Ben Bernanke successfully walked a tightrope in his Friday speech with just enough hints to satisfy all sides.
Bernanke gave a 24-page speech on changing monetary policy since the financial crisis and he waited until the very last sentence before he said what analysts wanted to hear.
"As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.
Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."
He discussed the various benefits and drawbacks of nontraditional (QE) monetary policy for several pages then he setup the close with the jobs mandate "enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years." Then in the last paragraph he basically said regardless of the costs and limits "The Fed WILL provide additional policy accommodation as needed." Since he just described why it was needed the last sentence was the message to the markets.
Full text of speech here: Monetary Policy Since the Onset of Crisis
The markets were not impressed at the beginning of the speech with the Dow falling -100 points from its opening high at 13,122 but then the Bernanke bulls rushed into the dip to power the index back to higher highs at 13,152. They could not hold the highs and the Dow bled points at the close but it still ended with a +90 point gain.
Dow Intraday Chart
Since Mario Draghi cancelled his appearance and speech at the Jackson Hole conference the next critical event is the ECB meeting on Thursday and then the Nonfarm Payrolls on Friday. The ECB is expected to announce a bond-buying program BUT it may not be announced until after the September 12th vote on the ESM by Germany.
Draghi said on Friday the ECB members will have an advance copy of the bond-buying plan on Tuesday so they can think about it before being forced to discuss it and vote on Thursday. Analysts at Commerzbank AG and JP Morgan said the apparent complexity of the plan may prevent the details from being released until after the Sept 12th German vote. They don't want to scare Germany into a negative vote and throw the process back another six months. Reportedly there will be caps on sovereign bond yields based on spreads on German bunds.
The German Bundesbank is openly opposed to further bond purchases. Reportedly Bundesbank president Jens Weidmann has considered quitting over the new Draghi plan.
Also clouding the issue is the imminent bailout requests by Spain and Italy. Merkel has "reportedly" asked each country NOT to ask for a bailout until after the German vote. Also, any country asking the ECB and ESM to buy their bonds would have to sign a Memorandum of Understanding agreeing to the conditions for the aid. Spain is already resisting agreeing to anything because the MoU could contain budget requirements, spending cut mandates, priority repayment rules, etc.
The next two weeks are going to see a roller coaster of headlines from Europe and from the U.S. with the FOMC meeting on Sept 12th, the same day as the German vote.
Economic reports in the U.S. on Friday were not exciting with a mixture of pessimism and optimism. The Chicago ISM (PMI) for August came in at 53.0 compared to consensus estimates for a decline to 53.5 but the internal components showed promise. The July reading was 53.7.
New Orders rose from 52.9 to 54.8 and production rose from 54.5 to 57.4. Employment rose from 53.3 to 57.1. Unfortunately the back orders component declined sharply from 52.8 to 41.7. That suggests future activity will slow due to falling backlogs.
Auto manufacturing has caught up with the pace of slowing auto sales and that will force a slowdown in the companies that supply parts to the automakers. I would expect the headline number to decline further in September as a result.
Chicago ISM Chart
The final reading on August Consumer Sentiment rose to 74.3 from 73.6 and nearly +2 points over consensus estimates for a decline to 72.5. The July number was 72.3 and the reading for the first half of the month was 73.6. Analysts blamed the gains on the rise in the equity markets to test the resistance highs. The present conditions component rose from 82.7 to 88.7 while the expectations component declined slightly from 65.6 to 65.1.
Consumer Sentiment Chart
Factory Orders for July rose +2.8% and well over the consensus for a gain of +1.8%. This compares to the -0.5% drop in June. However, as in the Durable Goods report last week if you remove aircraft orders the number fell to -4.0%. Overall the demand for capital goods continues to weaken and we are looking forward into the holiday season so orders today should be strong. This report continues to show weakness in the broader economy and these same numbers for Q3 could be ugly. Core capital goods orders are down -16.7% annualized over the prior three months.
The economic events for next week are headlined by the ISM on Monday, ADP Employment, ISM Services and ECB meeting on Thursday and then the Nonfarm Payrolls on Friday. Currently the estimates for Friday's jobs report are for a gain of +128,000 jobs compared to a gain of +163,000 last month.
