Buy the Dip? What Dip?

Dear Reader,

Another day, another rise for the major US equity indices.

Today’s excuse?

The start of fourth quarter earnings season. From The Wall Street Journal:

The Dow Jones Industrial Average edged higher Tuesday as big banks kicked off fourth-quarter earnings season with mostly strong results.

The blue-chip index ticked up 0.2%, while S&P 500 and the technology-heavy Nasdaq Composite wavered between small gains and losses.

Financial stocks were among the best performers in the S&P 500, rising 0.4%, after JPMorgan Chase and Citigroup reported strong results.

But get this…

US corporate earnings have been in a bear market all year. According to Factset, companies in the S&P 500 are expected to report a fourth quarter earnings decline of 2.4% compared to the same period last year.

This will mark the fourth consecutive quarterly earnings decline!

Download your free report to discover why some of Australia’s most popular Mining stocks Could take a Massive Hit in 2020…and What to Buy Instead.

So just to be clear: While corporate earnings have declined this year, the S&P 500 index jumped around 30%.

In other words, the market is not moving higher based on ‘fundamentals’. It is moving higher based on the view that the Fed will prevent a bear market from taking hold.

This is an extremely powerful belief.

You can see just how powerful it is by looking at the performance of Apple Inc. [NASDAQ:AAPL] in 2019. Net income in the year to 30 September increased just 3%. Yet its share price jumped more than 90%.

The stock market is forward looking. So we should take into account earnings expectations for FY2020. Here it looks slightly better. Net income is expected to increase 8.25% year on year.

But as of yesterday’s close, the stock price is up 105% year on year!

To a rational observer this makes no sense.

Until you break it down, that is.

The market is responding rationally to irrational behaviour

If you think back to this time last year, the market had just experienced a terrible fourth quarter of 2018. Stocks plunged heading into Christmas as it became apparent the Fed had tightened too fast.

As a reminder, during 2018 the Fed increased the official rate at the same time it shrank its balance sheet. Both of these actions removed cash (liquidity) from the market.

The Fed quickly realised that market forces were in the process of imposing some long absent discipline on the financial system. This being their greatest fear, they stepped in and did what they do best: Pump stocks up with an about face on monetary policy.

They started by reducing the Fed Funds rate, which is the official cash rate in the US. Then, as I explained yesterday, they turned to balance sheet expansion in September. This was after the ‘repo’ market blew a gasket.

Four months later, the Fed’s balance sheet is now US$400 billion larger.

Now, according to an article in The Wall Street Journal, the Fed is considering a new tool to allow smaller banks and hedge funds to borrow from it directly.

This relates to the stresses in the repo market that I discussed yesterday. Right now, only the big banks, known as ‘Primary Dealers’ can access repo funds from the Fed.

But the Fed appears to be exploring the idea of expanding this access.

The socialisation of our financial markets continues…

The thing is, having access to cash is the lifeblood of any business. A soundly functioning financial system should be the judge of whether a company or financial entity is worthy of borrowing cash.

When Bear Stearns and Lehman went bust, it was because the market realised they were bankrupt (liabilities were higher than assets). So they stopped lending. When the flow of cash stopped, it exposed the bankruptcy.

The socialists at the Fed obviously believe there are problems in the financial system. They think some players are having trouble getting access to cash. This is how the markets impose discipline.

But the Fed is having none of it. They want to remove discipline. Everyone’s a winner these days.

This feeds into the current market narrative that the Fed won’t let prices fall. No wonder prices are melting up. There is no longer even a dip to buy.

History tells you that this is a dangerous time for investors. We know it will end in tears, we just don’t know when.

There are two risks smart investors need to consider. The risk of being fully invested at a dangerous time and the risk of being out of the market while stocks continue melting up.

Right now, markets all around the world are in bullish trends. They don’t even look like breaking down.

It might not make sense to you. But that’s how it is. The bears will complain that the market is irrational. Sometimes that is the case.

Revealed: The 2020 ASX Blacklist – Stocks to Sell NOW. Download your free report.

But I would say that the market is responding rationally to irrational behaviour from the Fed and global central banks in general.

When the word from the top is that ‘losses will be socialised’, of course the rational response is to speculate like crazy.

Yes it’s insane. But don’t blame the market. Blame the central banks and governments that are turning society upside down.

Regards,


Signature
Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.


Leave a Reply

Your email address will not be published. Required fields are marked *

The Rum Rebellion