June 25, 2014

When this rally could end

I have been thinking that a stock market top was likely based on the growing evidence of a rising rate of inflation and a decelerating rate of domestic economic growth -- something the fixed-income markets have sensed throughout 2014 and the Fed, again, failed to anticipate.

Moreover, my bearish argument has centered on the recognition that QE is now having a moderating impact on U.S. economic activity. Indeed, one can argue that QE is now having an adverse impact by penalizing the savings class, potentially impregnating our economy with inflation and worsening economic equality (among other factors).

Even if the Fed's policy is moderately effective, the burden of stimulating growth continues to ring hollow in Washington, D.C., where fiscal policy is inert -- and will continue to be so, especially with the recent defeat of Congressman Cantor.

The disconnect between the real economy and stock prices remains conspicuous. But, for now the markets are singing "Everything's Coming Up Roses," endorsing the notion that price is truth and ignoring this potentially toxic cocktail, instead assigning a Goldilocks  scenario (not too hot, not too cold) to the investment backdrop.

I had been discussing the potential for a speculative stock market blow-off, thinking it was occurring two weeks ago.
"A bull market is a lot like sex. It feels best just before it ends."  - Warren Buffett 

The June 18 rally resembled a Sotheby's auction of Jeff Koons' artwork -- frenetic and furious. Similar to my market top call, Koons' art has recently sold well above estimates.

That said, Yellen et al. are risking central bank credibility by ignoring the very metrics (employment and inflation) that were supposed to determine central bank policy.

So while investors rejoiced last week, it is quite possible that they will begin to focus on the intermediate-term effects of a Fed that is losing its credibility.

This could occur as soon as this week's PCE inflation rate is released.

And by then the rally might be old news.

Article originally published on June 19, 2014 on http://www.thestreet.com/story/12752208/1/fed-losing-cred-bull-market-in-complacency-might-crack-best-of-kass.html