Tag Archives: quantitative tightening

The Stock Market Would Crash Without Central Bank Support

The mis-pricing of money and credit has also driven a terrible misallocation of capital and kept unproductive zombie debtors alive for too long. Saxo Bank, “Beware The Global Policy Panic”

“Mis-pricing of money and credit” refers to the ability of the Fed to control interest rates and money supply.  Humans with character flaws and conflicting motivations performing a role that is best left to a free market.   After the market’s attempt in December to re-introduce two-way price discovery to the stock stock market, the Fed appears ready to fold on its “interest rate and balance sheet normalization” policy, whatever “normalization is supposed to mean.

Tesla is the perfect example of terribly misallocated capital enabling the transitory survival of a defective business model. Access to cheap, easy capital has enabled Elon Musk to defer the eventual fate of the Company for several years. But as the equity and credit markets become considerably less tolerant, companies with extreme financial and operational flaws are exposed, followed by a stock price price that plummets.

The Stock Market Would Crash Without Central Bank Support – A few weeks after Fed head, Jerome Powell, hinted that the Fed may hold off on more rate hikes, an article in the Wall St. Journal suggested that the Fed was considering halting its “Quantitative Tightening” program far sooner than expected, leaving the Fed’s balance sheet significantly a significantly higher level it’s original “normalization” plan.

But “normalization” in the context of leaving the Fed’s balance sheet significantly larger than its size when the financial crisis hit – $800 billion – simply means leaving a substantial amount of the money printed from “QE” in the financial system. This is a subtle acknowledgment by the Einsteins at the Fed that the U.S. economic and financial system would seize up without massive support by the Fed in the form of money printing.

I suggested in the January 13th issue of my Short Seller’s Journal that the Fed would likely halt QT: “The economy is headed toward a severe recession and I’m certain the key officials at the Fed and White House are aware of this (perhaps not Trump but some of his advisors). I suspect that the Fed’s monetary policy will be reversed in 2019. They’ll first announce halting QT. That should be bad news because of the implications about the true condition of the economy. But the hedge fund algos and retail day-trader zombies will buy that announcement. We will sell into that spike. Ultimately the market will sell-off when comes to understand that the last remaining prop in the stock market is the Fed.”

Little did I realize when I wrote that two weeks ago that the Fed would hint at halting QT less than two weeks later.

When this fails to re-stimulate economic activity, the Fed will eventually resume printing money. Assuming the report in the Wall Street Journal on Friday is true, this is a continuation of the “mis-pricing” of money credit alluded to above by Saxo Bank. Moreover, it reflects a Central Bank in panic mode in response to the recent attempt by the stock market to re-price significantly lower to a level that reflected economic reality.

The Fed Panics And Gold Soars

First it was the loudly broadcast convening of the Working Group on Financial Markets – aka “the  Plunge Protection Team” – by the PPT’s el Jefe, Steven Mnuchin.  This was followed the “mouse that roared” speech from Fed head, Jerome Powell, hinting that the Fed would moon-walk away from rate hikes.

Today was trial Hindenburg launched by the Wall St Journal suggesting that the Fed was considering curtailing the the FOMC’s balance sheet Weight Watchers program.  The terminology used to describe the Fed’s actions is Orwellian vernacular. “Reserve levels” – as in, “leaving more reserves on the Fed’s balance sheet” – sounds mundane. In plain-speak, this is simply the amount of money the Fed printed and will leave in the financial system or risk crashing the stock market.

I suggested in the January 13th issue of my Short Seller’s Journal that the Fed would likely halt QT: “The economy is headed toward a severe recession.  I’m certain the key officials at the Fed and White House are aware of this (perhaps not Trump but some of his advisors). I suspect that the Fed’s monetary policy will be reversed in 2019. They’ll first announce halting QT. That should be bad news because of the implications but the hedge fund algos and retail day-trader zombies will buy that announcement. We will sell into that spike.”

Little did I realize when I wrote that two weeks ago that the assertion would be validated just two weeks later. When this fails to re-stimulate economic activity, the Fed will eventually resume printing money.  Ultimately the market will figure out that it’s a very bad thing that the only thing holding up the stock market is the Fed.

The policy reversal by the Fed reflects panic at the Fed. Nothing reflects “Fed Panic” better than the price of gold:

The Four Most Dangerous Words In Investing…

“This time it’s different.” That quote is from Sir John Templeton, a legendary investor who is considered the father of the modern mutual fund industry. For most of the month of December, I’ve been hearing ads from mortgage brokers who are promoting the idea of refinancing your house in order to take care of holiday bills. It reminded of the early 2000’s when then Fed Chairman, Alan Greenspan, was urging Americans to use their house as “an ATM” by taking on home equity loans as a means of drawing out cash against home equity for consumption spending. Adding more debt against your house to pay off big credit card balances merely shifts household debt from one creditor to another. What’s worse, it frees up room under the credit card accounts to enable the consumer to take on even more debt.

