What a
difference a week makes! Prior to this
week the markets were once again on a tear to infinity and beyond (to quote
Buzz Lightyear). Up more than 7.50% in
three months and all of this while the Federal Reserve is raising rates and
removing $50 Billion a month in liquidity.
The breadth of the market had shrunk to just a handful of names pulling
the markets forward and the cheering from the sidelines for Apple and then
Amazon to eclipse the $1 Trillion market capitalization mark was
unbearable. The market had finally lost
all links to reality and was tearing higher based on hope and the euphoria of
the previous decade of success.
A week later
and most of that gain is lost. The
losses are being blamed on short term profit taking and the fact that we are
entering earnings season so company buy-backs cannot support the market for the
moment. Hold on a second, the market is
rallying because the people who run the companies and who have no skin in the
game other than their gifted stock options are using the money given to them by
cheap loans to buy their overpriced stock so that they can benefit from the
increase in the price of the stock and THIS is what is supporting the
market! Wow reality definitely has left
the building as who in their right mind would invest money into the market if
this was the reason for market strength?
Looking at
reality shows a starkly different picture.
Yes, we have an historical low unemployment rate and yes company
earnings have been solid BUT the worker participation rate is still at multi
decade lows and the Federal Reserve is raising rates and withdrawing
liquidity. To date the impact of the withdrawal
of liquidity has been muted as the central bankers outside the USA continued
their lax policies. This has now changed
as Europe and Japan are removing their support as well. Added to this the trade wars that Trump is
waging with the rest of the globe are creating issues at home in the bond world
as previous large purchasers of US debt, namely Japan, China and Europe, are
now shunning the new issues moving the price of the bonds lower and propelling
the yields higher.
I have been
saying for a long time that should the 10-year Treasury yield reach 3.50% that
the market would be in trouble and recently it reached 3.23% within 27 basis
points of my target. This was the
inflection point for stocks which have sold off fast pushing the 10-year yield
down to 3.14% or almost 3.00%. I doubt
that the yield on the 10-year has reached its peak yet as the Federal Reserve
is continuing to raise rates and the government is running a massive $1.4
Trillion deficit and therefore has to sell more debt into a weak market. Both actions should continue to drive rates
higher in the short term but once the market breaks I expect a sharp reversal
in rates as the Fed pushes them down artificially once again. In fact, as far fetched as it seems, negative
interest rates will be the norm, but we will have to wait for that to unfold.
How do you run
a $1.4 Trillion deficit when you are in the longest expansion known to
man? Surely by now you should be running
surpluses as was the case back in 1999?
And what does this mean when a recession finally hits, and you are
called on to support the economy? Where
is that money to come from? There are so
many questions surrounding this issue it is like opening Pandora’s box, but the
short answer is that you are in a world of trouble BEFORE the market collapses
so the only thing you have left NOW is to raise taxes and cut expenditure
killing off what remains of the market rally.
The strategy used to support the market of cheap money is now gone and
once again has not worked!
As
the market is in the longest bull market in history, the only remaining reason
for the markets to rally is that consumers must be buying products left and
right and are flush with discretionary cash.
As I have mentioned before, while the economy has recovered somewhat, and
the unemployment rate is at all-time lows, not many have felt the benefit. The fat cats in their big leather chairs,
flying to work in their helicopters and going to trade shows in their private
jets have felt the impact of the support but they are alone. The average consumer is stretched with
massive credit card debt, automobile debt, student loan debt and housing debt
and with interest rates rising all of these are now costing them more each
month. Furthermore, with labor
participation rates at historic lows wage increases have not kept up with the
rate of inflation so the purchasing power of the consumer has weakened over the
past 10-years not strengthened. On top
of these issues the price of oil has crept higher and is now over $70 a barrel
up from $40 a barrel less than two years ago.
That is a 77.50% increase in less than two years. Healthcare expenses are up around the same rate
of increase and heaven help you if you make some money as once you move off the
subsidized health care programs to private programs rates triple! So no the US consumer is not the bastion of
support and this along with reduced international trade will severely impact
company results in the coming quarters.
Already
we are seeing the impact of the rate increases.
Last month house sales fell 1.5% year over year and car sales fell by
around the same amount. Both industries
are large employers and the ripple effects of a slow down in these two
industries will be wide felt. As an
example, the slow-down in the automotive industry will be felt in the chip
world as autos are a large consumer of tech innovations and the chip makers are
already reeling from lower smart phone sales and the lack of orders for
personal computers.
With
all of these roadblocks ahead I cannot imagine that the markets can recover
from here, but I have been wrong for so long that even I am starting to wonder
if a rally is not just around the corner.
What I do know is that money printing has never worked, every interest
rate hike cycle has ended in a market correction or a recession and every bull
market ends in a bear market. There is
no such thing as a Goldilocks economy as things are always overheating or too
cold and humans constantly think that they can “improve” the situation with
tinkering and the Federal Reserve is no exception. But as Clint Eastwood said’ “Don’t mess with
the bull young man or you’ll get the horns” or in this case a bear market.
