Liquidity Trumps Everything – For Now

The stock market chugs ever higher, but there seems to be little to support this run-up from a fundamental standpoint. For instance, fourth quarter corporate earnings for the SPX are expected to grow by 1.9%. Only three months ago they were estimated to grow by 9.9%. A little over six months ago the estimate was for 13.7% earnings growth. Three regional Fed business surveys in a row have come in way below expectations and the NFIB small business confidence index has just hit a three year low.

The main reasons why stocks keep getting bid up are probably the growing conviction that the euro area crisis is over (more on this below) and the acceleration in US money supply growth from an already elevated level. Below is a chart of the consolidated asset side of the Fed's balance sheet:

 


 

Fed-total assets

Assets held by the Federal Reserve – the central bank's balance sheet has hit a new high – click for better resolution.

 


 

This is expected to grow by another $1 trillion over the course of this year. Given the wobbly state of the economy – three of four major coincident indicators have topped out last summer already and are in decline – it is a good bet that the 'QE4' program will indeed continue for the remainder of this year. From 2014 onward, the Bank of Japan intends to monetize US t-bills to the tune of 10 trillion yen per month according to its latest inflationary plan announced yesterday.

 

Note here as an aside that Japan's money supply growth is actually decelerating markedly of late. Yen bears are so far relying on perceptions and announcements alone – but not on reality. The reality is that as of December 2012, Japan's true money supply (defined as currency plus all money substitutes exchangeable into standard money on demand) grew by a paltry 3.1% year on year, by an annualized 2.3% in the fourth quarter and actually shrank by an annualized 0.2% during the month of December. In short, money supply growth in Japan is slowing down from already very low levels. So far, no matter how fast the BoJ attempts to inflate, Japan's commercial banks are even faster in pulling back outstanding credit.

However, the US stock market is obviously driven by the Fed's inflationary ministrations, which are on the whole far more successful than Japan's. As of December 2012, broad US money supply TMS-2 growth has accelerated to 11.2% year-on-year, to 17.7% annualized in the forth quarter (note this is even before the Fed's 'QE4' program kicked in) and 29.6% annualized in the month of December. Now that's inflation!

 

Euro Area Fundamentals

A brief comment on the fundamental situation in euro-land: As we have already mentioned in our 2013 outlook piece, the most important positive development is that the periphery is regaining some of its lost competitiveness  as its wage and price differentials with Germany narrow. A recent chart by Morgan Stanley illustrates the situation:

 


 

competitiveness, euro-land

Euro area competitiveness indicators – the periphery sees a marked improvement.

 


 

Obviously financial market pressures on the debt of peripheral sovereigns has declined markedly as well, as can be seen in the 10-year government bond yields of Spain and Italy depicted below. Recently there has been extremely strong demand for Spain's sovereign debt at auctions, as the carry trade, respectively interest rate convergence speculation heats up.

 


 

Spain-10yryield

Spain's 10 year government bond yield: it's all good…but it hasn't yet broken below the major shelf of lateral support – click for better resolution.

 


 

 

Italy-10yryield

10 year government bond yield of Italy. At about 4.25% it is at its lowest since 2010, also hitting a level of lateral support (given by the 2010 summer highs) – click for better resolution.

 

 


 

So what's the problem? For one thing, although the pace of the economic contraction has recently slowed down somewhat, it still is a contraction. The main problem as far as we can see will be that the planned deficit targets will probably be missed – in some cases by a big margin. Especially Spain is set to miss its overoptimistic target, in all likelihood by up to 50%. Will the markets 'look beyond' such a miss as well? We actually doubt it.

 

The Syndrome

The Dow Jones Transportation Average has recently hit an all time high. Somehow we felt reminded of May 2008, when it also hit an all time high that was not confirmed by the DJ Industrial Average. Of course the fundamental backdrop cannot be compared, but it seems that such moves in the transportation stocks can at times turn out to be a late cycle phenomenon.

 


 

DJTA

The DJ Transportation Average hits a new all time high – click for better resolution.

 


 

DJIA

The DJ Industrial Average – close, but no cigar – click for better resolution.

