Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
Interest Rates Trumping the Weather
At the start of Wednesday’s FOMC meeting, stocks took a nosedive in the early going when the Fed tapered its bond purchases by another $10 billion (now $55 billion/month), and hinted at a possible rate increase as early as spring 2015. But stocks erased a good portion of those losses when Yellen made it clear during the press conference that policy changes will be dependent on the economic data. In the past, such language has been interpreted by stock operators as code for “we’ve got your back.” With the weather to blame for any bad news stemming from U.S. earnings reports and/or preannouncements, stocks were able to finish the week with modest gains. Treasuries, however, didn’t care for the tapering news and fell into dangerous technical ground. Meanwhile, the dollar bounced and the precious metals witnessed a healthy retracement.
Emerging markets took the Fed news rather poorly until China announced some long-awaited reforms Thursday night. The People’s Bank of China widened the Yuan’s trading band from 1.0% to 2.0% and allowed its banks to issue preferred shares. The former action typically boosts demand for the dollar – and subsequently Chinese exports – while the latter is intended to shore up bank balance sheets (no doubt in response to recent bankruptcies, e.g., Suntech Power). But the fact that banks are backstopping their loan assets by loading up the truck on obligations, and that markets are going so far as to celebrate the decision, should tell you something about the state of our markets and the financial affairs in China. Banks should have what’s commonly referred to as “loan-loss reserves,” or cash set aside from profits in advance of a spike in delinquencies. Since they are most likely deprived of such insurance, it’s unlikely the uptick seen in Asian and emerging market stocks has any real legs.
The important takeaway from this week is that Treasury rates rose again, while stocks moved higher despite the Fed’s best intentions to induce the opposite. In other words, policy isn’t serving anyone’s interests at the moment. Tapering is slowly choking off Wall Street, while higher long-term rates are choking off credit to Main Street. According to Lennar Corp, a 25% decline in mortgage originations was a drag on its results in the latest quarter, and a top concern moving forward. Something has got to give, and soon. Stocks can either retreat in earnest, potentially fueling a bond market rally, or the Fed will need to change its tune about tapering and/or the manner in which Fed funds are distributed (i.e., not through the banking sector). It’s our opinion stocks will lose this battle in the short-run and tumble, since larger amounts of QE haven’t proven to be of help to bonds recently.
An overnight drop in the ruble on Thursday (listen to Dave McAlvany’s Weekly Commentary for an analysis on Russia) provided some needed stability for the precious metals in the aftermath of the Fed’s tapering decision. But the larger picture for gold still rests on the US economy, the dollar, and, to some degree, stocks – all of which are set for challenges ahead if long-term rates remain restrictive to growth. Gold’s 50-day moving average is just crossing over its 200-day moving average to the upside, which may mean gold is poised for further price gains in the weeks to come.
VP Investment Management