There is evidence that deflationary forces are already taking hold in America

By Murray Gunn

When I was writing technical analysis reports for the customers of a major global bank, I received some interesting feedback from one of the bank's relationship managers. The customers liked the reports, she said, but it would be good if I made them less "technical." Making technical analysis reports less technical, hmmm. (To be fair, it is actually good advice because striking a balance between technical details and readability is an art.) Sometimes, though, an explanation of a concept cannot help but delve into some detail. So please bear with me on this one.
Evidence is emerging that banks in the U.S. are struggling to find the money required to fund their operations. The "Fed Funds Rate" that gets the headlines when it is changed by the Open Market Committee of the Federal Reserve is not the whole story when we are looking at the technicalities of the money market. That rate is actually the Fed Funds Target Rate (Upper Bound). You see, the Fed sets an interest rate range, currently between 2% and 2.25%. Every day, banks in America lend and borrow the reserves they hold at the Fed at a rate which fluctuates in between that range. That rate is called the Fed Funds Effective rate. If there is increasing demand for money from banks, the Effective Fed Funds rate will drift higher. Contrary to popular belief, therefore, the Fed does not control the Fed Funds rate.
But wait, there's yet another interest rate to consider. The Fed uses a rate called the Interest on Excess Reserves (IOER) as a tool to manipulate (sorry, influence) how close the Effective Fed Funds rate comes to the Target Rate (Upper Bound). If the Fed thinks that the Effective Rate is drifting too high, it will lower the IOER to encourage the Effective Rate back down (if the Effective Rate was above the IOER, banks would remove their excess reserves from the Fed to make more money by lending at the higher rate). I do hope you are still with me!
The Fed Funds Effective rate has been steadily rising in the range this year. In June, the Fed raised its Target Rate by 25 basis points but only raised the IOER by 20 basis points, a sign that it was concerned about the rising Effective Rate. However, the Fed Funds Effective rate has continued to rise. The chart below shows that the Effective Rate is now the same as the IOER and this indicates that there is still increasing demand for funds from banks.
The question is, why?
There are a number of explanations but one getting attention at the moment is whether banks are, essentially, running out of money. Since the Fed started taking away the liquidity punchbowl via its policy of Quantitative Tightening (QT) there has been increasing pressure on bank reserves, especially given that a lot of those reserves now have to be allocated to comply with new regulations. The relentless squeeze higher in the Fed Funds Effective rate could be a signal that banks are scrambling for funds.
The Fed itself does not buy that theory but, if there is an element of truth to it, here's the stunning conclusion. If banks are already scrambling for funding after QT has barely begun, imagine what it is going to look like in the future as the Fed seems hell-bent on continuing to reduce the size of its balance sheet. There may be a dawning realization that when you scratch the surface of the liquidity mask that the Fed created by Quantitative Easing, what lies beneath is still very ugly.

Murray Gunn has worked for several firms as a fund manager in global bonds, currencies and stocks, including long posts at Standard Life Investments, the Abu Dhabi Investment Authority and HSBC Bank as Head of Technical Analysis. He has served on the board of the Society of Technical Analysts (UK) and is editor of Elliott Wave International's European Financial Forecast Short Term Update.

This article was syndicated by Elliott Wave International and was originally published under the headline Deflation Alert: Money Already Scarce. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

How NOT to Be Among the MANY Investors Fooled by This Market Myth

By Elliott Wave International

October included a market phenomenon that left many economists and commentators scratching their heads.
US stocks and oil prices both dropped simultaneously. In fact, it was the worst month for oil in 2 years and the worst month for S&P 500 in over 7 years.
What was the "phenomenon"? Well, conventional wisdom says that rising oil prices are bearish for stocks. So, how could falling oil prices also be bearish for stocks?
In Chapter 2 of his seminal book, The Socionomic Theory of Finance, Robert Prechter covers 13 erroneous market correlations that most investor believe, but in fact are bogus. Armed with dozens of historical studies, Prechter scrutinizes the evidence regarding each claim. Here's what he writes about the supposed correlation between oil and stock prices.

(Note: If you haven't read The Socionomic Theory of Finance, you should. You'd be shocked how much of what you are fed is bogus. Learn more about the book, including how you can get it for free here.)

