September 26, 2013 Update

DJIA:15,273 S&P 500:1,693 NASDAQ:3,761 Gold:$1,338 Oil:$103.04 EURO:$1.35 YEN:98.69

A Bratty Little Market

Teaching a child independence seems to be one of the toughest parts about parenting. Children know the power that lies in a tantrum, and how easy it is to rely on the figure that will always be there to provide. Parents, who never want to their children to suffer, invest significant resources so that their child will smoothly transition into adulthood. The contrasting interests creates a disconnect between the aspirations of the parent, who only want the best for their kid, and the demands of the child, who do not yet understand what is best for them. And it’s this division of interests that prompts periods of emotional volatility that has the potential to lead to severe dependency. For instance, if a parent gives their child candy every time he faces discomfort then the child will begin to hope for signals of pain simply because he knows it will lead to more candy. And eventually the kid will become so dependent on the sugar that the thought of not eating candy will become inconceivable to the naive child, who doesn’t understand the danger too much sugar. The child will cry when he wants it, start to panic when he doesn’t get it, and sob when the parent hints about cutting back on the habit. And it’s exactly this disconnect of interests that make parenting so hard, because what is a parent to do when bad news for them becomes good news for their child? This parenting style is a metaphor for today’s market environment. Through the tools of quantitive easing, the Federal Reserve has developed a unique relationship with market. The US central bank stepped in shortly after the crash of the housing market to provide relief. And like a parent, the Fed has held the market’s hand, stuffed it with liquidity, sung it dovish lullabies, and invested significant resources in order to help it climb the mountain to reach new highs. But like keeping a child happy by handing it candy when it faces hard times, the Fed is not solving any problems by throwing liquidity at the system. The Fed is sending mixed messages to investors who have begun to read signals of economic slowdown as indications that the market will rally. Even setting interest rates seem to be getting out of the Fed’s hands since the market refuses to behave if it doesn’t get what it wants. Markets are refusing to move in line and have begun to rely so significantly on the Fed for liquidity that it has, in fact, manipulated the operation to get what it wants and is wresting for control from the central bank. Interest rates have backed up across the world, especially the yield on the 10 year government bond which has shot up internationally. Keeping interest rates low have created misleading signs of economic recovery. The only reason the housing market is “picking up” is due to how cheap it is to build and buy homes. The Fed has distorted the markets and violated the laws of economics. Other developed countries who have found themselves in similar stressful economic situations have adopted their own methods of quantitative easing. But unlike other countries, the US dollar is the word’s reserve currency. All other’s currencies are backed by the dollar, so if US markets are getting what they want than all other markets will misbehave until they are handed liquidity, too. And there we have it, a system of severe dependency the Federal Reserve has created and set a precedent for other developed countries to follow. The market, on other hand, is very happy with the Fed’s dishonesty as it has experienced growth by eating up all the free lunches. The disconnect that exists between a parent and child is the same disconnect that has developed between the central bank and the market. And what is the mother of central banks to do when it has overfed the market, confused investors, and encouraged other central banks to do the same? Unfortunately, many investors are choosing to ignore the fundamentals, like the fact that debt to leverage ratios are still too high. Due to the amount of debt issued by the US, it seems to me that rising rates back to the average of 5.25% is simply out of the question. Nothing the Fed does can reassure investors that tapering won’t end in disaster. The Fed has raised the market to new high in a bubble environment, and once the liquidity stops the bubble will pop and like weaning a child off his sugar habit, it will end in tears. 

Domestic News

• Market Update Futures are moving higher, despite the uncertainty about a government shutdown, ahead of economic data and speeches from Federal Reserve officials. 
• Data on the weekly jobless claims will be released at 8:30, which are forecast to rise to 327,000 from 309,00 the week prior.
• Figures for Q3 GDP growth will also be released at 8:30, which is expected to show growth of 2.7% vs. a prior estimate of 2.5% (likely a result of people taking advantage of the low interest rates).

International Updates

Asia

• Market Update Markets fell across the board as uncertainty rises about various economic and financial issues. 

Europe

• Market Update Markets are quiet except in Italy, where the MIB index sold off due to political disturbances that resulted in social unrest. 
• U.K. Q2 GDP with in line with expectations at 0.7%, and up from Q1’s 0.4% growth rate.