If You Like Volatility, Thank the Fed

by Victor Sperandeo with the Fiendbear




Using the S&P 500 as a benchmark, the close on 12/31/14 was 2058.90.  Two weeks later on 1/15/15, the S&P 500 closed at 1992.67, which was the LOW end of the S&P trading range until 8/21/15. The S&P 500 high was 2130.82 on 5/21/15.  Thereby the RANGE for 8.75 months - closing high/low - was an incredibly low 6.5%! This was effectively a massive top after a 6.2-year bull market (from 3/9/09) up 215% closing low to closing high.


Volatility (aka market declines) began on 8/19/15 when China (up 180% on the Shanghai Composite from June 2013) lost its reserve currency bid from the IMF due to its theft of 23 million US government personnel records via an internet hack. Initially, the failed reserve currency bid was discounted by Shanghai traders in June.

Also in August, the Fed hinted it would end its ZIRP and raise rates for the first time in 6.75 years at the September FOMC meeting.

After the S&P declined to 1867.61 on 8/25/15 (-12.4%) and a visit from Chinese President Xi Jinping to Washington DC in late September, the IMF then said it would reconsider the Yuan's reserve status. Soon after that, Fed changed its mind to NOT raise rates in September due to China's stock market decline.

The S&P 500 then rallied back to before the turmoil level of 2109.79 on 11/3/15. The S&P 500 was trading in a new narrow band until another decline began after the Fed raised rates by 25 bps and China’s reserve status (finally obtained) was deemed not effective until October 2016. The new S&P 500 decline has been with us since 12/30/15 and is testing its 8/25/15 closing low of 1867.61. 

If the DJI closes below its August 25 low of 15,666.44, a Dow Theory bear market will be confirmed.  If the S&P 500 also closes below its August 25th low, especially on high volume, the bear market will be corroborated.

Interest Rates—Still the essence of the markets movements

A handful of FOMC voting members spoke last week: Dennis Lockhart (Atlanta Fed), Jeffery Lacker (Richmond), Eric Rosengren (Boston), James Bullard (St. Louis), and Friday, William Dudley (New York). All of these Presidents impacted the markets as each spoke throughout the week.  Coming into last week, the S&P 500 declined (-7.52%) from 12/29/15 in a straight line with one minor up day (January 5th +0.20%).

Dennis Lockhart said on Monday (January 11) that he expects "the economy to enjoy enough self-reinforcing momentum to sustain gradually rising interest rates. Monetary policy decisions are not on a preset path and will be data-dependent, he states." The consequence of his comments—the S&P 500 gained 0.09%.

Jeffery Lacker said on Tuesday (January 12): "Falling energy costs and the rising value of the dollar have held down inflation recently, but inflation is likely to return to 2 percent over the near term. The decline in the natural real interest rate suggests that short-term interest rates are unlikely to reach the levels reached in previous expansions. Still, there are strong reasons to expect real short-term interest rates to rise in the near term. Such increases are a sign of the strength of the U.S. economy." The S&P 500 gained 0.78% after his statement.

Eric Rosengren said on Wednesday (January 13): “While monetary policy should not overreact to short-term, temporary fluctuations in financial markets, policy makers should take seriously the potential downside risks to their economic forecasts.” The S&P 500 was not impressed and plunged 2.5%.

James Bullard said on Thursday (January 14) that…the continued rout on global oil markets has caused a "worrisome" drop in U.S. inflation expectations that may make further rate hikes hard to justify. “We are 18 months into this and I am starting to wonder if my story is the right one," Bullard said. "For me inflation expectations are a key factor and if they continue to decline I would put increasing weight on that." The S&P 500 rallied 1.67% on these dovish comments.                                        

William Dudley said on Friday (January 15) that rates are to rise gradually, outlook unchanged. "In terms of the economic outlook, the situation does not appear to have changed much since the last FOMC meeting," he said. "Some recent activity indicators have been on the softer side, pointing to a relatively weak fourth quarter for real GDP growth." The stock market didn’t like this hawkishness so the S&P500 promptly tanked 2.16%.

When the Fed members say that rates will rise, the markets are flat to down 2%. When they (Bullard) say that they "worry" about raising rates then the market rallies. This is a 2+2 analysis of course.

