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War On Gravity

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War On Gravity

Read full newsletter: MarketShadows 9/30/12

As we noted last week, the global economy is slowing down, while the stock market continues to perform well. This week, we explore this disconnect in greater detail.

David Rosenberg describes six key variables that affect the stock market. These variables are: liquidity, fund flows, technicals, valuation, sentiment, and fundamentals.  (Here Is How Much QEternity Has Already Been Priced In) The relative influence of these factors changes over time.

Liquidity: Quantitative easing (QE) has been supporting the stock market. The latest, QE-Infinity (or QE3), results in a new $40 billion/month cash injection into the Primary Dealers (PDs) accounts.

David’s research indicates that every $40 billion of QE added to the Fed's balance sheet adds about 20 points to the S&P 500.

The chart below shows one way to quantify the Fed's money-printing ways on the stock market:

 

 

Describing the chart, Phoenix Capital Research wrote, "the New York Fed itself has openly admitted that were it to remove the market moves that occurred around Fed FOMC meetings [the times when the Fed announced new programs or hinted at doing so], the S&P 500 would be at 600 today..." (Draghi's Bazooka Fired Blanks)

The chart suggests that market participants were front-running the news. But had the increase in stocks been driven solely by anticipation, stocks should have later sold off. They didn’t. The higher prices were sustainable because liquidity was added to the financial system through the PDs--beneficiaries of the Fed’s QE programs.

In a ZIRP (Zero Interest Rate Policy) environment, with the Fed printing money and the Dollar losing value, “risk on” trades became increasingly appealing and money moved into stocks and commodities. The PDs also took advantage of more complicated investment strategies. According to Michael Hudson, the $800 billion QE2 was used by the banks to speculate on currency and interest rate arbitrage. They borrowed money at 0.25%, lent it to the BRIC countries at much higher rates, and then pocketed the interest rate arbitrage. Contrary to story line, the banks did NOT put this money into the economy. “The reality is that ever since QE1 and QE2, every time there’s a loan, the banks reduce their loans to businesses, they reduce their mortgage loans, there’s less mortgage refinancing, and in fact, the banks use the money to gamble, mainly abroad in foreign currency and interest rate arbitrage...” (QE3 = Jobs for Wall St.)

Fund Flows: Mutual funds and hedge funds have been underperforming the S&P 500. These funds have to buy the market to appear like they’re keeping up with the S&P benchmark.

Technicals: Technical analyses have been bullish. (Market Shadows includes commentary by Allan Trends, Springheel Jack and Lee Adler - they have been bullish recently.)

Valuation: Forward P/E ratios have been at the high end of the range for the past 20 months at 14x. The Shiller cyclically adjusted multiple is 25% above historical norms.

Sentiment: The shorter timeframe for the AAII Investment Survey is neutral, but longer term is bullish. David Rosenberg opined, “The bull camp is getting crowded — problematic from a contrary standpoint.”

Fundamentals: The world’s major economies are in slowdown mode. A question being raised in the financial blogosphere is whether the US is in or about to enter a recession. And if so, what is the likely effect on the stock market?

It might be expected that a recession would profoundly influence stock prices because, logically, lower economic growth is correlated with less spending, lower earnings, missed expectations, and lower stock prices. But such fundamentals are just one of many influences on the stock market. Lately, they have not been strong influences at all.

In The S&P 500 and Recessions, Doug Short examined whether recessions have led to declines in the stock market, and/or whether declines in the stock market have foreshadowed recessions. Doug’s chart below shows the market-recession correlation since the mid-1950s, with the daily closes of the S&P 500 overlaying periods of recessions (grey).

 

 

The S&P often peaked before a recession began and bottomed before it ended. Four of the nine recessions since 1957 saw the index higher at the end of the recession than at the start.

Describing the chart Doug wrote, "Since the inception of the S&P 500 in 1957, there have been 9 recessions and 9 bear markets (20% or greater declines). However, three bears were not associated with recessions, and three recessions happened without a bear market, although the 1990-1991 recession had the ultimate "near" bear with its 19.9%...

"Market indexes and recessions are two very different data series. The closing price of the S&P 500 is a real-time snapshot of equities. In sharp contrast, recession boundaries are determined many months, sometimes a year or more, after the fact, for both the starts and ends (peaks and troughs). The NBER makes its call after lengthy deliberations over economic data that has been subjected to extensive revisions.

