In a single week, $4 trillion in global stock market value has vanished. The stock market had become complacent toward the fierce rise in U.S. Treasury yields. Trump’s tax cut plan was clearly going to drive yields on Treasuries up by impacting the supply and demand at a time when the Federal Reserve was cutting back on its own purchases of Treasuries in order to normalize its bloated balance sheet in a hurried acceleration of its QE unwind.
Doves on the Federal Open Market Committee (FOMC) like Minneapolis Fed President Neel Kashkari regularly voted against rate hikes in 2017 because inflation was too “low.” As inflation edges up now, the story will change. In its statement after the January 31 FOMC meeting, the Fed specifically pointed at the “low” unemployment rate, and some Fed governors have said that the unemployment rate, at 4.1% for the past four months, might inch down to 3.9% by the end of the year and stay there in 2019, and that these levels would put further upward pressure on wages as employers might have to raise wages to attract workers.
But it is Trump’s political future that will ultimately be the biggest story for the markets. Up until now, Trump has been supported by a calm stock market regularly scaling new heights. No longer, not with the looming mid-term elections. The Republicans having nailed themselves to Trump’s mast will face problems, as Bradford de Long writes, extraordinary or not, Trump is ‘… playing to lose’. While he was insisting that his tax cut legislation had “set off a tidal wave of good news that continues to grow every single day,” actually the markets were reassessing how much that tax cut was actually going to add to the U.S. deficit; how much it would mean in new issuance of Treasury bills, notes and bonds; and weighing how far interest rates would have to rise so that this massive doubling of debt issuance would find buyers.
The Trump tax cut legislation reduced the corporate tax rate from 35 percent to 21 percent. The nonpartisan Congressional Budget Office has estimated that it will add $1.5 trillion to the deficit over the next decade. Now the chickens are coming home to roost, and the chaos of this presidency, and volatility in the markets, will begin to feed off each other. A new Gallup poll put global approval of US leadership at just 30%, behind China at 31% and Russia at 27%.
But as Wolf Richter writes: ‘What’ll happen next? Dip buyers will come in, maybe at this very moment, or maybe later, and some of them will likely get plowed under, but there is way too much cash lined up in hedge funds specifically set up to profit from sell-offs. And dip-buyers have been rewarded relentlessly over the past eight years, and it’s not until the dip buyers get massively destroyed and stop dip-buying that the market is in real trouble.’
We will see considerable turbulence which will probably feed off the ups and downs of the Trump political journey, with a bias to the downside as money will seek rising yields in the Treasury market.
A cause for concern should be that Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE) is now above 30 – a level previously reached only twice, at the peaks of 1929 and 2000 (see chart below), both of which were followed by stock-market crashes. Also if CAPE is particularly high for the US compared with all other countries, the reason is share buybacks by corporations. So if anyone tells you that the “fundamentals” of the economy are strong, you should know that shares prices and fundamentals have disconnected a long time ago. In a world of financial engineering they have nothing to do with each other.
10th February update: See Pam and Russ Martens for the observation that– on Thursday, February 8, the Dow and the NASDAQ traded in almost complete lockstep. Why would a far riskier market trade in lockstep with the far safer Dow during a market panic? This recalls the bust that began in March 2000. So there seems to have been indiscriminate, wholesale dumping of stock portfolios by traders desperate to raise cash any way they could. The monster difference between the volume of advancing stocks versus the volume on declining stocks also suggests wholesale dumping. Dow Jones’ MarketWatch reports that yesterday the New York Stock Exchange (NYSE) saw 2,683 stocks decline while only 342 stocks advanced. Similarly, Nasdaq saw 2,525 stocks decline while 453 advanced. Trading volume was swamped by declining shares. On the NYSE, declining share volume reached 4.74 billion while advance volume came in at a meager 556.45 million. Nasdaq’s volume tallied out at 2.35 billion in decliners versus 363.15 million in advancers.
The key thing is that hedge funds seems to be liquidating stock portfolios to meet margin calls, that would help to explain the inability of the stock market to sustain a rally. This is what was noted on this site back in December 1, 2017.