September 21, 2015

Market expectations for growth is too ambitious

The Federal Reserve failed to hike interest rates ....and Fed Chair Janet Yellen's press conference afterward underscored the anemic outlook for global economic growth that I've been warning of for months.

Among other headwinds, Yellen cited credit-spread concerns. When Yellen said that any rate-rise decision would take into account the U.S. stock market, quant buy programs were quickly triggered and the markets immediately soared. (The S&P 500 made a 20-handle move in a matter of minutes.)

But as the wise man once said, "sic transit Gloria" -- stocks collapsed by over 30 handles when Yellen said the Fed "does not have to fully meet its objectives to tighten." This shifted the programs into reverse and back into sell mode. The two-year U.S. Treasury note dropped by the greatest daily amount (in yield) since the Fed announced Quantitative Easing 1 six years ago.

While faith, low interest rates and liquidity buoyed markets coming out of the recession, the "aha" moment now seems at hand.

For too long, our markets have been slaves to the largesse of monetary policy.

Since the 2009 Generational Bottom, U.S. stocks have risen based on extraordinary doses of liquidity injections and growing confidence that global easing will trickle down -- improving confidence, lifting job growth, buoying economies and propelling corporate profits to records.

But after six years, monetary policy has lost its ability to catalyze domestic economic growth. Indeed, zero interest rates and massive infusions of liquidity may already be having a negative impact on growth as the savings class is disadvantaged, forced to hoard cash and reduce personal expenditures.

Moreover, with the time value of money being negligible, there's little incentive for companies to expand plant, equipment and payrolls.

Even more importantly, monetary policy has pulled forward sales and taken away from future growth over the last few years. 

Compounding the Boom-and-Bust Cycle

The extended period of zero interest rates has produced and introduced a significant amount of excesses -- in valuations and in the degree of malinvestment across several asset classes. It's also accentuating a boom-and-bust element of our economy that up until recently had been dismissed by a consensus view that a self-sustaining recovery was in place.

The problem is that our fiscal and political leaders have abandoned policy under the influence of unprecedented partisanship, which will only get worse in a few weeks as another budget confrontation and government shutdown looms.

In the absence of reforming our tax code, reducing expensive regulatory burdens and improving our country's infrastructure, we're now hostage to both fiscal inertia and the impotence of "more cowbell" as a byproduct of present monetary policy.

Moreover, as confirmed by the Fed chair, we are now vulnerable to structural economic problems that reside outside of the United States.

Much like The Princess Bride, Yellen has revealed the notion of America as "an oasis of prosperity" to be a fairy tale told by Wall Street strategists and "perma-bulls" to market to innocents.

    "The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets. Developments since our July meeting -- including the drop in equity prices, the further appreciation of the dollar and a widening in risk spreads -- have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activity somewhat, and are likely to put further downward pressure on inflation in the near term. Given the significant economic and financial interconnections between the United States and the rest of the world, the situation abroad bears close watching."

    -- Fed Chair Janet Yellen, Sept. 17 press conference

True, those gains were abetted in part by quants who know nothing of balance sheets, income statements or the intrinsic value of equities. But I believe those machines, algorithms and levered ETF's have broken the market's mechanism and converted Wall Street into a giant casino of price-chasing momentum and news-based stock prices -- producing awkward, bizarre and unpredictable volatile moves like yesterday's.

Consensus global economic and corporate-profit growth projections -- consistently too ambitious for the last three years (but ignored as valuations and "animal spirits" ever rose) -- still remain too optimistic.

The bottom line: Sell stocks.

Position: Short SPY