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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Central Bank Turkeys Tell Tall Tales

Stock-Markets / Financial Markets 2011 Nov 13, 2011 - 01:55 AM GMT

By: Barry_M_Ferguson


Best Financial Markets Analysis ArticleAs the calendar approaches the US holiday of Thanksgiving, we should all reflect on our blessings with thankful humility. For those of us fortunate enough to afford it, we will enjoy a traditional meal of turkey and vegetables. For those of us that seek capital appreciation through the stock markets, we should give thanks that we have money to invest, the brain power to direct our investments, and the courage to risk our capital. Most of all, we should be thankful that our world is now dominated with turkeys telling tall tales. The truth is ugly. Tall tales are pretty. The stock market responds to tall tales and the turkeys that disseminate them. Our brain power allows us to understand the truth and invest with the tall tales!

Let’s examine the turkey.

Here is a headline from a financial news webpage posted on November 10, 2011: ‘Bernanke Says Fed Focusing On Jobs, Sees Low Inflation’. The very next headline read, ‘Traditional turkey dinner costs 13% more than a year ago’. I think we all know the truth. Inflation is swelling like a currency drowning tsunami and a 13% rise in the cost of a turkey dinner from a year ago affirms this trend. Yet, the Fed Chairman denies truth either because he is either disingenuous or because his formulas are constructed to affirm the tall tale that makes the stock market go higher. Maybe the Fed is by function disingenuous! They have certainly become preposterous. But, they do make stock prices inflate higher!

Mr. Ahmadinejad vehemently denies Iranian aspirations to possess a nuclear weapon (despite much evidence to the contrary) but says at the same time that his country won’t back down one iota from their nuclear program. If there is no program, there is nothing from which to back down. A nuclear-armed Iran would likely change investment dynamics but the stock market prefers the tall tale.

A leading financial newspaper just reported in early November, 2011, that ‘More Housing Markets Improve’. They even have a nice little graph showing a steady rise in the number of improving markets. On the same page, they have a story that is titled, ‘Home Redos, Improvements Aren’t Paying’. That story goes on to report that home improvement projects are only recouping 58 cents on the expended dollar in terms of home equity. If housing was really improving, one would think that remodeling would be paying off. Again, the truth would make the stock market go down. The tall tale will make the stock market rise.

As for Europe’s current debt crisis, the ECB said that governments should do more to correct the euro zone’s debt problems rather than the central bank. ECB policymaker, Klaas Knot was reported to say, ‘There is not much more that can be expected of us’. Of course, as Italy’s 10-year note yields spiked above 7% for a day, the yield magically and immediately began a retreat. Nearly everyone on the planet believes the ECB was the buyer of Italian debt that resulted in the yield decline. This 7% Italian debt yield is widely believed to be ‘unsustainable’ and of course, Prime Minister Berlusconi was forced to resign. A central banker sympathizer was installed as the leader of Italy. A few days earlier, Greece’s Prime Minister ceded control to Mr. Papademos - a former central banker. The truth is sovereign debt is crushing the economies of countries that live beyond their means.  The debt is tied to derivatives and swaps. Debt default would trigger exponential banking losses and that would surely hurt the stock market. It won’t be allowed. Either heads of state must bow to central banker control or those heads of state must resign. The stock market would rather believe that economic stranglehold and central banker continuation of perpetual debt is the solution to sovereign debt that cannot be repaid. That is a tall tale that gives rise to the stock markets.

Back to the US, the Labor Department reported that October import costs ‘unexpectedly fell’. Really? I guess the US does not import turkeys. But I digress. Let us know the truth. The US Commerce Department (known to my readers as the DOPE or Department Of Pathological Embellishment) just reported that September 2011 enjoyed a narrowing trade deficit. According to the US Census Bureau, Canada is the recipient of 18.8% of total US exports. In turn, the US is the recipient of about 75% of Canada’s exports. 50% of those exports are petroleum and auto related. While Statistics Canada reported that Canadian exports grew in the month to $39.7 billion or 4.2%, they cautioned that units exported only increased by 0.3%. The rest was due to a 3.9% rise in prices. Maybe the ‘units’ part of the report is most important. The Canadian government said that their economy lost 54,000 jobs in October - the most since the financial crisis of 2009. 71,000 of those were full-time positions while they added 17,000 part-time positions. Bear in mind that Canada is just behind China as the number two importer to the US with nearly 15% of all US imports. Canada said prices were up 3.9% on their exports in September. Did this trend suddenly reverse and show a price collapse in October? This has the makings of a tall tale by either the government of Canada or the government of the US!

