In yesterday’s Rum Rebellion, I discussed gold’s response to the Iranian situation. While the knee-jerk reaction to the potential conflict has been strong, I pointed out a few reasons to be cautious.
It remains to be seen whether I’m right on that…or whether the market will make a fool of me yet again.
I’m not sure whether this is a good or bad omen for that call, but it appears as though the thinking in the oil market is similar to mine. As the Wall Street Journal reports…
‘Escalating tensions in the Middle East are giving oil prices a boost, but some investors are sceptical the rally has legs after other recent geopolitical flare-ups in the market quickly eased.
‘Crude futures shot up as much as 4.9% Friday after President Trump ordered a strike on Baghdad that killed a powerful Iranian general — Maj. Gen. Qassem Soleimani.
‘But the rally lost steam, with Brent crude and West Texas Intermediate futures paring some of their initial gains to settle up 3.5% and 3.1%, respectively.
‘Oil prices also gave up much of their early gains Monday, despite escalating tensions over the weekend.
‘By Tuesday, crude futures were falling. US crude edged down 0.6% to $62.90 a barrel, while Brent, the global gauge of prices, fell 0.6% to $68.50 a barrel.
‘“A lot of traders are selling geopolitical events,” said Rebecca Babin, senior energy trader at CIBC Private Wealth Management. “If you bought any geopolitical rally last year, you were wrong.”’
That doesn’t mean you’ll be wrong this year. But it does suggest that the market isn’t as quick to react to the beating of war drums as it used to be.
I’m not sure why that is exactly. But it could be due to the fact that the Washington swamp is no longer in complete control of the US war machine. It knows that war is unlikely.
It could also be that the market knows the US is so overwhelmingly powerful in relation to Iran that nothing of importance will happen.
Another explanation is that the US Federal Reserve has anesthetised the market to such an extent that it is almost in zombie mode. Whatever the day’s events, it doesn’t matter. The market simply responds to the amount of liquidity the Fed injects. Everything else is a sideshow.
Remember back in September when the ‘repo’ market froze up and sent the cost of overnight borrowing to 10%? US stocks then fell sharply into early October. This brought about a response from the Fed. It began to expand its balance sheet again.
As you can see in the chart below, the market hasn’t looked back since…
Source: J.P.Morgan, IHS Markit
The Federal Reserve’s actions were in part due to fears of a year-end funding squeeze. I think that means the Fed worried about everyone wanting cash for some seasonal reason…although who knows.
It’s safe to say that about 1% of players know what is going on in the repo market anyway…including those at the Fed. But when in doubt, just spray money blindly.
According to Reuters:
‘Wall Street’s worst fears of a year-end funding squeeze never materialized thanks in large part to the quarter-trillion dollars the Federal Reserve stuffed into the market to ensure nothing became gummed up’.
What happens next?
‘The Fed will continue pumping tens of billions a day into the repo market through at least the end of January. Its ability to exit from the repo market after that time will depend on how long it takes the central bank to make the balance sheet large enough so there are adequate reserves in the banking system — and the repo operations are no longer needed.’
How will the Fed know when repo operations are no longer needed?
When the S&P 500 falls 2%? 3%? 5%?
There really is no use pondering that question. We don’t know. What we do know is that major global equity markets around the world are nearly all in bullish trends, largely thanks to central bank assistance.
But it hasn’t just been assistance over the past few months. It’s a unique feature of the post 2009 rally. As Jim Bianco, writing for Bloomberg, points out:
‘As of November, the collective balance-sheet assets of the Federal Reserve, European Central Bank, Bank of Japan and Bank of England stood at 35.9% of their countries’ total gross domestic product, up from about 10% in 2008, according to data compiled by Bloomberg.’
That this is insane, morally wrong, and long-term counterproductive goes without saying. The market is amoral. It doesn’t care for your morals and beliefs. As an investor, you have to play along. Otherwise you sit in cash and watch your relative wealth diminish day by day.
The bottom line is that the markets are in an upward trend. Until that changes, smart investors should remain invested, if not fully, then ‘mostly’.
That goes for the Aussie market too (see the ASX 200 below). While it’s yet to break above its late July 2019 high, it still remains in a broadly rising trend.
Source: J.P.Morgan, IHS Markit
If you’re too bearish, the risk is that the index will breakout and head into a melt-up phase. And you’ll be left behind. If you’re comfortable with that, no problem. If you’re praying for a fall, you could be disappointed.
At this stage of the cycle, a melt-up is just as likely as a meltdown. But until the Fed and other central banks start talking about removing excess liquidity again, in my view stocks will keep pushing higher.