What Are the Markets Telling Us Right Now?

The market’s reaction to the Fed’s giant rate cut has been strange.  Since the Fed’s move on September 18, the yield on the 30-year bond has traded sharply higher while equity markets have been grinding higher.  Gold has screamed higher and oil prices have traded aggressively lower.  Bottom line, with the exception of price action in oil, the markets are sending out some signals that suggest investors are expecting the Fed’s first rate cut since March of 2020 to ultimately be quite inflationary.  Let’s examine the markets a bit more closely.

Below is a chart of the S&P 500.  As you can see, the slope of the rally has recently flattened out substantially, suggesting that the rally is running out of steam.   Are we nearing the end of the long-term rally, or is this lack of momentum simply a sign that we need some corrective price action before we have more acceleration to the top-side?  Either way, I am still expecting a major reversal, but I suspect that reversal will only come after a more violent blow-off top.  Regardless, I am expecting some short-term nasty corrections.  In the big picture, I am still looking for a major reversal, but we still may first need one melt-up to absolutely suck everyone into the market.

The decline in oil prices has not been in sync with the other markets to the extent that this decline suggests some serious disinflationary pressures.  Sure, there are some signs of serious economic trouble brewing, but these signs haven’t been explicitly disinflationary.  Let’s examine what is happening in the oil market. 

Well, unfortunately, the lower oil prices are essentially the result of a massive market manipulation by our government in their effort to try to make things look better than they really are.  While consumers may be welcoming the lower oil prices and the better prices at the gas pump for their cars, there is another side to this story.  In an effort to mask the underlying inflation in the economy, for years our government has been aggressively draining down the nation’s strategic oil reserves and dumping huge amounts of oil in the market.  Currently, our reserves stand at their lowest levels in over forty years.  The government has taken a major risk by depleting these reserves in order to give people the impression that inflationary pressures are not quite so severe.  As you can see, the price of oil has come down in the past couple of years, but at what cost? 

The fact is that the US initially built up its strategic petroleum reserves in 1975 in response to the OPEC oil embargo in 1973-1974.  These reserves are part of an emergency stockpile with a total capacity of 714 million barrels.  The stockpile maintained by the Department of Energy (DOE), when full, is the largest publicly known emergency supply in the world.  It is supposed to mitigate future supply disruptions, but the dangerously low current reserves threaten the effectiveness of the whole program in case our country were to face a supply emergency.

Of course, the huge liquidation of our strategic reserves over the past few years has helped drive oil prices lower, but what will happen to the price of oil when the government finally starts to replenish the reserves and buy back the many millions of barrels of oil that it sold?  What if we face a serious emergency and our stockpile is largely depleted?  The fact is that this is just another way in which our government continues to play kick the can, trying to kick the problems down the road to look better to the voting population, while leaving yet another mess for the next group of leaders to try to manage.

As we dig deeper into the economic data, it is easy to get quite cynical about the extent to which the authorities are systematically playing some mischievous games in order to give voters the impression that things are better than they really are.  For example, with regard to the jobs data, was it really just an honest mistake that led to the jobs data being overstated month after month to the tune of over 800,000 nonexistent jobs being reported over the prior year? The monthly reporting of false data certainly created a far rosier picture of the U.S. economy than what was actually the case.  I am simply posing the question, rather than making a specific accusation.  Regardless of the underlying reasons for some of the highly questionable data that we receive, we have more than ample evidence of the need to be very circumspect when we interpret economic data and policies.

Regarding gold, as you know well, I have been forecasting a major bull market in gold since it was trading at $1615 per ounce.  Periodically, I have recommended my readers to take some profits in a portion of their gold positions before re-loading their full positions after a period of corrective price action.  I am now recommending that my readers lighten up their positions of gold as the market is extremely overbought right now and in need of a breather.  I would recommend that perhaps you should liquidate about half of your exposure for the time being.  We should have a chance to buy back the gold at a lower price once the market has corrected a bit.

Shifting to the crypto market, after forecasting a sell-off in Bitcoin when it was trading over $70,000.00, I  recommended that people reestablish their long exposures in early July, when the price had corrected down to the $55,000 level.  The period of consolidation lasted longer than I expected, but it looks like the move higher is well underway now.  The recent move to $65,000 in Bitcoin looks like the start of a significant trend, and I persist in my view that Bitcoin might well reach $90,000 - $95,000.  In the meanwhile, we should already be enjoying the rally from the recent lows that has exceeded 20%.

In the bigger picture, the possible rise of another 35% to 40% could occur for a variety of reasons, but none of them are particularly positive.  Essentially Bitcoin and gold are quite closely linked as alternative assets to the dollar. The combination of massive budgetary deficits, concerted efforts by the BRICS nations to develop a viable alternative to the dollar, the cumulative fiscal deficit of more than $35 trillion, and a stock market that is grotesquely overvalued with a valuation that twice the size of our GDP certainly give us ample reasons to look for alternatives to the US dollar.  

