How Far Can We Go?
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Though I have for some time postulated that the market would put in one last push higher when it "eyes" the Fed about to pause/stop its rate hike tightening. It makes intuitive sense that the market would rise (even aggressively rise) as long as there is the perception that the real interest rate will stay below the neutral rate. If the delta between the two increases the more the liquidity driven lift increases. With the apparent increase in the economy, the delta between the real interest rate and the neutral rate gets greater and we get the subsequent increase in liquidity driven asset "reflation." This is what I feel we are now experiencing. The Fed is "measured," the economy is accelerating, the delta between real rates and the neutral rate is increasing, and the market is lifting.
Changes in two key variables that I feel will thwart/or hinder this liquidity driven lift are: 1) the Fed indicating the pace of tightening will have to increase above the current "measured" pace; and 2) a slowing in key economic metrics. Currently, this is not happening, so we continue to see a relentless march higher due to a liquidity flood driven by a widening delta between real interest rates and the neutral rate.
The question for today is, how long can this last, and the answer is (to my chagrin since I have fought much of this advance) probably further than most think as long as there is a stimulative (or widening) delta between the real interest rate and the neutral rate. As to our current juncture, I cannot get comfortable with the fade SPX 1250 -1260 too aggressively (except for a trade), because it has become the "known" market upside retracement level for too long. As long as two years ago we have heard TAs project that this was the upside target, and now that we are there it has almost become a universal accepted key resistance/fib retracement level. This tells me that though we may back up initially we will probably blow through it and I am projecting an SPX advance to the 1275 - 1300 level. This would truly suck in the last bear standing, issue the all clear sign, and then pull the trigger on the trap door.
Initial reply from John Succo:
This is good evidence that the top may already be, those that have been fighting the advance seeming to capitulate for a higher level.
In my opinion, the real mistake of your comments is this: the economy is not accelerating. It may be growing, although that is only due to excess speculation from zero interest rates, but it is not accelerating, which is as we know, an increase in the rate of growth.
There is a popular misconception that the Fed funds rate ALONE (and its relation to the prevailing rate of inflation) is what affects liquidity in the economy and the financial markets. The Fed has several other liquidity levers, most prominent among them the 'pool of funding' in terms of their day-to-day temporary and permanent repo's (treasury repurchase agreements). Too, commercial banks are the only other source of "money" in a fiat-based monetary regime. That is a long way of saying that commercial banks and the Fed each are the ONLY entities that can create liquidity out of thin air. So we must understand too what commercial banking activity is in terms of loans, credit expansion, etc. All-in, these are the two entities that can legally create money - create liquidity - and the Fed Funds rate is but one (and in some cases negligible) method of creating liquidity in the economy.
John and I follow a proprietary measure of liquidity called Money AMS (Austrian money supply) that differs markedly from MZM, M1, M2, or M3 in terms of what is defined by the term "money." It would surprise you to learn that one measure of this liquidity (one adjusted for nominal economic activity and for inflation and thus termed "real money AMS") has been in decline for the last eight months - contracting for eight months. It now stands at -4.1% y/y. This compares to the peak rate two years ago at +7.3% y/y (July 2003). That delta - the difference between the peak growth rate and the current negative growth rate - is at -11.4%. For comparison purposes, the change in the real money AMS figure from December 1986 to September 1987 was -15.8%, and stands as the ONLY other change in real money AMS growth rates larger than the current one.
Liquidity is contracting in the economy and the financial markets. Don't let your eyes fool you by looking at just the Fed funds rate. Things are much - much - more unstable in the economy than you might believe by listening to speeches from administration officials or their lackeys at the Fed. I stand on our current prediction that 2006 will see a recession and that the stock market is poised for a meaningful decline.
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