I suppose it was back in the late fall and reiterated again in mid-winter that I believed the market would simply go up for no real reason until QE2 ended and then it would begin to decline as liquidity ended. It looks as though I was somewhat accurate in that prediction although you did not have to be a rocket scientist to figure that out unless you were a permabull with your blinders on and absolute faith in the government and the Fed in which case please move along.

The Fed knew the same thing I and many others did and that is why at the last meeting they emphasized that they would continue to reinvest maturing paper and interest from the existing portfolio, kind of a QE infinity if you will, but on a small scale. I do believe they will let QE2 go and not announce anything new until the fall when they see the economy really weaken. I think a couple months of sub 100K jobs reports, with a healthy BLS birth/death adjustment, along with softening other indicators such as the PMI and so forth the Fed will get the point and step in with $1T in QE since $600B did not work.

That is how it works as one QE is ineffective the next one gets bigger. The really unfortunate part is that Japan has done the same thing and it did not work but there is a big difference between the US and Japan, we are the reserve currency and they aren’t. In other words, Japan could print all they wanted because their citizens bought their own debt and the world settled trades in dollars. However, the US is limited in what they can really do in QE because as the value of the dollar sinks, and we really had a nice scare a week or so ago, the world will pick a new reserve currency on its own. You know how that story ends.

Ben knows this and he knows that his QE options are limited and he can probably only get away with 1 more so it will be big, it has to be. If that one does not work and spur growth, well, the Fed is done and completely out of bullets in a traditional sense. We would see some new things coming to the table like in 2008 with all the new facilities and such, but I have no idea what they will be or what they will look like since we do not know how things will play out.

What I do know is that we should get a nice bounce in the dollar here sending commodities lower for a bit. This will give Ben and Washington a little relief and you an opportunity to buy, buy, buy every commodity you like. I love silver, still, wheat, gold, palladium, soybeans and corn (unless the subsidy is pulled). If those go on sale buy them either directly or via the growers or agricultural ETF’s.

In the mean time enjoy watching Ben sweat it out as he will not have answers for the weakness in the economy or the weakness is ‘transitory’ which is the longest transitory period I have ever seen. Kind of like this recovery it is the longest start of a recovery ever as it gains steam and loses steam every other week. Good luck.

Here we are in a New Year and as is tradition we see countless forecasts for what will transpire this year. My personal feeling is that they are all worthless since no one knows what the Fed is going to do and there is no denying that the Fed and the Fed alone has total control over the markets. Without the Fed we would not have seen positive returns in 2010, IMHO, and we only got those returns because the central bank flooded the market with extraordinary liquidity, again. The irony is that everyone knows something isn’t quite right, but they seemingly cannot put their finger on what is not normal.

As the weekly headlines come and go they are almost humorous now and completely contradict previous headlines. It is this that is contributing to that unsettling feeling most people have but cannot identify right now. Any given day you read about the recovery, often from a heavily seasonally adjusted figure, which signals a recovery in the economy, even though the unseasonal adjusted figure shows the data is not so hot, and everyone is bullish again. The next week we get a data point that is horrible and the world is coming to an end. Perhaps this is what many economists mean when they say this is a ‘muddle through economy.’ Regardless, things are better there is little question about that, but I would say we have stabilized ourselves in a less bad environment versus a real economic recovery.

I had previously said stocks would move higher and they did, but that is only because of the liquidity the Fed bestowed upon us and not because of truly better data points. We have seen unprecedented stimulus over the past 3 years from the federal government and the Federal Reserve which explains pretty much any positive data point. When you examine the real economy, i.e. Walmart, it is a different story. Frankly, when Walmart which has the largest customer base in the US is struggling when so many are preaching the resilient consumer something isn’t right. I know the high end retailers are doing OK and that proves my point which I made about a year ago that the recovery, thanks to the bailouts, and I use that term loosely, was lopsided to only the wealthy and not to Joe Six Pack.

This is also reflected in the unemployment figures and pretty much anywhere else you want to look. The rich are doing just fine thank you very much, but if you are in the middle class or poor the SNAP program is this way. While this is not fair it simply is what it is and is not going to change anytime soon, sorry. Perhaps that is what scares me the most right now, the inequality of wealth in America, don’t get me wrong I am a capitalist through and through, but it doesn’t take a rocket scientist to read history and what happens when the wealth gap gets this wide. On top of the middle class and poor becoming poorer we are now seeing what I thought was going to happen, inflation without an increase in money velocity.

Those who thought it was impossible for a country to experience inflation without money being in the hands of the people, well, you were wrong. When the central bank plays games, untested games, like QE it hurts the currency which drives up currency sensitive items, food and energy. When prices rise and wages stay the same it will more than likely exacerbate the underlying problems we are suffering from and may lead to civil unrest. We have food prices at the highest level ever and oil about to burst through $100/barrel, where is the outrage from the media on this, and people already feel poor, not a good combination. Again, all of that without an increase in money velocity, go figure.

Now, there are other reasons for the rise in commodities, but they are irrelevant in my opinion since Joe Blow could care less about why prices are rising he just cares about being able to feed his family. What is frustrating to Joe is that he is being told how great things are when he feels poor, is probably going to lose his house, can barely afford food, gas or his power bill. Joe is wondering what planet the commentators on CNBC are from when it is plain as day that things are not right in the real world. What Joe doesn’t understand is that the ivory tower announcers and the Fed are looking at the core CPI which says everything is hunky dory. The question is, do you think Joe cares that deflation is occurring in LED TV’s as much as Ben Bernanke does? Of course not because Joe looks at food and energy, but all economists look at is core CPI which excludes food and energy. That is where the disconnect is coming from, partly.

The public is slowly starting to not believe what they are being told anymore and that is a good thing. Remember how we were told that retail sales were going to be fantastic? They did not look so hot today, except for some high end retailers I might add. What I am getting at is simple, the real economy is catching up with the market. The really sick part is that when the economy does improve the Fed will have to kill the liquidity which will crush stocks. Those that preach stocks are a win-win because the Fed will pump money when the data is bad which is good for stocks or when the economy improves stocks should go higher are wrong, pure and simple.

