Thursday Thrills as the Markets Try to Hold Our Bounce Lines


Wheeee, this is fun!

We had a lot of fun in our Live Trading Webinar yesterday as we shorted the Russell (/TF) Futures at 1,550 after the release of the Fed Minutes led to an inexplicable rally and the Russell fell all the way back to 1,520 at the close for gains of $1,500 per contract in less than two hours – you're welcome!

What we saw in the minutes was a Fed that is firmly on pace to raise rates 3-4 times in 2018 and, as I predicted in the Morning Report, these was nothing to get excited about and the silly morning rally completely unwound over the course of an hour's trading. The S&P (/ES) Futures went over our 2,728 "strong bounce" line and topped out at 2,747 on a spike after the Minutes were rolled out (2pm) but then quickly fell back all the way to 2,701, good for gains of $1,350 per contract below our line and, after hours, it drifted even lower, all the way to 2,685 for another $1,300 per contract gain!

This morning, in an effort to spin the reaction to the Minutes (as we predicted they would on Tuesday), the Fed's Bullard attempted to soften the blow, saying:

The neutral rate is "still pretty low" and the Fed shouldn't hike interest rates based on the conception from the last two decades of the twentieth century, Bullard added. It is "not the world we're living in today," he stated. In the policymaker's words, the Phillips curve effects are so weak that unemployment at 4%, compared to the natural sustainable rate of 5%, adds only seven basis points to inflation. "A lot" would need to happen for four quarter-point hikes in the benchmark rate this year instead of three, he concluded.

The key here is 3. There WILL be three (3) rate hikes in 2018 – AT LEAST – and that's 1.5 more rate hikes than were anticipated when the market decided to get silly in November. Yes there are tax cuts, but do tax cuts trump rate hikes? The Fed MUST hike rates, they can't not hike rates as the US is selling a ton of bonds and, whether the Fed hikes or not, those bonds will command higher rates and the Fed would look foolish if they looked like they can't control the bond market, so the Fed pretends rising bond rates are all part of their plan.

They are also pretending inflation is part of their plan but it's really rising wages that are going to be leading to inflation and that's being brought on by a combination of low unemployment and rising miniumum wages that will have a long, rolling impact on the economy – mostly postive but, in the short-run, it can boost inflation and squeeze Corporate Profits – so not really market-friendly.

While the Federal Minimum Wage remains at a Dickensian $7.25 per hour, 18 states have passed their own laws putting them on a growth path and, already, $10 is the floor in AK, AZ, CA ($11), CO, HI, ME, NY, RI, VT, WA ($11.50) and, if those states don't implode by Summer, you can expect 10-20 other states to have initiatives on the ballot by November and, if that happens, the "biggest" gains we've had since 2008 this year will look like nothing compared to 2019.

While minimum wages are going up, workers at higher-paying jobs begin to feel more secure in a tight labor market and they too will begin demanding better compensation and that's where Corporate Margins really begin to feel the pinch but it's also the point at which money begins to move again and inflation kicks into a much higher gear than the one we're in now. It will take a few years, but bet against inflation at your peril!

As you can see from the chart of Monthly Inflation, prices have gone up 2% since July – that's only 7 months yet most forecasts (including the Fed) are clinging to an annualized rate of less than 2% in 2018 and that would mean the next 5 months would have to average zero to get back on track so every month we see inflation above zero is another nail in the coffin for the inflation deniers.

Although there's a period of adjustment, stocks do just fine in inflationary periods as they tend to keep up with inflation. If Apple sells an IPhone for $1,000 and it costs them $650 to make it and their cost of parts goes up $65 (+10%) and they charge you $1,100 (+10%) their profits go from $350 to $385 and now they are making 10% more money per share than they were before inflation – even though they are selling the same number of phones. Isn't inflation great?

The tricky part is the time between when their costs begin to rise and the time they are able to pass those costs on to the consumer. In the case of AAPL, that time is -9 months as they already raises prices tremendously but, for normal companies – they tend to agonize over rasing prices for fear of losing business (and this is why we love AAPL!). Still, rising wages is the tide that lifts all ships and workers getting 10% raises don't mind paying 10% more for a pack of gum or whatever.

As we were discussing in yesterday's Webinar: Wage increases increase the money supply for Consumers. With a higher money supply, Consumers have more spending power, so the demand for goods increases. An increase in demand for goods then increases the price of goods in the broader market. Companies charge more for their goods to pay higher wages, and the higher wages also increase the price of goods in the broader market.

Don't look for the Government(s) to stop inflation, they NEED inflation to pay off their debts because the US, for example, has borrowed $20Tn at about 2%, half of which is fairly fixed for 5, 10 and 30 years and they would love the GDP to grow, through inflation, by 7% a year from $19Tn to $37Tn over the next 10 years because they would still be paying off notes at the old prices, effectively causing what is a soft default for the bond-holders, who get back money that is worth 50% less than the money they lent out. With Global Debt now more than 100% of Global GDP – the soft default is our best-case scenario.

Bond holders (TLT) are catching on, of course. They may be slow but they are not entirely stupid and bonds have lost 5.5% of their value since Trump was elected, the steepest decline since 1999 and we're only just getting started as there's no putting this inflation genie back in the bottle – especially with the Global Money Supply up 200% since the 2008 crash.

Between 2008 and 2010, bonds crashed 25% so 5.5% is just a good start for what lies ahead in the bond market – and the Fed wasn't even tightening then! What's a little disturbing is all the money that plowed into the bond market at ridiculously low rates over the past few years and that's going to be a painful unwinding but, as usual, where else are they going to put their money if not into the stock market? Until ordinary deposit rates are back over 3.5% – we can still expect inflows to equities – no matter how shaky they look.

Meanwhile, as I said to our Members this morning, this short week is closing fast and we're back to watch and wait mode as we see if our strong bounce lines (see yesterday's Report) can be taken and held but, since they have to hold through the close and then for a full day after that without failing – it's not even possible we can head into the weekend bullish at this point.

We already pressed our hedges last weekend so not much to do but sit back and enjoy the ride – though we will be looking for some fun Futures plays to pass the time – the most obviousl of which, at the moment, is playing Gold long at $1,327.50 with tight stops below (because the Dollar failed 90) and, of course, Coffee (/KCH8) at $119 - because who doesn't like coffee?

Be careful out there,

  • Phil