Originally published at The Boock Report
We’re finally here. About 9 years after QE1 began, QT is about to start. If one believes that the stock market still is a discounting mechanism, then have nothing to fear with QT and that maybe it will actually be like “watching paint dry” as Fed members so desperately want it to be. After all, the S&P 500 is at an all-time high. If you think, like me, that the stock market is not the same discounting tool as it once was because of the major distortion and manipulation of markets via central market involvement and the dominance of machines that are reactive instead of proactive in response to news, then we must review again the previous experiences when major Fed changes took place. After all, they were all well telegraphed as this week’s likely news has been.
Before I get to that, let me remind everyone that the 3rd mandate of QE was higher stock prices. Ben Bernanke in rationalizing the initiation of QE2 in a Washington Post editorial back in November 2010 said in regards to QE1 and the verbal preparation for QE2: “this approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action.” He then went on to say “higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” Yes, the belief in the wealth effect which hasn’t worked in this expansion. Hence, the record high in stocks last week and the 2.9% y/o/y rise in core August retail sales, both below the 5-year average and well less than the average seen in the prior two expansions.
After QE1 ended when we knew exactly the full size and expiration date (March 31st, 2010), the market topped out 3 weeks after and then fell 17%. After QE2 ended when we also knew the exact amount and deadline (June 30th, 2011), the market peaked one week later and then fell about 20%. Around the time QE3 ended with the lead up being a very methodical process of tapering, stocks had a hissy fit of about 10% only saved by James Bullard who hinted that maybe they won’t end QE. In the two months after the well telegraphed first rate hike in December 2015, stocks fell by 13%. The stock market of course, therefore, wasn’t very good at discounting the end of major monetary stimulus actions even though they knew what was coming.
Subsequent rate hikes haven’t had a negative influence because of hopes for US tax reform and huge QE from the ECB and BoJ. I do though want to remind people that the DAX topped out 3 months ago and the Nikkei is still below where it was in the summer of 2015 notwithstanding all the ETF buying too.
As my friend David Rosenberg has pointed out, 10 out of the last 13 tightening cycles led to a recession. This tightening cycle is about to ramp up with liquidity being drawn each and every month and by another higher increment after 3-month intervals until at some point $50b per month of liquidity will suddenly disappear.
I was fortunate enough to have seen Paul McCartney Friday night at MSG. It was amazing. As my worries about US stocks have been predicated on excessive valuations coupled with Fed tightening, I will rework the Beatles song Yesterday as it relates to pre and post QE and how I think the tune markets will be singing will go over the next 12 months. As reinvestments are a form of QE because the Fed is still buying securities every month, the new era starts on Wednesday whereas Yesterday ends on Tuesday.
“Yesterday, all my market troubles seemed so far away. Now it looks as though they’re here to stay. Oh, I believe in yesterday.”
“Suddenly, the Fed Put is not what it used to be. There’s a shadow hanging over me. Oh, yesterday came suddenly.”
“Why’d the Put had to go, I don’t know, she wouldn’t say.”
“Yesterday, buying the dip was such an easy game to play. Now I need a place to hide away. Oh, I believe in yesterday.”
Bottom line, have stocks discounted an easy road ahead for QT or not? I’m highly skeptical as I think it’s been only focused on hopes for tax reform (which would be positive LONG TERM for the economy no doubt from a competitive standpoint but I’m mostly talking multiple compression for the here and now and possibly tighter credit). I’ll say this if the Fed pulls off QT along with more rate hikes in coming years, a soft landing is achieved and the stock market just keeps on keeping on, I will scream from some mountain top (not too high because I’m afraid of heights) that I was dead wrong.
Data wise, China reported that the pace of home price gains in August slowed down. Versus July, prices rose in 46 of 70 cities surveyed, down from 56 and vs 60 in June. Versus last year, 68 cities saw gains vs 70 in the two months prior. For existing apartments, prices though held steady in 54 cities vs July and went to 69 vs last year vs 67 last month that saw gains. In Beijing, home prices moderated to a 5.6% y/o/y rise from 9.6% in July. They slowed to a 3.2% y/o/y gain from 8.4% in July in Shanghai. In Shenzhen when last April prices had risen by 63% y/o/y, they actually fell by 2% y/o/y in August. There was only a modest reaction to the data as the Shanghai property stock index fell .3%. Copper though is bouncing by .7% after its 4-day selloff. Bottom line, we know the Chinese government continues to play whack a mole with its property market.
In Europe, there was no revision as expected to the eurozone August CPI report. It was left at up 1.5% y/o/y headline and 1.2% at the core. As a reminder, while 1.2% is modest, that core gain matches the most since March 2013. Also of note, on Friday Eurostat said eurozone labor costs rose 1.8% y/o/y in Q2, that is the fastest pace of gain since Q1 2015. The euro continues to trade well just below $1.20. On October 26th we’ll get the next tapering news from the ECB with only its start date likely in question at this point.
Lastly, Portuguese sovereign bonds are ripping higher with yields plunging after S&P gave them back their investment grade status again. They went from BB+ to BBB-. “The upgrade reflects our improved forecast for Portugal’s growth during 2017-2020, as well as the solid progress it has made in reducing its budget deficit and the receded risk of a marked deterioration in external financing conditions.” Fitch and Moody’s both have them at junk. Their 10 yr yield is down by 27 bps to 2.53%. Italian and Spanish bonds are rallying in sympathy.