I update each Saturday with my view of the stock market for the next few weeks (if occupied with family or travel, rarely I am a day or two late, just check back). The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a primary bear market, and buy back in for most of the next bull market. You can always scroll down a few weeks and find the latest “Long Term” update.
If you lose your bookmark to the blog, google “Rich Investing” and it should show up on the first page or so. The more often you google it and hit the link, the higher it will show in your results.
The monthly Long Term update was posted Wed., so scroll down for lots of good information on the position of the economy and stock market.
The four-week average of new unemployment claims nationwide, meanwhile, rose by 3,500 to 221,000. Existing home sales rose 1.9% in October, while the median price was up 6% over last year to $270,900. The leading economic index fell 0.1% in October to mark the third straight decline. The final consumer sentiment index in November was 96.8, above the October level of 95.5.
These economic statistics are concerning. Most concerning is that the leading economic index (LEI) has now fallen 3 months in a row. In general, this raises the probability of a recession beginning six months down the road. It does not always happen, but it happens often enough to be an indicator. Then we have unemployment claims ticking up, and +3,500 on the four week average is a significant uptick. I use the four week average so it is less sensitive to one week blips. Housing likes the low interest rates.
Today’s topic will be the Federal Reserve bond buying operations that recently restarted. It will be longer than I usually like, and I admit I am not an expert on central banking, I am not even moderately well informed. I know what I read and little more. I go back to an old theme of mine, when bubbles pop, it hurts. The dot com bubble burst in 2000 and it hurt, the mortgage bubble burst in 2008 and it hurt. I see a bubble in debt, government debt in particular. We have successfully managed our debt load for so long that some feel it cannot burst, the central bank can always bail us out because we are the United States and we have the strongest economy in the world. That is why things have worked for us, but everything has a limit. Some medicines can heal you, but if you take too much they can kill you. The US debt load and huge deficits will test that limit.
If the US government issues huge amounts of debt per year, who will buy it? Is there enough free cash in the world to finance a trillion dollars of new US debt per year? Japan and Europe have negative interest rates so their people buy US bonds to get some return. But what happens if we suck all the cash out of Europe? Who will finance the US debt? Apparently, the answer is the Federal Reserve, the US central bank.
At least one other market analyst is thinking along the same line, Ms. Lyn Alden. I found her website searching for information, and it is intriguing. She states:
To back up a bit for those that haven’t followed this chain of events, the U.S. government has been reliant for decades on foreign central banks and other foreign institutions buying our growing government debt. It used to be Europe and Japan buying most of it, and then with the rise of China in the early 2000’s, China became the biggest buyer.
But in late 2014, foreigners mostly stopped buying U.S. treasuries for the first time in several decades. So, for the past five years, U.S. institutions such as banks, pension funds, and corporations had to absorb over $3 trillion in new U.S. debt without foreign buyers helping to take some of the load, at the same time that U.S. deficits were expanding due to tax cuts that were not offset by decreases in spending.
My base case that I started writing about last year was that the Federal Reserve would begin monetizing debt during the next U.S. recession, which is why I started entering large long positions in gold, silver, and their associated mining and royalty companies in autumn 2018 for a portion of my portfolios. Those positions have since performed very well.
Two months ago in mid-September, domestic balance sheets seemingly ran out of space to absorb more and more government treasury bills. So, the U.S. Federal Reserve had to step in and start borrowing those treasuries from large banks in exchange for cash, which had run their cash levels down to regulatory lower limits in order to buy treasuries. As primary dealers, it’s the job of large banks to buy treasuries and make a market for them.
