The stock market keeps rallying. Has Rule Number One – Don’t fight the Fed – been repealed?
The answer is no. But there are many sources of liquidity. The Fed is the most important, but there are other contributors. And investor liquidity preferences can and do often shift between classes of assets, like stocks, bonds, and commodities.
There’s no longer sufficient liquidity in the US market system to allow for concurrent bull markets, and there is less and less liquidity all the time.
But there’s still enough for one market to rally at the expense of another. When dealers, and big institutions liquidate bonds, they’ve been buying stocks, and that has kept the pot boiling for a little longer than I thought it would. So stocks have headed for the obligatory test of the highs before turning down for the “big one.”
|Ready or Not, a Market BOMBSHELL Is About to Drop
If you have any money in the markets, you need to see this urgent information RIGHT NOW… because according to Bloomberg’s latest report, America could be heading for an economic disaster that would rival the Great Recession. And we have reason to believe the investments most folks consider “safe bets” will be the very first to fail in a crash. Once this wave of wreckage hits, you’ll wish you had seen the signs while there was still time to do something about it.
The Fed isn’t the only central bank in the world of course, and its two big partners in crime, the BoJ and ECB are still printing money. With the Fed pulling money out of the system in increasing amounts, we need to keep an eye on the big money printers in the rest of the world. They may hold the key to when US stocks begin to decline in earnest. Europeans in particular are big investors in US assets. So when the ECB prints money, some of that money instantly finds its way into the US.
There have been rumors for months that the ECB will end its QE purchases soon. They’re expected to announce cuts in their rate of purchases this Thursday – in their press conference following the Governing Council meeting. That will happen at 2:30pm CET, which is 9:30am EST for those of you who are not overseas. The conference will be live streamed right here at this link.
The end of QE in Europe could be enough to turn a flattening liquidity picture in the US to outright shrinkage. The liquidity graph of the combined assets of the Fed, ECB, and BoJ has already turned flat. A turn to the negative would be devastating for financial asset prices.
So if I were you, I would watch, wait, and prepare.
In addition to Europe, China also plays a significant role, as we’ve written before. Today, when China catches a cold, the US gets a bad cough, and with financial systems of China and the US so dependent on one another, we need to pay particular attention to that market.
Monetary data out of China is obscure. I don’t consider it trustworthy. But one thing I do consider trustworthy is the technical action of the Chinese stock market. It’s a tell-all meter of liquidity conditions in that country. And China isn’t like Las Vegas. What happens in China does not stay in China.
So here’s a closer look at Europe and China for an idea of how they’ll impact the US stock market.
The Next Downturn in Euro Deposits Will Severely Pressure U.S. Markets
|From The Wall Street Examiner Pro Trader: 1/20/17: All financial roads ultimately lead to Wall Street. The US markets may be crooked; they may be rigged. But they are still, the largest, most transparent (that’s not saying much), and most liquid in the world. When the Fed or ECB or BoJ pump money into the system, they do so mostly through the same mega investment banks that operate in all markets. That’s why I say “Liquidity anywhere is liquidity everywhere.”My focus is mostly on the ECB because the flows between Frankfurt, London, and New York are so massive and so important to the performance of US markets. I have demonstrated in past reports the strong correlations between ECB actions, European banking system responses, and US market performance. In fact the ECB seems as important in some ways as the Fed in driving US securities markets, particularly the US Treasury market. European banks are big investors in Treasuries.
The ECB cut its QE purchases to €30 billion per month in January. There’s talk that they will announce another cut, or even a schedule for ending it, at this week’s ECB meeting.
The cuts have already slowed deposit growth in the European banking system. Another cut could cause European deposits to begin to shrink.
That’s important because Europeans have traditionally been heavy buyers of US assets when they have excess cash. Most of the time that’s been Treasuries. But falling bond prices and rising yields means that there’s no longer enough demand from all demand sectors to keep Treasury prices up. Instead we have seen investor liquidity preferences shift toward stocks. There’s still enough liquidity around to support rising prices in one investment class, but not all. As the Fed reduces liquidity, if the ECB joins by cutting QE, there soon won’t be sufficient liquidity to support even one bull trend.
