You may be wondering why I don’t rename the family office to Schism Quantitative Strategies. First, I rattle off about “Everything Bubbles,” then I put 10% each in XLF (Financials) and XLB (Homebuilders)?
Well, we can be in a bubble (and likely will be for a bit longer), and we can find opportunities until it pops. So both can be true at the same time. What we know for now is that Fed Chairman Powell threw more fuel on the bubbling fire on Friday, just as I suspected he would.
We are more than likely starting another leg up in this market, bolstered by all the Fed cocaine in the pipeline. So the patient lives to fight another day – with no liquidity “withdrawal” yet. Vigilance and stops are the keys to any further participation.
Having owned a bank, I know exactly what the Fed is doing. In a nutshell, the Fed will begin tapering sometime late this year or early 2022. To keep interest rates down in light of the inflation the Fed is feeding, and given that there is no “real” demand for U.S. treasuries, the Fed is reopening the “repurchase” window, as they slow the “reverse repurchase” window.
So the U.S. Government will pay 25 basis points on a new treasury. The banks will buy them. Then, to get the cash they need, the banks will pledge the treasuries to the Fed every night for overnight loans, and the Fed will charge 5 basis points for the loan. The banks get the cash they need and are guaranteed a 20 basis point profit. That is how they will create artificial demand for treasuries, thereby keeping interest rates artificially low. This will cushion the tapering.
Keep in mind that the Japanese and Chinese are no longer buying our treasuries in any material quantities. The Russians long ago sold all of their US Treasury positions. So the Fed is buying most of the new treasuries (a legal Ponzi scheme). The new repurchase window is how the Fed will incentivize our own banks and a few friendly central banks to keep buying. So the bond market parties on, for now, as long as this new scheme works. But in the circumstances, don’t expect inflation to stop soon. My skeptical mind believes that the government does not want the inflation to stop anyway, as they monetize the debt on the back of American workers.
Small caps (IWM) breaking out of their six-month base would bolster my confidence in this new leg. I have a close eye on them and would like to take a 10% position. Junk bonds are already confirming the new leg after sputtering recently. Breadth should improve as well, and if it doesn’t, that will be a contrary indicator.
Respecting the S&P 500, our core index, I am looking for that trip to what I am calling the “Armageddon” high of 4600 on the cash index. This is tongue-in-cheek because I cannot come up with any other projection higher. I am just not sure how we get there.
We could slowly climb the current channel or break above it and move right to the target. But that is my best calculation of where we are headed for now.
While we should have a bit more of an attention-getter dip in mid-October, the most significant downward pressure comes in the third week of November on the next 20-week cycle low.
That could be a retest of an October low, or the market could dip even lower into a new trough. So the window between now and then is short. The chart above shows the interaction of the cycles.
I am out for this entire week. So unless there is a new buy or sell signal, this will be my last commentary until after the Labor Day weekend.
A.F. Thornton