This is the largest liquidity driven rally in the history of mankind or what TVland would call a bubble. Stocks are expensive and only going higher because of the Fed. However, when the Fed stops feeding free money to the banks it will end, badly. You can disagree with me all you want, that is what makes a market, but you know it is true. This is not a win-win situation for stocks. How can it be when just 6 months ago when liquidity was drying up the market tanked? We only saw a rebound when Ben spoke at Jackson Hole and said he would print and then he followed through, that is not the sign of a healthy market.

What we have is still a whole lot of uncertainty going on in the whole world. Nothing is certain except that central banks will merely print us into oblivion. Europe is a mess, we have some countries wishing to slow down fund flows to them, Korea’s on the brink of war, again, China is not buying UST’s like they once did, the US is awash in debt, which will not be solved by the Republicans, rising prices for food and oil about to go ballistic again. All that stuff is off the top of my head and I know I left a ton of stuff out, but this is enough, hopefully, to make one stop and think.

I said before that stocks will move higher and I continue that thought until one of two things happen, either the data really does improve or until QE2 ends in 2Q11. Both items are basically indications that the punch bowl or liquidity will dry up. I also believe stocks will underperform commodities, specifically silver and copper, in 2011 simply because the Fed will never stop the printing presses, they cannot. We are in a very odd period of time and, frankly, these are scary times with so many unknowns out there and a public slowly waking up to the fact that things are not as they seem, but that is a good thing, IMHO.

2011 will be a rollercoaster year with the schizophrenia kicking into high gear as far as the media is concerned, the world will be growing or coming to an end every other day, which should add more volatility to stocks. I also think we will see some things come to the forefront of discussion this year. How it ends is anyone’s guess and I will not even venture agues at the results. What I do know is that it probably will not be good. Here are my issues I think will be front page news this year:

-          Food prices continue to rise to scary levels

-          Treasuries begin to see a steep selloff

-          The US’s national debt will be a hot issue with China downgrading us, rightfully so, to junk level

-          The US is put on negative ratings watch by Fitch, but who cares about Fitch… right?

-          The tax cut extensions will prove to be a horrible idea, they really were to begin with

-          The Social Security tax break everyone gets moves up the date of depletion of the trust fund to, “officially,” the 2020 decade

-          Oil breaks through $100 probably eclipsing 2008 record price

-          The dollar will rally hard before it falls

-          Food shortages around the world will be a major problem

-          The Fed looses massive amounts of money on their treasury holdings

-          China openly sells US treasuries

I have previously laid out my thoughts as to what will eventually happen with the whole inflation-deflation debate, but the issue is still raging full speed ahead. It is interesting that it is hard to find 2 experts that actually agree on what will happen or is happening, deflation or inflation. I think it is obvious that we have disinflationary forces here as producers cannot pass along higher prices or they will lose business. In fact, only food, a basic necessity, has any real pricing power right now.

While I am comfortable claiming we have disinflation right now I do not think it will last for a very long period of time. I believe we will see more easing by the Fed via asset purchases, but that will not create immediate inflation. However, over a longer period of time we will see that inflation pick up and not because of money velocity, but because of straight out dollar devaluation. Let me explain.

We did not experience inflation in the 1930’s because no one spent large sums of money on a regular basis. People actually were starving even as food prices declined, sad really. The thing is that since we were on the gold standard, or a form thereof, it was impossible to have true inflation even though FDR was spending like a madman. The Fed was also not in the practice of buying assets because, well, they followed the rules. Because of the gold standard and there were no asset purchases, government bonds or otherwise, inflation remained tame, deflationary in fact. This is a very 30,000 foot view of the situation, but I think you get the gist of what I am saying.

Now we do not have the gold standard, I am not preaching for a gold standard either, just pointing out the obvious, and we have a completely fiat money supply. The Fed has used its “emergency powers” to do what it would not do in the 1930’s, buy assets. It is clear that the asset purchases are doing nothing for the economy other than keeping rates low on loans, which no one wants or are really willing to make unless you have a perfect credit score. It is not even kicking up much inflation, at all, which is because there is simply zero money velocity. Since there is no money velocity the typical economist will say that inflation is impossible and it can never happen, never say never.

What the heads buried in the sand do not realize, because they are using the Depression as their road map (they always do this at the wrong time I might add), is that the dollar is floating now with nothing backing it. That in itself is not bad, as a matter of general opinion, as long as the printing press is used sparingly and every country prints money at relatively the same pace. The problem is that now, after the crisis supposedly ended, countries are printing money at a slower pace or they stopped printing altogether. Many are certainly not doing asset purchases.

Forgetting the fact that QE will do nothing to ease the pain of the economy being bad, sorry, but it will do nothing whatsoever, what it will do is wreak havoc on the dollar. Since the currency is floating more printing and asset purchases will diminish the value of the currency. This has been Ben’s and Obama’s plan all along since Obama wanted to double exports within 5 years, something that can never be accomplished. We are seeing the impact of what more printing will do to the dollar now, unless you think 1.5 cent moves in the Euro/USD pair is normal, as investors move to a currency that is somewhat more sound, not that the Euro is sound, but perception is half the game.

The citizens, us, will not feel the devaluation right off the bat because we consume 87% of what we produce domestically. However, imported products will cost more and we do import a lot of goods, obviously. As domestic supplies are sucked up by foreign countries, as our dollar is worth less thanks to Ben, we will have to import more from elsewhere. This is how our next bout of inflation will begin, dollar devaluation without an increase of money velocity. If you think about it it will make sense, capital flows to the land with the cheapest goods and a weak dollar means China, Europe or whoever, will find more value, cheaper products, from America.

That actually sounds good, more purchases of American goods means higher production as we have to replace what others are buying, but that may not be the case. Why? Simple, prices domestically will be rising and our government, always trying to do the right thing will institute some sort of protectionist legislation to stop prices from rising as incomes are stagnant. It would be a form of capital controls of sorts, but in reverse. Can’t you see it now? Prices are rising and people are not able to get those big screen TV’s or something less important, food, so the government tries to stop it through making new laws. It sounds counterintuitive, but it would happen, look at what Congress wants to do to China in order to get the yuan to appreciate in value? Actually, if we do more QE Congress will not want that to happen because China will literally own us if or when the dollar is devaluated.

