Two undeniable trends behind the Federal Reserve’s asset price inflation

We come not to praise 2013 but to bury it. But in this first 2014 edition of Markets and Money, 2013 probably does deserve a little praise. It was a great year for gamblers, speculators, and quislings. By quislings, we mean those who chose not to fight the Federal Reserve but to trail along in its triumphant wake in the war against deflation. We view the Federal Reserve as an occupying power that’s invaded the free market on behalf of its banking masters.

But grand strategy aside, in the war against asset deflation, asset prices are winning. Have a look at the numbers from around the world for 2013: The All Ordinaries up 14.8%, the FTSE up 14%, France’s CAC-40 up 18%, Germany’s Dax up 26%, and Japan’s Nikkei 225 up 56%. And these were just the peripheral markets!

Closer to the centre of the world’s dollar-based financial system in New York, the healing powers of quantitative easing were even more evident. The Dow Jones Industrials index was up 27%. That was its best year in 18 years. The S&P 500 had its best year since 1997, rising by 30%. And as you’d expect, small stocks did even better. The Russell 2000 Index of small companies rose 39.5%, its best run since 2003.

Someone less intoxicated by the spirit of QE might wonder how healthy a market is when it’s being driven by those who are willing to borrow the most. In The Denning Report, we spent much of the last year tracking the correlation between margin debt on the New York Stock Exchange and stock prices. It’s not very complicated. Low rates induce speculators to borrow and gamble on stocks. They won big in 2013.

Meanwhile, gold and bonds took a hammering. Gold’s 12-year run of higher prices ended in 2013. It fell 28% in US dollar terms, the worst one-year performance for gold since 1981. At the same time, 10-year US Treasury bonds saw their biggest rise in yields since 2009. Ten-year yields started the year at 1.76%, and finished them at 3.03%.

All of the above would seem to indicate that your Markets and Money editors are idiots and that Ben Bernanke is a genius. Last year’s performance by the stock market is the kind of thing that causes people to forget all about the peril of 2008 and 2009. Never mind that real wages and incomes are in a long-term deflationary trend. People feel richer on paper, so stick that in your pipe and smoke it, DR!

Well, we’ll see. But in wondering if 2014 can repeat the exploits of 2013, your editor is reminded of certain events that took place at Iggy’s Bar and Grill in Salem, Oregon on December 22nd last year. Police reports show that it took 15 officers to subdue a man who was caught pleasuring himself at the bar. The 37 year old had the decency to retreat to the bathroom when confronted by the bartender.

But he says he was so high on methamphetamine that he has no recollection of events. That’s probably for the best, given that police repeatedly tasered the man to absolutely no effect. They called in backup…and then more backup…and then more backup…until finally, 15 of Salem’s finest subdued him.

Now, investors punting on QE are not meth addicts. But we have a feeling that before it’s all over, they’ll wish they had no recollection of buying stocks at these prices. It may feel good at the time, but it’s the kind of thing you regret later and hope everyone forgets.

The alternative, which also takes same cojones, is to avoid the crowds, panic now, and sell everything into a rising market. This is what our colleague Vern Gowdie advised last year. Understanding that most people think it imprudent to sell everything, Vern’s written a new report in which he names the five stocks you must sell in 2014.

If you want to watch for signs of weakness, look to the credit markets. The tighter credit gets, the worse it usually is for stock prices. The rise in 10-year US yields, for example, is early evidence that interest rates CAN rise even if they Federal Reserve remains a buyer of bonds. That’s probably the greatest ‘known unknown’ of 2014: will interest rates spike? Or can the Feds keep them low for, say, the next 20 years, while the Dow goes to 50,000?

The credit markets are where the real economy renders its verdict on the significance of higher asset prices. For example, the Financial Times reports that businesses in Europe’s weakest economies still face much higher borrowing costs than businesses in Germany. The European Central Bank is unhappy with this. It wants lower credit costs across Europe to fuel an expansion (and justify higher stock prices).
Making credit cheaper doesn’t make lending less risky. It’s faulty logic to think so. You see the same logic here in Australia when real estate advocacy groups claim that lower interest rates make homes more ‘affordable’. They don’t mention anything about the size of the monthly mortgage payment relative to take-home pay.

Careful, reasoned calculation was definitely ‘out’ in 2013. Will it come back into style in 2014? It always does come back. But it comes back in the same way a hangover comes back, after you’ve stopped drinking. How long will the party go on?

More on that tomorrow. In the meantime, let’s not forget that 2014 is the year the Police State comes to Australia. In point of fact, it’s here already, with surveillance cameras popping up everywhere and Australia’s complicity in US spying programs. But specifically, we’re talking about the G-20 summit in Brisbane in November.

When the world’s leaders gather in Brisbane November 15th and 16th next year, it will be a nice little preview of what it’s like to live a country where your government views you as criminal all the time. Under the ‘G-20 Safety and Security Bill’ passed by Queensland’s Parliament, you can be arrested without cause, detained without charge, and strip searched without a warrant.

Of course all of this is to guarantee safety and public order. But if you don’t see it for what it is — a preview of how life will be when civil liberties clash with ‘public safety’, then you’re fooling yourself. The word ‘power’ appears in the document 114 times. The word liberty? Zero times.

There’s an alliance between the world’s financial and political elite. The politicians write the laws that favour financial industries. In exchange, the financiers make big government deficits possible. The ‘people’ can be pacified with higher stock prices and wealth redistribution through the central government. They can also be pacified by more legislation, more controls, and more spying by the government on the people.

Does that sound paranoid? Well, that was the other lesson from 2013. When it comes to government’s grasping intrusion on privacy and personal liberty, no matter how bad you thought it was, it was actually worse. Whether that kind of over-reaching for authority can last is another big question for 2014.

But fret not! Life goes on and the centuries march past. The world is always in a state of low-level crisis. Another word for that is ‘life’. And generally, it is better to be alive than dead. So welcome to 2014, dear reader. May it be lively and prosperous!


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Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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