Feb. 14, 2016, Weekly Summary: This is an Emotionally Disturbed Market

This is an Emotionally Disturbed Market

These are emotional markets. We have no other way of describing or explaining them. There is no fundamental reason for a majority of participants to be so bearish on stocks. The SP 500 spent all of last year going exactly nowhere. Why? Fundamentally, what has changed from earlier years?

We think the FED may have had something to do with it; they spent the majority of last year preparing the market for some sort of rate hike, the first in nine years. Since rates where at zero bound, this warning should have been greeted with a yawn by the markets. A quarter point rise should not have worried the market so badly that it spent an entire 12 months going sideways and one-and-a-half months in free-fall. That demonstrates emotion not calculation.

The market should realise that the FED is made up of egos, both individual and collective. It seems obvious to us that the FED was forcing a hike, not because it fundamentally had to, but rather because they wanted to be seen as successful. They squeezed a quarter point in at the end of the year even though inflation was not a threat. They figured the market had been primed enough to accept their ‘proclamation of success’ without too much fuss. The market shouldn’t have reacted because the rate hike was not economically significant, but it did. That’s emotion.
Things just aren’t that bad.

Inflation is low at 0.73%.

US Inflation Rate

(www.multpl.com)
SP 500 PE is not excessive at 20.57.

SP 500 PE

(www.multpl.com)

The yield on the SP 500 is healthy, being the highest it has been in seven years. A yield of 2.33% will be attractive enough to bring money back to its senses and build a support for the market.

SP 500 Yield

Unemployment keeps dropping and income keeps rising.

US Unemployment Rate

(www.multpl.com)

US Inflation

(www.multpl.com)
GDP growth at 2.15%, while not something to dance about, is average for the last 60 years.
US GDP Growth Rate

(www.multpl.com)

A lot of ink has been spilt worrying over the US debt as a percent of GDP, but we don’t see this as so dangerous, for several reasons.

First, a substantial portion of this money went to bail-out the financial infrastructure through the various QEs, and much of it is on deposit at the FED. This is the very same money that was given to the Banks in exchange for their troubled Mortgage-Backed Securities. This money has been left sitting at the FED, instead of being put to work in the real economy, because it is earning interest risk-free. A negative interest rate, like that instituted by the BOJ, means that the FED would charge the banks interest for holding these excess funds, which should encourage the banks to lend this money out and therefore increase the velocity of money.

Second, owing a year’s worth of salary would not be viewed by most financial planners as an excessive amount of debt, especially if it had been spent on fixing the foundation of your house so it wouldn’t collapse on top of you.

Thirdly, if you need to spend money in order to prepare for the future, there is no better time to do it than when rates are near zero.

Lastly, we feel that the U.S. must move past monetary jiggling, and start serious fiscal stimulus that targets other infrastructure areas besides the financial, and that means spending money you don’t yet have.

For America to be “great again”, it has to spend on civil, education, social, and medical infrastructure. If you don’t have a healthy, educated, and motivated populace, how can you be “great”. Only then, can the majority (99%) start to build the economy and pay down the debt, like they did after WWII. The war had the very important effect of getting everyone to share in the common good. Without it, they would have been stuck in the depressive 1930’s where a few individuals had rooms filled with cash, while the rest where barely living. I don’t think anyone would call that “great”. The debt is not really a problem when it is used to prepare for the future.

(www.forbes.com)
When we look at sentiment (chart below), we see that 19. 20% are bullish and 48.70% are bearish. Every time the bullish sentiment has fallen below 22% (blue vertical lines), there has been a rally (green up-arrows).

The Rydex Bull Fund assets have not been this low since 2013. Note how minima in the Rydex Bull assets line-up with minima on SP 500 (same blue vertical lines that mark the bullish sentiment minima). Emotions are very depressed. This increases the probability of at least a short-term rally.

In conclusion, this market looks like it is emotionally disturbed, not fiscally sick.