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Has Bernanke Lost Control?

August 21, 2013 | About:
When there is no data to key off of, as has been the case so far this week, traders and their computers are basically left on their own to ponder the big picture. And based on the action of the last four days, it doesn't appear that anyone is feeling especially optimistic right now.

One Reason Stocks Are Falling

Usually, the catalysts behind a 3.7 percent decline in the market are fairly obvious. News, data and/or rumors tend to give traders cause to move the market in one direction or the other. However, this time around, the issues are more muddied and investors who have become accustomed to the market rebounding quickly from each and every decline may be left scratching their heads right about now.

One of the drivers behind the bulls' run for the roses over the past nine months has been the idea that central bankers around the world have been targeting asset prices with their policies. In plain English, this means that Mr. Bernanke and specifically his counterpart in Japan have been trying to push prices of stocks and real estate higher.

The thinking behind what is commonly called the "wealth effect" is that when folks see the value of their homes, their 401Ks and mutual funds rise, and they feel better about their financial situation. And when people feel better about their finances, they tend to spend more, which in turn, stimulates the economy. What's not to like, right?

Based on the steady improvement seen in the housing market over the past year and the new all-time highs in U.S. stock market indices, it is safe to say that Bernanke's bunch have achieved at least part of their goal. However, due to a variety of issues, the outlook for further success of the Fed's stimulus strategies may be coming into question.

With the Federal Reserve currently buying up more than one trillion dollars per year of bonds, rates have stayed low — artificially low — for some time. Until just recently, the thinking was that Mr. Bernanke and his merry band of central bankers would continue to err on the side of caution when it came to the economy. In short, Bernanke has pledged to do whatever it takes to make darn sure the U.S. doesn't wind up in a deflationary cycle.

And if this meant that rates had to stay low — again, artificially low — for an "extended period" and that asset prices would inflate along the way, so be it.

The Fly in the Ointment

The problem is that there appears to be a fairly large fly in the ointment right now. First, in an ongoing effort to make the Fed even more political than it already is, President Obama has declared that he's seen enough from Ben Bernanke. In what can only be categorized as a sacking, the president recently announced that the Fed Chairman would not be seeking another term come January 2014. According to the latest poll, Obama's close economic adviser, Larry Summers, is the front runner for the appointed post.

As a quick aside, does anyone besides me find it annoying that the most important financial and economic position in the country and perhaps the word is an un-elected one? But I digress.

The problem here isn't whether anybody thinks Larry Summers will do a decent job. No, the issue is that "Gentle Ben" will be leaving. And based on the discussions being held by Fed Governors in the media, so too will Mr. Bernanke's policy to err on the side of caution and easy money.

So, while everybody knows that the Fed's uber-easy monetary policy would end at some point, now there is an actual spot on the calendar to point to. Instead of Bernanke continuing to pump money into the system until unemployment comes down to 6 percent or so, or until inflation reaches a level that becomes a problem (which would undoubtedly include more wealth effect, by the way), now traders and investors have to decide whether or not the game will change completely in the next four to five months.

In short, this creates uncertainty. And as everybody knows, traders hate uncertainty. So, what do traders do when uncertainty rises? Yep, that's right; they sell.

Losing Control

The key is that because the Fed is "talking taper" and Bernanke is leaving, the Fed appears to have lost control of the bond market. Rates are spiking as the yield on the 10-year has moved from 1.63 percent to 2.88 percent in just a little over three months. In what may be the most publicized market move in history, investors are selling bonds. And the bottom line is this isn't likely to change any time soon.

So, with traders feeling fairly confident that the era of artificially low rates is coming to a close in the near future, it appears that there are simply more sellers than buyers in the bond market these days. And with the Fed ready to back away a bit in the near-term, well... you get the idea.

Publishing Note: My vacation time has finally arrived. I am traveling with family in France for the better part of the next 2.5 weeks. Thus, my oftentimes meandering morning market missive (aka "Daily State of the Markets") will be published as time and energy levels permit.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (listed in order of importance).

1. The Level of Interest Rates

2. The State of Fed/Global Central Bank Policies

3. The Outlook for the U.S./Global Economy

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as three days to three weeks, intermediate-term as three weeks to three months, and long-term as three months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Negative

(Chart below is S&P 500 daily over past one month)

%5Egspc

Intermediate-Term Trend: Neutral

(Chart below is S&P 500 daily over past six months)

%5Egspc

Long-Term Trend: Positive

(Chart below is S&P 500 daily over past 12 months)

%5Egspc

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

  • Near-Term Support Zone(s) for S&P 500: 1640, 1600
  • Near-Term Resistance Zone(s): 1657, 1680
The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend, i.e. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo":

  • Trend and Breadth Confirmation Indicator: Moderately Negative
  • Price Thrust Indicator: Neutral
  • Volume Thrust Indicator: Moderately Negative
  • Breadth Thrust Indicator: Moderately Negative
  • Bull/Bear Volume Relationship: Positive
  • Technical Health of 100 Industry Groups: Moderately Positive
The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • Overbought/Oversold Condition: The S&P 500 is oversold from a short-term perspective and is moderately overbought from an intermediate-term point of view.
  • Market Sentiment: Our primary sentiment model is negative .

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