The biggest mistake that I’ve seen perma-Bears make is that they underestimate the importance of low interest rates and a steep yield curve on the economy.
Interest rates are the pistons that power us through sector rotation and the Bull/Bear economic cycle. Yeah, interest rates are that important folks.
Check out this sector rotation wheel and notice how interest rates are in the very center of everything:
This is the reason the Federal Reserve will always lower interest rates to stimulate the economy when it’s in trouble.
Perma-bears told us that when the Federal Reserve stopped buying bonds, bonds would sell off and bond yields would explode higher. Bears told us that the bond bubble popping would be the mother of all bubble bursts and some even said it would bring about the end of our civilization.
Now here’s the awesome-crazy thing. Interest rates are not rising as the Federal Reserve tapers its bond buying program! But how could that be? The reason is that Europe, Japan, even China are slowing down at the same time the U.S. is picking up. This has put central bankers in Europe and Japan in QE mode where they will be devaluing their currencies in order to boost their export sales, while the central bank in the U.S. will be ending QE and tightening monetary policy.
In a flight to safety, and chasing yield, investors from around the world are buying U.S. bonds which are keeping bond yields and interest rates ultra-low. In other words, because these other countries are buying U.S. bonds, it’s providing the liquidity the Federal Reserve needs to exit its bond buying program without causing bond yields/interest rates to explode higher.
This all plays out in the yield curve. The Federal Reserve works to create a steep yield curve during recessions. This allows banks to borrow money at very low rates short term, and loan it out longer term and make money off the spread. By propping up banks and financial institutions like this, the Fed works to keep recessions as short lived as possible.
Normally, during a recovery phase like the kind we are in now, the yield curve is already starting to flatten at a much higher level. Bond yields/interest rates are normally much higher and so is inflation. We are in a beautiful Goldilocks recovery where inflation and interest rates are at ultra-low levels as the economy gets stronger. I don’t expect it to last for long but folks, it’s a thing of beauty to behold and something we are likely to never see in our life-times again.
This is an excerpt from this week’s show where I show you the yield curve over the last three recoveries and how they compare to the yield curve today:
Next week we have a possible Black Swan event coming with the start of earnings season on October 8, 2014.
Institutional traders and money managers make up 80% of the market action on any given day so whatever is important to the “smart money”, it is extremely important to us individual traders.
Word on the street is that the “smart money” will be especially focused on earnings season and measuring the impact of the rising U.S. dollar on earnings. Not only will institutional traders be focused on how much the rising dollar has influenced trailing P/E ratios, but the all important downward revisions to future earnings will be their focus.
FactSet.com just released a bombshell report to clients that says, “Over the course of the third quarter, analysts have lowered earnings estimates for companies in the S&P 500 for the quarter. The Q3 bottom-up EPS estimate (which is an aggregation of the estimates for all 500 companies in the index) dropped 4.2% (to $29.06 from $30.33) from June 30 through September 30.”
Remember, the U.S. dollar has been rising for the last 12 weeks. It has never been up for 12 weeks in a row, EVER!
Folks, keep your eyes on forward earnings revisions and what impact the rising U.S. dollar is having on those numbers.
Below is an excerpt from this week’s show where I talk about the negative impact of the rising U.S. dollar on the coming earnings season that starts next week: