Late last week something remarkable happened. The Fed announced it would close out its quantitative easing program…and stocks went up. This occurrence is what a psychologist would call cognitive dissonance.
We’ll have more to say on this in a moment, but first a review of some of last week’s other key happenings. First off, the dollar rallied and commodities were obliterated. Given the inverse relationship between commodities and the dollar this price action makes sense.
This relationship was clearly at work on oil and gold prices. Oil dropped below $80 per barrel and gold fell to $1,172 per ounce. Obviously, the Fed putting a stop to its mad money creation scheme should be positive for the dollar.
With fewer digital monetary units being credited to the financial system each existing dollar should retain its value or become more valuable. Accordingly, items priced in dollars, such as oil and gold, should become cheaper. However, this is only part of the story…and last week’s feat is just one moment in time.
Remember, the Fed’s zero interest rate policy is still in effect. This, by definition, cheapens the price of money and credit. What we mean is the Fed’s still operating policies of inflation.
Perhaps, the new trend is dollar up, gold down. But we don’t see this being a long term trend that extends into next year. There are too many variables at play and too many factors that could compel the Fed to do something dumb.
This, you see, brings us back to the stock market…and the cognitive dissonance the market displayed. Quantitative easing has been the hot gas blowing into the stock market over the last five years. The Fed said quantitative easing would boost employment and stimulate the economy. But what it really did was levitate stocks.
So what should happen when the Fed turns off the gas? Should stocks go up? Don’t be silly. They should go down.
The stock market’s tie to the underlying economy was disconnected by monetary policy years ago. Thus, it doesn’t matter if the economy’s strengthening. In the short term, it doesn’t matter if corporate earnings are up. The gas propelling stocks onward and upward is being turned off.
Despite last week’s push into record territory for both the DOW and S&P 500, stocks are doomed. Sometime within the next several months they will crack. We expect this to happen before the end of the year.
Why You Should Prepare Now for the Fed’s Next Money Pumping Scheme
It is a simple axiom. Stocks go up and they go down. After going up without interruption for the last five years, in no small part because of quantitative easing, it is very likely stocks will go down.
Plus, without direct Fed purchases of financial assets, the stock market will need to adjust to this new paradigm. The world as we’ve known it for the last five years is gone. This we believe will drive stocks down.
Yet when the stock market drops in earnest, what will the Fed do? Will the Fed stand by and watch their handiwork evaporate? Or will they step up and blow more gas into financial markets?
By now we all know how this works. That is, the experience of the last 15-years – or more – indicates they will pump massive amounts of money and credit into the financial system. Maybe it will be through a new round of quantitative easing. Or maybe it will be through some new scheme they dream up.
More importantly, it will be inflationary. It will devalue the dollar. Moreover, while it may reinflate the stock market, it will certainly breathe new life into gold.
Prepare accordingly, while gold’s cheap and stocks are expensive.
for Economic Prism