ON Again as Central Banks Goose Markets in October
by the Curmudgeon with Victor Sperandeo
Despite deteriorating economic fundamentals and lower corporate profits, "investors" piled into risky assets this week as global equity funds lured inflows of $15bn, while high-yield bond funds recorded their biggest weekly inflows in eight months.
· U.S. equity funds attracted $7.8bn, their biggest inflow in six weeks.
· The NASDAQ 100 (QQQ ETF) twice hit an intra-day all time high above 114 two days last week.
· European equity funds, which attracted huge inflows after Mr. Draghi announced the first round of quantitative easing in January, raked in $3.2bn, the most for eight weeks, taking the figure this year to $106bn.
· Emerging market funds experienced net inflows of $1.3bn, the most for 16 weeks, according to data from EPFR and Bank of America Merrill Lynch (BoA-ML).
· BoA-ML strategists noted that even commodities had recorded six straight weeks of inflows, their longest winning streak in eight months, and quipped that it was a case of “bears in hibernation.”
· The CBOE VIX (volatility index), the so-called equity “fear gauge,” has fallen ~ 42% this month. Those who thought the volatility from mid-August through September would continue (like the CURMUDGEON) were dead wrong!
NOTE: The above figures track flows up to Wednesday so do not include the repercussions of the Fed meeting that concluded on Wednesday Oct 28th.
What Almost Everyone Missed in the Fed's Press Release:
Not reported at all by the mainstream media is that the Fed continues to re-invest proceeds of maturing securities, which increases its balance sheet. As per the Fed's Oct 28th press release:
"The Fed is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions."
"The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."
Central Banks to the Rescue:
October witnessed unprecedented "talk the talk," but only two actual moves by global central banks.
· The Fed didn't raise rates last week, but analysts perceived "it's on the table" for their December 15-16, 2015 meeting. Really? And of course, it'll be "data dependent." Here's what the Fed actually said in its October 28th press release: "In determining whether it will be appropriate to raise the target range at its next meeting (December 2015), the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
· Does anyone really think the Fed will raise rates with economic growth slowing below the 1.5% advance estimate for the 3rd quarter of 2015 (see GDP section below), wage growth and inflation well below the Fed's 2% target?
· Mario Draghi, European Central Bank president, strongly hinted that more Eurozone “quantitative easing” was coming in December. Global stock markets rallied strongly after that remark, just like they did after Draghi said he'd do "whatever it takes" to save the Euro.
· The People’s Bank of China cut interest rates for a sixth time in just 12 months to buttress the Chinese economy and stock market.
· The Swedish Riksbank unveiled a scaled-up QE program this month while maintaining negative interest rates of -0.35%.
· The Swiss National Bank levies the largest negative interest rate we know of at -0.75%. Yet the Swiss Franc is still worth more than the U.S. dollar!
· Two-year German Bund yields have dropped to a historic low of below -0.3%.
· Here's a video summarizing global central banks propping up/inflating stock markets through creation of new debt (QE).
-->All of the above reinforces the view that central banks are still the primarily drivers of equity and high yield bond markets, as well as the appetite for even riskier assets.
U.S. 3rd Quarter GDP Slows Sharply:
The “advance” or first estimate of third-quarter 2015 GDP reflected a statistically-insignificant, real (inflation-adjusted), annualized, quarterly headline gain of 1.49%, a sharp pullback from headline growth of 3.92% in the second-quarter, but still higher than the 0.64% in the first-quarter.
In a note to subscribers, Shadowstats.com John Williams wrote:
"The present “new” recession or multiple-dip downturn remains likely to be timed from December 2014, although without headline back-to-back contractions of quarterly GDP currently in place, formal recognition of same still could be delayed for months. Recognition of the onset of the December 2007 recession was not formalized until November 28, 2008. Ongoing monthly economic-reporting detail for key series increasingly should confirm the patterns of declining economic activity, which should engender a formal recession call, irrespective of the timing of actual, headline quarterly contractions in real GDP.
Frequently discussed here, the headline GDP does not reflect properly or accurately the changes to the underlying fundamentals that drive the economy, at present. Fundamental, real-world economic activity shows that the broad economy began to turn down in 2006 and 2007, plunged into 2009, entered a protracted period of stagnation thereafter—never recovering—and then began to turn down anew in recent quarter."
Are Stock Valuations High?
We've previously noted that the S&P 500 earnings have been falling for the last two quarters while the P/E has been rising. The November 2nd issue of Barron's reports the S&P 500 P/E is 21.91 vs 19.57 one year ago.
Warren Buffett’s favorite measure of stock valuation, total-market-cap-to-GDP, is at 117.7%. That is the second highest in history and it is higher than the 2007 peak of 110.7%. In sharp contrast, market-cap-to-GDP fell to 62.2% at the 2009 March bottom.
John Auther's wrote in his Nov 1st FT column (on line subscription required): "S&P 500 earnings still look as though they will show an outright year-on-year fall, on revenues that are declining and lower than expected. A higher stock market will make it easier for the Fed to raise rates. So this implies that US stocks are dependent on money sloshing around the globe as other countries fight deflation. For six years now, we have had a repeating cycle. The US economy has stayed strong enough to avoid further recession, but weak enough to command continued doses of easy money — Goldilocks on ice. The bet underpinning the U.S. stock market is that this cycle persists, thanks to events beyond US shores."
Here's a quote from Zero Hedge on equity market valuations:
"Investors are now facing the second most extreme episode of equity market overvaluation in U.S. history (current valuations on similar measures already exceed those of 1929). The belief that zero interest rates offer no alternative but to accept risk in stocks is valid only if one believes that stocks cannot experience profoundly negative returns. We know precisely how similar valuation extremes have worked out for investors over the completion of the market cycle, and those outcomes have never been deferred indefinitely. The only question at present is how many grains are left in the hourglass."
Victor's Closing Comments:
The market must be seen relative to runaway, if not rogue, global central bank printing presses. In all of U.S. financial market history, no one ever imagined that government leaders would protect their power by risking the nation with excessive fiat money, while Congress and the people let them do so.
With the bad memory of letting Lehman go bankrupt in Sept 2008, the Fed will not allow stocks to fall and cause a recession. Evidently, they believe they can stop it by maintaining ZIRP, printing more paper dollars and buying financial assets. This must never be forgotten when trading.
An event that the Fed can't fix will be the endgame. There will likely be some surprise geopolitical event or an act of nature that causes great destruction. So the market will crash when the Fed can't control it with talk and more credit/ paper money printing.
Good luck and till next time…
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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