 


 

John Hussman points out in his weekly rant that the suite of indicators he is watching exhibits the “overvalued, overbought, overbullish, rising-yields syndrome” that has historically almost always led to major market declines. The 'almost' qualification comes from two instances in 1964and 1997 when the signal didn't precede a major drawdown. According to Hussman these were however still not necessarily propitious times to invest:


“For optimists, there is a false one-week signal in 1997 – during the internet bubble – that was not associated with a negative follow-through. That is, as long as one ignores that the S&P 500 was essentially unchanged 5-years later, underperformed Treasury bills for the next 12 years, and even through last week’s advance, has outperformed Treasury bills by less than 2% annually in the nearly 16 years since then (all of which would be surrendered by even a run-of-the-mill bear market decline – and then some). There is also a fairly uneventful signal in mid-1964 that was not followed by near-term losses, though the market was still lower two years later and would underperform Treasury bills for the next 20 years.”

 

There is of course one reason why this time could turn out to be different  – the Fed's massive monetary pumping. After all, the great monetary experiment in train at the moment is a historic first (for the Fed at least). However, if we look at the classical indicators of positioning and sentiment, it is quite clear that the current juncture is eerily similar to the situation near major historical market peaks. For instance, if we combine NYSE margin debt (which is only a smidgen below its 2007 all time high) with the net speculative long position in stock index futures (close to an all time high as well), it looks like market participants are 'all in' and then some. This is also reflected in record low cash holdings. Hedge fund cash reserves are at a record low, while the mutual fund cash-to-assets ratio is only 20 basis points above a record low.

 


 

cash holdings

Hedge fund cash holdings: a record low

 


 

mu-fu-cash

The mutual fund cash-to-assets ratio: at 3.6% it is only 0.2% above the record low recorded in 2011 – click for better resolution.

 


 

The 2-week average of responses to the NAAIM survey of fund managers shows the bullish consensus close to a new high as well (the high was made in late December). Not every sentiment survey is close to a new high in bullish consensus, but that may actually be a reason for caution – divergences between the surveys are actually always seen near market peaks. In 2007 there were very marked divergences between the various surveys – and interestingly, it was the individual investors survey that showed the greatest lack of bullishness at the time (and these respondents turned out to be correct with their skepticism).

 


 

NAAIM-2week-average

The two week average of the NAAIM fund manager survey (purple line). Note that this is the net exposure that is calculated from a range of responses that lies between “200% short” and “200% long”. In other words, leveraged positions are considered as well. A net long exposure above 80% is well within the highest readings recorded in the survey's history.

 


 

Not surprisingly, the Hulbert stock sentiment measure (which measures the net long exposure recommended by stock market newsletter writers) is at an extreme level as well, but it is noteworthy that there is now actually a divergence between the sentiment measure and prices:

 


 

Hulbert stock sentiment

Hulbert's stock sentiment index is very high, but it was already higher when prices were still lower – click for better resolution.

 


 

Why such divergences between sentiment measures and prices can be important can be demonstrated by looking at a very long term chart of Market Vane's bullish consensus measure. There are two divergences marked on the chart: the one between the 1990s bull market and the 2007 high and the one between 2007 and today:

 


 

market vane

Market Vane's bullish consensus: two long term divergences – click for better resolution.

 


 

Along a similar line of thought, we find it noteworthy that the yields of so-called 'safe haven' (ha!) bonds continue to remain extremely low. It may well be possible that the yields on US treasury bonds are suppressed by the Fed's buying. However, experience actually says that this is not a good explanation – after all, yields rose markedly during 'QE1' and 'QE2', a sign that rising inflation expectations normally trump the Fed's buying. In any case, no such argument can be forwarded in the case of Germany's bond yields. Yes, they have risen a little bit – but not by a whole lot. If everything is hunky-dory, why is the market not putting more pressure on these bonds?

 


 

Germany-10yryield

Germany's 10-year Bund yield. Why is it still so low? – click for better resolution.

