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    Fed impotence shifts power to politicians, can you afford the risk?

    September 23, 2020

September 23, 2020

Fed impotence shifts power to politicians, can you afford the risk?

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Contrary Thinker’s strategy is clear, its the process between short and long volatility

S&P 500 implied relative volatility is at new highs in the face of a 45% bull market by the underlying index. The level of VIX has been increasing as a bull market in fear is making new highs with the S&P new highs. The last time this technical event occurred was in the late 1999- early 2000 high pivot. So Contrary Thinker (CT) is clear the horizontal axis is the S&P price level, and the vertical axis is the VIX price level.

There is more volatility in the background with the presidential election coming up on November 3, 2020.  Historically, election-day changeability implies a swing higher or lower of 3% S&P and 3 1/2% Nasdaq.” Sources have these historical swings on a higher range of “change” expecting 2 ½ times the recorded amount on election day +/- a day.

If that is not enough, there is more that leaves the informed capital managers and advisors uneasy. While many continue to believe everything is back to normal from the economy to politics, the elite see a major disconnect between economic fundamentals and the stock markets. Hence, they are uncertain and searching for protection.

Why many market participants fail is by not understanding their own biases – like being fully invested all the time or believing asset allocation – some form of diversification – will provide Alpha.

Contrary Thinker at the end of 2017 – the lowest volatility year on record – began anticipating a transition to a far more volatile regime. At the end of 2017, I published my concerns and called (Market-Map-2018 1/18/18) the first quarter mini-crash in 2018 as a Regime change.  From that point forward, the market’s been a foghorn saying here it is, and yet, “short volatility” remains the idea to achieve Alpha, when faced with facts.

At that time, a regime of higher volatility appeared inevitable after 20 years of Neo-Liberal economics into 2000, and another 20 years of monetary interventions evolving into “preemptive monetary policy all of which left “The System” to be a ward of the State.

While the legends like Druckenmiller and Soros underestimated how the Fed can lift financial asset prices, they along with other independent capital managers and advisors also see the Feds impotence in its ability to stimulate the real economy. An inability that has unfolded over the last 20 years.

This is not a political point of view. It is part of a database of facts that everyone aka risk analyst/managers needs to work from. A fact like the wealth gap, to note a more noticeable result of the Fed failing.  It is this growing impotence that widened the chasm between asset prices and the real economy, simultaneously amplifying the wealth/income inequality and financial instability—the “disconnect” as it is being called in the social media.

The Fed understands this, Powell is increasingly calling on politicians to support monetary easing with increased deficit spending, aka monetary/fiscal coordination.

This Federal Reserve’s incapacity, as describe, transfers power from the central bankers to politicians. How does that shift impact your risk analysts? In context, how does that influence your risk management in a “contentious” presidential election year? Where streaming social media has the presidential race between a Communist and a Fascist.

Getting back to normal entails an independent central bank instead of playing the role of monetizing government debt.  But getting back to normal is painful, higher interest rates, higher commodity prices, higher wages, and there will be greater volatility on that side of the risk curve.

The flip side on the curve, with fiscal deficit spending determining the pace of economic growth, imports greater volatility into the system. Why? Because it is in the hands of politicians who, as their prime mover, may only have their seat of power considered and their “dreams of grand legacies.”

To be clear about tail risk, a change of parties on November 3, which inherits trillions of debts where small-dollar interest rate changes have little incremental real impact on economic growth. Thus, a move back to a normal focus on the economy vs “share-holder-capitalism – will lead the economy into recession and a dominos effect of defaults by States and significant businesses.

On the other side, where the core of power remains little change, the government’s fiscal and monetary policy coordination is applied to obscure – monetize- the problem and eventually deflate the dollar and in an attempt to inflate paper assets and bury the financial problem. Risk cuts both ways.

Contrary Thinking Starts Here

Great and Many Thanks

Jack F. Cahn, CMT

Contrary Thinker since 1989,
Copyright 1989-2020

Contrary Thinker 1775 E Palm Canyon Drive, Suite 110- box 176 Palm Springs, CA
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— Contrary Thinker does not assume the risk of its clients trading futures and offers no warranties expressed or implied. The opinions expressed here are my own and grounded in sources I believe to be reliable but not guaranteed.

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