Wednesday, September 22, 2010

Another Epically Good Post By Karl Denninger

From Market Ticker (The Folly Of Investing Today):

Investing is all about trying to determine a longer-term direction for the market such that risk and reward align in some meaningful way.

Yesterday, on Blogtalk, I stated that I was pulling all of my long-term investments that were market-related, and for an indeterminate time forward I would be only short-term trading this market.
That deserves an explanation, and toward this end, I would like to present the following 10 year weekly chart.



The regular "trace" is the S&P 500 price.  The white trace is the 10 year Treasury yield as a comparative.

You need to pay attention to this.

"This time it's different" is often said.

It is almost always wrong, and believing in it will almost always make you broke.

Here's reality folks.  Over the previous 10 years the TNX has never declined meaningfully without the S&P 500 following it, and declining to near or below it on a comparative basis.
The TNX almost always leads on declines too, sometimes by as much as six months.

Well, it's been six months.

In 2007, the TNX peaked in late June, after which it began a dive.  The market peaked in the middle of October of that year at 1576.  The decline essentially reached the comparative bottom.
Now the TNX has peaked the first week of April of this year, and is quite close to the March 2009 lows.  Yet the S&P, after it took a swoon, has recovered.

Exactly as it did in 2007.

We all know what came next.

The same thing happened in 2000, when the market peaked and fell apart.  Again, the TNX led.  It in fact peaked almost exactly at the end of the year in 1999. Three months later "it" began.
The TNX move today, as I outlined in Ticks in real-time, broke a triangle formation that should have moved higher.  That was a continuation pattern.  Instead, it broke the wrong way - hard - even before The Fed announcement.  After The Fed announcement the move was accentuated dramatically.


This is not a sign of "improvement" nor is it a sign to "buy stocks", as Cramer claimed today after the FOMC announcement.  To the contrary.  It is a strong signal to sell everything and get the hell away from the stock market.  It is an indication that the market should, if it follows past precedent, decline by as much as 30%, and perhaps more.

The market usually leads the TNX when it bottoms and the market heads higher.
The TNX always leads the market when it declines.
The 2yr is at all time record low yields.
Lower than during the decline in 2008 and 2009.
This strongly implies that the March 2009 "666" low in the S&P 500 is NOT a "generational low", AND IT WILL IN FACT BE BREACHED.

The bond market is very, very rarely wrong folks.  When it disagrees with equities you're a fool to believe the equities, unless of course you hate money.

This has always been true, and it will always be true.

The market is "betting" that Bernanke will come in with more "Quantitative Easing", or even better, that it can force Bernanke to implement more "Quantitative Easing."  Japan in fact did this, and has continued to do so.

Where was the all-time high in the Nikkei 225, and where does it trade now?  Did it ever get back to those highs?

No.

Does Japan have a massive foreign account deficit?  No - they have a foreign account surplus.  Their debt is owed to Japanese - not to foreigners, as ours is.

"Quantitative Easing" is a scam.  It's yet another sop and fraud to allow the government to deficit spend "allegedly" without consequence.  It covered $1 trillion of deficit spending the last time.  If they do come in again all they will do is cover another $1 trillion in deficit spending by the government, while your actual disposable income in terms of goods and services will see yet more declines, just as occurred from 2000-2010.

That's all folks.

The "scam" part of it is that there is no way The Fed can ever reduce it's balance sheet once it does
this, because to do so the government will have to decrease spending by an equivalent amount to that "eased."  It will never do so.  Not voluntarily, anyway.  Gold is moving higher on the bet that the attempt to "allow" continued government spending will fail and ultimately the government will be forced to default (either literally or through massive unsterilized money printing that destroys the currency.)  I don't think that will prove correct - I think our foreign creditors will pull our credit card first.  But that's what Gold is saying, and if Gold is right, then America as a nation is finished, and our government will eventually dissolve either into outright tyranny or civil war and you will be THROWING your gold at people to defend yourself.

The only way The Fed can "fix" the market and economy in the intermediate term is to raise rates.  That is, remove liquidity and force rates higher.  Doing so will cause the TNX to rise along with the rest of the yield curve. 

It will also shut down the Federal Government's deficit spending binge immediately as they will not be able to fund both that binge and the (higher) interest payments on the debt.

Bernanke is not going to do it.
Not now, not ever, unless he is forced by external events, and I believe eventually he WILL be

Unlike Japan we cannot play this game as they did, simply because of our foreign account deficits.  Japan got away with it for as long as they did for that reason, but even their capacity to do so is becoming strained.

The simple truth is that Bernanke can't pull liquidity at the present time because the government is spending all of its tax receipts paying for entitlements.

Even if the economy "recovers" he still can't do it because doing so means that interest expense would more than double, and the government doesn't have the money now and won't even under a rosy economic recovery scenario.

This is an environment in which it makes sense to own stocks as investments? 

The hell it does.

This is a classic "death spiral" situation and equity valuations are in a severe bubble as a consequence of all the government "cheese", despite "appearing" to be "cheap."

Bernanke has bricked himself into the outhouse and he knows it.  Thus, all the "soft threats" to "quantitative ease" and all the screaming from both the left and right for yet more of it - both sides know exactly what sort of box they're trapped in, and it's a box of their own design.
Oh sure, there can be short-term pops in the market.  They might even last months.  There could even be parabolic moves upward.  The Nikkei has had several of them.

But you cannot invest in them. 

You can trade them, and if you have the time and patience to do so in a dispassionate fashion then have at it, but you cannot invest in equities, nor can you buy any coupon (bonds) with any sort of meaningful duration.

If you do, you will ultimately be destroyed.

Those pension funds and other investors who are "reaching for yield" and "reaching for risk" at the present time are making the biggest mistake of their lives.  It is inevitable that this strategy will fail and when it does what you formerly thought was "safe" - whether it be your pension, your Social Security, your Medicare, your kid's prepaid college education - all of it will be gone.
This preoccupation with Bernanke's folly is not only unhealthy, it is certifiably insane.

The TNX does not lie folks.

It has not in the past - not even when "Easy Al" was running the joint and handing out money like candy.  Nor has it this time, with Bernanke doing the exact same thing Easy Al was doing.
Policies haven't changed and until they do neither will market relationships.
Act as you deem best, but ignore the bond market at your considerable peril.
It is rarely wrong.

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