THE TIPPING POINT HAS ARRIVED
By Comstock Partners (Weekly newsletter released Thursday)
As we pointed out from the get-go Bernanke’s QE2 policy was a gamble from its inception, and its consequences are now coming to the fore with the collapse of the commodities bubble. Throughout financial history parabolic market moves have inevitably collapsed, and there is no reason to think that this one will be an exception. Although there will undoubtedly be some attempts to buy the dips, once bubbles burst they don’t come back for a very long time. The chances are therefore high that this is a real tipping point for both stocks and commodities with a major downturn more likely than a mere correction.
The initiation of QE2 was a desperate move to begin with. QE1 most likely saved the world from a financial collapse and induced the start of a sub-par recovery along with a strong rally in equities. However, when QE1 ended in the spring of 2010, economic growth began to lag once again and the stock market dropped about 17%. With further stimulation from fiscal policy politically off the table, it was left to the Fed to do the heavy lifting even though the fed funds rate was already near zero, and obviously could not be reduced any further. The intention to start QE2 was announced late in August 2010, and implemented in November.
The original intention of QE2 was for the Fed to buy $600 billion of Treasuries by June 30, 2011 in order to lower medium to long-term rates, help increase home buying, weaken the dollar to aid exports and jump-start stock prices. The hope was that the resulting increase in assets including stocks and houses would spread to the real economy. Since this type of monetary easing had never been tried before on such a grand scale, it was an experiment fraught with danger and the potential of serious side effects that we pointed out at the time.
Although QE2 has helped some segments of the economy and jump-started the stock market, it has had important negative consequences as well. Since that time commodity prices have soared while long-term interest rates have climbed and the dollar has weakened. The rise in food and energy prices has caused top-line inflation to increase faster than wages, resulting in declining real income. In addition it has resulted in higher inflation in emerging nation as well as the EU, causing them to raise interest rates at the risk of slowing down global growth. Some nations have also initiated capital controls to prevent too many dollars from flooding their financial system.
Now the bubble (the third in 11 years) is finally in the process of bursting and reversing the market trends that have persisted for the past eight months when the dollar was down and everything else was up. Consumers in the U.S. are being squeezed by stagnant wages, higher commodity prices, continued weakness in housing, and high unemployment that is more than offsetting whatever benefits accrue from a weaker dollar. At the same time emerging nations and the EU are all tightening monetary policy and reducing fiscal stimulus.
Today the markets came as close as they ever do to ringing the proverbial bell that signifies things have changed. Suddenly commodities are collapsing, equities are declining, the dollar is rising and high quality long rates are dropping. In our view this constitutes a new trend that will persist for some time to come.
Solid note, agreed on all levels.
except for the “never been tried before” .. Japan tried it a few times.
New trend, maybe. Initial claims at 475k and the market sold off on bad news. Jobs beat and the market rocketed? This behavior was unAmerican in the post-ZIRP/QE world. Stock buying on good news and selling on bad news? WTF?
Oil is down 13 bucks in two days. Maybe that’s more the point than some volatility in equities.
Also, equities may have popped in the morning, but they sold off all afternoon, on a day where the BLS was throwing a party.
It does seem that “Risk-Off” is starting.
If the Fed decides to implement another round of QE I doubt this article will remain correct regarding this “tipping point”.
Excellent article, Comstock!
Comstock Partners
“Suddenly commodities are collapsing, equities are declining, the dollar is rising and high quality long rates are dropping. In our view this constitutes a new trend that will persist for some time to come.” What??
AWF says:
For the daytrader some commodities have had sharp moves -OK but lets look closer.
Gold: The Long Term and Intermediate Term Trends are in Intact–until there is a change in the IT-Trend – Gold will continue to move up–of course not “straight up”!
DBB-Industrial Metals-Commodity:-Looks to be making a slow U-Turn from its high level–Sharp Turns we expect and can live with–U-Turns we can’t–Risk-OFF!
DBA-Ag-Commodity: While the Short-Term Trend has taken a hit the IT-Trend is Intact–A sharp move from an “overbought/over-hyped” was expected with any move of the USD moving up. “Supply/Demand” favors higher prices in both the Intermediate and Long Term frames.
DBO-OIL-Commodity: Hold/Buy weakness–Consider these 4 factors
Mid-East supply oulook = Questionable/Unreliable
USDomestic production outlook = Lower/Stagnant production
World-Wide Demand outlook = Higher Demand
USDollar direction outlook = Favors the Downside
USDollar–FX: I have posted as recently as 2 wks a go the probable reflex rally of the US Dollar — 2 oversold/over-hyped–any whiff of weekness around the world would cause a “flight to safety” to the USD–
But the real question is “Can the US Economy stand on its own–and not require support from the Govrnmt and the FED” = not only NO ! but Hell NO !
Consequently a “Strong Dollar” would be a negative and cause “Bubbly Ben” to grow hair! “Cash for Cannoli” anyone?
Stockmarket: “Sell in May” — Hardly
Stock/Bond confidence: favors Stocks–Midcap/Smallcap trends remain Intact.
Bond/Bond confidence: favors High Yield–yes we see movement to the LT Bond but not violent enough to change this position.
Thats all folks
good article
In my opinion we are possibly seeing the first signs of “credit crunch Part II” with new lows in almost everthing but bonds
to come.
I cannot imagine how QE3 could be possible, given both the political and economic situations. At some point, the party will/must end..it is inevitable.
It will come the next time the stock market drops 12% from peak. Remember Ben thinks if you make the 1% that own nearly 50% of equities richer via fake asset prices everyone wins via the wealth effect. Plus it creates 3′ jobs. Or so says right hand woman Janet Yellen..
There will be a QE3 if Ben thinks we are not done depreciating the dollar, which is a possibility. We can easily have rounds of QE until Congress makes up its mind on how much we need to cut spending. Remember that at this point, devaluation is the only card Ben can play, and I doubt he will withdraw it as long as the debt is so heavy.
The end of the rally of the EUR against the USD coincides with, yes Trichet’s decision not to raise rates, but also with the last major auction of long term Treasuries in the US, so basically the end of QE2. The result: more confidence in the USD.
I wouldn’t be surprised if the reversal in the EUR/USD trend was only temporary. At best, we might only be taking a break from QE.
by “the last major auction of long term treasuries” I mean before the official end of QE2 obviously (June 30th I believe).
has anyone read what Comstock has written over the past decade. They are like Prechter.