Federal Reserve

Oh, Sweet Nothing

By David Stockman  |  July 18, 2018

He knew that all the hazards and perils were now drawing together to a point: the next day would be a day of doom, the day of final effort or disaster, the last gasp.

– J.R.R. Tolkien, The Return of the King (1955)

We’re back above 2,800 on the S&P 500 Index.

We’re a big day or two away from the all-time high we reached on January 26, 2018.

And Wall Street continues to pump out one meme after another to lure the next, next greater fool.

But the oft-promised breakout to new highs ain’t gonna happen.

The era of Bubble Finance is done.

When Wall Street gets reprogramed for “quantitative tightening,” the selling will be ferocious.

“It’s all priced in” is a talking head’s line, peddled on Bubblevision. Don’t fall for it.

There’s no reason whatsoever to “buy the dip.” But there are many reasons to keep your powder dry.

Three of them are huge.

First, valuations are ridiculous. The S&P 500 is priced at 24 times earnings, the small-cap Russell 2000 81 times.

Second, it’s the eighth inning of the second-longest expansion in history. And it’s been both low-scoring and error-filled.

Third, amid this weak-and-old “recovery,” central banks are fixing to drain a lot of cash from the casino. So, we’re set for a major yield shock.

It’s that third point that bears the most explaining right now.

We’re talking about the Federal Reserve, of course, and its groundbreaking “quantitative tightening” maneuver to walk back it’s trailblazing “quantitative easing” contortion.

That particular $600 billion bond-dumping program goes full scale on October 1.

(Side note: That’s also the start of fiscal 2019 for the federal government, which means $1.2 trillion in new borrowing requirements for the U.S. Treasury…)

The fact is, monetary central planners are getting their big, fat thumbs off the supply and demand scales in the global bond market.

They’re acting with greater or lesser reluctance, transparency, and lag time. And there’s a lot left to do. But they’re doing it.

Over the last two decades, central banks scooped up more than $20 trillion of sovereign debt, corporate bonds, and even stocks and exchange-traded funds.

And they paid for those assets with money spun from thin air.

This madness systematically, massively falsified the pricing of every financial asset, be it stock, bond, real estate, derivative, and everything and anything in between…

Now, they’re about to stop.

Global central banks have to follow the Fed’s lead and shrink their balance sheets.

Resistance here risks plunging foreign-exchange rates and a resulting surge of domestic inflation.

Those kinds of things are intolerable; capital flight will make them unsustainable.

As they grew their balance sheets over the last 20 years, global central banks accumulated huge dollar liabilities.

They kept those dollars in “virtual vaults” to suppress their own currencies. But now they’re vulnerable to what amounts to a global yield call by the Fed.

To paraphrase Warren Buffett, a lot of offshore dollar investors have been lured by their central banks into swimming naked because currency hedging costs into dollar securities were dirt cheap.

When foreign speculators are finally forced to sell, it will become more than evident that the massive explosion of leveraged corporate debt in the US during recent years was an artifact of central banking.

That’s just one “ground zero” among countless financial upheavals waiting to happen.

Consider the needs of “financial engineering.” Unearned dividends, share buybacks, mergers and acquisitions, “leveraged recapitalizations”… all that requires gobs of cheap debt.

When it disappears, Corporate America’s phony bid for its own stock will too.

That $24 trillion of monetary madness is the fat-tailed pooper that will end the party.

Anything else is a great big pile of nothing.

Former White House Budget Director: 50% Crash Coming!

The horrible start to October has investors on high alert. This market bubble – inflated by the Fed’s low interest rates and Republican tax cuts – may have finally run its course.… Read More
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