The market hasn’t said “Ho, Ho Ho,” at all this month. For most investors, this holiday season has been sheer torture. That’s because they failed to heed Rule Number One – Don’t fight the Fed.
But if you’ve been short the market or holding puts, you are laughing all the way to the bank. And if you are out, in T-bills, as I have recommended, you’re enjoying a peaceful and contented holiday.
One thing that the hardcore bulls failed to consider in their determination to fight the Fed was that “normalization” is just a euphemism for “tightening” monetary policy. Therefore, “normalization” meant not just getting the size of the Fed’s total asset holdings back to normal, and getting interest rates back to normal, it meant that inflated, bubble level asset prices would necessarily also go back to normal.
Tightening monetary policy has always meant that inflated asset prices would deflate. There was no reason to think that this experience would be different. In fact, a return to normalcy from the QE which deliberately inflated asset prices, virtually guaranteed that asset prices would deflate with the reversal of QE.
For diehard bulls who’ve been holdin’ and hopin’, it’s not about to get any better any time soon. In fact, I would not be surprised if this is not the only crash that we’ll experience in this long term downtrending market.
I have remarked in some quarters that this market reminded me of 1973-74. There were multiple, demoralizing plunges in that market. 2007-08 was no picnic either.
1929-32 was the granddaddy of all bear markets, with multiple crashes. I’m sure the Fed would start printing money hand over fist before anything like that happens. But that’s what it will take to stop this carnage–massive money printing. And that, my friends, is a long, long way away.
Now let’s get into the nitty gritty just a bit so that you can better understand why you need to stay in cash and out of the stock market. Or better yet, profit from the short side! So read on for the rest of this spine tingling thriller.
The most important component of what I call Macro Liquidity is the flow of cash between the Fed and Primary Dealers. The Fed stopped QE in late 2014. It started “normalizing” its balance sheet in October 2017, slowing its MBS purchases, and beginning to redeem its Treasury holdings. It started the normalization program in small bites and ratcheted it up every 3 months.
Two months ago, in October 2018, the Fed stopped buying MBS and it increased its redemptions of its Treasury holdings to a target of $50 billion per month in total reductions. This has steadily reduced the liquidity available for Primary Dealers to make markets, and it will continue to do so. It is the opposite of QE. Some call it QT, or quantitative tightening. I have called it “bloodletting.”
I have repeatedly warned that October would be the start of hammer time. And boy was it ever!
This “bloodletting” will continue until a market accident spooks the Fed into reversing policy. That’s still a long way off. Forget about a simple stock market crash. The Fed says that if the economy doesn’t sink too, it will stand pat on policy. It won’t ease until the economy contracts.
So the Fed says that it is not concerned about a decline in the markets that does not impact the economy. So far, this decline in the market hasn’t impacted the economy. We don’t know when, or even if, it will.
Well, the Fed says that, but I’m not sure how long Powell and the gang can stick to the plan of only reacting to an economic contraction. The pressure is building. Trump is throwing tantrum after tantrum.
Treasury Secretary Munchkin is starting to lose his “cool” too, with that little panic move on Sunday night. He reported publicly that he has called a meeting of the government’s Plunge Protection Team, and that he called all the big bankers who assured him there’s plenty of liquidity. It’s one thing to do that, but to announce it to the world? Seems dumb. But it really doesn’t matter. Liquidity IS a problem, regardless of what the Treasury Secretary says or does.
At some point the Fed will be moved to take a token step to throw Wall Street a bone. The first of those moves would be to lower interest rates. It may do so a couple of times. But that will not work to reverse the bear market.
Lowering rates would have no effect because it would not provide real liquidity. In fact, the Fed would have to dramatically increase liquidity to get rates down even a little. The US Treasury’s constant, massive need for funding will continue to put upward pressure on rates, regardless of what the Fed tries to tell the money markets about where it wants short term rates to be. Fed jawboning won’t work. Money talks. BS walks. Even Fed BS.
To reverse the downtrend in stock prices, the Fed would need to flood the market with new cash. Such a move is not on the horizon. Stocks will be much lower than they are today before that happens.
Meanwhile, other liquidity drivers aren’t doing enough to stem the tide either. If you’re interested in the details, I give timely in-depth reports with illustrative charts in the Wall Street Examiner Pro Trader Liquidity Reports. Here’s a synopsis of a few of the latest details.
Foreign central banks (FCB) have been buying Treasuries in quantities far less than their fair share of the increase in Treasury supply. FCB buying has been barely treading water, while the level of Treasury supply keeps rising. That’s a problem that isn’t going away any time soon either.
US commercial banks have dramatically increased their buying of Treasuries in recent months. In fact, their buying has reached near record levels this month. Think about that! Near record levels of bank buying have helped bonds to rally, but stocks have crashed!
The two trends certainly seem to be related. Bank buying of bonds has picked up because investors are selling stocks and depositing the cash in the bank. The banks then invest that cash in Treasuries because they don’t like the looks of anything else.
At the same time, the banks are under increasing liquidity pressure from the Fed pulling $50 billion out of their reserves every month. The banks can’t sustain this buying cycle indefinitely. The stock crash may worsen, and bonds, which are now getting the benefit, are likely to also come under renewed pressure, particularly as margin calls increase. Investors and banks will liquidate whatever they can to raise cash. Bonds will get their turn in the barrel again.
The bottom line? Stay away from both stocks and bonds. Stick with short term Treasury bills. And profit from market declines by holding and rolling SPY puts as I’ve suggested in past reports. Go out about a month. Buy puts that are slightly in the money. But them near chart resistance on the S&P 500. Keep mental stops just above. Sell half when the next support is reached, and keep rolling the remainder until a mental stop level is hit.
For more specific and frequent options trading recommendations, Chris Johnson has been knocking them out of the park in this market! Learn more about his research service here.