Wednesday, December 16, 2015

Fed decision and how we got here

I wanted to take a few moments to talk about the fed decision today. Expectations of an interest rate hike were  somewhere near 50% in October, and Janet Yellen decided last minute not to raise due to some weaker than expected economic data.  Now today in December,  the expectations are near 75-80%, which I would agree is the likely chance she will raise today.  Now a few quick points, first off all raising interest rates is not always deflationary, and likewise lowering is not always inflationary, as Europe is now finding out.  You can lower rates as much as you want, to negative as Mario Draghi is doing in Europe and you will find, that if the general confidence in the overall economy is still lack luster, this will never help to spark new businesses or increased economic activity.  Instead it simply forces asset inflation, meaning the stock market will rise despite an ailing economy.  In America now, after 6 years of Quantitative easing has pushed the stock market to all time highs while the economy has remained at a standstill, we may now see a rise in interest rates spark financial institutions to begin pushing money back out into the economy, that they have otherwise been hoarding.  This could actually be very inflationary.

There is always the chance Yellen chickens out again.  If she does, this would certainly be a disappointment to the market as nearly everyone is expecting it now.  The overall effect of the fed not having confidence to raise above the 0% crisis level will likely take its toll on the economy in general. Furthermore, a 2nd fake out would likely send the Federal Reserve's credibility to 0 and having the nickname "Janet girl-who-cried-wolf Yellen" doesn't bode well in the future when she inevitably HAS to raise interest rates.  Also, interest rates have remained the same for 7 years now, and so has general economic activity.  Insanity would be carrying on the same policy and expecting a different result to somehow magically manifest itself, so I think the idea of her not raising is a lot less likely.  

With equity markets at all time highs and commodity markets at decade long lows, we could very well see today's desicion be the beginning of at least a temporary top in stocks, and final bottom in commodities over the next few months.  We are fast reaching a point in commodities,  where producers are making $0 for the products they are producing and debt markets for these companies is approaching a quick and painful rise in defaults and bankruptcies. This is stemming over mostly from high yield junk debt in the energy market, which has begun already crossing over to high yield debt in all commodity markets.  This could easily and quickly expand to all debt markets in general.  Another tick on the side of raising rates today is that if this were to occur and become the next immediate crisis, the fed would much rather be at an interest rate they can then lower from rather than already be at 0% to begin with.

The purge in commodities and producers has and will continue effecting the better companies in the mix as well as the weaker ones.  As everyone's expectations begin to be that all commodity producers will be making nothing in their line of business, their stocks will get priced accordingly, in single digits, at multi decade lows in an all out capitulation like panic to sell.  This will lead to an unbelievable opportunity in some bigger names that run virtually no risk of bankruptcy.   Because when expectations are of earning a penny a share, earning 2 pennies a share is a 100% rise in earnings expctations, and the stocks will likely rise 100% or more as well.  (for a perfect example of what I mean see FCX, and the 50% rally it recently had from below 8 to above 12 in a period of 24 hours).  Both panic and enthusiasm make investors drive prices of assets to extreme levels in both directions, recognizing this is key to not losing your shirt in a quick downturn while everyone is patting themselves on the back, and making fortunes buying other people's junk as they quickly liquidate for "whatever they can get" in a panic.   

I want to now go back and retrace the footsteps of the Federal Reserve and the overall economy over the last 7 years.  In 2007, before the financial crisis was in the limelight,  wall street and the top 1% were busy selling worthless financial products to the public, while secretly betting against them themselves. In 2008 as the crisis loomed nearer, and these worthless products became a problem,  the agreed upon solution was to hand these institutions hundreds of billions of dollars to fix the problems with the illegal activities they were engaged in.  (And in the 7 years since, no one has gone to jail for this).  With the worst economic downturn on the horizon since the great depression, the middle class public did exactly what prudent people should do in such a situation; they sold some of their more speculative investments in the stock market to raise cash, they paid off some of their credit card debt and their mortgage debt, they downsized, they cut back on their spending habits and they kept a buffer of cash available to the best of their ability.  The Federal Reserve rewarded their prudent effort to save cash and cut back on debt by lowering interest rates to 0, making debt less expensive to have (only to the few who were deemed "credit worthy" which basically means "already has enough money to not need to borrow anymore") and making the return on cash savings 0% which actually works out to be a negative rate of return when you calculate increased cost of living and massive bank fees.  So as the prudent middle class public try to spend less and save more, they are penalized by watching their cost of living increase drastically over the last 7 years while their savings increase at 0% or less.  In the mean time, the top 1% on Wall Street who are very "credit worthy" began borrowing money at 0% simply because they can.  (You would too, but as I already explained, you can't)  But being that the overall economy looked rather dismal, and no one really had any confidence the situation would be any better 5-10 years later, there was no interest to start new businesses selling products or services to the middle class who are now determined to save and spend less, so instead, all that money borrowed went into investing in assets, ie, the stock market.  In the 7 years that followed, the middle class languished.  After a period of time, their savings were eaten away by increased cost of living, and high unemployment or underemployment, as many were forced after the crisis to take jobs for a significant cut in pay vs what they made only a few years ago, resulting in them having to dip into their cash hordes or 401ks or credit cards and home equity loans to pay their day to day expenses.  Eventually the pressure was too much and many of the middle class public had no choice but to resort to increasing their credit card debt or home equity loans, or going back to school for a graduate degree and taking on more student loan debt to try and get a better employment situation.  As it currently stands, Student loan debt is about $1.3 trillion dollars, over 150% more than what it was in 2007.  Credit card debt, which paused it's rise in 2007 just under $1 trillion is now back up and close to breaking over that level.  Auto loans have increased dramatically, taking over the subprime lending void left by the housing market and have now also exceeded $1 trillion dollars.  Mortgage debt in this country is also now nearly $14 trillion.  All of this falls mostly on the back of the middle class keep in mind, because obviously the rich can just pay cash for their cars, homes, and education. 

In the mean time, the top 1% who put all their money and then again all additional borrowed money into the stock market, saw a 250% rise in stocks over the last 7 years, which is about the best 7 year performance the stock market has ever had in 198 years since the founding of the NYSE back in 1817.  Now today, here in 2015 the stock market is actually DOWN about 2-3% for the year for the first time since the financial crisis and it looks to most of the Wall St 1%, like it is time to cash out on their winnings and do something else.  Conveniently, right at the same time the Federal Reserve is looking to RAISE interest rates, making it more profitable to be holding cash, while making debt more expensive.  The debt that the middle class has been forced into against their will and their own prudent mindset, due to the Federal reserves policies of trying to force an economic rebound by manipulating the rates of borrowing and saving.  So over the course of the last 7 years, every step the Federal reserve has taken has benefited the top 1% in every way possible, and hurt the middle class in every way possible.  (And thats just the last 7 years, look back over the last 100 years, as I have spent my entire career doing and I assure you, the same basic outline has not changed) So as we look at the problems with the wealth gap, and the left blames big business, and the right blames government (that is assuming those on the right even bother to bring up the subject of wealth gap to begin with)  let us all look at the actual evidence laid before us, because the real culprit in this is, and always has been our money system and how it functions.  

Europe has been endlessly in the news recently as some of it's countries are beginning to default on their massive debt holdings and are rolling over into a depression, like Greece.  I see a lot of people on the right have proudly exclaimed that, "This is what happens when a Socialist society fails".  Ok, I will not argue Greece is failing, I will also not argue that they more often than not, have been more of a socialist society then say, America, or Japan.  Speaking of Japan, that CAPITALIST society, which has 10.3 trillion dollars in debt, which is 250% of their GDP vs Greece's debt of only 175% of GDP, who has been in an economic standstill and has been suffering massive deflation for almost 2 decades, I would argue it is also a "failure".  So one could look also at Japan, and argue this is what happens when a capitalist society fails.  Hmm, pretty similar. So clearly one can take away from this that the "answer" to our problems is not at all a debate of capitalism vs socialism.  Throughout Japan's history, and Europe's as well as our own, we have all had a fair share of politicians in power that have been both on the conservative right side of things, as well as the more liberal left.  Despite the best efforts on either side, here we still are.  So the meaningless debate over republican vs democrat, as if your guy getting elected will magically fix everything and the other guy will always be "Hitler", is also pointless.  The simple fact is, the barometer, the yard stick, the unit of measurement for which we judge all things for which all economic activity calculated, for which wealth, minimum wage, spending, budgets, jobs, welfare benefits, every aspect of everything is calculated, is the US dollar; our money system.  If you want to live in a world where politicians can't spend $4 trillion dollars on illegal wars in the middle east, where governments can't endlessly borrow money to fund it's own bureaucracies, where the richest 1% don't have access to 100% of the money supply while everyone else gets trampled, where minimum wage keeps up with the cost of living, where a dollar spent as a consumer is equal to a dollar earned as an employee is equal to a dollar earned to the investor is equal to a dollar earned by the CEO, across the board, linear for small businesses as well as large and individuals, then you need to realize who your real fight is against.  The money system itself, not the specific politicians, not the economic system.

In conclusion, no one really knows what will happen today but it looks as if NOT raising rates today will be a massive disappointment. I think the likelihood is they do raise, and I described a likely scenario going forward if that is the case.  What happens today will paint the picture of the next few years to come and the general trend going forward, whatever that may be.  We will find out soon. No matter which way this goes, at 2pm EST today, will be the most important event for the economy and financial markets in almost 7 years.

-Jonathan M Mergott

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