While all of this is happening the treasury market, after an initial huge ramp up in prices, this is what the Fed will be buying, will be in freefall as no one will want to be repaid, without a substantial risk premium, in devalued dollars. This will lead the Fed into more massive buying because even at this stage Americans will not even want to buy our own debt. Also, China will have no need to hold their massive treasury holds so they will be selling like mad. All of this is happening without money velocity picking up. Even if you think I am wrong about the previous paragraph think of it this way, if our production did pick up because of foreign country buying sprees that means we will have the money to buy things, but it will only increase the inflation rate… damned if it does, damned if it doesn’t.

It has nothing to do with actual money velocity anymore, we even have mild inflation with dwindling velocity now, and has everything to do with confidence in the system. More QE will be bad news for global confidence in the USD, it is on shaky ground as is. If we look at today’s market action it proves how the market will react, lower dollar, higher commodity prices and equities stuck because it is good news on one hand and bad news on the other hand. Longer term high inflation is bad news for stocks, in my opinion, and bullish for commodities, obviously. Stocks are horrible inflation hedging instruments, look at the last 10 years for proof, while silver (by far my favorite investment right now), gold and other metals should do very well. Of course, precious metals are not really an inflation hedge, but a currency hedge instead. Since we are looking at a currency issue rather than straight out inflation it makes bullion of any flavor very attractive.

Could anything change my mind about what I think will happen? Sure. If no QE happens it will be great news, but the likelihood of no QE ever happening again are about as long of a shot as you can get. While I am using QE for my defense of my position in this article I believe we can safely assume that budget deficits will not get better so even if no QE happens our spending will accomplish the same thing. I say that knowing that if the deficit does not resolve itself the Fed, to save the US, will still have to do QE eventually on a massive scale no matter what, to keep rates low so the interest doesn’t bust us. However, the Fed cannot suck in all that paper and treasuries will fail eventually.

Outside of no QE I think there is not much that can change my mind about what I think will happen. It is pretty much in stone and will happen either as I laid it out or in a somewhat similar fashion. In the near-term I am still bullish on treasuries, now that we sold off, and on silver, gold too, but I am more partial to silver right now. I am not crazy about stocks and would be very hesitant about committing major capital to any position right now, the market is trading odd to say the least. At this point bullion is your best play, silver looks very promising and a recent Scientific American article points out that there is only 19 years left of easily mined silver, a no brainer to me, buy it.

People always wait to buy metals to “see how it does” and while they are waiting the price goes nuts and then they buy it and wonder why they lost money. Don’t be one of those people, but buy it smart, some every month. Because even if you think the bulk of my argument is wrong, or all of it, we have disinflation and higher bullion prices, what do you think will happen when we do have inflation? Not to mention silver is not only a precious metal, but an industrial metal. So, if you think the world is going to end, buy silver. If you think we are in a real recovery, buy silver.

It is official, we live in Bizzaro World for sure. In this new normal there is no such thing as efficient markets, price discovery or any rational reason for the erratic movements in the markets from day-to-day. Just a couple days ago Europe was falling apart causing the markets to selloff hard, but today all is good again and the markets are up a couple hundred points. Bad news is now good news while horrible news is temporary, literally.

As for valuations of equities, who knows anymore, but one thing is for sure, price to earnings ratios are under attack, for the second time in a decade. I have read several stories talking about why P/E ratios are so passé and you need to measure a stock via the PEG or some other nonsense. We had this argument in 2000 and the traditional fundamental investors won that argument and I assume we will win it again. The P/E ratios are under attack because, drum roll please, earnings estimates are coming down. So much for the $90+ earnings estimates for the S&P 500 which, if those earnings per share were met, priced the forward P/E ratios, which is an absurd notion to begin with, at an attractive 12 or so right now. However, lower estimates means a higher forward P/E of say 16 or so, that is less attractive.

Fundamental analysis or value investing is about finding cheap stocks and those are getting tougher to find in today’s market. Not only that, but investors are leaving stocks, how many weeks or net outflows have we had? The outflow from equities is, I am afraid to tell you, permanent. Why? The Baby Boomers, it is that simple. They are retiring and making a fundamental, permanent, shift in their portfolios which involve less risk. That means fewer stocks for this group of investors which are the wealthiest generation, dare I say, in the history of America. I always wondered what would happen when the Boomers all started to retire, I always thought that systematic withdrawals would simply lead to wild swings in the market, never did I believe that they would just pack up and leave the market. Well, they are leaving the market after investing through 2 major crashes, plus worthless property now, in the markets they simply want much less risk. I do not blame them.

The big question is, with all this money leaving equities who is buying and why are we still at the current levels? It makes little sense, if you ditch the permabull thought process for a minute and use logic. More sellers than buyers means lower equity prices, that is always the way it worked until now. Today we have more sellers than buyers, based on net fund flows, and the averages are holding their own. We certainly have a ton of volatility, which makes the VIX seem really cheap at this level, but no real movement in the markets, either way. It simply makes no sense whatsoever and I am positioned neutral in the market right now so I have no vested interest in anything that might happen.

If we look at today’s data, for example, it was not good, mixed with the Beige Book it was horrible, we had a huge trade deficit, certainly smaller than last months, but wow, and we had 451,000 initial jobless claims. In what world were that data is good? Obviously in today’s world it is for some reason, but the facts remain that we are losing 1.85M jobs a month, through firings, almost 3 years into this mess. That is unreal. As Rosenberg points out these are the numbers we saw right after Lehman collapsed, so how is this good news? I can hear some people saying, well it is getting better or it could have been worse. Sure, but you have been saying that for a year now and it is the same, bad. At some point you have to realize that it is not going to get better anytime soon and the faster you realize it the sooner you can exit your positions, hopefully at a profit. The retail investor already figured all of this out, hence the wholesale selling of their funds.

