This Chart Shows Exactly Where The Cash Came From for the Rally and Why That’s a Problem

If ever there was a chart that graphically illustrates where the money came from the fueled the post Christmas rally, I think I just found it. I’ll show it to you, but first give you a brief story about why it’s important.

Every month I update the data on Treasury auction investor class allotments. Pretty dry, right? Not at all. It’s actually quite fascinating. This data gives us a wealth of information on total Treasury auction supply and who’s buying it. Treasury supply is one of the key determinants of the direction of stock prices. The more Treasury supply there is, the more cash is diverted to Treasuries and away from stocks.

The data shows us the trend of total supply every month. It also shows which class of investors are providing the demand, and how the demand from each of those classes is trending. That’s important too. Knowing who’s buying how much can also give us big clues about what to expect for stock prices.

Something very unusual came up on the charts for December.  It stuck out like a sore thumb. And it gave us visual proof of just where the money came from the drive the post Christmas stock market rally. More importantly it raises a warning about what comes after.

I’m always most interested in how much the dealers are buying, how much investment funds are buying, and how much foreigners are buying. That’s because they’re the only ones who absorb any significant amounts of this paper. Individuals, banks, and pension funds don’t. Foreign and international participation is hardly significant either.

No, they’re small potatoes. That’s why I always laugh when I see talk about the fact that individual investors aren’t playing a role in a market. The idea is that therefore the market can’t be a bubble, or overheated, or whatever excuse the bulls want. The fact is that individual investors never play a significant direct role in any market. Any focus on them, or excuses about them not being in the market, are simply carny barker stuff.

The simple truth is that the big mahoffs, as we call them in Philly, are the dealers and the investment funds. Now, there’s quite a bit of tracking of investment funds available. I don’t follow it directly because unless it’s at an extreme, it tends to simply follow the market. Professional investors are like herds of sheep. They follow the leader. But when their cash holdings or equity positions hit record levels, we hear about it in the news.

At that point it’s useful information. It’s contrarian. Last year we heard news reports about them holding record low cash positions and record high equity allotments. It certainly supported my analysis that the market was building a major top.

My interest lies primarily with tracking the dealers. The information on them is limited, and no mainstream outlet that I know of reports it regularly. But there is some data.  I track it to see if it’s telling us anything about what we can expect from the market.

There’s weekly data on Primary Dealer positions in fixed income. I update and report on those charts monthly. There’s also monthly data on these Treasury auction takedowns. And this month’s chart on Treasury bills was a real eye opener.

T-bills are especially useful because they are easily converted to cash.  They can be repo’ed, which means simply that they are easily used as collateral for overnight loans. But that’s typically a tool only used by dealers and hedge funds. Investment funds typically hold them as a means of earning interest on cash, not lending them out in return for cash.

Total T-bill issuance is also a useful indicator, because the greater the supply of short term T-bills, the less buyers will be willing to pay for them and the higher their discount rates will be. This is expressed in the market as rising short term money rates. I’ve shown you those amazing charts of skyrocketing T-bill rates here for months.
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After the tiniest pause over the past 2 months, get ready for T-bill rates to start rising again. Rising rates on government paper tends to pull money out of stocks.

But that’s old ground that we’ve covered repeatedly. I’m sorry to keep repeating it, but it just holds a sort of macabre fascination for me because it just so clearly shows everything that is wrong with the markets. More importantly it tells us to keep holding and rolling those bills.

But it’s not what I wanted to show you today. I’m presenting this chart twice, once to show the status at the end of November, and the second to show the amazing turnabout in December.

In November total bill issuance was still rising, although more slowly. The Treasury still needed to borrow more cash than the year before. The dealers took down a greater percentage of the total issuance in November than the year before.

Investment funds went the other way. Apparently they thought that the pullbacks in the stock market in November were just more buy the dip opportunities, so they diverted funds from their 3 year trend of increased T-bill purchases.
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But look what happened in December. Total issuance collapsed to the lowest level since 2007 (not shown). That meant that some maturing bills were getting paid off. That put cash back into the accounts of all the holders of the maturing bills. That included dealers and institutional investors.
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Forcing cash into dealer and portfolio manager accounts can have only one outcome. They buy something with it. They couldn’t buy more T-bills. There weren’t any to be had. The Treasury did boost their bond issuance year over year, but less than the cuts in bill issuance. Dealers and investment funds did buy some of those bonds, and yields did come down.

But they mostly bought stocks. Hence the rocket launch in stocks that began on the day after Christmas.

Here’s the problem. With the ending of the government shutdown, the Treasury will need to reverse that decline in bill issuance. It will be borrowing more money in the market. Maybe they’ll shift some issuance toward longer durations. Maybe they won’t. But they will need to borrow more. The plunge in issuance was a one shot deal. It pushed billions into the accounts of dealers and investment funds. It was a one time shot in the arm for the stock market. It won’t be repeated.

The operative phrase is one-time. We’ve seen the effects. Now that this episode is complete, the Treasury will go back to business as usual borrowing. There will be no more cash windfalls to drive stock market rallies until mid April when corporate tax payments come rolling in to support the usual seasonal paydowns of Treasuries.

So the question is how the markets will get through the couple of months until then. Common sense says that it won’t be pretty.

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