Another week of Fed printing, another week of stock prices melting up. This time the S&P inched up 0.68%, on the typical light-to-moderate volume. Volatility, still pinned to multi-year lows, barely changed. To state that the US stock markets are ripe for a pullback is a huge understatement. Arguing that this is not the case means that you’d have to believe that simple and normal market fluctuations have been permanently eradicated from risk asset markets and that typical and normal economic fluctuations either will not happen anymore, or if they do, then they will not affect stock markets anymore.
If so, good luck with that.
The US macro picture continues to stay weak. While durable goods orders beat expectations, all of the beat came from a jump in the usually volatile aircraft orders. Pending home sales fell much more than predicted. Consumer confidence plunged to its lowest level in 13 months. Fourth quarter GDP was expected to clock in at a mere positive 1.0%. Instead the actual result was a shocking NEGATIVE 0.1%. While personal income beat expectations (mostly due to year end dividend pull forwards), personal spending missed. Initial jobless claims jumped back up—not surprisingly—back to the upper 300 thousand range. The payrolls report generally disappointed. Fewer new jobs were added (vs consensus). Headline unemployment rose, instead of falling as predicted. The average workweek also fell, instead of remaining steady.
Technically, the S&P is extremely overbought on the daily charts. As noted above, unless the Fed has permanently eradicated normal market forces and has become the sole driver of stock market prices, then stocks are well overdue for at least a modest drop. But if the continue to creep higher, then the ultimate correction will only be that much more devastating. Because as the world saw in 2000 and in 2008, the Fed is most certainly not able to manipulate risk asset prices forever, and when it does inevitably lose control, then modest corrections tend to turn into violent plunges.
Meanwhile, one asset that continues to enjoy steady annual appreciation (now over ten years running) is gold.
And the fundamentals that have been driving the price higher all these years look as bullish as ever….. also courtesy of the Fed.
Most casual observers of gold’s appreciation cannot understand why it’s been rising in an environment where headline inflation has been firmly under control. In other words, the rise in the dollar price of gold doesn’t make sense to them when inflation has been falling, not rising over the last decade.
What they fail to understand is that the correlation between the price of gold and headline inflation is not strong at all. As detailed in an academic paper by none other than the former Secretary of the Treasury Larry Summers (when he was an economics professor at Harvard), the price of gold is driven primarily by real (nominal less inflation) interest rates. And real interest rates have been falling consistently for the last ten years.
How’s that possible when inflation is so low? Because nominal interest rates are even lower. Recently, when the five year US Treasury was yielding 0.75%, the inflation rate was roughly 1.75%. This means that the REAL rate of return on that Treasury was actually NEGATIVE 1.0%.
This drives smart money to gold, which tends not to preserve value when those holding Treasuries are losing value.
And what about the prospects for gold going forward? Well the Fed has all but guaranteed that interest rates (not just ultra short term rates, but even longer term rates) will be pinned down for at least the next two years.
This strongly suggests that the upward pressure on gold will be very strong for…….at least the next two years.
Of course, the price of hold is much higher than it was even five years ago, but it’s very probable that as the Fed continues its program of rate suppression that gold’s run is far from over.