That is what it comes down to, who is going to be able to get out before it is too late? I still find it hilarious that market pundits still preach the bull market is here and the sky is the limit for equities. These are the same people who never saw the tech bubble or the housing bubble, both times saying ‘this time is different,’ but now they claim they can see bubbles and everything is now a bubble, gold, bubble, treasuries, bubble, stocks, undervalued. Have you ever noticed that stocks are ALWAYS undervalued? Sorry, but we played this game before and the only one that loses are the investors while the pundits are still on TV making huge money while, clearly, being subpar at their chosen profession.

The bottom line is that computers are running the markets now. This explains the huge outflows from funds and the sideways movements of the markets as computers get the advantage of liquidity rebates and sub-penny pricing. In this environment I cannot explain bad news sending stocks higher other than computers taking over. I have nothing against them, I think they are a problem, but at the same time what kind of advantage does the ordinary investor have competing against algorithms that react in milliseconds. Yes, one can make money, but this action really screws up price discovery and creates a false sense of confidence because we could have another flash crash when the computers decide to back away, again. This is also, in my opinion, another reason why investors are moving away from stocks and heading to bonds, precious metals and dividend yielding stocks.

Based on what I have seen I am not interested in trading right now. I have a select few investments, precious metals and that is it. I had some nice trades, leveraged treasuries and more gold from the beginning of August, but have moved out of those positions. I see no value in this market and think it is merely a matter of time before we see a major move lower, but who knows when that will be. When we have that move lower I believe that will be the time to buy and only then might we see the retail investor come back to stocks. However, they will not be chasing growth stocks rather stocks that pay dividends. I do believe that when the selling subsides we will see a crackdown on HFT, but it will have been too late, as always. Boring is back and that is a good thing, but until we get true price discovery there is little sense to chase this market and those that do will get hurt.

When I wrote last week that the Fed would do QE 2 and the trade of the century, granted that was over the top, was leveraged bull 20+ year ETF’s I received some flack, a lot actually. First, let’s talk about the economy and what is going on there. Second, let’s talk about the treasury, gold barbell trade that seems wild and crazy. To clarify something, no, I am not drunk as one commenter asked.

The economy, oh, how this recovery summer is not such a recovery after all. Perhaps Geithner’s op-ed in the Times should have read, “Sorry, we screwed up any chances of a recovery” instead of “Welcome to The Recovery.” Any improvement we have seen within the economy has been purely statistical or for the very wealthy, period. Yes, Saks and Macy’s are indeed having good years, but look at Walmart, not such a blockbuster year. If you strip away the stimulus spending and government transfers you have poor GDP readings, period. I cannot see how anyone would or could really dispute that, but I am sure there are some that will try.

The truest test of any economy is unemployment and I was saying, before it was popular by a certain ‘New Normal’ guy, that unemployment was a leading indicator, not a lagging indicator. Our employment situation is poor at best considering that we are having more and more people leaving the workforce because they are giving up. Imagine just giving up all hope of finding work, not that you don’t want a job, but you just can’t find one, but since you have given up our government says you do not count anymore, nice. Anyhow, if we include all those people who dropped out of the workforce we are up to 10.2-10.5% official unemployment. As far as the U-6 we are still around the 17% area, but I am willing to bet it is much, much higher and who knows, exactly, how many people simple have been unemployed so long they just don’t count anywhere anymore. Regardless, our unemployment issue is the truest test of our economic situation and has indicated for well over a year that the economy is in poor condition.

As far as the other economic data points and indicators, well, show me one that points to an actual positive improvement please. Hint, there is not one that points to a significant improvement in the economic condition in recent months. In fact it is so bad that the Fed is turning to a form of QE which they know will do nothing to boost the economy, but it will look like they are doing something. It is so bad you had Ben Bernanke testify in front of Congress and say; “I don’t know what is going to happen,” basically when he said ‘unusual uncertainty.’ You have the Fed Presidents talking about recessions, QE, Japan scenarios and a host of other issues, but don’t worry because CNBC says no double dip. You know what, they are right. There will not be a double dip because we never made it out of the first depression.

We got the Fed doing this reinvesting of interest and repayment of principal now, to the tune of about $300B or so, into treasuries. What is that going to do for the economy? Nothing. Ben is trying to force banks to lend by doing a bull flattener to the yield curve, good luck Ben. What he doesn’t realize yet is people do not want to borrow. In fact, people want to pay off their debts instead, go figure. Ben cannot boost demand and QE will not do anything at all besides make bond investors very happy. It is a dog and pony show to make everyone feel good and like the Fed has some ammo left, they don’t and the game is over for them. All more QE will do is damage the dollar at some point in the future, that is a certainty. Consumer demand will return only after the deleveraging period is done and that could take 10 more years, who knows. It will be a tough ride, that is for sure.

Now, for those who thought I was nuts for going long a leveraged 20+ treasury ETF and gold, well, you don’t have to say, my account says it for me. UBT was about $85 a share when the article came out and it closed today at about $90.50 and gold was at about $116.50 and it is at $117.73 (I am using GLD as a proxy). I do not believe the trade is done, I wouldn’t enter it here, but I am not exiting it either, especially after CSCO missed their revenue estimates tonight. This was not a crazy trade, it was the most obvious trade in the world. Easy money like this does not happen very often so I am not sure why anyone would think this was ‘high risk’ or abnormal. You can hold leveraged ETF’s, if they go in your favor, over a period of days, just not long-term.

Everyone knew the Fed was going to do something, anything, because the Fed is staunchly independent and not influenced by politics, yeah right. Come on, the Fed knew it had to do something to show it was helping the economy, but not too much because we have an election coming up. What could be safer than maintaining the balance sheet, but reinvesting loose change into treasuries to bring down long-term treasury rates? It does not raise any eyebrows, everyone knew they would do this and it does help borrowers, but it doesn’t help the real economy. Regardless, this was telegraphed and sets up the Fed for real money printing and QE after November.

In the meantime, I plan on locking in profits on my UBT soon and rolling into TLT on weakness. I fully expect that we see the 30 treasury move towards the 3% area, maybe 2.5% as Ben wrote about in the past. That makes longer duration treasuries very attractive still and inflation is not an issue now. However, inflation will be at some time in the future and QE will damage the dollar, hence the gold hedge. I think gold goes back to its high and make a run towards $1,300 an ounce, maybe higher is full blown QE kicks in this fall. Equities are not attractive, in my view, unless they pay an outsized dividend and have a strong balance sheet. Stocks like AAPL, no thanks, they do not work in this environment unless they pull a new killer product out of their back pocket every other month. Good luck.

