Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

The Real Culprit is Liquidity – or the Lack Thereof

Equity markets recouped much of their earlier losses in the week when on Thursday Fed Governor Bullard made an unexpected remark that the Fed should consider a “delay” to the end of QE this month – which should be no surprise to our readers. The rally in stocks that followed was not because of a solution to the world’s ills – the economic turmoil in Europe, the Ebola outbreak, or political unrest in places like Hong Kong. It was simply the prospect of more QE that turned the markets. I say this because, prior to the rally, everything BUT the Fed’s tapering agenda was being tossed around as THE reason for the volatility in stocks. But the rally that followed Bullard’s remarks confirms that, for now, QE far outweighs any other variable in play for highly leveraged operators.

MWM 14, 10-17 Box ScoresThat fact implies that the Fed will ultimately need to do more than just talk. Significant damage has been done – which has placed the Fed dangerously behind the curve in this recent bout of deleveraging. At last look, stocks have lost somewhere in the vicinity of $1.5 trillion in market cap from interim highs, and have struggled to reestablish any real traction to the upside. These are losses that can put leveraged operators upside down on the books, which can in turn trigger more selling. And when trillions are at stake, only the Fed is perceived as big enough to turn matters right side up. That said, any bad news that hits the tape in weeks to come will be fodder for Fed-induced rallies. But with mortgage rates dipping below 4.0% (refis are up) and gas prices plummeting, consumers may carry the economy a bit longer than some traders can remain liquid. The downside volatility in stocks therefore stands a good chance of continuing until the Fed actually steps in with additional stimulus.

If and when the Fed does so, a decent-sized rally in stocks will be expected, though from what level we’ll just have to wait and see. But the bigger issue down the road, of course, is whether or not QE is really producing enough growth to outweigh the associated costs (i.e., debt service and/or inflation). Judging by perpetual US deficits and the rising tide of non-performing debts worldwide (China, Greece, etc.), the presumed answer to that question right now is no. Incidentally, China and South Korea both cut rates this week, to no avail – stocks in both markets still sank.

As for the precious metals this week, gold prices stabilized further alongside the mining shares and inventories at the COMEX. Contributing to that development was a slip in the dollar spurred by Bullard’s dovish comments and fairly weak corporate retail reports from eBay, Netflix, and Walmart. All in all, the metals have responded well as a safe haven to just about anything that hits the tape. Then again, it could be that the metals are simply attractive in both relative and absolute terms. Whatever the case, the price action continues to improve, which bodes well for a breakout sometime soon for gold above $1,250 level.

Best Regards,

David Burgess
VP Investment Management