I’ve been watching a big football-related problem on TV this weekend – but not the one you might think.
If you consume a lot of mainstream financial media, you’ve probably heard dozens of analysts talking about a magical place where trillions and trillions of dollars are stored just waiting to get into the stock market.
I’m talking about “the sidelines.”
I’m sure you’ve heard it. A talking head on CNBC or Fox Business says something like “There are trillions of dollars on the sidelines, just waiting to jump into the markets.”
But here’s the thing…
“The sidelines” are just as much a fiction as Oz or Narnia or Westeros. They don’t exist. They’re a fabrication. Yet there’s no shortage of “experts” pointing to this financial fantasy land and positing that trillions of dollars will suddenly flood the financial markets.
The market is not a football field, and this is not a game, with players on the sideline just waiting to enter the game whenever the coach decides. The CNBC crew and its guest analysts act like they’re calling play by play with live color analysis. They just love colorful code words that make them look insightful.
But that’s not how the markets work. And any financial analyst worth his or her salt knows this. CNBC’s play callers and color analysts, however, are in the financial infomercial business. They’re not reporting financial news. They represent the marketers of securities trying to snag your investment dollars. Their job is to move you in the direction that their clients, the advertisers and program guests, want you to move.
Of course, in the last eight years, we have seen trillions of dollars appear from nowhere to inflate stock prices to the stratosphere. But it didn’t “come in off the sidelines” like some heroic quarterback jogging into the huddle to save the day.
The Fed printed it. It came from the Fed’s Quantitative Easing program.
As a reminder, this is how QE works…
As part of its Open Market Operations, the Fed buys bonds from the Primary Dealers – mostly Treasury bonds and mortgage bonds guaranteed by the government. When the Fed purchases these bonds, it credits the Primary Dealer’s Fed account with cash. The dealer gets cash in exchange for the bond it sold to the Fed.
Where did that cash come from?
Nowhere. The Fed created it. It didn’t exist before that. The money did not exist before the Fed purchased the bond. The dealer’s resulting cash deposit becomes the dealer’s asset held on deposit at the Fed.
And that money is then injected into the markets by Primary Dealers, who use it to buy securities, including stocks, and also bonds of course. But they bought plenty of stocks. Ben Bernanke even said they would in his famous November 2010 Washington Post editorial justifying QE2. And they did.
So this money didn’t come from “the sidelines.” It came literally out of nowhere.
Here’s Where This Financial “Fantasy Land” Came From…
When it comes to the worldwide pool of liquidity, there are no “sidelines.” This is not a football game. The money is in the banking system, and it circulates constantly through market transactions, the purchase and sale of securities.
Think about your own account. When you buy a stock, you pay a seller. Money goes from your account to the seller’s account. The seller is not on “the sidelines” and neither are you. You had the money yesterday, they have it today. Most of the time, the guy on the other side of your trade is a dealer whose time horizon is a lot shorter than years, maybe only days or minutes, or milliseconds.
So somebody else will be holding that money in short order. And so on.
Financial analysts talk about “the sidelines” as though there are just millions of players waiting to enter the game adding their cash to the market. It does not work that way.
There are no sidelines. There’s one massive pool of money. It exists all the time, and it circulates constantly. The stock market is just a point of transaction, a series of transactions. Money does not exist in the market. It exists in the banking system, all the time.
So why do so many analysts talk about the sidelines?
I’m no psychologist but, like you, I have been observing human behavior in the media and the markets for a long time. Most of us don’t pay much attention to the repetitive processes that take place in human interaction. But it’s part of my job to notice and to try and understand what’s going on. Doing that better informs my analysis and my understanding of the markets.
Financial journalists and Wall Street media talking heads are, like most humans, guilty of groupthink and herd behavior. It may be difficult to ascertain how a silly idea takes root, but once it does, it becomes the currency of pseudo-reality.
The idea germinates somewhere. Perhaps it comes from the lips of a clever and influential economist, or Fed Chair, or media analyst. Other talking heads hear it and think. Yeah, that sounds good. Then, what I call the Washington-Wall Street media echo chamber takes over.
Let’s face it. CNBC’s total daytime audience is tiny. Their average audience at any one time is no more than 200,000 people. But the performers who appear on its programming all know that other influential market players and spokesmen are listening. They want to sound smart, and they want to remain in step with their peers. The vast majority of them, other than the few “nutcase” permabears who are occasionally trotted out for ridicule, repeat these groundless myths so much that they simply become thought of as fact.
