The Real Threat Remains - Brandon Smith Warns "Do Not Be Fooled By The Fed's Magic Show"

Authored by Brandon Smith via Alt-Market.com,

I remember back in mid-2013 when the Federal Reserve fielded the notion of a "taper" of quantitative easing measures. More specifically, I remember the response of mainstream economic analysts as well as the alternative economic community. I argued fervently in multiple articles that the Fed would indeed follow through with the taper, and that it made perfect sense for them to do so given that the mission of the central bank is not to protect the U.S. financial system, but to sabotage it carefully and deliberately. The general consensus was that a taper of QE was impossible and that the Fed would "never dare." Not long after, the Fed launched its taper program.

Two years later, in 2015, I argued once again that the Fed would begin raising interest rates even though multiple mainstream and alternative sources believed that this was also impossible. Without low interest rates, stock buybacks would slowly but surely die out, and the last pillar holding together equities and the general economy (besides blind faith) would be removed. The idea that the Fed would knowingly take such an action seemed to be against their "best self interest;" and yet, not long after, they initiated the beginning of the end for artificially low interest rates.

The process that the Federal Reserve has undertaken has been a long and arduous one cloaked in disinformation. It is a process of dismantlement. Through unprecedented stimulus measures, the central bank has conjured perhaps the largest stock and bond bubbles in history, not to mention a bubble to end all bubbles in the U.S. dollar.

Stocks in particular are irrelevant in the grand scheme of our economy, but this does not stop the populace from using them as a reference point for the health of our system. This creates an environment rife with delusion, just as the open flood of cheap credit created considerable delusion before the crash of 2008.

Today, we find our economic fundamentals in complete disarray, but the overwhelming fantasy within stocks still remains. Why? Because yet again, for some reason, no one is ready to accept the reality that the Fed is pulling the plug on America"s fiscal life support. Nary a handful of economists in the world think that the Fed will raise interest rates one more time this year if ever again, and the threat of a balance sheet reduction is the furthest thing from everyone"s mind. Daytrading investors are utterly convinced they have the Fed by the short hairs. I say, the situation is actually in reverse.

The minutes from the Fed"s July Open Market Committee Meeting indicate that while the central bank has been the savior of stock investors for several years, the party is about to end. Comments on the risks a bull market might pose to "financial stability" have been more frequent the past couple of months

Only a few weeks ago, former Fed chairman Alan Greenspan commented that bond markets could collapse and bring stocks down with them do to overvaluations and increasing interest rates.

Recent spikes in markets despite a steady stream of natural disasters, threats of war with North Korea, as well as "increased inflation" (according to Fed models) due to the damage wrought by Hurricane Harvey suggest that the Fed will indeed continue hiking rates into our ongoing financial collapse.

The next FOMC meeting will conclude on the 20th of this month, and the question is, will the Fed surprise with a rate hike and/or balance sheet reduction program? I believe the odds are much higher than many people seem to think. [ZH: we now know that The Fed did announce the start of the balance sheet reduction program as Brandon forecast]

First, let"s be clear, historically the Fed"s predictable behavior has been to skip major policy actions in September and then startle markets with renewed and aggressive actions in December. People placing bets on a Fed rate hike in September would look at this pattern and say "no way." However, the narrative I see building in Fed rhetoric and in the mainstream media is that stock markets have become "unruly children" and that the Fed must become a "stern parent," reigning them in before they are crushed under the weight of their own naive enthusiasm.

In my view, the Fed will continue to do what it says it is going to do — raise interest rates and reduce and remove stimulus, and that the mainstream narrative will soon be adjusted to suggest that this is "necessary;" that stock markets need a bit of tough love.

If the Fed means to follow through with its stated plans for "financial stability" in markets, then the only measure that would be effective in shell-shocking stocks back to reality would be a surprise hike, a surprise announcement of balance sheet reduction or both at the same time.

If the Fed intends to continue cutting off life support to equities and bonds in preparation for a controlled demolition of the U.S. economy, then there is a high probability at the very least of a balance sheet reduction announcement this week with strong language indicating another rate hike in December. I also would not completely rule out a surprise rate hike even though September is usually a no-action month for central banks.

