Beware August

Posted On Jul 21, 2016 By Dave Gonigam

  • The market shock that didn’t happen today
  • Your finances at the mercy of clueless and unelected pointy-heads
  • The Fed’s three-year spin cycle and “the August joker in the deck”
  • Taking the economic pulse: Still weak but not recessionary
  • Congress frets over Pokémon GO and data plans
  • America “shoving debt bubbles up the global tailpipe”… reader urges Rickards to give it up with the Shanghai Accord… a new twist on “Federal Standard Time”… and more!

We begin this morning by attempting to end-run the inevitable “boy who cried wolf” emails from readers.

Late yesterday, we sent you a message saying the European Central Bank was set to make an announcement this morning that could sink the market in a matter of seconds.

The potential for a shock was surely there: It was the ECB’s first meeting since Great Britain voted to leave the European Union. Also the first since stresses in the European banking system became glaringly obvious.

In the event, the announcement was a nothingburger. The ECB made no sudden changes to interest rates or monetary policy. ECB chief Mario Draghi was full of noncommittal butt-covering platitudes: “Over the coming months when we have more information… we will be in a better position to reassess the underlying macroeconomic conditions.”

Traders could barely rouse themselves to react. The Euro STOXX 50 index ended the day flat; Germany’s DAX was up a bit, France’s CAC 40 down a bit.

At last check, the major U.S. stock indexes are slightly in the red. Treasury rates are moving back up, the 10-year note at 1.6%. Gold is rallying a bit at $1,322, even as the dollar is holding steady relative to other major currencies.

Here’s the problem: Nowadays, every “routine” announcement from the globe’s biggest central banks has the potential to throw markets into a frenzy. Your finances are at the mercy of unelected pointy-heads who, if you can catch them in an unguarded moment, will admit they have no clue.

“Don’t ever think for a minute that the central bankers know what they’re doing,” Jim Rickards told me during a conversation more than two years ago.

“And that’s my own view, but I’ve heard that recently from a couple central bankers. I recently spent some time with one member of the Federal Open Market Committee and another member of the Monetary Policy Committee of the Bank of England, which is the equivalent of their FOMC — both policymakers, both central bankers.

“And they said the same thing: ‘We don’t know what we’re doing. This is a massive experiment. We’ve never done this before. We try something. If it works, maybe we do a little more; if it doesn’t work, we pull it away and we’ll try something else.’

“The past three years have seen endless repetitions of the feedback loop between the Fed and the markets,” Jim says now, assessing the state of play at the Federal Reserve.

“Here’s how it works,” he explains in a briefing that went out today to readers of Rickards’ Intelligence Triggers. “First economic data are weak and markets are listless. Then the Fed engages in easing activity through QE, forward guidance and happy talk. Markets expect easy money as far as the eye can see and start to rally.

“Sooner rather than later, the rally looks like a bubble. The Fed views a strong market as a sign of easier financial conditions. Next the Fed gets tough. They start dropping hints that rate hikes are ‘on the table.’ They send out regional reserve bank presidents like James Bullard as hit men for the hawkish message. Based on new expectations of rate hikes, the dollar strengthens, deflation gets worse, corporate earnings take a hit and the stock market gives back its gains.

“Just when it looks like markets are ready to implode (think August 2015), the Fed flips back to dovish. The happy talk starts up again. Conditions ease and markets rally. Wash, rinse and repeat.”

By Jim’s count, we’ve been through this spin cycle eight times since May 2013 — when Fed chief Ben Bernanke spooked the markets by suggesting the Fed would “taper” its bond purchases.

Just for old times’ sake, our friend the tapir (Newer readers, you had to be there)
[Wikimedia Commons photo by Sasha Kopf]

So here we are this morning, the Dow and the S&P 500 near all-time highs, based on zero fundamentals — unless you count the expectation that “investors” are willing to pay ever-higher multiples of earnings.

