Home > Uncategorized > 2011/08/10: How We Got Here-IV: Welcome to the Island, Survivor (…we hope)

2011/08/10: How We Got Here-IV: Welcome to the Island, Survivor (…we hope)

Yep, it seems to have all turned into a big game of Survivor… And the two-way stretch from the stress factors is obvious. Getting through this is going to be a test of who can stand the huge amount of cognitive dissonance imposed from the outside. That includes the increasingly tedious and blindingly benighted machinations of the political class and alleged financial luminaries, and the radical, rabid dog reactions it foments in the markets.

It increasingly seems this is going to be a test of endurance, as Ben Bernanke was probably right to indicate that there won’t be much need to raise rates between now and mid-2013. In other words, after his previous soothing views on the economy and markets, the Fed head has thrown in the towel on expecting anything truly positive to develop in the intermediate term. And that’s not just us playing off his perceptions, as we have been great skeptics of the ability to return to an upbeat economic environment in spite of any improvement in equities and risk assets. And neither is it plain old bearish talk. Beyond the fiscal and debt ceiling dilemmas, there is good reason to believe it can’t get better this side of the next US general election.

That is because it is going to be impossible to address the real problem facing the US economy while Mr. Obama still resides at 1600 Pennsylvania Ave. regardless of how far they get in any surface level address of the spending problem, as sheer cuts in federal budgets are going to make much difference. Not while business is feeling overregulated to the degree it is restraining their desire to Invest in America. JP Morgan head Jamie Dimon was on CNBC today pointing out how the highly partisan nature of the US government means that everything happens on an emergency basis at the last minute (like the recent mediocre Debt Ceiling deal.) As such, US domestic policy is (in his words) “incoherent and inconsistent.”

Well, in that case why don’t we just get Congress to play nice, and tell the centrists to start ignoring the bomb throwers in the extreme wing of each party? That won’t help. This is because the US CEO sitting at 1600 Pennsylvania Ave. will absolutely not sign any significant regulatory reform legislation. In fact, the social justice agenda has seen major legislative efforts to push it ever further out to the fringe (Obamacare, Dodd-Frank, etc.); and there is no way the President will sign any bill that significantly reduces it.

An even greater disincentive to business expansion than taxes rests with the additional regulatory burdens that have been enacted by Executive Order. This includes the highly aggressive activity on the part of the Environmental Protection Agency, National Labor Relations Board, and others to implement those parts of the social justice agenda that Mr. Obama could not get passed as legislation. It would be pretty inconsistent to think he’d reverse any of the edicts he had created as part of an end run around Congressional rejection of similar legislative efforts (even when the Democrats had control of Congress.)

General Market Observations

And that is why it’s hard to see the US economy strengthening again to any degree unless and until the Republicans replace Mr. Obama at the end of 2012. That also makes it very interesting that Ben Bernanke should allow that he doesn’t see where he’ll have any reason to raise the US base rates until the middle of 2013. In the first instance, the fact that he gave no indication he would be ready to provide further quantitative easing was a very important change of sentiment on his part. He has joined S&P in putting it back on the politicians.

In sequence they have said they can’t just keep mindlessly providing a debt rating that’s not reflecting the bad path (NOT the inability to pay) that the US is on, and can’t keep pumping liquidity. I think even Bernanke now realizes the hugely counterproductive side effects of QE (which it is now plain was generally bad for the economy even if it boosted assets/portfolios.) It’s also important as an answer to that question many will continue to ask after the Fed has stemmed the tide of disaster several times: “What’s the Fed going to do?” That would seem to have been clear from the lack of any reference to quantitative easing in a very downbeat FOMC statement. Bernanke’s answer to vox populi and their representatives in Washington DC on the next Fed move? “We got nuthin’; except for not worrying about a rate hike, you’re on your own.”

So unless there is some miraculous change of heart on a regulation reform consensus in Washington DC, it’ll likely get worse before it gets better no matter what they do in the near term on the budget. A client who is one of the more astute observers of long-term cycles as well as being an excellent portfolio manager reminded us of something we discussed as the markets and economy were recovering back in 2009. What are the chances the 4.0% growth rates that we saw back in 2006 might’ve been a steroidal bubble level of economic turnover that was driven by the credit and housing bubbles?

What if the natural level of sustained growth is something more on the order of 2.0%-2.5%? Of course, under the current circumstances it might be questionable whether it could even perform that well with the regulatory drags that are currently impacting it. So there’s just one problem with all these fiscal reform plans that are being floated, whether it’s Simpson-Bowles, Ryan, Obama, Domenici-Rivlin, or any others: they all operate under the assumption of a return to 4.0% growth.

And neither that, nor anything resembling it is likely to happen until after the next US general election; and only if indeed the Republicans manage to take control the White House, and institute major regulatory reform. In the meantime we are likely to see dramatic fiscal reform lead only to the same sort of results as occurred in the Greek learning laboratory: a weak economy made weaker by less government spending will not deliver the tax revenues necessary to fulfill the improved projections.

Even one of the other pet plans to jumpstart the US economy isn’t going to do much good in the near term: a tax holiday for the repatriation of US corporate profits held offshore. Once again, a huge amount of liquidity coming back into a system where it cannot be transmitted to the grass-roots level to create jobs, because businesses feel constrained. As one wag put it today on CNBC, it’s like gunning your engine with the transmission in neutral. You’re likely to just overheat while not getting anywhere.

So in spite of the fact that pretty much all Americans would like to think that the suffering of the past few years was the price to pay for previous excesses, it seems that movie has a sequel: get ready for “Lousy Economy II” opening soon at the Survivor Island Drive-in. It’s likely to be a tedious grind as the equities alternate dramatic downdrafts with somewhat sustained rebounds and holding actions. We think that Ben Bernanke is probably right. Mid-2013 is not only six months into the new Congress after the general election; on historic form it is also the classical five-year horizon for the deleveraging of a major credit bubble (1929-1934; 1969-1974.) Hmmm.


