The Stock Market Is At Record-Breaking Highs. Time To Be Wary?

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As I write this, the stock market as a whole (Primarily the Dow, but also the NASDAQ and the Fortune 500) has just reached another record-shattering high. As the longest bull market in history rages on, the threat of war comes and (apparently, at least for the moment) goes, and the trade deal with China evolves through a complicated set of thrusts and parries with no discernable progress, the stock market just keeps climbing… And climbing… And climbing. Despite the notable lack of widespread, systemically healthy and sustainable growth in American business and manufacturing, the stock market still behaves as though the 1950’s have returned. A year of incredible increases only lightly dampened by a couple of short-lived, panic-inducing drops have propelled the market heavenward and its main indices are currently poised to reach nosebleed heights that only cranks and visionaries once believed possible. Currently, if reports by seasoned traders like Jim Cramer are accurate, and if the data on buying of stocks says anything about human behavior, then investors have gone… excuse me for saying this… completely nuts. Apparently, the sky is no longer the limit on how far the market will rise in the minds of the masses of stock market millionaire wanna-be’s. That leads to the million (literally) dollar question: should anybody be investing in the stock market right now? Should you?

IT DEPENDS.

Before choosing whether to commit your money to stocks at this time, there are several factors to consider. Any decision is personal and should depend upon whether an investor understands the real reasons behind the incredible performance of the market during 2019, what’s driving it now, and whether said investor has the time, education and propensity to keep abreast of cues indicating when the party is likely to come to an end. It also depends upon an investor’s appetite for risk, and whether he or she possesses the self-discipline necessary to be honest about what’s going on, and then act on the numbers rather than on emotion or market sentiment. Oh, and it also depends upon how much an investor can comfortably stand to lose if their timing or judgement are less than perfect.

In my personal opinion, based upon my own research, analysis and experience (although remember that I’m not a trained economist or financial advisor, so proceed on my outlook with caution), right now – during truly volatile times and in the heat of a market mania – it’s probably a good time for the average investor, like you and me, to “stay out”. There’s a feeding frenzy currently underway, and the little guy is chum for the sharks. Manias are infamous for luring in the unwary, who don’t understand market mechanics, and the lazy, who think that investing consists of dumping their money into the laps of their financial investors without thoroughly understanding the products they’re being sold or how to make genuinely informed decisions about risk, return, and underlying performance metrics. When your best friend’s cousin’s ex is “riding the rocket and making a killing in the market”, that should be your cue to consider getting out of the water because the tide is likely to turn – violently, and soon.

AN ADDITIONAL CONSIDERATION

Besides the off-putting characteristics of market manias, there is one additional unique and problematic aspect of the current market that potential investors may want to consider. This is the fact that the market’s enormous gains may not be a sign of good health, but actually the symptom of a great underlying crisis and the (so far) successful ongoing attempts of the Fed to control that crisis. Dan Amerman offers a compelling theory that, since the popping of the tech bubble in 2001, the economy and the markets have been dominated not by free forces, but by cyclical eruptions of economic crisis and subsequent attempts by the Fed to contain those crises to fend off serious economic depressions. (To read his considerable work on this subject, please visit his web site at Https://www.danielamerman.com). By his analysis, it’s quite reasonable to suppose that the markets are rising primarily because they’re being artificially propped and pushed up via increasingly desperate attempts of the Fed to prevent free market forces from imposing a very natural, and necessary, periodic correction. In the section below, I discuss how the Fed actually IS intervening in the markets in a shockingly spectacular way, perhaps to prop up the markets, or perhaps to actually take them down surreptitiously. In either case, the Fed’s current massive and continual market intervention, largely unknown to the public, may serve as another warning sign that there’s danger lurking below the surface. So, proceed with caution!

OTHERWISE OK?

If you still think you want to jump in and brave the currently raging tide, at least educate yourself first about a fundamental aspect of the financial system called the repo (short for “repurchase”) market. The repo market is a lynchpin that holds the financial system together. And right now, it’s not working very well. Having some basic knowledge of what this market is and how it’s supposed to function – versus how it’s currently being manhandled and (mis?)managed by the Fed -is critical if you want to gain useful insight into how the banking system works and why the stock market is behaving as it is.

Briefly, the “repo” market is the market in which banks lend money to each other overnight. If a bank thinks it will be short on cash for operations the next day, it offers collateral (usually Treasury bills, or sometimes mortgage backed securities or other items agreed upon by both parties), to other banks in exchange for a loan. They then repay the loan, with interest, the next day. ( Repos can actually be of varying lengths of time, but overnight is the most common.) The interest rates on overnight repo loans are normally kept within guidelines set by the Federal Reserve. On the night of September 16, 2019, however, the lending between banks nearly stopped and the interest rates briefly spiked from about 2% (which was in the Fed’s desired ballpark), to almost 10%. Banks were suddenly afraid to lend to one another! The banking system was seizing up! A banking collapse was unfolding! And nobody a the helm of our financial system – the Fed – knew why or even saw it coming!

