Today the market was waiting on pins and needles for Janet Yellen to tell us her omniscient perspective on the state of the economy. And further to let us in on what the all-knowing Fed will be doing to rates. Ok I am being facetious, the market shot up 1% in the first couple minutes of the trading day and so the indication was that the market knew exactly what Janet was going to say, which essentially is whatever it takes to make markets move up 1% in a few minutes. We should note the market didn’t move during her speech so there really was no surprise. The rhetoric leading up to the Fed chair comments was ridiculous. I mean we all know that Janet goofed in her last speech trying to gauge what the market saw as enough time lapse post taper to be raising rates. Janet thought the market would feel 6 months was sufficient but oh boy did she miscalculate. And so this time round she was simply going to iterate that interest rates will stay zero as long as the market dictated they should remain zero and the market knew that upon market open.
There are a couple things to note about the Fed today. First is that the Fed’s old objective of keeping the economy in equilibrium (whatever that means) is an extremely difficult thing to do and many believe Fed actions do the exact opposite. That is, Fed actions create disequilibrium, namely booms and busts, a perspective that empirical historical data certainly supports. The second take away is that the Fed has been reduced to an objective of trying to control market behaviour (i.e. forward guidance). The glaring reality is that the market is controlling Fed behaviour. While this little dance between the Fed and the market carries on, the economy continues its decline. Perhaps the Fed now understands it has very little affect on the economy and that the economy is in bad shape and so the only thing it can reasonably hope to move is an upward market which provides the only message mass media rhetoricians can point to as a positive. Well that and inflation is not affecting the wealthy at this point.
We get a glimpse now and again that even the Fed recognizes the fact that the economy is in decline despite the ‘indicators’ suggesting improvement. For instance, the purchase program was supposed to end when U3 unemployment hit 6.5%. Well despite U3 moving to 6.5% and the executive branch of the government touting a huge success the Fed actually discontinued use of U3 as an effective benchmark. They qualified their action suggesting they weren’t abandoning U3 because it isn’t a good measure but for ‘other reasons’ that were not expressed. Well we all understand that if something works well one doesn’t abandon it. The reality is that U3 doesn’t give a true read of the employment status of the overall economy and so despite U3 indicating all is good with the job market the Fed recognized that U3 simply does not represent reality. Moving to U6 would require an explanation that the job market in the US is still very much the overwhelming problem in the economy and so that was not an option.
So look, the point to all of this is that the Fed is going to continue to work toward an upward moving market because there is nothing else it can do. If you are a trader you have a free put option on all long positions. This does not mean the market will necessarily move up but the market can certainly be a self fulfilling prophecy. So as long as everyone in the market believes it will go up it should continue to go up especially with a free put option provided by the Fed. So until there is a shock that unnerves the market beyond the free put, markets should continue to go up. This will provide sufficient rhetoric by talking heads to convince the American people that all is fine here in America. And so the spending will continue, the printing will continue, the inflation build and debt build will continue and thus the destruction catalyst will continue to build like pressure in a geological fault line. Similarly to fault lines, the amount of pressure that builds without relief in the economy leads to much more devastation once the pressure does release.
As with earthquakes we simply cannot predict the timing of the release. What I can say for sure is that those who are willing to give up some of these undeserved market gains and build their economic fallout shelters will be far better off subsequent to the fallout.
Have a look at the following charts which depicts the amount of profits being reinvested back into the economy versus being sent out as dividends (essentially simply paying out to top 1%) . The concept is that reinvestment should lead to expansion of the economy (production and jobs) whereas less reinvestment should lead to less expansion and even contraction. Corporations must allocate profits to where they see the most potential upside. The attached chart makes it clear those generating most of the income in the US are not confident enough in our economy to reinvest that income back into the economy. This is the main catalyst for a deteriorating economy. As the financial market can be a self fulfilling prophecy so too can be the economy. Where market investor beliefs are creating an upward moving market, economic investor beliefs are creating a downward moving economy and no amount of printing will push economic investors who are not confident in an economy to allocate capital to that economy. Not even at 0% interest rates as has been proven over the past 5 years. Relative value is in favour of the market and not the economy. Meaning there is a much greater probability those with capital can make better returns in the financial market than in the US economy and hence we get the following charts.
Dividends as % of GDP