Comstock Partners, Inc.October 09, 2017
THE PURCHASE OF BONDS BY THE FED OVER THE PAST 8 YEARS DROVE STOCKS UP
Now that the Fed is About to Start Selling these Bonds, Stocks Should Soon Turn Down
Asset prices (especially stocks) clearly have risen because of Quantitative Easing (QE, the Fed lowering ST interest rates and purchasing bonds). So, if that is the case, why doesn’t it make sense for assets and stocks to decline as the Fed, and soon other central banks, will reverse their stance and sell the bonds previously purchased? As the Fed, and other central banks, are planning on raising interest rates and tightening, by reversing what they have been doing for the past 8 years, it is obvious to us that assets and stocks will surely decline substantially. Clearly, the QE that has been taking place for years will be reversed and it will probably be called Quantitative Tightening (QT) (and it will be called QT for a reason—if they don’t tighten, inflation could be next).
Our Fed is slowly tightening, as the other large central banks, such as the Bank of Japan (BOJ), the European Central Bank (ECB), Peoples Bank of China, (PBOC), are all moving much more slowly than our Fed. It looks like these central banks are listening to our Fed, and plan on following them. After all, this QE started for most of these central banks about the same time as our Fed (because of most of them following our Fed) and so far it has worked well to help all of the countries using it to boost their stock markets and prevent recessions. It is the reversal of all of these QEs that may wind up having “unintended consequences” since the QEs, and the reversal of QEs have never been tried before. We expect the “unintended consequences” to take place before, or during, the first quarter of 2018.
The other potential problem we have trouble understanding is that most of our country believes that President Trump will be successful in achieving his broad agenda items such as Tax Reform, Repeal and Replace Obama Care, Infrastructure Spending, and much more. We don’t believe that most of these agenda items will be passed at all (just as the repeal and replace was stopped cold). Many stock market mavens are putting a number on the “Tax Cut”, or “Tax Reform” and incorporating the increased earnings into their forward valuations to give stocks a lower P/E multiple for next year. And even if the “Tax Cut or Reform” comes close to being approved many in Congress will realize that the Budget Deficit will skyrocket, and will clearly be a major factor in potentially leading to a downgrade of our debt (just as what took place in the U.S. in 2012, and more recently in China and Hong Kong). We also expect that much of the tax cut will only benefit the very rich such as with the “estate taxes”. And also, if interest rates increase as the Fed keeps tightening, the dollar will also rise and restrict the US multinationals from selling goods abroad.
As far as the U.S. stock market, we are still concerned about the extreme valuations, and the fact that we don’t seem to be able to grow fast enough to break through and achieve our “old norm” of GDP 3 % or higher, and get to the goal of "escape velocity".