It’s easy enough to engineer a meltup in advance of a Fed meeting. We’ve seen it countless times. But, what about after a meeting, particularly one where an actual taper or rate hike is announced? The countdown has begun. Stay tuned.
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Equity markets rarely fail to rally into the end of the year. But, there have been several noteworthy Q4 exceptions over the years, each of them marked by VIX’s bounce off well-established trend lines.
Note that SPX’s yellow channel has been rising at a compouned 12.2% per year since the 2009 bottom – historically a very decent rate of return. With SPX currently testing the channel top as VIX tests the rising purple trend line, SPX is at a critical juncture where it must either correct or break out.
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Futures are off slightly this morning, passing on the opportunity to make new highs in the after-hours.
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In an excellent interview on CNBC this morning, Paul Tudor Jones echoed what many on Wall Street have been thinking and we have been writing for the past year or so.
Inflation could be “much worse” than feared, billionaire hedge fund manager Paul Tudor Jones says. “It’s probably the single biggest threat to certainly financial markets and probably I think to society just in general.” https://t.co/OoMbhdnsm0 pic.twitter.com/yCP11BVELO
— CNBC (@CNBC) October 20, 2021
Has the Fed committed a policy mistake? Most certainly. Even more outrageous, it did so deliberately.
If yours truly, sitting in his home office with a Mac Pro and a public school MBA, can accurately forecast soaring CPI long before the convenient supply-side disruption pretext came along — then the Fed’s brain trust of MIT grads with supercomputers certainly saw it coming even sooner. How did they respond (besides protecting their own portfolios)?
1. changed their inflation target language to accommodate higher inflation
2. lied about their expectations of it being transitory
3. continued to pour $120 billion per month into fixed income markets
4. manipulated interest rates lower with said injections of QE
5. thereby eliminating price discovery in bond markets, potentially permanently
6. reinflated bubbles in virtually every financial and real asset market
7. reduced housing affordability to 13 year lows
8. enriched the top 10% of Americans by $17.5 trillion
9. subjected the bottom 50% to contracting real discretionary income
The kicker is that they are still pouring $120 billion into the markets every month, even though they have publicly admitted that inflation has “surprised” to the upside and is not transitory. This is in stark contrast to Powell’s assurances that the Fed would use its “tools” to prevent such an occurrence.
Now, I don’t for a minute believe the Fed is an evil cabal bent on ruining the middle class and subjecting the poor to unbearable hardship. I believe they entered into the latest round of QE with the intention of staving off an economic collapse and saving financial markets from crashing even further. They successfully accomplished this.
But, somewhere along the way, probably in June 2020 as SPX fell below its 200-DMA for the second time, the conversation turned to making sure the rally continued. It took almost 10 weeks, but on Nov 4 SPX rose above 3393 for the last time. It hasn’t looked back, bouncing on its 50-DMA over and over until last month when it finally backtested its 100-DMA – registering a meager 5.9% decline.
The Fed has demonstrated the astounding power of its tools: ever-increasing oil prices, currency manipulation, interest rate manipulation, and the periodic crushing of vol. But, it has caused, not moderated, higher inflation.
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Futures nailed our 4424 target overnight. Most will attribute it to Powell’s (completely unsurprising) resolve to support the economy the stock market. But, we know that the algos were spurred into action by VIX’s drop back into the falling channel from Mar 2020 and its dip below its 200-DMA.
Remember, it ain’t over till it’s over. Follow this headfake at your own peril.
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If you liked yesterday, today is shaping up as more of the same. But, there are still a few warning signs tugging at the market’s sleeve.
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Futures are continuing their meltup in the pre-market on a 4% bounce in crude oil and the usual overnight slump in VIX.
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The correction is gathering steam, with ES off 40 points earlier this morning before getting a bounce. From a technical standpoint the culprit is VIX, which broke out of the falling channel which has guided stocks higher since March 2020. 
Our downside targets remain unchanged.
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The Fed detests gold and silver because, like higher interest rates, they are a stark reminder of the soaring inflation the Fed hopes we’ll ignore. Interest rates can be manipulated lower by buying up every bond in sight. The Fed has been doing this to the tune of $120 billion per month.
