Canadian Market

Brooke Thackray: "Not Your BFF!"

by Brooke Thackray, Alphamountain Investments

Market Update - July 2017

I tweeted the meme on the left “NOT YOUR FRIEND” on July 6th @BrookeThackray.

Maybe the tweet should have said....NOT YOUR BFF!

For those of you without small children, BFF is an acronym for “Best Friends Forever.” This term did not exist before the prevalence of the internet, but with keyboards in young children’s lives it is easy to see how the term has spawned.

For the last eight years, investors have been partying with the U.S. Federal Reserve (and other central banks) providing the punch bowl to keep it going. The U.S. Federal Reserve has expanded its balance sheet to the tune of $4 trillion through its quantitative easing program. Major central banks now have a total of $13 trillion on their balance sheets. Initially the Fed launched its QE programs to provide liquidity to stave o. a financial crisis. After a financial crisis was averted, the Fed, like other central banks, has used quantitative easing to try and stimulate the economy back to, or close to full employment. When this target was reached for the Fed, then continued to in.crease liquidity into the system in order to stimulate the economy up to a 2% target inflation rate. Initially, the rationale for such action was that the economy could slip into an unwanted deflationary mode. More recently, the rationale…well…has changed to helping the economy grow. The problem is that there is a growing consensus that the lion’s share of the benefits from increased liquidity has helped “Wall Street” and not “Main Street.”

Up until recently, the Fed has been a friend of investors, pumping money into the system which has helped bond prices and stock prices. Investor’s thought that Yellen was their BFF. Yellen is not a BFF, she is a fair-weather friend. Investors somehow believe that the Fed can manage the economy into perpetuity without it ever going into a recession. Nobody wants a recession, but they are inevitable.

The longer the economy is engineered so that it does not enter into a recession, the damage from a recession when it does occur, will probably be more destructive. Low interest rates have encouraged large amounts of personal and corporate debt. Consumers have treated debt as free money with very little expectation that it will have to be repaid in the future. Governments have acted similarly.

If interest rates were high and consumers had large amounts of debt and the economy started to stumble, the solution is fairly straight forward….and the Fed would cut interest rates. When interest rates are next to zero, this option is o. the table. There are other creative ways to keep pumping liquidity into the system. Japan has been a “hothouse” of experimentation with some of these meth.ods, with limited success. It is running out of options to keep stimulating the economy with huge government debt and low interest rates.

The Fed is trapped. It wants to keep the party going, but it realizes that its actions are creating a misallocation of resources in society and its actions are possibly pushing up the stock market to high levels. It knows that it needs ammunition for the future; it needs to be able to stimulate the economy when it really needs it in order to avoid a recession or make it less severe. On the other hand, it doesn’t want to cause a recession.

Many investors were upset with the Fed because they felt that the inflation numbers did not justify a rate increase on June 15th. The Fed basically said that it was looking at a general trend of expansion and was justified in their actions.

The rate increase was a big deal because it showed that the Fed is less data dependent than most investors expected. It raised rates on the faith that the expansion will continue, rather than the data. Investors and the Fed are no longer BFF’s. It is not personal. The Fed is trying to sneak in a rate increases when possible to reach a more normalized level.

Another Theory-

I have not read this anywhere else...but I believe that Yellen’s career risk is playing a part in the decision making....not that she would ever admit it.

There is a significant chance that Trump may replace Yellen next year when her term expires. If this is the case, she will not want to go out like Alan Greenspan. While Greenspan was the chairperson of the Federal Reserve, he was cheered like a rock star for stimulating the economy with low interest rates. When the stock markets collapsed he was vilified for not implementing a tight monetary policy much sooner.

Yellen could su.er the same fate as Greenspan if she hangs on too long with low rates. It is better to start the process and at least get the ball rolling with higher rates. At least she will not be ostracized for letting the party go on too long.

Another Theory-

Given that governors need to be instated next year, to the Fed, Trump is going to help determine the future direction of the Fed. Given that Trump has shown a liking for debt, there is a good probability that he would push for.ward governors that would support such policies, which could mean lower interest rates. Yellen may be trying to get ahead of such action by raising rates now.

Eye of the Storm-

It seems that every investor is familiar with the saying “Sell in May,” which applies to the six-month period from May to October where the stock market tends not perform as well as the other six months of the year. What is less well known is that the stock market tends to per.form well in the last few days of June, into mid-July. I have written about this phenomenon previously and I included it in my latest book (“Thackray’s 2017 Investor’s Guide,” page 80).

Despite the stock market being at high valuation levels, the stock market can still perform well in the Eye of the Storm. Investors should take note that a rally in this period does not necessarily lead to a sustained rally in August and September, which have been the two worst contiguous months of the year. Investors beware.

Read/Download the complete report below:

Thackray Newsletter 2017 07 July by dpbasic on Scribd

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