As you know, the Fed dictates the direction of the markets…but there’s actually a way to predict the Fed’s actions ahead of time. And this indicator is available to us every day in real time.
There’s an economic indicator (actually, indicators) that gives a much clearer picture of the U.S. economy than the official and unofficial economic statistics that are reported in the mainstream media. It’s hard cold data of what actually is. It’s not collected by survey, not constructed from tiny samples and then extrapolated a millionfold, and not manipulated by statisticians and economists. It isn’t misreported by the media because they never report it.
The U.S. Treasury publishes this data every day, one day after those taxes are collected. When it comes to the U.S. economy, it doesn’t get any more real time than that.
It is U.S. government tax collections, and right now it’s telling an important story that we all need to pay attention to.
But economists and Wall Street talking heads and PR merchants seemingly ignore this data. If they do track it, they don’t report it to us. I do. I have been tracking, accumulating, and reporting this data for many years.
Economic activity does not drive stock prices. Liquidity does. But if we know what the U.S. economy is actually doing, we can get an idea of how policy makers will respond to economic data. And since we’re up to date on the tax data, we know in advance what the lagging official economic statistics should tell them.
Sometimes, the massaged and manipulated official statistics don’t match up with reality. Then we know that the narrative about the economy that is being fed to investors is false.
All of that helps us to understand whether the current market trend is sustainable or not. It tells us whether the dominant narrative about the economy is mostly true or not. Most importantly, it tells us how central bankers, particularly the Fed Chair and the FOMC, will formulate policy.
And today’s “crystal ball” tells us something very interesting.
These Numbers Tell the Fed to Keep Right on Shrinking
The question today is whether the tax data supports a continuation of the bull market. Or conversely, will it tell policy makers to continue to tighten policy?
Janet Yellen has told us that the policy of “normalization,” which really means shrinking the balance sheet and pulling money out of the banking system, is on autopilot, barring “a material adverse event.” I expect that policy to end the bull market in the next year. I have given you the reasoning for that in previous reports.
Yellen did not define what she meant by “material adverse event.” But the clearest and most obvious such event would be a sharp decline in stock prices.
The media long ago declared that a 20% decline in the Dow is a bear market. My guess is that the Fed would start lowering interest rates as a first step in trying to stem a decline once that level is hit.
Lower interest rates alone won’t stop a bear market. Pumping money into the system will. Money is the fuel of demand. To turn a bear market around, first there needs to be more money. The market is likely to be down significantly more than 20% by then.
Right now, the market hasn’t even started down. So it’s a sure thing that real monetary tightening is near. Within a few months, that tightening will stop the bull market. Money is the fuel of demand for securities. When there’s less and less of it, there will be less and less buying. Stock prices will fall.
How does current tax data fit into that scenario?
Booming withholding tax collections tell us that top line official economic data will continue to show strength. As of October 3, a smoothed four-week moving total of withholding taxes collected by the IRS showed a whopping 8.3% gain. That’s before inflation. If wages are growing at 2.5%, then that implies real growth of 5.8%. Apparently, Trump is a genius! Or the luckiest man on the face of the earth. Stock market bubbles have a way of making presidents look smart.
On the other hand, maybe this is more about huge gains in withholding from those at the very top of the income spectrum and not about broad-based recovery. Big percentage gains by those earning millions could easily skew the topline totals to obscure weak gains, if any, in the middle of the spectrum.
I think that’s material in the long run, but in the short run, it doesn’t matter. Only the totals matter because that’s what investors and policy makers see.
The fact that there is no sign of recession is bearish. It will encourage the Fed to stay on course in its determination to begin shrinking its balance sheet. Markets top out when the economic news is good because that’s when the central bank “pulls the punchbowl.” And, make no mistake, this central bank is pulling the punchbowl.
However, if you look through the data the way I have, you’ll also notice some red flags. It looks as though the Fed may be pulling the punchbowl into an economy that is weakening below the surface. That’s a worst-of-all-worlds scenario.
