A lot of talk/words on the internet about the inflation that the Fed is pumping into the system. I’m no fundamental expert, but it seems obvious to me that the Fed is not causing any inflation now. Nor are the Fed’s actions going to spur inflation in the next year or two. The 10 year bond shows no signs that the smart investors are worried about inflation in the next year – maybe two.
So what is happening with all the money the Fed has poured into the system? It appears obvious for me. The system has been built on a significant amount of leverage for the past 10-20 years. Investors changed their minds in 2007 and do not think that amount of leverage makes sense anymore. As it is removed, the Fed’s money is only replacing enough of the leverage to stop the system from imploding. But there has not been enough added to do more than to slow the implosion and allow the big money to exit the system gracefully.
Think of the Fed money as sawdust. It fills the hole and stops the sides from collapsing. But the sawdust does not have the same properties as real money (or leverage of real money). No one will put real money on top of the sawdust as it is “weak handed” money. It can be removed on a government whim. It does not provide a foundation for a billionaire to make his/her next billion. The risk of losing the seed money is too high so the billionaire puts the money into a tangible investment – say US Treasury bonds.
The saying is that “time heals all wounds”. This relates to our financial system. It may take years, but eventually some with big money will forget the pain and start craving higher returns. They will start to replace the sawdust with real money again and the system will begin growing again. Some assume Bernanke can gracefully take out the sawdust as real money returns (many do not think he can do it). I believe he can remove it but the larger risk is that the money does not return until long after someone else runs the Fed. What if it takes 10 years for the holders of big money decide to take risks again?
Back to the market…
In spite of the great rally off the March low, the swing chart off shows a pathetic effort. Price of the SP500 Index (SPX) is miles from the high and not even back to a 50% retrace off the high. It is very tough to be bullish long term when viewing this chart.
In the short term, the move off the March low continues to close in on the second ninety day cycle. It is rare that a move lasts beyond the 180 day point without a significant correction. Price is about 360 points off the low and maybe that is all we get. The short/intermediate should be read in the context of the long term chart. Since the monthly swing chart above looks so weak in the long term, my assumption is that the correction will be nasty. But I am also guessing that it will not be a quick as the 2007 and 2008 drops and that price will slowly drift down for at least 90 days. Remember that the 1938 market looked very similar to the Nasdaq market and the depression market retest lasted from 1938-1942.
My guess is that the slow correction will last at least to next spring, and probably until next October. As always, I could be completely wrong.
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