This would fit the trend of central banks around the globe strategically distancing themselves from artificial support for the financial structure. Last week, the Bank of England surprised investors with an open indication that they may begin raising interest rates "in the coming months." The Bank Of Canada surprised some economists with yet another rate hike this month and mentions of "more to come." The European Central Bank has paved the way for a tapering of stimulus measures according to comments made during its latest meeting early this month. And, the Bank of Japan initiated taper measures in July.

Even Forbes is admitting that there appears to be a "coordinated tightening of monetary policy" coming far sooner than the mainstream expects. If you understand how the Bank for International Settlements controls policy initiatives of national central bank members, then you should not be surprised that central banks all over the world are pursuing the same actions and the same rhetoric. The only difference between any of them is the pace they have chosen in taking the punch bowl away from the party.

The point is, when it comes to the fiat peddlers, there are indeed a few sure things, but continued stimulus is not one of them. One thing that is certain is that they will act in concert as they are clearly doing now in terms of policy tightening. Another thing that is certain is that if they plant a notion in the mainstream media — such as the notion that they are "worried about overvaluations in stocks" and that interest rates must rise, then they will follow through as they always have. Perhaps not at the pace the mainstream expects, or the pace I expect, but certainly somewhere in-between.

Finally, it behooves me to mention again that the Fed has done all of this before. In the lead up to the stock market crash of 1929, the central bank bloated stocks with easy credit measures and low interest rates, only to hike rates in the name of "quelling inflation." This hacked the legs out from under markets with a machete, and the rest is history. The hidden purpose behind this tactic is extraordinary centralization on a global scale. The Fed is not interested in the health of the U.S. economy, it is interested in total globalization of all economies under one totalitarian umbrella. To make an omelet, you have to break a few eggs.

Of course, the Fed will not engineer a market crash in a vacuum. It is my suspicion that the next Fed meeting will be followed by a geopolitical distraction — the most likely candidate being increasing conflict with North Korea.

Do not be fooled by the magic show. The real threat to us all is the central banking and international banking apparatus, including the BIS and the IMF. From now until the end of this year, remain vigilant.

Goldman's Clients Are Confused About Inflation: Here's Why

In his latest weekly kickstart, Goldman"s chief equity strategist David Kostin (who has maintained his year end S&P price target of 2,400 of -3% from current levels), says that the one topic most confusing (and important) to Goldman"s clients in the past week, was what happens to inflation next: "the US inflation outlook and its equity investment implications were key topics of discussion during recent visits with clients in Boston, Chicago, and New York. Core Personal Consumption Expenditures (PCE) data released [on Friday] showed a year/year inflation rate of 1.5% in 2Q. Wednesday’s Fed statement acknowledged that inflation was running “below” its 2% target, a revision from the “somewhat below” description used previously."

Kostin points out that while fixed income managers have always had to take a view on inflation, now that the Fed"s "reaction function", to use an IMF-ism, is entirely driven by concurrent and future inflation expectations, and as a result "equity investors must also take a stand and position portfolios accordingly. The anticipated path of inflation is an important determinant of the trajectory of Fed policy tightening. Bond yields will be affected in turn via expectations of future hikes and the term premium, and stock prices by extension will be influenced through the equity risk premium."

As for why Goldman"s clients are "confused", Kostin points out something we have discussed on several occasions recently: depending on what indicators one uses, inflation can be expected to rise, drop, or stay the same: 

"Looking forward, will the rate of inflation in 2018: (a) decelerate, (b) accelerate, or (c) stay about the same? The answer depends on the information source. Treasury Inflation Protected Securities (TIPS) imply inflation will decelerate; Goldman Sachs economics forecasts an acceleration (to 1.9%); while corporate pricing varies both across and within industries. For example, branded pharmaceutical prices are rising by 9% (offset partially by rebates) while generic drug prices are falling by 9%."

Some more details behind these perplexing numbers:

• The TIPS market implies inflation will average 1.3% annually during the next two years and 1.8% annually through 2027. As a result, fed funds futures currently imply just a 50% probability the FOMC will hike once more by year-end 2017 and expect just two hikes in total through the end of 2018.


• In contrast, Goldman Sachs economics believes underlying inflation will trend towards the Fed’s 2% objective. Specifically, our economists forecast core PCE will reach 1.6% by year-end 2017 and climb to 1.9% by the end of 2018. The trend in inflation will prompt steady policy tightening starting with a 25 bp hike in December followed by four hikes in each of 2018 and 2019 that will lift the funds rate to 2.4% and 3.4%, respectively.
  