The Mad Dog Market on the downside of equities at least seems to be responding to the inoculation administered by the major upside shockwave from Tuesday’s massive late session recovery. Which is not to say it’s necessarily a bull market again, yet does seem to be developing a more orderly (of still volatile) two-way trade. That might be indicative of a market that will continue to hold the September S&P 500 future 1,100-1,090 support; just as it did yesterday, even though it hit it while making a new low for the day session with barely an hour to go prior to the Closing bell.

However, even any stabilization would feel significantly like the recovery after the sharp selloff in early 2008. Not that we are necessarily projecting that this market will head back to the 2009 lows. But after the sort of damage the market has experienced over the past two weeks, it is important to note that Tuesday’s major short-term recovery was only back to levels that are still significantly lower on the week. That is also still below the significant Fibonacci confluence in the 1,192-1,185 range, leaves a not insignificant gap lower from last week’s 1,197.80 Close, and that there is still hefty congestion and failed Fibonacci support up into the 1,116-28 range.

All of which is also somewhat below the major combined channel and Head & Shoulders Top DOWN Breaks in the 1,260-65 area that got the whole downside debacle rolling from Tuesday of last week. While there is also lower support into the 1,050 and 1,000 areas (fresh and from last summer), any break to those levels might damage the market’s ability to push back above the important mid-1,100 area again anytime soon.

The indication of short rates remaining low for the next two years and initial post-FOMC statement drop in the equities provided the September T-note future with a rationale to push out decisively above its somewhat major historic 128-01/-08 resistance (including November 2010 high prior to the QE2 implementation debacle.) Not surprisingly, that led to an immediate surge to the 129-28 December 2008 high Close, with the 130-20 high also from December 2008 as the next resistance. Much above that, oscillator projections suggest a swing to at least 132-00 area or even higher is possible.

Of course, the strange bedfellows on this entire cycle have been the government bonds and Gold. As the yellow metal was classically a harbinger of inflation back in the 1970s, there was a massive bond market break as a counterpoint to Gold’s inflation hedge rally. While we have not been tempted at any point to fight a technical trend that has been as solidly bullish as the Gold market, it was a bit counterintuitive to stay committed to it during those phases when all the govvies were also strong. Yet, what can we say about a market that Runaway Gapped out above a major channel topping line at 1,685 on Monday, and is seemingly on its way to the Objective and major oscillator resistance (from back in January of 1980) in the 1,900 area?

Two market geniuses of years gone by come to mind. W. D. Gann’s famous adage was, “Never fight the tape.” And in addition to Gold this time around, it’s probably advice that many of the bond ‘vigilantes’ wish they would’ve taken long before this juncture. Buried in an obscure couple of pages of R. N. Elliott’s seminal works on the retracement aspects of wave theory is the insight that it never happens exactly the same way twice in a row. The current combined government bond and Gold mega-rally is certainly paying homage to that little gem of a market insight.

Thanks for your interest.

    August 11, 2011 at 10:25 AM

    Interesting perspective on the politics of Fed.

    Just the other day I heard in the news (it is outisde the US) some expert say that the particulars of QE3 had been already “presented to, and agreed upon by, both fractions of the Republicans (the House and the Senate)

    Any truth to that?

  2. August 11, 2011 at 10:41 AM

    That’s a very good question. I’m not a big Fed watcher, so not tuned into that channel. What I will tell you is that it is likely this is a contingency plan; just like the ones SAC used to have for a retalitory strike against the Ruskies… and much like that sort of situation (opposed to what quite a few of the bulls have postulated or hope) they can’t justify it unless and untill the equities are quite a bit lower. That is due to the obvious pernicious QE side effects we saw from the last round.

    As such, my near term bearish view is more likely than not to be right (especially failing after any significant rebound) until we see more definitive hints of QE3 that won’t occur uless the equities continue to weaken… just like last year.

  3. August 11, 2011 at 3:04 PM

    The only thing not mentioned is that the financial well being of corporate executives are tied to compensation packages. These comp packages recognize profit and loss. CEO’s recognize that hiring staff is a cost. There is no incentive to hire while Rome Burns; the workers are rowing exceedingly hard (productivity is way up under the lash).

    Why change course when feathering your own pocket works so well for the individual corporation? Doesn’t work so well from a larger societal sense, but then again corporations aren’t set up to be social animals.

    Just adding a note to your analysis…

    • August 12, 2011 at 5:54 AM

      All true, yet with one other factor… stockholders. And that’s the only reason the situation will improve if the reduced regulation clears the way for more corporate investment: the competition is going to invest in expansion in that case, and the execs will need to show they are also in the renewed economic growth game…

      …which is kind of like a poker table where the stockholders want to see good growth compared to the competition, or the execs can get canned. Everyone is watching the other players’ betting structure, and right now they’re all standing pat. As soon as one shows it is confident enough to up the ante, the others need to respond to that bet. None of which will happen while they are all content to play it safe based on the collective fear of regulatory drags. It’s all back to Keynes ‘animal spirits’ insight, and right now they’re content to hibernate.

    • christopher maytum
      August 15, 2011 at 2:35 PM

      Kent – Power without responsibility, the prerogative of the harlot throughout the ages – Stanley Baldwin, in denouncing newspaper proprietors eighty years ago but a remark that could apply to all those ‘managers’, who enjoy employee stock options, with the attached benefits of employee options and their pre-emptive rights, over genuine stockholders. I think that sounds like communism – at the top!!

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