Gold and silver, on the other hand, can simply be shorted, which is exactly what has happened – once again breaking a significant long-term uptrend and dashing gold bugs’ hopes for a breakout.
Silver, having reached our next downside target, faces a particularly important test.
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I’ve recently discussed this very issue with several friends who are a little nervous about the sharp runup in prices…and very nervous about the prospect of a selloff.
Most of us remember how ugly things got during the Great Financial Crisis: the sharp rise and the much sharper plunge when the bubble burst. According to HUD, the median sales price of a home fell about 20% from $257,400 in Q1:2007 to $208,400 in Q1:2009. 
The fallout was both disastrous and widespread. Yet, years later, it appears modest compared to the subsequent reinflation. The median sales price reached $358,700 in Q4:2020. 
It’s the size and speed of the bubble’s reflation that has many worried – particularly given the Fed’s involvement. How so, you ask?
In the wake of the pandemic, the Fed cut short-term rates to zero and began large scale asset purchases which have been more than enough to purchase the entirety of Treasury’s monthly borrowings: $120 billion per month, including $40 billion in mortgages. The net effect was to drive interest rates to all-time lows and keep them there.
If you’re feeling pretty smart about all the money you’ve made in real estate over the past year, make sure you fire off a thank you note to Jerome Powell.
Most home buyers purchase as much house as their income will allow. That is, they focus more on the monthly payment than the purchase price. Lenders, likewise, use a formula to compare your monthly housing costs to your income.
These debt-to-income ratios vary. But, in this example, we’ll assume a 33% ratio – meaning the total house payment should be no more than 33% of your monthly gross income.
A home purchased for $1 million with a $200,000 down payment at the current jumbo mortgage rate of 2.6% would require a monthly payment of about $3,203. Toss in $1,000 per month for taxes and insurance, and you’d be looking at a total payment of $4,203. With a 33% ratio, the required annual income would be around $152,826.
If mortgage interest rates had been 6% instead of 2.6%, the monthly payment for that same $1 million house would have been much higher: about $5,796, requiring an income of $210,778 to qualify for an $800,000 mortgage.
And, there’s the rub. Cutting rates to all-time lows clearly reinflated real estate prices. People have been able to afford more and more expensive homes because the Fed kept cutting rates, keeping the payments super low even as the prices soared.
What happens if rates ever rise back to normal levels? The chart below shows the relationship between falling rates and rising prices. But, you can read it the other way around too. If rates rose, what would the price need to drop to in order to maintain the same monthly payment?
A rise in rates from 2.6% to 3.6% equates to a price drop from $1 million to $880,000. A rise to 4.6% would mean a drop to $780,000 – enough to wipe out your equity and leave you owing money at the closing.*
The Fed has managed to hold interest rates low by buying up all the bonds it sees. The flood of QE required to suppress rates has bid up not just real estate but most other categories of goods and services as well, thereby amping up the pressure to raise rates.
The Fed could mitigate inflation by raising rates or suppressing oil prices, but either would do some damage to stocks – another overinflated market. So, instead, they keep insisting that everything’s just fine, even as they paint themselves into a corner.
Is it time to sell your home? If you’re planning on it any time soon, consider the above and keep a very close eye on the market and on interest rates. It won’t necessarily happen tomorrow. In fact, sales/prices typically increase in the short run when rates begin to rise because buyers fear even higher mortgage rates to come.
But, spoiler alert: it will happen by this time next year. The Fed is playing a dangerous game – not because they love taking enormous risks but because, having reinflated all these bubbles, they have no other choice.
We all remember what happened the last time inflation reached these levels. From the July 2008 FOMC statement to Congress, the only time in the past 30 years that CPI has topped last month’s 5.4%:
According to these projections, the economy is expected to expand slowly over the rest of this year. FOMC participants anticipate a gradual strengthening of economic growth over coming quarters as the lagged effects of past monetary policy actions, amid gradually improving financial market conditions, begin to provide additional lift to spending and as housing activity begins to stabilize.
Stocks crashed 50% over the next 8 months as the Great Financial Crisis decimated the economy.
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* the spreadsheet below shows the effect on price of a change in mortgage rates, while holding payment and qualifying income steady.
