Bernanke's Character Test: Pre Fed Meeting Jitters, Indeflation, and a Prediction

by Michael Nystrom | April 28, 2008

The Wall Street Journal - the mouthpiece of Business itself - had some stingingly harsh criticism of the Fed on its Monday Opinion page. An editorial titled "The Fed's Bender" begins:

 

So Federal Reserve officials are whispering to reporters that they will consider a "pause" after another interest-rate cut this week. Perhaps we should be more respectful, but this sounds like the alcoholic who tells his wife he'll quit drinking next weekend, after one more bender. What Chairman Ben Bernanke needs isn't a gradual withdrawal from easy money but membership in Central Bankers Anonymous.

 

The Street wants a rate cut, and it is being pushed heavily in the Media. Bloomberg tells us: Bernanke May Have to Follow Volcker to Avoid Being Tagged Burns. Today MarketWatch has a story which lists the many compelling reasons for the Fed to halt its interest rate cuts. And the sooner the better! The story ends thusly: "Finally, a pause could even be taken as a sign that the worst is over for the economy. Wouldn't that be a nice surprise?" This calls to mind recent analysis by Dr. Marc Faber, who has proven himself to be one of the most thoughtful and level-headed analysts around. In this particular piece, he demonstrates convincingly that inflation and deflation can and do occur in different markets and in different parts of the world simultaneously. Over the past 25 years, as a bubble has inflated in one market, a corresponding deflation has occured elsewhere. His conclusion:

 

The point that I cannot stress sufficiently is that when a bubble bursts, it is a signal that the economics of a region or sector have changed, or are about to change for a very long time, if not permanently. I am, therefore, surprised by how complacent and optimistic economists and strategist have remained in the wake of the total collapse of the CDO market and the widespread damage caused to financial stocks. Over the last 12 months or so, one sector of the financial industry after another has been hit, with the latest casualties being credit card companies such as American Express.

 

This short paragraph should put tomorrow's Fed announcement into better perspective than the hours of MSM (mainstream media) speculation on the minutia of whether the Fed cut a quarter point or not. What Dr. Faber is saying is that whatever they decide is irrelevant. The late, great American bubble economy was built on cheap and easy credit, and regardless of what the Fed does tomorrow - a quarter point or whatever - that era is over.

Inflation has no doubt been bad, thanks to a falling dollar and rising oil and food prices. But let's take a look at what the market is saying via some visual inspection of commodity charts. Data is as of midday, Tuesday:

Crude oil, one of the recent inflationary all-stars, is still in an undeniable uptrend, though it is pulling back a bit today:

Likewise, corn remains near its recent high. The recent ethanol craze makes corn a quasi-oil subsitute:

And rice, the subject of global panic, looks like it might be cresting. (On the other hand, it may just be consolidating for a further push higher.) The important thing to note is that the rise has become parabolic, and we know what happens to all parabolic rises.

But remember just a few short weeks ago? It was wheat that was the subject of global panic. As I heard it, a form of wheat rust was threatening the entire global wheat crop! Friends prone to panic (of which I have many) were calling me up - how to I buy wheat!? That was right near the second peak of a possible double top on the wheat chart. Important point: Markets are emotional and at times irrational.

Soybeans also are well off their highs, and this chart is starting to get "that look:"

What "look" is that, you ask? That toppy, crashy kind of look. A new high, a failure to reach the old high, then a collapse, as seen below in sugar. Don't forget that sugar is also a quasi-oil substitute. Nearly all of Brazil's cars are powered by ethanol made from sugar. This leads me to believe that oil may have put its top in, at least temporarily.

What else has got that "look?" Sad to say it to the gold bugs, but gold has got the look too, and is down nearly $20 today. Am I bearish gold? I have been short since the last Fed meeting via futures contracts. But I am not bearish long term on gold - never long term. Gold is money, end of story. Buy the bullion - physical gold and keep it forever. But if you're trading shares or futures, beware of excess leverage, as you can be wiped out completely if you're long and fully leveraged. Read Jim Sinclair's site for good advice.

