Interest Rates at Zero Until 2014 Mean Only One Thing

I have never seen anything like this…

In its most recent Federal Open Market Committee meeting, which concluded yesterday, the Federal Reserve announced that it would extend its near-zero interest rates policy until at least the end of 2014—further down the road from its previous timeline of mid-2013.

What this means for investors like me and you…

This historic move by the Fed (I have a feeling I’ll be using the “historic move” line again in 2012) is a bid to help the U.S. economy, which is obviously in the doldrums regardless of what the statistics say.

Businesses and the average person have now been told that higher interest rates won’t be an issue for at least the next 35 months. The idea is interest rates that are low will spur consumers to borrow and businesses to initiate capital projects (to create jobs).

But, hold on a minute. With consumers hobbled with debt they can’t pay off and jobs being scarce, won’t consumer demand remain weak?

The Fed’s decision not to raise interest rates for 35 more months will not spur economic growth, as it is up to the White House, and not the Fed, to repair the structural issues with the U.S. economy.

The Fed has cut its economic growth forecast for 2012 to 2.2% from 2.7% (I predict a further downward revision), while predicting 2.8% to 3.2% growth for 2013 (highly unlikely). Remember that these low growth rates are predicted in a period where short-term higher interest rates are nonexistent.

Yesterday, the Fed described the unemployment rate as “elevated” and acknowledged that business investment has slowed (issues I’ve been talking about) and, in light of this, it predicts that the U.S.unemployment rate will only come down slightly.

Dear reader; short-term interest rates have already been kept near zero for almost four years. This is unprecedented. Over the last 40 years, interest rates have normally been in the four percent to five percent range, with the Federal Funds Discount Rate moving at least one half of one percent, up or down, at least every six months.

Over the last four years, with interest rates at historical lows and the Fed expanding its balance sheet with QE1 and QE2, economic growth has been in the two percent range, which is far below growth rates from normal recovery periods after a recession.

And, during a normal economic recovery period, interest rates rise—they don’t decline!

The immediate conclusion is that we have not experienced a normal recession; it was closer to a depression. Nor have we experienced any type of meaningful recovery, which is what I’ve been saying all along (and the reason why I believe we will fall back into hard economic times once more before this is all over).

Precious metals and gold mining stocks reacted to the news that the Fed has decided to keep interest rates at zero until late 2014 by moving significantly higher in price. Gold bullion jumped almost three percent to over $1,700 an ounce yesterday. Why? Because real interest rates continue to remain negative and the real rate of return on short-term bonds is negative (i.e. loss of purchasing power).

Ultimately, what the Fed announced Wednesday—that it will keep short-term interest rates at zero until late 2014—will lead to greater inflation. Furthermore, with the Fed acknowledging that economic growth is slowing significantly, if economic growth continues to fall (which I believe will occur), then more money printing will happen. (See also: Lower Rates and More Money Printing: Just What We Don’t Need.)

I’m telling you; gold mining stocks and precious metals stocks are the place to be in 2012.

Michael’s Personal Notes:

Now it’s the blue-chip leaders in the stock market warning of slow growth.

The stock market has experienced a 20%-plus rise since October, spearheaded by blue-chip names. But the party may not last for long…the bear market rally is showing cracks.

Many companies have been reporting their fourth-quarter numbers with their earnings outlook for 2012:

Kimberly-Clark Corporation (NYSE/KMB), a worldwide consumer products blue-chip leader, reported fourth-quarter earnings that disappointed Wall Street and issued an earnings outlook for 2012 that was anything but rosy. The company cited a slowdown in developed economies—the U.S. and Europe being the principal ones—as what is reducing demand.

LM Ericsson Telephone Company (NASDAQ/ERIC), the world’s largest maker of equipment for mobile phone networks, surprised the market with a 50% drop in quarterly profit. The results were even worse than the blue-chip firm had anticipated, with its 2012 earnings outlook very weak.

Siemens AG (NYSE/SI),Europe’s blue-chip engineering group, also reported weak earnings and a tepid earnings outlook, as delays in orders impacted revenue and profits. Siemens warned that Europe is facing a mild recession.

What was surprising was not so much the trouble from Europe, but the fact that orders from China slowed 17% in the quarter, a source of growth Siemens was banking on.

Siemens’ earnings outlook calls for a pickup in growth in the second half of 2012. With consumer demand flat on its back in both the U.S. and Europe, which in turn is affecting the export markets in Asia, it is difficult to see where the rise in consumer demand is going to come from.

Expect earnings outlook reports from the major eurozone blue-chip companies to be very negative in the weeks and months ahead. The stock market is a leading indicator; it trades based on the earnings outlook for companies that trade in the market.

The bear market rally that started in March 2009 is unraveling on several fronts. Economic growth will slow worldwide in 2012 (see: 2012 Economic Growth Slashed Across Most Countries). Blue-chip companies from Asia, to Europe, to America are delivering earnings outlooks for 2012 that are negative. The most accommodative monetary policy we have seen in our lifetime, a combination of money printing and multi-year zero interest rate policies, will eventually lead to rapid inflation, which will bring interest rates higher.

Earnings outlooks from blue-chip companies that are negative, rapid inflation, and higher interest rates…a lethal three-way combination for stocks! Rapid inflation will not happen tomorrow. Neither will higher interest rates. They will creep in. But, remember, the stock market is a leading indicator. The market will head down before these events start to happen.

Where the Market Stands; Where it’s Headed:

We are in a bear market rally in stocks that started in March of 2009. Yesterday, by attempting to spur economic growth by saying it would keep interest rates near zero until the end of 2014, the Fed gave its first shot in months at extending the rally.

The next silo, I believe, to be fired by the Fed is QE3. After that, there’s not much that can be done to stop the bear market rally from expiring. Enjoy it while it lasts.

What He Said:

“Consumer confidence does not change overnight. In the U.S., 70% of GDP is based on consumer spending. And in my life, all the recessions I have seen or studied have only come to an end when consumers started spending. With consumer sentiment getting worse, and with the U.S. personal savings rate near record lows, it may take two or three years for consumers to start spending again.” Michael Lombardi, in PROFIT CONFIDENTIAL, February 25, 2008. By the end of 2008, the rest of the world was realizing that the recession would be much longer and deeper than most had realized.