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Tuesday, December 15, 2015 6:44 PM

Knowing the Unknowable; Reflections on the Fed Hike

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In the past week, two readers, one of them a blogger, professed to "know" something that cannot possibly be known.

"Epocalypse" Now

The first person, an economic blogger, tells me a global economic collapse of biblical proportion is coming. He labels the collapse an "epocalypse" and offered a guest-post article that I passed on.

I responded "No one knows the precise timing of a collapse. There might not even be one.
Stocks could do a slow decline like Japan for years."

You can start a countdown, because yesterday he pinged back "Check in with me at the end of the week."

Crunch Time

Reader "BL" wrote ...

Hello Mish,

It is crunch time. An escalation in interest rates will immediately bankrupt the United States because the country will be unable to service the eighteen plus trillion dollar debt.

The United States economy will collapse fifteen days after an increase in the interest rate. That is the real reason that Janet Yellen will do nothing forever. Do the math. What is the cost of a 1% increase in the national debt?

What are you afraid of? Speak the truth. Stocks are overvalued and will continue to be so until the crash. When will the crash occur? You know the answer. You have always known the answer. Tell the truth. The crash may occur before the next presidential election. What will that mean? You also know the answer to that question.

It is crunch time. Speak the truth or be buried by the truth. Your choice.

Impossible to Know the Unknowable

I responded to BL with the following challenge (slightly abbreviated from my original reply).
Anyone who claims they know precisely when stocks will collapse is either a fool or a charlatan.

But since you "know" stocks will collapse 15 days after a hike, I suggest you put everything you have on it with PUTs. What could you possibly be afraid of?

It's crunch time, do as you say or don't tell me you know what will happen. Your choice.
Second Thoughts

BL had second thoughts.
Hi Mish,

I appreciate your humor. Thus I take on the dual moniker of fool and charlatan.

So, you have two points. The first is that no one can "know" that the market will collapse if the "Fed" raises interest rates. And your second point is that only a fool or charlatan can claim that the market will collapse within 15 days of a raise in interest rates.

I actually believe you are better equipped than I to find and identify a number of macroeconomic reasons why the market will collapse with a raise in interest rates. You have touched on many of the reasons in the last year by pointing to other articles and sources.

We are not on opposite sides of a financial war. We are on the same side in the same battle. Up until now, it has been a "cold" war. It becomes a "hot" war when stocks go down precipitously. Then what happens?

Thank you for responding. It means you are listening to your readers. That's a good thing.

Reflections on the Fed Hike

We can all find countless reasons why the stock market should sink. But we had the same reasons a year ago, even two years ago.

Will a simple hike be enough to prick the bubble? Don't be so sure.

Recall that the stock market rose for two years after housing topped. I have the peak of housing summer of 2005. Case-Shiller has it summer 2006.

I believe Case-Shiller misses the mark because of under-the-table kickbacks like free cars, free trips, and even free cash back at closing that were not accurately accounted for.

Regardless, even if Summer of 2006 was the top, the market rose for another 16 months after housing topped. So why can't the market rise for another three months or more after a hike?


Realistically, 1/8 or 1/4 point will do nothing fundamentally. As a function of sentiment, it's entirely conceivable a smaller than expected hike causes a spike-high euphoria.

How Big the Hike?

I made the claim many times over the past few months that if the Fed hiked, it would likely be by 1/8 point (12.5 basis points). We will see. But even if the Fed gives the expected range of 25-50 basis points tomorrow (up from 0-25), that does not mean I was wrong.

We have to see where the Fed actually targets the rate within the range it provides. If the fed targets 25 basis points, up from roughly 12.5 then a 1/8 of a point hike was the correct call.

Gaming the Reaction

What will the reaction be to a range of 25-37.5 basis points? To a range of 25-50 hike with an initial target of 25? With an initial target of 37.5?

How the hell can anyone possibly know? The Fed doesn't even know.

Any reaction is possible tomorrow, including nothing. And a big yawn would wipe out both PUTs and CALLs by everyone who thinks something must happen. The winner in that scenario would be the option sellers, not buyers.

It's all a guess. I have no particular edge as to what happens over the course of the next two weeks let alone three days. I believe I do have an edge as to what happens over the long haul when valuations get as stretched as these.

The important point is neither sentiment nor valuation is a timing mechanism. To that one can add baby step interest rate hikes that are fundamentally meaningless.

I strongly advise market participants to not act as if they know that which is simply unknowable. 

Mike "Mish" Shedlock

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