Last week’s FOMC meeting may have signaled a coming change in the investment markets. During the press conference, Janet Yellen began to lay out how the Fed will start to reduce its balance sheet (i.e. all of the bonds that they have purchased through QE). She said it could begin in the very near future. This is important because QE has been the primary driver of risk assets the past few years, namely stocks and high yield bonds. We’ve seen the world’s top central banks – The Fed, the European Central Bank, the Bank of England, the Swiss national Bank, the Bank of Japan, and the People’s Bank of China – work very closely together to prevent financial asset prices from falling. That might sound good but it’s not because it just builds risk in the system.
For example, when the Fed went on hold with new monthly purchases (blue line), other central banks, the ECB (yellow line) and BOJ (black line) in particular stepped it up big time to keep liquidity flowing.
You can see the effect by looking at to charts below, posted last week by Chris Carolan. In the short run, stocks typically follow the direction of economic data relative to expectations. This can be measured by the closely followed Citi Economic Surprise Index (CESI). Well, they use to follow the CESI….
The second chart shows the MSCI World Stock Index vs. the combined balance sheets of the major central banks. Notice how they kicked things into overdrive once stocks started a second dip lower back in January of last year. The effect has been a reflation of the markets back up to new highs on record low volatility. By the way, year-to-date the top central banks have collectively printed and purchased over $1.5 trillion worth of securities!
Despite improving data in their respective economies, the ECB and BOJ have made it clear that they’re not stopping with QE anytime soon (they know they can’t). See here and here. This is counter to the Fed who just raised rates again and is now discussing a roll-off of the balance sheet despite a few months of weakening data. The whole “data-dependent” spiel is pretty comical. It’s becoming clear that the Fed is raising rates to delay a balance of payments issue with the federal government as long as possible. Meaning they’re trying to defend the dollar as other countries are quickly moving away from holding USD/treasury bonds as reserves at the same time that the new administration is about to increase the deficit. Somebody needs to buy those bonds…. I think they’re looking at reducing the balance sheet in an attempt to steepen the yield curve. They hoped raising the federal funds rate would do that but that’s not how it works. The long end always starts to sniff out a weakening of economic data once the Fed starts raising rates. If they continue raising short-term rates and the economic data doesn’t improve (we need Congress to come through for that), there’s a good chance we see the yield curve invert. We’re now approaching new lows for the recovery.
I’ve been a little quiet on the blog the past couple of months, partly because the markets have been quiet, but have been busy on the research front piecing together this whole picture of where things are potentially heading. I started writing it up but it got so long that I figured it would be better to just record a video on it, so keep an eye out for that soon. I’m going to break down the whole macro picture and the types of investments I think one will want to own over the next 3-5+ years. I’ve also built a nice shopping list of new investments I’m close to making that match some of these themes.
Quick side note – I sold Cogint (COGT), a company I wrote about last month. Some news came out about a potential SEC investigation of insiders over securities fraud. It could very well be a made up story by a short seller (those happen often) but I don’t mess around with illegal activities. Best to exit at a small loss and let things settle. If there aren’t any issues then you can always buy back in but it’s just not worth the risk if it’s true.
Thanks for following!
-Nick
Hey Nick…Good information.