During that research process, I wrote on September 19th that the Federal Reserve would start permanently buying treasuries, and then elaborated with more detail over the next two weeks in a variety of articles and comments. For two examples:
This time, balance sheet expansion will be for a different reason, and they’ll need it whether or not there is severe economic deterioration (that would just accelerate their need for it). It’s a more specific problem. Domestic balance sheets, and particularly primary dealers, are tapped out and can’t hold the incoming deluge of more USTs at this point. This problem has been building for a year (and further back, about five years). The recent Treasury cash-refill and corporate tax payment timing are just the straw the broke the camel’s back (like a wave on a rising waterline that was already just under the top of its container, the wave wouldn’t have hit the top if the container wasn’t already 95% full). This will be different than an optional QE for injection. This will be QE to avoid hard limit of running out of liquidity among primary dealers that literally have trouble coming up with cash for more UST.
-Lyn Alden, September 25th, Seeking Alpha
The media reporting on the Sept. problem in the repo funding space was benign, and so was the reporting on the Fed restarting QE at $60 billion a month for six months. When I look at the body language and raised eyebrow looks when the TV talking heads mention it, it seems they know something they don’t want to say, like this is dangerous and the Fed is sounding like it is not. Greenspan said he saw nothing wrong with the expansion of exotic mortgage products in 2004-2006, and they brought down the banking system. You have to be suspicious of what the Fed says, they probably do not want to spook the people. And they lie at times.
The root of the problem is NOT the Fed, the root of the problem is the trillion dollar deficit the government has created by cutting taxes and increasing spending.
The importance of this topic to your investing is simply this, IS THERE ANOTHER FINANCIAL CRISIS LOOMING, AND IF SO WHAT SHOULD I DO ABOUT IT?
This is a scary ugly topic, one that most of us would rather avoid. Yet, if it is true, we must deal with it. We can deal with it well, or we can deal with it poorly, but we have to deal with it.
Can the US government pile up debt at phenomenal rates is generally good economic times, without end in sight, while the US economy perks along in good shape forever? For me, the answer is NO. I don’t know when it will hit, but I suspect we will take a hit. My best guess is the next recession things will get very uncomfortable. Do you have a Plan A (times are good), and do you have a Plan B (times are bad)?
The stock market lost about .5% last week on conflicting statements about progress on the China trade talks. Time is short to get anything signed by the end of the year, but we’ll see.
Technically the market is in fair shape. RSI at the top of the chart is near overbought, having pulled back a bit to 68. Momentum shown by MACD at the bottom of the chart looks like it is starting to decline slightly and the histograms are below zero. The price action last week was negative, but just slightly.
I don’t see the case for a significant rise to stock prices here. Earnings season was flat, GDP for Q3 was back to the 2% area we saw for much of the last decade, which is fine but not great. GDPNow for Q4 is estimating 1.6% which is lackluster. My concern is that just a few big companies with good business are driving up the index averages, but that can go on. You have to look at the valuation level of those companies and ask, how long can this go on?
Will the small selloff turn into something bigger? It could, or not. I think the market is waiting the outcome of the China trade talks and the whole thing seems to hinge on that. Depending on what is decided, the market could go up 5% or down 5%. That will be the short term reaction. Then, analysts will evaluate the deal and reality will set in, what does the deal say, who won, and is this really that good for the US? I expect a wennie of a deal, so initial exuberance may not hold.
What am I doing? Not much. I sold most stocks that I held during the uptrend from October. I hold lots of cash. I hold some TLT and it is up, I bought it for a short term trade because it had gotten oversold, I have a profit, and it will probably be sold soon. The case to keep TLT would be if the economy slows and the Fed continues to lower rates. The case to sell TLT would be the US signs a significant trade deal with China, tariffs get lowered and commerce flourishes, causing rates to rise and bond prices to fall.
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You can use the hyperlink below the chart of the S&P that will open a larger picture of the chart in a separate window. The reader who suggested this wants to look at the chart side-by-side with the blog text so he can look at the chart while reading the text. To do this in Firefox you can open a “private window” from the browser menu and have two instances of Firefox up, then size each window to about half of your monitor size. If you bookmark the link to the chart you can look at it each day of the week to see how the market is progressing to certain milestones. The picture in this post is a static .jpg so it does not update, but if you bookmark the link to the live chart on stockcharts and look at that daily, it does update.
Rich Comeau, Rich Investing