In a humorous swipe at his own economics team, Kostin writes that "we have met no equity investors who subscribe to this forecast."  So much for Goldman"s once legendary ability to shape and sway investor sentiment. 

Then there are the government"s own measurements of inflation:

The components of measured PCE inflation are split 25% in Goods and 75% in Services. The goods category has shown consistent deflation for several years and our economics team forecasts that trend will persist in 2017 and 2018 (see Exhibit 5). A leading driver of disinflation has been the Video, Audio, and Computer category where prices dropped by 5% in 2015, by 10% in 2016, are declining at an average pace of 7% YTD, and we forecast will fall by 4% and 7% in 2017 and 2018, respectively.

However, Services PCE inflation is the more important category and the trends are mixed, which is why market participants have such divergent views on the underlying pace of inflation. The four largest Services categories account for 65% of core PCE inflation and include Medical Services (19%), Housing (19%), and Financial Services (9%).

Separately, what inflation information can investors glean from corporations and the equity market?

Confirming what the latest Census data showed last week, namely that asking rents across the nations just fresh all time highs...

... Goldman flags that apartment owners suggest rental inflation remains above the Fed’s overall inflation target of 2%. Six public apartment REITs own 357,000 multifamily units (AVB, ESS, EQR, AIV, CPT, UDR). Same-store rental growth in REITs has been a leading indicator of the change in owner’s equivalent rents (OER) in the government’s housing inflation measure (Ex. 3).

Average rental growth for these REITs equaled 5.6% in 2015 and 4.8% in 2016. More notably, Kostin writes that "because analysts forecast rental growth will slow to 2.9% this year and 3.1% in 2018, housing inflation represents a fading tailwind to core PCE inflation." To be sure that would be great news to a middle class that has never had to pay more out of pocket for the monthly rent...

On the other hand, a conflicting picture emerges from the deflation observed in certain parts of Financial Services. The Investment Company Institute (ICI) reports that average fees for active equity management have dropped from 108 bp in 1996 to 82 bp today, although we doubt that one can seriously claim with a straight face that there is delfation because millionaire LPs are paying not 2 and 20 any more but 1 and 10 or less.

Meanwhile, inflation and interest rates affect equity valuations. The gap between the S&P 500 earnings yield and ten-year Treasury yield represents a short-hand measure of the equity risk premium. The gap in the “Fed Model” currently equals 320 bp (5.5% less 2.3%), below the average of the past 10 years (460 bp) but above the average of the past 40 years (250 bp).

Which brings us to Goldman"s summary: based on all the initial assumptions, Kostin"s S&P 500 price target of 2400 suggests the yield gap will narrow to 300 bp by the end of 2017. The yield gap has narrowed by 300 bp since February 2009.

Our economists forecast the Treasury yield will rise by 50 bp to 2.75% at year-end. Higher interest rates coupled with a slightly lower risk premium is consistent with our S&P 500 year-end target of 2400 (-3%). However, if inflation remains subdued and the bond yield hovers near the current level, the Fed Model would imply a S&P 500 fair value of 2650 (+7%) (see Exhibit 4).

Finally, and going back to the original underlying confusion, Goldman concludes that "whether they are bullish, bearish, or neutral, every equity investor is implicitly or explicitly taking a view on the inflation outlook." That... or simply taking a view that no matter how this latest inflation vs deflation debate plays out, the Fed and central banks will always be there, ready to bail out the wealth effect that they have so carefully cultivated over the past 9 years with $15 trillion in liquidity injections, and which nobody seriously thinks they will let go to waste just to make a statement that the market can levitate on its own without constant central bank manipulation.

Are 401K Holders About To Feel A Savers Pain?

Authored by Mark St.Cyr,

There’s an old truism people forget all too often. It has many variations and is attributed to even more, its core meaning goes something like this:

“If the government can give it to you, than it can also take it away.”

Some of you might be wondering if I’m talking about the current “tax” advantages that have made these vehicles so popular over the years. To that I’ll say no, not at this current time. But I feel that will be the least of worries coming down the pike in the not so distant future.

No, what I’m directly addressing is what is now emanating from the one and only non-government, privately held institution, directed by a consortium of non-elected, Ivory Towered, policy wonks: The Federal Reserve.