However, the weekly jobless claims have been rising with the last two weeks at 374,000 each compared to the mid 350,000 range in July. This suggests there will not be a big upside surprise in nonfarm payrolls this month. This is the report that could drive the Fed to ease again the following week. If jobs are weak then Bernanke's long term unemployment warning in the Friday speech will come into play. Most analysts expect a weak jobs report and that is why the market rallied after Bernanke spoke. They don't expect the report to be bad, just weak.
The ECB meeting could move our markets more than anything else until Friday. After Draghi's promise to do "whatever is necessary" analysts and investors are going to expect him to follow through on his promise. If the ECB wimps out again I doubt any amount of can kicking is going to rescue the equity markets. This is a do or die meeting for the ECB and Draghi. Even dragging out the announcement until after the German vote on the 12th could be market negative simply because expectations are so high.
Announcements next week that are stock related include the Wednesday announcement by Microsoft and Nokia of a new generation of Nokia phones running the Microsoft OS. Also on Wednesday is the Motorola and Verizon announcement rumored to be a phone with a display that runs from edge to edge. No more wasted borders. With the trend to larger phones with larger viewing areas this could be an interesting proposition.
Lastly Amazon is expected to announce the new version of the now sold out Kindle Fire. Existing Kindles have been "sold out" according to Amazon for several weeks now so their scheduled announcement is expected to be a new Kindle line. Included is a 7 inch Kindle Fire and according to the WSJ it is an advertising supported Kindle. When you turn the device on an advertisement pops up before the menu page. Since they have had advertising supported Kindle e-readers you have to wonder what took them so long on the tablets.
There are rumors that Amazon could give away a mini Fire with a Prime membership. What a great way to induce more buying on their website and build brand loyalty among their best customers.
The following week on the 12th is Apple's big announcement, which is expected to be the iPhone 5 and possibly a new iPad as well. Apple is expected to announce a 7 inch iPad mini.
With only 115 days until Christmas all of these offerings are expected to produce a buying frenzy in electronics. The best part about it is the expected reduction in prices. With so many firms competing for your electronics dollar the prices are going to fall. For those buyers that can control their emotions and wait until January the prices should be even lower.
We could get a different kind of phone announcement next week as well. It is rumored that Google and Apple are in the midst of a summit meeting after Apple won the suit against Samsung. At risk is the Android operating system and the phones that run it. If the two companies can bury the hatchet and call a patent truce then Google should prosper. Google is in a lot better position after it acquired Motorola and their 7,000 wireless patents. I am sure they have explained to Apple that several hundred of those could cover something that Apple may have done in the iPhone and iPad that may have infringed the Motorola patents. Both companies are very patent savvy and odds are good they will reach an agreement to cross license and peacefully coexist. The problem for Google is that the company will want Apple to coexist with all the Android phones in production not just the ones made by Google and Motorola. That is the only way Google can continue to push the Android OS. Apple may not want to sign a peace treaty that covers the planet for anything with an Android OS. Time will tell. On Friday Apple petitioned the court to add four more devices to the Samsung suit and ban them from the USA.
Google shares closed at $685 on Friday and right at an all time high. Apple shares have faded slightly from their post Samsung high. Apple faithful should remember that Apple shares typically rally into the product announcement but then decline immediately afterwards in a bout of sell the news profit taking.
Facebook shares hit a new historic low at $18 on worries over slowing earnings and the 1.5 billion shares still to be unlocked before year end. FB still has a PE of 67 and declining earnings so investors are fleeing the stock. Those who thought there would be a sell off and then a bounce have given up looking for the bounce. I was hoping to see a decent bounce to the resistance at $22.50 so I could launch a new short but it does not look like I am going to get that chance. BMO Capital Markets cut their price target by $10 to $15. Bank of America Merrill Lynch, an underwriter of the IPO, cut its target by $12 to $23.
Crude prices rallied $2 after the Bernanke speech as shorts were forced to cover on expectations for QE from the ECB on the 6th and FOMC on the 13th. After three days of declines the losses were erased in one session as is normally the pattern in the futures market. Crude closed at $96.50 for WTI and $115 for Brent.
Most oil and gas companies in the Gulf were in the process of restarting production with no reports of any major damage. Only one refinery, the Phillips 66 Alliance in Belle Chase LA, reported flooding. The 247,000 bpd refinery was working on pumping out the water so they could restart.