In reference to the mortgage and housing market collapse in 2008, Ben Bernanke wrote, “Clearly, many of us at the Fed, including me, underestimated the extent of the housing bubble and the risks it posed.” It’s hard to know if that statement is genuine or not, given that many of us saw the housing bubble that was developing as early as 2004.

The Federal Government’s low-to-no down payment programs via Fannie Mae, Freddie Mac, the FHA, VHA and USDA, combined with the hyper-promotion of cash-out refinancings (bigger 1st mortgages and/or second-lien mortgages) tell me that, once again, most people in this country believe – or rather, hope – that the outcome will be different this time.

The graphic just below  is an interesting way to show the affect that Central Bank monetary inflation has on asset valuation vs income. Asset valuation should be theoretically derived from the income levels connected to the assets. Either the asset requires a certain level of income level to purchase and maintain the asset or the asset itself generates income/cash flow.

You’ll note the pattern that developed starting with the tech bubble era. Prior to the Clinton administration the Fed subtly intervened in the financial system by been printing money in excess of marginal wealth creation (GDP growth) once Nixon closed the gold window. But, in conjunction with the Greenspan Fed, the Government’s willingness to print money as an official policy tool took on a whole new dimension during the Clinton administration.  Note:  I’m not making a political judgment per se about the Clinton presidency, because the Fed’s ability to print money to prop up the stock market was established with Reagan’s Executive Order after the 1987 stock crash. You’ll note that the household net worth to income ratio began to rise at a sharp rate starting in mid-1994, which was when the Clinton-Rubin strong dollar policy was implemented. It’s also around the time that Greenspan began regularly printing money to address the series of financial problems that arose in the 1990’s.

The current ratio of household net worth to income is 6.75 – the highest household net worth to income ratio in history. It peaked around 6.5x in 2007 and 6.1x in early 2000. You’ll note that from 1986 to 1995 the ratio averaged just around 5.1x.

A graphic that is correlated to the household net worth/income ratio is the household net worth to GDP.  The pic to the right shows household net worth (assets minus debt) vs. a plot of the U.S. nominal GDP. As you can see, when the growth in household net worth deviates considerably from the growth in nominal GDP, bad things happen to asset values. Note: household assets consist primarily of a house and retirement funds. Currently the level of household net worth – that is, the value of homes and stock portfolios – relative to GDP is at its highest point in history. This will not end with happiness.

I wanted to present the two previous graphics and my accompanying analysis, in conjunction with the theme that “it is not different this time.” The extreme degree of household asset inflation relative to incremental GDP wealth output is yet another data-point indicating the high probability that a nasty stock market accident will occur sooner or later. To compound the severity of the problem, household asset inflation has been achieved primarily through massive credit creation. The amount of debt per home sold in this country currently is at a record level.

During this past week, the bullish sentiment of investors continued to soar.  A record level of investor bullishness never ends well for the stock market. Speaking of which, there has been an interesting development in the Conference Board’s Consumer Confidence metrics. The headline-reported index showed an unexpected declined from 129.5 to 122.1 vs 128 expected. This is a big percentage drop and a big drop vs Wall Street’s crystal ball. However, while the “present situation” index hit its highest level since April 2001, the “expectations” – or “hope” – metric plunged from 113.3 to 99.1. It seems the current euphoria connected to the stock and housing markets is not expected to last.

The chart above shows the spread in consumer confidence between “present conditions” and “future conditions” (present conditions minus future conditions). A rising line indicates that future outlook (“hope”) is diverging negatively from present conditions. I’ve marked with red lines the peaks in this divergence which also happen to correlate with stock market tops (1979, 1987/1989, 2000).

The above commentary in an excerpt from the last issue of IRD’s Short Seller’s Journal.  I think retail stocks are going to be hit relentlessly beginning some time this quarter. In fact, one stock I presented as a short in early December was down over 12% yesterday after it released an earnings warning.  Some of the best SSJ short ideas in 2017 were retailers.  You can learn more about this short-seller newsletter here:  Short Seller’s Journal subscription information.

“Congrats on the [retail stock short] call. What a disaster. You have to love how the chart collapsed with the news. These algos are going to destroy people when they unless selling on stocks eventually. I made a 8X on my puts. Now I need to roll them into something else.” – SSJ subscriber who actively trades