PicoBlog

I didn’t like school much growing up. For starters, I wasn’t a good student. I couldn’t pay attention, and found the whole thing extremely boring.

However, there was one school day I always looked forward to, field day.

Field day happened once each year, in the spring. It was on a Friday. It was a half-day. And instead of being stuck inside all morning, we assembled at the school soccer field. No books, no homework, no pop-quizzes, just bizarre outdoor physical contests.

Each class picked its most able-bodied student to compete in the egg toss, the 100-yard dash, the three-legged-race, potato sack race, tug-of-war, and my personal favorite, the dizzy bat race.

Dizzy bat requires the player to disorient themselves before starting the race. This happens by spinning around at least ten times using a baseball bat as the pivot point. Once properly disoriented, the participants run as fast as they can to a cone twenty yards down the field. First one there and back wins the race.

Here’s what it looks like. These two gentlemen demonstrate how challenging it is to run after disorienting yourself.

As you see in the video, ten spins around the bat make walking difficult. I can tell you from personal experience, twenty spins make it impossible. Your body doesn’t know which way is forward.

Disoriented By Money Games

With the natural senses tricked, people get into all kids of trouble. Falling on the soft spring grass of the soccer field is no big deal. When it comes to something more serious, like your life savings, being disoriented is a big problem.

The big money picture is a confusing mess right now. That’s by design. If you saw things clearly, you’d feel fleeced.

For instance, if a committee of unelected former private equity executives got together in an ornate Washington DC office to decide where to fix the price of money, you’d complain. That sounds Soviet.

If we call it the Federal Reserve, and blend the DC office with other federal buildings, everyday people feel good about it. The experts inside must be doing their best to “manage” our free market. We see them as helpful.

But the facts don’t add up. If you see through the confusion that is.

Take last week for instance. The Fed had a meeting to decide where to fix interest rates. These meetings end on Wednesday afternoon with a printed statement followed by a press conference.

Going into the meeting, analysts expected the committee to fix interest rates at the levels shown below over the next few years. Equal parts confusing, and sophisticated, these colorful graphs do appear credible.

This is quite unusual for a free market. But the savvy Fed realizes the entire $50 trillion dollar U.S. stock market stands hat in hand outside its office. The collective chant rattling the building is, “more juice.”

Backed Into a Corner

With the central planning committee in charge, the numbers keep getting bigger. They have to….

If we went back to a system with less borrowing, where people had to come up with higher down payments, the price of everything would crater.

It’s easy to see in your own neighborhood. With 5% down and a 3% mortgage, everyone’s a buyer. Those days are over.

As rates climb, lenders retreat. Buyers need a real down payment and stable income. While there’s always a market for a great home on a great street, the strong buyers have control right now.

It’s not just housing. The same goes across all markets. Notice the chart below. It tracks Fed assets, which tend to rise during periods of low rates, and fall when rates rise.

What once was a small institution with ~$400 billion worth of assets in the early 1990s, today’s Fed is almost 25-times larger.

The numbers go up, never down in a material way. Any decline is like winding up before throwing a punch. That’s where we are now…and the Fed knows it.

They have to hint at more juice to keep the stock market steady. They realize, correctly, they have a spigot controlling the entire U.S. market. Raising or lowering rates slows or speeds the flow of money through our economic plumbing.

It’s When…Not If

We’re a long way from free market capitalism. What we have now is a centrally-controlled economic system. We use lingo and jargon to keep people distracted.

Think of it like a wealthy father who keeps saving his son from consequences. First, it’s a speeding ticket, then a DUI, eventually it’s getting rid of a body. In trying to save the kid from pain, you cheat him out of essential life lessons. What started as good intentions created an entitled monster.

The Fed manages what used to be a free market system. It’s all in the name of preventing consequences from its last intervention. It uses dozens of economists, governors, and experts to keep us distracted. It’s monetary dizzy bat.

To show you exactly how this works let’s look back to last week. We’ll use the gold futures market to monitor investor reaction to Fed messaging.

The gold futures market is highly liquid. On active days it can turn over as much as ~$80-100 billion worth of bets on the direction of gold prices. While very little actual physical gold changes hands, speculators use it as a betting mechanism for short term market moves.

Wednesday December 13 at 2:00 PM EST, Fed Chairman Powell gave the market the impression he might be finished raising interest rates. He led speculators to think rates might fall sooner than expected.

Remember, this means cheaper borrowing costs, less cash needed to control more assets.

