Market Now Unconcerned About Fiscal Cliff Fallout As Fed Pumping Accelerates

by The Curmudgeon

This Thursday, the U.S. Congress passed a continuing resolution to fund the government until September 30, 2013. The vote of 318-109 in the House of Representatives and 73-26 in the Senate was sufficient to avoid a government shutdown on March 27.  The House passed the bill as amended by the Senate. It reflects the $85 billion sequester (forced U.S. government spending cuts) for the rest of year.  But this stop-gap bill really just "kicks the can down the road" with hard decisions and comprises required in a few months.


Congress faces very serious budget issues for fiscal year 2014 (which begins October 1st). In addition to discussing and agreeing on the 2014 budget, the federal debt limit will be reached in late May and a new budget bill must be passed by July or August. There could be very contentious negotiations again later this summer.


What puzzles the CURMUDGEON is that the market sold off immediately after Obama's re-election in November 2012 due to potential negative economic impact of going over the Fiscal Cliff.  But since late November, the market has rallied strongly- even though we've gone over two cliffs already- the payroll tax was raised on January 1st and the automatic federal government spending cuts (sequestration) kicked in on March 1st and will remain in effect for the rest of the 2013 calendar year.  And we really do NOT have Congressional agreement on a sustainable federal government budget (beyond the next few months). So one must assume the market has cast aside its concerns over the negative economic consequences of falling over the fiscal cliff(s), which will surely reduce GDP and corporate profits.


Meanwhile, few in the mainstream media have called attention to the harmful consequences of Fed debt monetization.


1. The ballooning balance sheet of the Fed stands at $3,208,553,000 Million as of March 20, 2013.

If the Fed keeps up its $85B a month purchases of debt securities its balance sheet will be at $4T by year end.  How long can this Ponzi scheme continue?  If other major currencies weren't so weak, we think the U.S. $ would have collapsed quite some time ago!  And there's the possibility of hyperinflation if the Fed doesn't sell the securities it has purchased as money velocity and loan demand pick up (as they should in any true economic recovery).  At that point monetary inflation will become real headline inflation.


The CURMUDGEON has written several articles about the many dangers the Fed's exponentially increasing balance sheet poses for the U.S. economy.  We've referred to this as a "no win scenario." But the stock market is ignoring those dangers.  


2.  Meanwhile, the Adjusted Monetary Base (high powered money that can multiply when there's strong loan demand) has recently exploded higher and has reached $2,976.579B as of March 20th!  Again, this excess liquidity has potential inflationary consequences when money velocity and loan demand pick up.


Graph of St. Louis Adjusted Monetary Base


The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks. These data are adjusted for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.


Again, the market ignores this monetary inflation.  What me worry? That's the day after tomorrow's problem.  It seems the market only cares about today -or maybe just the last few minutes of trading, e.g. 20% of SPY volume on Friday March 22th occurred in the last minute of trading as the granddaddy ETF spiked sharply higher as the market close).


Michael Pento seems to agree with the Curmudgeon' position on the reckless Fed and overvalued stock prices (based on future corporate earnings which we think will be drastically less than forecast).  


Here are a few quotes from his latest blog post titled: Equity Bubble is Based on Unsustainable Earnings


"To believe that stock prices are now fairly valued investors must also be convinced that massive deficits, free money and central bank debt monetization can be reversed without affecting the economy and corporate earnings."


"Whenever the Fed finally backs away from all its money printing, equity prices will suffer, as investors begin to receive a real rate of return on fixed income and their bank deposits. Rising interest rates will send service payments on corporate, private and government debt skyrocketing and that will severely hamper economic growth. The economic fallout from the end of artificial stimuli cannot (in the short term) be supportive of the level of corporate profits."


"If market forces were allowed to prevail and the government permitted the economy to deleverage, earnings of U.S. corporations would be in a depression. And the price to earnings ratio would reveal that stock prices are already in a bubble. A bubble that is only becoming more dangerous with each day of the Fed's money printing."


That's a lot to think about!


Till next time.....................................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.