The 2Q10 GDP report came out and it was an eye opener for many people as it showed that the recession, depression, was deeper than most believed and things are surely not as rosy as we are being told. Aside from the inventory rebuild there is not much else going on, final sales are dead as a door nail and some firms, like Samsung, are reporting good earnings, but warning of weaker times ahead. I take the Samsung warning pretty seriously as they are a large or the largest supplier of electronics which had shown signs of strength recently. So when they say things may not be rosy in the near future I suspect that will apply to more than just TV sales.

What made the news cycle this week was a report by Fed President Bullard about the threat of a Japanese style deflation here in America. I am kind of shocked that people were caught so of guard by this news, about 10 economic data points already indicated this to be if not already occurring a very real near-term threat. I suspect we are in for some really tough times ahead and worse yet I suspect we will see the Fed start moving towards quantitative easing, again. As I have said, repeatedly, this will not do anything to boost economic demand as we must wait for the deleveraging cycle to be completed by the consumer before demand will return. Zero Hedge just wrote a piece about this tonight which illustrates exactly what I have been saying for a month now, but no one is listening. Here is what they said:

“In other words, all those who say QE2.0 will do nothing to stimulate the economy are correct, as all such a greenlighted action would encourage is the warehousing of yet more cash by banks. And since banks have no incremental incentives to lend it out, it doesn’t matter if the Fed’s liabilities are $2.5 trillion or $2.5 quadrillion. Instead of stimulating inflation, which is the end goal, all such an action would do is to create further doubts about the stability of the dollar, which in turn, as Ambrose Evans-Pritchard discussed, is a sure way to go to hyperinflation without first passing either Go, or inflation.”

They also indicate my thoughts exactly, we bypass money velocity inflation and go straight to dollar devaluation, i.e. currency crisis, hyperinflation. The irony is that you would only feel this pain on imported goods and we do consume 87% of what we produce domestically so it may take some time before any real currency devaluation hits home. Regardless, Bullard indicated along with prior reports by Ben Bernanke himself that QE is on the table. The question is what kind of QE, treasury purchases or other asset purchases? Also, how much, I bet $3-5T in total purchases, but who knows.

What we do know, compliments of David Rosenberg, is that Ben Bernanke said IF we hit a Japanese style deflation that the target rate on the 30 year treasury would be 2.5%. Rosenberg says that if we hit that rate, down from the current 4% yield, one would receive about a 30% rate of return. I think he is right and if one followed his recommendations of treasuries and gold, along with high yield stocks, you would have avoided much volatility this year and had nice returns. I am happy to say I bought 2’s and 5’s when the yield was 1.10% and well over 2% so I am happy. I suspect the rally in treasuries will continue and if QE happens, wow.

The trade of the century, although risky, would be to leverage a long position into the 20+ year treasury market, UBT (2X bull) or TMF (3X bull). IF Rosenberg and I are right and this happens, QE, deflation or a major selloff in equities, those positions would do very well. However, they are risky, they are leveraged ETF’s, but if you time it right I believe that you could do very well. I also believe that the bull market in bonds is in full force again, very similarly to the summer of 2008 I might add which adds a bit of mystery to the rally in treasuries. The mystery is, what is going on and is the bond market telling you that something really bad is coming?

A look at the chart above looks like there is something going on in the bond market. We broke above the 123/4 mark on the 30 year futures and now that is support. I believe it goes higher because of, at least, of deflationary pressures and, at worst, because of QE. However, while I am short-term bullish on treasuries I hate them long-term since it will be impossible for the U.S. to meet its long-term debt obligations which means they will default somehow in the future, in my opinion. I also believe, as stated earlier, that QE will wreck our currency maybe not now, but at some point in the near future which makes gold very attractive as well. If QE is announced treasuries will go nuts and so will gold. If one is levered into treasuries you could do well, if you want the risk.

What QE means for stocks, I do not know. I would think QE would be bad for stocks as it signals things are not good and the economy is weak, but we are living in bizzaro world where good news is fantastic and bad news is even better.

Jim Cramer finally officially eliminated himself from any serious discussion about any economic issue, forever. I know, to many he eliminated himself a long time ago with his ludicrous housing is bottoming call a year ago, but for some reason he is still being hailed as some type of guru on CNBC. It is easy to do a hit piece on Cramer, I know, but this time he has gone a bit too far.

First, he claims he told people to sell last week before the big selloff on Friday, he did not on his Mad Money program. Second, he ran a piece tonight HERE, claiming he is giving you tomorrows headlines today, at 6 PM, what good is that, about the housing data tomorrow. Guess what he said? It is going to be bad. Really, no one had any idea since the data has been horrible for how long now? Not to mention everyone is expecting the data to be bad so even I am not convinced it will be the catalyst it should be. Regardless, the insanity doesn’t end there, it gets better.

He claims he gets his information from the home builders who sell thousands of homes and have been extremely negative on housing versus economists who own only one home. He goes on to say how overly optimistic economists are and so forth which is not shocking to anyone since they have all overestimated the economic data we have seen recently and, frankly, he had also overestimated the data as well. Basically, he is jumping on the bandwagon which means the data is probably going to be better than we all think to begin with because Cramer is the freaking kiss of death for everything, seriously, he is. But it gets even better!

Cramer goes on to say that the poor housing data doesn’t mean anything because it is such a small part of GDP. He said; “Housing, he added, is not a big percentage of the economy and said executives who have appeared on Mad Money have moved “well past” housing as the drivers of their earnings.” WHAT!? OK, housing is not a big part of the economy, sure, I guess that depends on exactly how you define housing. Sales or residential investment account for about 5% of GDP, but I would hardly call that inconsequential. However, it is the services that go into housing that is the driver of GDP growth, like appliances, materials, jobs, etc. which account for about 12-13% of total GDP. That is a combined total of 17 to 18% of GDP that is impacted by the housing market being in the tank, conservatively, according to the NAHB. That is not inconsequential to the economy and that is something that companies cannot just “move past” in their earnings cycle.

