Chris Ciovacco: As Ben Bernanke clearly stated during this week’s press conference, the Fed is trying to inflate the value of 401(k)s and residential real estate, which is another way of saying the Fed is trying to create positive inflation. Inflation is bad for low-yielding investments like bonds and money markets. In the intermediate-term, inflation should drive precious metals (NYSEARCA:GLD) and global stocks (NYSEARCA:VEU) higher. If you missed this week’s Fed press conference, this is straight from Mr. Bernanke’s mouth:
“If people feel that their financial situation is better because their 401(k) looks better or for whatever reason — their house is worth more — they’re more willing to go out and spend. That’s going to provide the demand that firms need in order to be willing to hire and to invest.”
If you are sitting in cash or have a heavy allocation to bonds, the chart below is telling you it may be time to make some changes. The Fed has basically started an unbounded/unlimited round of money printing, which we highlighted on August 27. In technical analysis, charts tend to fill white space. The long-term chart of the Treasury Bond ETF (NYSEARCA:TLT) has quite a bit of potentially bearish white space below, which is a good sign for stocks (NYSEARCA:SPY), precious metals (NYSEARCA:GDX), and commodities (NYSEARCA:JJC). Note the 22% drop in TLT that occurred during the Fed’s first quantitative easing program (see 2009 below). The bearish divergence between the slope of price (see A below) and the indicator (see B) foreshadowed the recent drop in TLT and gains in risk assets. We pointed out the divergence weeks, if not months ago.
You’ll also remember that stocks performed quite well after bottoming in March 2009. The 2009 bottom in stocks was formed with the help of QE1. We are now in the early stages of QE3-to-? (the current round has no termination date). The Fed will print and assess. If the economy and employment do not improve, they will continue to print.
Did the market respond to the Fed’s latest announcement? It did. The Treasury Bond ETF TLT was down 4.62% this week. The S&P 500 ETF SPY was up 2.02%. The Metals and Mining ETF (NYSEARCA:XME) was up an eye-popping 8.61%. If you want more proof, look at these extremely high volume levels on QE-friendly ETFs.
Contrary to the commonly held belief that “QE money will just sit at banks and have no economic impact”, the freshly printed money has a well-defined path to reach the accounts of hedge funds, sovereign wealth funds, and everyday investors. The path is shown in this flow chart and described in detail in an October 2010 QE video.
Why would the Fed want to inflate stock and real estate prices? Balance sheets have been out of whack for several years, with liabilities dragging down the asset side of the ledger. Attacking the liability side of balance sheets is difficult since it involves write-downs or defaults. Printing money and inflating the asset side of the balance sheet is “easier”. If you want to dig a little deeper, these concepts are covered in a 2010 video that still applies today.
We first pointed out bullish weekly divergences in stocks, precious metals, and commodities in this May 25 video. The video clearly stated that we “should be open to a rally in risk assets and a drop in bond prices”. Since the video was published the S&P 500 has tacked on 148 points. Since the reasons to be bullish remain in place, it may be helpful to revisit them.
Below are the six bullish points we made on August 10. The only things that have changed in the last five weeks are (a) the European Central Bank has intervened (see 3 below), (b) the Fed has committed to print more money (see 4), and (c) China has responded with a stimulus program (see 6). Since the points below were argued, the S&P 500 has added 60 points.
Why stocks may post surprising gains in the months ahead (from 8/10/12):
- The pattern of risk-off followed by central bank-induced risk-on is alive and well.
- Inter-market relationships look similar to the pre-melt-up period in 2009, 2010, 2011.
- The European Central Bank (ECB) is readying for serious market intervention.
- More money printing is coming from the Fed.
- Oil and commodities have perked up according to the pre-melt-up script.
- China may respond to weak economic data with more stimulative actions. According to a CNBC report published on Friday, “action by China’s central bank could come as early as the weekend.”
The four primary reasons “risk assets can move higher than most can rationally comprehend” below were outlined on September 7; the S&P 500 has risen 28 points since then. Points 3 and 4 below also remain in place with the German high court clearing the way for the European bailout mechanism this week.
- The Fed will take action (it did this week)
- Open-ended QE could mean unbounded money printing.
- Spain and Italy have avoided the worst case scenario.
- The charts don’t lie (still bullish).
This article opened with “if you are sitting in cash or have a heavy allocation to bonds, the chart below is telling you it may be time to make some changes”; that statement applies to the chart below as well. In terms of point 4 above, the chart below tracks the performance of stocks (NYSEARCA:SPY) relative to bonds (NYSEARCA:AGG). When the ratio rises, stocks are in favor relative to bonds. This week the ratio cleared a key resistance point in a bullish set-up known as an inverted head-and-shoulders pattern. If the bullish breakout holds, stocks could move much higher and bonds could move much lower in the coming months.
We recently made bullish arguments for metals (NYSEARCA:SLV), materials (NYSEARCA:XLB), and emerging markets (NYSEARCA:EEM). To emphasize cash and bonds are not the place to be, SLV has gained 18.4% since we wrote about it 25 days ago. We will continue to favor inflation-friendly assets as long as the charts, and more importantly, central bankers allow. You may or may not agree with all the bailouts and money printing, but we are in search of profits, not serenity. When central banks print, profits tend to congregate in stocks and commodity-related assets, not cash or bonds.
Chris Ciovacco began his investment career with Morgan Stanley in Atlanta in 1994. With a focus on global macro investing, Chris uses both fundamental and technical analysis to assist in managing risk while looking for growth opportunities around the globe in all asset classes. If you are looking for an independent money manager or financial advisor, Ciovacco Capital is worth a look. Chris graduated from Georgia Tech with Highest Honors earning a degree in Industrial and Systems Engineering in 1990. His experience in the professional ranks began in 1985 as he began working as a co-op for IBM in Atlanta.
Ciovacco Capital Management, LLC (CCM) is an independent money management firm serving clients nationwide. By utilizing extensive research, disciplined risk management techniques, and a globally diversified approach, CCM prudently manages investments for individuals and businessowners. Our focus is on principal protection and purchasing power preservation in an ever-changing global investment climate.