Headwinds

Despite dire predictions, the US stock market is up over 38% since Trump was elected president. However, there are now serious headwinds that likely will keep the breaks on further dramatic advances in equities. They are:

- The Federal Reserve's easy money policy (Quantitative Easing) has stopped. In fact the Fed is well into the process of reducing its balance sheet by about 3.5 trillion dollars. This means that this much liquidity is being removed from our economy.

-Yes, Trump's fiscal measures (tax and regulation reform, trade terms, infrastructure spending) have boosted our economy and corporate earnings. But price-earnings ratios in the stock market are still above historic averages.

- The geo-political risks of Iran and North Korea still pose a dire risk to the world order and stock markets.

- The Fed is on track to raise interest rates multiple time both this year and next. Higher interest rates increase the discount that must be applied to corporate earnings.

- Robert Mueller's team of crack partisan investigators seem hell-bent on taking Trump down. This is a pall on his ability to keep things moving forward.

- Current trade negotiations with China and NAFTA could easily result is trade wars that would take at least a short-term to the US economy.

So, will the stock market make dramatic new highs despite these many headwinds? The odds seem against it. But then Trump has a way of defying the odds.

Enter Japan

Nikkei 225

The focus on stock market corrections in the Far East has been China ... but now there is another worry there ... Japan. The Nikkei 225 stock index in Japan has dropped over 15% just since mid-July ... from 20,953 to 17,792 ... dropping 390 points this morning. Whether this is Asian contagion or some other fundamental problem, I can't say ... see: CNBC Analysis. But this is occurring in the midst of a large amount of Quantitative Easing on the Bank of Japan's part ... an action that normally props up stock markets.

Japan is also carrying government debt equivalent to something like 200% of GNP versus about 74% here in the United States. This also worries me ... for, if both China and Japan swoon in tandem, can the rest of the world be far behind?

How Many Angels …

can dance on Ben Bernanke’s head?  I just finished watching the Bernanke news conference after the Federal Open-Market Committee (FOMC) meeting yesterday and today … and a vigorous round-robin discussion on CNBC with about eight monetary policy experts.  All the while the stock market sold off over 100 points (at closing, it is now down over 200 points) and the yield on the ten-year note bounced around and then climbed to as much as 2.4%.  This was because Fed Chairman, Bernanke said that, if economic conditions continue to improve in the direction of internal Federal Reserve Bank forecasts, its quantitative easing (QE, or $85 billion monthly purchases of U.S. securities and mortgages) would begin to be scaled back later this year … with the possibility that they would end entirely by mid-2014.

What does this all mean?  Only Big Ben really knows … markets move not just on the absolute direction of interest rates … but on the first, second, and even third derivatives of same.  This is reminiscent of the middle-ages theological discussions about how many dancing angels could fit on the head of a pin … or the Talmudic discussions among Hebrew scholars about the implications of a single scripture word.

One thing investors might be able discern from this calculus … and that is, if Bernanke’s sage words do come true, the Fed will soon be "removing the punch bowl" and our economy should slow down … even from current anemic levels.  This means that the Democrats might have a more difficult time recapturing the House of Representatives in 2014 and maybe even holding onto the Senate … but then, because of the resulting economic bounce, they possibly would have an easier time retaining the presidency in 2016. 

And they say that the Federal Reserve Bank is not political …

What Are the Chances ...

that the Federal Reserve Bank will initiate a third round of Quantitative Easing (QE3) anytime soon?  The New York Times weighs the pluses and minuses in a thoughtful analysis (see: NY Times Article).  Basically quantitative easing consists of the Fed issuing more debt and, simultaneously, buying it up so that more money is placed in circulation.  This makes the stock market go up, drives down interest rates even further, and weakens the dollar.(which seems acceptable since the dollar has been kicking the Euro's backside of late.)

However, the Fed is just one horse in an economic troika team that includes the fiscal side of the federal government and U.S. industry.  These other two horses are clearly not pulling their weight ... the administration and Congress because they are locked in a cage-match fight over whether Keynesian economics will ever work (it won't) ... and U.S. industry because it sees the new-taxes cliff looming in January and a much smaller chance that Obamacare will vanish (also add a hostile-to-business Obama administration).

My guess is that there is a strong possibility that the Fed will pull the lever on QE3 no later than its September Open Market meeting for no other reason than it too is a political animal (as we recently discovered the Supreme Court to be).  Fed Chairman Bernanke (and his sidekick, Little Timmy Geithner at Treasury) want to keep their sinecures and there is almost no chance that they will if Romney is elected.  Therefore, despite QE1 and QE2 not really pulling the U.S. out of the financial doldrums, Bernanke will force through QE3 to at least give Obama a fighting chance for four more years.  This is all The Barry will need to pulverize fully the U.S. economy.

Funny Money

Quantitative Easing (QE) ... this seems to be the central banks of the world's solution to their mounting debt crises. The European Central Bank (ECB) has just taken its cue from Ben Bernanke of the U.S. Federal Reserve Bank (Fed) and embarked on a three year binge of QE (see: Boston.com Article)  What does this mean?

It means that European banks can borrow at a 1% rate from Mario Draghi's (ECB's President) piggy bank and turn around and lend it to various European countries at north of 5% (sometimes well north) ... government largess that rivals the green-energy give-aways in the United States. This is meant  to recapitalize these banks which have been weakened by the haircuts they are taking on Greek bonds (and others to follow?)  I sometimes wonder why the ECB doesn't just give the damn money to these banks instead of this obvious artifice.

This mimics what has been happening in the United States where the Fed has been lending money to our banks at below 1% and they, in turn, have been buying government bonds at higher yields ... not quite as lucrative as in Europe, but largess nonetheless.  And where does the Fed get this money to fire-hose out to the banks?  Not from the U.S. taxpayer, but it creates it out of thin air.  It sells U.S. bonds, bills and notes to get the cash to lend out to U.S. (and foreign) banks (and to fund our huge annual deficits).

And why, you ask, does not all this selling of U.S. government debt obligations push down prices and push up yields.  Simple ... because the Fed buys for its own account around 80% of everything it offers.  This financial slight-of-hand has increased the Fed's balance sheet almost three-fold in the last three years (see: QE Comparison) ... a dizzying statistic ... if we can rely on this reporting since the Fed may also be playing Enron-like accounting shenanigans (see: Finger on the Scale).  Zowee!  If the Wall Street Occupiers only knew these funny-money tricks that were taking place at the Fed, they might move north one block and become Pine Street Occupiers (where the Fed is located).

I'm not quite Ron Paul on this issue yet, but I am getting closer.  For those not yet nodding off, I intend to blog more on this whole mare's nest later ...