When the Fed realized what was going on, it reacted swiftly to prevent the banks from becoming too low on their cash reserves and having to keep their doors closed in the morning. They instantly created $53 billion in electronic cash out of the nothingness, and poured it into the repo market. And on each and every night since then, the Fed has been doing the same thing, in varying amounts. It’s extremely difficult to calculate exactly how much the Fed has created, since the money that was created one day, has to be paid back the next day (or whenever the term of the repo expires.) So after the first couple of weeks or so of money creation – after the first 14-day repos expired – much of the money going into the repo market from the Fed is actually recycled money. How much that is is difficult to calculate, although an excellent article from Wolf Street (“The WallStreet Journal (and Other Media) Should Stop Lying About Repos”, 1/10/20, http://Www.wolfstreet.com) indicates that it would be less than the $8 hundred-something billion total that’s been floated in some publications. Still, some days, the amount of money that the Fed has injected (new or recycled) hasn’t been enough to satisfy demand so the Fed does have to create more cash or risk letting the system begin to die. Since Sept. 17 until today, approximately $413 billion has changed hands in the repo market, and the data clearly shows that the market is completely dependent upon the free flow of sufficient repo offerings.

Why should I care?

The issues with this are several and far-reaching, therefore best covered in a separate article. For now, I’ll just touch on what I see as the two primary consequences without much detail. First, the repo issue indicates that the Fed has now become the lender of FIRST, rather than LAST resort, indicating that the system is not functioning as intended. It’s really become a centrally controlled instead of a free market. And second, the repo crisis is a sign that there’s a vast ‘black hole’ somewhere in our financial system and it’s either sucking cash out of the banking system or re-directing it within the system to places from which it can’t escape and circulate properly. Or maybe both problems are operating simultaneously. Nobody seems to know why a hole may have gaped into existence, though theories abound. They range from overly restrictive regulations preventing banks from unleashing their reserve holdings, to deliberate manipulation of the repo market by J.P. Morgan bank trying to force the Fed to start QE4, to simple incompetence by Fed middle management, and even to deliberate sabotage of the markets by Fed employees wishing to derail Trump’s election chances. (The latter two theories, though they may sound far fetched, actually have a lot of merit. You can access the excellent article about them here: http://danielamerman.com/va/ElectionHacking.html) What we DO know is that the Fed’s current commitment to pump “whatever it takes” (their words) daily into the repo markets – plus a few billions extra as a guesstimate cushion, because the Fed has no idea how much newly-created money the banks (and hedge funds, which also participate, to a lesser extent, in the repo market), will need on any given day – will go on at least through April, per Fed statement. And the evidence IS clear that this repo money is what’s keeping the market afloat, the banks open, and by extension, the economy running.

SO WHAT HAPPENS IF THE MONEY SPIGOT CLOSES?

Should the Fed now try to stop backstopping the repo market every day, or should they grossly miscalculate how many billions the repo market will need in fresh or recirculated cash for several days in a row, the market will quickly begin to crash. And there will be precious little to prevent it from blowing down below the average (inflation adjusted) valuation of the stock market from the 1960’s through 2001, when the Fed unleashed its first experiment with quantitative easing in the wake of the bursting of the tech bubble. Remember that most things, over time, revert to their means, so if the mean (as in the average valuation for stocks) has been elevated for a while, the system will generally reset by diving back below its long-term mean. That way, it balances out overall in the long run. That’s just an iron law of statistics. Holders of stock could therefore experience massive drops in the value of their holdings very quickly, with no mathematical hope for most investors anywhere near retirement to ever recover their losses. Sadly, there’s likely to be very little time for investors to react once the markets start to fall when the Fed decides that it either cannot, or will not, prop them up any longer. The bottom line is that if the Fed can’t muster enough electronic cash (recycled or out of the nothingness) quickly enough, or if it can’t fix the repo problem in some other way, then there will be no stopping the black hole (whatever it is) from wreaking carnage on the entire global economy. Whether that day will be tomorrow, in April (when millions of businesses and taxpayers will be simultaneously pulling cash out of their bank accounts to pay their taxes), shortly before the November elections, or in a year or two, isn’t knowable right now. However, what IS knowable is the fact is that serious, and probably unrecoverable, damage will be done to investors who don’t get out of the way quickly enough once the house of cards begins to fall. So forget the (pending?) war, the trade deal, the impeachment chatter and all the other news that is currently only serving as a backdrop to obscure the main event, which is the Fed’s interventions into the repo market. The continued functioning of the repo, and by extension the stock, markets, and, by further extension, the economy, is now entirely dependent upon the actions of the Fed. Knowing that, is this really the time you want YOUR money invested in the market? It may be better to stay out of the water at least until you can read which way the tide is flowing.