There’s something going on in Europe that you need to know about. It could directly impact your portfolio, not in a good way. And no one else is telling you about it. Here’s what you need to know to protect your assets, and profit on the short side.
Unlike Vegas, what happens in Europe doesn’t stay in Europe. In fact, European banks and investors play a huge role in US markets. This is nothing new. After all, it was European investors who financed the exploration of the New World. French money helped finance the American Revolution. And so on.
While Europeans don’t play nearly as large a role in US markets as the Fed does, at the margin their participation is critical to the direction of the US Treasury market. And as the money used to purchase Treasuries passes into US dealer accounts it then has an impact on stock prices as well.
Bottom line: European money directly influences the bond market, and indirectly influences the stock market. And if they start pulling their cash out of our system…then what’s good for Europe could be very bad for the U.S.
In fact, it could help trigger a massive stock market crash this fall. Here’s how.
Europe Is Already Quietly Pulling Its Money Out of The U.S.
This one chart illustrates how European money directly impacts the bond market. When the ECB prints money through its QE or its occasional, massive lending programs, European bank deposits rise. Some of those deposits flow out of Europe and into the US when European dealers and investors purchase US Treasury bonds, notes, and bills. After all, 5 of the 23 US Primary Dealers are European. And the other 18 all have European operations. Money flows freely and instantly between European and US markets.
The correlations between ECB money printing, European bank deposits, and the behavior of the US bond market were very strong through mid 2016. The amount of European deposits increased or decreased in tandem with the size of the ECB balance sheet. The direction of the price of the 10 year US Treasury Note (price is the inverse of yield) moved in tandem with bank deposits.
But two strange things happened beginning last year. First, deposits stopped growing apace with the size of the ECB balance sheet. Then, since late last year, Treasuries began to lag behind surging European deposits.
Might the US election have had something to do with that? I spend 8 months a year outside the US in Europe and Canada, and I have seen that negative feelings toward the Trump Administration are especially strong both in Europe and in our neighbor to the north.
It would not surprise me at all that foreign investors might be pulling their cash out of the US. Since Trump was inaugurated, the US dollar has lost 10% of its value against the euro. That’s an indication that Europeans are repatriating their capital out of the US.
We’re also seeing evidence of this repatriation in European bank deposit data. The evidence is not showing up in total bank assets or total deposit growth because the European financial sector is shrinking itself as fast as it can.
But it is definitely showing up somewhere else.
Here’s Where Europe Is Putting Its Cash (Instead of America)
In spite of the lack of growth in total assets or liabilities, household and non financial corporate deposits have shown marked growth this year, significantly above the levels of prior to last November. That suggests repatriation of capital from the US. Concurrent strength in the euro supports that idea. So does a leveling of growth in US deposits, which I cover in my US Banking report.
While Europe’s weak sisters around the perimeter of the continent continue to lose deposits, that’s not the case in the EU’s two biggest economies, France and Germany.
Household deposits in Germany are up 4.9% year over year. German household deposit growth has accelerated since the US Presidential election in November. Deposits are up 3.5% since just before the election. There’s a deep distrust of Trump in Europe. The spurt in deposit growth post-election has the earmarks of Europeans repatriating funds that they had invested in the US. This trend will eventually begin to have a negative impact on US stock prices, particularly after the Fed pulls the plug, as it has indicated it would do, probably later this year. We need to be on the lookout for that in our regular reviews of the stock market technical indicators.
The annual growth rate of household deposits in France is now 5.4%.
Note that since the election of Donald Trump as US President, French household deposits have risen by 5.2%, a much faster rate than before the election. What else has changed? Nothing. As with Germany, this smacks of repatriation of assets, possibly resulting from distrust of the new US Administration. Trump has does nothing but encourage that.
Other forces in the US, such as the Fed buying MBS securities every month, continue to prop up US stock and bond prices. But the Fed has promised to reverse those purchases later this year and begin pulling funds out of the financial system. At that point, if the European capital repatriation trend does not reverse, it will be two strikes against US stock and bond prices.
For ECB money printing to prop up US stock prices, European investors must want to send their capital to the US. Throughout modern investment history, all capital roads have led to Wall Street at some point. This is the norm. But if European and other foreign investors lose faith in the US government, they will not only stop sending their money to the US, they’ll start pulling it out.
There are now signs that European individual investors have lost faith, and are taking their money back home to the Old World. If that’s the case, then what’s good for Europe, will indeed be very bad for the US.
Without European Support, We’re Headed for A Sharp Decline
After the election, I expected American investors to quickly lose confidence in the Trump Administration. It hasn’t happened. Those who make the markets are cynically, and I believe diabolically, holding prices up, in the face of potential chaos. The narrative that the US economy is growing with modest inflation and rising corporate profits has yet to be punctured. It is, after all, true up to this point. It’s relevant.
But it’s not the driver. It’s a corollary. Part of the reason that the US economy seems to be swimming along is that we are awash in excess liquidity. Some of that liquidity does flow into the US economy via government spending. But when liquidity begins to diminish, the first place that reduction will be felt is in the financial markets. Economic data won’t lead the market. Liquidity data will, Fed liquidity in particular.
While that’s going on, investors are being conditioned to continue buying as dealers and market insiders prepare for the fall. Meanwhile, at the margin, some European investors have a sense of what may be coming. They are tiptoeing out the door under cover of darkness. We shouldn’t ignore the signal they’re sending.
European dealers, banks, and investors were big helpers during the Fed-led the bull market in both US bonds and stocks. Without them actively buying at the margin, and even liquidating instead, the US markets would no longer have the support that European investors provided. That will aggravate the market’s decline when the Fed starts shrinking its balance sheet this fall.
This calls for a prudent program of reducing or hedging your exposure to US stocks and bonds, and even, for the more aggressive, placing long term bets in pilot short positions against the US stock and bond markets.
Note: A different version of this report originally appeared in the Wall Street Examiner Pro Trader European Banking Report on July 3s1, 2017.