The Middle

Keep it between the lines, advises an old country song from my youth.

“Quast,” you say. “If it’s from your youth, drop the modifier ‘old.’ That’s a given.”

You’d be right. Yesterday was ghoulish, as my Halloween trick was turning 50. Dead in the middle between zero and a hundred. And so now that I’m an elder I can pontificate with more gravity. Or such is the hope.

The Federal Reserve wraps a quiet meeting today where no doubt much pontification by elders ensued, and the trick for the Fed is to keep it between the lines. I expect the Trump administration, if the next Fed head is current Fed governor Jerome Powell, hopes to hew to the middle. No rocked boats or roiled waters, is the thinking.

The stock market is the same. It migrates to the mean. So successful is the average in 2017 that we’ve not had a single short-term market bottom (I’ll explain shortly).

The Wall Street Journal’s list of international indices shows none in the red the last 52 weeks. Root through Bloomberg and you’ll find a few deep in the ranks. Qatar is down 20%. Pakistan, Montenegro, Botswana and Bosnia in the red. But losers are few.

In the deep green are the Merval in Argentina, up 62%, the S&P 500 in the US, 21%, and the Dow Jones Industrial Average comprised of plodding blue chips, up 29%.  Even economically beleaguered Venezuela (native son Jose Altuve guilds baseball’s Astros) should’ve told citizens to buy local stocks as they’ve rocketed 4,700% in a year.

I tallied data on DJIA components.  The average blue chip is trading at 27 times earnings, with shares up 90% the past five years, 18% per annum on average. Yet a survey of financials the past four years across the thirty shows average revenue DOWN 2%, earnings down 7%.

There are some strong blue chips. But money and market structure have distorted the valuation picture (where markets and the Fed dovetail). While we’re not wary, we know it’s true and there will be blood. We’re just in the middle where everybody forgets about cause and effect.

We use the ModernIR Behavioral Index to predictively meter short-term movement of money on a 10-point scale. Over 5.0, more money is coming than going.  Under it, the opposite.  Historically, over 7.0 was a market top predicting profit-taking the next 30 days, and under 4.0 was a near-term market bottom, a value signal.

The market in 2017 is in the middle. That’s a buy and hold market, yes. But it lacks value signals too. People are overpaying. Stocks in 2012 dipped below 4.0 on 41 trading days out of roughly 260 total.  In 2013, there were 31 market bottoms; in 2014, 22; 2015, 39, and 2016, 31.

In 2017, none. Zero. The ModernIR Behavioral Index was 3.5/10.0 on Nov 8, 2016, the last bottom (those who bought then correctly read sentiment!).

I’m glad the US economy is posting numbers many thought impossible – 3% GDP growth for consecutive quarters. It can deliver even better data.  But right now too much money is chasing too few goods.

There’s one source of blame: The Federal Reserve.  Other central banks influence money supply but there’s still just one reserve currency (all efforts thus far to change it notwithstanding).

Result: Picture a Cape Canaveral launch. The space shuttles now retired would blaze 37 million horsepower fighting off gravity. The Falcon Heavy from SpaceX lifts goods to the space station with power like 18 Boeing 747s strapped on and throttled up.

There is no floating economy in space where gravity doesn’t exist. A great gout of central-bank money cannot as with space travel blast the planetary fisc past the gravitational pull of debt and spending. It can only create a long comet trail of stock prices and real estate prices and bond prices.

We think we’re in the middle. And we are. But not how we suppose. We’re between.

The Shiller PE as we wrote last week is the second steepest outlier in its history. Fundamentals don’t match stock prices. Gravitational pull is coming. We’re nearer the edge than the middle, viewed that way.

Many have decried central banks for opening floodgates, claiming it would produce a monetary Katrina. I supposed it would be two years from when the Fed’s balance sheet stopped expanding in latter 2014. But the Trump Rocket took us to zero market bottoms.

What’s tripped up doomsayers is a misunderstanding of the middle. The space between actions and consequences can be long. What is the Fed getting wrong?  It’s keeping us in the middle. It’s eliminating winners and losers.

We’ve got to get out of the middle before the bottom of it drops out.  Jerome Powell, can you help?