Unlimited QE and a Perspective on Stocks

Money creation by the Federal Reserve continues to intensify.  As of April 1, the Fed’s balance sheet hit $5.8 trillion an increase of $557 billion in just one week.  You read that right; the fed created more than a half-trillion dollars in just one week! (Source:  https://www.zerohedge.com/markets/feds-balance-sheet-hits-6-trillion-16-trillion-3-weeks)

The Fed officially revived the quantitative easing program (money printing) on March 13 as it began its current “bailout everything and everyone” program.  Since then, over the last few weeks, the Fed has printed more than $1.6 trillion.

Money creation at this pace may mean that my projection of a $10 trillion Fed balance sheet at year-end will be low as incredible as that seems.

Lest you think that high-volume money creation is a new phenomenon in response to the corona-virus situation, think again.  This “printing massive amounts of money response” first began in September of 2019 when the Fed began printing money to prop up the repo market; the overnight lending market between banks.

While coronavirus was not predictable, the eventual outcome of this Fed policy has been completely predictable.  I wrote this on October 7, 2019 (you can scroll back and find it)(emphasis added):

There is currently a grand experiment taking place.  Policymakers are trying to determine how far below zero yields can actually fall.  Our take is that on a global basis, yields can continue to fall for a little while yet, but the bottom can’t be far away.

When the bottom hits and bond investors panic, that may very well be the catalyst that drives stocks and bonds lower.

At that point, the policy response may be more money creation.  Since that is a real possibility, owning some tangible assets like precious metals along with highly rated corporate bonds might be a good idea.

          In my view, we are now on our way to the bottom.  The Fed is pulling out all the stops to attempt to reflate the bubble.  Given the numbers, it’s my firm conviction that they will fail.  At best, they may delay the inevitable for a brief period of time.

          History teaches us that massive money creation schemes always end badly.

          History also teaches us that tangible assets are the best hedge against inflation.  I am in the process of helping my clients find physical gold, silver, and platinum in order to add to their holdings of tangible assets.  While it requires a bit of work to locate precious metals in which to invest at a reasonable price, it can now likely be accomplished.  That was not the case last week.

          If you don’t own physical gold, silver or platinum, I’d urge you to get some.  These metals can also be held in an IRA or a Roth IRA account.

          I am surprised at the level of bullishness that still exists as far as stocks are concerned.  It’s important to understand that the biggest purchasers of stocks since the financial crisis have been the companies that issued the stock.  Stock buybacks have been one of the primary driving forces behind the bull market in stocks that, at this point, is just a fond memory.

          In his excellent weekly newsletter, “Thoughts from the Frontline” (Source: https://www.mauldineconomics.com/frontlinethoughts/notes-from-lockdown) publisher and economist John Mauldin commented on this phenomenon this week (emphasis added):

The stock market had a rough first quarter. The second one may not be much better and could be worse. But more than a few traders expect a quick recovery once the virus is under control. Many expect the various Fed injections and stimulus programs to drive asset prices higher in late 2020. I have my doubts.

A report I just saw from Canaccord Genuity analysts Tony Dwyer and Michael Welch says the market may have another problem. For prices to rise, the market needs a) willing buyers who b) have the cash to spend. Who is going to fill that role?

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Well, since the Great Financial Crisis, the primary stock buyer has been the listed companies themselves via their stock repurchase programs. Their net purchases dwarf all others.

This is a problem for bulls because the main buyer is suddenly leaving the scene. One reason is political pressure. It’s a bad look to be rewarding shareholders when the country is in such dire straits. But that aside, many companies are already highly leveraged and, with a recession looming, need to conserve their cash and borrowing power. Buybacks are not a priority. On top of that, the CARES Act restricts buybacks from companies receiving federal loans, loan guarantees, or other assistance.

All that means buybacks will likely be scarce for a while, and stock prices may have a hard time rising unless some other large buyer appears. Bull markets require people willing to buy. Bear markets develop simply in the absence of buyers.

          I agree with Mr. Mauldin. 

          It will be difficult for stocks to rise to their prior levels.

          Last week, I shared the market capitalization to gross domestic product chart with you.  It’s Warren Buffet’s favorite indicator to evaluate stock prices.  A fact that has gone largely unnoticed by many market pundits it that after the recent stock decline, valuations fell to a level that was equal to stock valuations at the start of the 2007 decline.

          During the great recession, the biggest hit to gross domestic product in any quarter was 8.4%.  We are looking at 4 times that level in the second quarter of this year. 

          Speaking of Mr. Buffet, Berkshire Hathaway held massive levels of cash at the end of 2019.  This from “Barron’s” (emphasis added):

The company held $125 billion in cash and equivalents at its insurance and other key businesses at the end of 2019. Some $101 billion, or 81% of that $125 billion was in ultra-safe U.S. Treasury bills, equal to nearly 4% of the $2.6 trillion of T-Bills in public hands. Berkshire has another $3 billion of cash and equivalents elsewhere at the company. The cash and equivalents account for about 25% of Berkshire’s market value.

Let’s read between the lines here a bit. 

If you’re a raging stock market bull, you don’t have 25% of your assets in cash with almost no yield.

And, while I have no first-hand knowledge of Mr. Buffet’s thinking presently on financial markets, it’s interesting that he just dumped airline stocks.  This from CNBC (emphasis added):

Warren Buffett’s Berkshire Hathaway said on Friday it sold about 18% of its stake in Delta Air Lines and 4% of its holdings in Southwest Airlines this week, as the coronavirus pandemic drives the airline industry into perhaps its biggest crisis ever.

According to regulatory filings, Berkshire sold nearly 13 million Delta shares for about $314 million and roughly 2.3 million Southwest shares for about $74 million.

The sales were conducted on Wednesday and Thursday, the filings show. Berkshire previously owned about 11.1% of Delta stock and 10.4% of Southwest stock, according to Refinitiv data. 

Again, reading between the lines, is that action you take if you’re anticipating a “V-shaped” recovery?

I think not.

          We are living in unprecedented times.  Be informed.  Be educated.

          If you are a client of my company, you are receiving an invitation to a weekly educational webinar on which we provide analysis and comment. 

          I do have a public educational webinar coming up this week as well.  If you would like more information, call my office at 1-866-921-3613. 

          Again, blessings to all of you in these difficult times.  Stay safe.

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