The reason housing is such a big deal is because it touches so many parts of the economy and when housing falters so does the broader economy, obviously. To discount weak housing data from the overall economy or to not know how big housing is within the overall economy is incredulous. This matters because this impacts people’s lives, especially when construction workers are one of the largest segment of the workforce unemployed right now, and shows that this person has no business talking about broader economic issues. I respect the fund manager and he has one hell of a track record, but as a macro guy or a guy putting the pieces together to figure out what the economy looks like he is officially, totally, disqualified now. His horrible housing call a year ago combined with not knowing how important or big housing is today proves it.

The market has had a spectacular run lately, both up and down, which has been fantastic if you are a trader, but not if you are a long-term investor. Odds are that if you are a long-term investor you should be in bonds or cash anyhow at this stage of the game as the data clearly shows that equities are about to, or should be at least, take a rather large decline. The bulls have no data to stand on, zero, and the bears have all the evidence in the world including the Federal Reserve telling us that there is little to be excited about and what meager recovery we do have will take years to play out. How that could be interpreted as bullish is beyond me, but I am sure someone will read it that way. As for those waiting for quantitative easing part 2, keep waiting because it is not going to happen unless something different happens, like higher rates or a much stronger dollar.

What data am I pointing to? Pick a data series. The ECRI has been my favorite lately since it has never thrown off a head fake in the -10 range, we are at -9.8 now. Unemployment is also a favorite of mine, where is it getting better? Initial claims are stuck at 450,000+ per week, last week was a gift of seasonal adjustment, that will work itself out in the next couple of weeks. The employment reports are terrible and even the JOLT report was bad. I will say employment has stabilized kind of like how the Titanic stabilized when it finally hit the bottom of the ocean, but I fear there is a ravine close by and we are sitting very close to that edge, look for downside surprises in the employment reports. Housing is DOA and that is certainly not going to change, as I write this the Home Builder Confidence came in at a disheartening 14, need I remind you above 50 is considered positive? Tomorrow we are facing more housing data that is more than likely going to be worse than expected. Face it, there is little data in the bull’s camp except the data can’t get much worse or can it?

On the earnings front, well, we certainly had some great numbers last week, but what about this week? IBM missed on the revenue component and guided down by a couple of cents, no big deal, but big enough to emphasis a slowing in the second half. Texas Instruments met expectations, revenues were mildly light, but considering it is usually easy to beat estimates by a penny or two they couldn’t. Zions Bank, the fabled regional banks that were going to go gang busters this quarter, came in way below estimates, ($.84) vs. est. ($.54) and were light on the revenue side as well. Worse, on the top they said credit was improving, but they are setting aside more for credit losses and their charge offs increased between 1Q and 2Q10, how that is an improvement is beyond me, and we are talking about banks that get to carry loans at make believe values. Even Tupperware missed when people are spending less and eating leftovers! As I write many of these companies are trading lower off between 3 and 6%, not good news for the S&P futures.

Of course, we have a whole slew of earnings this week, a couple hundred companies, so why make big deal over these few firms. Oh, wait, they are IBM, Texas Instruments and Zions Bank, pretty big and respected companies that are leaders in their respective fields. Could earnings improve? Yes. Will they? I honestly do not know because, frankly and like it or not, earnings have been a mixed bag this quarter, but I also think earnings do not matter right now. The macro data is overwhelmingly bad and considering CEO’s do not want to repeat 2009 with negative warnings it is unlikely they will give negative guidance. I do not blame the CEO’s since they were punished relentlessly by the likes of Cramer in 2009 for not being positive enough and even today you only see CEO’s that give the most optimistic forecasts given air time on the TV. It is also or should be widely known that CEO’s are terrible at giving accurate forecasts, look at 2000 earnings releases and see what kind of guidance CEO’s gave back then. Clearly they did not see the slowdown coming when people like myself saw it a mile away, the same may hold true today.

So, is it too late to get short this market? Maybe, it depends on what happens tomorrow. My forecast is for the S&P 500 to initially drop to the 960-980 area where it will rebound, I obviously have no idea when it will happen or how long it will take. After it rebounds I believe it will drop to 860 so there is plenty of time to get short, depending how you plan on shorting it. If you are using options you have to be careful and trade them. If you are using leveraged ETF’s I think there is a lot of danger in holding them, but unleveraged ETF’s, like SH (I own SH), is safer to hold. I believe the best time to get short was 100 points ago, obviously, but last week was a great opportunity as well. Tomorrow, Tuesday, everyone is going to be looking to get short so you will pay a premium to jump on the bandwagon and will be assuming more risk than reward in the short-term.

What is interesting is that the rally, the whippy 7% gain, was a 61.8% retracement from the lowest closing low, 101ish on the SPY. It goes to show that the rally in itself was nothing more than a technical bounce and was rejected when it tried to go higher. That, to me, confirms that there is much more room on the downside than there is on the upside right now. Yes, stocks can move higher depending if ‘something’ happens like a stress test that was designed to not fail actually impresses people, but I actually believe that is irrelevant at this point. Europe is not the cause of our problems, we are as the data is all U.S. data that shows we are if not in another recession/depression certainly going to slow down significantly. I am short so I do not have to worry about working in new positions, I hope you were short as well. (I own various SPY put options, SDS, SH, TZA, BGZ, TYP)

Much has been made about the death cross of late, the 50 day moving average crossing through the 200 day moving average, although I think and know it is a significant event it is nothing compared to something else I have noticed. We are all aware of the primary reason of the bull run over the past 12 months, massively oversold markets, combined with marginally better economic data and, most importantly, a weakening dollar. Why the dollar weakened is important to note, quantitative easing via the Federal Reserve’s asset purchases or the printing of money. Although we will not know the long-term implications of QE for some time to come it is safe to assume it accomplished its goal, weaken the dollar and boost the economic data through negative interest rates, essentially.