Stocks shot higher. Notice the action in the gold market at the time of his speech. The red arrow on December 13 shows the market reaction.

Not so fast… within 36 hours the Fed paraded experts around major news channels to slow down enthusiasm. Notice the second red arrow in the chart above coincides with this news release.

The news story printed around 1:30 PM EST right in the middle of trading on Friday December 15. If a company did this, they’d be banned from public markets forever. For the Fed, it’s all in the name of helping.

And the warnings carried on all weekend. It sent regional lieutenants on all the Sunday news shows to talk circles around the issue. Think of it like a 20-spin episode of dizzy bat.

This lieutenant reminded us, the fight against inflation isn’t over.

Depends on the Definition…

The Fed defines inflation as the pace of price growth. By that definition, it’s dropping like a rock.

Most of us define inflation as the cost of things… and it’s way up.

Take groceries for instance. We all feel the sky-high cost of real food. That means things that grow, live, and die before ending up in our cart. The substitute products, Soylent beverages, or compromises in quality don’t factor into our view.

You could call our gauge of inflation the “actual wallet effect.”

The Fed called price increases “transitory” which sounds temporary. The costs won’t come down, and they know it.

The bottom line is the excesses of last decade went extreme in 2020. Unemployed serfs became day traders. Middle managers toppled hedge fund managers. It went too far. There was too much money chasing too few assets. The Fed knew it had to reign in the dollar system before it lost credibility.

The issue is, it can only go so far before something breaks. It won’t let that happen…

Just Play the Game...They Want you to Win

Instead of griping about the Fed, let’s play their game. They want us to play. In fact, they want us to win.

It’s a centrally-planned system now. That means we engineer a business cycle, or attempt it at least.

We intervene to stop panics. We stimulate to start expansions. We want the good times to go on forever, only not too much too fast.

It’s a lot like managing a drug addiction. What starts out as an effort to keep the party going becomes constant work to avoid withdrawal. The party stopped a long time ago.

The reason the Fed wants to keep prices going up is simple. Higher asset prices mean more capital gains tax, more income tax, more commerce.

Every time a home sells it generates about ~10% in fees and commissions. A slow real estate market means less commerce.

However, as rates fall, deals pick up. More people make money, pay taxes, employ others, and the system keeps going.

It means debt is the engine of commerce.

Stocks work the same way these days. The cost to borrow falls, companies take advantage. They start new divisions, buy competitors, and take risks. It all adds up to a system hooked on debt.

Stocks Know What’s Coming

The Fed is now the biggest catalyst for stock prices. It’s much more important than underlying fundamentals.

The economy needs access to cheap sources of funding. It can’t expand without an uptick in sales. Consumers can’t spend more without credit. The whole system sits like a panting dog before each Fed meeting.

And Mr. Powell delivered last week. In so many words, the minister of interest rates led the market to believe cheaper money is right around the corner.

These days, company analysis is less important than Fed analysis. Get the Fed move right, and the odds of success go way up.

Professionals have it figured out. Blackstone (BX), Citi (C), JPMorgan (JPM) and slews of other financial and private equity firms have big bets on lower rates. They’re practically tripping over themselves to lend as much money as possible at today’s high rates before they fall again.

Taking the place of traditional banks, there’s a ~$1.7 trillion unregulated private lending industry forming. Known as “private credit” this segment of the alternative banking world lends to risky borrowers.

The lenders figure if Powell delivers on lower rates, the shark loans to risky companies will either be repaid with cheaper borrowing or boosted sales.

The whole U.S. market looks to Powell for signals. When will the party start back up… The answer, soon.

At Least We Know it’s a Game – The Plan for 2024

Knowing it’s a game is 90% of the battle. Most people think we’re in a capitalist system. They try to predict recessions, and position ahead of them. Even if there is a crash, odds are if you blink, you’ll miss it. The Fed can’t withhold support without rapid collapse.

What collapse means now is loss of U.S. primacy. Early last year we felt tremors. It was a warning sign something might break. The Fed responded with a rapid, radical increase in short term interest rates.

As tensions flare, the U.S. needs its dollar strong. It’s a whip to use on the world…for now. And the whip doesn’t work if the pace of inflation gets out of hand.

We might be on a slow race to the bottom, but we can position ahead of it.

The trick is to watch for signs the Fed’s work is done. It wants to rein things in, without destroying the system.

Instead of playing dizzy bat with media headlines, we’ll keep an eye on the obvious excesses of 2021.

An Unusual Indicator of Fed Action

Subscriber Lance A. keeps us up to date with reports from the field.

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