Offshore Shell and Anadarko were going to restart production platforms on Friday. At one point last week 95% of gulf oil production and 73% of natural gas was offline. As of Thursday 936,500 bpd of refinery production was still offline due mostly to power issues. The EIA said the majority of the 1.3 mbpd of oil production and 3.2 Bcf of gas production should be back in operation by early next week. Pipelines had been restarted and the Louisiana Offshore Oil Port (LOOP) and Henry Hub gas terminal were operating normally Thursday night. Rail shipments of crude were expected to resume on Friday.
WTI Crude Chart - Weekly
Brent Crude Chart - Weekly
Crude prices have been supported by the headlines over a potential Israel/Iran conflict. Israeli Prime Minister Benjamin Netanyahu said he will speak on the dangers of Iran at the U.N General Assembly in New York in late September. In his statement he said he would "Tell the nations of the world in a clear voice the truth about the terror regime of Iran, which represents the greatest threat to world peace." This should be an interesting speech. Israel is being pressured by numerous nations not to attack Iran alone. The timing of this speech should mean there will not be any attack in September.
Crude rose more on the falling dollar and expectations for QE than on Isaac damage, which was very light. The Dollar Index fell to a three-month low on expectations for QE. That pushed commodities including silver, gold and oil higher. Silver rallied for a +4.4% gain of +1.34 to $31.79 and a four-month high. Gold rallied +2% or $35 to $1692 and a five-month high. Citi is still expecting gold to reach $2400 in the next 12 months.
Dolar Index Chart
The market moved sideways all week before ending with a minor gain on Friday. Volume for the last week of the summer hit a new low for the year on Thursday at only 3.9 billion shares traded. Friday's volatility was good for a spike back to 5.1 billion and the most volume in the last six days but still relatively weak.
We should not have expected much in the way of volume for the last vacation week of summer. Friday was expected to post a gain assuming Bernanke did not spoil the party. Since 1928 the Friday before Labor Day has posted a gain 73% of the time.
Monday is a holiday and Tuesday will be recovery day where vacation returnees try to figure out what they missed and where the market is going. Since Friday was month end we "should" see an upward bias on Tuesday from retirement contributions but the ISM report could be a pothole.
Thursday is the key with the large calendar of events. This should be the pivotal day for the market. The S&P found support at 1400 twice over the last two weeks and that remains the critical level to watch. Initial resistance is 1415. Trading this horizontal pattern should be a slam dunk. Buy the breakout and short a breakdown.
S&P Chart - 90 Min
S&P Chart - Daily
The Dow broke down on Thursday to a new four-week low at 13,000. Support at 13,100 failed and now appears to be resistance. IBM, CVX and AXP were the big gainers on Friday with only MRK and T posting losses. Friday was not a fundamentals day. It was strictly Bernanke related in a low volume market.
The lower low at 13,000 is now the critical level to watch. Since September is normally a bad month for the markets the bears will be watching the support levels like a hawk for signs of a failure.
Dow Chart - 90 Min
Dow Chart - Daily
Unfortunately for the Dow the Transports imploded last week to end with a -111 point decline for the week. It could have been cancelled airline flights because of Isaac or high fuel prices or any number of things. However, the +14 point rebound on Friday was nothing. For an index that has lost more than 200 points in the last two weeks the minor gain was a definite lack of confidence.
If the transports slip below that 4930 support level it could be lights out for the Dow. A breakdown will not go unnoticed.
Dow Transports Chart - Daily
The Nasdaq has been moving perfectly sideways between 3040-3085 and showing very little volatility. The Nasdaq has been holding near its highs and has not dipped like the Dow. Support at 3040-3050 has been firm. If Apple and Google can bury the hatchet somewhere besides in each other then the tech outlook is positive. Apple's Sept 12th announcement is expected to provide upward momentum until at least the 12th. The other phone/tablet announcements this week should also be positive.
Nasdaq Chart - 90 Min
Nasdaq Chart - Daily
The Russell 2000 took a hit on Thursday and failed to recover on Friday. The index was weak relative to the large cap indexes. The 805-808 level as support is now critical. Resistance at 820 has been solid.
Russell Chart - 90 Min
Russell Chart - Daily
In theory the threat of QE by the ECB on Thursday should support the markets. However, threats only work if you actually follow through on them from time to time to show you are serious. Mario Draghi has failed to follow through on more than one occasion and there is always the possibility they will try to kick the can down the road until after the Sept 12th vote in Germany. It all depends on how they phrase the delay if it appears.