And those emanations are anything but 401K holder friendly. Let me explain…

I know many are wondering how a government inspired quote, a private institution, their retirement account, or savings account fits under one banner, or are some how all connected. Well, that’s easy:

The Federal Reserve has been the sole entity that dictates what any of them are currently worth. And if you don’t like their choices or decisions? Tough. There’s nothing you can do about it. Period.

Maybe that’s not quite correct: It’s not that there’s “nothing you can do.” The problem is – there’s nothing you’ll want to do. Hence where the real issues lie.

The following is for those who know of no other “investing” world (or 401K holder) other than after the financial crisis of 2007/08. Or put differently – if you’ve been working and saving only for the last decade or so. i.e., in the 35ish – 40-year-old bracket and younger.

Back in ancient history before algorithmic HFT parasites roamed the trading world (circa 2008 A.D.) One could retire comfortably with a modest sum of money and find relatively safe places to hold their assets receiving some form of interest payment for its usage. CD’s (certificates of deposit) bonds (such as U.S. Treasuries) and others were some of the most popular.

That was until the Fed. decided interest rates and everything that was connected to them was secondary (and even expendable) as to subjugate the financial markets and bring them into such a reflexive corollary that even if a Fed. official whispered- the effect on Wall Street was a realtime example of that other adage “When a butterfly flaps its wings…”

That’s what pumping (and printing) $4+TRILLION dollars via differing iterations of QE, Twist and a relentless death grip for years at the Zero-bound will buy you.

For those who don’t remember, it used to be when understanding investing prowess people used to say (or was advertised) things like, “When E.F. Hutton speaks – people listen.” Now it’s: “When The Federal Reserve whispers – Wall Street jumps!”

That’s what the greatest expression for capital formation the world has ever known has now become. i.e., Nothing more than a trained jumping flea circus. And again – all in less than 10 years.

Does a “Mission Accomplished” banner come with that? But I digress.

One of the reasons I can attest to much of what has been thrust upon (or taken from) retirees and others is that I actually am one, became one right at the beginning of the financial crisis. I was fortunate enough (via hard work and forethought) as to retire at the age of 45. A “dream” or ‘brass ring” many find elusive if not near impossible back in 2005.

It was a dream come true. However – it was also smack-dab right before, and squarely into the teeth of the “out of the blue” financial shock and market melt down for the ages that would transform everything. And I do mean: everything!

Suddenly the idea of diversifying one’s financial assets into relative safety was gone – and I do mean just that – gone. Which is, by-the-way, why I detest and so adamantly stand against all this over-simplified drivel once again appearing from so-called financial “expert” landscape. It’s going to hurt far more people than it’ll ever help.

The Federal Reserve decided in its infinite “wisdom” that interest rates were now to be considered a “poison” to the economy and not only cut – but slashed them, and held them at the Zero-bound for years. What this meant was one could no longer expect to receive any interest bearing accounts to live. i.e., Eat, pay bills, et cetera. And I won’t even get into what it has done to pensions and insurance companies.

But no one has cared – especially the Fed. Let me use the following for demonstration purposes…

Let’s say you were an entrepreneur and sold your business, or were able to some how via thrift or shrewd business acumen, and were able to amass a nest egg of let’s say $3Million dollars for the entrepreneur, and $1Million for the shrewd. Both scenarios are quite feasible for the prudent minded.

Just 10 years ago it was also not only feasible, but rather probable, one could safely allocate their resources finding returns of 5% (and higher, depending) in such mundane vehicles as CD’s, Treasuries, and more.

So, using nothing more than napkin math, one could easily calculate using the $1MM example that money would generate approximately $50,000.00 per year without touching the principal for one to live on. This was also a relatively accurate proposition because there was precedent going back decades. Sure, $50K ain’t what it used to be, but it’s sure a hell of a lot more than Zero – which is precisely what interest rates have been now going on years. And on $3MM? It’s the same. i.e. Zero, as in zip, zero, nada.

“But wait! There’s more!!!” as they say, but it’s not a bonus anyone wants to hear about. What is that you say? Glad you asked…

Not only does having a $Million dollars get you nothing at a bank (correct, not even a lousy toaster) if you are one of the fortunate (or unfortunate depending on perspective) who wants to put that hard-earned money safely under “lock and key” via the auspices of some bank – it’s going to cost you! And in some instances – they might not even want your deposit at all. Why?

Why else – it’ll cost them, and that’s a no-no in banking. Costs are something you pay – not them. And if enough profits can’t be made on legitimate transactions? See Wells Fargo™ for clues.

