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April 04, 2011 – Comments (10)

Excellent thoughts from TPC. I highly recommend you read the whole article. Here is "thing" number 1.

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THREE THINGS I THINK I THINK
4 April 2011 by Cullen Roche

http://pragcap.com/three-things-i-think-i-think-22

How will Bernanke let this market down softly with the end of QE2? Mr. Bernanke has done something that Alan Greenspan always attempted, but never made so explicit – he has kept asset prices “higher than they otherwise would be”. It’s a dangerous precedent to set. It’s a lot like giving your children a treat every time they start to cry. After awhile they become conditioned to believe they will always get their treat so long as they cry long enough. The result is a child who never actually earns the treat and instead becomes spoiled rotten. Similarly, market prices no longer have to rise on fundamentals alone. So long as the Fed is there with their safety net speculators can feel confident that they will be rewarded with a treat every time the market declines and they begin to cry.

The result has been obvious – equity investors are eager to take excessive risk by buying every dip in the market with the knowledge that the market can no longer decline. It’s a lot like walking a tightrope knowing that there is a cushion just 5 feet beneath you. There is no need to be overly careful. The problem arises when too many people start jumping on the tightrope with you and create a disequilibrium in the system. At some point the rope becomes unstable and possibly snaps. Except this time your cushion isn’t a soft padding, but someone else’s head. People get hurt. You get the picture. What Bernanke has created is not all that different. It’s an environment of spoiled tightrope walkers who are conditioned to take risk and believe they will always receive their treat when they begin to cry. It might be “working” for speculators, but is it good for the US economy?

The problem for Mr. Bernanke is that he must take the pacifier out of the baby’s mouth without causing a temper tantrum. And yes, Wall Street will throw a temper tantrum when the pacifier is removed. If I had to venture a guess I’d guess that Mr. Bernanke will end QE2, continue reinvesting interest payments, thus slowly removing the pacifier. But that’s just a guess. Either way, he will tread carefully and likely remain close at hand with the pacifier at the ready just in case the baby begins to throw a temper tantrum.

In a similar note to thought #1 – there is the potential for a very frightening market development in the coming years (work with me through this hypothetical). Let’s say the Bernanke Put continues to cause asset prices to deviate from their fundamentals – the economy continues to recover (marginally), but the Bernanke Put becomes so ingrained in market perception that the disequilibrium in markets expands. This results in an imbalance so severe that market bubbles appear (could already be occurring in the commodity space). What happens to the market if the disequilibrium Ben Bernanke causes results in some sort of serious market dislocation similar to 2000 or 2008? All it would take is a minor exogenous threat to cause a global panic. It could be surging oil, a slow-down in China, a repeat of the Euro scares….The result would not only be economic slow-down (into an already weak developed market), but potentially crashing asset prices as bubbles have a tendency to overshoot on the downside. But it’s not the recession that would scare the markets. It is the potential backlash against the Fed.

After three bubble implosions in less than 15 years (all somehow directly tied to Fed intervention), I think the public would call on Congress to revisit the Fed’s dual mandate, its impact on markets and whether their actions over the last 20 years have been appropriate. The rational response would be to reduce the Fed’s role in markets. From a societal perspective I think this is an enormous long-term positive. The sooner we get the Fed out of the market manipulation game the sooner this economy can stabilize, definancialize and get back to becoming the economic growth machine that it has been for so long. For the markets, however, this would be a traumatic event. Imagine 20 years of Greenspan/Bernanke Put being sucked out of the market…it might sound far fetched right now, but I have a feeling the Fed will be far less involved in markets at some point in my lifetime. It might be wishful thinking, but I am confident that America will wise up to the destruction this institution causes by constantly distorting our markets and economy.

10 Comments – Post Your Own

#1) On April 04, 2011 at 10:08 AM, mtf00l (43.58) wrote:

Now that is wishful thinking...

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#2) On April 04, 2011 at 10:49 AM, Mary953 (66.50) wrote:

I hope pacifiers and temper tantrums are not a way of life yet.  The market you describe sounds like financiers with a case of the "Terrible Two's" that terrorize parents. 

Binve, is it too terribly selfish of me to hope that you are wrong?  It isn't that your scenario is a bad one - I know that it is the best for the country over all.  It is just that when you are finally looking at retirement, the idea of a looming economic collapse is an unnerving idea.  Something that will suck the value out of your life savings and leave you with no way or time to replace it is not a comfortable situation.

Then again, I was absolutely certain that by this point in time, Social Security would be broke (true) and we would all be on our own for retirement (not so much).  As it is, the payment date is just being pushed out further and further...

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#3) On April 04, 2011 at 11:02 AM, ChrisGraley (30.25) wrote:

Very good article binve!

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#4) On April 04, 2011 at 11:13 AM, binve (< 20) wrote:

mtf00l ,

perhaps

Mary953 ,

Hey Mary!

I hope pacifiers and temper tantrums are not a way of life yet.  The market you describe sounds like financiers with a case of the "Terrible Two's" that terrorize parents.

:)

Binve, is it too terribly selfish of me to hope that you are wrong?

Not at all. I hope I am wrong too (well, in the case of the above article, I hope TPC is wrong, I just happen to agree with it completely).

