Ben Bernanke has a generally positive disposition. In 2005 for example, he claimed that a housing bubble was a “pretty unlikely possibility.” Even in 2007, Bernanke went on record to state that the Fed “does not expect significant spillovers from the subprime market to the rest of the economy.”
Regardless of what your definition of a “significant spillover” is, it is safe to say that his assessment missed the mark by a wide margin.
One of the Fed’s more recent remarks reflects quite a change from the cautiously optimistic stance it displayed over the past year: “Financial conditions have become less supportive of economic growth.” In his last assessment, Bernanke described the macro outlook as "unusually uncertain." Wow, that’s not good.
The ETF Profit Strategy Newsletter, one of the only outfits that predicted the massive rally from the March 2009 lows (via the March 2, 2009 Trend Change Alert), always maintained the opinion that this rally is a counter trend rally.
On April 16, 2010, the ETF Profit Strategy Newsletter stated that: “The cork seems to have popped. Reality is setting in. Despite the market’s resilience against any sort of pullback, we need to point out that historically, there has rarely been a more pronounced sell signal.”
At that time, we also took the liberty to shed some light on statements made by Ben Bernanke or the Federal Reserve, and interpret the real message between the lines.
Fed Statement:
“The staff did make modest downward adjustments to its projections for real GDP growth in response to unfavorable news on housing activity, unexpectedly weak spending by state and local governments, and a substantial reduction in the estimated level of household income in the second half of 2009.”
Interpretation:
Today the government lowered its estimate of how much the economy grew in the first quarter of 2010 yet again. This has almost become a predictable pattern. The actual GDP came in 10% lower than the projected GDP (2.7% vs 3%). Real estate (NYSEArca: IYR) remains the troubled sector; homebuilders (NYSEArca: XHB) are hit hard as May's new home sales plunged 33%.
Housing income is not recovering. Spending for consumer discretionary (NYSEArca: XLY) remains muted. Despite the surge in Apple (NYSE: AAPL) shares, which make up 18% of the Nasdaq (Nasdaq: QQQQ), the Nasdaq has dropped below its 200-day MA.
Much has been written about strategic mortgage defaults lately. Bank of America is fielding more than 125,000 calls a day from people seeking mortgage help. Hundreds of thousands haven’t made a mortgage payment in more than a year.
That is hundreds of thousands of home-owners who have decided that they won’t pay the mortgage on an underwater home. The only way banks (NYSEArca: KBE) could motivate mortgage holders to pay is to reduce the loan principal. If banks were to do just that, they’d have to report some $500 billion in losses, so they turn a blind eye to uncollected mortgage payments month after month.
Meanwhile, the banks can successfully hide a big black hole called shadow inventory, while home-owners spend their mortgage money on the new iPad or a flat screen TV. How does that affect GDP?
Fed Statement:
“Real disposable personal income in January was virtually unchanged from a year earlier and would have been even lower in the absence of a substantial rise in federal transfer payments to households.”
Interpretation:
Despite massive government stimulus and billions of dollars freed up via strategic defaults, disposable income is the same as it was in January 2009. We look at the GDP and wonder how much of the Gross Domestic Product (GDP) is based on real economic growth?
By extension, it would be prudent to ask how much of the 75% gain in the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), Nasdaq (Nasdaq: ^IXIC), Russell 3000 (NYSEArca: IWV) and many other indexes was based on real growth? How much of the profits that financial corporations’ (NYSEArca: XLF) are reporting are “true” profits?
Fed Statement:
“While recent data pointed to a noticeable pickup in the pace of consumer spending during the first quarter, participants agreed that household spending going forward was likely to remain constrained by weak labor market conditions, lower housing wealth, tight credit, and modest income growth.”
Even Mr. Bernanke expects household spending to remain constrained by weak labor conditions. The employment picture is the lynchpin for the U.S. economy. Without jobs, consumer spending won’t see real growth, real estate will continue to fall and banks will continue to hoard money rather than lend it.
The chart below shows money on banks' balance sheets categorized as cash. More money for banks means less money for loans, which translates into lower consumer spending and business development. This ultimately results in a negative feedback loop.
Falling off the Cliff?
As long as stocks went up, there was little concern about the implications of Bernanke’s hidden messages. In fact, right before the April 26 highs, investors and investment advisors had felt more optimistic about stocks than they did at the 2007 all-time high.
Washington was even trying to sort out who should get credit for the remarkable recovery – Mr. Bernanke, Mr. Geithner or the Obama administration. Credit where credit is due. Only time will tell if optimism transforms into rage. It has happened before.
The optimism seen a few months ago was eerily similar to that seen in 1930. After the initial 1929 collapse, stocks rallied 50% into 1930. President Hoover was moved to exclaim the following:
“While the crash only took place six months ago, I am convinced we have now passed through the worst — and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.”
After a serious consolidation since the April highs, the risk of stocks falling off a cliff has drastically increased. The market seems to be teetering on the edge of the cliff right now.
2008 All Over Again?
On April 16, the ETF Profit Strategy Newsletter warned that “the pieces are in place for a major decline. We are simply waiting for the proverbial first domino to fall over.” The first domino seems to have toppled, triggered by the European (NYSEArca: FEZ) debt crisis. Since the April 26 high, the market has fallen as much as 17%.
Additionally, surrounding the April highs, many sentiment indicators – such as the CBOE Volatility Index (Chicago Options: ^VIX) – reached levels compatible with a major market top. Fittingly, sentiment had reached optimistic extremes not seen since the last market top in 2007, or right before the technology (NYSEArca: XLK) bust in 2000.
But nothing moves in one straight line. When the S&P closed and dropped to 1,011 a few weeks ago, the ETF Profit Strategy Newsletter noted that "the S&P is butting against the 100-week SMA, lower accelerations band, 38.2% Fibonacci retracement level, round number resistance at 1,000 and weekly s1 at 994. There is a good chance we will see some sort of a bounce develop from the 990 - 1,015 area.
Even though this bounce has certainly developed (and seems close to being over) an ueber bearish technical pattern has appeared that should accelerate the decline. The ETF Profit Strategy Newsletter includes a detailed short, mid and long-term outlook along with the one chart that reveals just how big the bearish potential is.
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