Stock Market

Anatomy of a “Bubble Finance” Operation

By David Stockman  |  November 29, 2018

Bonasera: Be my friend… Godfather.

[The Don at first shrugs, but upon hearing the title he lifts his hand, and a humbled Bonasera kisses the ring on it…]

– “The Godfather” (1972)

There’s something else to consider here with regard to Chairman “Jay.”

Let’s take him at face value and accept that, at the end of the speech, it’s all about the data.

So, maybe he kissed the Donald’s ring… maybe he didn’t?

Yesterday’s 600-point spree for the Dow Jones Industrial Average was all about Wall Street seeing one more rate hike in December and then… something else, something not “normalization.”

That’s hope.

It won’t work. It never does.

Here’s some substance.

Futures markets now “price in” an 83% chance of a 25 basis point increase to the target range for the federal funds rate when the Federal Open Market Committee (FOMC) meets in December.

That’s actually up from 70% a month ago and 76% a week ago.

I’d add that Jerome Powell risks forever the “independence” (even its appearance) of the Federal Reserve if he does indeed bend the knee and offer the Donald the Christmas cheer of “easy money”…

And all he said was interest rates are “just below” neutral. Remember, not so long ago the Fed said it wanted to go above neutral.

Those 600 Dow points are a bullish spasm in the early stages of a bear market. The yield on the 10-year U.S. Treasury note barely budged. The U.S. Treasury yield curve, for that matter, is rising on the short end and falling on the long end.

Consider, too, that maybe what Chairman “Jay” saw of Shopmas Season’s opening weekend scared him to flight…

That is, what Wall Street took as a “dovish” turn from “normalization” is the first sign that the Fed is finally worried about this old and weak recovery.

Yesterday’s rally had nothing to do with fundamentals, certainly. (But when has it with Bubble Finance?)

Powell’s aware of what’s happening in the U.S. housing market, I assure you. It’s in a downtrend, with sales volumes and prices falling.

It’s more than that, though…

Nation of Renters

The housing recovery is ultimately a story of the “real” employment situation.

Roughly a quarter of the home-buying cohort is unemployed and living at home with their parents. So, the option to buy simply is not available.

Another large chunk of that group is employed, but they’re at the lower end of the pay scale. And that pushes them to rent due to budgetary considerations and an inability to qualify for a mortgage…

The mistake mainstream analysts have made is assuming recent increases in real estate prices were driven by first-time home buyers. They saw an “organic” market.

The reality, however, is that market increases were driven by speculators in the “buy to rent” game. It was a Bubble Finance operation.

Mortgage rates are rising, and demand everywhere is going to take a hit.

Here’s the bare-bones outline of the beginning of the Mother of All Yield Shocks.

At first, the effect on the broader economy is minimal. Consumers, companies, and governments are confident. None will let what looks like a few more basis points in financing costs stop their consumption.

It starts on the margins; remember “subprime” in 2007?

But, eventually, rising rates hurt everyone. Borrowers get scared, and lenders do too. But way too often, it’s way too late, on both ends. And the “leverage machine” is jammed into reverse

A bear market comes on Wall Street, threatening stock-option packages. Corporate America cuts jobs and closes plants, thrusting recession on Main Street.

It’s not this linear, of course. But you can see signs: General Motors (NYSE: GM) and the housing market are pretty big ones.

Adjusting the target range for the federal funds rate – the interest the Fed charges big banks to borrow overnight – is an important part of our central bank’s toolkit.

But, in the 21st century, this era of “unconventional monetary policy,” it’s only the most obvious.

We talked about major, major member of that set one yesterday.

That’s “quantitative tightening.” “QT” is the converse of “QE,” which stands for “quantitative easing.”

Here’s an “easy” way to understand it: It’s QE on the way up, QT on the way down…

The Road to Normal…

As far as the Fed is concerned, it’s “normalization” now, “normalization” tomorrow, “normalization” forever. That’s because the Fed is concerned with the Fed and the Fed’s power.

Creating “dry powder” is about preserving the institution. It’s about getting ready to reap the whirlwind…

…Only, when it comes to monetary central planning, that whirlwind is eventually reaped by Main Street.

We may see some fits of short-term buying that create things like 900-point intraday swings, which can be frightening… for “buy and hold” investors.

I have a different approach. And its strategy and tactics are flexible enough for the Mother of All Yield Shocks.

Our “survive and thrive” plan includes specific asset types and allocations by percentage. But it’s built to suit your approach to the market.

The Stockman Letter is about protecting wealth and profiting opportunistically.

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR