Fátima, our new 10-year-old English-language student, is a stranger to modern economics… as well as to vernacular English.
“What do you think of central bank policies?” we asked.
“What’s a central bank?”
“It’s the bank that provides money to the other banks.”
“Where do they get the money?”
“They create it out of nothing.”
“Would you like some money from the central bank?”
“I guess so.”
Fátima must be aiming for a career on Wall Street.
Yesterday, we promised clarification. Central banks are desperately pushing up stock prices. But we have our “Crash Alert” flag flying over the ranch house.
What gives? Which is it? Higher stock prices or lower?
The short answer: both.
Yesterday, the Dow shot up 227 points – or 1.3%. Gold was up $14 to settle at $1,164 an ounce.
What will it do tomorrow or the next day?
It’s up to Mr. Market. He will do what he wants in his own sweet time.
He must be deeply conflicted.
On the one hand, central banks are tempting him to loosen up… to get him to have some fun… and let stock prices fly.
On the other hand, he remembers what happened the last time he did that: Everybody was having a great time, until someone called the cops.
Over the last six years, it’s been a case of “laissez les bons temps rouler!”
“Do you want some money from the central banks?” ask the authorities.
“I guess so,” answer banks, hedge funds and speculators.
But as stock prices rise, the day nears when they must fall. Already, Warren Buffett’s favorite indicator, market cap to GDP, tells us that the value of all outstanding US shares is at the highest level relative to GDP that it’s been in 100 years, except for at the peak of the dot-com boom.
The stock market cannot become infinitely large relative to the economy that supports it.
And the more expensive stocks become, the less attractive they are to seasoned investors. That’s because the higher valuations go, the less of a chance investors have of buying low and selling high.
Now, Mr. Market sees the smart money selling out, as the dumb money still makes its bets. As Newsmax reports:
[Warren Buffett’s] Berkshire [Hathaway] sold roughly 19 million shares of Johnson & Johnson, and reduced its overall stake in “consumer product stocks” by 21%. Berkshire Hathaway also sold its entire stake in California-based computer parts supplier Intel.
Fellow billionaire John Paulson, who made a fortune betting on the subprime mortgage meltdown, is clearing out of US stocks too. Paulson’s hedge fund, Paulson & Co., dumped 14 million shares of JPMorgan Chase according to a recent filing. The fund also dumped its entire position in discount retailer Family Dollar and consumer-goods maker Sara Lee.
Finally, billionaire George Soros has sold nearly all of his bank stocks, including shares of JPMorgan Chase, Citigroup, and Goldman Sachs. Between the three banks, Soros sold more than a million shares.
With US stock market benchmarks still near record highs, the economy slips, slides and slinks. The latest disappointment comes from the housing sector.
From former Reagan budget adviser David Stockman at Contra Corner:
The “incoming data” was disappointing again this morning – this time the culprit was housing starts, which were off by 17% from January. But please don’t blame the “weather” again.
The data below is for single-family starts, which are less volatile than apartment construction. At an annual rate of 593k units in February they were almost exactly flat with last February at 589k.
Our guess is that, in the not too distant future, stock prices will drop. Investors will run scared. And the Fed will panic.
What’s an investor to do?
We’d stay out of US stocks for now. Too expensive. And too dangerous. The day of reckoning is probably too close to make much money.
If we were a gambler, we’d wait for a few days of desperate selling. Then we’d probably get back in.
It won’t take the Fed long to follow the Japanese example and become a direct buyer of stock market funds.
The Fed cannot make the economy function better (except by getting out of the way). But it is capable of goosing up the stock market. It has the money (unlimited) and the stupidity (profound) to do it.
But we’re not a gambler; we want our money in quality businesses bought at good prices.
Where can you find them? Tune in tomorrow…
But here’s a more difficult contradiction. We’ve noticed that: (1) EZ money seems to encourage cheap financial engineering tricks – buybacks, mergers, carry trades, speculating and so forth.
It also discourages savings, which deprives the economy of capital formation – key for making economic progress.
We’ve also noticed that: (2) Some industries and some companies seem to take the cheap funding and use it to add capacity. Housing in 2004-07. Energy in 2010-14. China from about 2000 until 2014.
Which is it: No. 1 or No. 2? Is the cheap funding being used in place of capital formation? Is it adding to capacity or not?
We don’t know. Maybe both are true.
Maybe cheap credit provides speculative funding – such as to Tesla, biotech stocks and selected speculative ventures. At the same time, it seems to encourage short-term bets, self-serving scams and gambling.
“There’s a difference between money you work for and save,” says Stansberry & Associates analyst E.B. Tucker, visiting us here in Argentina from Florida, “and money you get for nothing.”
“You spend the money you work for carefully. You spend the money you get for nothing as though you had stolen it.”
Further Reading: Bill is not the only one concerned about the smart money dumping US stocks. Bonner & Partners senior analyst Braden Copeland says that when the next crash comes it could be MUCH worse than the collapses in 1987, 2000 and 2008. Find out what has gotten Braden so worried… and how you can protect your assets and your savings, right here.