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Excerpted from The Socionomic Theory of Finance by Robert Prechter
Claim #2: "rising oil prices are bearish for stocks."
It would take months to collect all the statements that economists have made to the press over the past forty years to the effect that rising oil prices are "a concern" or that an unexpected (they're always unexpected) "oil price shock" would force them to adjust or rescind their bullish outlook for stocks and the economy. Academic papers supporting this claim are legion.
For many economists, the underlying assumption about causality in this case stems from the experience of 1973-1974 after the Arab Oil Embargo, when stock prices went down as oil prices went up. That juxtaposition appeared to fit a sensible story of causation regarding oil prices and stock prices, to wit: Rising oil prices increase the cost of energy and therefore reduce corporate profits and consumers' spending power, thus putting drags on stock prices and the economy.
These headlines are compatible with this claim:

Earnings, Lower Oil Prices Rally Stocks—USA Today, April 8, 2006
Surging Oil Prices Pull Stocks Lower—ABC News, July 14, 2006

Is the claim valid?

 

In response to these very headlines, the July 25, 2006 issue of The Elliott Wave Theorist offered Figure 6, showing the preceding three-year market environment. Examine it and see if you can discern any indication whatsoever that lower oil prices make stocks rise or vice versa. As I said at the time, "Oil and stocks have trended mostly in the same direction for more than three years, so these headlines are backwards." Switching to forecasting mode, that issue added, "A falling oil price probably won't be bullish for stocks, either. When deflation takes hold, they will probably both go down together." That's exactly what happened two years later, as you can see on the left-hand side of Figure 7.

One of the most revealing headlines of this period occurred a month into oil's crash:
It's hard to lose betting on stocks as oil falls
—USA Today,
August 12, 2008
The accompanying article offered a 20-year study that predicted how much each stock sector would rise during a bear market in oil. An economist and chief portfolio manager explained, "If oil prices are falling, a key cost for both consumers and businesses is also falling. It acts as a benefit for the stock market overall." A fellow money manager agreed, saying, "Nothing bad happens if oil prices keep falling. But if oil prices turn up, uh oh."¹ The causal case could hardly have been clearer. As it turns out, the very next trading day capped a three-week stock market rally, after which the Dow began to accelerate downward in its biggest bear market in three generations, all while plunging oil prices were providing their supposed benefit to consumers, businesses and the stock market.
On February 21, 2011, the price of oil rose for a day (ostensibly on unrest in the Middle East), and U.S. stocks fell. The media once again quoted many economists warning that an "oil-price shock" would be bearish for stocks and the economy. At least three world-class news publications ² ran lead editorials detailing the financial and economic damage said oil price shock might cause. Those assertions prompted our publication of Figure 7. Observe that as oil prices crashed 78% in five months, stock prices were cut in half; and then, as oil tripled, stocks doubled. These are not minor moves that one could dismiss as being anomalous. They include the biggest, fastest decline in oil prices ever along with the deepest stock market decline in 76 years, and the fastest oil-price-tripling on record along with the fastest two-year stock market rise in 72 years. Consider also that during most of the decline in both markets a recession was in progress, and during most of the rise in both markets an economic recovery was in progress. These are palpable refutations of economists' causal hypothesis.
No one looking at these histories could wrest from them the idea that rising oil prices "shock" the stock market into a decline and the economy into a contraction and vice versa. Only those not looking at data who are married to their causal explanation and who routinely ignore evidence could tell reporters in February 2011 that a one-day rise in the oil price was bearish for stocks and that further rises in its price would wreak havoc on the stock market and the economy. Yet dozens of experts did just that, in dozens of articles.
As with our interest-rates example, an economist could account for the evidence in Figure 7 and stay true to his exogenous-cause model by reversing the direction of his exogenous-cause argument—as we did earlier with respect to the stock market and interest rates—to postulate that an expanding economy makes stock prices and oil prices rise and fall together. He could offer the following logic: As the economy expands, business picks up, so stock prices rise; and as businesses operate at higher capacity, demand for energy rises, pushing up the price of oil. That's why prices for stocks and oil go up together. That makes sense, too, doesn't it?
An economist who made that case, however, would have to tell the media that the one-day rise in the oil price was bullish and that a falling oil price would jeopardize the stock market and the economy. Would economists ever say such a thing?
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In the rest of this chapter, Prechter investigates the correlations between stock prices and interest rates, corporate earnings, employment … and much, much more. It's an essential read for serious investors. Learn more here.