So what was the flip side? Here’s my opinion…

Welcome to the “markets” (or should I say casino) of today. Where 401K holders, and corporate buy-backs supported via the Fed’s balance sheet accrual, and zero interest rate financing meet the front running, algorithmic, headline reading HFT parasites which enabled the BTFD phenom to appear time, after time, after time, after time. Which, by its very nature and existence has allowed “investing” to be the equivalent of nothing more than following the strategy of a chimp hurling darts at ETF symbols backed by a central banks “bulls-eye.”

Ah, but what a difference an election does make, no? For that was then – and this is now. And “now” seems to be that the Federal Reserve is hell-bent as to raise interest rates regardless of what the “markets” desire.

Can you say, “Oh-oh?”

For years the cries of savers, pension plans, insurance companies and more have fallen on deaf ears. Actuary tables that prove these bedrocks of society can not sustain or endure under a Fed. policy such as what has been thrust upon them was relegated to the, “Who cares the “markets” up – deal with it!” status.

Now – That all seems to have changed.

Suddenly (as in the last few months) interest rates not only need to go up. They need to go up stat!

The Fed. via its differing speakers in public comments are signaling that not only is the raising of rates further, and quicker on the table, but so too is the balance sheet as to begin down sizing it.

If the above is to be taken at face value (and why shouldn’t it, after all, isn’t this why the Fed. makes public comments to begin with?) with signaling (via the Dot Plot and more) now stating 3 rate hikes for 2017 and some Fed. speakers signaling the possibility of even 4. Along with the abrupt metamorphosis of doves turning into hawks (using Ms. Yellen, and Ms. Brainard as examples) the “markets” are going to find fuel to propel them higher using what precisely?

The only fuel that has enabled the “markets” to propel this high has been all Fed. funded. And now this same Fed. is in no uncertain terms professing they’re out of the “hopium” business. Or at least – want to appear that way.

If this is true, taking them not just at their words, but rather via their actions – we now have 2 rate increases in 90 days with near shouting (as compared to prior discussions) that the Fed. is far more interested in raising further, and faster, than previously discussed. All while remembering it was only a few short weeks prior the Fed. Chair herself was touting the need for running a “high pressure economy” and has now flipped to jettison anything of the such – and is now the undisputed leader of “hawks are us.”

The issue here is – the “markets” have been levitated via the “wings of doves.” Suddenly – those “doves” have all but vanished. And if that’s true? What’s vanished with it may just be the BTFD genius along with it. And that will turn into a very big problem indeed if correct.

When savers were (and still are) getting crushed, no one cared, not even the Fed. The problem?

It seems just as the Fed. turned its back on savers pain all these years – they might be signaling how they’re going to feel about any 401K holders losses that may appear via their new-found policy stance. To Wit:

ZeroHedge: “What is the biggest S&P drop the Fed will accept before intervening?”

Minneapolis Fed. president Neel Kashkari: “Don’t care about stock market fall itself. Care abt potential financial instability. Stock market drop unlikely to trigger crisis.”

And with that, only one last saying comes to my mind:

Dear 401K holders – welcome to a savers world. Oh yeah, and buckle up. For things might get a little “bumpy” as that other saying goes.

Warning Signs

Authored by Lance Roberts via RealInvestmentAdvice.com,

Bull Market Still Intact…For Now

This past Wednesday, on the Real Investment Hour, I spoke with Greg Morris about the technical backdrop of the market. During that interview, he discussed that from a technical perspective the bullish trend of the market is still in place, and despite fundamental underpinnings being stretched, investors should remain allocated to the market.

This is shown in the chart below.

For now, portfolios remain allocated to the market currently. However, as I stated two weeks ago, we did lift profits and rebalance current holdings. Furthermore, we are not adding any “new” positions currently until some of the extreme overbought conditions are resolved. 

This is what the “technicals” dictate, at least for now.

As noted in the chart above, the market is very close to a short-term “sell signal,” lower part of the chart, from a very high level. Sell signals instigated from high levels tend to lead to more substantive corrective actions over the short-term. I have denoted the potential Fibonacci retracement levels which suggest a pullback levels of 2267, 2230, and 2193. To put this into “percent terms,” such corrections would equate to a decline of -4.7%, -6.2% or -7.8% from Friday’s close.

