Stocks are sitting at or near record highs, so, naturally, Jerome Powell's Federal Reserve is expected to do its part with another 25-basis-point rate cut this afternoon at 2 p.m.
After all, the stock market is up - the Fed's unofficial, unsanctioned signal to open the cheap-money taps a little wider.
If the Fed moves as markets are "expecting" (read: demanding), this'll be the third reduction in the Fed funds target rate since July, totaling 75 basis points in all, just as it did in 1995 and 1998.
The Fed would be cutting against a backdrop of sky-high stock valuations, decelerating economic growth and job gains, a deepening manufacturing recession, and a political situation that threatens to boil over into full-blown constitutional crisis at any minute.
So this is a really dicey time for investors, but there are some opportunities for savvy folks who understand how to play the Fed against Wall Street - and Wall Street against economic reality.
Let's talk about what to do...
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Uh-Oh: The Stock Market Is the Economy Now
Why is the Fed moving to save the stock market's bacon? Because it has no choice in the matter.
It all goes back to the fateful decision the Fed took to slash interest rates to zero in the wake of the financial crisis. That move facilitated the creation of trillions of brand-new dollars, and with that, a facsimile of "recovery" that the Fed's D.C. political masters could point to come campaign season... and their Wall Street masters could depend on to stage massive stock buybacks to boost valuations and compensation packages.
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That decision sacrificed the savings, security, and net worth of hundreds of millions of middle-class Americans who were left with smoldering 401(k)s, IRAs, and savings accounts stuffed with ever more worthless dollars.
But it also created an unholy Franken-creature: the melding of the stock market and the wider U.S. economy. The Fed essentially can't let rates rise, because all of the debt corporate America took on to stage those buybacks would become that much more expensive - that is to say, "completely unaffordable" - to service.
The Fed tried to "normalize" last year, and the stock market was swooning by double at Christmas. By New Year's, it was clear even to the Fed that it couldn't stem the flow of cheap dollars to which Wall Street had become cripplingly addicted.
That's why in the space of about a year, the Fed's rhetoric has shifted from hawkish talk of "tightening" to the all-too-familiar, dovish tune of easing.
The trouble is, like a junkie who's 10-plus years into a blistering heroin addiction, it takes more and more dope to get that same feeling they've been chasing all along. No matter how much cheap money floods the markets, it's never quite enough to obtain the desired effect.
The last two times the Fed cut rates, the markets - which should have reacted enthusiastically, addicted as they are to cheap money - actually fell. Because a 25-basis-point cut (or two or three) isn't enough to "do it" anymore.
But just when the Fed's rate-cutting act begins to fail to cut the mustard, it's actively pumping $60 billion a month (on an annualized basis, around $720 billion) into the frozen-up "repo" markets; that's quantitative easing in all but name only, and it is wreaking some potentially lucrative havoc in the bond markets (more on that in a minute).
Long-term, this is a disaster in the making...
The Fed's Magic Dust Is More Like Weak Tea
In a turn of events that must have central bankers feeling pretty queasy indeed, investors seem more fixated on the "why" of rate cuts, as opposed to the "when." Investors are worried, and they're climbing straight up that wall of worry.
You don't hear "rate cuts" framed this way on the news, you don't hear it said out of Washington, and you certainly don't hear it from Wall Street, but rate cuts are emergency measures, and on some level, at least some investors still know that.
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Annualized Q3 2019 GDP (quarter/quarter) is surveyed to print (and tumble) this week at 1.6%, down from 2% last quarter. That's not good news, and it's quite a drop from the lofty 3.5% prints in December 2018 and again last June. That growth is well in the rearview mirror now.
Economic momentum continues to slow, retail sales continue to slow, capital goods orders continue to slow, purchasing manager data continues to decline, industrial production continues to weaken, and consumer inflation expectations have fallen to the lowest level since 1979.
Without too much fanfare from the media, this month, the International Monetary Fund lowered its global growth forecasts - again - thanks to rising trade barriers and heightened uncertainty in places like China and the United Kingdom.
And of course there's the creeping, roiling liquidity crisis - excuse me, "dollar shortage," as Wall Street politely puts it - that's instigated this new round of easing.
How's that for a wall of worry?
As rotten as the whole thing is, we can't ignore the fact that stocks, buoyed by the Fed's "stealth" treasury-buying and money-printing, are making every effort to plumb new highs. The fundamentals aren't supported by the technical signals; that's confusing and difficult to resolve, but it's not uncommon these days.
How to Cash In in the Twilight Zone
We're left with the inescapable fact that markets will probably climb higher from here, at least a little - no matter how much they might need (or deserve) a minimum 20% haircut.
In the near term, one should expect the bullish steroid-effect of $720 billion in annual printed money to be a meaningful tailwind for Wall Street.
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The Fed is using this money to purchase Treasury bills, so that's a fairly clear signal that T-bills will go artificially up in value, and yields at the short end of the curve should come down a bit. Short-duration T-bills look like a smart buy in this environment.
Low yields mean low rates, and hence yet another green light for corporate America to extend its record-breaking borrowing binge to even greater highs.
This means (1) more stock buybacks for more darling blue-chip companies like Apple Inc. (NASDAQ: AAPL), (2) more Wall Street carry trade/cheap leverage for the hedge fund class, and (3) a nice artificial boost for the S&P 500, already past any metric of natural price discovery.
If you're protected with a nice cash hedge, it's worth speculating here to grab what upside is left in big caps. The SPDR S&P 500 ETF (NYSEArca: SPY) is one way to do that; the Vanguard Russell 1000 Value ETF (NASDAQ: VONV) is another.
And lastly, sane allocations in precious metals make good sense at a time like this, having been in a long-term rising trend since bottoming in 2015. Like the Swiss, I recommend a 10% to 15% position in gold and gold stocks, like the Sprott Physical Gold Trust (NYSEArca: PHYS) and SPDR Gold Trust (NYSEArca: GLD).
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About the Author
25-year run as a hedge fund portfolio manager, family office chief investment officer, managing director and general counsel. Internationally recognized expert in credit and equity markets as well as macro risk management.