We see prices continue to rise in a few areas: oil, rice, corn and copper (not shown). Dr. Copper is near its high, but appears to be having second thoughts about it. Elsewhere, we see corrections in beans, wheat, sugar and gold. More commodities are correcting than are rising. In my opinion, this is the effect of the global deleveraging that we hear so much about. Commodity speculators speculate with borrowed money. Borrowed money is getting harder to come by, so the number of commodities still rising is shrinking.

The global deleveraging is also starting to be reflected in the US Dollar, the currency in which all the above are priced. Yes, the chart is ugly, but it may just be starting to turn up. Keep your eye on the buck, which everyone has given up for dead.

Its pattern mirrors the 10-year Treasury yield. The Fed does not set interest rates. The market sets rates - the Fed simply follows along. And whatever the Fed decides tomorrow, the market has already decided that it is time for interest rates to rise.

A global credit bust means - recession or not - less business activity overall. Rising interest rates lead to a rising dollar, which in turn leads to lower prices for anything priced in dollars. This includes US stocks. The SPX has been unable to break through 1400 on the upside. Currently it is sporting what appears to be an inverted head and shoulders pattern that projects an upside target of around 1550. But patterns are not certainties - they merely represent probabilities of what might happen next. A failed head and shoulders is an excellent contrary indicator. Keep your eye on the 1400 level on the SPX in the coming days. Sign up here for updates.

A couple shorts in my portfolio:

The Chipotle Mexican Grill (CMG). Do you like spending $7.25 on a rice and bean burrito? I don't. I don't like overpaying to feel like a peasant. I can do that for free. This chain is a fad, beans and rice are expensive (even though they may have seen their highs), people are eating out less, and when they do, I don't think they want to pay $7.25 for a rice and bean burrito. And at least in my area, there are several mom & pop burrito places that are both better and cheaper. And the chart also has "that look."

Whirlpool. Housing bust means Whirlpool should continue down the drain:

One to keep an eye on as an indicator that stocks really are in the tank: Apple (AAPL). I got a newsletter this week that just put Apple on their buy list. I read an article by Jim Cramer about how he loves Apple. Everyone loves Apple. And their products are affordable. Anyone can go to the Apple Store and buy a new laptop for $1,200, or an iPod for $250. Affordable? Yeah, just put it on your credit card and the payments work out to about $25 - $30 per month. Easy. But what if you don't have a card, or any more room on your card? Then Apple's shiny products cross into the realm of "I wish I could afford one of those."

How long will it take the average worker, making $12 per hour, to save up for Apple's cool gadgets, after paying his rent, gas, food, other living expenses - and don't forget, taxes? The time is not yet right to short AAPL, but keep your eye on it. As one of the leading stocks of the past decade, this stock's direction should act as a leading indicator for the economy. Apple is not yet ripe as a short. Sign up here to stay updated on when (or if) to short AAPL.

If the credit bubble has indeed burst, and Dr. Faber is correct that the economics are now changed for good, we are in for a massive deflation that will be reflected across all sectors of the economy for a long time.

The Fed will announce its interest rate decision tomorrow at 2:15PM ET. The WSJ article that I quoted above states:

The Fed's problem has been both political and intellectual. Politically, Mr. Bernanke has been unwilling to say no to Wall Street and the Beltway political class, which reflexively demand easier money in a crisis. This demand has become almost Pavlovian since Wall Street came to believe during the late 1990s in what was known, fairly or not, as the "Greenspan put." It takes character to resist this political pressure, but that is what Fed chairmen are supposed to have.

Will Bernanke show character tomorrow? Not that it matters, I predict that he will. No rate cut. Markets will react in shock. Stay tuned for followup analysis.

Comments welcome here.

 

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