When the Fed embarked on its mission to rescue the economy in 2009 it did so on the following premise: Save the banks by re-inflating the housing and stock markets via easy money and, as a result, companies would hire and the eventual scarcity of labor would produce wage growth with the end result that the resulting inflation would permit for a tightening cycle to normalize rates.
The problem: After 7 years and trillions of dollars in debt and balance sheet expansion there is no inflation nor is there any wage growth. And the reason for this is a structural one that central banks have been refusing to acknowledge and admit: The massive underlying shift in technology that is radically changing the global labor market. Not for the better, but for the worse.
And this shift has enormous implications for investors, the economy, society at large and the stock market. And these implications have the potential to signal Game Over for this bull market.
Before we get into this let’s briefly address the recent history in the stock market:
For years investing was easy. You just threw money at a market that never stopped going up. And when it occasionally fell, it was because the Federal Reserve had just ended a QE program. But not to worry, the next one was just around the corner. And sure enough every Federal Reserve press release or press conference produced an orgasmic buying feast every time the word “accommodative” was mentioned. Easy money, we have your back, the Bernanke put. You know the gig. Then we had the taper tantrum when Ben Bernanke merely mentioned the possibility of QE ending. Oh, but not to worry, we will stay at ZIRP. Free money for a long time to come and don’t worry we will let you know way in advance when we will raise rates. And even better: QE will be everywhere. In Japan, in Europe. And if things were to get really bad (i.e. the Ebola scare) we will bring QE4 back (Bullard, October 2014). But not to worry any issues are just transitory. Inflation is just around the corner don’t you know?
And for years the narrative worked. Markets went on to make ever new highs, even in 2015 after QE3 ended, spurred on by an unprecedented move of global QE and dozens of interest rate cuts. The ECB launched QE and the DAX even got to over 12K, the Nasdaq went over 5,000 and new highs and the news media and bloggers were giddily writing articles how it was different this time. But there was something odd about these new highs. Most stocks were not participating, in fact, most stocks started correcting while markets made new highs despite this negative divergence. It was a rally of the few, the big cap stocks, while the majority was left behind and we could see it in the charts:
But then something happened. Something symbolic at first. A young woman threw glitter at Mario Draghi in April and the DAX lost 12K and never saw it again. Then there was anxiety about Greece. The math didn’t work, but as we expected they found a way to kick the can. Then China numbers didn’t add up and its growth story began to implode.
In July we outlined the Big Bad Bear Case and pointed toward this structurally weakening $NYSE price chart:
Since then the August flash crash has reconnected price with the moving averages highlighted in the chart:
Price discovery took place in the course of only a couple of days and was stopped by circuit breakers during that flash crash day in August.
From a trading perspective it was a good time to pursue a “buy weakness” strategy as we had been outlining ( i.e. Navigating the next rally), but the next move was in Janet Yellen’s hands. Would she exude confidence and give markets certainty by raising rates finally or would she blink again and extend the uncertainty that markets had been struggling with.
We made our continued “buy weakness” stance very much contingent on this outcome. In “Biding Time Remix” we outlined:
If Janet Yellen doesn’t raise rates and chickens out it’s the same nonsense all over again as it indicates weakness and a worried Fed. So ironically not raising rates may be bearish.
We know the answer now and we promptly flipped bearish into the ramp toward 2020 $SPX as we discussed in Technical Charts on September 17.
So why didn’t the Fed raise rates and why has the reaction been so bearish this time around?
To start with the Fed propagated complete uncertainty again and markets don’t like uncertainty. The “when will they hike game” immediately restarted with predicable results:
Well done Janet, well done. pic.twitter.com/1ef9oLtxAo
— Northy (@NorthmanTrader) September 18, 2015
But this is the side show. The real issue, in my mind, is a global recognition that the next downturn may have already begun which brings us to the real meat of the issue here and one that the Fed is very well aware of, and indeed is reacting to: The destruction of middle class jobs.
In this context note that the most important news flashes this past week or so did not come from Janet Yellen, but rather came in the form of large scale mass layoff announcements:
HP -30,000, Deutsche Bank – 23,000, Johnson Controls -3,000, Qualcomm -1,300
My take is that these large layoffs are just the beginning. And in this new economy of little to no wage earnings power by employees coupled with ongoing technological advancements these trends will continue to erode the structural economic base as all these high wage workers will not be absorbed into other high paying jobs.
Read closely what HP’s CEO Meg Whitman stated justifying the layoffs:
It’s remarkable what’s happening to our services business. As new technologies come in, we’ve got to restructure that labor force to low-cost locations, to much more automation than we have today.
