Ben Bernanke nearly collapsed a lung patting himself on the back last week at the annual Jackson Hole economic wonk confab. According to the Great One himself, it is only through the heroic efforts of the Fed and Treasury that the financial sun continues to climb above the horizon each morning. Of course, he didn’t mention that it was the unholy triumvirate of Bernanke, Bush and Paulson who caused the panic last year and all the other attendees were either too polite or too solicitous of their host to mention it. The consensus among the economic conformists gathered in Wyoming seems to be that Bernanke saved the world late last year and should be reappointed forthwith. I suppose there is some truth to that idea, especially if one is part of the economic elite that benefitted greatly by the world that existed prior to the great panic of 2008.

For the Too Big to Fail Bankers at Jackson Hole, who were as thick on the ground as protestors at a town hall meeting, Bernanke has certainly been a savior. He’s cut their funding costs, loaned them money on dubious collateral at rates that would make Santa Claus blush and allowed their competitors to fail. If I belonged to the Too Big to Fail Club for Men, I’d be pretty happy too. For the rest of us mere mortals, the Fed’s actions are not quite as beneficial. CD rates are only high enough to ensure a loss after taxes and inflation, while getting a loan now includes the financial equivalent of a colonoscopy without the benefit of anesthesia. It might be what’s best for us in the long run, but one would think that what’s good for the goose is also good for the pluckers of geese.

Even the Fed induced bull market in stocks and other markets is primarily beneficial to the financial institutions who are the first recipients of the new dollars pouring out of the electronic printing press. A good portion of the public bailed on the market last fall and most of them are watching this rally from the sidelines. Of course, its difficult to commit to a stock market that is increasingly divorced from reality and the fundamentals, especially when you’re spending the majority of your time looking for a job or trying to keep the one you have. Fortunately for the future of the Republic, the large and well connected financial institutions don’t have to worry about such picayune matters and also have some newly printed Fed bucks burning a hole in the vault.

I can’t help but notice that the Fed’s current policy is eerily similar to the policies that produced the housing bubble and its aftermath. The “considerable period” of low interest rates that convinced one and all that house prices only rise has made an unlikely comeback. The old saying about insanity being defined as doing the same thing over and over and expecting different results certainly applies. Since Paul Volcker strangled the inflation monster back in the early 80s, each recession has been met with ever lower rates. The subsequent tightening cycles have also pushed us into recession at successively lower rates:

The observant will notice that there aren’t any negative numbers on this chart, so while the Fed may be able to inflate one more bubble, one really has to wonder what happens next. Forced to guess (and I suppose that is my job), I suspect that this chart will soon start to resemble the period that immediately preceded the great moderation. Avoiding that outcome would require a coordination of monetary and fiscal policy that seems unlikely in the extreme. All those expecting sustained deflation would be wise to remember that inflation benefits all the right people. CEOs, bankers, politicians and the wealthy generally benefit from inflation while it only hurts the frugal and the poor who are notoriously tight with a campaign contribution. And with most of the country (read voters) in debt up to their collective eyeballs, deflation is not an option conducive to continued re-election of politicians or a certain Fed Chairman.

Bernanke and other Fed officials used the Jackson Hole meeting to assure everyone that monetary tightening is a long way off. The Fed is trying to create inflation and only the foolhardy would expect them to fail when they control the printing press. One of the few Wall Street adages that still holds some truth is, Don’t Fight the Fed. For now and the forseeable future, the Fed is telling us loud and clear that the new money will keep flowing. With little incentive to make long term productive investments, it seems likely the new money will continue to find its way into financial markets. And if the dollar keeps falling, it will soon start finding its way increasingly into real assets - commodities and real estate.

Weekly Economic and Market Review

Like almost everyone else on the planet, I’ve been looking for some kind of correction in stock prices and in last week’s update I said it was time to “take some chips off the table”. True to my word, I did some selling early Monday - not much - but then something happened (or rather didn’t happen) that convinced me to take a wait and see attitude. The market sold off hard Monday morning; the open gapped lower and the S&P 500 quickly traded down 26 points and then….nothing. I had pegged support in the 975 area and the low of the day was around 978, so it appeared that the market was holding steady at first support. I took that as a bullish sign; the desire to sell just wasn’t there.