To garner a 10% decline, stocks would currently have to fall 237.8 points on the S&P 500 to 2140.20.  Given there is little technical support at that level, the market would likely seek the next most viable support levels at the pre-election lows of 2075 or a decline of -12.7%. Such a decline, of course, would not only wipe out the entirety of the “Trump Bump,” but would also “feel” much worse than it actually is given the exceedingly long period of an extremely low volatility environment. 

Speaking of low volatility, the market has now gone 108-trading days without a drop of 1% for both the Dow and the S&P 500. This is the longest stretch since September of 1993 for the Dow and December of 1995 for the S&P 500.

This is a pretty impressive feat given the rise in policy uncertainty since the election, geopolitical tensions on the rise, and economic data remaining weak.

In other words, there is a whole lot more downside risk than upside potential in the current environment.

This is particularly the case following the FOMC’s decision on Wednesday to hike rates further.

An Unlikely Outcome

On Wednesday, as the Fed hiked rates for the second time in the last three months, and a third time since December of 2015, the Atlanta Federal Reserve released their latest GDP NowCast which reduced estimates for first quarter growth to just 0.9% from nearly 3% in January. 

Interestingly, following the Fed’s announcement of a rate increase, stocks, bonds and gold all surged.

The reason I say “interestingly,” is that higher interest rates increase borrowing costs which slow economic growth and quells inflationary pressures. Therefore, since the primary argument to support the second highest valuation levels in history is an economic and earnings recovery story, higher rates slow both of those supports. 

Of course, the wisdom of hiking interest rates, thereby removing monetary accommodation, at the lowest average level of economic growth on record is also questionable.

Furthermore, there is also some doubt as to the veracity of the following justification from Ms. Yellen regarding the policy change:

“The simple message is the economy is doing well. We have confidence in the robustness of the economy and its resilience to shocks.” – Janet Yellen, March 15, 2017.

First, I guess we have to quantify what we mean by the “economy is doing well.” In 2016, the economy grew at 1.60% which is well below the expected average of 2.0%. But more importantly, take a look at the chart below of annual “real” economic growth rates.

There are three things of importance to note:

1. The economy did well prior to the last two crisis as well. In 2000, the annual growth rate was 4.09% and 1.78% in 2007. It was a “Goldilocks” economy. 


2. While there was a recession in 2001, the economy averaged a real return that year of 0.98%.


3. The current “real economy” is currently growing, as of 2016, at a rate lower than that prior to the last two recessions and “crisis” in the market and only slightly above that of the recession based 2001 average. 

At a 1.6% growth rate, there is very little wiggle room between Fed rate hikes and a negative growth rate in the economy. The chart below adds the Fed Funds (effective rate) to the chart above.

Two important points:

1. As soon as the Fed has started hiking rates previously, economic growth began slowing.


2. While it is often stated the economy remained buoyant following rate hikes, it was ONLY a function of the time for starting economic growth rates of 4.09% and 3.79% to fall below ZERO.

The table and chart below show the historical time frames for the economy to fall into recession following the start of a rate hiking campaign. At 1.6%, historically, the economy has found a “crisis” withing 1-3 quarters. 

IMPORTANTLY: The number of times the Fed has started a rate hiking campaign and NOT pushed the economy into either a recession, crisis, or both equals ZERO.

So, as to Ms. Yellen’s second point of a resiliency to shocks, there is actually no historical evidence of that being the case. The only question is what “shock” eventually ignites the “gasoline” of excessive complacency, exuberance and leverage into a “panic fueled” explosion of liquidation.

Unfortunately, I do not know the answer to the “what” or the “when” of when such will occur. I am certain that it “will.”

But, if you need more evidence, here is this tidbit from Nautilus Research’s Tom Leveroni:

“Many are familiar with the Wall Street adage ‘3 Steps and a Stumble,’ popularized by Marty Zweig, for the tendency of stocks to sell off after the 3rd Fed rate hike in the cycle.

The S&P 500 has endured significantly below average results from 1 to 12 months after 3rd rate hikes in 11 events back to 1955. Six (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999).

The only exception was in 2004, when stocks rallied for another three years before the Great Recession.

Hikes are generally bad for stocks, somewhat bad for the US dollar, and bullish for 10-year yields and commodities. Will rate hikes derail stocks this time around? In a general sense, yes. Is there a deterministic formula or trigger for precisely when? Probably not.”

