Your Independent How-to Guide: Prospering During a Market Downturn

I’ve been hard at work, writing reports and delving into the latest Fed and Treasury data.

But every once in a while, I like to set aside some time to respond to some of the comments that you’ve been pinging me with.

Many of you agree with my forecasts – and others of you disagree.

I even received a few snarky comments, and I never hesitate to return the favor.

Consider this your how-to guide on how to navigate – and remain prosperous – throughout these stormy and uncertain times.

So without further ado, I present to you a handful of my most adamant replies.

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George Ambrose: Thank you for the overview and your comments. There are a lot of stats unspoken like employment, low defaults on loans, the dollar will ease in strength…we are in new economic territory with people getting accustomed to higher inflation. As the tax cuts come in next year, this market will stay afloat. Yes, a 2019 correction is coming, and we will have another 2018 mild correction before the year out. However, earnings will remain strong and this is your forecast Achilles heel. And the europhia will be in this market till Trump leaves office in 2 years. Higher priced stocks are thru 2019 and 2020 with a correction, it will be a nice one, more like what your stating, in 2020. For what it’s worth… you can consider trusting what was given in this comment. Again, stay in touch. Thank you

Lee: George, you have stated the bullish arguments elegantly and succinctly, and you have lots of company around our offices, and in the mainstream media. And you may well be right.

Obviously, I have been surprised, and wrong, about the market’s ability to rise in the face of diminishing base liquidity-that created by central banks and absorbed by governments and other users of capital.

So the question becomes whether we have left that paradigm of the past 10 years where the forces of liquidity were, if not the only things that mattered, at least the things that mattered most. Or has the mania been reignited, with dealers and speculators piling debt upon debt to finance ever higher stock prices while base liquidity shrinks.

And in so doing have they merely delayed the consequences of shrinking liquidity and created even more dangerous conditions? Has this last surge of buying created an even greater and more proximate risk? That the market may crash, and do so sooner rather than later?

Again, I’ve been wrong about the market’s ability to continue higher, and I know that you have made your decision to keep buying. I’ll just respectfully disagree. I’ll largely stay out of the market and participate in rallies by holding and rolling a small amount of SPY calls for as long as the rally persists.

Greg Fahrner: Fear monger just kidding – you are correct about the overvalued market BUT it keeps going higher? The late Jan early Feb sell off was significant – eventually we will get the pullback but I think those left out will keep buying. Maybe the projected interest rate hikes and the yield curve will be the catalyst … eventually your warning will be correct.

Lee: Thanks for agreeing with my prediction!

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James Fritz: The US is a bubble economy. Wealth is created by manufacturing money by creating a bubble. Unfortunately all bubbles break. Germany has a 300 billion dollar trade surplus because they invested in manufacturing. In the US we invested in shopping centers that are now empty.

I agree with these observations. The issue is timing. Liquidity analysis lately hasn’t been helpful in that regard. But the context of rising markets against shrinking liquidity is problematic. I believe that it must result in a major reversal and bear market.

Technical analysis is the basis for fine tuning timing, and my TA work that I report weekly in the Wall Street Examiner Pro Trader Reports started to get bullish in early July. It remains so, but the market is approaching the most recent projections for the highs. So keep your seatbelts fastened.

Edward Mack: Just looking at charts of companies while I was reading at night (boy, can that put one to sleep), I chose some familiar FAANG (you know Facebook, Apple, Amazon, Netflix & Alphabet or Google) stock charts. Then I stretched out the timelines to 10 years. Astonishing. The charts of most, especially Amazon, look like those of the Tulip mania, South Sea company & internet bubble charts, rising precipitously at a faster pace more recently. Like I said before, I was surprised and now I’m shocked. Can these stocks continue to rise at the current rates without falling?

Lee: Nope.

Dude from Canada: It may start happening sooner than most think. Companies have until 8.5 months after the end of 2017 to fund their pension plans and continue to do so this year at a much higher rate than typical because they want to take advantage of the higher tax rates (thus higher tax deductions).

Once this ends at the end of September there will simply be less buying of bonds and their prices will start rising again.

This will happen at the same time as the waves of new federal debt hit the market, the Fed increases its quantitative tightening to $50 billion/month and the ECB drops its quantitative easing to just $15 billion/month.

