The Fed Is Dead Wrong

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You do realize this is NOT a crash, right?

That’s the start of an instant-messaging conversation that I had with Jocelynn Smith, Sr. Managing Editor of Sovereign Investor Daily, on Monday, when the U.S. market was in the throes of a China-inspired fit.

Of course, plenty of analysts and financial talking heads were rushing out claims on TV and in emails to subscribers that this was the beginning of the collapse they’ve all been predicting. And why not use that moment for opportunism? The Dow Jones Industrial Average opened down a sickening 1,100 points on Monday and ultimately racked up losses for six consecutive trading days before finally closing higher on Wednesday.

As of Thursday’s close, the Dow is down 6.6% for 2015.

But this isn’t a crash.

Let me share with you the conversation I had with Jocelynn to explain why China is not the economic threat that others are claiming, and what the message is that the markets are sending to the Federal Reserve…

Jocelynn: Well, yeah, this isn’t a crash. I just don’t see how everyone is blaming one country — China —for crushing all the markets around the globe. I feel like it’s China PLUS stocks were really overvalued so traders were thinking that it was a good time to take some profits.

Jeff: The China panic is that the devaluation somehow implies that China’s GDP is slowing faster than expected. But you have to put all of this into context. China’s GDP was slowing BECAUSE of the U.S. dollar. The yuan is pegged to the dollar, and as the dollar rose 30% since 2011, China GDP slowed because its products were less competitive globally (which freaked everyone out and led to the whole theory about the China slowdown). So what does China do to resolve the issue? It devalues the currency to gain momentum again in selling to the world! It makes perfect sense when looked at holistically, but the market in these moments is a knee-jerk response mechanism. It says: “Devaluation = Slowing. RUN!!!!!” … And then in a quarter or two, the market is going see that China’s GDP is OK, and it will say: “BUYYY!!!” across the emerging markets.

Jocelynn: Where does this leave the Fed? The dollar had an absolutely horrible day.

Jeff: There’s now NO WAY POSSIBLE for the Fed to raise rates. The market [on Monday] told the Fed if you raise rates in September, you are going to destroy the emerging-market economies. DO NOT DO THAT, FED! Which is why the dollar had its worst day in seven months. The bloom is off the dollar rose now.

The Fed won’t raise rates until the world economy looks healthier, but the world economy is actually OK. Even China is OK. (Apple said that the China consumer is pretty healthy). World economic numbers will look much better in 2016, and central banks outside the U.S. will begin raising rates … and that will finally give the Fed the cover it needs to raise.

Jocelynn: And, of course, Atlanta Fed President Dennis Lockhart had to come out after 2 p.m. [on Monday] to state that the Fed needs to raise rates THIS YEAR. He single-handedly routed the market, leading to the end-of-the-day heavy selling.

Jeff: Lockhart is totally wrong. Raise rates this year, and emerging markets get slammed. That comes back to hurt the U.S. because the gap between U.S. interest rates and world interest rates will widen and the additional dollar strength that comes from that will kill multinationals that are already hurting from a strong dollar and cause layoffs in America, which will kill the Fed’s policy of maintaining full employment.

Jocelynn: I feel like the biggest lesson I’ve learned from watching Greenspan, Bernanke and now Yellen is that the Fed feels so out of touch with how everything is connected … or they just don’t care. The Fed is the world’s biggest source of chaos.

Jeff: Exactly!!! They are the reason the world is a mess right now! It’s what I wrote in Sovereign Investor Daily recently. They are the source of all known chaos today. If they raise rates too soon, the world is screwed. It’s what Greenspan said in ‘99 or ’00, that the U.S. cannot be an island of prosperity in a world of economic stagnation, meaning the U.S. cannot survive in that world because its actions will come back to haunt itself due to the knock-on effects in such an interconnected world.

I would not be surprised to see the rest of the week up. Not dramatically probably. It might not erase the losses, but what is the fundamental reason to take 5% off the market today? There isn’t one.

Worries about a China slowdown?

The Fed? It’s not likely to do anything now.

This was a knee-jerk reaction that was blown out of proportion. People know the U.S. market is overvalued, so they used this as the “kitchen sink” moment to rationalize all their fears and to get out. Maybe I’m wrong. But I would not be surprised to see the market drift higher the rest of the week….

Until next time, stay Sovereign…
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Jeff D. Opdyke
Editor, Profit Seeker