Europe was on vacation for most of August and will be back at work next week. The lull in headlines should end. The Olympics are behind us and there is nothing to distract Europe from the problems in Portugal, Greece, Spain and Italy. Expect them to take center stage once again.
On this side of the pond the critical reports are the ISM, ADP and Nonfarm Payrolls. Depending on your market view you want either blowout reports suggesting the economy has begun to rebound or weak reports so the Fed will act again.
I had a reader email me last week asking this question. "Do you want the Fed to announce more QE?" I thought that was interesting since it shows me that I have not expressed my opinion correctly. I get in the habit of reporting the facts as others see them and not making it clear how I stand. Some may not want to know where I stand while others may be interested. While I am not as rabid as Ron Paul against the Fed I do believe the constant QE is damaging our economy long term. I would rather they not do any more QE but that decision is up to people smarter than me. Personally I have been buying silver for quite a while now in anticipation of more QE and rampant inflation farther down the road. I have recommended silver for an investment/hedge several times in these pages so that should not be a surprise. We can be against something and still profit from it. I am against QE long term but I will profit from it because of its impact on oil and silver.
Bill Gross said again on Friday that QE3 was "almost a certainty" because the Bernanke Fed likes to telegraph moves in advance and "I can't remember such explicit hints such as this without follow through." He is a prime example of someone planning on profiting from events beyond our control.
However, QE is only an attempt to buy time while the economy repairs itself. QE has limits and consequences. Eventually it has to end and the withdrawal process is going to be very painful. Before this is over the Fed will likely have more than $3 trillion in securities bought with QE funds. They will have to return their balance sheet to a reasonable level in order to be prepared for the next crisis. There are only two ways to reduce this $3 trillion balance. They either have to sell those securities back into the market at which time interest rates will spike as a result or they can wait for the securities to mature and be paid off. When the balance sheet was weighted towards the lower end of the curve in the 18-36 month range the waiting for maturity process was acceptable. With their recent Operation Twist program they sold their short dated securities and bought long dated securities in the 7-10 year range. Now they can't afford to wait for the maturity process. They will have to sell these back into the market in order to be prepared for the next crisis, which normally occurs on a five year cycle.
Goldman Sachs reported last week that the U.S. budget is facing an additional $8 trillion shortfall through 2022. That assumption assumes a "business as usual" stance and no significant spending cuts. The same estimate applies regardless of who wins the election. If Obama wins taxes will go up but spending will go up more. If Romney wins taxes will go down along with spending so the deficit result is the same according to Goldman.
That would put the deficit around $25 trillion by 2022 when you include interest. Eventually the world is going to quit buying our debt once they understand that it is mathematically impossible for us to pay it. That means interest rates will go up because of weaker debt sales at approximately the same time the Fed will need to be unloading their $3 trillion hoard.
Here is where the U.S. public gets the raw end of the deal. The Fed will have to allow inflation to rise to previously unacceptable levels in order to generate revenue for debt payments. For every dollar spent today somebody pays taxes on it eight times as that dollar winds its way from a retail purchase back through the supply chain to the manufacturer. The remainder eventually makes its way back into a paycheck for someone and the entire process starts over. If inflation begins to rise significantly then the goods purchased by that dollar cost more and requiring more dollars to purchase them. That inflation moves up the supply chain and eventually requires higher salaries to bring incomes in line with inflation. The government's revenue increases significantly because there are more dollars moving through the system and taxes received from those dollars increase.
The government (Fed) understands they will need to foster inflation at some point in the future in order to raise revenue and make debt payments. QE cannot solve this problem and actually will add to it when the cycle reverses. Inflation will move significantly higher. Count on it. QE cannot make up for the fiscal cliff or for inaction in Washington. At this point the only thing QE can do is force interest rates to remain low for a couple more years while inflating the stock market. Bernanke even took credit for inflating the equity markets and increasing the wealth effect in his Friday speech. Apparently the Fed has decided it has three mandates instead of two. Stable prices, low unemployment and higher equity prices. The current QE cycle will eventually end badly. Since the Great Depression the Fed has NEVER been able to successfully remove monetary stimulus from the economy without a market crash. The Fed has NEVER before had this much stimulus in the economy. Do the math.
"Politics is not the art of the possible. It is choosing between the unpalatable and the disastrous." John Kenneth Galbraith (hat tip to John Mauldin)
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