You Have Been Warned… Again

You Have Been Warned… Again by Dennis Slothower – Outsider Club

Effects of Tightening Fed

In a rising interest rate environment, businesses are less inclined to make big purchases on credit. Purchases like a new home or a new car could be put on hold when people know that a series of rate hikes are the posture of the Fed. This causes recessions. Businesses anticipate and start to cut back.

This, in turn, causes banks to restrict the availability of money in anticipation of harder economic times. Fewer and fewer people qualify for money as money lending standards are significantly raised. Mortgage, auto, and credit card interest rates immediately rise.

When that happens, it limits expansion, hiring, and capital investments by companies and that means less spending and less activity in the economy.

In our current economic environment, inflation is giving us a mixed picture. The core PPI rose above 2.1%, while the CPI has failed to beat expectations for the last three months in a row, feeling the effects of falling oil prices.

As I have argued on many occasions, it is not the GDP you need to pay attention to as it is not a leading indicator.

However, oil prices are a leading indicator, which brings on deflation and then undercuts the GDP. Oil prices fell 22 cents to $44.51 a barrel on Friday, pressured lower by higher interest rates following a rising dollar.


Given that June is the peak demand in terms of seasonal strength for oil prices it is altogether bearish to have just witnessed a technical bear market signal in crude oil in what is called a “death-cross” where momentum is so negative its 50-day moving average penetrates through its own 200-day moving average. This is very bearish for the economy going forward, whether the stock market can perceive this or not.

The bond market certainly perceives it.

Notice, the difference in yields in a two-year Treasury bond verses a 10-year Treasury bond is narrowing with these rate hikes this year. The bottom chart is the yield curve, which is plunging presently.


In a healthy economy, this spread should be widening, indicating stable economic conditions in coming times. However, plunging spreads, as we see now, indicates the bond market believes that worsening economic conditions are in the future, resulting in a flattening yield curve.

By this fall, the difference between a two-year and a 10-year Treasury yield could be close to inverting as has already happened in China.

The Fed is planning on reducing its balance sheet likely beginning in September. What happens to the markets when it takes back $2 trillion or so in the following year? The plan is $30 billion in Treasuries and $20 million in agencies per month by 2018! That is $50 billion in liquidity drain each month.

This will set up a bear market and postures the socialists well for the mid-term elections. This ends up being all about politics and has been now for quite some time.

Housing Trouble Continues

Stocks were mixed last week as the Nasdaq indexes continued to sell off for a second consecutive week. Despite the strong selling and mixed trading in the broader market, traders were not put off by another terrible housing report.

The U.S. Commerce Department said housing starts slumped by 5.5% for May, strongly divergent against a period of the year when housing starts are normally increasing rather than declining. Perhaps builders don’t have enough lookers to justify going out on the limb this year.

The strong decline in housing starts surprised most economists, who had projected that starts would climb 4%, not drop 5%, meaning they were almost 10% off in their estimation of the housing construction industry.

To add insult to the housing starts injury, the Commerce Department also reported a decline in building permits by 4.9%. This measure of future building activity combined with declining starts suggests that builders are preparing for a pullback in housing, a strong correlation with an economy that is shrinking, not expanding.

It didn’t matter much to the market though, as the mixed selling was subdued and well contained.

But in another nervous omen on Friday, the University of Michigan Consumer Sentiment Report for June dropped to 94.5 against expectations of unchanged at 97.1 or a slight improvement.

The economic data for months continues to show weakness against a stock market looking like any pause is another excuse for a ramp up.

So while you hear the politicians brag about the economy being great because stock prices are near all-time highs, remind yourself over and over again that the true economic statistics are saying just the opposite.

In my mind, because the data is going down and the prices have been going up, it makes this an even more expensive and overbought market, likely floating near peak prices.

David Stockman Warns Investors

I guess near the top of any market cycle, the gloom-and-doom prognosticators are going to get a lot of press — mostly with a generous side of ribbing about how wrong they are. David Stockman, who recently appeared on Fox Business with Varney and Co., is the latest.

Varney tried that good-natured ribbing on David Stockman, a former cabinet member who served as Director for Office of Management and Budget under President Ronald Reagan.

Varney asked Stockman to please defend the claim that this market is due for a 35% correction any time now, pressing the point that Stockman had been professing this claim for years. Stockman retorted, “I could have said that in February 2000 and the market dropped by sixty percent. I could have said that in November 2007 and the market crashed. I am old enough to remember October 1987.”

Stockman went on, “Markets go up on an escalator, they come down on an elevator. This is the most hideously overvalued market in history.”

“I think it will happen any day, because we’re a country that’s out of control.”

“You want to pay twenty-five times earnings going into a world where the Fed yesterday said ‘we’re going to shrink the balance sheet by $2 trillion over the next several years?’

“Where we have a government that is in total chaos. A president that they’re trying to unseat. A debt ceiling that can’t be raised. A tax bill that will never pass. Going into all of that, to say nothing of the red Ponzi in China that one of these days will spill its guts all over the world economy.”

“And you want to pay twenty-five times earnings for today’s stock? Be my guest. This is a mania.”

But Varney wasn’t done, as he pointed out to Stockman how quickly the markets came back in 1989 and again in the most recent crash, 2009.

Stockman dryly and wryly returned to his sane logic, “That’s because the Fed opened up the stimulus shoot and printed money like there was no tomorrow.”

“Seven weeks after the Lehman bankruptcy [former Federal Reserve Chairman] Bernanke doubled the size of the balance sheet [of the Fed] from $900 to 1.8 trillion. He did in seven weeks what the Fed did in ninety-four years. My point is, they can’t do it again. They’re out of dry powder.”

It is hard for anyone to say they have not been warned. As we enter solidly into the summer trading months… you have been warned again.

To your wealth,

Dennis Slothower Signature

Dennis Slothower

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Outsider Club

Jimmy is a managing editor for Outsider Club and the Investment Director of the personal finance advisory The Crow's Nest. You may also know him as the architect behind the wildly popular finance and investing website Wealth Wire, where he's brought readers the stories behind the mainstream financial news each and every day. For more on Jimmy, check out his editor's page.