The Rebound In Stocks Won’t Last

After taking a beating in January the S&P500 has rebounded by about 5% in February, and this uptrend has continued into March. But before you think it’s safe to jump back into long positions, it’s important to realize why the market went down in the first place, and why February’s rebound won’t last.

In December of 2015, the Federal Reserve ended its Zero Interest Rate Policy (ZIRP). At that time the Fed’s median dot plot showed the Federal Funds Rate was expected to rise to 1.5% by the end of 2016. The market plunged on the expectation that the Fed, now that it actually showed the willingness to move off of zero, would then follow through on subsequent planned rate hikes. The combination of sub-par growth coupled with a hawkish Fed policy led to the worst start of any year in stock market history.

But as the stock market began to crash, more and more Fed voting members started to walk back the notion that the U.S. economy was strong enough to endure a rising rate environment. Adding to this dovish sentiment, the formerly-hawkish James Bullard began voicing concerns about reaching the Fed’s 2% inflation target based on the plunge in oil prices. Talking to a group of bond traders, St. Louis Fed President James Bullard recently said: “The Federal Reserve must act to stop inflation expectations from getting too low.”

But the truth is that oil prices had already plunged from $105 in the middle of 2014, to below $48 per barrel by the end of 2015. So, the commodity plunge wasn’t a new issue.

Therefore, you have to ask yourself: why was the Fed suddenly so concerned about not achieving its inflation target?

The real reason the Fed claims to be so worried about reaching its inflation target and is changing its tune on future rate hikes has little to do with falling oil prices; but rather, everything to do with a falling stock market. This faux concern about inflation supports my contention that the Fed is an institution whose sole creation and existence is to help banks and Wall Street.

The Fed Funds Futures Market began pricing in just one rate hike for all of 2016, instead of the four telegraphed by the FOMC. Taking three rate hikes off the table served to weaken the dollar, which put upward pressure on commodities, relieved pressure on foreign dollar denominated debt and improved the perceived potential earnings power of U.S. multinationals.

But the simple reason this equity rally won’t last is because the markets have become completely addicted to money printing, a weak dollar and perpetually falling interest rates in order to perform their levitation act. Without the Fed adopting negative interest rates and/or launching another QE program, the U.S. dollar will not weaken substantially from its current level. The divergence between monetary policies between that of the U.S., and in particular the ECB and BOJ should, stop the dollar from falling further. Therefore, expect more downward pressure on commodities, stress on U.S. multinationals and a significant percentage of defaults on debt held by corporations in the commodity sector.

Furthermore, China’s crash landing is now upon us. This is despite the Sino Scam Artists that run the communist country trying to kick start the debt-disabled nation by constantly lowering the reserve requirement ratio. But this doesn’t change the fact that the two biggest economies in the world are beginning to tighten monetary policy. The Fed has ended QE and has started raising rates. And China has been forced into selling US treasuries to support the yuan, which drains bank reserves. 

This pace of decline in China’s reserves accelerated as the PBOC attempted to keep the yuan’s value from falling too rapidly in the midst of speculative selling offshore and capital flight at home. All of this is made worse by China’s slowest economic growth in 25 years.

The Fed ended Quantitative Easing (QE) in October of 2014 and went off ZIRP in December of 2015. China’s selling of US Treasuries to support the yuan has an effect of shrinking its monetary base, and this is causing asset bubbles to burst worldwide.

This condition will remain in place until the Fed seeks to aggressively weaken the dollar on a more permanent basis. Thankfully, the FOMC is not ready to admit defeat yet and switch to a dovish monetary policy. Therefore, there will another leg down in stocks as the free market attempts to unwind these massive imbalances. Of course, wrecking your currency isn’t a long-term solution. In fact, it will lead to complete economic chaos and meltdown on a global basis once central bank inflation targets are finally achieved.

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Michael Pento produces the weekly podcast “The Mid-week Reality Check”, is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”