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The short-term LAMPP is slightly in red territory, but the market keeps rising. What's up with that?
The LAMPP (Liquidity and Monetary Policy Profits) was little changed last week, remaining red for the short term and still green on the long-term indicator. The red signal for the short term is not an exact timing indicator. It does tell us, however, that the market is ripe for a decline.
For the time being, liquidity flowing from other sources, such as foreign capital inflows, continues to drive stock price inflation.
That is a common feature of the late stages of a bull run. I call it residual momentum. We have been indoctrinated to buy dips and chase rallies. There's never a price to be paid for that behavior. So we keep buying until the cash runs out.
That could happen soon. A huge amount of new Treasury debt will hit the market this month. In fact, $40 billion in net new supply was issued on Friday, and another $8 billion was being issued on Monday. That has caused some indigestion in the bond market. But stock buyers covered their eyes and sang "tra-la-la" at the top of their lungs. They don't want to hear any bad news.
This kind of denial is a hallmark of an end-stage bull market.
Furthermore, the supply problem will only get worse over the course of the rest of October. The TBAC forecast calls for around $140 billion in new supply to hit the market during the month. The actual total may vary because they got a head start on lifting the debt ceiling with the deal coming early in September. But supply should still be gargantuan. That will suck a lot of cash out of the pool of money that drives demand for both stocks and bonds.
That will keep the short-term LAMPP on red and push the long-term LAMPP toward red.
The short-term LAMPP could appear to be wrong for awhile, but do not be seduced by the fact that the market is still going up. The Fed is no longer supporting this market.
And rule number one of investing is "don't fight the Fed!"
Starting this month, the Fed will no longer be there to help absorb new supply. It will now all be up to private investors.
The Primary Dealers Are Going on a "Starvation Diet" Soon
The Fed's program of "normalization," which is a euphemism for getting rid of assets and siphoning funds from the banking system, starts very slowly. Its effects will probably be too small to be materially bearish for the first three months, while stock market players are still drinking the Kool Aid.
But the Fed will ratchet up its withdrawals. It withdraws $10 billion per month for the first three months. Then it increases that by $10 billion a month every quarter until the Fed is withdrawing $50 billion per month from the banking system. That's an annual rate of $600 billion. It reminds me of the old joke. Another hundred billion and pretty soon we'll be talking real money.
Well, the Fed will be killing real money, and that will take a toll. Stock and bond prices will get crushed with that much money being pulled out of the pool of cash that fuels investment and speculative demand.
Consider this. Under QE, the Fed was buying enough Treasuries and mortgage-backed securities (MBS) to fund virtually all new Treasury issuance. Of course, there were other buyers too, so there was plenty of cash left over for the dealers to buy stock inventory, mark it up, and distribute it to their customers. Most of their customers are hedge funds and institutions, and some of them are us, retail customers.
In 2015, the Fed stopped buying Treasuries, but it continued to buy $40 billion to $45 billion of MBS per month from the primary dealers. At that point, the dealers were still getting enough cash from the Fed to absorb half of the net new Treasury supply every month. And of course there were other buyers. So the dealers were getting plenty of money to keep bond prices high with enough left over to fund the stock market bubble.
The amount of MBS purchases dropped to around $25 billion per month over the past year. Don't anybody look now, but the fact is that bond prices topped and yields bottomed out in 2012. They've never been able to do better since. The amount of funding from the Fed was no longer sufficient to push bond yields below where they were in 2012.
Consider that the 10-year yield ended last week at 2.3%. Briefly in 2016 it was as low as 1.40%. But $25 billion a month is no longer enough to keep bond prices rallying and bond yields falling.
Yet, the CNBC talking heads and the Wall Street PR merchants are still talking about the secular bond bull market.
So what happens next? Soon the Fed will fund zero of net new Treasury issuance. It won't happen right away. It'll cross that Rubicon either in January or next April. In January, the Fed will reduce its monthly purchases of new MBS to around $15 billion. At the same time, it will redeem $12 billion in Treasuries every month.
Without getting into the nitty gritty, that means that the Fed will be sending just $3 billion per month to the primary dealers. That's down from $25 billion a month now and $40 billion to $45 billion a year ago. And lest we forget, under QE at various times between 2009 and 2014, the Fed was cashing out the primary dealers to the tune of $100 billion to $150 billion a month!
The Fed will now put the primary dealers on a starvation diet. The dealers won't have enough cash to absorb any new Treasury supply at all.
Then in the middle of next year, and again in the fall, the Fed will tighten the screws some more. The dealers will not only not have the cash to support the bond market, they will definitely not have the cash to speculate in buying and marking up equities inventories to be marketed for sale to their customers.
Here's their problem. The primary dealers are REQUIRED to participate in the Treasury auctions. They must buy some of the issuance. If they don't have sufficient cash to absorb new inventory, then they'll need to raise cash to do so.
That is a big problem for stocks.
About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.