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Wall Street remains addicted to the sugar rush of monetary easing, and the rise in asset valuations over the past years have largely not occurred because of fundamental reasons.
Money managers continue to trade on central bank policies, and it is easy to see that the case to remain over weight in U.S. equities is very thin while asset bubbles exist. Very high valuations as measured by PEG ratios are stemming from slowing EPS and a weaker overall economy.
Yes it is true that certain classes of equities are attractive long-term but high beta, such as tech, clearly are not. So many hopes hinge on the recovery in the second half of 2016, where EPS is supposed to magically reaccelerate because of more central bank actions.
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However, as U.S. Secretary of Treasury Jack Lew stated in a Bloomberg interview on February 23: "Don’t expect a crisis response in a non-crisis environment".
In other words things have to get a lot worse before we will see the central bank add more short-term sugar to our economy. Actually, rather than sugar, monetary stimulus should be called "artificial sweetener" because it may satisfy a short-term craving by providing a low calorie substitute, but in the medium- to long-term it only serves to slow your metabolism.
Not surprisingly, that is exactly what all the central bank money printing and rate cuts have done for the economy: boosting asset prices in the short-term, giving false hope for real growth, only to ultimately fail in that endeavor. What’s different this time around is that the ineffectiveness of monetary stimulus is finally becoming exposed. Yet those who desperate still hope for it, much like a drug addict. Others quietly reduce exposures in the dead of night while being all smiles on TV about the U.S. economy.
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In my prior articles I stated that the Fed is boxed in. If it does more QE it will unleash more hell on the middle class via already high inflation as it crashes the dollar bubble.
Sec. Lew encouraged more of the same this week: more jaw boning from Fed (maybe now on negative rates while saying everything is great) and even more action from foreign central banks to perpetuate the dollar bubble. The end result is to use the commodity complex as the QE substitute, wrongly assuming that it would boost consumer spending. We already see the real effects on manufacturing, cap-ex and industrial sectors overall as the commodity crash has negatively impacted growth. Essentially what the U.S. is admitting is that we have run out of artificial sweetener. The government appears to be running out the clock, hoping we can stall the inevitable bubble collapse until 2017.
The use of artificial sweetener isn’t a substitute for real fundamental investing nor is it a replacement for policies that actually create economic growth. Japan is the poster child of ineffectual monetary policy. Our problem as a nation is that our recipe for growth is flawed as our taxes and regulation have made us less competitive globally and all the artificial sweetener in the world still won’t make it taste any better.
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The decline in energy prices has been exaggerated by the rise of the U.S. dollar, which to reiterate, began its ascent in June 2014 when oil began to fall, when the EU & Japan signaled more QE, and when the U.S. signaled that it was done with monetary expansion. Jack Lew’s recent comments point to more of the same and thus keeping pressure on commodities as the U.S. dollar remains strong.
Oil production has declined and will continue to fall through 2017 as hedges roll off. That will help the markets adjust, but the robustness of demand is now coming into question as inventory levels remains high (although, I still maintain that they are exaggerated in the media) and that will put lid on how high prices can rise in 2016.
By Leonard Brecken for Oilprice.com
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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.