"Economists often make generalizations about business cycles that suggest a substantial commonality among them. But that's true only at a 20,000 foot level (and on a partially cloudy day). Recessions are dramatically different from one another if viewed within their individual economic and market contexts. Exogenous events can play a role...

"The US economic recovery since the official trough in June 2009 has been much weaker than hoped, and there are many financial pundits who agree with ECRI's latest assertion that a new recession is underway, a view which, I would counter, is not supported by the Big Four economic indicators."

The normal business cycle results in periodic recessions, but the character of these recessions can vary widely. The relationship between the stock market and recessions can also vary widely.

Economists and commentators disagree about whether the US is in a recession. Recessions are not declared officially until after substantial evidence accumulates over time. Current signs that the US is in the early phases might be recognized, in retrospect, but that isn’t very helpful in answering the question NOW.

Mish Shedlock argued that a recession in the US began in June: "I am very comfortable with pegging of the start of the recession in June and I expect more downward revisions in GDP and employment are on the way.”...

"Unexpected weakness and downward revisions are hallmarks of the beginnings of recessions. And so it is with durable goods. Economists had forecast a gain, instead there was a 1.6% drop. Moreover July was revised lower as well.

"Bloomberg reports Orders for U.S. Goods Excluding Transportation Unexpectedly Drop: 'There was broad-based weakness,' said Tom Porcelli, chief U.S. economist at RBC Capital Markets... 'What this now means is that capital expenditures are now going to probably fall for the first time since the recovery started. It remains a terribly challenging backdrop in the U.S.'..." (Durable Goods Orders Ex-Transportation "Unexpectedly" Drop, Down Third Month, July Revised Lower; GDP +1.3% Second Quarter; June Recession Call Looking More Likely)

[See also: Case for US and Global Recession Right Here, Right Now; Recognizing the Limits of MadnessECRI's Lakshman Achuthan Says US in Recession Now; That Makes Three of Us]

Writers at Zero Hedge are also in the Recession Now camp: "QE1, QE2, Operation Twist 1, Operation Twist 2, a Fed balance sheet that is now expected to be $5 trillion in 2 years, and all we get is a lousy manufacturing economy that according to the Chicago PMI just dipped into contraction, or for all intents and purposes, recession, printing its first sub-50 print, 49.7 specifically,... But not all hope is lost: at least prices paid soared for the third consecutive month... Cue not just recession, but stagflationary recession... Time to start pricing in QE X to be followed 24 hours later by QE X+1. The central bank cartel is starting to lose control."

Whether we are in, on the brink of, an inevitable excursion into recessionary times, the US economy is weak, as are the other major world economies. The race is on to print money and devalue currencies, and this supports more risky assets such as stocks and commodities. This is the current theme of the markets and why the economy and stocks are not moving together. Fundamentals have taken a back seat to Liquidity, and this trend is likely to last into the near future.

DECOUPLED

Wolf Richter reflected on the real economy and contrasted it with the recent gains in the stock market:

"A veritable chorus of large US corporations has chopped their forecasts down a few sizes, citing the China slowdown, wobbly demand from emerging markets, the ongoing fiasco in Europe, or weakness in the US...

"But you wouldn’t know it from the stock markets, which are supposed to predict future turns in the economy better than any other measure, based on the collective wisdom of innumerable astute market participants—or rather computers, algos, and fat fingers. The S&P 500, for example, is up 22% over the last 12 months. A phenomenal run...

"That the CEO Economic Outlook Index evokes the dark days of double-digit unemployment is not a particularly good sign. It crowns a pile of slashed forecasts from bellwether companies. The old-fashioned among us would expect stock markets to have anticipated that corporate downdraft. But that hasn’t happened.

"If QE, QE2, QE3, the bubbly expectations of QE4, and of course QEx have accomplished anything [read... ‘Forceful and Timely Action’ to Nowhere], it is the miraculous decoupling of the stock markets from reality. Gravity can be turned off, apparently, in this new QE world of ours where no one has gone before. But then, gravity has the nasty habit of reasserting itself at the worst possible moment." (The Miraculous Decoupling Of Reality, For Now.)

So when will gravity reassert itself? We don’t know but will be watching for signs of falling debris as the foundation of our house of cards starts to waver.