This will all lead to bond falling and yields rising. Jamie Dimon and Lee Adler will be correct by the end of 2018/beginning of 2019.

Lee: Dude! I was curious about the pension contribution thing and did a quick search. I found this quote from the WSJ.

“Companies with underfunded pensions have a rare opportunity to score a tax break in the coming months.

Pension contributions made through mid-September can be deducted from income on tax returns being filed for 2017-when the U.S. corporate tax rate was still 35%. That means a company that contributes $100 million to its pension plan now can save $35 million in taxes, while a company contributing the same amount after the deadline would save just $21 million, based on the new 21% corporate tax rate.”

So Dude, it appears that you may be on to something that I was unaware of, and could definitely be helping to drive this manic rally.

I just want to point out a misstatement re your point that there will be “less buying of bonds and their prices will start rising again.” Of course you meant that there will be less buying of bonds and their yields will start rising again.  Pension funds also buy stocks. To the extent that they’ve been chasing this rally, they’ve also helped to drive it. That won’t end well for them.

Tim Higginson: Lee has not made clear how the recent tax cuts have affected the level of tax take and how his tax figure from the IRS relates to the retail spending he outlines in his article.

Lee: Correct me if I’m wrong, but I think I’ve written about this very subject here once or twice a month. I cover it in depth twice monthly in the Wall Street Examiner Pro Trader Federal Revenues Reports. But if I haven’t made it clear let me just say that Federal revenues appear to be down around $20 billion per month on average as a result of the tax cuts.

As for retail spending, I don’t know that there’s any way to quantify a relationship between the tax cuts and retail spending. On a per capita, inflation adjusted basis, they are barely growing at all, and are not growing materially faster than in the years before the tax cut.

Virgil: Gold is a safe haven. I have bought it while stationed in Guam. I held it many years. Is’nt taught in schools. I rather have Gold than a public-private currency. Paper assets are easy until you have to fight for physical certificate ownership. Gold is hated because Wall Street doesn’t make money on it. Rent and debt are taking a majority of individuals money. Copper is cheaper.

Lee: This is the religion of Goldism, not supported by facts and data.

Wall Street makes money on gold, just like it does on any commodity. It creates paper derivatives and trades them for profit.

Cash is a paper asset. It’s pretty rare that you need to fight for a physical certificate.

Gold, on the other hand, must be converted to cash before you can spend it. How much of a haircut do you take when you sell your gold coins for cash? Can you take them down to the supermarket and buy groceries? What exactly can you buy with your gold coins or gold bars?

Gold is a unique commodity, and it’s a store of value. In some eras it does great, and in others, not so much. It’s not a safe haven in times of financial duress. It’s a commodity that needs to be traded, in order to maximize returns.

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Sohail: That is a good balanced analysis. Many gold pundits have been wrong for some years. President Trump has indicated he wants a weak dollar. This may help. I am unclear on which assets will be safe havens? Us Equities ! Bitcoin

Lee: I think that the search for safe havens is a waste of time. Follow a few asset classes. Try your best to understand their trends. Ride those trends. It sounds simple, but it’s not. It takes a lot of work and experience, and even then we get it wrong at times. The trick is to limit that, control risk, and find ways to minimize and even take advantage of mistakes. Above all don’t lose money!

Brian Meeker: You are all wrong! Taxes are leveling off. Yes, but only because citizens are keeping more of the money they earn. Trump lowered taxes on the individual. This allows consumers to choose between spending and saving more of their dollars. Citing only reduced tax collections is an incomplete analysis. If anything it shows we are finally putting the money into the wage earners pockets. Not into government runaway waste spending. Government has been out of control for way too long. The private sector is finally able to begin saving instead of spending every dollar they earn. The consumer will decide when to spend, not the morons in Washington DC. The public and pseudo analysts have been brain washed into thinking the government knows best. Citizens are finally seeing the light. The financial markets will adjust. But with a more realistic approach for the future. Government has been putting the cart before the horse entirely too long. Let’s give the horse a chance to do its thing. Knee jerk analysis is your problem. Have some patience!

Lee: My job is to analyze the supply of and demand for investment securities to help me make an educated guess about their likely direction.

