(Guest article by David Haggith of the Great Recession Blog) The Fed’s rise in rates has turned my counterintuitive predictions true by resulting in a rapid rise in the stock market. Trading only had about an hour and half left after the Fed put out its word; so, the Dow only rose about 200 points. I wouldn’t be surprised to see the euphoria kick in full force today and push the market even higher.
How do soaring stocks square with my predictions of an economic apocalypse?
US stocks are rising on pure adrenaline. Nothing changed in a positive direction economically because of the Fed’s announcement. A rise in rates isn’t economic stimulus. Companies didn’t start making more money. Global recession didn’t slow down. Customers didn’t start buying more Christmas toys or all run out and buy a car. Employment didn’t jump upward.
In fact, the main data that came out on Wednesday was all about growing recession in the US:
Industrial production came in at the Econoday low forecast, down a very sharp 0.6 percent in November. This is the biggest drop in 3-1/2 years. Utility output fell a monthly 4.3 percent after falling 2.8 percent in October. Mining, reflecting low commodity prices and contraction in energy extraction, has also been week [sic.], down 1.1 percent for a third straight decline. (Bloomberg)
And I’ll let NewsMax summarize the main economic news of the previous two days:
Oil prices plunged, junk bonds hit a two-and-a-half-year low, stocks took a nearly 4 percent hit, a junk bond fund halted withdrawals, the country’s biggest pipeline operator cut its dividend by 75 percent and two of the biggest mining companies in the world suspended theirs completely.
With no good economic news topping the headlines on Wednesday, this rise was just an emotional sigh of relief that the much-feared event is behind us. The rate at which the market goes up now is a measurement of pure euphoria. It’s the big kick of adrenaline I said we could expect as the long years of wondering if the Fed will end zero interest are finally behind us.
In the minds of the bulls, it also says the economy must be exactly as sound as the Fed believes, or they wouldn’t have made this move. So, I would expect euphoria to build on itself, rising simply because its rising. Call it a euphoric bubble.
There is one reality-based reason behind it, too — a new source of fuel (money) now that the Fed’s free money is winding down. Investors who are now leaping out of high-yield bond funds need somewhere soft to land. However, movement from bond funds to stocks will accelerate the bond implosion, wiping out billions in paper wealth on the high-yield bond side. Unfortunately for the market bulls, such mega-bond crashes almost always lead directly into stock-market crashes.
Awareness that a bond implosion has become a full-on reaction will cool the euphoria, and the people who are celebrating over in the stock market will take a breath and look out their Wall St. windows and say, “Whoa! Look what’s happening over there to the bond guys. Oh my gosh, their whole building is on fire!” Suddenly all the stock-market bulls will run to the windows to stare at the bond fire. The euphoria ends.
Of course, the end of emotional stock buying could happen before the bond implosion is recognized if other negative forces crushing against the US economy burst the bubble first. Safety net gone now that free loans are gone, bad news is always just bad news now. (And don’t think the Fed can just whip the safety net out again if things start to slide quickly. That could have a real chilling psychological effect on the whole economy: “Whoa! We really are going back down the rabbit hole. Even the Fed knows we’re going down if it’s willing to take out its old magic again.” If the Fed thinks about what that kind of move indicates, it will be very reluctant to move.)
That is what changed on D-day. Reality is now here. There is no more cushion from the Wonderland effect where down was up because bad economic news meant the Fed would keep the free-money tap open. For the past several years, bad economic news almost always caused the stock market to rise as it stirred visions of Fed sugar plums in the dreams of investors.
Now we are back to a world where bad news is just bad news. It’s just a cold, rainy day. Bad news has no buoyancy effect at all (and it never should have had such an effect, but it did). That means things go down, down, down from yesterday on (once the euphoria cools off) because there has been a swale of bad economic news that was helping the stock market back in its Wonderland daze, but we left Wonderland yesterday. Young investors have never experienced Reality World because we have lived in the Fed’s Fantasia for so long now. So, there is some real adjusting to do.
Am I playing fair?
You’d have a right to cry fowl over my calling the market rise the first phase of a crash if I hadn’t said prior to the Fed’s decision that, the crash would be upward at first if the Fed raised rates — counterintuitive and self-contradictory as that may seem.
Many contrarians and permabears are, I’m sure, scratching their heads this morning, wondering what went wrong with their predictions. Why did the market go up, instead of down; but if you read my D-day article yesterday morning, you already understand. If you didn’t read it …
After the Fed’s announcement, the market bulls looked to see if things immediately crashed and then started to party, throwing champagne into the air, ecstatic that their market didn’t immediately crash. Their party could last for days or end tomorrow. They don’t read this blog, so they don’t realize that, when you leave Wonderland, the only way out of Upside-down World is up the rabbit hole — a manic crash up. And manic rises, from what I have observed in human behavior, are nearly always followed by depressive crashes.
To use a simpler simile. Think of it as being like the cliché boiling pot after you’ve turned the burner off. You take the lid off, and it boils over even though the source of heat is gone; but then it cools down and boils no more.
Getting back to the motif of leaving Wonderland, there was a big updraft through the rabbit hole the instant the Fed ended its magic, and that’s likely to grow fierce from the chimney effect, but once it launches the bulls out the top of the hole, you know what happens next? The updraft effect from any chimney ends after you shoot out of the tube back into Reality Land. Particularly watch out, however, if the euphoria cools quickly because, after more than a year of concern over what would happen when stimulus ended, there is a lot of relief the bulls would like to celebrate. If the euphoria cools quickly, it’s likely to mean things are ready to go down hard and fast.
The metaphor I used yesterday was that the gas runs out on the bull’s hot air balloon as soon as the Fed ends zero interest, but their balloon would hit an updraft that would give it one last lift, even as it starts to deflate. Regardless of what they feel in the upward rush, the greater reality is that the gas is out, and their balloon won’t stay inflated without that fire. There will still be some bounces on the way down — as there has been in every market crash — but the trend will be all down.
Today, you can expect the talking-head fools in the clown balloon to get out their cell phones and call the bears and prattle, “Yay, the Fed’s fire is out, and we’re still rising! See, we didn’t need the gas any more. Bet you wish you had stayed in here with us!”
No, I don’t. I think they’ve been breathing the gas, and I wouldn’t want to be in the buffoon balloon for anything. Let them have their last days in the setting sun, reveling in their fireless flight. It is all as expected here, so I’ll watch from my lawn chair on terra firma.
Then, as the skies darken into the winter of our discontent, I’ll walk back into my warm little farmhouse and let the bulls fall from the cold night sky. Inside, where I’ve already marked December 16 on my calendar as the day that ended the bull’s balloonish dreams, my grandson will ask, “Daido (Irish for grandfather), what is that faraway screaming?”
“That,” I’ll answer, “is the sound of a lot of bull … finally going away when all the hot air has ended.”
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