The Treasury, like the Fed, is watching over us: "The Treasury Department is closely watching market movements”, the White House said Friday as the Dow Jones Industrial Average DJIA tumbled more than 400 points (-2.39%). "Market indices closed somewhat higher yesterday, and now they're down again today. Obviously these are market movements that are closely watched at the Treasury Department," White House spokesman Josh Earnest told reporters. He said the Treasury watches world financial markets and evaluates what kind of impact they could have on the broader U.S. economy.

The economies around the world are slowing dramatically. The Japanese Nikkei at 17,147.11 is only 3.2% away from closing at new 12-month low (16,492.57 on 1/16/15) while Japan has used Keynesian concepts beyond anything ever done in human history. The bottom line--it does not work!  The proof? On 11/15/15 Japan’s reported GDP contracted 0.8% and which pushed the economy towards another recession. However, an “adjustment" from September to +0.2% GDP from -0.3% GDP avoided the two down quarters definition of a recession. I wonder if the Japanese government fudged the number?

According to Fox News Ben Weinthal, "(Angela) Merkel’s red carpet for refugees is decried by some Germans as cultural suicide". If you don't think that the economy of the strongest member of the EU is not going to grow far less than the 1.7% GDP projected growth rate, due to its refugee policy, I have a bridge to sell you. Add the Volkswagen problem, and you have Germany heading for recession. Confirming this is the DAX all time high of 12,374.73 in April 2015 now trading at 9,545 down 22.9% and firmly into a bear market.

We covered China and it remains headed for a hard landing with a huge debt load. The growth numbers are not to be believed, but assumed to be a GDP of around 2-3% not 6.5-7.0%. The Shanghai Composite closed at 2900.97 and the low of 2850.71 on 8/26/15 is less than 2% away.

The U.S. economic stats are doing a "Barany" (front flip with a half twist) flop. Retail sales were down 0.1%, the Empire Manufacturing Index sank 19.4% (the lowest level since March 2009 with estimates projecting only a 4% decline), and Industrial Production MoM lost 0.4% (its third straight monthly decline). New Orders declined 23.54%, Capacity Utilization was down to 76.8% (declining from 77.0% the previous month), the Manufacturing ISM Report on Business is at 48.2% and is interpreted as indicating that the US has an 85% chance of being in recession. At 46% it's 100% guaranteed (historically) of being in a recession.

As reported by Zero Hedge: “US Freight Volumes Fall For First Time In 3 Years As Baltic Dry Crashes Under 400”. Walmart, the mother of all retailers, is closing 269 stores (154 in the US) affecting 16,000 workers. It should be noted that the employment report of +292,000 jobs created in December was seasonally adjusted to +281,000. All of this is not good news?

We spoke in "Year End Recap and 2016 Projections" on the coming economic weakness and the consequences. The equity markets since then are very close to confirming a Dow Theory bear market. The Dow Industrials need to trade below the 8/25/15 low of 15,666.44 or just 2% from Friday's close (the S&P 500 needs to drop only 0.68%). Virtually all other indexes are below the August lows except the NDX 100 which is only 3.0% above. Volume has increased on the decline, and the S&P 500 is below its 200 day moving average (DMA), while the DMA is trending down (a critical difference than when it's trending up), and another long term bear market signal.

Raising rates is causing many problems, which has been obvious to everyone but the Fed. Rates should have been raised back in 2013, then lowered a year or so later with the Fed allowing for a typical business cycle short/small recession and possibly forcing fiscal policy change. But now it's far more than a bubble to pop, it's more like the Hindenburg blimp. When they finally do change their mind to stop raising rates, the market will rally, but it won't matter. The die is cast and with the little ammo the Fed has left, being virtually out of bullets, the economy is toast. Therefore, a downturn is coming (100%) in my view. Oh and forget negative interest rates. How's that working out for the EU? QE 4 is not going to happen as government debt is getting scarce and will cause the bond market to become illiquid. 

The Fed was about “an agenda” not about intelligent policy that's good for "all people." Their incompetence was in not changing policy when it obviously wasn't working. The Fed’s policy actions (or inactions) are among its worst in history. We have not even seen the end result of this policy yet.

This cast of bureaucrats at the Fed is in the band of people Ben Franklin was talking about when he said:         

"We are all born ignorant, but one must work hard to remain stupid".

Good luck and till next time...


Victor Sperandeo


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

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.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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