Fed Stumbles, Buybacks Are Dangerous, Stocks Declining Right On McClellan’s Schedule

The Fed Stumbles

Yesterday, the Federal “inadvertently” released early the minutes of the July FOMC meeting momentarily sending stocks soaring. Well, that was until somebody actually READ the minutes which were less than optimistic. Stocks dove a few minutes later. As Jon Hilsenrath noted:

“The Federal Reserve’s next policy meeting is four weeks away, and officials show no clear sign of having settled on a decision about whether to raise short-term interest rates at that time.

Their assertion that they were approaching a rate move might be read as a hint that they saw a September move in the cards, but the minutes showed that officials had wide-ranging views about taking that step and some notable trepidation.

Some also worried about moving prematurely and lacking tools to address downside shocks to the economy, and about downside risks to the economy from developments abroad, particularly China.

There was push back against hesitating. A number of officials argued that a rate increase could convey confidence to the world about the economic outlook and that the Fed needed to move in acknowledgment of the progress the economy had already made toward normalcy.”

The admission by the Fed the economy remains far weaker than headline statistics have suggested, was not surprising. It is also the major issue for the Fed as they understand economic cycles do not last forever. Given that we are closer to the next recession than not, the potential risk of hiking rates in a weak economic environment could very well accelerate the onset of a recession. However, from the Fed’s perspective if just might be the ‘lesser of two evils.’ Being caught at the “zero bound” at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic and market decline.

This is particularly problematic given that monetary stimulus programs (QE) have failed to produce any sustainable, organic economic growth. While I have made this point in the past, it was finally admitted by the Federal Reserve itself earlier this week. To wit:

“There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed inflation and real economic activity. Indeed, casual evidence suggests that QE has been ineffective in increasing inflation.”

Of course, if you have been reading my posts over the last couple of years none of this should be of any surprise. The following series of articles have suggested that the realization by the Fed of their precarious position was only a function of time.

Who’s Right – Commodities Or Fed (July 22nd)

“As I have suggested previously, Ms. Yellen likely realizes that hiking rates at this late stage of the economic cycle is extremely risky. However, she also understands the danger of being caught in an economic downturn with interest rates near the zero-bound.

Economic indicators, China and commodities (including oil prices) are all suggesting that the Fed should NOT raise interest rates in September.

Fed’s Window For Hiking Rates Continues To Close (July 6th)

While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility they will anyway.

The Fed understands that economic cycles do not last forever, and we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed’s perspective it might be the ‘lesser of two evils. The problem is that they may have missed their window to get there.”

Fed At Risk Of Missing Window To Hike Rates (June 2015)

The Federal Reserve may have missed their window for hiking rates for the time being. However, as I stated earlier, the clock is ticking towards the next recession and for the Fed this could be a real problem.”

4 Charts Why Fed Unlikely To Raise Rates (May 6th)

“Please review the chart on monetary velocity above. This is a major issue for the Federal Reserve, which remains firmly committed to a line of monetary policies that have had little effect on the real economy.

While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility that they will anyway – “data be damned.” (Which is ironic for a “data dependent Fed.”)

Being caught at the “zero bound” at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline. The problem is that it already might be too late.”

The Fed is slowly coming to realize that “forward guidance”, “QE” and artificially suppressing interest rates does indeed boost asset prices and creates a burgeoning “wealth gap.” However, since those programs only affect the top 20% of the population that actually has money to invest, it does little to create real prosperity across the broad economy.

But here is the real question: “If, after six-plus years of economic expansion, the economy is not strong enough to withstand a hike in rates now, when will it ever be?”

The Problem With Debt-Financed Buybacks

I have written previously about the problem of debt-financed buybacks and the potential issue with the markets when that cycle comes to an end. To wit:

“The rush to market (for stock buybacks) suggests a near ‘panic’ by companies to take advantage of both low rates and investor appetites.

The question that investors need to be asking is: ‘what happens when companies inevitability reach ‘the end of road?’ Importantly, with the Fed determined to begin hiking interest rates, despite weak economic data, the end may be nearer than most are currently expecting.”


The always brilliant Dr. John Hussman recently further addressed this important issue.

The larger problem with repurchases is that debt-financed buybacks effectively put investors on margin. As corporations have borrowed in order to aggressively buy back their stock near the highest market valuations in history, existing stockholders have quietly become heavily leveraged, without even realizing it.


So not only is the equity market at the second most overvalued point in U.S. history, it is also more leveraged against probable long-term corporate cash flows than at any previous point in history. As we observed during the housing bubble, yield-seeking by investors opens the door to every form of malinvestment. The best way to create a debt-financed wave of speculative and unproductive activity is to starve investors of safe return. In 2000 that wave of speculation focused on technology. The next Fed-induced wave of speculation focused on mortgage securities, which financed a housing bubble. In our view, the primary avenue of speculation in the current cycle has been debt-financed corporate equity purchases.”

The entire article is worth your time to read.

McClellan – Stocks Set For Decline…Today

Talk about getting your timing right. Via MarketWatch:

“Tom McClellan loves doing what financial advisers tell you not to do. He tries to time the financial markets — to the exact day, if his charts align just right. But bulls should be ready to flee, as soon as this week.

That’s because McClellan said his timing models suggest ‘THE’ top in stocks will be hit some time between Aug. 20 and Aug. 26. He expects ‘nothing good for the bulls for the rest of the year.’

But if he’s so sure that ‘a major price top’ is coming, why is he still bullish for his short-, medium- and long-term trading styles?

‘If the top is still out in front of you, you don’t want to exit yet,’ McClellan said. In other words, you don’t wear a raincoat today because a storm is coming tomorrow.'”

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Good advice.