Don't Fight the Fed

The bottom line today is that we still have a Federal Reserve (Fed) that is fully committed to resuscitating the US economy...and practically every monetary commission in the world is doing the same thing.  The best truism that I've heard in my 43 years of observing what really works in the stock market is: "Don't fight the Fed."  Investor psychology (as measured by our Psychology Composite) is very good at calling market bottoms and short-term corrections, but bull markets don't end until the Fed takes away the punch bowl.

In every instance when the Fed is priming the pump, the skeptics abound.  Why else would the Fed be "priming" the pump if the headlines were not still nervous?  We are still in the "bad news is good news" zone of this bull market.  That will remain until you see our Monetary Composite move into the M3 zone, and then "good news will be good news."  Yet, here's where our Asset Allocation Model stands today.


We've mentioned several times recently (with one example here) that there are a few "flies in the ointment" affecting the current ratings of our Psychology Composite; however, this morning, we want to focus on the ratings of our Monetary Composite.

Let me say it again, "Bull markets don't end until the Fed takes away the punch bowl," and that can be measured by a move to M5 or M6 by our Monetary Composite.  However, today (as you can see above) this composite is in the M2 category (and just barely, following its move from M1).

In my opinion, there is no better individual indicator to measure monetary liquidity than the yield curve (10-year Treasury vs. T-bill).


The ratio in the chart above isn't really viewed as being bearish until it gets dangerously close to zero.  As Warren Buffett is known for saying, the skinny dippers don't get exposed until the tide goes out.  When the monetary tide goes out, then those depending on heavy leverage (borrowed money) have to scramble to cover as the higher short-term rates are robbing their potential gains.  So when the yield curve (as seen in the chart above) gets down close to zero, it's a sign that the Fed is about to punish the drunks that have stayed too long at the party.  Yet, you can see that today's yield curve is still very much in the middle of the process, which suggests that, similar to many times in the past, this bull market is still alive.

So remember, the bottom line is that bull markets don't end until the Fed begins to take away the punch bowl, which is the opposite of their current approach.

Don Hays

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