I’m not here to argue the merits of increased deficits, whether by tax cuts or increased spending. The Trump Regime has cut taxes and increased spending. I absolutely agree with the notion that increasing the deficit stimulates the economy. I have said so in my reports. Have you even bothered to read them, or are you just here to engage in mindless diatribes in favor of increasing the Federal deficit?

So yes, the cut in taxes and increase in spending should stimulate the economy, but so far, they aren’t. The economy is growing no faster now than in the years immediately preceding this massive increase in deficits.

And if your argument is that  people are saving more because of the tax cut, then why is the savings rate pretty much right in the middle of the range of the past 5 years, and lower than at any point during the Obama Reign of Terror?

Edward Mack: I like looking at FEDS notes every once in a while. I know that may be weird. I find some interesting, like going back to the FRB/US model: A Tool for Macroeconomic Policy Analysis, April 2014. Figure 2, Stochastic Simulations has estimates running to quarter (Q) IV (or 4) 2018. It shows that their models have such a wide range that they could get a wide difference and show that they ended up in the predicted range. Unemployment starts at about 6.5%, falls to about 5% by Q42016 and stays there through Q42108. Actually, Unemployment fell to the 4% range and has stayed there (now 3.9%). But the range for Q22018 is about 2.8-6.8%. I don’t call that very accurate forecasting. I call it fudging big time, or WAG (a wild @ss guess). Nonetheless, interesting. Also, looked at “Predicting Recession Probabilities Using the Slope of the Yield Curve”, Mar 2018. Their models predict a very low, though slightly raised, possibility of recession. I’d like your take on the above FEDS notes or any other.

Lee: Oh my God, the Fed’s forecasting record is atrocious. I did a study of it a number of years ago. Several others have reiterated that the Fed stinks at forecasting. Their history has been one of serial long term blunders. So I just watch what they do and try to figure out how it will impact markets.

If they put money in, markets should rise. If they take money out, markets should fall (Sounds like Randolph Duke – Ralph Bellamy – explaining supply and demand in Trading Places J )

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Jim: Thank you for your work, I get the bottom line to all this, there is a lot of cash coming out of the system, but there is still a lot of cash moving around also, it’s going to take time for people to realize that this giant boat is slowing down, with the economy humming along. There is a lot of free cash in people’s pockets.

It does not seem like we are a nation of savers at all anymore, we spend next years money before we have made it. At some point that will change also and then the markets will have to deal with a slowing economy and numbers that cannot be pushed higher, I feel bad for all the people who have no idea that there money is at rick of large losses? I pulled my retirement money out in late 2007, and ended that year with a very small gain, now in my 60s I have no room for large errors, I am happy to get my small interest tomorrow and be safe, rather than sorry before long? Maybe this will be like the 70s a very long and slow but harsh move down? all be it 73 to 74 was nasty. Again that you for your work.

Lee: My technical work indicates that yes, there may be a bit more upside before this game ends. Traders see round numbers as likely targets, and they’ll trade the long side until the market approaches those level. Now that 3,000 is within spitting distance, they’ll leverage up until the market gets close to that level before they start peeling off.

Is there lots of excess cash around. I don’t think so. The banking system deposit data isn’t showing that. Deposit growth is persistently slowing.

However, the pension fund issue is something that I did not account for. Corporations repatriating cash may have used some of it for even more stock buybacks above the record levels reached in the first quarter. I have previously shown that record levels of buybacks are associated with market tops. That game has a limited shelf life. Finally, we have seen a relentless increase in lending for leveraged financial activities by shadow banks and brokers. That only increases the danger of a disorderly adjustment when prices stop rising.

Interest rates keep rising relentlessly whether or not the Fed rubber stamps a rate increase in a given month. Treasury bill rates are a meter of liquidity. The rise in rates there show clearly that there’s less money in the system as the demand for money for speculative purposes grows back into an echo mania. With the Fed constantly destroying cash, this story will not end well.

Mark Handschy: Repetition = GOOD! However, as long as ECB and BOJ keep printing (QE) that money is flowing into US Stocks. The crash is coming, but unclear when, as long as the foreign money is printed. Chart shows total QE doesn’t invert to QT until late this year (maybe). Agree with 99% of what you say, but FED+ECB+BOJ is the correct metric.

