I’m no prophet. Well, not exactly. But my technical analysis is uncannily accurate.
As I was working on my Federal Revenues Report this week for The Wall Street Examiner Pro Trader, I noticed three very telling signs that we are indeed entering a bear market.
I wouldn’t wear a sandwich board saying “The end is nigh,” but I might just hold up one of these three charts.
Sign #1: Rising Treasury Cash
Withholding tax collections pulled back a little over the past few weeks, but the trend remains strong. This means that top-line economic data will continue to look strong, despite the steady hollowing out of the U.S. middle class.
Therefore, the theme continues to be that the lack of any sign of material weakness would encourage the Fed to stay on track for a real tightening of monetary policy. “Real tightening” means shrinking the balance sheet, not the sham tightening of increasing the interest rate subsidy to the banks by increasing interest on excess reserves.
The Fed has made it official that the real tightening started in October as the Fed took the first step toward shrinking its balance sheet. That will pull money out of the banking system. The program starts very gradually. The effects will be minimal at first. But over time it will increasingly reduce the pool of cash available to purchase stocks and bonds. This has set up the conditions for a bearish stock market, but, as I wrote last month, it “won’t necessarily trigger them immediately.”
With the lifting of the debt ceiling, the Treasury began selling the predicted large quantities of new debt in the second half of October. Treasury cash has risen and will continue to rise. The TBAC (Treasury Borrowing Advisory Committee) wants the Treasury to rebuild a $500-billion contingency fund. As that cash is pulled out of the markets, it will put downward pressure on stocks and bonds.
The impact of such Treasury cash builds in the past has been immediately bearish. But this time, stock prices have not yet fallen. I expect a delayed reaction as the Treasury continues to raise cash. The timing is a matter for technical analysis. Recently, our short-sale picks on The Wall Street Examiner Pro Trader Daily Trades List have been working well. This is probably a sign that the end is nigh.
The Treasury balance is shown on an inverse scale on the chart below to show the usual relationship between it and stock prices. The Treasury has begun rebuilding its cash since the debt ceiling was lifted in early September. Normally stock prices would fall as investors bought the heavy Treasury issuance. Some Treasury buyers liquidate other investments to raise the cash for the Treasury purchases. That selling at the margin depresses normally stock prices.
That did not happen this time. At least it has not happened, yet. But the TBAC has told us that the Treasury would continue selling a ton of new debt through December. It is only a matter of time until stock prices succumb. I view this divergence as a warning sign. It is not a sign of strength. It is a sign of dangerously extended stock prices.
Sign #2: Gains in Withholding Tax Collections
Total withholding tax collections are available to us virtually in real time in the U.S. Treasury’s Daily Treasury Statements, released with just a one-day lag, which makes them an excellent analytical resource. However, they are extremely volatile day to day, so I rely more on a monthly moving average of the 11-day total collections, comparing that with the prior year. Smoothing sacrifices a bit of timeliness to get a clearer picture of the trend without losing too much of the edge that the daily data provides. Unfortunately, I have found even the 11-day total data too noisy for meaningful comparison, so I’ve had to resort to additional smoothing, which ordinarily I don’t like to do. As a result, the smoothed data is a little slow, so I also look at raw-data trends to get a better sense of timing.
Withholding tax collections have begun to tail off after two very strong months where they were gaining around 8-9% on a year-to-year basis. The annual growth rate slipped to +5.2% as of November 7. That’s before inflation. If wages are growing at 2%, then that implies real growth of 3.2%. Trump is a genius! Or the luckiest man on the face of the earth. Stock market bubbles have a way of making stupid people 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 top-line totals to obscure weak gains, if any, in the middle of the spectrum.
Despite the slowing in recent weeks, the yearlong uptrend remains intact. There’s no sign of softening in the U.S. economy yet.
That’s bearish because it will keep the Fed on its tightening course. Markets top out when the economic news is good because that’s when central banks pull the punchbowl. That process is underway again. We already know what the outcome will be. It is only a matter of time.
Sign #3: Uneven Economy Growth
There are no quarterly taxes due in October. The next big month for collections and a solid indication of the economic trend will be in January for the fourth quarter of 2017.
Quarterly corporate income taxes are 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.
You do the math. 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 U.S. 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.
I did not do a deep dive to find an explanation for the massive bulge in September excise tax collections from 2014 to 2016. Collections not only fell back to the trend this September, they were actually a bit below the trend. August was flat. October made up some of the September decline. It’s all but impossible to tell if the trend is broken from this data. We’ll need a few more monthly prints before that becomes clear.
This suggests that the U.S. economy is growing unevenly, at best. The top-line tax 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 most households are treading water.
This type of uneven growth will ultimately lead to a degradation of the U.S. economy. 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. And we know where that is headed. Down.
As we recently discussed, the LAMPP will soon cross below its 78-week moving average. That will be a red signal. It will be time to get out of stocks. Tops take months to roll over, so there’s probably no urgency to “sell everything,” but we should stay on a systematic program of regular sales to build a substantial cash holding by March of 2018. I’m looking at 60-70% of a portfolio in cash. Your goal would differ depending on your personal needs. As an older person, I might want to hold an even higher percentage of cash.