Well, everybody seems to think that interest rates are going to go to 6 percent plus in the blink of an eye. But, this is not the first time the bond guys have gotten it all wrong. However, this time they have it wrong for all the wrong analytical reasons. Let me explain.
For as many years as I have been in this business (and that's a lot!) nearly every analyst uses interest rate charts as the guide to good times or bad. For years before I got into the business, as far back as the Great Depression, interest rates were considered the key to everything — and, well, I should add, for the Depression years the gold standard (may it rest in obscurity) was a major ingredient in that mix, too. But, more on gold in a moment.
It was taken as gospel that the Federal Reserve's moves on interest rates would make or break our economy. The last Fed Chairman, Mr. Greenspan, was the most vocal champion of this interest rate philosophy.
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Even today, he still makes all his predictions and comments based on this "law." Of course, now he gets paid millions for saying what he does. In the old days, there was just the itsy-bitsy government check for all his efforts. Oh my, how times change.
But, back to the point. The economy, over the last 50 years, has endured good times and bad times as the Fed moved interest rates up and down. But, the result was just that. Really good times or really bad times. There was no mild or middle to the good or bad times, typically.
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Why? Well, the secret was that interest rates were always very slow to impact a good economy and very slow to invigorate a really bad economy. Everyone just bought that scenario as part of the plus or minus of having to use the interest rate tool to govern economic activity.
But, nearly a year and a half ago, a new Fed Chairman was named. His name is Dr. Ben Bernanke. He is a "dyed in the wool" college professor type, a pretty regular guy in that he simply says "yes" or "no" to yes or no type questions.
And for the politicos (they are just not used to such straight talk, you know), well, they just do not understand a simple answer (thanks to the Fed speak of Mr. Greenspan for 18 years). So, they seldom therefore ask any follow-up type questions.
Let me give you one such exchange. And I pick it because it is highly important to illustrate the differences between Dr. Bernanke and the Old Guard in politics (and in my business for that matter).
This question was asked last spring by a member of the Congressional committee that periodically has the Fed Chairman on the Hill to question him. (Forgive, but I am paraphrasing as the actual question was nearly a page long!)
"Dr Bernanke, are we going to experience another recession soon as a result of the current market rally." (Again, I really simplified it, but that was the real heart of the question.)
Dr. Bernanke answered (again my paraphrase): "I am of the opinion that there is never a need for major recessions in our economy. I believe that properly governed, we can have a sustained growth in the 3 percent — 4 percent range without any recession." (Now, remember I am paraphrasing, but this also was the impact of his answer.)
The committee member gave a blank stare and the conversation went quickly to another topic.
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Now, tell me why did the Congressional member fade the comment made by Dr. Bernanke? I believe it was because he instantly dismissed the answer as foolish.
"Anybody knows, after all, that the history of the last 50 years proves that what you (Dr.Bernanke) say is not true," I surmise he thought to himself. Herein lays the fundamental difference with Dr. Bernanke's philosophy and the philosophy of nearly all of the financial minds in the — well — the world!
Simply stated, Dr. Bernanke believes that interest rates are sledgehammers to kill a fly. He firmly believes that it is MONEY SUPPLY controls that make all the difference in controlling an economy — any economy! AND I MEAN ALL!!
Take a look at this from the New York Fed in September 2006. Dr. Bernanke (do you mind if I just call him Dr. Ben?). Dr. Ben had only been in office four-five months and the NY Fed President pretty much spoke his own mind and I am quoting from that report:
"By the early 1990s, the relationship between M2 growth and the performance of the economy also had weakened."
"In 2000, when the Humphrey-Hawkins legislation requiring the Fed to set target ranges for money supply growth expired, the Fed announced that it was no longer setting such targets, because money supply growth does not provide a useful benchmark for the conduct of monetary policy."
"Greenspan (stated), 'The historical relationships between money (supply) and income, and between money (supply) and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. (my bold)'"
Now, that pretty much summarizes the philosophy that says money supply is a waste of time in controlling the economy in my book. The NY Fed President was still spouting the Greenspan philosophy.
