The WSJ Sounds Bullish Here. But They’re Ignoring Half the Equation

An article in the Wall Street Journal this week reported that private equity firms are sitting on a trillion in cash. That, of course is supposed to be bullish for stocks.
Click here to view the article.

But that’s only half the story. Or less than half. It’s about the demand side of the equation for one investor sector out of many.

Let’s look at some of the factors on the other side of the ledger that show why this bullish WSJ piece is misleading and what we actually need to do…

PE Firms Might Put It In. But The Fed’s Still Pulling It Out.

One factor that the piece ignored is that the US government will suck a cool trillion out of the market in the next 10 months as it issues that much new debt. Then there’s the fact that the Fed will pull $120 billion out over the next 3 months, and then $600 billion in the following year. Finally, corporations will likely issue a couple of trillion in new debt and equity paper, if the recent trend is any guide.

With regards to the bulls touting all this cash that’s supposedly just lying around waiting to be committed to the now “fairly valued” stock market, here’s what I have to say:

There’s no free cash! It’s all encumbered by debt, and what cash there is will be sopped up by new issuance in the blink of an eye.

While the Wall Street mouthpieces in the finanfomercial media bray about all the cash waiting to fuel the market to unimaginable highs, they ignore the other side of the equation. Where’s all that the money coming from? Well, from Q1 2017 to Q1 2018, nonfinancial corporations issued $400 billion in net new debt.

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Financial businesses-banks, shadow banks, and broker dealers issued over $300 billion in new debt.

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And here’s the weird part, while the bulls were snorting about the corporate buybacks being such a huge boost for the market, something else was going on that they’re not talking about. The Fed tells us that despite a dip of $300 billion in the first quarter, there were $1.8 trillion more in nonfinancial corporate equities outstanding in the first quarter than in Q1 2017. All of those buybacks have barely made a dent in the trend of increasing supply of equities.

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And financial corpses, banks, shadow banks, insurers, and brokers issued a cool trillion in net new equities. There’s more supply, not less!

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But stock prices rose over that year anyway. And they have refused to give ground here in Q2 of 2018. Clearly, recent buybacks which have reduced the supply of equities has helped, but that also lowers their cash levels. According to the Fed, financial businesses, which includes, banks shadow banks, insurance and investment companies, held $700 billion less cash in Q1 2018 than in Q1 2017.

So how have stocks continued to rally. Bonds have been buoyant as well, so there hasn’t been enough liquidation there to support rising stock prices.

There are obviously many moving parts to the entire supply and demand picture for investment paper. I cover as much of that spectrum as possible, but there will always be things that I may miss, or dismiss as unlikely.

I Was Bearish Too Soon. But Here’s What To Do

My analysis this time was too bearish, too soon I believe because of two factors that I’ve previously alluded to. One is that the Treasury uses some of its $350-400 billion hoard of cash to occasionally pay down some outstanding Treasury debt, putting cash back into the pockets of dealers and other institutional investors. That burns a hole in their pockets, and they start chasing stocks. The Treasury has done that in recent weeks, but that cycle is due to turn down in the second half of July. The Treasury will issue more debt, pulling more money out of the market.

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The second, which I covered in Wednesday’s post, is that speculative fever among institutional investors and hedge funds has heated up. They have increased their borrowings in an effort to chase an overheated market higher. The increased use of leverage has only increased risk.

And of course, there have been the corporate buybacks, which I also covered in Wednesday’s post. Corporate executives are rushing to use their corporate cash as their own personal piggy banks to sell their option grants at the highest possible prices.

Back in April I recommended shorting the SPY and RWR, but with the idea that we should have mental stops at 2675 and 87.10 respectively. Those got taken out shortly after. More recently I have recommended them again. With the mania heating up here, the 2803 area on the SPX is critical resistance.  If the market closes materially above that, say above 2813, then a full retest of the January high with a possible minor new high becomes likely. Such tests are typical of bull market tops. But I’d prefer to step aside and let this admittedly unexpected phase of the mania burn out before reshorting.

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The same goes for RWR. If you followed my advice to short it since the earlier go round in April, 95.73 is obviously a critical resistance level that we would not want to see materially broken. Conversely, a drop below 94 would be a signal to reshort.

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Meanwhile, if you are looking for other trading ideas, long, short, or market neutral, check out our ideas here, or check out Shah Gilani’s put play research and recommendations in Zenith Trading Circle.

Sincerely,


Lee Adler

4 Responses to “The WSJ Sounds Bullish Here. But They’re Ignoring Half the Equation”

  1. It appears you, along with many others, are having difficulty accounting for this massive bond buying spree. Should we put on our tinfoil hat and start looking for phantom bank accounts in high places? Thanks for the site Lee!

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