As we saw with last month’s sell-off, the U.S. presidential election is already bringing some drama to the markets. But the real fireworks are still weeks away.

The country is divided, and passions run high on both sides of the political spectrum. Even if the economy were doing well, I would expect to see some serious risk reduction between now and November 3.

The U.S. stock markets started to sell off again this morning on news that President Trump tested positive for Covid-19.

I can easily envision another 10% to 15% drop between here and Election Night, as the market had become astonishingly overbought, and the fundamental outlook remains highly uncertain.

There are a number of factors driving my thought process, Trump’s diagnosis aside, so let me clarify why I am immediately bearish.

First of all, the behavior of Jerome Powell and the other Federal Reserve presidents has been quite remarkable, but not in a constructive way.

Powell, in particular, might be the world’s worst poker player.

During his recent Congressional testimony, he said 10 times that the central bank has a “powerful” new monetary policy roadmap for returning the U.S. to full employment and lifting inflation temporarily above 2%.

I lost count of the number of times he said “strong,” but I got to 49 before giving up out of boredom.

If Powell’s roadmap were so powerful, he wouldn’t need to keep telling us that. And he wouldn’t need to keep begging Congress for more fiscal support. Clearly, he’s very nervous about the shape of the economy, and his artillery is largely shot.

In fact, as I have pointed out multiple times, the Fed has become emasculated. They can print money, buy assets, and then pray that people will spend, but that is about all they can do right now.

They don’t see the benefit of going negative with interest rates, as that has proven to be a lousy catalyst for growth in Japan and Europe. That means lower rates are not going to be in the picture anytime soon. If they do come, it will be proof that the Fed has become overwhelmed with fear.

Balance sheets in every segment of society are already heavily leveraged, so people are unlikely to borrow more money for investing purposes whether interest rates are at 0.25%, minus 0.25%, or even minus 0.75%.

Powell knows that the Fed needs the pandemic to go away and the government to keep borrowing and spending. Well, the pandemic isn’t going away so fast, and the government is not cooperating with extra fiscal stimulus right now.

Trying to convince us that he is powerful and that he has everything under control is starting to backfire. More and more people are wondering what he is really scared of today.

Being more specific, the Democrats and Republicans are unlikely to agree on a new spending package before the election unless stocks have dropped at least an additional 15% to 20%.

Only then would the fine folks in Washington likely act, although it is not clear how long the positive reaction will last. Otherwise, we are probably looking at no major new initiatives for quite a while. This is bad news for the Fed.

Plus, it is not helpful when the Fed presidents regularly contradict one another and paint entirely different pictures of the country’s economic prospects.

Boston Fed president Eric Rosengren, for example, said we’ll be lucky if we get to 2% inflation within four years.

Really? And they don’t want to raise rates until we have an average inflation rate of 2% for a long time? We could easily be looking at zero interest rates for eight to 10 years if he is right.

Then we get Jim Bullard, president of the St. Louis Fed, saying that the fiscal stimulus already provided was more than needed, so we don’t need any more.

Depending on the Fed official, we get very disparate views on the world and the economic roadmap ahead of us.

That simply reinforces my view that they really are very confused right now. They don’t speak with one voice, and they appear somewhat desperate.

That impression is slowly sinking in, and I would expect the markets to test them to find out what ammunition they really have left in their arsenal.

My advice? Don’t be fooled by the false notion that the Fed’s super-easy monetary policy is an inviolable put option that will protect you from all downside market risk.

Stocks are in dangerous bubble territory. Tread carefully.

Regards,

Andy Krieger
Editor, Money Trends