Surging deposits in Europe have in the past been a bullish sign for US markets. The correlation had been strongest with Treasuries as Europeans with cash tend to buy US Treasuries. Some of the deposits created when the ECB prints money were also used to buy stocks.
Deposit growth in Europe slowed in the first 4 months of this year. That’s a caution flag for the US stock market.
The surge in deposits since 2016 has had no impact on the US Treasury market. US Bonds have been weak. But Europeans were still sending some cash to the US to buy Treasuries, and maybe even stocks, outright. Some of those investors who sold Treasuries to European buyers used some of the the cash from those sales to buy stocks. Regardless of the route that European money took to get into the US stock market, the correlation between European bank deposits and US stock prices is clear on this chart.
So beware of the next downturn in Euro deposits.
That downturn is coming. In January, the ECB cut its asset purchases to €30 billion per month from €60 billion. Deposit growth slowed, especially because NIRP (negative interest rate policy) remains a punitive measure for holding deposits. When the ECB makes further cuts in their QE, perhaps as soon as this week, deposit growth is likely to stall altogether. That will be less money available for US stocks.
The political backdrop doesn’t help. The US has begun a trade war against our former European allies. Europeans are likely to feel far less disposed to sending their money to the US under the circumstances.
As the ECB cuts QE, the time is coming when deleveraging will overwhelm deposit creation from ECB QE. European banks will probably liquidate US stock and bond positions to pay down the ECB’s targeted loans to them (TLTROs), just as they did when they were able to start paying down the original long term lending programs (LTRO) early in this decade. The political chaos in Italy and Spain, the critical problems for Italian banks, and especially German giant, Deutsche Bank, could again motivate Europeans to liquidate assets to pay down debts and extinguish deposits.
All of that will result in shrinkage of European bank deposits. There will be less money, and more of it will stay home in Europe.
The results will be catastrophic for US markets. This is a ticking time bomb.
Now let’s take a look at the latest developments in the China situation.
If China’s Stock Market Closes Below 421 This Week, Watch Out
|From The Wall Street Examiner Pro Trader: 5/9/18: China’s stock market gradually trended higher from the end of its crash in 2015 until January 2018, when it hit the upper channel line of the 2 year uptrend. I had expected a reversal from there, and the Chinese market did not disappoint. Now it has broken the bottom of the channel. Normally we’d expect another bounce. If it’s weaker than the previous bounce, a breakdown should follow. The number to watch is 421. A weekly close below that would signal that a resumption of the secular bear market, with attendant financial crisis, is under way.
China’s monetary policy data is still less than trustworthy so I rely on China stock index price data to tell us what impact their market might have on ours.
The downside is the more important aspect, because when Chinese markets fall sharply, the margin calls go out around the world. Chinese wealth funds often can’t sell to raise cash at home because the authorities frown upon it. The penalties are slightly steeper in China for selling than they are in the US- little things like jail or the death penalty. So Chinese investors sell whatever they can around the world when the margin man comes calling.
We saw it in June 2013. Wall Street disingenuously attributes the US market selloff at that time to a “Taper Tantrum,” when it was really Chinese margin selling. We saw it again in August 2015 when China crashed, and again in February 2016.
China’s stock market is once again on the brink of a breakdown. This needs to be watched closely. If China breaks, margin calls will roll out from there into the rest of the world’s markets. A weekly close below 421 would signal that a resumption of their secular bear market, with attendant financial crisis, is under way.
If that happens, the ripple effects around the world, especially in the US, may be the trigger for the next meltdown in US stocks. This time, the February lows would be more likely to break and the US market will be firmly caught in the teeth of the bear market that I have been expecting.
Therefore I continue to warn not to chase this rally. If you are out of the market, stay out. Timing short sales and put purchases can’t be done from this information alone. That’s a matter for technical analysis.
If (for some reason) you’re still in the market, and interested in learning how to make profits on the downside, you can look at our ideas here, or check out Shah Gilani’s put play research and recommendations in Zenith Trading Circle.