Enjoy the Melt-Up While It Lasts

Shah Gilani|August 31, 2020

Don’t get me wrong – just because I’ve started to write about how crazy the market’s become, how it’s like déjà vu all over again, doesn’t mean I’m not bullish.

Because I am – bullish, that is.

Because, you know, it’s all good until it isn’t.

Because, “as long as the music is playing, you’ve got to get up and dance.” That’s what Chuck Prince, Citigroup’s chief executive in July 2007, told the Financial Times. The party would end at some point, but there was so much liquidity it wouldn’t be the U.S. subprime mortgage market stopping the music.

It took another 15 months for Prince’s preamble prediction which was, “When the music stops, in terms of liquidity, things will be complicated,” to come true, at least that part. The part about subprime mortgages not being the cause was just a little off. Just a little.

Does that mean we have another 15 months? Maybe.

The Dow was up 723 points last week, or 2.6%. It’s now 3.2% from its all-time highs of last February. The S&P 500 notched another all-time high last week, ending the week up 3.3%. And the Nasdaq Composite hit a record high, ending the week up 3.4%.

Since the March 23, 2020 lows, in only five months, the Dow is up 54.11%, the S&P 500 is up 56.78%, and the Nasdaq Composite, wait for it…is up 70.47%

But, it’s all good… until it isn’t.

Just keep on dancing – and there’s plenty of music, thanks to the Federal Reserve.

Jerome Powell, the music maestro, and Fed chairman promised virtually from Jackson Hole the Fed was going to move all its targets, whenever it must, to either hit them dead center, or miss them altogether.

Yeah, the Fed’s that precise.

The two-part target moving plan, for inflation and maximum employment, is straightforward enough.

Step 1: Keep Interest Rates Lower for Longer

Since 2012 the Fed’s forward guidance has been its articulated goal of getting inflation to 2%.

That “target” was established so the Fed could “re-liquefy” the banks that sunk themselves in the financial crisis. That’s what quantitative easing was about.

The Fed’s excuse for manipulating interest rates lower, by means of successive rounds of QE, wasn’t going to ever cause inflation to get to their magic target of 2%, which would kill the dreaded bugaboo of deflation, and make all things good again.

The Fed’s massive money printing went to banks, not into the economy where it would have an impact. It was sucked up by banks so they could arbitrage Treasury issuance and Fed QE and collecting interest on their excess reserves, so they could make billions in profits, and buyback their shares to reward their “management” for the good jobs they all did.

And it went into financial assets.

The only inflation we’ve seen because of the Fed’s 2% targeting, is asset inflation.

Now, the Fed says it will move its inflation target to something above 2%, if we get any inflation. Or to 3%, or an average of 2.5%, or whatever, or wherever they move the target to.

It’s about interest rates being kept lower for longer.

Step 2: More Jobs, Now

And, as if that weren’t enough, the Fed is going to move its target on fulfilling its second mandate, generating full employment.

As if the Fed ever could move the dial on employment.

It’s got one lever, and it doesn’t work on employment, it works on interest rates.

So, to generate full employment, to make up for “shortfalls” it sees in its goal of maximum employment it’s going to keep rates lower for longer.

That’s what the Fed’s doing.

Why? Because they’ve manipulated things so badly for so long, they’ve destroyed free markets and true price discovery, and in the process inflated the greatest bubbles (especially in bonds), since the last bubble they inflated with their manipulation.

But, it’s nothing new.

They’re adding “liquidity,” because they must, because if they don’t, the music stops.

We all have the playbook.

Just keep on dancing until the music stops.

While it’s really anyone’s guess when there might be a “reckoning,” at least a short-term one, which means a good selloff would look like a buy-the-dip call to everyone who missed this rally, my estimate is it’s approaching, as sure as the election’s approaching.

The trigger might be the election, or the outcome, meaning the make-up of the government and what taxes and programs it might enact.

So, be careful out there.

Until then,

Shah Gilani