Also in this week's MarketShadows Newsletter:

Springheel Jack's TA

Allan's Trends - Shorting the Nasdaq

Virtual Portfolio - House-cleaning

Weakening world economies - an odyssey from debt to tribulation

 

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Tue, 10/02/2012 - 01:12 | 2847485 blindman
blindman's picture

by the time unemployment is down to 7% the financial
war will have wiped out india, china and all of europe
through inflation, then the jobs can come back to
the usa. it is a globalists parity dream which is
the nightmare of the people of the world. i guess
the first rule in financial war is to have the
biggest guns and use them aggressively and everyone
not in your camp and in support of your weapon
is the enemy and to be leveled while the money for
fraud based securities swap accelerates through helicopter deliveries. key figures in the global array will be paid
off and become unpopular in their locals and struggle
to remain in influential position, that is happening
and will probably become more common. the illegitimacy
of the money system translated to illegitimacy of the
political representation of global members/parties.
same old story ongoing. makes one wonder who is the
identified enemy in the 'FINANCIAL WAR' ? the victim?
the generals? people assume the lines are drawn on
a national basis, perhaps it is along a class basis?
could be.
.
01 October 2012
John Ralston Saul: It's Broke, How Can We Fix It?
.
"This is a video of a talk given on 26 August 2012 at the Sydney Opera House."
...jca
.
http://jessescrossroadscafe.blogspot.com/
.
minute 38 about.
.
" the slowest people in the world are economists, with few exceptions,
they just don't learn. they think we're so dumb because we haven't
learned to do what they tell us to do, which is the theory and therefore
true." ...
.." when did saving a bank become more important than
saving a country? or its citizens? when did social scientists, tenured
professors begin to believe that the source of legitimacy in a democracy
wasn't you citizens but was administration and commercial contracts?
.
.... why are personal debts and state debts wrapped up in cheap, romantic
christian moralizing, while private sector debt is just utilitarian stuff?
what is that differentiation?"
.
why does a healthy society mean a society which is stimulated to consume,
which is a very uninteresting idea of civilization to be polite.
so , we are in an era when power.... and thinking are not equated,
there is almost no relationship in the developed economies, democracies, between power
and
thought. ...... it's an era when managers and most politicians don't read, the most
they can read
is maybe a 2- 3 page briefing paper which isn't written in any known language. except
for
managerial ism, so it is not something that could have any effect because it is
meant to be dead language. and the result of that is that we slip into this sort of
passive
idea of stability and continuity and we lose this idea of choice , the fundamental choice
central to democracy" ........ jrs

Mon, 10/01/2012 - 21:40 | 2847153 razorthin
razorthin's picture

There is so much gravity, we shall soon be sucked into hell.  The more the Fed inflates, the graver our fate.

Mon, 10/01/2012 - 21:28 | 2847126 DTCC 1999
DTCC 1999's picture

"Gravity is a harsh mistress. " - The Tick

Mon, 10/01/2012 - 18:26 | 2846701 Quinvarius
Quinvarius's picture

Gravity is pulling on paper money, not stocks.  After 4 years, the perma-bears remain as ludicrous as ever.

Endless free money to banks = no banking panic = no market crash. 

This is not 2009 anymore.  The rules are all different.  Maybe no one has noticed the Fed doesn't ask permission anymore.  That is how it works from now on.  Too "experts" are stuck in their "maginot line" mentality.  Your paper fort cannot repell printing of this magnitude.  You might as well build a submarine out of water as hide in dollars.

And if the Bernanke gets spooked on political interference, he might one shot the banking system with "the final printing fix".

Mon, 10/01/2012 - 19:41 | 2846855 disabledvet
disabledvet's picture

Yep. Plus there is no asking the simple question "is QE CAUSING the market rally?" the answer is obviously no because the only result of all this debt monetization is confirmation that the recovery sucks. Outside of a weak dollar what has the Fed acoomished again? Economically I would say ZILCH. Indeed how does a bank make money in this environment again? The yield curve has pancaked, inflation in what we need remains high, deflation in where we want job creation even higher. And of course the war keeps expanding...as per Fed diktat. I think this Administration is politicking on a VERY weak foundation. Traders beware!

Mon, 10/01/2012 - 18:20 | 2846692 max2205
max2205's picture

Bear markets are banned. Only crashes till the Fed gives up.

Since when did the FED EVER GIVE A SHIT ABOUT JOBS...

Mon, 10/01/2012 - 19:23 | 2846821 fourchan
fourchan's picture

the job of the fed is to make money for its shareholders by any means. the means it has always used is to create boom and bust cycles. these cycles capture loaned on property and enslave the borrowers to debt. to those who are not enslaved already, the fed devalues their savings of frns through inflation, which is only another word for devaluation. the "system" is working perfectly and as planned by its creators 100 years ago. the fed has stolen america and enslaved a free people

Mon, 10/01/2012 - 18:08 | 2846669 lasvegaspersona
lasvegaspersona's picture

selling data is where the real money is...I'm holding a vintage pre 2008 7.9% that I'll let go for say...half a ton.

