Saturday, November 16, 2013

Yellenomics & deflation watch

Janet spoke and the market celebrated!  That encapsulates the entire week in the equity market with multiple major indexes reaching historic all time new highs.  With that said, there's really little more to say so this will be an extremely short commentary.  I will simply be reiterating the themes I've been emphasizing in past commentaries as I believe they pose an increasing danger to the global economy and the efficacy of the global central bank experiment of the past five years.

Here's how the S&P ended the week:


(click on chart for larger image)

I've delineated short term and intermediate term support lines but there's no reason outside of an exogenous shock for the S&P to even attempt to bounce off the first support line.

According to my calculations, we've blown through the 1.618 Fibonacci price extension of 1781.40 and there's nothing to impede a move to the 1864 level.  My target of 1860 may be exceeded by year end but I'll stick with it as the market might want to catch it's breath on the way up.

Gold hiccuped this week almost in lockstep with the leaked news of Janet Yellen's prepared introductory statement and her remarks in front of Congress:

(click on chart for larger image)

As a leading indicator of inflationary pressures Gold's muted reaction to Yellen's testimony only serves to accentuate the fact that those pressures "are running on fumes".

The next chart is one I haven't posted in some time and I've amended it to include the S&P 500. It's a ratio chart of the iShares Barclays TIPS Bond ETF (TIP) divided by the iShares Barclays 7 to 10 Year Treasury Bond ETF (IEF) with the S&P 500 superimposed behind it.  The chart attempts to measure investor expectations of future inflation:  

(click on chart for larger image)

TIPS are Treasury Inflation Protection securities that are indexed to the Consumer Price index (CPI) and are purchased in order to protect investors from the negative effects of inflation.  When TIPS outperform Treasury notes or bonds, investors are anticipating a higher rate of inflation and are fleeing to a vehicle that will protect them from anticipated inflation.  When TIPS under perform, investors are more than willing to park their money in regular Treasuries which, up to recently, were yielding in many cases a negative rate of return. 

The chart is illustrative of the lack of inflationary pressures in our economy and is representative of the dangerously low inflation rate in this country and deflationary forces that seem to be gaining an upper hand in Europe.  But notice the strong correlation between the ratio and the S&P 500 up to about the end of 2011.  That correlation ended and the divergence between stocks and inflationary pressures became pronounced going into 2013.  

I promised this would be a short commentary and so I will not reiterate the thesis that has been articulated in many of my commentaries over the past six months.  But folks, this cannot end well unless global economic activity accelerates significantly in coming months.  Much of Europe is in the grips of deflation with the other parts teetering on the edge and our country's inflation rate is too close to zero for safety's sake.  

Yellen and company cannot start tapering without pushing the economy into deflation but the more time that passes under the present monetary regime, the more probability that cracks in the system start to form, whether they be currency or bond related.  Remember, the bond market is the "dog" that wags the equity market's "tail".

I'll attempt to expand further on these themes in future commentaries but for now, any money manager would be insane not to be taking this ride higher.  If a deflationary scenario becomes a reality the key will be getting his clients out in time so they can take advantage of the cash they will have to ride the throes of a deflationary economic landscape.  Cash will be king in such an environment and that cash (globally) will be the US Dollar regardless of what any "naysayers" have to say about our country, it's debt or the currency.

Have a great week!