Friday, September 21, 2012 - It's Not Whether You're Right or Wrong

It's Not Whether You're Right or Wrong

by Sinclair Noe

DOW – 17 = 13,579

SPX – 0.11 = 1460
NAS + 4 = 3179
10 YR YLD - .02 = 1.76%
OIL + .47 = 92.89
GOLD + 4.50 = 1774.00
SILV - .12 = 34.62
PLAT + 11.00 = 1641.00

Let's be very clear on what has happened over the past week or so. You already know the Fed announced QE3 to infinity or 5.5% unemployment plan (whichever comes first). What does that really mean? It is probably a very, very bullish event for stocks and commodities. We talked about commodities and equities moving higher in anticipation, and we saw silver move up about 33% over the past month; gold up 14%; the Dow Industrials picked up almost 600 points; the S&P 500 up about 60.

Since March 2009, Gold is up 97%, silver is up 162%, oil is up 122%, and the Continuous Commodity Index (CCI) is up 55%. And then we've seen some consolidation over the past week, exactly as we anticipated, because this was the pattern that we saw after previous QE announcements, but you've got to suspect QE3 means the Fed has flipped the switch to risk-on.

Maybe you also remember that back in the Spring I brought up the old adage about the best and worst 6 months in the market; you remember, “Sell in May and stay sway.” Well, the S&P 500 is up about 50 points from May 1^st. If you missed that, don't feel bad because you also missed the roller coaster that saw the S&P 500 drop 150 points. I don't see the need to rush back in, at least until the dust settles.

And based upon past performance we should anticipate precious metals going back to test old highs. Based upon past performance we should anticipate stocks moving higher. Remember what has happened over the past 3years? Remember when the S&P dropped down below 700 in March 2009? That is a double; that is more than 100 percent in gains from the lows to now. What happened? Big chunks of money were thrown at the markets; TARP, TALF, QE1, QE2, Operation Twist, and more.

There's another old saying, “Don't Fight the Fed”, but let's look at the fight the Fed has taken on. After all, the Fed was compelled to announce QE3 and there are more reasons than just 8.1% unemployment. Industrial production dropped 1.2 percent in August. That was far below forecasts and the worst reading since March 2009. The first of the regional manufacturing indices we're getting for September look nasty, too. The Empire Manufacturing Index for the New York area plunged to -10.4 from -5.9 a month earlier, while the employment subindex dropped to 4.3 from 16.5.

Retail sales, excluding autos and gas, rose 0.1 percent last month. That was far below the 0.4 percent gain economists expected. Another "core" sales number fell 0.1 percent. And it appears the spending numbers may have been propped up by Americans taking on more debt. I don't think this is a change from the deleveraging trend, just a bump in an established trend going back 17 quarters. And while we have seen job growth, and that is a good thing after the massive job losses of 2008 and 2009, it hasn't been enough. Real inflation adjusted incomes are suffering. Average hourly earnings dropped 0.7 percent in August, the biggest decline since the summer of 2009.

FedEx is like a canary in the coal mine; after all, businesses need to ship their products, if they are shipping products. Back in June, FedEx cut its forward earnings guidance due to waning demand for its services worldwide. Then it cut its guidance for a second time in early September. And then, just this Tuesday, it cut its future guidance again. That's three warnings in four months, a sign that business is deteriorating at a rapid, and unexpected, pace.

The railroad, Norfolk Southern says it’s shipping fewer things in a slow economy, and declines in coal and merchandise shipments will slash revenue by $120 million, causing it to miss quarterly profit targets by as much as 28 percent.

The Dow Jones Transportation Average has been trending sideways for pretty much the entire year. The lackluster trading bothers adherents of Dow Theory, one the oldest and most respected models for timing the market. One tenet of Dow Theory is that industrial and transportation averages should confirm new highs together in a healthy bull market. The Dow Industrials are near their highest levels since 2007. Are the Transports undervalued or is the Industrial Average artificially high? I don't know, but I know that the more the trend-lines diverge, the more reason to worry.

Speaking of worry, the Volatility Index is grinding along in the low teens and that indicates the markets are more than sanguine, they are downright complacent. Think of a super low VIX as a runaway train; nobody's paying attention to the controls in the locomotive and it's just a matter of time till the train comes off the tracks.

We've talked extensively about the problems in the Euro-zone and the slowdown there affects us here. There is a global slowdown. The ECB has enacted their own version of QE, also the Bank of Japan this week announced accommodative easing. The People's Bank of China is expected to follow suit.

Can the Federal Reserve lift the US economy out of the doldrums? Will lower interest rates compel anyone to buy or will it merely punish savers? Can the Fed's monetary policy accomplish the job without the assistance of fiscal policy?

This past week, Congress showed the wheels have come off the track. They couldn't even manage to pass a $1 billion jobs program putting veterans back to work tending to the country's federal parks lands and bolstering local police and fire departments. Veterans of Iraq and Afghanistan face an unemployment rate of about 10.5%, roughly one-third higher than the general population. Here's the deal; we ask the troops to defend us and put everything on the line; in return we pay squat but we promise to take care of them when they come home. That's been the deal with every army in every nation throughout history. If we can't get this right, what hope do we have for dealing with the looming fiscal cliff?

So, there are some problems, but again I remind you that past performance indicates QE should be bullish, and you don't want to fight the Fed. Of course, it takes a while for the effects of QE to work through the economy, and the more the Fed goes down this path the more the returns diminish.

Jim Rogers, the co-founder of the Quantum Fund, back in the 70's, was interviewed on CNBC and he said: “The Federal Reserve is pumping huge amounts of money into the market… This is a Federal Reserve rally. The money has to go somewhere, and it's going into the stock market and the commodity market.”

Rogers thinks the artificial rally will end badly but he didn't care to guess when. Right now, it is a rally; it won't go up in a straight line, and there will be some shakeouts along the way, but it is a rally. The Fed will keep interest rates lower than you can imagine for longer than you can imagine. And the Fed will pump more money into the big banks than you might believe possible. And they will redistribute wealth to their banker buddies much more than any benefits that might accidentally trickle into the broader economy. And asset prices will go up, and that includes stocks, real estate, and commodities including energy and precious metals.

You may not be in lockstep with the Fed. You may not agree with their methods or even their reason for being, but don't fight the Fed. Now, that said, I'm reminded of a quote from Jim Rogers partner in the Quantum Fund, all those years ago. George Soros said: “It's not whether you're right or wrong that's important, but how much money you make when you're right an how much you lose when you're wrong.”