Take for example the idea that a 20% decline is an official bear market. Think about that for a minute. You will hear them say that about almost any instrument in creation, regardless of its normal volatility, or normal range of movement. For example, the Dow Jones Industrial Average has very low volatility. It rarely moves 20%. The NASDAQ, on the other hand, is more volatile. 20% moves are more common.
And what about commodities? How many times since the oil bear market started in 2014 has CNBC said that oil was in another bear market? It’s the same bear market folks. It’s not a new bull market when oil or any other commodity rises 20%, and then a new bear market when it falls 20%. That happens 2 or 3 times a year.
But you will hear this nonsense repeated over and over and over. And they even use the word “official” bear market. Official by what? What governing body has anointed 20% with some kind of official status?
No, it’s just groupthink, herd behavior, the media echo chamber at work.
How “The Sidelines” Can Hurt Your Bottom Line If You’re Not Careful
So it is with “money on the sidelines.” There are currently around $4.5 trillion in bank reserves. There are currently around $13.7 trillion in M2, money supply, which includes most common forms of money as we know it-checking and savings deposits and money market funds.
Is that a lot of money? Hell yeah, but in case the talking heads haven’t noticed, stock prices inflated all along with the growth of that pile of money. The money did its work, and now its work is done.
The two moved together because it is a mutual cause and effect relationship. The Fed created money by printing. The banks created money by lending. Money also flowed into the US from Europe and other places around the world where central banks were doing QE.
All that money flowed in while the supply of stocks remained relatively fixed.
What did we get as a result? The supply of money, the fuel for investment demand, increased massively. The supply of stocks did not increase at all. As a result, we got what we always get when too much money chases too few goods. INFLATION! But not in consumer prices. We got massive asset inflation, not just in stocks, but in bonds, real estate, art, and collectibles.
All of this massive money creation has done its work. It has created massive asset inflation. But it failed to create consumer price inflation.
We have now reached the point of exhaustion of this process.
How do I know that?
The Fed has TOLD us so! The Fed has tired of the fact that its money printing has only created asset inflation. They have admitted to themselves that the expected trickle down didn’t happen. All the money it created pooled at the top, in the hands of securities dealers, hedge funds, and other giant investors and leveraged speculators.
There has been plenty of inflation, in fact, an insane amount of asset inflation. But the Fed wasn’t able to force that down to consumer goods. The mechanism of monetary transmission, through Primary Dealer trading, insured that the money only impacted the financial sphere.
The Fed has now admitted defeat. Janet Yellen, to her credit, seems determined to reverse this massive monetary mistake. The Fed will now begin to withdraw money from the system. The amount of money available to support stock prices will decline at an accelerating rate over the next 12 months, and then it will continue at a high rate for another year or more.
No doubt, soon, the ECB and BoJ will stop adding money to the system as well. There’s evidence that the inflows of cash from Europe to the US have already begun to slow. If the ECB stops printing, those flows could stop altogether or even turn negative as Europeans repatriate their cash. The pool of money available to support US stock prices will shrink even faster.
If the Wall Street infomercial media wants to persist with this “money on the sidelines” mythology, you can look at it this way. All of that money supposedly on the sidelines will be retiring. In fact, it will be going to its extinction. It will no longer exist. On the sidelines, or anywhere else.
Keep selling into rallies.
And that brings me to this week’s LAMPP update. We have a signal change…
The Short Term LAMPP Has Finally Turned Red
The short term LAMPP has turned red. It’s only by a hair, but it did cross the line. This is no surprise to us. I have been reporting to you every week that we were getting closer and that a signal change was imminent.
I have been warning you that Treasury supply would soon increase radically. As expected, the Federal Government is now moving to raise the cash it needs to pay back the funds it raided internally under the debt ceiling and to rebuild cash. The Treasury will issue net new debt of $54 billion over the next few days.
At the same time, buyers of that new debt will no longer have the Fed’s help in financing those purchases. In October, the Fed will start draining cash from the system, instead of adding $25-$30 billion per month to Primary Dealer accounts as it has been doing.
The Long Term LAMPP signal should turn red within the next month or so.
All in all, this is not the time to be dawdling about selling some of your stocks and raising cash. Continue to do that on a regular basis in the months ahead. Get to your goal of having a substantial cash cushion. Mine is 60-70%. Only you and your adviser know what’s best for your situation.
Just don’t be fooled by rallies. With both the Fed and the Treasury pulling cash out of the system for the foreseeable future, don’t buy the dips! Sell the rips!