The Dow has finally climbed passed 14000 for the first time since 2007. It’s still a few hundred points shy of the 14300 where I said it could go last April, but given the strength of the market and potential short coverings, we could see this number breached later in the year; especially considering that there still remains a record amount of money sitting on the sidelines.

However, we have to keep in mind that we just had one of the best January market performances in history, with the markets rising 12 out of the last 14 days. This could mean that near-term buying may soon be exhausted. 

Let’s also consider some historical factors. 

As I mentioned last week, the Dow Industrials has not performed this well since 1994. But that same best January in 1994 was followed by a nasty decline of 10% the month after.

Following an election year, the market has a tendency to go higher up until the beginning of February,  From here, it historically takes a slight correction for about two months before going higher and peaking around May. 

 

Believe it or not, QE has been working. Before you send me comments and angry letters saying otherwise, just hear me out. QE is not good for our future, but if you just take one look at the markets, you will see it has done what the Fed wanted it to do.

The goal of QE was to instill confidence in the market by inflating asset prices. The stock market is now back to near all-time highs and the price of assets around the world are near record bubble levels. 

While the market is still giving investors jitters, it has shown tremendous strength from QE. 

It may not feel like it for many Americans, but with the Dow breaching 14000, shareholders and investors have seemingly recovered more than $8 trillion in wealth lost during 2008. 

The market cycle has forced those investors who lost their money in 2008 out of the market, but has brought in new money from new investors. It has created a wave of new millionaires and billionaires, with the population of millionaires in America now higher than in 2007. 
According to the Federal Reserve, between 2007 and 2009, more than a third of the top one percent was replaced by new money.

And this new money is spending big time. 

Prices for wine, fine art, collectibles, luxury cars, jewellery, and watches are all climbing far past their 2007 highs. Prices for exotic mansion homes are also soaring. And the wait-list for Ferraris and Lamborghinis are back to pre-crisis levels.

How can anyone say QE hasn’t worked?

It would seem everything is back on track and back to normal. Employment is slowly rising again, along with housing. The stock market is back to pre-2008 levels and investor sentiment is climbing higher. We have been on a major bull run since the 2008 crash.

That’s scary. 

While QE most certainly has its positives, it also comes along with a lot of negative consequences. 

 

First of all, just like the banks around the world*, the Fed leverages its accounts and lends using the money that is assumed to be in their vaults. Banks never have 100% of their deposits in their vaults at any given time. As a matter of fact, they only keep very little money in their vaults, hence the name “fractional reserves.” 

(*the big difference between the Fed and other banks is that the Fed is the one bank that never gets audited.)

In short, every bank runs a Ponzi-like credit scheme. For example, when you go to the bank and deposit your money, the bank takes that money and lends it out to others willing to pay the price. The bank uses your money and receives interest from those who want to borrow it. 
But your bank never holds the same amount of money that has been deposited there. In other words, it lends money out, even if the money isn’t there. As more deposits are made, more credit is created; thus forcing a leveraged multiplier of credit that is ever-increasing. 

Everything has its cycle, including the banking system; including the Fed. 

When a bank begins to lend money, interest rates are setequal to the amount of money in the system. But as more credit is created, and thus more money in the system, interest rates begin to drop and the borrowing begins to become more speculative as both borrowers and lenders take on more risk. Eventually, this process multiplies and gets to the point where additional credit is required just to cover the interest payments on the original loans. 

Compare this to America’s current situation. Where do you think we are in the cycle of the banking system? 

Is America able to pay off its debt without having to borrow? No. 

Is America able to pay even the interest on its debt without borrowing money (ie. printing)? No.

What’s the eventual end result of the cycle? Accelerating inflation. 

We are seeing the markets move up, but it hasn’t moved up because of productive innovation or real growth. It has moved up because of market speculation based on cheap credit and a growing money supply. 

Investors and the CEOs of many junior companies can’t seem to understand why the bankers are not pouring money into small business development and transitioning them into the public markets. The answer is that the system is now dominated by leveraged speculation that hinders real growth. 

All of the money being created is being fuelled more and more into the hands of creditors and market speculators, and less and less into the real growth of the economy. That is why we will likely continue to achieve even less economic growth in the coming years, despite what the stock market is telling us. 

The current credit bubble in the US is now at $58 trillion and counting. The more money printed the less affect it has on the real world economy. Every dollar of new credit generates less and less dollars of real GDP. It now takes us $20 of new credit to generate $1 of real GDP; it took only $4 in the eighties. 

There’s no turning now. That is why Bernanke just announced last week that he isn’t close to easing up on the $85 billion in monthly bond purchases, despite remarks earlier in the month that hinted he might. 

Let’s get real. As I have mentioned time and time again, the printing cannot stop now; not until we see major growth in the economy or a major growth in inflation, neither of which seem within reach in the short term. 

Obama and the Fed will do whatever they can to spur growth. This includes allowing the no-money down mortgages again; the same strategy that pushed many homeowners into foreclosure during the housing bust.  

More credit will be forced into the economy through many different vehicles, leading a cycle that only ends with higher inflation in the long term. 

 

Luckily, the Canadian banking system is nowhere near as leveraged as the American. That means our currency is far better protected as we have less debt and less hyperbolic credit systems. That may also be the reason why many Canadians are choosing to keep their cash locked up, instead of pumping it into the Canadian markets.

In the last year, we have witnessed the US market, including the NASDAQ, DOW, and S&P 500, climb over 10%. Yet here we are with a much more stable monetary system, and our Canadian market remains subdued; climbing less than 2% over the last year and down nearly 2% over the last five. Meanwhile, in the last five years, the S&P is up over 13%, the Dow up 15%, and the NASDAQ up an astounding 38%. 

I’ve always said the retail market and the media is often late to the party, and that is how we’ve been able to accurately forecast market events. But when it comes to timing, no one is later than the Canadian market. 

So what do we do from here?

Again, I must stress that the market is fuelled by sentiment more than fundamentals. This is especially the case when it comes to our less liquid Canadian market. The fact that there are many Canadian companies trading at cash value says it all. We’ve done nothing for the last five years but watch the world markets climb. 

We need a real spark to get the Canadian markets moving again, and I am not exactly sure where it will come from at this point. 

However, from a historical timing perspective, now may be the time to get involved. 

From now until the first week of March, the TSX has outperformed, on average over the last 20 years, the S&P 500 by about 2.5%. Not only is it RRSP and TFSA contribution time, the seasonality of the TSX-dominated sectors (financials, energy, and materials) generally do well around this time. 

We’re already seeing the financial sector move up slowly, and energy has been climbing over the last 2 weeks (as predicted in Prepare for a Crisis two weeks ago). While the materials sector hasn’t produced results yet, we just saw the price of copper, nickel and zinc break above key resistance levels this week. While this hasn’t translated into stocks, we could see a little fuel into the sector over the next month. 

If the market continues in this speculative manner, we may soon see PE (Price-to-Earnings) ratios that are too high relative to growth risks. That’s when credit will be used in exchange for real assets such as gold, silver and real estate. This won’t happen overnight, but it is already slowly happening; beginning with the wealthiest people in the world…

The idea is to turn paper into something tangible such as gold and other commodities; anything that can’t be created or reproduced as easily and as fast as credit and currency.

I will be pulling the triggers on some new investments soon. 

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