Lee: I do track the impact of the ECB and BoJ. It’s included in my regular monthly Wall Street Examiner Pro Trader Macro Liquidity Reports. The ECB has announced that it will cut QE to €15 billion per month in September. That’s nothing. According to the ECB, European net debt issuance has averaged €13 billion per month over the past 2 years. The ECB said it will end its bond purchases in December. What then?

Meanwhile, the BoJ has engaged in a steal tightening, gradually reducing its securities purchases, without announcing a program to do so. Each month I publish a chart of the dollar value equivalence of the combined market operations of the Fed, ECB, and BoJ. It looks like this overlaid against the S&P 500. It speaks for itself. The US stock market has been bucking the trend of the past 6 months.

Despite the tightening, the stock mania has resumed. I believe that the Fed will continue to tighten the screws for as long as necessary to bring this mania to heel. I will continue to hold mostly cash as a result, but I’m willing to use technical analysis to buy and hold call options on the broad market until technical evidence tells us that the market has reversed. That way we can preserve our capital while participating in the mania with limited risk.

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Rapier: Chomsky makes perfect sense to those who are relentlessly literal minded. Recall he is a linguist first, involved with words on the deepest levels. The vast majority of people do not interpret words by their literal meaning but rather by their emotional response to words and they use words not to serve some truth but to further their selfish motives.

For myself it is only later in life that i have come to realize my own hyper literal-ness is what has set me apart, literally in many aspects of my social life. (I’m not living in a cabin in MT mind you.)

The point is Lee, that as money becomes ever more ephemeral, ie. crypto, that grand deflation becomes ever less likely. Literally hundreds of billions of dollars have been lost and continue to be lost by fracking oil and gas, yet the credit flows still and everyone knows it is a stupendous success, making the US the worlds largest producer now.

I’m not saying there will not be a bear market, or worse, but it won’t be because there is literally not enough ‘money’ to cover existing debt. Not unless or until Mother Nature delivers some bills that can’t be paid for with money.

Lee: Who’s talking about there not being enough money to cover existing debt? That’s not the issue. The issue is that the supply of securities is increasing and the supply of money, which is the source of the demand for securities, is decreasing.

Stock buyers are finding ways around that for the time being.

But let’s not lose sight of the fact that bond prices have fallen massively since they topped out in 2016. Bond yields have risen from 1.4% on the 10 year, to 2.8%, and have only recently pulled back from 3.1%.

Junk debt and emerging market debt has gotten destroyed. Emerging market equities have gotten destroyed. Other foreign markets are down from their highs.

Is the US still the last Ponzi Game Standing? Yes, always. But it will eventually collapse as money steadily dries up.

Meanwhile the pressure of increased federal borrowing, and decreasing money has shown up relentlessly in T-bill rates.

Their behavior suggests that the Fed and its cohort central banks have made a deal to bring this mania to a close. The Fed believes that it can engineer a soft landing.

If you agree with that, then stay long the market.

Steve: Lee, One core question: who is buying the bonds and why? If interest rates are going to increasingly rise – why are there buyers for virtually each dip in long term bonds? Today we had a bad labor report and bad economic data generally – yet stocks rose > 0.45% S&P 500 and bonds were well bid. Are we really seeing the situation correctly at least in the short-term? Is it all explained by a $23 billion treasury buying spree against over $100 billion needed each month for funding US deficits?

Lee: There are still buyers for Treasuries at these levels for any number  of reasons, not the least of which may be that the US still looks like the least dirty shirt in the laundry to some investors. Then there’s the repatriation of corporate money. There’s the pension fund buying. There’s been short covering as evidenced by the massive spec short position in the futures.

There’s been a lot of one shot deal stuff that will be exhausted. I think that exhaustion will come within the next couple of months. The US Government will be in the market borrowing hand over foot. The Fed will be extinguishing money. The ECB will stop adding money, and the BoJ will be doing too little to matter.

The 10 year will go through 3%, and this time when it does, there will be no stopping.

2 Responses to “Your Independent How-to Guide: Prospering During a Market Downturn”

  1. What about the money that is coming here from all over the world where their currencies are tanking—Argentina, Turkey, India, etc. Won’t this keep our stock market up and treasury yields low until this flow stops?

  2. Second Question—Will Jay Powell and the rest of the board members of the Federal Reserve sit twiddling their thumbs while the USA sinks into a recession and heads towards a depression? Why wouldn’t they stop draining liquidity and maybe add a little back in?

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