I have been writing about the importance of the US Treasury market for stock investors since late last summer. As recently as just last week I told you that “Your Treasury-Fueled Windfall Ends Today.” That morning, the S&P 500 opened at 2701, down over 7 points from the April 18 close. The SPX closed yesterday at 2622.
I warned about the Treasury yield problem even before last week. On March 3, we headlined “Get Out of the Stock Market Before This Line Climbs Past 3%.” I was talking about the yield on the 10 Year Treasury note. That yield traded above 3% for about 10 minutes yesterday morning. It then pulled back a bit to around 2.98 at the end of the day. But that didn’t matter. The stock market rout was on. The SPX dropped 66 points from the time that the 10 year traded at 3.0 until about 2:40 PM.
What happened? Around 10 AM, the bond selling diminished and bond buyers showed up. At the same time, an early rally in stocks peaked. Stock prices began to fall. This illustrates another fact that I have been reporting about this market. With the pool of money (liquidity) that is available to buy stocks and bonds shrinking, one type of investment can only rally if another is selling off. Bonds can only rally if stocks are liquidated.
That’s exactly what happened yesterday. There is not enough liquidity to support rallies in both markets. The problem is getting worse and it will continue to get worse.
That means that it’s now time to get out of the markets. The time for patient systematic selling has come to an end.
No more waiting, no more hedging bets or hanging around or gradual, slow withdrawal.
Take your marbles right now, and get out.
We’ve Been Listening to The Fed, and This Is No Surprise to Us…
There’s nothing new here, nothing we did not already know. The Fed has told us that it will steadily pull cash from the markets until it gets back to a tight reserve position. It has even published the schedule for us. We know exactly how much they are withdrawing, and when. We know the rate of increase in the size of those withdrawls. We know that the goal is to get back to a tight reserve position, or what the Fed calls “normalization.” We can calculate that that will take until mid 2020 if they stick to the program.
This is not rocket science! The Fed told us EXACTLY WHAT IT WOULD DO! There’s no mystery here. The only mystery is why so few have been paying attention. Are we the only ones who respect Rule Number One, The First Commandment, “Don’t fight the Fed?” This is so basic, so elementary to investment success, that it is shocking that virtually the entire investing public and Wall Street soothsaying community ignores it. How can anyone be bullish under these circumstances?
As the Fed continues to pull money out of the system, it becomes more and more difficult for dealers, banks, and other institutional investors, to absorb the regular flow of new Treasury supply. One of two things must happen. Either buyers will lower their bids and reduce their size, pushing yields upward. Or if they decide to keep buying all the new Treasury supply, they must sell other assets. And the easiest and most plentiful assets available to them to liquidate are stocks.
Yesterday was an object lesson. At the end, both markets were liquidated, but stocks more than bonds.
This would be happening regardless of whether or not Treasury supply was increasing. But therein is an additional problem for1 the stock market that is just as big, if not bigger than the one created by the Fed sucking cash out of the system. That is that Treasury supply is absolutely mushrooming.
The budget deal and tax cut are adding an average of roughly $50 billion a month to the deficit. That’s money that the government will need to raise by selling new debt. The Treasury must also sell $30 billion per month in additional debt to pay off the holdings that the Fed is now redeeming each month. That amount will grow to $40 billion per month in July and $50 billion in October.
On top of that, the Treasury is committed to increasing the size of its cash kitty to $500 billion. Right now it’s at $365 billion thanks to the massive inflow of tax dollars on April 17.
Now, I doubt that the Treasury will ever reach its goal, but if it tries, that will require another $135 billion in new debt issuance. That would just be more bad news for the markets. I don’t think it will happen, because as we saw a couple of weeks ago, the Treasury is not averse to using that fund to pay down debt, thus injecting money into the markets. In essence, the Treasury has taken over the task of goosing the market from the Fed’s QE program.
