Foot on The Gas
Posted on Sunday, November 24th, 2019
Will the Fed ever normalize or even just stop adding liquidity? If, in 2007, you had a discussion with anyone in our industry and predicted where we would be with monetary policy in 2019 they would have laughed you out of the room. Policy at this juncture reminds us of the Weimar Republic Germany during the 1921-23 period. In preparation for WW I, the German government borrowed for the costs of the war. They would easily win the war and pay for it with the reparations they would demand from their defeated enemies – as was the custom of the day. Turns out taking the Kaiser and giving the points was a bad idea. Now, having lost the War to End All Wars the Germans were forced to pay up – not collect. What could they do? They decided to print money, buy foreign currencies with it and pay back their debts. Only thing is – that had a double – whammy effect on the German currency. The German currency went lower because they were printing more of it and the foreign currency they bought went up in price driving the German currency even lower. Inflation got so out of control that the cost of bread would double by noon. The problem was that the only thing worse than continuing the policy was stopping it.
The Federal Reserve is in the same position as the German government. The only thing worse than continuing QE is stopping and reversing QE. There is a clear result to their stopping and/or reversing QE. Markets will go down. If markets go down the corporate debt market will seize up. If the corporate debt markets seize there are no more buybacks and the support pillars of the stock market are removed. Remove those and you lose consumer confidence. Lose confidence and the economy spirals. We had a bump in the road in the money markets earlier this year and, fearing disruption in the markets, the Fed resumed QE at a faster pace than QE 1, 2 or 3 all with the S&P 500 at all time highs. Does anyone really believe they will be able to stop QE let alone reverse QE? Stop QE and you are faced with an economic recession, if not, depression. Don’t stop QE and you are left with a gravity defying stock market that has lost its logical underpinnings. We are beginning to believe that we have to have a monstrous blow off top in equities in order to convince government regulators to take their foot off of the gas pedal.
There is a palpable feeling of FOMO in markets as we approach year end. We have entered the seasonally favorable period for stock market returns and investors are chasing asset prices higher. It doesn’t help that corporate buybacks are hitting all time levels while the amount of stock shrinks propelling stocks ever higher. Equities are bit over bought here and due for a rest but FOMO is strong as professional investors lag further behind benchmarks.
Bonds and stocks diverged a bit in the past two weeks in a risk off pattern. We feel that corporate debt and high yield in particular hold the key. A massive amount of debt is piled in the BBB region. Should that debt fall into junk territory corporate buybacks could suffer and they are the linchpin of markets. High yield seems to be struggling here as distressed investors look at the junk laden energy sector as their next playground.
“if the economy encounters a downturn, we could see a good deal of corporate distress. If corporations are in distress, they fire workers and cut back on investment spending. And I think that’s something that could make the next recession a deeper recession”. – Janet Yellen former FOMC Chair
Small caps and transports refuse to budge out of their recent ranges. It is getting hard to argue though as the S&P break higher is dragging financials, tech and health care with it. The Fed is dragging us all back into markets with their adding to liquidity.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.