The Dow Jones was up for the week with its BEV plot below closing above its -10% line. Nothing wrong with that as it enters its third month correcting from its last all-time high of 26,616 of January 26th. As double digit corrections go, this one has been a fairly wimpy one – so far. The Dow Jones’ last correction occurred from May 2015 to July 2016 (fourteen months); twice the Dow Jones dipped below its -12.5% line in the BEV chart below, or 16,000 points on a point chart in August 2015 and again in February 2016. Since then the Dow Jones has put two years and 10,000 points behind it.

Assuming last Friday’s BEV value of only -11.58% will be the ultimate low of this correction seems a bit unreasonable. Considering the gains the Dow Jones has made since February 2016, expecting a correction lasting only a few months may be optimistic. So, if this were a normal bull market, I’d still expect deeper declines in the Dow Jones in the months to come before it once again resumes making new all-time highs.

C:UsersOwnerDocumentsFinancial Data ExcelBear Market RaceLong Term Market TrendsWk 542Chart #1   DJ BEV 2013_2018.gif

But this isn’t a normal bull market, and hasn’t been since Alan Greenspan became Chairman of the Federal Reserve in August 1987. Below is a chart plotting the Fed Funds Rate and the US T- Long Bond Yield from 1954. There’s a lot of history in this chart, but I’ve broken it into three eras:

  • “Policy Makers” Fight Inflation (1954-1982).  Monetary inflation flowing into consumer prices.

  • “Policy Makers” Fight Deflation (1983-2007).  Monetary inflation flowing into financial asset valuations.

  • “Policy Makers” Fight for Their Lives (2008-2018).  Risks of a catastrophic deflationary depression dominates “monetary policy.”

  • During the fighting inflation phase below, long bond yields (Red Plot), and Fed Funds Rate (Blue Plot) increased from low single digits to well over 10%. In July 1981, Fed Funds peaked at 22%!

    Bond yields were rising in response to “monetary policy” inflating consumer prices. The Fed Funds Rate was rising because the FOMC routinely increased its Fed Funds Rate above bond yields, hoping to check rising consumer prices by inducing the economy into a recession.  And the higher bond yields rose, the higher the FOMC had to raise its Fed Funds Rate to invert the yield curve.

    It wasn’t working. Consumer prices continued absorbing excess dollar production from the Federal Reserve like a sponge. By the late 1970s CPI inflation had increased to double digit percentages as gold and silver became the investment of choice by many people.

    Here’s a small sample of articles published by Barron’s during this period. These articles covered topics the financial media hadn’t written about for decades, but frequently did when bond yields increased from 1950 to 1981.

    Summarizing 1954 to 1982, the Federal Reserve’s inflationary monetary policy pushed the bond market into a twenty-eight year bear market. From 1966 to 1982 the stock market also underperformed increases in consumer prices.

    The Fed’s reaction to rising consumer prices (rising bond yields) was to invert the yield curve; increase their Fed Funds Rate above the yield for US long term T-bond, inducing the economy into a recession. The thing that stands out in the chart below is how frequently the Fed inverted the yield curve, and how far above bond yields they were willing to push their Fed Funds Rate to check consumer price inflation.

    C:UsersOwnerDocumentsFinancial Data ExcelBear Market RaceLong Term Market TrendsWk 542Chart #2   Fed Funds & Long Bond Yield.gif

    But inverting the yield curve didn’t have the desired effect of containing rising consumer prices. Consumer prices were rising because the Federal Reserve was issuing paper dollars into circulation in excess of what the Bretton Woods $35 gold peg allowed. However from January 1979 to October 1982, then Fed Chairman Paul Volcker increased his Fed Funds rate far above long bond yields, and held them there for over three years. Inflationary dollar flows streaming from the Federal Reserve stopped flowing into consumer prices, and began flowing into financial asset valuations.

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