Mon, 10/01/2012 - 17:45 | 2846612 q99x2
q99x2's picture

Gravity is by far my greatest enemy and I expect it to eventually win the battle.

Mon, 10/01/2012 - 17:28 | 2846581 ebworthen
ebworthen's picture

Has the Bernanke been informed of this "gravity" you speak of?

He seems to have trouble grasping "employment" and "inflation" so...just wondering.

Mon, 10/01/2012 - 17:24 | 2846570 Bear
Bear's picture

We have not been able to trust any data coming from the Feds over the last few years and from now until Nov 6, I think we can expect only data points that support the current bureaucracy as they have a real vested interest to make things look better than they are. Friday unemployment down, down, down .... maybe ever under 8.0 and even a better call for October. If the market cannot move forward from now to Nov. 6 ... then Armageddon awaits.

We are now on the power stoke of a roller coaster taking us to the pinnacle before the attendant releases the car for its cascade toward oblivion.   

Mon, 10/01/2012 - 17:15 | 2846542 Meesohaawnee
Meesohaawnee's picture

translation. .. A short ban.

Mon, 10/01/2012 - 16:26 | 2846385 LawsofPhysics
LawsofPhysics's picture

I had the opportunity to attend a recent eCONomic forum with some of "the worlds most advanced and innovative thinkers".

They talked about a perfect world with everyone sharing a common currency and being caught up on trade balances etc.

I actually got to ask a question.  I simply asked the following "In this perfect world you have constructed, what is the one world currency backed by in order to insure that everyone in this world you describe is getting something real in exchange for their labor, moreover, now that the the earth has become an efficient producer (like germany or China) of real goods and services.  In order to balance the earth's books, who are we selling to and what are they giving us in exchange of real value?"

Halarity ensued as all the distiguished guest realized each others contradictions and began pointing them out.  the one thing you can count with these guys is arrogance and trying to prove the other guy "inncorrect".  The general answer I got was that "innovation will solve all our problems".  My follow up was, "but what if all the capital and more importantly the resources had been mal-invested and mis-allocated? Real innovation requires real fucking inputs"  At that point they threw me out.

Mon, 10/01/2012 - 21:02 | 2847041 nmewn
nmewn's picture

"At that point they threw me out."

Thats usually the point where I re-enter through the kitchen disguised as a waiter serving "just desserts".

Mon, 10/01/2012 - 17:17 | 2846552 Sweet Chicken
Sweet Chicken's picture

I have a huge man crush on you

Mon, 10/01/2012 - 16:53 | 2846487 Skateboarder
Skateboarder's picture

+kudos.

Did you actually get thrown out? Like physically escorted? Asked to leave?

Either way, you're a champ.

Mon, 10/01/2012 - 17:04 | 2846518 LawsofPhysics
LawsofPhysics's picture

Politely escorted.  I am a taxpayer after all.  Stupid me for being caught up and actually having some significant savings.  Shit, if I could get a decent rate of return, I might even be willing to lend it out.  That's how you get real fucking economic activity going.

Bloody bankers need to all be hung.  Start the fuck over.  Plenty of people like me with savings who would be willing to get things going if we knew that there would be real consequences for bad behavior by these fucks.

Mon, 10/01/2012 - 19:01 | 2846772 Skateboarder
Skateboarder's picture

Awesome. Yeah man, I feel ya. When money, and effectively wealth, starts moving away from people and into institutions, backed by nothing, all that's left is the thin air by which the nothing-money is backed. Monetary transactions should operate in debits. If the need for credit arises, it should happen person-to-person, not institution-to-person.

Mon, 10/01/2012 - 16:12 | 2846350 Skateboarder
Skateboarder's picture

Isaac Newton is a terrorist and a threat to our freedom and democracy.

Mon, 10/01/2012 - 16:25 | 2846393 LawsofPhysics
LawsofPhysics's picture

Dead already, something about a "burial at sea" consistent with the "traditions of a physicist."

Mon, 10/01/2012 - 18:31 | 2846713 3rdgrader
3rdgrader's picture

Sell.

Mon, 10/01/2012 - 16:00 | 2846304 balz
balz's picture

S&P below 0?

Do NOT follow this link or you will be banned from the site!