Could the Fed Cause Blood to Flow on US Streets?

“Bulls call 20pc gain, bears 5pc”

That was an Australian Financial Review headline back on the 4th January.

The paper had surveyed a bunch of stock market analysts asking for their year-end index forecast.

The most bullish was Alva DeVoy at Royal Bank of Scotland, forecasting the S&P/ASX 200 index to reach 5,700 points by the end of the year.

Most bearish was Paul Brunker at JPMorgan and Adnan Kucukalic at Credit Suisse – both forecast the index to reach just 5,000 points by 31st December this year.

How are they looking so far? It’s still early days…

On 4th January the S&P/ASX 200 index opened the year at 4,758.30 points.

At the close of trade yesterday it stood at 4,862.30… that’s a gain of 104 points… or 2%.

Better than a poke in the eye. But still not great.

But we do like the idea that stock market bears are now just analysts who think the market won’t go up as much as everyone else. What happened to bears being analysts who forecast falling markets?

Where are the real bears? We demand to know.

Local analysts aren’t the only ones calling for a big year. According to the Financial Times this week:

“Moody’s Investors Service and Standard & Poor’s have forecast another strong year of revenue growth, underlining the continued profitability of the credit rating agencies in spite of sharp criticism over their role in the financial crisis.”

Of course the ratings agencies are bullish. They always are. Until everything has goes pear-shaped. That’s when they issue their downgrades.

You saw them play that game with European government debt last year.

And it is a game. One helluva game. With central bankers calling all the shots. Because as far as they’re concerned the market isn’t allowed to fall this year… or ever!

Let me show you what I mean. It’s what I call the Torrent Effect of new money propping up and pushing up asset prices.

Money Morning reader Wesley Legrand of Grand Private Equities in Adelaide sent us this chart during the week:

If you’ve been in any doubt of the impact of central bank money-printing, this chart should clear things up.

There is a direct and inarguable link between rising asset and commodity prices and central bank money-printing. And while the following chart may not look quite as dramatic (due to the y axis scale) more proof is available if you look at the Index of Commodity Prices from the Reserve Bank of Australia (RBA):

Source: RBA

The blue line is commodity prices in Aussie dollars. The green line is commodity prices in US dollars. And the red line is Special Drawing Rights (SDRs), this is a basket of currencies used by the International Monetary Fund.

As you can see, in US dollar and SDR terms, commodity prices have gained about 73% since early 2009… roughly when the US Federal Reserve announced its first quantitative easing programme.

The beginning of QE2 late last year then helped give commodity prices another kick-along. And if QE2 doesn’t do the trick, then get ready for QE3. Here’s what US Federal Reserve chairman Ben Bernanke told media on Thursday in the US:

“If output is too low and unemployment is too high, then that would be a situation that requires more stimulus.”

It seems the Fed chairman and most others in the markets still don’t get it. They see higher US corporate earnings, but can’t figure out why this isn’t translating into lower unemployment.

The reason is simple. It goes something like this…

The US Fed prints a lot of money. This devalues the US dollar. The devaluation of the US dollar increases in US dollar terms the foreign-earned income by US companies. This is reported as higher revenues and higher profits by US companies.

But here’s the problem. Those US dollars are actually worth less than before. While the immediate impact shows an increase in revenues and earnings, when those same US companies need to reinvest in their business – buy more supplies, machinery, etc – they’ll find costs have risen.

Even if they pay out an increased dividend, shareholders will find the higher income won’t match the increased costs of goods and services.

By the time investors spend the money or businesses reinvest it, the windfall they thought they’d gained has gone.

And when your costs increase, especially raw materials which remember are up 73% in US dollar terms, odds are businesses will have to get by without hiring more workers. They may actually have to fire workers if costs have risen.

Pity those businesses that have been fooled into increasing investment in their firm in the false belief that the good times are back. They’ve paid out higher costs thinking customers will spend… only they won’t… or not enough to justify the increased business investment.

The fact is central bank money printing isn’t helping the US economy. It’s damaging it. It’s creating inflation. Inflation that gives the impression of increased wealth and increased profits.

But it’s all a cruel mirage.

And Bernanke’s solution for “more stimulus” will just make this even worse.

So the analysts surveyed by the AFR could be right. And so could the guys and girls at Moody’s and Standard & Poor’s – stock prices and commodity prices could move higher, but it won’t create any extra wealth for the economy.

All it will do is keep more people out of work, drive costs higher and lead to more blood on the streets.

The way the Federal Reserve is going it won’t be rioting on the streets of Tunis and Cairo it’ll have to worry about. The rioting will be on the streets of Baltimore and Detroit. Perhaps then Bernanke and his cronies may stop to think about the damage they’re causing… or perhaps they’ll decide that QE4 will fix it!

Cheers.
Kris.

Monday: Boy, it sure isn’t a good look for the land of the free and the home of the brave that American-made F-16s and M1 Abrams battle tanks are out in force across Egypt now. But cosmetics and theatrics aside, there’s a bigger story here: the entire geopolitical arrangement that has grown up around the U.S. dollar standard is unravelling. Click here for more…

Tuesday: One of the more banal and annoying statements we hear whenever share prices fall is that ‘markets hate uncertainty’. It gives the impression that the stock market would be fine if only things weren’t so uncertain. Click here for more…

Wednesday: Economic figures released in the States overnight show the recovery could be picking up steam. The Institute of Supply Management (ISM) manufacturing index rose to 60.8% in January from 58.5% in December. If the ISM figure is above 50% it means manufacturing is expanding. A 60.8% figure is a strong number. Click here for more…

Thursday: It has been a week for the commodity markets. Dr. Alex Cowie, editor of Diggers & Drillers has been banging on the copper drum for the past year or so. It’s paid off. After a big pull-back early last year, the copper price has been moving upwards and so have the Stock Doc’s tips. Click here for more…

Friday: This ‘George Soros tipoff’ could make you 226% to 389% in 24 months. (Just don’t share it with anyone else). Click here for the most intriguing stock story of 2011. Click here for more