The durable goods number dropped sharply by -4.9% in August after a +6.1% gain in July. The orders component for new aircraft is swinging the total number more than usual. Excluding the -11.2% drop in transportation goods orders for July and August shows a drop in new orders from a gain of +3.4% in July to a drop of -1.6% in August. Shipments for durable goods also dropped, down -1.6% in August which as the largest drop in eleven months. Businesses also reduced their orders for capital equipment, a sign of economic weakening, by -0.7%.
The stock market rallied on the news. Go figure. We of course can guess what market participants are thinking--a weak economy must be good for the stock market because it means the Fed can get more aggressive about lowering interest rates. This is such hogwash and belies the truth about what's happening, and will happen to the market, but don't argue with it when it goes against fundamentals (it's why I insist you can't trade the market from a fundamental perspective, except for perhaps very long term swings). Instead understand the obtuse logic it sometimes uses for doing what it does. Only later will the facts prove how stupid the market really is (personal comment not shared by many).
The longer term view of the market in a slowing economy should be very clear--it's bearish. A slowing economy means slowing businesses means layoffs means lower consumer spending means fewer products/services purchased means lower corporate earnings means lower stock prices. Show me the illogic in this argument and I'll gladly buy you a cup of coffee (the limit of my betting). A slowing economy will always have the Fed lowering interest rates in an attempt to re-prime the economic pump by making credit cheaper and more available (whether people do anything with easier credit is the real issue).
So when the Fed starts to drop interest rates it is mind boggling to me that the market thinks this is bullish. It's usually good for short term bursts higher (why, I have no clue) but it's always bearish longer term. Charts like this one bear this out:
SPX weekly chart, 2000-2007
This chart has been updated through yesterday's price. After the market peaked in 2000 and the economy headed south the Fed stepped in and started aggressively lowering interest rates. Greenspan was trying to flood the market with liquidity, which he did and those who get hurt in the collapse of the housing bubble can thank him for that. But those 12 rate cuts between January 2001 and June 2003, so over 2-1/2 years, did not give us a stock market rally. Bursts higher following rate cuts were followed shortly thereafter by stronger selloffs.
Just the opposite happened after 2003. As the market strengthened the Fed started removing their "accommodation" but the market kept rallying because the economy was getting stronger. And therein lies the message--follow the economy and not the Fed (since the Fed also follows the economy). Understand we'll see short term bursts higher, like we're seeing after the last FOMC meeting and the rate reduction, but don't get sucked in thinking the brief period of euphoria is going to last. It is a gift presented to you to get out of your long positions. Bow and say thank you (like your mother taught you) and exit your long positions. You will have another opportunity to put that money to work later (but first use a little of it on the short side).
With the Fed and other country's central bankers flooding the monetary system with liquidity there's been a lot of speculation as to how bullish that will be in several areas. I've mentioned the stock market--many believe the added liquidity will inflate most assets and that's generally the reason that many traders position themselves for the coming rally. It's when the rally fails that these new buyers suddenly jump ship and cause the big selloffs.
Re-inflating the economy is the goal of the central bankers (which is like giving a junky more crack so he feels better, but usually only crashes harder later) and the result is traders think the result will be either inflation of assets and/or higher economic activity. After all, that's what the extra money is being pumped into the economy for--banks lend it out and the credit expansion continues. So traders rush to buy those assets they feel will do better with inflation (stocks, commodities) and dump that which will not do well with inflation (the US dollar).
But a funny thing happens in a period of credit contraction--the central banks aren't in charge, the market is. So when they try to pump extra liquidity into the system the bankers are afraid to lend it out and the credit contraction continues. It's why I've been saying when it comes time for the Fed to try to re-inflate the economy they will be pushing on a string.
I came across an interesting chart in an article by GaveKal in one of John Mauldin's recent newsletters. They talked about the velocity of money (meaning velocity of money growth) and showed this chart:
GaveKal Velocity Indicator,
As GaveKal pointed out in their newsletter, buyers of gold and oil (and sellers of the US dollar) have been focused on the idea that the extra liquidity push by central bankers is going to inflate the money supply (in other countries as well, not just the U.S.) and that it will be good for commodities (bad for the US dollar). But they're failing to realize that the Fed and other central bankers don't control the money supply. The market does. If credit is not created through the aggressive lending practices that led us to where we are today then the central bankers couldn't possibly create enough new money to compensate (not without creating hyperinflationary problems).
And the chart above shows the velocity of money growth is now in negative territory and has been trending down since 2006, just as it did from 1999 to 2002. The central bankers know this and have been attempting to plug the dike by dumping helicopter loads of cash into the market. The stock market followed the money in 2000-2002 and it's very likely it will do the same thing again this time. And the sharp spike up in commodities (such as gold and oil) will very likely get reversed quickly once traders realize what's happening (the EW count I've shown on gold the past couple of weeks supports the idea that the gold rally will likely fail hard).
Banks have recently been forced to buy back many of the loans they were hoping to farm back out to investors. Having these loans back on their balance sheets has taken a lot of cash out of the market place. This will force banks to severely curtail further lending as they will literally have run out of money to lend. The credit collapse is likely in the very early stages.
The problem has become one of fear instead of greed. Investors are now fearful of taking on debt instruments that they don't know or understand. They don't want to see their investment turned to dust. Therefore much of the commercial paper (short term collateralized loans between banks and corporations) that is coming due will end back on the banks' balance sheets.
Today started the Congressional inquiry into the ratings agencies (Moody's, Standard & Poor's and Fitch) and how "they let this happen." First they will be accused of rating everything AAA or AA when it was in fact at best BBB, and then they will be accused of the credit collapse when they started downgrading these investment-grade assets to something less than. They're in a can't-win situation and out of this will come more onerous legislation and fearful bankers and ratings agencies. To think that lending will suddenly become easier out of this mess is to not recognize reality. Like I said, I hope the string that the Fed is pushing on is a stiff one.
Be prepared,
Regards,
P.S. Nav, I just saw your post. Not pointing to you with my sign. LOL