Warning Signs

So…let’s add this all up.

The bullish trend is intact which keeps portfolios on the long-side of the ledger for now. However, such does not mean one should become complacent and ignore the rising number of warning signs.

Valuations are stretched by most measures. While valuations are not reliable “timing” indicators, they are useful in predicting forward rates of returns.

Leverage is extended. Margin debt, or the dollar volume of stocks bought with borrowed money, surged just before the US election to a record high.

Retail investors are suddenly rushing to buy. Following eight years of net outflows, they poured nearly $80 billion into mutual funds and exchange-traded funds in the post-election rally. This year, however, corporate insiders have been selling at the fastest pace in nearly 30 years.

The technicals are showing vulnerability. From Monday through Thursday last week, the number of stocks making 52-week lows surpassed new highs. It was the longest streak since November 4 and was a sign of a toppy market, Rosenberg said. Also, the S&P 500 has traded as much as 10% above its 200-day moving average.

Investors are complacent, and it seems like the calm before the storm. The Chicago Board Options Exchange volatility index, or VIX, remains unusually low. The S&P 500 has not swung 1% intraday for almost 60 days, the longest streak in at least 35 years.

The Fed is raising rates. The rise in short-term yields could invert the yield curve before the Fed Funds rate is at 3%. An inverted curve — which reflects investors’ expectations for slower future growth — is seen as a precursor of recession.

Inflation is picking up. The core personal consumption expenditures index is at a 30-month high. Though it is likely not sustainable, it is a “classic late-game signpost.”

The gap between economic growth and sentiment is large. The pace of policy change in Washington could disappoint investors.

Households have over-ownership. Their exposure to the stock market is 42% above the norm.

Credit markets are frothy. The compensation investors demand for choosing risky US high-yield bonds over risk-free assets — the risk premium — is widening.

Like gasoline, all of these warnings are “inert” and, other than smelling really bad, are harmless.

Well, that is until your cousin “Randy” shows up and decides to have a quick smoke.

"What Will We Be Talking About This Time Next Year" - Here Is Jeff Gundlach's Answer

Over the weekend, Barron"s published its annual roundtable in which prominent investors previewed what they expect out of 2017: "a year of seismic shifts for the markets and, quite possibly, the world. Or, as Goldman Sachs strategist Abby Joseph Cohen said at this year’s Barron’s Roundtable, “We are breaking a lot of trends.” As Barron"s dubbed it, "this could be the year the movie runs backward: Inflation awakens. Bond yields reboot. Stocks stumble. Active management rules. And we haven’t even touched on the coming regime change in Washington, which will usher tax cutters and regulatory reformers back to power after an eight-year absence."

While there were many insightful observations by the group of participants - whose sentiment was decidedly more bearish than during last year"s event - which included Scott Black, Felix Zulauf, Mario Gabelli, Meryl Witmer, Brian Rogers, Oscar Schafer, and Abby Cohen, we will focus on the predictions of Jeffrey Gundlach, if only due to his track record from the similar Barron"s roundtable one year earlier, in which he turned out to be far more prescient than most of his peers, not least of all because he "made the greatest prediction at last year’s Roundtable—that Trump would win the presidency."

The first question posed to Gundlach was also the broadest one: what are you predicting now?

People have forgotten the mood regarding stocks and bonds in the middle of 2016. Investors embraced the idea that zero interest rates and negative rates would be with us for a very long time. People said on TV that you should buy stocks for income and bonds for capital gains. This is when 10-year Treasuries were yielding 1.32%. Someone actually said rates would never rise again. When you hear “never” in this business, that usually means what could “never” happen is about to happen. I told our asset-allocation team in early July that this was the worst setup I’d seen in my entire career for U.S. bonds. It occurred to me that the bond-market rally was probably very near an end, and fiscal stimulus would soon become the order of the day.

Based on a comparison in July of nominal Treasuries to Treasury Inflation-Protected Securities, or TIPS, the bond market was predicting an inflation rate of 1.5%, plus or minus, for the next 30 years. Now, that is implausible, and kind of proves the efficient-market hypothesis is wrong. More likely, the inflation rate would increase not in five or 10 years, but one year, because commodity prices had already bottomed. The Federal Reserve Bank of Atlanta’s wage-growth tracker is now up 4%, year over year. Oil prices have doubled since January 2016, to around $52 a barrel, which likely means that headline CPI [the consumer-price index] will be pushing 3% in April.