But to be clear, I don't think there will be an 'economic' collapse coming. checklist and I have been going back and forth on this one for the last few months. We both believe we are in a secular  market. And based on the cycles of previous secular bears, it won't be over until 2016-2020 (see http://caps.fool.com/Blogs/real-secular-bear-markets/556697). We also both think that corporations are much healthier now (at least on an economy wide basis) than they were in 2009. And so like I write here (http://marketthoughtsandanalysis.blogspot.com/2011/03/valuation-bottom-of-2009-rehashing-once.html) and here (http://caps.fool.com/Blogs/the-valuation-bottom-of-2009/549216#comment553546), I don't think the end of this bear will be marked by an 'economic' collapse. I think it will be the clearing out of some unhealthy economic activity, mainly by financials and the banking industry. I think we will make a lower low in the markets as a whole (in say the SPX) in both real and nominal terms at the end of the secular bear. checklist does not. But I think we both agree that there are many companies and probably even sectors that have seen their lows in 2009. My take at any rate :)..

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#5) On April 04, 2011 at 11:13 AM, binve (< 20) wrote:

ChrisGraley ,

Thanks Chris!..

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#6) On April 04, 2011 at 11:49 AM, outoffocus (23.59) wrote:

Mary,

First, conventional wisdom says that if you are close to retirement you should be switching to more conservative investments. If the majority of your life savings are tied up in the market right now and you are going to need those funds within the next decade then you are playing with fire and guaranteeing yourself a spot at the door greeting at Walmart. 

Second, you can hope Binve is wrong all you want but hoping isn't going to get you anywhere.  When the weatherman tells you its going to rain, do you go outside and "hope" that it doesn't? Or do you go grab and umbrella? If theres anything that can be learned from the economic turmoil over that last three years is that if someone warns you of something, do your due diligence and protect yourself. I'm sure people where "hoping" the dollar didn't fall in value (I was one of them) but that didn't stop the fall.  So what did I do? I decided to invest in commodities.

Regardless of how I feel I know there are a few more bubbles that will need to pop within the next decade and each pop will be incredibly messy and will hurt alot of people.  My only job is to be vigilant and protect myself by trying to cushion the blow (and make some money while doing it). 

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#7) On April 04, 2011 at 3:46 PM, Mary953 (66.50) wrote:

Binve and Outoffocus,  I am planning to avoid the greeter's station at WalMart if possible.  That is the reason that most of my funds are tied up in very conservative stuff, the house is paid for, etc.  It is also the reason that I don't try options, puts, and all the other tricks of the market.  I work with small amounts and tight stops and try not to be too frustrated when the extrodinary profits pass me by.  I know that the extrodinary losses do as well.

My concern is more along the lines that I have these frightening long-lived family members in all parts of the family tree.  How on earth do you prepare in your 50's for a lifespan that will probably stretch into your 80's easily and probably your 90's?  (My father-in-law is just down the road, a healthy 97!)  Economic bubbles and wholesale collapse are unnerving things in that context.  All I can do is try to save enough to live off of the earnings and leave the principle untouched.

In the end, I return to my only safe investment - The Lord is my shepherd.  I shall not want.  He will take care of my needs if I trust in His love.  The very best umbrella of all.  :-)

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#8) On April 04, 2011 at 4:20 PM, binve (< 20) wrote:

Mary953 ,

Hey Mary, I know that you are prepared, probably more than any of us. The fact that your house is paid for and that you are trying to live off investment earnings instead of seeking (or chasing) capital appreciation is exactly where you want to be (and, frankly where I want to be).

That is why I said that the last leg of the bear market is unlikely to be an 'economic' collapse and that a lot of quality companies will likely never trade down to their 2009 lows again. I think consumer staples and high quality dividend yielders are a fantastic place to be for the next 10 years.

So while I am definitely not hoping for another crash, I think it is likely to happen. But as monolithic of a crash as 2008-2009 was, I think the next one will not be that way, as I discuss in my links in comment #4.

Personally I think you are in great shape both financially and spiritually :) ..

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#9) On April 04, 2011 at 5:21 PM, davejh23 (< 20) wrote:

It's looking increasingly likely that the next major market decline could start very soon.  Many stocks that have led the market higher are breaking down...are well below recent highs and important moving averages.  Many earnings reports have been full of caution, signs of margin compression, etc..  Even when expectations are met, we've seen stocks fall 10% following earnings.  Besides the earnings reports, we've seen a lot of negative sentiment out of manufacturing and other economic reports, even as investor sentiment stays elevated, margin useage is climbing towards historic highs, and insiders continue to sell.  With the Fed starting to hint that QE operations will not be continued, I'm staying very cautious.  If QE operations are, in fact, suspended, AND FY'11 S&P EPS estimates start falling along with GDP estimates, just about any shock would lead to an all out crash.

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#10) On April 04, 2011 at 6:55 PM, davejh23 (< 20) wrote:

In addition, most financials didn't even make new highs in February, and they're well below January highs and trending downwards. 

The largest Russell 2000 component, a stock that led the recent rally, is nearly 25% below it's recent high.  There are a good number of small caps that ran up 200%+ in the last year that could probably easily fall 50%+.

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