We all know the market action of late, a horrendous selloff which was only a surprise to the parade of bulls on CNBC and those who kept their heads buried in the sand, but those out in the real world knew it was coming. What was unexpected was the 4^th of July rally that took us back up some 7% on the backdrop of pretty bad economic data. Some of the bounce was because of a technical bounce and some of it was because of the expectations of stronger earnings which started last week. I fully expected 2Q10 earnings to be good, but I expected to see more top line misses and the outlook from CEO’s to be downgraded as well. So far, it is a mixed bag, but the outlook or guidance remains very bullish for many firms, however, a look back through prior earning announcements, particularly 2000 releases, as Mark forwarded to me, shows that Intel did not foresee a slowdown there either, so trust the economic data rather than CEO guidance going forward.

Back to what is going on in the equities market and why the dark cross is less important than the other ‘grey swan’ that is going on. First, everyone and their grandmother knows or knew about the dark cross, not that it takes away from its importance, but when everyone knows about it very rarely does the market deliver the results we are looking for. Except the market kind of did deliver, but stopped short and rallied all the way back to some important moving averages where it failed to break through, very bearish from my lens. At the same time we saw the selloff begin the dollar was moving towards the 89 mark on the DXY, but it stalled after a dramatic breakout and reversed course. Not only did the DXY reverse course, but it got crushed moving down from 89ish to about 82.5, not an insignificant move.

Exhibit 1-1 2 Month DXY Chart

Why is this a big deal? It is a big deal because stocks went up on a weak dollar trend which meant a better environment for U.S. companies to sell products abroad. Basically, a weaker dollar is better for U.S. exports and sales as we become more competitive in the world. It made sense for the markets to not like the move of the DXY from the low 70’s to 89, but to not like the move from 89 to 82.5, well, I am perplexed. The market should love this and we should be flying to at least 1,100 on the S&P 500, but we are not. This is a huge warning sign that stocks cannot rally on a weak dollar and it means more than the dark cross.

Exhibit 1-2 1 Year S&P 500 and DXY

The charts show the trends pretty clearly, lower dollar higher equity prices, higher dollar, lower equity prices, but over the past couple of months things have been out of whack. What else is going on during this time period? Treasury yields are collapsing to historic lows. We have the 2 year treasury under .60%, the 10 year under 3% and the 30 year under 4% which is a sign of 2 things, risk aversion and fear of deflation. My belief is deflation is the clear danger as of right now, it is fairly evident from my lens and the market is pricing it in as we speak. The credit markets have been pricing it in for some time and will continue to, I am bullish on debt securities, have been for some time now, but the equities markets, well, it has not priced in any real deflationary pressure at all.

Exhibit 1-3 Yield Curve

Granted, we have not seen total deflation yet, just the beginning sign of it, but the evidence is pointing towards it. Here is the rub, everyone says the Fed will do QE2, but they won’t do it. See my other posts as to why they will not do it, but from my lens they would be insane to even attempt QE2 at this point. The problems in the U.S. economy has nothing to do with what is happening in Europe, a little I suppose, but not directly related. My past posts about Europe relate directly to actual defaults by countries and to corporate earnings. I think anyone will find it hard to believe that the Jones’s are not buying that new car because they are worried about Hungary being kicked out of the IMF-EU rescue package. They are not buying a car because they are worried about their job and do not want to take on much debt or because their credit score is so lousy they cannot get financing, 25% of Americans have a credit score below 600 now. Instead the Jones’s are paying off debt and buying what they need, not what they want which is deflationary.

This trend will continue and so far only the credit markets are pricing this in, the equity markets are in La-La Land, still. The DXY – S&P cross is very bearish if the trend continues and will mean a big correction in the near future especially if commodities head lower as well. Commodities are not performing well and that is reflected in the Baltic Dry Index and combine that in with the above information and it is putting the explanation point on the whole theory. So far the only strategist I know for sure who is putting all of these pieces together, and has been ridiculed relentlessly by the bulls on CNBC and such, is David Rosenberg. All of the rest of the strategists are telling you to buy the dips even when they see everything I presented to you, they know what it means and, to top it off, they know the ECRI is rolling over and housing is going down the tubes. It is incredible to say the least. Be ready for some fireworks soon unless this trend breaks.

What works in a deflationary environment? Income and dividends, pure and simple. I like (and own) the following: CTL, MO, PM, WM, PFE, MRK, LLY, BPT, RYU, PEY, INB, DNH, CGO, VZ, high quality corporate bonds, strategic income bond funds, emerging market debt funds (PCY has been good to me), short and intermediate term treasury funds. Many of the above mentioned stocks have underperformed, which I like, and pay very nice dividend yields, which I love, but may not do well in an inflationary environment. This is why one has to hedge with precious metals or, at the very least, TIPS.

All the talk of the town is deflation, disinflation or disinflationary trends, what does all of this mean, is it bad and more importantly, should the Federal Reserve try to stop it? First, deflation is negative price growth year-over-year, we are not there yet even though I often say we are in a deflationary period, because we will get there, in my opinion. Disinflation or disinflationary trends are signals that show prices are declining and is how many economists or snarky bloggers, like myself, describe the trend before we hit outright deflation. In a nutshell, deflation is demand destruction or no end demand which means companies must drop prices in order to attract business. The most commonly referenced period of deflation is the 1930’s where, sadly, food was cheap, but people starved, houses were cheap, but people went homeless. Deflation has been framed as ugly, horrible and something that must be avoided at all costs.

Deflation during the good times is fine and we all reap the rewards, such as cheaper technology, i.e. cell phones or computers, which become cheaper because of competition from outsourcing and technological advances. No one minds paying lower prices during these periods of times and the Fed even doesn’t mind deflation during these periods, but they like it to remain in check. Because lower prices do not mean people are not buying the products, the opposite is typically true. Plus, other indicators usually show that only certain items are prone to deflation under normal conditions, usually technology related items. The Fed would only be concerned if they saw other items start to lose pricing power and the money supply shrinking, people saving more money, basically.

