Adios QE 24 Sept 2014 War Room

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Market Update Fed Hijinks Scenarios Past Fed Action QE MythBusters Adios QE

HiddenLevers MARKET UPDATE

Market Update Syria Airstrikes Manufacturing = 5y high New Era for Chindia sources: HiddenLevers, MarketWatch, BusinessWeek, Huff Post, Washington Post, ReutersMarketWatchBusinessWeekHuff PostWashington PostReuters Gas = 3 bucks

Macro Snapshot Jobless claims at 2006 levels Are jobless claims signaling a peak? Commodities suffer despite industrial rebound (hint: it’s the dollar) – meanwhile S&P is middle of the pack among global indices.

FED HIJINKS SCENARIOS HiddenLevers

Review: End of QE Scenarios Not Sure Easy Money, No Hangover Good Economy Back on Track Bad Deflation Strikes Back WHAT REALLY HAPPENED 66% priced in based on SPX at This becomes the GOOD scenario now. Scenario priced in 10y target = 3% S&P target = y = 2.54% headed down. Commodities in deflation, Equities + GDP not so much.

GOOD: Steady as She Goes source: HiddenLevers, WSJ, Bloomberg, NY TimesWSJBloombergNY Times Fed raises rates in mid-2015 as stated EU rate cut gives Fed breathing room US manufacturing hitting its stride Fed has kept its word on 2014 QE taper Low inflation means no need for rate squeeze Fed balance sheet still bloated until 2020

BAD: Rate Hike Postponed Weak economic growth might force Fed to postpone Equities caught between easy money and bad growth Poor global growth + deflation are catalysts Fed waits until 2016 due to economic malaise source: HiddenLevers, NELP, New Yorker, MarketWatchNELPNew YorkerMarketWatch Rates continue downward drift of 2014 Yellen watching labor market like a hawk

UGLY: Fed Pops Bubble Yellen said Fed is prepared to use rates to pop bubbles Low VIX and corporate bond spreads worrisome Worry is more about junk bonds than equities Failure of labor market recovery makes this unlikely sources: HiddenLevers, USA Today, NY Times, ThinkAdvisor, SeekingAlphaUSA TodayNY TimesThinkAdvisorSeekingAlpha QE withdrawal or pre-emptive rate hike backfires Goldman thinks impact begins when taper ends Acknowledged that low rates led to housing bubble Acknowledged froth in tech/biotech sectors

Scenario: Fed Hijinks Good Steady as She Goes Bad Rate Hike Postponed Ugly Fed Pops Bubble If economic recovery continues, the Fed can stay the course and the present rally may continue into If poor economic growth causes the Fed to postpone hikes, weak growth and continued easing might offset each other. Investor sentiment might shift if the Fed acts more rapidly. Stocks, bonds, and real estate could suffer in a bubble pop.

HiddenLevers FED ACTION $

2014 QE Wind Down Plan Step 1 Remove last $15B of QE next month sources: Federal Reserve Releases, Yellen Conference TranscriptFederal Reserve ReleasesYellen Conference Transcript Key Takeaway No Fed governor sees rates reaching old 5% levels … ever Step 2 Rate hike mid 2015 (1.27% fed funds target) Step 3 Normalize Fed Balance Sheet “by end of decade”

Past Fed Action: Reaction UGLY scenario: Fed Pops bubble PeriodFed Funds Change (bps) S&P Change (%) 12/65 – 12/ % 8/67 – 9/ % 4/71 – 9/ % 3/72 – 9/ % 3/74 – 9/ % 2/77 – 5/ % 8/80 – 7/ % 1/82 – 3/ % 3/83 – 9/ % 2/87 – 11/ % 4/88 – 4/ % 2/94 – 3/ % 4/97 – 5/ % 7/99 – 7/ % 6/04 – 8/ % S&P reaction Max Drawdown: % Max Rise: % Average Change: -0.22% source: Business InsiderBusiness Insider

similaritiesdifferences Correct Analogue = Feb – Nov 1987 sources: HiddenLevers, Federal Reserve, St. Louis Fed, Time MagazineFederal ReserveSt. Louis FedTime Magazine dramatic increase in program trading, now called HFT market spooked by interest rate hike rumors ( ) brand new fed chair in office overvalued stock market (P/E) Then - rates rising globally Now – nope Then - USD declining Now – USD rising Then - inflation concerns Now - nope Then - Fed Funds rate 7.3 Now – 0.0 P/E ratios 1987: : 26 technical resistance

HiddenLevers QE MYTHBUSTERS

QE Myth:USD is getting weaker sources: HiddenLevers Charts Despite a steady rise in the US money supply, the dollar is getting stronger. Falling velocity of money means new money doesn’t cause deflation or devaluation. Reality: USD is getting stronger

QE Myth: Rates are Rising sources: HiddenLeversHiddenLevers QE 1 QE 2 QE 2.5 (Twist) + QE3 Reality: Rates dropped Post-QE 1, 2 and in 2014

QE Myth: QE is Ending sources: Wall Street Journal, Wall Street JournalWall Street Journal Info on ECB QE and Rates Bank Deposit rates reduced to -0.1% in June Further cut to -0.2% in September ECB new asset purchases will increase balance sheet 700 B to 2.7 trillion Euros ECB likely to expand QE Info on BOJ QE program First case of QE done by Japan to fight deflation in early 2000s. Recent QE began April 2013 and expected to double money supply. In addition to bonds, domestic ETFs also purchased (1 B USD) beginning Aug 2014 Reality: QE outsourced to Japan + Europa

Adios QE – Recap S&P rising + Lower rates make an odd couple INTEREST RATES ARE NOT RISING 1987 analogy is about rate cycle, not just stock market crash Global factors have given Fed breathing room

HiddenLevers Use Cases data center 10y/CPI/PMI scenario Global Deflation Adios QE macro theme Strong Dollar scenario Fed Action

Product Update I just love these guys Dude, check out that new look New site coming in early October