David Stockman … Right and Wrong
By Staff News & Analysis - September 19, 2014

Fed and TWTR Overvaluation, Evidence of Looming Market Crash … The Federal Reserve Wednesday reassured investors that it will hold interest rates near zero for a "considerable time" after it ends the bond-buying program known as quantitative easing in October. In response, the Dow Jones Industrial Average (,DJI) closed at a new record high. Former Director of the Office of Management and Budget and author of the book, The Great Deformation, David Stockman, has significant concerns about that very policy. – Yahoo

Dominant Social Theme: Don't worry about the stock market. Relax … and enjoy.

Free-Market Analysis: It's hard to pick stocks these days because what's going on is so wrong. Surely a crash must be looming at any second.

And yet when Yahoo sat down with David Stockman for an interview, the questioner pointed out that since David Stockman had last warned people to leave the insanity of the modern stock market, stocks were up 28 percent!

Stockman answered that the market would eventually conform to his expectations and many people who stayed in were going to end up losing a great deal.

And yet that 28 percent lingered …

That's a lot of money to leave on the table – even if the percentage is manipulated by a few large stocks, etc.

Here's more:

… In an interview with Yahoo Finance, Stockman blamed Fed policy for creating that madness … "We have been shoving zero-cost money into the financial markets for 6-years running," he said. "That's the kerosene that drives speculative trading – the carry trades. That's what the gamblers use to fund their position as they move from one momentum play and trade to another."

And that, he says, is not sustainable. While Stockman believes tech stocks are especially overvalued, he warns that it's not just tech valuations that are inflated. "Everything's massively overvalued, and it's predicated on zero-cost overnight money that continues these carry trades; It can't continue." And he still believes, as he has for some time – so far, incorrectly – that there will be a day of reckoning.

"When the trades begin to unwind because the carry cost has to normalize, you're going to have a dramatic re-pricing dislocation in these financial markets." As Yahoo Finance's Lauren Lyster points out in the associated video, investors who heeded Stockman's advice last year would have missed out on a 28% run-up in stocks. But Stockman remains steadfast in his belief that the current Fed policy and the resultant market behavior cannot continue.

Stockman is correct; but there is a theoretical "reality" and then there is real life as it occurs in real time. Yes, stocks are absurdly puffed up via asset inflation, regulations that concentrate capital flow and even government policies that create plunge protection teams and actively encourage large central banks to intervene to stabilize the market with asset purchases. But that doesn't mean a collapse is imminent.

We understand what's wrong, but we also understand that the powerful upward bias of the marketplace can yield considerable profits to those who approach markets intelligently and keep in mind the balance between risk and reward.

This Wall Street Party may end soon enough, but Stockman's perspective followed theoretical logic and thus he left 28 percent on the table. His analysis was right and reasonable. He's a courageous man in this regard. And yet from an investment standpoint he was "wrong."

An alternative approach, of course, is to deny the wrongness of the current system entirely. That's what The New York Times just did in an article entitled "Monetary Policy: The Fed Is Boring Again. That's a Relief."

For the last six years, Federal Reserve policy has been sexy, or at least as sexy as monetary policy can ever be. Leaders of the central bank have had to improvise answers to tremendously consequential questions. What should the Fed do to combat a severe financial crisis? (Pretty much anything they could think of, and then some, was the answer.)

… But now, the big questions of Fed policy have mostly been answered, all the more so after this week's meeting of the Federal Open Market Committee and the news conference on Wednesday by Janet L. Yellen, its chairwoman. And that is terrific news.

… You may not like the Fed's policy strategy. But the problems with it now are not a lack of clarity or transparency. Yes, something could come along to throw an unexpected wrench into all this, but if the American economy proceeds pretty much the way it has the last couple of years, with steady and gradually improving growth and few inflationary signs, we know what Ms. Yellen's policy will look like.

…That may be less exciting for those of us who make a career out of parsing the words that emanate from the Marriner S. Eccles Building, the Fed's headquarters here. But it's better for everybody else …

Stockman's analysis is rooted in theoretical reality rather than current reality. This sort of analysis is just plain nuts.

There's never been a central bank prognostication – or adjustment for that matter – that really worked out. No one in central banking anticipated the 2008 crash, though later reports tried to pretend that some "good, gray men" did get it right.

But they didn't. They can't. They won't. And this time won't be any different.

The idea that the next years are going to be smoothed by a recovery that will create a kind of Fed-on-autopilot is ludicrous. The Golden Bull remains in force, for instance. From the standpoint of the 1970s, we seem to be located around 1976 or 1977. We never had a gold runup and blowoff that would signal the end of the cycle.

What we had instead was an unprecedented central bank intervention and probably some sort of gold manipulation. And thus, this is a stock market on borrowed time.

It seems to us that this bull may run on for a while, thus making Stockman's predictions more wrong still. On the other hand, the fall is the market's bloodiest time …

And that's why we've pointed out that people should be careful if they are going to participate – that they should hedge and allocate and take profits to put into gold and silver.

This Wall Street Party is a wild ride, and wrong in so many ways. And yet there is no arguing with 28 percent.

After Thoughts

That's why David Stockman is wrong, even though he's very right.

Posted in Gold & Silver, STAFF NEWS & ANALYSIS
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