There’s just one problem with that. If the Treasury keeps its goal of maintaining a $500 billion cash kitty for “emergencies,” then every time it uses that cash to boost the market, it will then subsequently need to replace it. So it will then need to pull that money out of the market again. And it will always be doing so with a steadily shrinking pool of cash, thanks to the Fed’s constant draining operations.
So this won’t be a straight down crash. I have no doubt that Treasury Secretary Mnuchin will step in to inject Treasury funds into the markets by paying down Treasury debt any time the market does threaten to crash. Likewise, the Fed would probably take short term actions beyond merely lowering interest rates to stem any waterfall decline.
But none of these actions would reverse a major bear trend until the Fed actually reverses policy from one of tightening to one of easing. Certainly, the market will force the Fed’s hand at some point. But that, my friends, is a long way off. And we don’t know where it will be.
The Fed wants to take the noxious bloom off the asset bubble rose. It is prepared to accept a measure of pain in the process, particularly if the economic data stays strong. And with $100 billion a month in deficit spending stimulus, the topline economic numbers probably will stay strong for the foreseeable future. That will only encourage the Fed to stay tight. And that will be bearish for both stock and bond prices.
If You Stay In The Market Here, You’re Playing with Fire
I know that I’m not omniscient about what the market will do. I have been around the market long enough to have been humbled by it more than once. I have been saying that we’re in a bear market but that idea will only be proven when the Dow and S&P break their February lows.
And please! Forget that stupid 20% rule for a bear market! No one has any idea who even made up that nonsense, but everybody in the Wall Street captured-media mindlessly repeats it.
I’ve even heard some refer to a 20% decline as an “official” bear market. Oh yeah? Says who? By what standard? That’s not what Dow, Hamilton and Rhea said in the development of the Dow Theory in the Wall Street Journal a century ago. They said that intermediate term lower highs and lower lows in two market averages would indicate a bearish major trend. They talked about a pattern, not percentages.
When the SPX breaks the February low, it will be a decline of about 12%. The media will start talking about an “official correction,” based on the similar nonsense that a 10% drop is a correction. But they will once again have missed the boat. It will be a confirmed bear market as far as I’m concerned, and I suspect, as far as most chartists would be concerned.
When that happens, we’ll have the first clear, unequivocal sign that my analysis and identification of this being a bear market has been on the mark.
In the meantime, the market has done nothing to suggest otherwise. It’s behaving as expected. I think that we are on solid ground here in obeying the First Commandment. Those who don’t are worshipping at the altar of Wall Street’s Golden Calf, and my good book says that there will be a price to pay for that sin.
Another way of saying this is via the old Wall Street dictum: Bulls make money. Bears make money. And pigs get slaughtered.
Bulls have made money in this market for 9 straight years. 9 years without a bear market! And now the Fed has loudly and specifically turned hostile to asset price inflation. It told us that it would pull the punchbowl. Then it told us that it is pulling the punchbowl. Then it started to pull the punchbowl. Now it is continuing to pull the punchbowl at an ever-increasing rate.
And the US Treasury is exacerbating that by doubling the amount of supply it is bringing to market.
It just does not get any more bearish than that.
An investor who continues to buy the dips or buy and hold this market under conditions of Fed monetary tightening after a 9 year run is no longer a prudent bull. Such investors are now, indeed, fighting the Fed. They have become the pigs on their way to the Wall Street slaughterhouse.
So let’s avoid that fate, shall we. Let’s avoid becoming Wall Street’s pickled pigs’ feet. Let’s pay attention to the signs. Get out of stocks and bonds to the extent possible. I have been recommending systematic selling since September, first to be largely out of the market by the end of January, and then by the end of March. Then I allowed for the usual seasonal April-May rally.
Now I’m worried that the usual rally into early May won’t happen. I would still expect a bounce, but from where, and how big? The risk is that it will come from much lower and won’t amount to much. So I think that the time for patience and gradual selling has come to an end. It’s time to be out. Don’t buy the dips. Short the SPY on rallies. And hold on to our set it and forget it short, RWR, the REIT ETF.
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