Smaller Line Items Hint at a Weakening Economy, But…
The fly in the ointment is that other types of taxes are not booming. The gains in withholding are not showing up in the other key line items in the Daily Treasury Statement. Here’s a summary of those items from the September, end-of-month Daily Treasury Statement.
First, we should note that there was one fewer business day this September than in September 2016. Despite that, withholding taxes were still materially higher this September than last. The smoothed moving average method is a better indicator of withholding tax growth in this case even though it has a built in lag of a couple of weeks. In any case, withholding is strong.
Here’s what’s interesting. Individual and corporate estimated taxes would not have been affected by the calendar. They are due mid-month. So why the drop? We don’t know, but it could be a canary in the coal mine that profit margins in both big and small businesses are getting squeezed.
This is one to watch, but the next big, quarterly estimated tax collections are not until mid-January. If the economy is really slowing, we’ll see other clues before that.
The big drop in excise tax collections is a mystery. The excise tax calendar is complicated. Big bulges or drops in some months are not unusual. One tax was suspended for a time a few years ago, and there was a subsequent deferred collection that may have boosted September collections for a couple years. So we’ll just have to wait to see how excise taxes settle out over the next couple of months. I wouldn’t give the current drop any weight.
Individual quarterly estimated taxes were due in September. Collections were flat year over year. Small businesses and gig workers did not have a good quarter. That follows a so-so second quarter with growth that barely exceeded the growth rate of the CPI or wage rates. Q3 would have been negative in real terms.
It’s clear that self-employment income growth ended in 2015. Since then, they have been doing worse. Gig work is a tough gig.
A trend of falling individual income tax collections has now persisted off and on for over two years. Small businesses are apparently struggling to maintain profitability, probably even more than these lines suggest. That is because individual taxes include capital gains tax. We know that there have been immense capital gains in the past couple of years. If capital gains tax collections are growing, then individual taxes from sole proprietors and gig workers are falling even more than shown.
Quarterly corporate income taxes were also collected in September. These are estimated taxes for the third quarter. They declined by 5.3% year to year after a 4.9% decline in the second quarter.
Corporate earnings per share
may be rising, but gross corporate income taxes are falling. This is the shell game Wall Street is playing by buying back more shares than are being issued. It boosts EPS, but total profits aren’t growing.
Profits are slowly disappearing from the broader U.S. economy as the gains continue to pool at the very top of the economic spectrum. The economy has become little more than a massive skimming operation by corporate and financial plutocrats. Outsized income gains of corporate executives could explain the rapid growth in withholding. Job gains aren’t the driver. Rapidly increasing executive salaries are the likely culprit.
The U.S. economy is growing unevenly at best. The top-line numbers only count the totals. They do not consider the distribution of the benefits of economic growth. It appears that the masses are not experiencing the gains that those at the top are getting. The growth accruing to the top skews the totals, but, in reality, most households are just treading water.
This type of uneven growth will ultimately lead to a rapid degradation of the U.S. economy. But we do not know when. Will it be this year, next year, or in 20 years? It’s an interesting question, but not relevant to the question of the direction of stock prices over the intermediate term. That’s a function of liquidity.
Fed Monetary Tightening Will Lead to a Sell Signal Soon
Remember, these numbers help the Fed decide how much money to put into the banking system or, now, how much to take out. And that in turn is what shows up in the LAMPP and what directly impacts stock prices. (To learn more about what the LAMPP is and how we use it to profit, click here.)
There is nothing in this data that would deter me from continuing a systematic program of regular liquidation of a stock and bond portfolio to build a substantial cash holding by early next year. My personal goal would be to have at least 60-70% of my holdings in cash. But everyone’s situation is different. How much cash to hold would depend on a person’s age, income, personal goals, and comfort level with being largely out of the market.
When the evidence shows that the bull run has exhausted itself, I will be looking for opportunities to short the market via selling short market based ETFs, possibly buying inverse ETFs, or even buying puts. Success in shorting or put-buying requires good timing. It’s important not to be early. Since the market trend is still up, it’s still too early for that.
I will keep you posted and will alert you to lower-risk shorting opportunities right here. So stay tuned! The time is coming.