Shock and Awe
Flexible Plan Investments
By Jerry Wagner
September 18, 2012
Almost twenty years ago, the US initiated a campaign of “Shock and Awe” with its bombing campaign on the Iraqi capital city of Bagdad. According to Wikipedia:
‘Shock and Awe’ (technically known as rapid dominance) is a military doctrine based on the use of overwhelming power, dominant battlefield awareness, dominant maneuvers, and spectacular displays of force to paralyze an adversary’s perception of the battlefield and destroy its will to fight. The doctrine was written by Harlan K. Ullman and James P. Wade in 1996 and is a product of the National Defense University of the United States.
In the case of Iraq, the bombing campaign commenced on March 21, 2003 with approximately 1,700 precision air sorties of which 504 were using cruise missiles. Coalition forces marched into Bagdad on April 5th of that year. Film from that night.
I bring this up because some commentators are comparing the Federal Reserve announcement made last week (not to mention the shocking new Arab unrest and murder of our Ambassador!) to the “Shock and Awe” of the first day of the Iraq War. In that announcement, the Fed’s Chairman Bernanke announced that it would buy agency-backed, mortgage-backed securities and long-term Treasurys, expanding its balance sheet by around $85 billion a month through the end of the year.
What made it “Shock and Awe” was that the new Fed policy differed, according to John Carney at CNBC, in three ways from past Fed actions. First, it was unlimited in time. There was no termination date, causing commentators to designate it QEI or Quantitative Easing Infinity, instead of following the custom with QE3 after the previous QE1 and QE2. Second, it focused not on fighting inflation but instead on generating jobs. Now, we know that the Fed can’t directly generate jobs. But it hopes that by putting pressure on interest rates, rates will stay low and stimulate the economy (regardless of the fact that three years of the same medicine have not brought unemployment down substantially). Different from any previous Fed action on interest rates, this one’s success and duration are to be determined purely by the employment picture here in the US.
Third, Bernanke went to great lengths to assure the markets that the Fed’s actions were not the result of a weakening economy. While this is the usual reason for Fed policy moves, the Chairman made clear that he thought the economy was still in recovery mode, just recovering way too slowly.
Yet despite what the Chairman was saying, the week’s economic reports were, if anything, neutral. Of the fourteen reports last week, seven were stronger than expected, six were weaker, and one was the same. It was hardly a show of strength, and employment numbers were again the worst of the lot. At the same time, the sentiment numbers from three different sources all shot higher, suggesting optimism among the populace and encouragement for the President’s reelection.
And interest rates did not retreat as expected; instead, they rose a bit in reaction to the news.
As I have explained the last few weeks, these quantitative easing programs, once they’ve ended, have little effect on bonds and most other asset classes. Commodities, like gold, tend to do best as inflation accelerates and the dollar weakens.
In fact, most asset classes ranked as more risky will do better during this time of QEI. When the Fed turns on the printing presses, “risk is on!” Bonds and currency trades tend to suffer. For another example, check out the Dollar.
We were rallying substantially earlier this year (while I was in Europe, thank you very much!), but now we are in a steep decline. As I demonstrated here with our QE2 analysis, the dollar will likely continue to suffer during quantitative easing this time as well.
Gold did soar last week and so did the stock market. While the Street has been calling the Fed move “Shock and Awe,” our readers were not surprised. We have been suggesting such a move was highly probable for weeks. Nor should you be surprised by the stock market reaction. We have continued to be positive on stocks throughout the summer and our account values generally reflect stocks’ ascent.
We have warned that September can bring a correction in a Presidential Election year, but that it was likely to be a pause. We also counseled to beware of Mondays, and today is not disappointing. Just as has been the case most of the year, this Monday is down again, even in an up-trending market.
Finally, you need to be careful at this juncture. The euphoria and “shock and awe” from the Fed announcement have dazed the bears. Stocks have shot to new rally highs. In fact, a couple of indexes (the Russell 2000, Dow Industrials and S&P 500) are close to finally reaching breakeven with their October 2007 all-time high levels. The through-the-roof returns last week on some of these indexes suggest that they are overbought and primed for a decline. The bears may shake their heads, clear their minds and offer some stiff resistance.
See how the S&P shot straight up last week and pierced the overbought red danger zone on the chart:
Despite these new highs, and some short-term concerns, I have little doubt that stocks in this QEI environment are going to be higher by year’s end. Many of the sector asset classes that make up the S&P still have a very long way to go to catch up to their all-time highs reached five years ago. Notice that Technology, Telecommunications and Financials still need 95% or better return to get back to break-even!
There is still room for stocks to grow. And when the S&P is up, as it is this year by more than 10% by mid-September, the market has gone higher most years – in fact, following 1987, it has continued higher in every year where the YTD return exceeded 10% (seven instances). And in Presidential election years, it’s done that regardless of which party wins.
On April 27th, within two weeks of the United States’ victory declaration in the Iraq War, The Washington Post published an interview with Iraqi military personnel detailing their demoralization and lack of command in the face of the “Shock and Awe.” According to the Iraqi soldiers, Coalition bombing was surprisingly widespread and had a severely demoralizing effect. (Wikipedia)
In contrast, Wikipedia also reports, “in an October 2003 presentation to the United States House Committee on Armed Services, staff of the United States Army War College did not attribute their performance to rapid dominance (“Shock and Awe”). Rather, they cited technological superiority and “Iraqi ineptitude.”
So it is with the latest “Shock and Awe” – the Fed’s action can create the right environment for victory – but you still need the Flexible Plan troops on the ground and the technology that our computer-based strategies bring to bear to try to take advantage of the targets of opportunity that are suddenly everywhere.
All the best,
Election Year Update:
RealClearPolitics two-month average: Obama +3.0%
Average of Likely Voter polls: +3.1
On this date in 2008: Tied
On this date in 2004: Bush +5.7%
14 Battleground State Polls (10 reporting since conventions):
RealClearPolitics two-month average: 7 Obama/3 Romney
Last State poll: 7 Obama/3 Romney
Improving over average poll: 4 Romney/6 Obama
All but Oregon, Nevada, Iowa and Wisconsin were completed after both conventions.
The latest Rasmussen 3-day tracking poll came out today. This poll of Likely Voters is the largest likely voter poll (500 participants) and was the most accurate in calling 2008′s election. It had Romney up by 2%! More Shock and Awe???? Go figure???
This entry was posted in In My Opinion and tagged asset classes, Bonds, Chairman Bernanke, Commodities, Dow Industrials, Federal Reserve, Gold, Presidential Election Year, Russell 2000, S&P 500, Shock & Awe, US dollar index by Jerry Wagner. Bookmark the permalink.
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