Fed Up with the Fed

May 21, 2016

Think smart guys can’t  get it wrong ?

Our ” Best and our Brightest ”  got it terribly  wrong  in  Viet Nam and did it again , a generation later , in Iraq.

Now, enter our  regional Fed officials ,  letting us,  know they have the  power, can toy with our financial anxieties  and that the jury is out on a June interest rate increase.

There seems to be no rational explanation why regional Fed officials can’t constrain themselves and just  let the next move, or non-move, be obvious and be data driven, rather than an ego driven mouth trip.

We used to play a game called ” Bullish or Bearish “.  This is a game for wannabe ” traders ” and requires fast and intuitive thinking.

An event is announced,  and it is your task to verbally pinpoint the impact on different areas of the financial  market; currency,  precious metals, the stock market,  the bond market,  housing market etc  that would be positively or negatively impacted by the event.  And, that’s at the macro level.  You can drill down through sub categories into specific situations.  The more specific you  get the more valuable your correct answer.

For instance, at the start of the financial crisis ,  I had  said the housing market was collapsing  and mortgage loans were beginning  to default. And , you said  you were  bearish on buyers  of Collateralized Debt Obligations, CDOs ,  and ultra bearish on issuers of Credit Default Swaps ( Credit Insurance Issuers ) and named AIG as a short target you would have been a gzillion percent correct !

This week,  the Fed hinted strongly  about a rate increase in June.  So  investors,  ( governments,  institutions , hedge funds,  and individuals ) ,  must consider the hint tantamount to an announcement and see the need to consider the  bullish or bearish implications of the hint becoming  reality.

Any increase in interest rates by the Fed will strengthen the  dollar because, simultaneously,  interest rates in Europe are being  lowered  to stimulate economic activity. Europeans  will buy dollars and invest  in USA issued bonds, because money seeks a higher return.. ( Short the Euro ? )

A  stronger dollar will make it more difficult for USA firms to export because a stronger dollar will weaken the purchasing power of the local currency of  overseas buyers ).  Loss of exports will mean loss of USA jobs. ( Buy equities targeting USA sales, including overseas exporters  to the USA , and avoid USA exporters carrying a cross currency sales pricing handicap.? )

The stronger dollar will make it more difficult for USA firms whose overseas manufacturing , operating  and sales activities, result in an accumulation of foreign ( local ) currency profits.  These profits need to be considered converted back  into dollars  whether or not the actually  remitted home to the USA, because such non-repatriated profits will still get included in the USA parent’s consolidated income statement. But,..at a lower cross currency valuation  , and thus  have the net effect of reducing  the consolidated  world wide profits of the USA firm.

How many times have you heard that the quarterly result of  a USA company was a disappointment because overseas earnings did not translate well on the USA firm’s consolidated  income statement ?.   Also, lower stated profits will have  an inhibiting effect on the capital investment decisions made  by USA Boards.. ( Avoid USA firms which generate a substantial amount of operating profits overseas ? )

As the dollar gets stronger, the price of commodities, including oil,  gold and precious metals weakens.  And this means closing down rigs, mines etc and the loss of more jobs.

The down stream impact of a strong  dollar will negatively impact overall consumer confidence and undercut any attempt to create the ” wealth effect”  required to get consumers to buy houses and big ticket items. The consumer is 70% of GDP and a stronger dollar can be the psychological wet blanket the stock market can absolutely  do without to push toward  higher stock prices.

Bottom line, based on the present lackluster performance of our economy, a rate increase by the FED could dramatically increase the possibility of a recession. Not Needed YET !  Got the picture ?

So then ..Why increase interest rates ?

1 – To keep Russia and Iran on their heels ?

2- To give the big USA banks the profit margin they need to create profitable loans. ?

3- To give China the possibility to keep exports ( including to us ) steady so that China’s expansion doesn’t falter and create the need for further  Chinese currency devaluation..?

4- To give Europe and under developed countries an opportunity to reflate their own economies by exporting to the USA while American expansion takes a time out for the sake  of world prosperity.?

5- To give the market a rest and re-set of valuations  before the next leg up.?

None of the above are worth snuffing out an upward trending stock market ( wealth effect )

To me, it seems the smart money, including George Soros and Carl Icann, already recognize this and they  are bad mouthing the Market because they have established positions which will allow them to invest at more ” realistic ” valuations if the FED makes good on its hint…

Count Mini Me in with the smart money because   I am way under invested,  but still invested enough  to check my year to date  unrealized Profits at the end of each day.

We are still on a ” buy SPY ” signal.  But,  I am committed to accept  SPY shares  at $180 and $ 185 per share if SPY falls below$ 180 and $185  by July 15.  I do not consider it prudent for me to blindly buy SPY  at today’s closing price of  $205.89. when I can get paid a premium equal to SPY’s yield for being patient instead of exposed.

Remove the interest rate cloud and I will consider getting  much more involved and aggressive, bearing in mind that for the past 50 years between May and November the average gain in the market has been only 1.3%……November thru April 7.2% average gain.

Richard Maurice Gore

 

 

 

 

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