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Leonard Brecken

Leonard Brecken

Leonard is a former portfolio manager and principal at Brecken Capital LLC, a hedge fund focused on domestic equities. You can reach Leonard on Twitter.

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Seven Years Of Distortion By The Fed Are About To Take Their Toll

Seven Years Of Distortion By The Fed Are About To Take Their Toll

The past seven to eight years in the financial markets have been especially unique. No two periods of time are ever exactly alike, but the time since the financial crisis has been unprecedented in many respects.

Since 2009, central bank intervention has distorted prices versus historical norms to an astonishing degree. Also I continue to hear the talking heads in media push the bearishness on oil. On Fox Business News this week, there were at least two times in one day in which I heard repeated ideologically-driven calls that said that oil “will never recover and technology is where to be.”

This shows how closely investor sentiment has followed Federal Reserve policy. The majority of institutional investors share the view that central bank interventions are necessary, which goes far in explaining the unprecedented disparity between NASDAQ and commodity prices.

Jack Lew, Treasury Secretary on CNBC this week, summed up the central bank-driven policy for the U.S. economy when he said that a “strong dollar reflects a strong U.S. economy.” Related: Oil Prices Approach $26 After Bearish IEA Report

Not only is that not true – as it is a reflection of Fed policy rather than economic fundamentals – certain sectors like capital spending and manufacturing are in recession already. The additional strain put on small businesses and individuals from health care rises are more than offsetting the benefit of lower commodity prices. Moreover, there are signs that the recession just described is tied to the commodity sector.

The fed clearly wants markets to think that the U.S. economy is good through its strong dollar policy. But that ends up distorting prices once again as it tries to have its cake and eat it too. Markets are falling, but the game might continue if the Fed capitulates and alters course by enacting negative interest rates, as Fed Governor Dudley recently hinted at.

Also the fall could be short-lived as some Fed action (or more likely another central bank) will occur in the summer ahead of the election cycle. I’m convinced that the Fed will act one way or another, but it isn’t clear at this point which course they will take. But the Fed is boxed in. With two-thirds of U.S. consumers living day-to-day, there is no room for commodity prices to eat into discretionary income.

As a result, the Fed has decided not to erode the U.S. dollar through more QE that it knows has already failed to work. Nonetheless the Fed may be forced into action again before autumn, creating the appearance of a stock market bounce. You can see this sentiment already starting to change in the commodity markets, as the leader in the “follow the Fed” strategy, Goldman Sachs, is no longer bearish on oil at all. Watch as the narrative and the propaganda oil fundamentals begins to reverse, as it will coincide with that change in Fed policy. Related: OPEC Still Sees Oil Markets Balancing This Year

Let’s review some key trends that emerged over the past seven to eight years.

1) Record commodity price crash duration. Last fall the energy bear market exceeded the period it took for energy to recover versus 1986. It exceeded the length of time oil prices have fallen by over 25 percent .

2) Record commodity price divergence. There has never been a period where NASDAQ (i.e. technology and Biotechnology) has had a sustainable performance gap vs oil.

3) Seven-year “recovery”. The length of the recovery, which currently stands at 77 to 78 months and counting, has well exceeded the average of 27 months. Although the chart below is dated back in May of 2014 it shows this clearly. It is also important to note that the recovery is unlike others in that it has been driven by debt leverage (stemming from Fed policy), and not real growth. So that raises the question over whether or not the recovery is real or just manufactured by the Fed? And if it is the latter, is such a recovery sustainable? Much of the record growth in corporate EPS has been driven by lower interest expense, lower commodity prices and share buybacks as top line growth has been sub-par.

4) The last year of the last term of the last three administrations saw market MAJOR corrections. The last three presidential terms have now coincided with major corrections in markets: Clinton, Bush, and now Obama. This reflects the growing amount of government intervention in markets and wealth concentrations, as well as the use of asset price manipulation as an extension of policy by government.

5) Record pace of debt Issuance. Don’t need to say more.

(Click to enlarge)

6) Highest food stamp recipients on record. Food Stamp recipients are up 42 percent in the last seven years, which demonstrates how the employment picture is distorted. Lower-paying jobs were created and supplemented by food stamps as overall wages fell. Home ownership also fell and so did the overall standard of living. I don’t recall a period where these divergences have occurred in a so-called recovery period. 

7) Record low labor participation rates. One has to look back to the 1970s to find a time when the labor participation rate was this low. The propagandists want you to believe that this is a function of baby boomers leaving the work force due to age and choice. But this does not make sense given that fixed incomes are under severe pressure by the Fed’s ZIRP policy and income-producing vehicles such as MLPs have eliminated dividends because of the commodity crash. No, it’s not a coincidence that low paying/part-time jobs in retail service sectors are not the desired career of choice for baby boomers. So if a baby boomer’s income just got slashed it probably does not make sense that they don’t need or want to work. 

(Click to enlarge)

8) Record Quantitative Easing. Need I say more?

(Click to enlarge)

9) Record High Biotech Bubble

(Click to enlarge)


10) All-time highs on most major indices. NASDAQ 100

(Click to enlarge) Related: Oman Offers to Slash Oil Production If OPEC Follows Suit

11) Record Corporate Profits. Again, the big question is what has driven record corporate profits during a period in which we experienced the weakest GDP recovery in modern times following a recession? The answer: the Fed.

(Click to enlarge)

12) Record U.S. Oil Output. Driven by a debt binge by the E&P space, which was enabled by the central bank policy, the U.S. oil industry was able to achieve record oil production.

The overall message is that things are not what they seem, nor are they driven by the real fundamentals. Instead, the markets are simply following central bank actions. Are most investors aware of how the so-called financial professionals are investing their hard-earned money?

Any rational person can sense that what is going on in the financial markets today is much different from what appears, and much of these distortions are the result of Fed policies.

Please see my Twitter/Periscope video @lbrecken13 for further discussion on this article.

By Leonard Brecken

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Leave a comment
  • bub grub on January 22 2016 said:
    profits go up
    profits go down

    stocks go up
    stocks go down

    interest rates go up
    interest rates go down

    people get greedy
    people get fearful

    people win one and pat themselves on the back
    people loose one and swear they will never do it again

    People get lucky
    People get unlucky

    Some people actually believe in mercury/hermes/gods in control
    Some people believe they can outsmart the market


    people are never going to try to stop market timing
    The fed wont stop distorting market prices

    Its hard to swim with gold in your pocket
    fiat currency is imaginary

    live free or die
    death and taxes are certain

    gold standards over
    get used to distorted prices
  • Lee James on January 22 2016 said:
    Thank you for this article focusing on the effect of the Fed. To say that I have felt uneasy about Fed policy and devices, is an understatement. I do not understand why more people do not weigh in against what the creation of cheap money.

    The coup de gras in knowing what we get from what the Fed is this: We seem to have no more tricks left that have the appearance of doing something "positive." Where do we go from here -- except to undo what should never have continued for so long?

    When it comes to the petroleum industry, my view is that Fed policy has mostly affected shale and deep-water extraction. Those areas became overheated with cheap money and investor hype. We need to face the fact that unconventional extraction and transport is expensive. Yes, technology may help off-set some of the expense ... but we need to face up to dumping countless pollutants for free, and it should not be "for free."

    -Time to shift our energy emphasis to the cleaner forms!

Leave a comment

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