I expect the history books will say that interest rates bottomed in July 2012, and double-bottomed in July 2016. At some point, the backup in rates will create competition for stocks. Bonds could rally in the short term, but once the yield on the 10-year Treasury tops 3%, which could happen this year, the valuation argument for equities becomes problematic. When the long bond [the 30-year Treasury] was at 2%, bonds had a P/E of 50. Compared with that, a P/E of 20 on stocks didn’t look all that bad. But if the 10-year yield hits 3%, you could be talking about 4% on the 30-year, which implies a P/E of 25.

Something else happened in 2016: The Fed capitulated, as I predicted a year ago. The Fed gave up on its forecast for higher interest rates and lowered its dot projections for 2017, just when it might have been right. [The Fed’s so-called dot plot shows the interest-rate projections of the individual members of its policy-setting committee.] In December, the Fed had to reverse itself and raise rates.

Is an inflationary spike possible?

Fed Chair Janet Yellen suggested a few months ago that running a “hot” economy might not be such a bad idea. But when unemployment is low, wages are rising, and significant fiscal stimulus is likely, inflation could exceed consensus expectations. Jim Grant, the founder of Grant’s Interest Rate Observer, wrote a fantastic article a few years ago likening the current environment to the 1940s and ’50s. Short-term interest rates were at 3/8s in the late 1940s, and long rates were around 2%-2.5%. Inflation was running at 2%. Everyone had been predicting higher inflation rates, but after a long period of 2%, they gave up. Then inflation spiked to 8%. It came out of the blue.

His take on the strong dollar:

 A strong dollar keeps inflation lower. It is helpful to the bond market. A weak dollar isn’t helpful to the bond market. However, I brought along a quote from President-elect Trump today because it makes me think. He said, “While there are certain benefits to a strong dollar, it sounds better to have a strong dollar than it actually is.” Is it really a given that Trump will bring us a strong dollar if he is supposed to be helping the forgotten middle class?

His view on market risk at this moment

People are underestimating the risk of loss right now.

On Germany being the big winner currently in Europe:

The German population doesn’t quite understand this. According to ,a poll by Pew Research Center, 38% of Germans disapprove of the EU’s handling of economic issues. In France and Italy, two-thirds-plus of the population are dissatisfied with the EU. In polling terms, that is enormous. Those countries have almost maxed out on dissatisfaction.

What worries, and excites, Gundlach about 2017:

The shift in sentiment to positive from negative, regarding the efficacy of Trump is one of the biggest I’ve seen in my career. I wonder if sentiment can swing just as quickly the other way. Many people who voted for him think something is going to change for them. They expect their wages to rise, and America to be “great again.” What will happen by July or August if nothing has changed? Put that together with the timing of an interest-rate rise, and we potentially could see a very different psychological environment.

Are bonds in a bubble:

People say bonds are in a bubble, that they are over-owned. I agree with that. But anything that is momentum-driven is in a bubble. This passive stuff is in a bubble.

On portfolio construction for the next 12 months, and what may be the "best trade" of the year:

Some things should be avoided in a major way because they have risk without rewards. One of the greatest trades of the year could be shorting German Bunds... Portfolios need to diversify away from deflation-oriented trades, which worked for a long time.

On the trajectory of the stock market over the course of the year.

Zulauf: Stocks could easily rise another 10% into the middle of the year. But after a soft period, bond yields will rise again, with the 10-year Treasury yield hitting 3% or going a little above it. That will trigger a big correction in equities, just when everyone is fully invested after buying into the Trump rally. I expect the S&P 500 to be slightly negative for the full year.

Gundlach: Did I give you my notes? That is almost exactly my view.

Where will the S&P close the year?

Gundlach: GDP growth has been unbelievably stable at 2% for the past six or seven years, despite quantitative easing and other nutty interest-rate policies. At last year’s Roundtable, I said the easiest forecast was that the Fed wouldn’t raise interest rates four times during the year. We are going to break out of the land of stability this year, and certainly by 2018, and there will be an inflation surprise. That isn’t going to be helpful for equity valuations.

I look for the stock market to make new highs in the first part of the year, but when rising interest rates bite, stocks will fall. I see a single-digit decline for the full year.

Finally, Gundlach was asked "what will we be talking about this time next year." His simple answer: "Trouble in the euro zone."