Welcome back to What’s Happening Now, your weekly guide to what’s going on right now and why it matters to you – and your money.
In this topsy-turvy world of Fed markets rather than stock markets, bad news (as in the economy is worsening) can often translate to good news to investors, because it means more Fed “support” – i.e. the “faking it” policies of a now openly rigged to fail market.
Coming off a week with no less than seven Fed officials, including Fed Chair Jerome Powell, opining on interest rates and the state of the economy, markets closed last week confused for good reason.
We’re going to dive into why what the Fed says doesn’t matter; rather, it’s what it does and how the markets react to it…
History Doesn’t Repeat Itself, But…
Back in January of 2008, then-Fed Chair Alan Greenspan famously said, “The Federal Reserve is not currently forecasting a recession.”
Unbeknownst to the so-called Fed “leadership,” the Great Recession of 2008-2009 had in fact already begun the month prior- in December of 2007.
Not shocking. But drumroll more of the same…
Last Wednesday, the now-retired Mr. Greenspan told CNBC that the stock market will determine the next recession.
How’s that for extraordinary guidance from above? Not only is this a statement of “duh,” it’s likely not even correct. In fact, it’s more likely that a recession on Main Street will lead to a market fall.
Here’s a jewel from our current Fed Chairman…
Speaking from Zurich, Powell said, “Our main expectation is not at all that there will be a recession, either in the U.S. or the global economy.”Sound familiar?
Wow. This is the leadership equivalent of saying the sun sets in the East and rises in the West. Thanks, Mr. Powell, for the continued straight talk…
But as Mark Twain said: “History doesn’t repeat itself, but it often rhymes.”
In other words, waiting for an honest word to come down from the Eccles Building is like waiting for Lance Armstrong to admit to artificially enhancing his performance. Eventually, it will take disgrace (i.e. a crash) rather than courage for the Fed to confess its sins.
This now means it’s not what the Fed says, but rather, it’s how the markets react to what the Fed says (and does) that matters most.
And that’s why our latest risk tool, something we call the “Fed Red Day,” is so critical, as it measures the market’s response to Fed actions, not words.
We’re calling it “Fed Red Day” because it’s bad news when stock markets fall on good news (i.e. the Fed drops rates and markets fall). Red is bad; folks long the stock market will lose = red ink.
Here’s how it works and here’s how it’s derived…
Cause and Effect
A market’s adverse reaction to good news (and a market’s gleeful reaction to bad news) is more telling than the news itself.
Such distorted scenarios of cause and effect are valuable tools when it comes to assessing what’s next.
That is, a “good” cause that generates a bad effect can mark turning points.
By example, when it comes to equity markets, the S&P 500 Index should go up when rates go down, right? After all, lower rates make it easier (as for over a decade) for companies to borrow, invest, spend, whatever.
Today’s markets should thus be just itching to roar forward, if the Fed would just assist with more rate cuts, right?
Well, not so fast…
Here’s the thing… markets don’t always go up when rates go down. There are times when rates go down and no one salutes. That’s a bad sign…
Take July 31, 2019, for example. Powell’s Fed lowered rates by 25bps. That’s supposed to be good news. Markets should have gone up… except they didn’t. On July 31, the S&P 500 Index fell 1.09%, the Dow Jones Index fell 1.23%, and the Nasdaq Composite Index fell 1.18%.
Rates down, markets down. That’s what we call a Fed Red Day.
Fed Red Days occur when investors are nervous, because there’s something down in that coal mine that’s suffocating the canary.
The fancy folks at the Fed get this, but they won’t say it. They see a wheezing canary now and are trying to pump down a little fresh air (low rates) to encourage a longer life. Trouble is, the canary’s not buying it; the air being pumped down is not fresh, but old and stale (10+ years of stalling “stimulus”).
This canary has been down in that coalmine for over a decade now and it sees that time is running out. It sees that growth is slowing, that tariff wars are impacting, and that investors are flocking to the good, the bad, and the ugly like headless chickens – some going the wrong way into increasingly overvalued and toxic stocks while others are wisely seeking the fresher air of cash and precious metals.
Now, there’s a pattern here…
Rates and Dates
Let’s do the math.
Going back to January 1990, there have been three recessionary periods: (1) the Oil Price Shock Recession in the early 1990s, (2) the Dot.Com Bubble Recession in the early 2000s, and (3) the Great Recession of 2008-2009.
During these three recessions, the Fed lowered rates 40 times, and in the majority of those times (55%), the S&P 500 Index fell because the then underlying economy (that canary in the coalmine) was suffocating.