It’s all right there. Low cost and automation. Throw out people. So they save $2.7 billion a year and immediately spend another $1 billion on buybacks and of course won’t stop there:
Jim Cramer had an on point segment on this issue this week. He gets it and also understands that this is the primary reason the Fed did not raise rates. Money quote: “Hiring lower numbers of lower wage workers to do the remaining jobs that are not wiped out by automation”:
What an insult to these employees who now have to figure out how to make a living elsewhere. No, jobs are being destroyed globally through automation and fewer people are needed. The trend has been in place for years and is only accelerating:
So fewer people needed due to technological innovation. But it gets worse. While fewer people are needed rapid population growth is increasing the supply equation: Recent projections have been upped again and the latest stats have to make one wonder how there will be enough infrastructure, resources and jobs to sustain the ever increasing masses of people:
It’s no coincidence that global headlines are dominated these days by immigration and mass migration toward American and Europe. More and more people looking for better jobs and lives and wealthy societies looking for ways on how to deal with the influx of people.
This is the structural firewall all the central banks have been and continue to be up against and it’s rapidly coming to a head. For years and decades central bankers have sought to manage any bad news. Recessions, crashes, wars, economic cycles, etc. In the process of attempting to ward off any bad news they also created or helped foment one bubble after another. The tech bubble, the housing bubble and now the debt bubble.
The reality is all these bubbles and subsequent economic disasters have been managed by one primary tool: Long term reduction in interest rates:
But what has it produced with the Fed all in?
Here’s the brutal reality:
Bullish? I don’t think so, and this is before the next downturn has officially begun and with central banks all in.
So with this backdrop the Fed claims it wants to raise rates. Good luck.
Which brings me to the here and now. What I continue to see is a binary set-up. In order to avoid a massive bear market bulls need new highs. Full stop. That $COMPQ chart in my double top tweet the other day makes this perfectly clear:
— Northy (@NorthmanTrader) September 16, 2015
The plainly observable fact remains that stock markets have not been able to sustain new highs without central bank intervention:
In lieu of any evidence to suggest that markets can make new highs on their own, one has to surmise that the Fed will, at some point, have to bring back QE. The trigger? Lower stock market prices. And this what it’s all about at the end of the day. In Europe an expansion of QE is already on the table:
- ECB’S COEURE SAYS GLOBAL GROWTH PROSPECTS HAVE DARKENED, HAVE WORSENED MARKEDLY IN EMERGING MARKET ECONOMIES
- ECB’S COEURE SAYS ECB CAN ADAPT QE ASSET PURCHASE PROGRAMME IF DOWNWARD RISKS TO INFLATION ENTRENCH
And in the UK there’s now talk of a rate CUT amidst signs of a signs that the third phase of global financial crisis is looming:
In a wide-ranging speech that called on central bankers to think more radically to fend off the next downturn – including the notion of abolishing cash – Haldane warned the UK was not ready for higher borrowing costs.
“In my view, the balance of risks to UK growth, and to UK inflation at the two-year horizon, is skewed squarely and significantly to the downside,” he said. “Against that backdrop, the case for raising UK rates in the current environment is, for me, some way from being made.”
Given the range of risks facing the economy, there is every chance the next rate move could be a cut instead of an increase.
“Were the downside risks I have discussed to materialise, there could be a need to loosen rather than tighten the monetary reins as a next step to support UK growth and return inflation to target”.
So central bankers know what’s up and so does Janet Yellen and hence they are staying all in and are ready to do more.
And hence the rest of 2015 and into 2016 is very much a binary battle for control with very different potential outcomes.
Technically markets are facing massive potential heads and shoulders patterns and broken trend lines with bearish price implications on confirmation on the one hand:
Yet on the other hand central banks are eager to right it all yet again by the time positive seasonality takes over by the end of the year paving the way for a 1998 like save and push to new all time highs:
In principle the stage is now set for a retest of lows and potential break of price into October. Remember the Fed is not data dependent as it claims, it is market dependent. And, for now, the market has sent a clear message with its price rejection at the monthly 5EMA this week:
The message: The game is over. The trend has changed. And the Fed knows it. The question is: What will it do about it? Roll-over or fight? But will it matter much if it fights? Janet Yellen clearly lost the crowd this week as “accommodative” was met with a resounding SELL as confidence has been shaken. Her job is now to win back confidence. Whether she can or not is now largely determined how the binary set-up we face here plays out. Bottom line: Bulls need a 1998 like repeat to save this year.
How did the Fed manage the big correction in the Fall of 1998: It cut rates of course:
Well, good luck with that this year.
Categories: Market Analysis