 


 

To summarize, in spite of abundant central bank provided liquidity lending support to the stock market, there continue to be plenty of reasons to be wary. If one dismisses the data presented above, one is in effect saying 'it is different this time'. That has invariably turned out to be a very costly attitude, regardless of the circumstances.

As John Hussman remarks, it is 'easy to dismiss' the warning signs, but then again, it always is. As Hussman notes, the idea that the Fed has removed all risk has become so widely embraced that this fact alone should ring alarm bells:


“My concerns here are understandably easy to dismiss given that the S&P 500 is now more than 5% higher than it was in March of last year, when our estimates of prospective return/risk (on a smoothed horizon from 2-weeks to 18 months) first plunged into most negative 1% of market history. Yet despite the intervening monetary heroics, history suggests not that these conditions will persist without resolution, but instead that their resolution is likely to be that much worse.

Anyone who followed me in 2000 or 2007 will easily recall a similar frustration before the bottom fell out of the market on each occasion. I can’t assure that the same will occur in the present case, but I believe it would be reckless to assume that the Fed has these risks covered. With margin debt over 2% of GDP as it was on three prior occasions – 2000, 2007 and early 2011 – it’s clear that investors are all-in when it comes to faith in the Fed. Still, when an investment thesis becomes so universally embraced and so apparently easy to follow that anyone who resists is considered foolish (as was the case with tech stocks in 2000), my risk aversion needle hits the red zone.”

 

(emphasis added)

This is indeed the crucial question: can the central bank remove all risk from the market? Hussman doubts it, and so do we. After all, the artificial low interest rate distorts prices across the economy and malinvestment and capital consumption therefore continue apace. At some point the economy will have to readjust no matter how much money is printed.

 


Charts by: Sentimentrader, BigCharts, NAAIM, St. Louis Fed, Morgan Stanley


 
 

Emigrate While You Can... Learn More

 
 

 

Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “US Stock Market – No Worries?”

  • benwood:

    I would think that the mutual fund cash balance level is being driven down due to QE. Cash pays next to nothing now, versus 3 to 6 percent in e.g. ’07. I’d think this Fed-incited distortion will produce an even greater all-in tenancy than ever before, implying to me at least that unless something tips the apple cart, that level could sink to the lowest level in history.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • French labour union workers and students attend a demonstration against the French labour law proposal in Marseille, France, as part of a nationwide labor reform protests and strikes, March 31, 2016. REUTERS/Jean-Paul Pelissier/File PhotoHow the Welfare State Dies
      Hollande Threatens to Ban Protests Brexit has diverted attention from another little drama playing out in Europe. As of the time of writing, if you Google “Hollande threatens to ban protests” or variations thereof, you will find Russian, South African and even Iranian press reports on the topic. Otherwise, it's basically crickets (sole exception: Politico).  Gee, we wonder why?   They don't like him anymore: 120.000 protesters recently turned Paris into a war zone. All...
  • offendFree Speech Under Attack
      Offending People Left and Right Bill Bonner, whose Diaries we republish here, is well-known for being an equal opportunity offender  - meaning that political affiliation, gender, age, or any other defining characteristics won't save worthy targets from getting offended. As far as we are concerned, we generally try not to be unnecessarily rude to people, but occasionally giving offense is not exactly beneath us either.   The motto of the equal opportunity...
  • The-answer-is-yesToward Freedom: Will The UK Write History?
      Mutating Promises We are less than one week away from the EU referendum, the moment when the British people will be called upon to make a historic decision – will they vote to “Brexit” or to “Bremain”? Both camps have been going at each other with fierce campaigns to tilt the vote in their direction, but according to the latest polls, with the “Leave” camp’s latest surge still within the margin of error, the outcome is too close to call.   The battle lines are...
  • water houseA Market Ready to Blow and the Flag of the Conquerors
      Bold Prediction MICHAELS, Maryland – The flag in front of our hotel flies at half-mast. The little town of St. Michaels is a tourist and conference destination on the Chesapeake Bay. It is far from Orlando, and even farther from Daesh (a.k.a. ISIL) and the Mideast.   St. Michaels, Maryland – the town that fooled the British (they say, today). Photo credit: Fletcher6   Out on the river, a sleek sailboat, with lacquered wood trim, glides by, making hardly a...
  • nails-in-a-bed-of-nails-new-yorker-cartoonGoing... Going... Gone! The EU Begins to Splinter
      Dark Social Mood Tsunami Washes Ashore Early this morning one might have been forgiven for thinking that Japan had probably just been hit by another tsunami. The Nikkei was down 1,300 points, the yen briefly soared above par. Gold had intermittently gained 100 smackers – if memory serves, the biggest nominal intra-day gain ever recorded (with the possible exception of one or two days in early 1980). Here is a picture of Haruhiko Kuroda in front of his Bloomberg monitor this...
  • queen_gold-840x501Rule Britannia
      A Glorious Day What a glorious day for Britain and anyone among you who continues to believe in the ideas of liberty, freedom, and sovereign democratic rule. The British people have cast their vote and I have never ever felt so relieved about having been wrong. Against all expectations, the leave camp somehow managed to push the referendum across the center line, with 51.9% of voters counted electing to leave the European Union.   Waving good-bye to...
  • junkThe Problem with Corporate Debt
      Taking Off Like a Rocket There are actually two problems with corporate debt. One is that there is too much of it... the other is that a lot of it appears to be going sour.   Harvey had a good time in recent years...well, not so much between mid 2014 and early 2016, but happy days are here again! Cartoon by Frank Modell   As a brief report at Marketwatch last week (widely ignored as far as we are aware) informs us:   “Businesses racked up debt in the...
  • MACAU, CHINA - JANUARY 28: Buildings of Macau Casino on January 28, 2013, Gambling tourism is Macau's biggest source of revenue, making up about fifty percent of the economy.What Could Possibly Go Wrong?
      A Convocation Of Gamblers The Wall Street Journal and BloombergView have just run articles on the shadow banking system in China.  This has put me in a nostalgic mood. About 35 years ago when I was living in Japan, I made a side trip to Hong Kong.   Asia's Sin City, Macau Photo credit: Nattee Chalermtiragool   I took the hydrofoil to Macau one afternoon and the same service back early the next morning.  On the morning trip, I am sure that I saw many of the...
  • saupload_loves-me-loves-me-notA Darwin Award for Capital Allocation
      Beyond Human Capacity Distilling down and projecting out the economy’s limitless spectrum of interrelationships is near impossible to do with any regular accuracy.  The inputs are too vast.  The relationships are too erratic.   The economy - complex and ever-changing interrelations. Image credit: Andrea Dionne   Quite frankly, keeping tabs on it all is beyond human capacity.  This also goes for the federal government.  Even with all their data gatherers and...
  • rate_hike_cartoon_10.15.2015_largeJanet Yellen’s $200-Trillion Debt Problem
      Blame “Brexit” BALTIMORE – The U.S. stock market broke its losing streak on Thursday [and even more so on Monday, ed.]. After five straight losing sessions, the Dow eked out a 92-point gain. The financial media didn’t know what to say about it. So, we ended up with the typical inanities, myths, and claptrap.   “Investors” are pushing the DJIA back up again..apparently any excuse will do at the moment. The idea may backfire though, as exactly the same thing happened...
  • deflated-souffleThe Fed’s  Doomsday Device
      Bezzle BALTIMORE –  Barron’s, in a lather, says the market is facing the “Two Horsemen of the Apocalypse.” Huh?   Only two? There were four last time!   Supposedly, the so-called Brexit – the vote in Britain this Thursday on whether to leave or remain in the European Union (EU) – and uncertainty over where the Fed will take U.S. interest rates are cutting down stocks faster than a Z-turn mower. But Brexit is a side show. As our contacts in London...
  • Brexit supporterGold and Brexit
      Going Up for the Wrong Reason Gold is soaring. It should—and a lot—but in my view not for the reason it is. Indeed gold is insurance for uncertain times, a time that Brexit seems to represent. But insurance is an administrative cost — one must minimize its use.   August gold contract, daily – gold has been strong of late, but this seems to be driven by “Brexit” fears - click to enlarge.   Moreover, insuring against Brexit might ironically be equivalent...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com