Watch This Indicator if You Want to Get Tipped Off to Approaching Volatility

By Elliott Wave International

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You're hearing a lot of explanations as to what's going on with the stock market. Here's an explanation you won't find in the mainstream – and it's one of the most useful of all.

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The stock market's volatility from late July through early October was extraordinarily low. For 50 straight days the S&P 500 had not closed more than 0.8% in either direction, the longest such streak since 1968.
Yet, on October 3, all that changed. The markets dropped hard… and the VIX suddenly spiked even harder.
The sudden explosion in volatility blindsided almost everyone – investors, media talking heads, economists and market watchers alike. Volatility is a great disruptor, but not in a Silicon Valley sense. Instead, think: bull in a China shop.
Could anything have foreseen this sudden reversal?
Most investors, and even pros, don't realize it: YES!
Several indicators reliably predict volatility. You just have to know about them. (For a good overview of the best ones, check out 5 Tells a Market May Be About to Reverse.)
Here's one: Watch the "bets" made by so-called Large Speculators, hedge funds and the like. As explained below, this is a contrary indicator. Here's what one market analyst, Steven Hochberg, told his subscribers about the indicator on October 8th, just before volatility spiked and stocks plunged:

Large Speculators are making their largest bet in nearly a year that market volatility will remain subdued. Last week, this cohort of speculators increased their net-short position in VIX futures to 140,444 contracts, the largest bet on a low VIX since November 2017. … Large Specs often make their biggest bets near trend reversals, catching them in wrong-way bets at the wrong time.

Large Specs and other "big boys" tend to make "wrong-way bets at the wrong time." That propensity was again on display just two days after the forecast you see above -- on Oct. 10, when the DJIA closed more than 800 points lower. That was the index's worst day in eight months, and the worst whipping for technology shares in seven years. Moreover, the volatility continued the very next day, with the DJIA closing down another 545 points.
Of course, volatility implies moves in both directions. By Oct. 16, the DJIA closed up more than 500 points, only to surrender more than 300 points on Oct. 18. Then came other triple-digit declines on Oct. 22-23.
The bottom line is that watching large speculators (and other sentiment metrics) can prepare you to take advantage of volatility rather than being blindsided by it.
If you are an investor who wants to be ready for volatility, download the 5 Tells a Market May Be About to Reverse report here, instantly. It's 100% free!

This article was syndicated by Elliott Wave International and was originally published under the headline Watch This Indicator if You Want to Get Tipped Off to Approaching Volatility. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

How NOT to Be Among the MANY Investors Fooled by This Market Myth

By Elliott Wave International

October included a market phenomenon that left many economists and commentators scratching their heads.
US stocks and oil prices both dropped simultaneously. In fact, it was the worst month for oil in 2 years and the worst month for S&P 500 in over 7 years.
What was the "phenomenon"? Well, conventional wisdom says that rising oil prices are bearish for stocks. So, how could falling oil prices also be bearish for stocks?
In Chapter 2 of his seminal book, The Socionomic Theory of Finance, Robert Prechter covers 13 erroneous market correlations that most investor believe, but in fact are bogus. Armed with dozens of historical studies, Prechter scrutinizes the evidence regarding each claim. Here's what he writes about the supposed correlation between oil and stock prices.

(Note: If you haven't read The Socionomic Theory of Finance, you should. You'd be shocked how much of what you are fed is bogus. Learn more about the book, including how you can get it for free here.)

