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You, like me, may be a bear at heart. You probably joined Sure Money a long time before I got here. The guy whose place I took was a brilliant market strategist who was just a little early in my view. There is not a scintilla of doubt in my mind that his view will ultimately be proven resoundingly correct. Those of us of a bearish persuasion will make a lot of money over the next few years.
And it looks like we're going to be able to start in January 2018 (and we should be prepared and at least partly positioned before that). Here's why.
The Real Reason This Rally Has Lasted So Long (and Confused the LAMPP)
Most of the time, you should ignore the headlines. But every once in awhile, one comes along that you should sit up and pay attention to.
Whenever you see a news item with the words "economists say" in conjunction with anything central bank-related, you had better pay attention. It is the clarion call of the central bankers. These so called "economists" are really the lackeys and mouthpieces of the monetary policymakers. Regardless of whether it's the Fed or one of its two major partners in crime, the ECB or the BOJ, when you see the words "economists say" in reference to those central banks, it matters.
Yesterday there was just such a case, and it matters to the well-being of your investments. It matters big time. So listen up.
Recently I have been speculating with you on why I think that the short-term LAMPP has been way early, if not wrong. I think it's just early, but I'm biased. I hate to think I might be wrong, but alas, s*** happens.
Now the LAMPP is based entirely on what the Fed and U.S. Treasury are doing in the market. And it has worked very well for the last 10 years since the time when the Fed started directly intervening in the financial markets in a way that it had never done in the past.
But there are outside forces that come to bear, in particular the actions of the Fed's two biggest cohort central banks.
Under normal circumstances throughout history, big central banks have moved in the same direction over roughly the same period. So the ECB's and BOJ's actions would normally be in step with the Fed. While the timing of their actions would differ somewhat, it would normally be unthinkable for central banks to be working at cross purposes.
That's what's happening today, and why I think the short-term LAMPP gave us a sell signal seven weeks ago and the U.S. markets have kept plowing higher. So Booyah or Boohoo! Rule No. 2 – "the trend is your friend" (aka don't fight the tape) has superseded Rule No. 1 – "don't fight the Fed" for a few weeks.
I believe that the reason that the short-term LAMPP signal has been wrong so far was because Yellen's fellow central bank godfathers, the BOJ's Kuroda and the ECB's Draghi, have continued to print money and pump it into world markets hand over fist. While that money goes first into their own domestic banking systems, the fact is that all roads lead to Wall Street, and some of that homegrown money, in Europe in particular, hits the road to Wall Street as soon as it comes hot off Draghi's press.
Thirteen of the Fed's primary dealers are also major operators in Europe and Japan. In fact, five of those U.S. primary dealers are Eurozone banks that are direct correspondents with the ECB. They are Deutsche Bank, Societe General, BNP Paribas, Credit Suisse, and UBS. They operate in both European markets and the United States simultaneously. And of course all the other U.S. primary dealers have massive trading operations in Europe. For instance, the giant squid, Goldman Sachs, has its tentacles everywhere. So, of course, do JPM and most other big U.S. dealers.
Therefore, money that the ECB prints in Europe is instantaneously available to be traded in New York. Make no mistake, the banks use that money to buy U.S. Treasuries. That injects cash into the U.S. markets that can then be used to buy stocks.
The chart below illustrates. It represents the total U.S. dollar equivalent of the cash that the Fed, ECB, and BOJ inject into the worldwide liquidity pool. (Note: The terms money, liquidity, and cash are essentially interchangeable. That's all that liquidity really means – money or cash.)
As you can see, even though the Fed stopped injecting net new money into the system at the end of 2014, the BOJ and ECB were just getting revved up. It is unprecedented in recent history, but the fact is that the foreign central banks kept the U.S. markets liquefied throughout the period where the Fed was essentially dormant.
I say "essentially" because the Fed kept its balance sheet flat by buying mortgage-backed securities every month to replace its MBS holdings that were being paid down every month. Even though those MBS replacement purchases served only to keep the Fed's balance sheet flat, they have still been cashing out primary dealers, lately to the tune of around $25 billion a month.
That cash helped the primary dealers to continue to support rising stock prices. Those flows into dealer accounts are integral to U.S. market performance. They are included in the LAMPP for that reason. They are one of the reasons the LAMPP stayed green in spite of the Fed keeping its balance sheet flat.
Between that cash and the inflows from the ECB and BOJ, the dealers were able to continue to mark up prices. Their customers, primarily big institutions and hedge funds, were like pigs, happily feeding at the stock market garbage trough.
Back to the ECB. No doubt some trading firms are using ECB cash to buy stocks directly. But even if they don't, money that is punished by negative rates in Europe and Japan heads for the United States where it can get a positive return. The banks hedge the currency risk and get cash flow off the arbitrage.
So money continued coming into the United States even after the Fed stopped printing. And money will continue to flow in from Europe and Japan, even as the Fed starts draining funds from the U.S. banking system under its euphemistically named program of "normalization." I believe that that foreign money along with increased leverage in the United States as latecomers pile on and shorts get squeezed have driven this rally.
That rally is getting very tired.
And it's about to get worse.
The Party's Over – the ECB Is Now Cutting Off Our Cash Supply
The ECB is about to print a whole lot less money. Next year, as the Fed ratchets up its withdrawals of cash from the banking system and the market, the amount of those drains will exceed the amount of money that the ECB is printing.
Only some portion of that ECB cash reaches U.S. shores. We can't say exactly how much. But we do know that in October 2018, the Fed will start pulling $50 billion per month out of the U.S. money pool. We've just been given a heads up that the ECB will be printing less than that.
That pool of money is what drives stock pricing. If it is shrinking, so will stock prices shrink. The ECB and BOJ will no longer be sending enough cash to the United States to fully offset that.
How do we know that Draghi is about to begin reducing ECB purchases? Because the ECB sent its propaganda henchmen out on the hustings this week to tell us. No doubt Draghi will codify it in Thursday's ECB policy announcement. But yesterday, we saw it in Bloomberg, and if Bloomberg says it, then yes, Virginia, it must be true.
Santa is about to put coal in your stocking.
Here's how Bloomberg headlined it on Tuesday: "Draghi Seen Going for Bond-Buying Limit in QE's Last Hurrah".
With a subhead: "Economists see about 270 billion euros in extra buying in 2018".
That sounds like a lot, but it's only €22.5 billion ($26.2 billion) per month, which is three-eighths of the current purchase rate. The BOJ will also start cutting back purchases soon.
Bloomberg summarized its findings thusly: "The European Central Bank will halve monthly bond purchases to 30 billion euros ($35 billion) next year, stretching out the program's remaining capacity as it waits for inflation to pick up, a Bloomberg survey of economists shows."
The chart below shows how Bloomberg constructed the consensus forecast of these "economists." These aren't just guys on the street. These are connected guys. They work for the banks that deal directly with the ECB. They're plugged in to the top echelons of the ECB. They get the policy skinny directly from the big mahoffs (mahoff is a Philly word that means exactly what it sounds like). It's not just rank speculation by a bunch of Wall Street TV talking boobs.
There just won't be enough foreign cash to keep U.S. stock prices afloat as the Fed's cuts become increasingly draconian over the next 12 months.
According to this, the actual cuts won't start until January, but no doubt there will be some preemptive selling. That and the initial cuts will kneecap the U.S. stock rally. We are talking a tire iron directly to the knees starting in January. Before that, sure, maybe the market can make a marginal new high. But if you're thinking about adding to your longs, you'll be picking up nickels in front of a steamroller.
How to Prepare Yourself for the Big January Meltdown
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.