Friday, June 21, 2013

Stock Market Diving? You Haven’t Seen Anything Yet

I had to laugh yesterday as Rebecca Jarvis, would -be financial guru on ABC News, said that even though the stock market dropped 353 pts yesterday, people with 401ks were still “10 percent ahead”. I want to see what she says next week when they’re 10 percent behind, with bigger drops every day. Even Jarvis had to remark on the irony of it, since in effect, the economic news was good: lower unemployment (6.5%), higher growth (3.5% ) and lower deficits. But, of course, this good news meant the basis for Ben Bernanke’s quantitative easing was no longer justified.

So what spooked the markets the past couple days? Seeing growth ramping up, as well as inflation now at nearly 2%, Bernanke was forced to adcknowledge quantitative easing via bond buying wasn’t needed any longer. But note Bernanke didn’t even say it would end when he spoke Wednesday, only that the bond-buying program would be “slowed later this year” and end next year if the economy continues to improve. These bond purchases have kept long term interest rates at record lows forcing conservative savers to pinch pennies even as they earn only pennies (literally) on their passbook or even money market accounts. But now with higher interest rates on the horizon, thanks to Ben’s stated plans, it will be time for the savers to smile as the speculators pout, cry and whine with the sinking of the DOW.

“BWWAAAHAH! Ben took our crack away! WAAAH!”

“Crack” being cheap money, of course, which – let’s not fool ourselves – has been fueling the stock market surge and effectively turning it into a bubble.

Ben assured the Wall Street green- eyeshade types that his reductions would occur in “measured steps” with all bond purchases ending by the middle of next year. By that time interest rates ought to be near or about one percent at least, maybe more. Bernanke also likened the reduction in the Fed’s $85b a month bond buying to a driver easing up on the gas pedal, as opposed to applying the brakes. Didn’t matter, as the Street and its resident speculators – so addicted to the Fed’s  stream of cheap money -  saw it as braking and they reacted in kind with a 353 points- plus sell off for the DOW.

Think that was it? Not by a long shot! The thing is that stock speculators are like spoiled brats- especially after being handed freebies like Bernanke doled out for years-  and when they don’t get their way they pitch hissy fits reflected in volatility of the markets and in this case, huge sell offs. This was directly incepted by the speculators anticipating higher interest rates which of course will mean their gambling chits (shares) will cost more, since also corporations’ costs of doing business will rise even as there are higher rates on home mortgages.

Today you likely will see at least a 250- point drop continuing on from the market’s reaction yesterday. Even if not, any uptick will indicate volatility and a rough ride next week. Personally, if I were still invested in stocks or mutual funds I’d take this as a sign to get out, while I’m still maybe 10 percent ahead of the game – to cite Jarvis on ABCNews. Waiting until next week, you may find yourselves 10 percent down. Another week maybe fifteen percent down. Thus, rather than one dramatic blowout for stocks, I see a slow erosion as the markets try to adjust to Bernanke’s new bitter medicine. Perhaps by mid-July the DOW will return to where it should be, around 13,500 and out of its current bubble territory.

Meanwhile, Maul Street’s traders and firms are increasingly worried Ben’s new medicine along with the higher interest rates it’s likely to produce will chase small fry investors out of stocks and stock mutual funds and into higher yielding bonds. Others fear that the economy might not be ready to absorb higher rates and consumers and businesses will pull back on borrowing, I call this lot the “nervous Nellies” who really can’t seem to get a handle on reality. The fact it, consumers are likely to continue spending no matter what the rates, and if they want that new car or Notepad, dammit they will buy it. Even home mortgage interest rates won’t shoot up all at once, rather more steadily, The problems in the latter are more connected to lenders still being tight- fisted and wary of prospective buyers' credit scores, than anything to do with interest rates.

As for corporations, hell, they don’t need to borrow any money! They’ve been sitting on nearly $2 trillion for the past four years. Why should they borrow more? The problem with the corporations isn’t borrowing but their failure to plow their existing money back into the economy to create more jobs. Bear in mind that 122,000 new jobs a month just barely meets population replacement level. I.e. covers the number of new workers entering the labor force.

Those who are sad to have seen the DOW drop 560 points the past two days need to wake up and smell the coffee. Bernanke’s cheap money crack has sent the stock market up 141% over the past four years (Denver Post Business, June 19, p. 11A) Recall Arch-forecaster Nate Silver, in his book, 'The Signal and the Noise- Why So Many Predictions Fail But Some Don’t ' noted the danger signals for a crash (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987."

Given the historical average for stocks is about 7 percent return per year and the last four years indicate a 141%/ 4 = 35% / year or more, we are clearly flirting with crash territory. So, better to have a slower progressive erosion of returns now rather than a major crash (i.e. 1500 pts.)  happening in one day! Maybe it’s finally time for people to grow up and realize that money doesn’t grow on trees nor does it come endlessly “free” via stock returns because a Fed Chairman likes to prime an artificial pump.

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