Markets' Message: There Is No Cavalry Riding Over the Hill

Remember those old Hollywood western movies? The hero and heroine are surrounded by bad guys and their chances look dim.

Suddenly, we hear the sound of a far off bugle call, the frantic pounding of horses hoofs and over the hill rides the US cavalry to the rescue with pennants flying and six-shooters blazing.

Well, that aint happenin' in this here movie we call real life.

Yesterday's market meltdown is being attributed to various causes: Greece, a double dip recession, the proposed Obama billionaires' tax. We believe the basic reason is that the US Federal Reserve is out of figurative bullets. It has done what it can financially. Politically, it stood up to those whose only priority is defeating President Obama in next year's election and warned the Fed that it should do nothing to help the economy. But without further approval of aid from Congress and the Administration, as well as Germany's ongoing reluctance to agree to a sustainable European deal, there is only so much it can do.

In effect, the markets were absorbing the death of what the financial sector calls 'the Bernanke Put.' A put is a contract to buy a security in the future for a predetermined price. It is a kind of guarantee. The Bernanke Put (and its predecessor, the Greenspan Put) was an unspoken assurance that the Chairman of the Fed would always find a way to bail out the traders and bankers. With the announcement of the Fed's latest action earlier this week, Chairman Bernanke signalled that he did what he could, but understood that it was not what the markets' hoped for and so desperately wanted. He can not ride to their rescue again, in part because they have so resolutely opposed the imposition of controls that would damp down the dangerously unfettered pursuit of risk. The Fed, in its role as modern day financial cavalry, said it was done with fighting, and as in those old westerns, is riding off into the sunset. It is going to take the markets a while to adjust to that reality. JL

Barry Ritholtz comments in The Big Picture blog:

There is no cavalry coming to the rescue. That is the takeaway from yesterday’s FOMC meeting. No QE3 was announced, no extraordinary measures were taken, no rabbits were pulled out of any hats. On top of that, the Fed’s language was far blunter than it had previously been discussing deceleration of the economy, possibly risks of an economic slowdown, weak job market, and depressed housing market.

The long-only, fully-invested contingent were hoping for much much more out of the US central bank. They are disappointed. I suspect the Fed’s blunt language was telegraphing a message to Congress. Rates are at zero, mortgages are at 60 year lows, and yet demand simply is not there. The Fed has done pretty much all it can do.
responding to the weak economy at this point requires fiscal policy, rather than further monetary approach. “The Twist” and purchases of mortgage-backed paper is an attempt to rates down even further. It is hard to see how that can be effective in the current environment.

Don’t expect a policy response from the Austerians. These misguided politicos are in charge in D.C., despite having gotten the past few economic cycles precisely backwards. During the last expansion (2003-07), instead of raising taxes and cutting spending — managing the deficit, creating a better private/government spending ratio — the hypocritical deficit peacocks in the USA did the exact opposite. We cut taxes during (2) wartime, created yet another entitlement program, and raised yet other government spending during private sector economic expansion.

That approach makes much more sense in the current environment of consumer de-leveraging, weak private sector job creation, modest CapEx investment, and low growth. Instead, we suffer from the opposite:

Based upon a fundamental misunderstanding of the works of John Maynard Keynes, they are once again out of phase. Now, the same crowd is looking at raising taxes and reducing government spending when an already frail economy cannot support it. Hence, the Austerians and a complicit White House are all but guaranteeing a 1937 like recession will be increasingly likely.

Excess government stimulus during expansions and austerity during (or immediately after) contractions is simply misguided economics, bad politics and awful policy.

With the Fed out of bullets, traders are now left to their own devices. That means decelerating growth, little in the way of new hiring, and peak profits retreating 15-25%. There is no cavalry coming over the hill, traders are on their own.

Next stop SPX 1100,with 950 as a realistic downside target . . .