The stock market spiked up last week as Trump started in with his trade war optimism tweets, which excited the algos and momentum chasers. As Monday rolled around, however, it was determined that a “Phase 1” trade agreement amounted to nothing more than a commitment from China to buy some farm products. On Tuesday China made the purchases contingent on Trump removing tariffs. So there is no “Phase 1” trade deal.
But the hedge fund computers don’t care. Now the market is bubbling higher on the reimplementation of Federal Reserve money printing. Call it whatever your want – QE, balance sheet growth, term repos, whatever. But the bottom line is that Fed is printing money and injecting it into the banking system, which thereby acts as a transmission mechanism channeling some portion of this liquidity into the stock market.
The semiconductor sector is traveling higher at the fastest rate as hedge fund computers and daytraders are chasing the highest beta stocks up the most. The SOXX index is pressing its all-time today. This is in complete disregard to underlying fundamentals in the sector which are melting down precipitously.
For the 1st ten days of October, exports from South Korea fell 8.5% YoY with chip exports down a staggering 27.2%. Remember back in January when the CEO of Lam Research forecast an upturn in 2H of 2019? Does that look like an industry upturn? Two of the world’s five largest chip manufacturers are based in S Korea: Samsung is the world’s largest and Hynix is ranked fourth.
Today the Fed’s daily money printing repo program surged to $87.7 billion, which is the highest since “QE Renewed” began in mid-September. Recall back then the popular Orwellian narrative explained that the “temporary” funding was necessary to address quarter-end cash needs by corporations and banks. Well, certainly the banks need the money…
But on Friday the Fed announced that it was going to extend the overnight and term repo operations at least until January. In addition, the Fed added a $60 billion per month T-bill purchasing program. The Fed explained that it was implementing the operation to supplement the liability side of its balance sheet. Besides currency and coin issued by the Fed, deposits from “depository institutions” – aka demand deposits from banks – represent the largest liability on the Fed’s balance sheet.
This means that this liability account needs more funding because either bank customers are holding less cash at banks OR banks need to increase reserves to maintain regulatory reserve ratios. The latter issue would imply that bank assets – aka loans – are deteriorating more quickly than the banks can raise the funds needed to meet reserve requirements. Given the recent data on MZM, it would appear that customer cash deposits at banks have increased recently. This implies that banks are experiencing stress in the performance of the loans and derivatives on their balance sheet, thereby requiring more reserve capital.
Money printing apologists want to point at DB or JPM as the target of the Fed’s money printing. And I’m certain they are among the largest contributors to the problem. But GS, MS, BAC, HSBC, C should be included in there as well. They’re all connected via derivatives and I’m guessing subprime asset exposure at all the big banks is blowing up, causing cash flow shortfalls and counterparty derivatives defaults on credit default and interest rate swaps. Just look at the dent WeWork is putting into the exposure to the failed unicorn at JPM and GS. Then there’s the melt-down going in energy/shale sector debt…
Eventually the Fed will have to announce that it is permanently implementing temporary liquidity relief programs – or “organic” balance sheet growth operations. Jerome Powell will take painstaking measures to assure the market this is not Quantitative Easing. And he’ll be right. That’s because it is outright money printing.
I expect the stock markets to get a temporary “meth” fix that pushes the SPX back up to the 3,000 area of resistance. I also expect that it will fail there again, triggering a sharp sell-off into the end of the year, similar to last year. The risk the Fed is running here by using more money printing to juice the stock market is that eventually – like all heroin or meth addicts – stocks will become immune to increasing doses of the happy drug. At what point will the Fed be forced administer a dosage level that kills the market?