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A Read of the Tea Leaves
by Stanley C. Clayton
November 20, 2009
“Tea Leaves” from now on will be divided into two distinct parts: Economic Tea Leaves and Stock Market Tea Leaves.
Economic Tea Leaves
The Fed is in full court press mode to flood the world (especially U.S.) with enough dollars to stimulate growth. Results so far, not good. Banks and Wall Street have been saved from their blunders in high risk trading, but the economy continues to do poorly. Top line growth (sales) is going nowhere. The only growth is bottom line (profits) achieved mostly by cost savings and layoffs. The one quarter of 3.5% GDP growth is directly attributed to this and government spending. Many economic writers agree, usual economic growth is almost non-existent.
I find it of special interest that while the Fed continues to expand the supply of dollars, and expresses intentions to continue far into the future, significant head winds are now evident that can curtail this endeavor. 1. Governments and investors around the world are increasingly worried about the expanding supply of dollars decreasing the value of the dollar which reduces the value of the trillions they have invested in U.S. bonds and such. 2. When bonds go down, interest rates are pushed up which runs up the cost of servicing the U.S. debt and slows the U.S. economy. 3. This is forcing other countries to work hard to replace the dollar as the sole currency for international trade settlements.
In short, the Fed imperative is to get the U.S. economy moving on its own before the Fed is forced to stop expanding the money supply. Their stated belief is that failure to do so will result in a major depression. As well it may, as the U.S. will have spent itself into a sinkhole of mind numbing debt. Some have calculated that debt now totals $1,000,000 for each and every household in our country. If that is the case and we stopped running up debt (and did not have to pay interest) and each household paid $200 per month toward the debt, it would take over 416 years to pay it off. Is it any wonder the rest of the world worries we will stiff them for it?
The mortgage market problems that provided the initial trigger for the financial crisis continue to worsen. The mortgage default and foreclosure rates continue to rise, commercial real estate defaults are now being added to the mix, unemployment keeps increasing, new home builders are on the ropes, and banks continue to fail.
It seems fair to say that both current economic conditions and trends look awful.
Stock Market Tea Leaves
The markets continue to power ahead with brief intermissions. I find there is but a single underlying cause: the widespread investor belief that has been in place for decades that when the Fed is easing (i.e.- low interest rates and increasing money supply) the stock market always goes up. “Everybody knows” that this leads to boom times ahead with business growing, retail flourishing, factories humming, and such - so you must buy stocks before they go to the moon. The Fed is stoking the flames by assuring investors that it will keep interest rates super low and expand the money supply way into the distant future. At this juncture, I can find little evidence that investors are concerned that serious progress toward boom times is not evident.
Under these conditions, the logical expectation is the rising stock market will come to a screeching halt should the Fed be forced to stop its monetary expansion before real boom times actually arrive. There is an excellent and readily available indicator that tells us how much longer the Fed can keep its foot on the accelerator. It is the Velocity of Money. [Google this term and find excellent explanations.] This is calculated for us by the St. Louis Fed on their web site. The exact URL is:
This is updated periodically for us by the Fed. The measure of money supply preferred by the Fed is MZM, and its velocity has been in decline for some time reaching about 1.5. It has just started to turn the corner and may be headed up or sideways. Nail biting time for the Fed will probably be when it gets up to the 2 to 2.5 range especially if it is accelerating upward. They will know inflation is on the move up. This will kill the market if it has not already rolled over and died - likely from the U.S. dollar losing its status as the sole currency for international trade.
We had best hope the Fed is successful, because if it is not, we will be radically in debt and likely falling into a full scale depression. This is a very high stakes game. What are the odds the Fed succeeds? At this juncture, our debt is increasing far faster than real economic recovery making the odds look poor.
If this assessment is anywhere near correct, it leads me to expect the market to continue up but with increasing down ticks as people start to worry. This seems likely to continue for months rather than weeks or years. Upward movement in the Velocity of Money should be useful as an advance indicator of impending inflation.
In the prediction business, there are “black swans” that are unpredictable events that may happen often rendering predictions somewhat off to hopelessly off base. Black swans are inherent in the real world and may arise at the most unexpected moments. The only thing for sure is that we are likely to be surprised by them from time to time.
NOTE: This is intended as an educational exercise and certainly not as stock market advice. Hopefully by writing this down and sharing it with others, we can learn from seeing where predictions go right and where they go wrong and gain some further practical insight into the world of investing.
