Janet Yellen said “Goodbye” to us yesterday.
After studying her moves over the past 4 years, beginning as a harsh critic, I say to her now, “Goodbye Janet, it’s been good to know ya.”
Here’s what Yellen said at her press conference yesterday, and what she has said and done before that caused me to change my opinion. More importantly, here’s why it matters to you and your investments.
You need to understand this, and you need to take action to at least protect yourself, if not profit, from the course that Yellen has set. It is a course that will not be easily changed.
Yellen’s Last Speech Started with Classic Misdirection…
On Wednesday Yellen held her final dog and pony show with the mainstream media hacks. Rather than repeating verbatim her usual rambling, circuitous answers, I’ll just summarize the key points that essentially reiterated the things we already knew, along with a few new wrinkles.
Yellen admitted that the Fed doesn’t quite understand inflation and she said that policy should remain relatively accommodative even if inflation overshoots their 2% target.
This is a misdirection for a couple of reasons. First, the Fed does not measure general inflation. It measures only a narrow, arbitrary, and artificially suppressed index of consumer goods and services prices. It excludes asset prices, and thus ignores, and even promotes and causes, the most dangerous kind of inflation-asset bubble inflation. When asset bubbles ultimately deflate, as the always do, they cause financial crashes because collateral values no longer are sufficient to cover the attached debts. Loans start getting called, particularly securities margin loans, and the downhill snowball begins.
We currently have asset bubbles driven by loose, overly plentiful, and cheap credit in housing, commercial real estate, stocks, bonds, and of course, bitcoin. When one of these starts to deflate, it will start a chain reaction that destabilizes the financial system. I believe that’s where we’re headed, although it’s probably at least a year to 18 months away.
Now here’s the key point.
The Fed believes asset values in general are “elevated” – at the high end of historical levels. But Yellen says that doesn’t mean the stock market or other assets are “over valued.” Higher valuations are supported by lower interest rates.
As far as the Fed is concerned, the major consideration is what impact a sharp decline would have on the economy? And there she believes the risks are not significant.
“On the list of risks, it’s not a major factor.”
-Rex Nutting, Marketwatch
Constable Yellen is telling us, “There’s nothing to see here. Move along now.”
Here’s how I see it. If she is willing to say that asset values are “elevated” you damn well know that the Fed is understating the problem. It ALWAYS understates, or just ignores, the most serious problems, to avoid panicking the markets. I read Yellen’s thoughts here as the Fed itself being panicked, but somehow hoping to manage a soft landing by downplaying just how bad the problem is.
When she says that a sharp decline in asset prices would not pose a significant risk to the economy, you know that that’s BS. The financial system and economy are just as highly leveraged, or even more so, than they were at the top of the housing bubble. Any sharp decline in the price of any leveraged asset class will pose a very serious risk to the stability of the economy.
But as investors, we shouldn’t care about the economy. We are worried about the first order effects, the effect on the value of our investments. In this case, overleveraged, easy-credit driven asset bubbles represent a grave risk of another severe adjustment in asset prices, regardless of the second order effects on the economy. Forget about the economy. Focus on the direct effect of asset bubbles on your assets!
Then she got to the other elephant in the room, Bitcoin. Marketwatch put it this way in their reading of what she said:
“Bitcoin is a “highly speculative asset,” and it has “very small role” in the payment system, Yellen says. It is not a stable store of value and it is not legal tender, she says.”
The Fed isn’t ignoring a potential risk of bitcoin to the financial system. The Fed has learned that threats can come from anywhere.
However, “I still see the financial stability risks from it as limited,” she said.
“So undoubtedly, there are individuals who could lose a lot of money if bitcoin were to fall in price, but I really don’t see that as creating a full-blown financial stability risk,” she said.
-Rex Nutting, Marketwatch
So, in other words, it’s another case of “Move along, there’s nothing to see here.”
Bitcoin and other cryptocurrencies are, in my view, in the most insane mania in my 50 years of following markets closely. They may not have a direct effect on the financial system if (when?) they crash, but their psychological presence in the minds of investors is huge. A crash in the cryptocurrencies could be Cryptonite to the minds of the worldwide leveraged speculating community. Any severe break in Bitcoin could metastasize quickly to the conventional financial markets if bitcoin speculators need to raise cash in other markets, or if investors simply get nervous about a bitcoin break.
But here’s Yellen’s most important thought from that presser. It was glossed over fleetingly and the assembled media shills had no followup questions. It shows just how ignorant, or complicit, the Wall Street reporting community is.
Yellen Is Doing The Right Thing – and It’s Going to Cause A Bear Market
As Nutting paraphrased, “Yellen says the Fed doesn’t anticipate changing its plan to gradually reduce its balance sheet by letting maturing securities roll off.”
Yellen has repeatedly told us that the balance sheet reduction program is on “autopilot.” She told us previously that the Fed would only reverse policy to ease if there’s a “material adverse event,” which I take to mean at least a 20% decline in stock prices. That is what the entire Wall Street chattering class has associated as a bear market for no good reason than somebody once said so, and they all liked the sound of it. And Yellen has told us that the first policy response would be to lower the Fed Funds target rate, not restart QE.
Finally, in the FOMC meeting minutes we were told that they would not even bother to report the “autopilot” reductions of the balance sheet from now on. The schedule is set, and they’re going to gradually increase the draining operations to $50 billion per month next October, come hell or high water!
So, the Fed is prepared to take a good deal of pain before it eases again. The FOMC has made up its collective mind. Fed balance sheet reduction will literally pull cash out of the banking system. At the same time, the US Treasury will need to sell more debt just to redeem the paper the Fed isn’t rolling over. Add to that a growing deficit due to the massive tax cut about to be passed into law, and we have a formula for a couple of years of bear markets across all asset classes.
That’s Yellen’s legacy to us.
Start spreadin’ the news, she’s leaving today! She’s doing the right thing by reducing the size of the Fed’s balance sheet and taking excess money out of the system. But it will cause the asset bubbles that the Fed created with QE to deflate. The Fed has decided that it is quite willing to have you pay that price. It is incumbent on you to recognize that and take the appropriate defensive action.
Keep selling toward your personal goal of having a very substantial cash cushion built up by the end of January. Or if you haven’t started selling yet, my goal would be to get to 60-70% cash by the end of the first quarter. Your target would vary depending on your personal circumstances.