---
Excerpted from The Socionomic Theory of Finance by Robert Prechter
Claim #2: "rising oil prices are bearish for stocks."
It would take months to collect all the statements that economists have made to the press over the past forty years to the effect that rising oil prices are "a concern" or that an unexpected (they're always unexpected) "oil price shock" would force them to adjust or rescind their bullish outlook for stocks and the economy. Academic papers supporting this claim are legion.
For many economists, the underlying assumption about causality in this case stems from the experience of 1973-1974 after the Arab Oil Embargo, when stock prices went down as oil prices went up. That juxtaposition appeared to fit a sensible story of causation regarding oil prices and stock prices, to wit: Rising oil prices increase the cost of energy and therefore reduce corporate profits and consumers' spending power, thus putting drags on stock prices and the economy.
These headlines are compatible with this claim:

Earnings, Lower Oil Prices Rally Stocks—USA Today, April 8, 2006
Surging Oil Prices Pull Stocks Lower—ABC News, July 14, 2006

Is the claim valid?

 

In response to these very headlines, the July 25, 2006 issue of The Elliott Wave Theorist offered Figure 6, showing the preceding three-year market environment. Examine it and see if you can discern any indication whatsoever that lower oil prices make stocks rise or vice versa. As I said at the time, "Oil and stocks have trended mostly in the same direction for more than three years, so these headlines are backwards." Switching to forecasting mode, that issue added, "A falling oil price probably won't be bullish for stocks, either. When deflation takes hold, they will probably both go down together." That's exactly what happened two years later, as you can see on the left-hand side of Figure 7.

One of the most revealing headlines of this period occurred a month into oil's crash:
It's hard to lose betting on stocks as oil falls
—USA Today,
August 12, 2008
The accompanying article offered a 20-year study that predicted how much each stock sector would rise during a bear market in oil. An economist and chief portfolio manager explained, "If oil prices are falling, a key cost for both consumers and businesses is also falling. It acts as a benefit for the stock market overall." A fellow money manager agreed, saying, "Nothing bad happens if oil prices keep falling. But if oil prices turn up, uh oh."¹ The causal case could hardly have been clearer. As it turns out, the very next trading day capped a three-week stock market rally, after which the Dow began to accelerate downward in its biggest bear market in three generations, all while plunging oil prices were providing their supposed benefit to consumers, businesses and the stock market.
On February 21, 2011, the price of oil rose for a day (ostensibly on unrest in the Middle East), and U.S. stocks fell. The media once again quoted many economists warning that an "oil-price shock" would be bearish for stocks and the economy. At least three world-class news publications ² ran lead editorials detailing the financial and economic damage said oil price shock might cause. Those assertions prompted our publication of Figure 7. Observe that as oil prices crashed 78% in five months, stock prices were cut in half; and then, as oil tripled, stocks doubled. These are not minor moves that one could dismiss as being anomalous. They include the biggest, fastest decline in oil prices ever along with the deepest stock market decline in 76 years, and the fastest oil-price-tripling on record along with the fastest two-year stock market rise in 72 years. Consider also that during most of the decline in both markets a recession was in progress, and during most of the rise in both markets an economic recovery was in progress. These are palpable refutations of economists' causal hypothesis.
No one looking at these histories could wrest from them the idea that rising oil prices "shock" the stock market into a decline and the economy into a contraction and vice versa. Only those not looking at data who are married to their causal explanation and who routinely ignore evidence could tell reporters in February 2011 that a one-day rise in the oil price was bearish for stocks and that further rises in its price would wreak havoc on the stock market and the economy. Yet dozens of experts did just that, in dozens of articles.
As with our interest-rates example, an economist could account for the evidence in Figure 7 and stay true to his exogenous-cause model by reversing the direction of his exogenous-cause argument—as we did earlier with respect to the stock market and interest rates—to postulate that an expanding economy makes stock prices and oil prices rise and fall together. He could offer the following logic: As the economy expands, business picks up, so stock prices rise; and as businesses operate at higher capacity, demand for energy rises, pushing up the price of oil. That's why prices for stocks and oil go up together. That makes sense, too, doesn't it?
An economist who made that case, however, would have to tell the media that the one-day rise in the oil price was bullish and that a falling oil price would jeopardize the stock market and the economy. Would economists ever say such a thing?
---
In the rest of this chapter, Prechter investigates the correlations between stock prices and interest rates, corporate earnings, employment … and much, much more. It's an essential read for serious investors. Learn more here.