When people save their money, in an economy such as the U.S., it is devastating because such a large portion of our domestic growth comes from spending money freely on stuff we really don’t need. When we save we stop that wasteful spending this grinds our economy to a halt. In order to get sales going again companies start to offer incentives to get shoppers in the door. This usually means lower prices through either temporary or permanent sales on the price of the products they sell. Since these products are not selling the stores are not ordering new products which mean the raw materials to make the clothes or whatever begin to decline. Even if the product begins to move at reduced prices the company selling to the end user begins to demand lower prices for the product and even if they don’t ask for it the orders are so much smaller prices would fall anyhow. Essentially it is a chain reaction, this is pretty common knowledge, but it comes from one simple thing happening, people saving their money.

The other part of the equation of people saving their money is that money is taken out of circulation. This sounds counterintuitive to those who rail against the fractional reserve banking system since this system allows for more loans to be made if the deposit base grows. However, if the economy is bad banks simply do not make loans because they fear not getting repaid. Therefore, a higher savings rate means lower monetary circulation, commonly referred to as M3, which the Fed no longer produces by the way. In order to boost the money supply the Fed will try to encourage banks to make riskier loans by lowering interest rates. By lowering interest rates banks make lower rates of returns for doing nothing with their money so by loaning out the money to borrowers banks can make higher interest rates. In turn the borrower will go out and spend that money which will ultimately boost the money supply and, hopefully, boost final demand.

That is how things work in normal business cycles, but that is not what we have now. We have a very abnormal business cycle that happens once every few generations where we go through this huge leveraging cycle and then have to live through a period when we deleverage all the debt. The last time we went through this was in the 1930’s and the time before that was about 60 years before the 1930’s so about every 60 to 80 years we go through a super cycle of debt leverage that blows up. During these super cycles the consumer has so much debt that they just try to pay it off and does not waste much money on other items. This is bad for our economy which is built on a consumption model to the tune of 70% of our GDP. This lack of demand or demand destruction means people just will not spend unless it makes absolute sense to them, i.e. a generous tax credit from Uncle Sam. This demand destruction leads to lower prices which starts out as disinflationary forces, moves to deflation when prices finally start dropping YoY, which will happen soon.

No matter what the central bank does, the Fed, it on its own cannot change this deflationary trend when it has spent all of its ammo. When interest rates hit zero there is nothing the Fed can do to spur demand from a monetary policy point of view. Remember, this is a very unusual situation because in these super cycles not only are consumers saddled with debt, but so are the banks and the banks are usually saddled with worthless debts which make them insolvent. That was true 80 years ago and the same thing is true today because banks are not making loans nor do they want to. So what can the Fed do? They have insolvent banks and consumers that don’t want to spend and are trying to shed their debt loads.

Some people say more quantitative easing will be helpful. I ask how? We already did how much QE? $2T+ that we know of and that did nothing. In fact, mortgage rates have dropped even more after QE stopped and we have falling demand for housing so what will another round of QE do? All it would do is cripple the dollar and trust me, the dollar is going to be in trouble soon enough anyhow because of the bloated balance sheet the Fed has and our national debt load. QE will not boost money velocity at all. It might give banks more money for their balance sheets, but other than that it will not boost the overall money supply so I am totally perplexed as to why anyone thinks QE will work. We have no problem selling our debt right now either, so it is a total waste of time and resources. The negatives far outweigh the positives.

What else can the Fed do? Nothing. They are done or have done everything they can do. Sure, they can roll out with TALF again, but the market has no problem placing junk paper right now so what would the point be? The problem is simple, the consumer does not want to spend. Businesses do not want to spend. Does anyone know why this is happening? I think it is pretty simple, no one knows what is going to happen. The President is keeping everyone in the dark about where taxes are going to go, heck, we are not even going to get a budget for 2010, unreal! We still have no idea how health care reform is really going to impact us yet, how much will it cost, etc. The business environment is weak at best and CEO’s are too afraid to admit it, look how they get treated by the administration, as traitors!

The consumer, well, I wonder why they aren’t spending. We have weekly initial unemployment claims coming in at well over 400K, 4 week average is 455K. We have more firings than hiring’s going on right now. The work week declined and so did wages. There are 6 people for every open job. It is taking 35 weeks to find a new job if you get fired. People were feeling more secure about their job, but when initial claims began to heat up again that confidence disappeared, even H-P started laying people off again and I bet Google will announce layoffs very soon. Their debt loads are through the roof and banks raised all their fees on the consumer so it is taking longer to pay down debt. Foreclosures, delinquencies and now a story broke tat home owner associations are foreclosing on homes for pennies on the dollar over the dues not being paid, come on. To top it all off the Senate is not extending unemployment benefits, but they can pass a 2,300 page Fin Reg bill with no problem, what is wrong with those people?

It is fair to say that there are plenty of reasons to not spend money from the consumer’s point of view. From corporate America’s point of view there is also little reason to spend money and even if they did it is so little of GDP it doesn’t even matter. The bottom line is how do we get M3 to increase? Can money velocity get positive again and should we even try? In my opinion, I do not believe we can get money velocity to get positive again without a drastic event such as WWII. These super cycles have to work themselves out and that takes time and the more tinkering we do the longer it takes. Look at housing, if we did not do the tax credit we might have bottomed in housing prices already, but we will never know now.

The Depression lasted as long as it did because of the tinkering and those who say we had a relapse because stimulus was removed in 1937-38 simply do not get it. If we cannot attract buyers to the housing market at 4.5% interest rates and prices significantly lower than the peak it just is not going to happen for some time to come. The market has to find its own bottom and it will be painful, but we cannot simply throw money at it and hope it works out. We could do that in the 1930’s because we had savings and we had manufacturing, we have neither now. We started out in a horrible position, greatly in debt, and to get ourselves out we are advocating going much deeper in debt. The problem is we cannot grow our way out of the debt we have, we cannot afford another New Deal. The most important thing to remember about the New Deal to begin with was that it did not work, it was a majorly failed policy.

As painful as it is going to be I say we have to let it be. No more QE and I hope we do not do another stimulus, but we will, look for a Bush style check coming right around October. Money velocity will sort itself out when the deleveraging is over and that could be as fast as next year or as long as 2015, no one knows except the collective minds of the consumers. The bottom line is we may come out, the consumer and corporate America, stronger than when we came into this thing with less debt and important lessons learned. Our government and the Fed, well, I do not believe they learned anything and look for QE and stimulus money just in time to buy your vote in November.