The Fed’s Financial Conditions Index is now screaming “loose policy,” but I still expect further rate cuts.  The macro scenario is a big mess.  The massive government borrowing and spending is inflationary, but the nominal level of interest rates is still very high.  Mortgages are very expensive, and the housing market is stuck with record high prices and inadequate supply. In fact, residential mortgage demand is at the lowest level in over thirty years.  The commercial real estate market is under even heavier pressure, with record vacancies and staggering amounts of refinancings coming due.  The current level of interest rates makes these refinancings very difficult.  

I have written at length about both the lack of affordability of houses and the coming crisis in the commercial real estate market, and the Fed is certainly well aware of these issues.  It is a logical conclusion that the Fed will continue to push rates lower, risking a reigniton of inflationary pressures in order to address these other problems.  Of course, the Fed won’t talk about these problems directly, but rather will talk about our wonderful economy even as they continue to cut rates over the coming months.  Welcome to the world of double-speak.

In Asia, the Chinese leaders pledged just yesterday to deploy "necessary fiscal spending" to meet this year's economic growth target of roughly 5%, acknowledging new problems and raising market expectations for fresh stimulus on top of a host of other stimulative measures. China’s real estate market is under serious pressure, and even the US Treasury Department is publicly encouraging China to do more to support their economy.   In case you want to venture far afield, Chinese equities will rally sharply on these policy moves as they are very stimulative.  

Returning to the US, part of the reason that some of the data is so confusing is that the economy is largely bifurcated between the wealthy and the rest of the nation.  Rising unemployment, cumulative inflationary pressures, and dangerously high levels of delinquencies in FHA single-family loans tell us a somewhat depressing story.  An FHA loan is a type of mortgage for borrowers with lower credit scores who do not qualify for a conventional loan. These sorts of loans have accelerated in the past several years to levels beyond the 2008 levels.  Overall, the FHA loan delinquency share is below the 14.2% peak in 2009, but dangerously high at over 10%. At the same time, however, delinquencies on standard single-family residential mortgages are at their lowest level in eighteen years.  Clearly, people with lower credit ratings are really struggling, while the others are managing just fine.

So, we have a very mixed picture.  Tens of millions of Americans are struggling.  US Credit Card serious delinquencies of 90+ days are at their highest level since 2011. Credit card debt is $1.1 trillion, with nearly $78 billion of credit card debt close to a default.  On the other hand, we have the wealthier people whose net worth is climbing as the stock market continues to make new highs.  This is a dangerous situation as the gap between rich and everyone else continues to expand.  

Ultimately, I would have to blame the collective policies of the lawmakers and the Fed for this disparity. The long-term solution is clear – the US government must inflate in order to deal with our massive debt problems or else it must face a crushing economic contraction. Ideally, the inflation will continue to be somewhat tolerable, so the juggling act must continue for quite some time. This is not to say that we don’t need a vigorous audit and cleanup of government waste, but the need to inflate our way out of the problem is likely the least painful solution.  

If we are lucky, the Fed’s very soft monetary policy will enable us to muddle along with our economic growth slowing to 1 ½% per annum and our annual inflation settling around 2 ½% to 3%.  Frankly, I think that inflation rate is too high as it is a nasty, but somewhat invisible tax that really hurts badly, but only over longer periods of time.  It is more like the cumulative impact of too much eating and too little exercise.  Eventually, this will lead to severe health problems, but not immediately.  In the same way, inflation leads to severe economic health problems over time, but not immediately.  

At the same time, however, the US economy is remarkably robust, and the entrepreneurial spirit in our country is incredible.  Over time, we have been able to face and surmount many enormous challenges, and I suspect that over time we will find a way to deal with the current mess our leaders have created.  No, I am not forecasting a nirvana-like economy with wealth, happiness, and prosperity for all, but neither am I forecasting gloom and doom.  Sure, we will have some very tough patches, with periodic nasty sell-offs in stocks (long overdue), and potentially some significant dollar depreciation, but the US will ultimately adapt and adjust. 

In fact, the dollar will almost certainly depreciate over time, and the biggest drop will likely be against the yen.  The dollar has staged a nice corrective rally against the yen since its spike low at 139.60.  The move was too much too fast, and this correction was well-needed.  Earlier today the dollar reached 146.50, nearly a seven-yen bounce from the lows, and this may prove to be enough to reset the downtrend for the move to my longer-term targets below 130.00.  Next week I will fine tune some of my forecasts, but in the meanwhile, I have laid out a general road map for you to follow.  

Wishing you all the best of luck with your trading.

Andy Krieger