There were a number of financial articles I found intriguing this week, particularly centered around the following:
“The net effect of these investor groups is that they together shed $1.1 trillion of shares (included in these categories, and spread over them, are ETFs). But the $1.1 trillion of shares that these investor groups shed over those five years was overpowered by $2.95 trillion of share buybacks over those five years.”
You can read the whole article if you’d like the charts and such, but it’s an interesting phenomenon to think about. Investors actually pulled 1.1 trillion out of stocks while corporate buybacks flooded 2.95 trillion in, resulting in a massive bull market as buying outpaced selling by 1.9 trillion.
Most investor classes have been bearish because they are trained on classic valuation models, and no matter how you slice it the idea of a “new normal” of slower growth does not justify P/E ratios that are way above average.
So will the stock market plummet? It’s tempting to think so. However, a very interesting podcast on RealVision by Brain Reynolds explained an interesting phenomenon.
After the problems with Detroit pension funds, remaining labor groups have been increasingly pressuring politicians to fill pension shortfalls. State and local taxes have been rising and putting larger amounts of money into these funds. The funds are typically expected to make returns around 7%, and they attempt this by throwing ever more money into leveraged forms of corporate debt.
This corporate debt goes more and more into stock buybacks. 2018 had a record $800 billion in corporate buybacks, and I’ve seen predictions of $1.2 trillion for 2019. If that holds true, stocks have no option but to tear higher.
Brian Reynolds explained that when credit markets start to freeze up, the cycle can quickly turn to panic like in late 2018, yet the market will be tearing higher like a switch has been turned on once the credit thaws again.
In such a market, credit is by far the most important indicator. Credit creation spills over into all asset classes, flooding the stock market with liquidity so it will blindly tear higher only to let it drop in a panic when credit creation drops to a smaller level.
So what credit metrics are there? Well, the primary ones tend to be the yield curve, such as 10 year bonds vs 1 year, and bond spreads, such as corporate debt vs government debt. These can be problematic indicators however when central banks around the world try to directly manipulate these measures.
I tend to think that the volume of credit creation is the key here, and a manipulated rate is not a reliable indicator. That begs the question, what do we use? I’m not sure if ordinary investors like me can access more direct information. Some things that might help however include:
1. Overall debt levels, perhaps found from various articles… make sure you sell if they stop rising.
2. Central bank policy – the Fed can talk more dovish, but I’m nervous about stock price declines until they lower rates and switch back from reducing the balance sheet to enlarging it.
3. Technical Analysis on the S&P 500. This may actually be your best bet because the way the money flows which drive the price work differently in a low-liquidity selloff than a high-liquidity rise. Thus the way the price itself moves may be the best tell, as these patterns will help determine direction. If the credit creation switch is turned on, that will show and likely last between a few months to a couple years before being switched off again.
Caution: this is not the same as saying buy the dips … buying the dips in this market will actually be dangerous. It is saying buy when you have confirmation of the loose credit trend continuing and sell when you see signals of credit tightening.
I’m no expert in technical analysis and I can’t tell you what price signal will work – I can only suggest you find what metrics fit the trend in the last 5 years and ride them through until we eventually hit another regime change in what drives the market. This regime change could involve the slowdown in the rest of the world affecting the US, but I think it will more likely be driven by politics, when politicians are driven to find other economic levers to mess with.
Buena suerte, and as always I hope this gives you something to think about.
—– Some afterthoughts —-
It occurred to me that there was a recent regime change we need to think about… expansionary fed policy was the main driver, leading to credit spillover into stock buybacks, until 2018. After that the Fed tightened policy, and the rest of the world started responding to the tighter credit and going dow.n
Then the tax change was the next policy lever pulled which highly incentivized corporations to “repatriate” dollars – many of which were used for stock buybacks. That’s why we see record stock buybacks going forward for now. That begs the question of how long can it last?
Of course the money going in to fill the pension funding gap is pouring in as well – but if this money comes from local taxes while credit is tightening and world growth is slow, we’re bound to hit a recession which would spook the markets.
This leads me back to my original thought which was wait for the fed to actually reduce rates toward 1% before hitting a high conviction bullish outlook. Until then think cautious … when the steady climb starts to turn be ready to cut and run until you see a solid base forming. Be prepared for prices to drop as fast as they did Jan-March 2018 and again Sept-Dec 2018.
I don’t think this tax change repatriation spillover will be as steadily reliable as QE spillover in driving stock markets higher … it could be more high intensity but short-lived as companies rush to take advantage of the tax law before it can be changed. Also keep in mind that the money allocated to stocks will be dispersed over more high profile IPO’s this year. This will be a drag on the overall market because it will absorb money allocated for stocks (most of which is invested blindly and bluntly ETF-style). Essentially, if Uber is valued at $10 billion, then the IPO will pull $10 billion which would have been allocated to other stocks – acting the same as if $10 billion was pulled from stock ETF’s.
Anyway, I didn’t want to rewrite yesterday’s post but I though this was important enough to mention.