In the Oil and the Dot.Com recessions, equities rallied on the first Fed rate drop. Makes sense. Thanks for the Kool-Aid. But in both instances, Fed Red Days kicked in on the very next rate drop and the rest was history.
During the Great Recession, early forgiveness was apparent. No Fed Red Days until the third drop in rates. Then the partying was over. The Kool-Aid had run dry.
That’s how you know you’re in a recession before NERB tells you. Fed Red Days start popping up.
Where Are We Now?
You already know… and it’s worse. The first Fed Red Day appeared on July 31, the day of the very first rate cut since the Great Recession. Fed Chair Jerome Powell said that day, “The outlook for the U.S. economy remains favorable and this action is designed to support that outlook.”
We now know what happened by the close on that day (above). The Dow Jones Industrial Average fell more than 450 points intraday before paring losses to close down 334 points, or 1.2%. The S&P 500 and the Nasdaq both fell more than 1%.
Again, don’t trust what the Fed says. Do as the markets tell you.
This was a classic “Fed Red Day.”The canary was coughing.
You see… markets and market canaries are smarter than the Fed – always have been. Markets know when the game is up. And this time, unlike the last three times, there has been no first rate cut forgiveness. Again, investors sold on the very first Fed Red Day.
Some say that was driven more by tariff tweet escalations than Fed moves. Maybe yes, maybe no. Maybe both? Let’s wait and see what happens with the next rate cut.
The FOMC next meets to determine rates on Tuesday-Wednesday, September 17-18 (then again on October 29-20 and December 10-11). Mark your calendar. If the Fed cuts again on September 18 and markets fall by the close, look out below.
That’d be not just one, but two Fed Red Days in succession, which would be worse than in all three prior recessions. Let’s wait and watch.
Two Fed Red Days in a Row
How could this happen? So many reasons. Storm Tracker is clocking at 45-47 knots, holding steady over all the bad stuff we’ve been writing about.
Déjà Vu (the spread between the stock market and interest rates) is stretched to the breaking point, much because global interest rates are so low (even negative) as global yield curves tumble to mind-blowing levels of crazy.
In the chart below, we’ve plotted the latest yield curves from China, the U.S., Japan, and the Eurozone, in that order, ranked high to low. And herein lay two good reasons why markets may selloff on the next Fed rate drop, creating two Fed Red Days in a row.
First, even if the Fed took rates down by 50bps, you can see above that 50bps would be insufficient to straighten out the U.S yield curve. It would, indeed, remain inverted. Problem not solved.
Second, the faster the Fed takes rates down on the short end (and the markets take them down on the long end), the faster our yield curve will shift towards the Zero % Line – the point of no return when it comes to entering negative interest rate territory.
Japan and the Eurozone are already cooked. Dead canaries.
The bottom line is this: It won’t be the dumb money that sells if rates go down in September. The dumb money will buy the Kool-Aid, not sell it. It’ll be the smart money that takes the markets down… and if that happens, there’s your second Fed Red Day, signaling recession at hand and doing so ahead of the NBER.
Useful? Let us know in the comment box below.
In the interim, and as an homage to my law school days, let’s always consider the other side of the argument as well.
For example, the U.S. may be technically (think yield curves) and fundamentally (think skyrocketing CAPE multiples) sick, but we are still not as sick as the rest of the world.
As the last horse standing in the global glue factory, we may continue to see bullish flows from Asian and European markets coming into our dying, but relatively “better” markets. This buys time and “air,” but that air is foul and loaded with risk.
As always, your reader questions and comments have been excellent. Given the numbers, we try to address them collectively, as there’s just less and less space to answer them individually here.
When gold questions came pouring in from folks like Neil and Richard T., we followed up with a gold column; the same was true when folks like Sumanlal K., Ben, and Mindy H. were asking about retirement concerns, which prompted our most recent series on pension funds.
We pledge to keep future critiques and updates in line with YOUR concerns and questions, which we track carefully. After all, that’s why we’re here.
Moving on, this week is a heavy week for consumer data. Just how much longer can consumer confidence hold up as economic sentiment tumbles? Retail sales and preliminary consumer sentiment numbers will give us some more clues by Friday.
Stay tuned for the next part of the pension debacle this Wednesday, as I’ll disclose just how risk-loaded pension funds are and how their very fall could accelerate the speed, depth, and range of the next recession.
In the meantime, stay well, stay informed, and stay prepared.
9 responses to “What the Fed Says Doesn’t Matter: Here’s Why”
September 09 2019