One reason for the lack of selling pressure may be that traders have been buying protection for their portfolios. There are large open positions in the SPY (S&P 500 ETF) puts; more than 100,000 put contracts are outstanding in a series of strikes below the market starting with the 97 strike (SPY closed Friday at 102.97). The strike prices with more than 100,000 contracts outstanding are: 97, 95,91,90,88,85 and 80. That’s a lot of downside protection.

In addition to the purchase of puts, investors have gravitated to the new VXX exchange traded note introduced by Barclay’s in February. These notes are designed to track the VIX, the volatility index. As everyone now knows, when the market takes a dive, the VIX rises, so being long the VXX ETN is a good way to buy cheap protection. According to the IPath website, there are now 8,468,300 shares outstanding which at the current price gives a market cap of $488,705,593. With all this downside protection in place, the urgency to sell in a correction is limited and unhedged sellers are quickly exhausted.

Regardless of the reasons for the limited correction, it seems pretty obvious that the bulls are still in control and the naysayers are increasingly frustrated. One thing this upswing hasn’t lacked is skeptics. I don’t listen to CNBC everyday (I rarely watch) to get good advice about investing; that would be like watching C-SPAN to get good advice on governance. No, I listen to CNBC everyday to hear what the endless parade of portfolio managers have to say, so I know what not to do. Over the last few weeks, the dominant theme has been the anticipation (or is it desire?) of a correction in the stock market. There was also a lot of talk about how we are entering a seasonally weak time for the stock market. September is the worst month for the market, blah, blah, blah. One thing I’ve learned after 17+ years of doing this is that  the anticipation of an event is inversely correlated to the likelihood of it happening. The more people expecting something, the less likely it is to happen.

I am also comforted by the quick drop in the number of bulls in the weekly American Association of Individual Investors poll.  For most of this rally there have been more bears than bulls, but the last two weeks had bulls around the 50% level with bears falling back to the low 30s. For those of you who don’t know, the AAII poll is generally used as a contrary indicator; lots of bears in the poll is bullish (as they may turn bullish and buy at some point) while lots of bulls in the poll is bearish (as they may turn bearish and sell at some point). The bull percentage had been rising pretty steadily but the selloff Monday showed they had little conviction in that opinion. This week’s poll had the bulls falling back to 34.1% while the bears regained the upper hand with 40%. From a contrarian standpoint that is good news. We’ll see if they flip flop again with the latest rally. 

There seems little doubt now that the recovery is proceeding apace and last week’s data continued to point toward a sharp recovery in economic activity. The week started with the Empire State Manufacturing survey turning positive for the first time in over a year. Housing starts were mixed with single family continuing to rise and the volatile multifamily data falling hard. Producer prices were lower but the drop was almost entirely due to a fall in energy prices. Furthermore, core intermediate and crude goods were higher in price. Jobless claims showed a surprising rise of 15,000 but the trend is still down. Employment, as has been said repeatedly, is a lagging indicator and I suspect it will lag for a long time in this recovery. The Philly Fed survey confirmed the NY Fed version and also turned positive; that’s the first positive reading in almost two years. The Leading Economic Indicators rose again with 6 of the 10 components rising. And finally, on Friday, existing home sales were reported to have surged by 7.2% which set off the stock market rally that moved the averages to new highs for the move.

For now, I have to remain bullish despite the fundamental backdrop. There is simply too much money sloshing around the system to expect a significant correction near term. I am still nervous and have one foot edging near the exit; I hope it isn’t poised over a banana peel.

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Selected Charts

The S&P 500 broke out to new highs. There is little overhead resistance until the 1100-1200 range that remains my target.

Commodities are still lagging stocks and have yet to break out.

Long term bonds appear to have failed at resistance. I don’t think the bear market in Treasuries is over by a long shot.

Riskier credits continue to outperform. High Yield bonds held at the 50 day MA

And TIPS broke out of the recent range to the upside

Foreign bonds also continue to trend higher

And the dollar is threatening to break down again

Healthcare continues to perform well. Whether that is due to the impasse on healthcare reform or not is hard to say, but this is not an expensive group.