Paradoxical effects in the economy

We got a few down days early in the week, but still ended with new record highs on a number of indexes. Even the German DAX is clocking in new records. As I said last week, pullbacks can be very shallow as long as enough investors are looking for a chance to get back in. And December is normally not a month of big corrections. We have a few more days of lunar red period to go and then we will be starting another green period until the final days of the year. So, it seems to be increasingly likely that we will end 2014 at or near the highs. Or not?
Here is the current S&P 500 chart (click image to enlarge it):

S&P 500

The S&P has basically gone sideways for the past two weeks. Will it pull back or will it push higher?
There is room to rise to 2125-2150 before an overhead trend line comes into play. Technically the slower Earl2 (orange line) has clearly peaked, indicating a correction or sideways phase is starting. But the faster Earl (blue line) seems to be etching out a shallow bottom and may turn up again. It is dangerous when the market makes new highs with Earl below zero, because that has given some nasty drops in the past. We saw that as recently as early September. So no, it is not safe and we may see a sudden 5% drop if some rabbit gets pulled from a hat. But, December being December, we may just as well grind higher for the rest of 2014 and then get a pullback in early 2015.
Back to 2000, up to 2150, 2000 before 2150,… all are quite equally possible at this point. I don’t know.

One of the rabbits that many observers expect to see is a new quantitative easing (QE) program announcement by the ECB. We will see if that comes true. But I am wondering, what do they need QE for if just talking about it is already enough to lower the Euro and give the desired boost to exports (presumably)?
The problem is that once an economy is completely messed up by Central Tampering you start getting more and more paradoxical effects. Paradoxical effect is a term mainly used in medicine. A typical example is taking a medicine for pain relief and getting more pain as a result. So, this differs from the so-called unintended consequences, where action on a given point leads to undesirable outcomes elsewhere in the system. A paradoxical effect means we don’t get our intended result but its exact opposite.
And it doesn’t only happen in medicine. Another beautiful example, and one that every student should take a look into, is described in this study. Repeating information for two or three times will help to put it to memory. So, logically we would think that repeating it more often will lead to even better memory. Wrong! At some point more rote rehearsal starts having the paradoxical effect of making our memory worse.

Typically, paradoxical effects start to be seen when a certain saturation point is exceeded. I think we have already reached the point where zero interest rate policy and QE are having paradoxical effects. Instead of creating inflation they may lead to more deflation. How? As we see in Japan, the latest QE program has knocked down the value of the Yen. While this has temporarily pumped up their inflation rate by making exports more expensive, it also has prompted many Japanese to save more because now they figure that they will need more Yen to have a comfortable retirement. As a result of the drop in consumption they have an economic contraction that may eventually lead to even more deflation once the inflationary effect of the lower Yen fades away. And because consumption is down, Japanese businesses may decide to invest less rather than more.
There is also a second way in which zero interest rate policies can become deflationary. Zero interest rates make it cheap to invest in new capacity, easily leading to overcapacity in some sectors. It’s hard to get any real inflation when there are no shortages (and why would we want shortages anyway?). The overcapacity created by cheap money can become a deflationary force. That’s a paradoxical effect.
If they want higher inflation, then interest rates should be raised. That would raise costs for companies, bankrupt some of them, and lead to shortages down the road. Then we would have real inflation after a few years. But would anybody feel any better because of that?
Enough food for thought.

Be well,


By Dan

Author of LunaticTrader and Reversal Levels method. Stock market forecasts based on proprietary indicators, seasonal patterns and moon cycles.


  1. Interesting read. I think that repetition at some point stops to work, beacuse our mind starts to assume that the ‘object’ (word) is omnipresent and passive so there is no need to memorize : as much as we don’t notice things we see everyday or we find dificult to describe out of memory things we see or hear everyday. This applies to commerical adds as well, I think that people hammered with too much information stop to absorbe the add content. Another aspect is ‘active use’ : if we use something or learn by using, we memorize better and faster, but after too much repetition we get some kind of routine to do it automatically, without noticing or controlling it : we may forget a number we dial frequently, and recall it only by dialing. As to inflation, I have been living for the past couple of years as if some kind of inflation was about to come and many times I woke up thinking ‘gosh, all I got is paper’, so now I have things around me, for example 100 years’ supply of shaving razors or 150 photo cameras. Were I wrong? As to markets, we had a weak US session yesterday which may be the beginning of a pullback but still no technical signals to short.

      1. Intraday-wise the price behaves like at end of September/start of October, long sleek up and down drives, good volatility. So it’s like decent selling pressure meeting decent buying. Althought this pullback should continue, it would be nothing more than a pullback. At the October correction, every daily green candle was a sell signal. No green candles this time :) The chances for a down December I would rate now at 65%.

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