Don't Mess With The Bull!

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.