Alan Greenspan

A bearish take on U.S. stocks is about as fashionable as a beehive hairdo at the moment, which makes it a decent time to think like a contrarian.  Sell-side strategists with a sense of reality are few and far-between but as ConvergEx's Nick Colas warns, the most important reason for caution currently is, obviously, valuation and complacency.  U.S. stocks currently reflect, both in price level (16x current year earnings) and implied volatility (an 11 handle VIX), an economic acceleration which has yet to fully flower.  In addition, Colas adds, domestic equities look good in part simply because everything else – Europe, Japan, emerging markets, etc... - look so bad.  Wouldn't an accelerating U.S. economy spill over to other regions?  So what is lurking around the corner for the next lucky Fed head? And what about the three main memes for why the 'bull' can keep running?

Just a few days ago on July 27th President Barack Obama said that the next Fed head had to consider average Americans when setting monetary policy. If only that were true.

Problem ... What Problem?

While hardly a surprise, following recent speculative punditry (which failed miserably in forecasting Mark Carney as the next BOE head, something Zero Hedge predicted half a year ahead of the event due to one simple variable - he is from Goldman) and numerous trial balloons on Bernanke's successor coming hot and heavy from every direction, it was time for the Fed's own mouthpiece, Jon Hilsenrath, to speak, and bring back much needed drama and confusion.

Federal Reserve Chairman Bernanke's term expires January 31, 2014. While his continuation as Fed chair cannot be ruled out, he has given no public indications that he plans to seek another term and most market participants - as well as many members of Congress in last week's Humphrey-Hawkins hearings - seem to believe he will retire from public service early next year. As Goldman notes, the announcement of the next Chair of the Federal Reserve seems most likely to come in October, though nominations for Fed Chair have been announced as early as five months before the current term expires and as late as less than a month before expiration. There does not appear to be much risk to the Senate's ultimate confirmation of whomever the President chooses, though the Fed nominations have become more politically controversial over the last few years, which is likely to lengthen the confirmation process. Following previous confirmations, financial market volatility has typically increased slightly, though whether this occurs following the upcoming transition will of course depend on who is nominated.

In testimony yesterday on Capitol Hill before the Senate Banking Committee, Federal Reserve Chairman Bernanke remarked:

“Gold is an unusual asset. It's an asset that people hold as disaster insurance. A lot of people hold gold as an inflation hedge.  But movements of gold prices don't predict inflation very well, actually. But anyway, the perception is that by holding gold you have a hard asset that will protect you in case of some kind of major problem.

The recent decline in gold prices and the drain from physical ETFs have been interpreted by the media as signaling the end of the gold bull market. However, our analysis of the supply and demand dynamics underlying the gold market does not support this thesis. In our view, the bullion banks’ fractional gold deposit system is testing its limits. Too much paper gold exists for the amount of physical gold available. Demand from emerging markets, who do not settle for paper gold, has perturbed the status quo. Thus, our recommendation to investors is the following: empty unallocated gold accounts and redeem your gold in physical form (while you still can).

Larry Summers has been failing up since he entered the public sphere. The reults have been catastrophic for many main street Americans.

It can't happen... It can't happen...It can't happen...  It just happened.

Before the current turmoil began, Ben Bernanke's hope was that rising asset prices would lead to a "wealth effect" that would encourage the American consumer to start spending again, and thus help the American economy finally leave the "Great Recession" behind. However, the empirical data does not support this notion and equally the economy isn't booming sufficiently to make the reverse case that the economy drives the stock market. So what is causing the markets to boom right now? Steve Keen notes that during the period from 1890 to 1950, there was no sustained divergence between stock prices and CPI, and that almost all of the growth of share prices relative to consumer prices appeared to have occurred since 1980; and then, boom! - what must certainly be the biggest bubble in stock prices in human history took off - and it went hyper-exponential in 1995. So are stocks in a bubble? Yes - and they have been in it since 1982. It has grown so big that - without a long term perspective - it isn't even visible to us. It has almost burst on two occasions - in 2000 and 2008 - but even these declines, as precipitous as they felt at the time, reached apogees that exceeded the previous perigees in1929 and 1968.

Benjamin Strong was near the end of a long stint as head of the New York Federal Reserve Bank (he passed away in October 1928), where he enjoyed the same immense power that Ben Bernanke has today. The economy had just begun to recover from a recession in December 1927, and there was much unemployment and spare capacity.... Agriculture was booming during and immediately after World War I, based on thriving exports to Europe. Overinvestment during the boom then gave way to stagnation in the 1920s. Europe was in a bad state in the late 1920s, just as it is now. What’s more, two of the world’s three largest economies are now in Asia, and these economies face similar challenges to those of 1920s Europe. While analogies are never perfect, the parallels with early 1928 are troubling. When the world slipped into depression in the late 1920s and early 1930s, it was on the back of imbalances and debt overhangs that are oddly similar to those that we face today.

“That’s the whole dilemma!” As the G-20 is already getting cold feet....

The market deals extremely poorly with paradigm shifts or cycle changes. One reason for this is that there has been no need for any strategy except for the just-buy-the-dip mantra. This may have ended and that could be the best signal to the markets since the global financial crisis started. Sorry to be the messenger, but the only way for investors to understand risk and leverage is by having them lose money. Essentially then, the balance of this year could be an exercise in re-educating the market to long-lost concepts such as loss, risk, inter-market correlations and price discovery. We even predict that high-frequency trading systems will suffer, as will momentum-based trading and, most interestingly, long-only funds. Why? Because, at the end of the day, they are all built on the same premise: predictable policy actions, financial oppression and no true price discovery. We could be in for a summer of discontent as policy measures and markets return to try to search out a new paradigm. This will be good news for all us.

There is no greater crime in Washington today than speaking truth about the US economy in public.  This is why Ben Bernanke is not being reappointed for another term as Fed Chairman.

Both the U.S. and China are now attempting to deflate asset bubbles. The former is likely to have second thoughts while the latter isn't.