To further this point, US officials report a shrinkage in the trade deficit in part because the US imported less oil. The truth is Canada’s imports to the US hit an all-time high and much of what they export to the US is energy related. Again, tall tales make the stock market rise.

How can we apply truth and tall tales to our portfolios? First, we have to acknowledge that turkeys tell tall tales. They do so to stay in power. If the populous knew the truth, there would be rioting throughout the world like we have never seen. To keep us pacified, the turkeys tell tall tales so our portfolios rise. Second, we must acknowledge the true effect of our turkeys. I have included a 15-year chart of the Dow Jones Industrial average (below) showing two blue rectangular boxes. The red/black line is the Dow, the gold line is the price of gold, and the green line is the CRX index (commodities basket). This chart is set to show performance of our three variables relative to one another. We can see that the Dow outperformed gold and commodities over the beginning of this period until about 2003. This is when the central bankers took over and decided to inflate the markets higher through currency devaluation. Did this strategy work?

Yes, stock indices did rise. As exemplified in the chart below, the Dow rose as the Fed printed US dollars in a currency devaluation process. In turn, a devalued dollar proved to be the launching pad of inflation as measured by the CRX and currency valuation erosion as measured by the rise in the price of gold. While stock prices may have appreciated, the true living standards of the populace decreased due to the rise of inflation. As investors, we must concentrate on the tall tale. Central banker manipulation has not led to any meaningful recovery in terms of affluence expansion. In fact, we have witnessed the reverse or an affluence contraction in that real affluence is now held in fewer hands. Poverty is increasing along with this trend. However, this central banker manipulation does affect the markets in a positive, yet inflationary way.

Notice the two blue rectangles. They are the periods now known as quantitative easing one and quantitative easing two. The Federal Reserve bought Treasuries and mortgage backed securities during these periods. No doubt, they also selected numerous opportunities to intervene in the stock markets via the PPT actions. What did the Fed use to buy these securities and thus expand their balance sheet by more than $2 trillion? What did the Federal Reserve Bank use to book nearly $90 billion in earnings in 2010 (three times the earnings of Exxon and Walmart combined)? I’ll let readers use their own imagination on that one but suffice to say it wasn’t their money. Clearly, the Dow experienced the positive inflationary effects of these actions.

That brings us to the present. Clearly September was a disastrous month for the stock indices. The Dow plummeted some 6%. It threatened to continue the same trend as the month of October began. The first two trading days of October were met with strong selling. Finally, the PPT had had enough on October 4, 2011 and enacted one of the most profound reversal days the markets have ever seen. In the last 45-minutes of trading, the PPT orchestrated a 400-point rally. This was apparently the signal that they stood ready and well armed to create another blue triangle of sorts. The Fed began ‘operation twist’. In a effort not to expand their balance sheet any more, the Fed is now buying longer maturity Treasuries while selling shorter maturity Treasuries. In truth, we must ask, ‘to whom are they selling short maturity Treasuries?’ We must assume market makers are facilitating this deal but why would anyone holding a Treasury yielding 2% (10-year Treasury yields) sell that security to buy a Treasury yielding .23% (2-year Treasury yields)? The Fed is committing about $40 billion a month to this program.

The point is the truth is not important. The tall tale makes the stock market go up. Turkeys tell the tales but judging from October, we may be at the beginning of another blue rectangle of market gains. See the chart below. 

DJIA in red/black, GOLD in gold, CRX in green - 15 years; Blue rectangles QE1 and QE2
Chart courtesy

Barry M. Ferguson, RFC
President, BMF Investments, Inc.
Primary Tel: 704.563.2960
Other Tel: 866.264.4980
Industry: Investment Advisory

Barry M. Ferguson, RFC is President and founder of BMF Investments, Inc. - a fee-based Investment Advisor in Charlotte, NC. He manages several different portfolios that are designed to be market driven and actively managed. Barry shares his unique perspective through his irreverent and very popular newsletter, Barry’s Bulls, authored the book, Navigating the Mind Fields of Investing Money, lectures on investing, and contributes investment articles to various professional publications. He is a member of the International Association of Registered Financial Consultants, the International Speakers Network, and was presented with the prestigious Cato Award for Distinguished Journalism in the Field of Financial Services in 2009.

© 2011 Copyright BMF Investments, Inc. - All Rights Reserved
Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented.

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