Here’s Why Capital Preservation is Still THE Name of the Game

I’m hoping to heck that the recent bone jarring losses in the stock market aren’t hurting you! If you have followed my advice, you’re sitting pretty. While all about you are losing their heads amid the noise and strife, you took your money home and let it hug you.

If you haven’t taken my advice, but you’ve been in the market for the better part of the past 9 years, there’s still time to harvest the massive gains that you’ve accrued. Then you can rest easy through the difficult times that lie ahead.

In the light of the Fed’s actions yesterday, and Chairman Powell’s words at his press conference, the overwhelming weight of the evidence continues to show that capital preservation is the name of the game.

As we’ve been over many times, it’s not about rates. The arguments about the Fed’s pace of rate increases are pointless. This is about the shrinking supply of money in the system versus the increasing demand for it. When money is in short supply, investors liquidate assets to raise cash. The Fed has made sure that money is in short supply, and has made clear that it is not about to deviate from its course.

The Warnings Were Persistent, The Consequences Delayed But Not Denied

In the spring of 2017 I began warning Wall Street Examiner readers that when the Fed starts talking about shrinking the balance sheet, it would be time to start worrying about the QE driven bubble market coming to an end. Then in July 2017, the idea of that balance sheet reduction process showed up in the Fed meeting minutes. In September 2017 the Fed announced that it would begin the policy of starting to shrink the massive holdings of Treasuries and MBS (mortgage backed securities) that it had built up under QE.

That’s when I started to warn you to gradually get out of the stock market, and get to 60-70% cash by the end of January, 2018. I allowed that for latecomers, the end of March should be the goal. As the market rallied into mid year, I continued to warn you that as the Fed gradually increased the size of its balance sheet reductions, the pressure on the markets would grow.

The bond market did buckle, but stocks continued to rally, fed by a couple of features of the new tax law. US corporations repatriated cash they had accumulated around the world. They used that cash to fund buybacks so that CEOs and their C-suite cronies could cash out their self-granted stock options at the highest possible prices using corporate cash. In effect, they were using the tax law to grant themselves massive pay raises.

Helping that along was another provision in the tax code that allowed business to take advantage of higher deductions for pension fund contributions under the 2017 tax code until September 14. Fund managers took that cash and spent the next week buying stocks.

Meanwhile, all that cash created a feel-good atmosphere in the stock market. Despite the Fed having already pulled the punchbowl, bullish revelers had their last hurrah at the bacchanal.

And surprise, surprise the market topped out a week after those last tax law driven pension fund contributions, on September 21.

Of course, that rally made us nervous. Having failed to account for these stock market friendly provisions of the new tax law, I had thought that the market would begin to crack in July. But I held firm in my analysis that the combination of the Fed starting to remove $50 billion per month from the stock market in October, and the Treasury pounding the market with hundreds of billions in new supply month after month, would spell the end of inflated asset prices.

I had become so alarmed at the continued expansion of the bubble that I even went so far as to recommend that you go to 80-100% cash and short the SPY to profit from coming market declines.

One Media Guy Did Point Out Powell’s Most Important Point!

Wednesday, after the Powell dog and pony media show, the stock market broke down, closing below the February lows. While the professional Wall Street propagandists focused on the utterly meaningless rate increase, most glossed over what Powell said about the most important thing, the Fed’s balance sheet reductions.

First, contrary to the facts, Powell said that the “…runoff of the Fed’s balance sheet has had very little impact on the credit markets.” (Nutting, Marketwatch)

In essence, Powell has pledged to keep dissembling about what we know is a fact – that removing $50 billion a month from the banking system while the Treasury needs to raise $100-150 billion per month on average, definitely has a massive impact on the credit markets. T-bill rates have risen relentlessly as a result.

Powell reiterated that the Fed will ignore stock market declines and will not reverse policy until the economy has an accident. “Some volatility, doesn’t probably leave a mark on the economy.”

Meanwhile, the market is leaving marks on professional investors who ignored Rule Number One – Don’t fight the Fed – and stayed fully invested in stocks.

Skidmarks in their underwear. Chairman Powell doesn’t care.

Steve Goldstein at Marketwatch made the most important point.

One takeaway from the Federal Reserve’s decision and press conference on Wednesday is that the central bank will continue its so-called quantitative tightening policy.

The Fed said it would keep reducing its balance sheet by up to $50 billion per month. And Chairman Powell said that policy would continue.

Then, quoting Powell:

“We thought carefully about how to normalize policy and came to the view that we would effectively have the balance sheet run off on automatic pilot and use monetary policy, rate policy to adjust to incoming data. I think that has been a good decision,” he said.

“I think that the runoff of the balance sheet has been smooth and has served its purpose and I don’t see us changing that. And I do think that we will continue to use monetary policy, which is to say rate policy, as the active tool of monetary policy.”

So, Powell reiterated the policy that Janet Yellen, to her credit, set in stone tablets in religion of central banking. Come hell or high water, the Fed intends to continue shrinking its holdings of Treasuries and MBS. It will do so not only until the market has an accident, but until the economy has one as well.

It means that the market will get much worse before it gets better. In Part 2 of this report, I’ll give you specifics about where the market is probably headed and for how long.

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2 Responses to “Here’s Why Capital Preservation is Still THE Name of the Game”

  1. The one conundrum that I have trouble unraveling is treasury note rate drops, for example, the 10 yr falling from around 3.25% to around 2.7% and TLT (iShares 20 yr treasury note) going up. The Federal Reserve is raising interest rates not lowering them. Even with investors dumping stocks and bonds and buying a perceived safe haven treasury note, should the rates drop this much? Are investors anticipating interest rate drops which will drive down treasury note rates? I hold SPDR Bloomberg Barclays 1-3 mo treasuries (BIL), following your general advice, although you don’t specifically advise buying this investment.

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