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Ah, but comes along Dr. Ben. Here I want to quote from Dr. Ben's book titled "Essays on the Great Depression," published in 2000, while Dr. Ben was still an academic type at Princeton University, heading up its major economic department. I quote from page 21 near the bottom:
"Tables 2 and 3 (not shown here) are generally quite consistent with the conclusions that (1) monetary contraction (meaning money supply)was an important source of the Depression in all countries; (2) subsequent to 1931 or 1932, there was a sharp divergence between countries which remained on the gold standard and those that left it; (meaning, a gold standard retarded growth) (3) this divergence arose because countries leaving the gold standard had greater freedom to initiate expansionary monetary polices." (again, my bold and underlines)
What Dr. Ben is saying is that the Depression never needed to happen! Smoke on that pipe for a bit. The Depression of the 1930's was a result of a new Fed (not yet 20 years old in1929) just not realizing that money supply was key to economic expansion.
Note in the item (3) further reference was made to the role of gold as a monetary brake to countries that used it as the basis for governing economic activity (using the gold standard). You will note that not one of the major countries in the world today is any longer on the gold standard. No big surprise here.
Item (3) further states that those countries NOT on the gold standard have greater flexibility when it came to expanding money supply and that this initiated expansion in their economies.
Now, I would like you to look at a chart I got from nowandfutures.com, an excellent source for really cutting edge economic data in graphic form. This chart is of the now defunct M3 money supply. I say defunct, because several years ago, Mr.Greenspan decided that the M3's data was too expensive to gather to continue to publish.
Let me tell you, there was uproar among folks like me that used this data to get at what the Fed is really doing to money supply. Most of us realized that Mr. Greenspan wanted to hide important actions of the Fed from us. (The Fed just didn't like the problems that this data brought to the surface in our reports.) But, nowandfutures.com has been able, using other sources of data, to reconstruct the M3 to current times.
Here is what the chart says. Money supply has been rising really fast since 2004, when the Fed began to raise interest rates. My view is that this is the result of influence by Dr. Ben, then an influential advisor to the President in the White House. I believe that he partially influenced the Fed to offset any gathering of economic black clouds (due to higher interest rates) with a higher and fast expanding money supply.
And now, Dr, Ben is actually in charge of the Fed! And while he talks the game the financial types want to hear — "Inflation is the bad guy" — he really is hyping the economy with a huge inflow of money. These financial types are sure that interest rates are going to go through the roof. None — and I mean none — are getting on the airwaves or print media and talking the money supply.
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No, all of them are saying that the Fed is going to raise rates. But in my office (a change from six weeks ago), we now expect that the Fed will stand pat on rates when it meets the end of this month.
I had expected (with a 65 percent likelihood) the Fed would cut rates later this month to 5 percent. But, not likely for the moment with the bond sell-off. However, I see that money supply continues, to this date, to climb at nearly a 12 percent year to year rate. Simply mind-boggling! And that portends an easing yet this year, in my book. We shall see. We shall see.
So, when you hear the shouts of 'run for the hills' because the stock markets are going to tank, or you hear the cry of recession, or you see the wringing of hands and grimaces all around, I suggest that you begin thinking about being a buyer of bonds soon (and stocks if they pull back a bit more. On this subject, see my next week's report that gives you specific support and resistance levels to observe on the DOW and S&P. This report will give you an outline of the perfect roadmap to follow as the next 3-5 months unfold.)
And for my final note today, I am including a Treasury bond chart that tells the whole story on bonds. (But, allow me to make one comment before we start. The Super Chart Keyline looks as if it is coming up from way down low in 2003. Not so. This is a distortion due to a lack of data for the chart from my data supplier. That lack just makes it look that way. So, discount the keyline before 2004.)
Now, here is the analysis. In my May 17 column, I predicted a huge market rally that I believe will unfold over the next four years or so.
In that report, I included this bond chart and told you we needed to hold the upline of the symmetrical triangle I had laid out for you. But, we did not hold this key support. It was broken two weeks ago and today we are flirting with the low in bond prices set in 2004 @ 104 (today we are at 105 15/32). I believe that it is a result of the bond types believing that the interest rate scenario means 6 percent plus interest rates soon.
Poppycock! Like everything bond traders do in haste, it is being substantially overdone. Rates will not go to 6 percent or anywhere near that level. Much too much for Dr. Ben to lose if that were to happen.
I expect that a good buying opportunity will occur at maybe 104. But, it will take holding 104 for several weeks to know. So, be patient. If the 104 level were to break down, then the 100 or even the 98 level would be the next supports, but then rates would be over 6 percent and I DO NOT expect that to happen.
So, keep your cash cool and wait until I see a good base form that signals us to begin buying bonds. Bond traders have overdone the selling and you will be the richer for it!
So, that's about it for this week. Do hope you have a good investing week coming up. In the meantime, you keep in touch. I do! See you next week.
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