“We have nowhere to go but down,” Jim affirms. “I might take a different view if the market rally were based on fundamentals, but it’s not. It’s based on hot air from the Fed.”

And as we’ve mentioned the last couple of days, that hot air is suddenly blowing cold again with the Fed’s chatter about interest rate increases “back on the table” for September.

“They’re not,” says Jim, “but that’s what the Fed wants you to think. Meanwhile, the Chinese are back to their old tricks with stealth devaluation. August 2016 looks like a replay of August 2015, with further to fall.

“Another myth is that August is a ‘quiet’ month because so many are on vacation,” Jim points out. “Don’t believe it.

“Some of the biggest shocks of the past 30 years have occurred in August, including the Kuwait invasion by Iraq (1990), Russian coup attempt (1991), Salomon Bros. bond market fraud (1991), Russian default and LTCM collapse (1998), Hurricane Katrina (2005), Chinese shock devaluation (2015) and many more.

“With a bubbly market, hawkish Fed, low volatility and an August joker in the deck, we could be in for an interesting month. I feel safer in cash, gold and selective short positions.”

[Ed. note: Readers of Rickards’ Intelligence Triggers got the word this morning: Jim’s proprietary “Kissinger Cross” indicator flashed sell on a position they were urged to buy last December. Result — 96% gains in a little over seven months.

And that comes on the heels of a spectacularly successful trade surrounding the “Brexit” referendum last month that generated up to 129% gains in a mere three days.

If you want to exploit the “August joker in the deck” for maximum gains, you’ll want to be on board for the next trade. Access here.]

We got a gaggle of numbers this morning that paint a portrait of continued, nay perpetual, mediocrity in the U.S. economy.

The Conference Board’s leading economic indicators pushed up 0.3% in June. But the biggest contributor to that increase was continued low interest rates.

The Chicago Fed National Activity Index for the second quarter clocks in at minus 0.12. That’s “below historical trend” but nowhere near the minus 0.70 threshold that says a new recession is underway.

Existing home sales in June notched their best number since February 2007 (low interest rates again).

We also got one so-far-in-July number. The mid-Atlantic factory sector as measured by the Philadelphia Fed survey is once again shrinking, though not much.

Because they’ve solved all other problems, Congress is wringing its hands over Pokémon GO.

Rep. Frank Pallone (D-New Jersey), the top Democrat on the House Energy and Commerce Committee, has sent a sternly worded letter to Pokémon GO creator Niantic. “We are writing to better understand what measures Niantic has undertaken to ensure consumers are informed of Pokémon GO’s effect on their mobile data usage.”

They’re also concerned about Pokémon GO’s impact on — get this — battery life.

Get real, writes Ed Krayewski at Reason. “It’s up to individuals how much they want to consider their data usage when playing Pokémon GO. Most smartphones allow you to check data usage by app — I’ve used about 300MB of data on Pokémon GO in the last two weeks, hardly my most data-taxing app — and there are even apps to help monitor data usage instead.”

Oh, and as far as battery life is concerned, there’s a battery-saver setting for the game.

Rep. Pallone’s letter — also signed by Colorado’s Diana DeGette (D) and Illinois’ Jan Schakowsky (D) — does not explain which clause of the Constitution gives them the authority to muck around in Niantic’s business. Interstate commerce? General welfare? Necessary and proper?

Anyway, we’re confident that despite congressional meddling, Pokémon GO continues to signal an epic, multiyear profit opportunity — for reasons our Ray Blanco explains here.

“Dave, great stuff,” a reader writes after yesterday’s episode. “There’s a reason China (and others countries) believe the U.S. is double-crossing them: because we are.

“It’s one thing to fight a currency war when you’re a developing country with a small economy. It’s quite another thing when you’re the world’s biggest economy with a reserve currency so prominent that it is the ‘petrodollar.’

