US Fed continues monetary stimulus

Behavioural finance analyst Ken Norquay ponders a dilemma: For stock market investors, negative news about the economy is good—positive news is bad. Go figure.

Skeptics like to say: “Seeing is believing.” But in my stock market book, Beyond the Bull, I propose that the stock market is a financial war. And the first principle of war is deception. Military officer cadets are taught to not believe everything they see.

Right now, the world is battling a pandemic virus and the central banks of Western economic superpowers are fighting the economic consequences of this Corona War. The world’s central banks are all deploying the same economic weapon: the monetary printing press. And, so far, it appears to be working! But we all know that an ungoverned money printer leads to uncontrolled inflation. Furthermore, citizens staying home instead of going to work, shopping, or living ‘normal’ lives—leads to deflation and depression. The battle lines are quite clearly drawn between these two disaster scenarios. This is easy to see: should we believe it?

Long-term pain

Let’s look ahead toward the next battle in our financial conflict. Imagine that central banks win the battle, someone discovers a cure for this foul flu and the skill of central bankers successfully defeats both hyper-inflation and deflation. Economic victory is declared and the central banks stop the printing presses. What will happen to the economy when the monetary printing presses are decommissioned?

Will there be a counter attack by the forces of deflation? Many of us have long forgotten that it was the monetary printing press that saved the day in the 2008-9-10 US real estate collapse and the 2010-11 European banking crisis. Remember QE I, QE II, QE III? (QE stood for ‘quantitative easing’—a much more dignified phrase than: ‘printing money’.) The ensuing economic recovery was caused by the monetary printing press. Central bankers kept printing money and economies kept growing. But, last year, the COVID-inspired economic assault took the US stock market down 35 per cent in 32 days, in spite of the three monetary QEs. The underlying problem is that there is too much debt and very little ability to pay off that debt. And every QE just makes the debt load bigger. The economic generals of the world’s central banks have only one strategy: print more money and hope it works. And, so far, for the last 12 years, it has worked. But sometimes short-term gain produces long-term pain. It’s that long-term pain we are worried about.

Investors are not spectators in the theatre of global economic warfare—we are combatants. Your investment portfolio is not a media event. It’s your economic future. It’s important to behave like a general in these economic wars—not like a private. Privates are loyal and obedient. Generals are cagey and don’t always believe what they see. Above all, generals have a strategy. That strategy contains a provision for error. “If I have misjudged the economic situation and my portfolio losses start to mount up, what will I do?”

Danger Signs

With this attitude in mind, let us examine our usual economic trends. How will we know when we’re in danger?

US Stock Market. A long-term up trend began on March 9, 2009, and it is still intact. Most analysts have a different interpretation of this trend. Most think that the 35 per cent decline last year was a complete bear market and the S&P500 is in a new long-term up trend. I cannot agree that the longest bull market in US history would be followed by the shortest bear market. The real bear market has not yet begun. Since January 2018, the market has staged a series of ever-increasing short term up and down swings. This indicates an ever-increasing level of speculation in blue-chip American stocks. This is dangerous.

American portfolio managers seem to be shifting away from the stocks that led the way up this past year—the internet darling stocks. The S&P500 and The Dow Jones Industrials broke to new highs this month, but the former leader, the NASDAQ index, did not. This divergence gives us a clue. Perhaps the big investment managers are cashing in their high tech profits and hunkering down into the more conservative stocks in anticipation of tough markets ahead.

Canadian Stock Market. This same overall outlook is true for the TSX, but the long-term up trend has been weaker than the American stock market.

US Long-Term Bond Market. The price of 20-year+ US treasury bonds has declined 21 per cent since the July 2020 high (as measured by TLT, the long term treasury bond ETF). Technically, it is not yet a trend reversal, but it’s close. If TLT (currently $138) drops below $133, the topping pattern will be complete.) Long-term treasury bonds are a lead stock market indicator. Bonds normally peak about 6 months before the stock market peaks. It’s been 10 months now.

Canadian Long-Term Bond Market. The Canadian bond market has been weaker than the American. The trend has reversed from up to down. If XLB, the ETF representing Canadian long-term bonds, drops below $24, the down trend will be confirmed.

US Dollar vs. The Basket of non-US Currencies. So far in 2021, the US Dollar has risen about 4 per cent and dropped about 3 per cent. On the long term, it has been trading in a trendless sideways trading range since 2015.

Canadian Dollar vs. US Dollar. This past month’s price change has moved the Loonie slightly above its 2018 high, confirming that the short-term trend is up. The long-term trend is still neutral, but the strength of the Loonie this past year is hinting that the long-term trend may have turned up. Other analysts believe the Loonie has become a petro-currency again, linked to the price of oil. They believe this link is the cause of the short-term up trend. We prefer to analyse the two trends (oil and Loonie) separately. Most correlations in the financial markets are temporary phenomena: just as we get used to a price correlation, it shifts. Sometimes oil and the Loonie march in lock-step; other times they go in independent directions. The short-term trend is up—the long-term trend is neutral.

Energy Prices. The price of oil is responding well to the monetary printing press. Following the 2020 collapse, oil’s price has steadily climbed higher. The short-term trend is up. The long-term trend is the tricky one. We know that, if inflation continues to rise, central banks will reign in their galloping money printers. We also know that this will place downward pressure on oil prices. But we don’t know when this might occur. In the meantime, portfolio managers have been filling up their investment tanks with oil and gas stocks. Energy sector stocks are in a dynamic up trend—a complete reversal from the collapse in 2020. It’s a short term trader’s dream market. Long term investors should delay purchasing oil stocks until the inevitable ‘test’ comes, until the world’s monetary crisis is resolved.

Last month my editor pointed out a discrepancy in my reporting of the price of crude oil. There are several different benchmarks we can use; and the prices are all slightly different. West Texas Crude is different from Brent, which is different from Saudi Arabian Light etc. For now, for consistency, we will use ‘NY Mercantile Crude Oil, near-by month’ as our benchmark.

Precious Metals. Gold is in a long-term up trend vs. the US dollar. It had been in a short-term decline since summer of 2020. That decline ended in March. I encourage long-term investors to add to their investments in gold and silver now. Investors with a more speculative bent should consider gold and silver mining stocks or precious metals mutual funds. Gold is often perceived as a safe haven in times of economic uncertainty. Whether the forces of over-inflation or deflation win the war, gold and silver will benefit.

There is a perverse irony in the stock market at this time. It was enunciated in several articles in the financial press on May 7. The US government had released certain statistics regarding employment. There had been an unexpected slowdown in job creation: negative economic news. But the stock market went up that day. Why? Because the negative news meant that the Federal Reserve Board would have to continue monetary stimulus. Printing money is bullish for the stock market. For stock market investors, negative news about the economy is good—positive news is bad. Go figure . . .

Ken Norquay, CMT, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance.

This is an edited version of an article that was originally published for subscribers in the May 2021, Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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