’s expectations toward a return to normalcy. An acceleration in the taper or even just a hint that rate rises may come sooner, anything that would slowly diminish the central banking excess that has flooded global markets with unprecedented cash that has nowhere to go but to chase risk wherever it can find it.

Janet Yellen’s response to all these concerns was a clear: “Yo”.

And so the markets celebrate the words and not the ultimate meaning and the animals continue to adulate Napoleon:

“No one believes more firmly than Comrade Napoleon that all animals are equal. He would be only too happy to let you make your decisions for yourselves. But sometimes you might make the wrong decisions, comrades, and then where should we be?”
― George Orwell, Animal Farm

What Janet Yellen and cohorts continue to believe in is the illusion that somehow all this liquidity will magically produce meaningful employment and growth as part of a cyclical problem that only they can help solve by throwing money and debt at the problem. The reality yet is one of large structural issues that are evolving as a result of large technological advances that will continue to incentivize employers to reduce their work forces and not expand them and the signs are visible everywhere. In combination with employers prioritizing buybacks over CAPEX the long term structural issues will still have to be faced.

It is for these structural reasons that QE1 did not produce the desired long term results, neither did QE2, nor QE infinity, nor did ZIRP and nor will NIRP courtesy of the ECB. As is evident markets continue to lack any trigger to produce any real selling in this environment, not military hot spots, divergences, economic misses and so the historical deviations continue to widen making the eventual reconnect ever more painful.

I’ve been trading long and short successfully all year, but admittedly scaling into a swing position has been a bit challenging the past few weeks. Day trades and scalps have been keeping things in check, but frankly I don’t mind so much about getting the last 2% wrong, my focus remains on the next 8%-15%. And while Yellen is keen to assure people that donkeys live a long time I’m pretty certain that they still do die eventually:

“Donkeys live a long time. None of you has ever seen a dead donkey.”
― George Orwell, Animal Farm

To the charts then:

Up 6 days in a row in true “buy everything” mentality markets actually got 75% of their gains from Yellen’s pablum. Prior to that it was a rip the mornings, sell the rest and barely nudge upwards a few handles in advance of Yellen’s speech. There is little doubt that the market’s reaction would have been different if she had shown just an inch of vision toward higher rates:

SPX week

But so it is. Yet note the latest bout of new highs was not uniformly celebrated as new highs show a decisive divergence:

New Highs

The bears’ last chance also suffered in the fall-out as the heads and shoulders pattern in the $RUT got taken out (as all other H&S patterns have in the past), yet the structure remains decisively similar to the 2011 case:

IWM weekly

The negative RSI divergence is not unique to the Russell but rather is a common theme across all the major indices and time frames:

QQQ weekly

NDX monthly

INDU monthly

My view remains a variant one here, but as the dislocations widen without any sort of breather I find myself more comfortable in the correction camp:


Post June OPEX expiration has been negative biased and while seasonality seems to be out of the door as nothing matters any longer I’m looking for at least a retest of the 1,900 area before too long. And if that’s all bears get so be it, but let them enjoy at least a momentary glimpse of freedom 😉


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