“We’re not just exporting debt bubbles and inflation to other nations. We’re shoving them up the global tailpipe — causing real problems and hardships for real people around the world. I appreciate what America used to stand for, but there’s a reason this country is not well liked internationally now. I fear the blowback is just getting started.

“Love The 5!”

; “Shanghai Accord, meet ‘confirmation bias’: I.e., when the only tool you have is a hammer, everything looks like a nail,” writes a reader who is less enamored with yesterday’s episode.

“Over the past few months, we have heard about the Shanghai Accord, yet we have not heard offsetting evidence. This takes me back to my early days as an engineer when I was tasked with interpreting data, in which data contradicting the believed ‘trend’ were cast aside as outlier data.

“Please spare us from this rookie error. Present all of the data for the Bayesian belief that is related to the Shanghai Accord theory or discard all of the data and move on to a more concrete theory supported by all of the evidence.”

The 5: Well… As a quick refresher, Jim’s inverse-probability technique builds on a two-centuries-old formula developed by Thomas Bayes. In plain English, it looks like this…

Description: Formula21.png

A thesis — in this case, the ‘Shanghai Accord’ — is on the left side of the equation. The numerator in that fraction on the right is new incoming information. And the denominator represents all of the possibilities the thesis is wrong.

Jim is constantly evaluating new incoming information to see whether the thesis is still valid. Let’s examine today’s new incoming information relative to the Shanghai Accord…

  • Back to today’s decision from the European Central Bank: “Investors are keen to know if the ECB will extend quantitative easing past the soft deadline in eight months’ time,” says CNBC, “but Draghi provided no new clues on Thursday”
  • Meanwhile, Bank of Japan Gov. Haruhiko Kuroda ruled out using “helicopter money” to finance Japan’s budget deficit.

Both of those developments violate expectations of “easing” policy. But they’re right in line with the Shanghai Accord — under which both the ECB and the BoJ agreed to “tighten” policy.

Just because the Fed isn’t playing by the rules right now doesn’t invalidate the Shanghai Accord at this time. Again, there’s new incoming information every day. Jim’s on top of it. Stay tuned…

“My personal experience reflects a different point of view,” a reader weighs in on medical marijuana.

“To the ‘medical doctor’ who expressed concerns about what marijuana users may experience in the future some 30 years forward — essentially, that they will face the same issues of health challenges that the tobacco smokers experience — I have this to say:

“I have enjoyed the wacky tobacco for 50 years almost daily, and during that time I learned to excel in 50 different sports; was a successful CEO of an organic food company, and in that industry for 30 years; am 72.5 looking like 55, according to almost everyone I know; have a telomere count of 11,570; possess amazing health with no lung or respiratory issues; and drink and eat copious amounts of Himalayan pink salt daily, additionally.

“I think the MD is better off telling folks to lower their cholesterol with statin drugs, stay away from fats in foods, continue to eat margarine and, of course, lower their intake of salt regardless if it is real salt or not!

“In other words, it’s not the pot, dummy!”

“OK, I’m shocked no one else has brought this up to you,” writes our final correspondent, “but maybe you should put FST (Federal Standard Time) in small letters under the 5 Min. Forecast moniker, letting everyone know that it takes five minutes of FST to read it!

“I think it’s hilarious that this complaint has been going on so long. THIS will fix it once and for all! I love your work!”

The 5: Funny, we ran across a reference to “Federal Time” last night while reading an Atlantic article about the vulnerability of GPS to everything from hackers to solar flares.

Turns out the Coast Guard’s been working for years on a navigation system that would serve as a cheap backup for GPS — an updated version of its old Loran system developed during World War II. There’s even a working prototype… but no effort and no urgency about bringing this backup into widespread use.

“There are two kinds of time,” complained Rep. John Garamendi (D-California) last year — “real time… and then federal time, which seems to be the forever time. The e-Loran system was identified as a backup 15 years ago, and here we are, federal time, not yet done.”

Best regards,

Dave Gonigam
The 5 Min. Forecast

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