Ad Hoc Commentary – are we on the verge of a stock market selloff?
About 11 months ago, we wrote:
“…a Trump presidency coupled with US dollar strength will cause the S&P500 to jump, doubling or even quadrupling. This is mainly because the Donald has the willingness to default…”
When Trump won the presidency, we gave three reasons for a broad based rally under Trump, but cautioned against a pump and dump:
“…However, the concentration on Goldman Sachs is curious, and bewildering. Yet, there are many reasons for a broad based rally under Trump.”
“…Beware a pump and dump.”
There are three reasons to believe that we are ready for the stock market selloff/dump.
Firstly, Trump is embroiled in a largely self-made political turmoil. One should not be too pessimistic on the Trump administration because sometimes a failed coup is necessary to drain the swamp. A recent example would be the 2016 failed coup in Turkey. However, what this means for Mr Markets is a postponement of Trump’s pro-stock market agenda. In particular, tax reforms, regulation rollbacks, and big infrastructure will have to take wait until we clear the quite-likely-to-fail coup over the summer. As a treat, all of us would be spending the summer watching real life political soap-opera.
Goldman Sachs is probably the canary in the coalmine. Her share prices had lost about one third of the approximately 90 dollars post-Trump elections gain. In other words, at 225 dollars per share, Goldman is 30 dollars below the 255.15 high that was reached on Mar 1, 2017. Since Goldman lead the charge up, it is probably not unimaginable that she is the signpost for those who would like to see the near future.
Secondly, despite what the pundits say, yours truly finds that the Fed minutes are not bullish. There are two parts to monetary policy:
- Price of money – rate hikes are bullish
- Quantity of money – shrinking Fed balance sheets are bearish
On one hand, on the price of money, since the public sector is price insensitive, rate hikes are inflationary because the government will simply borrow more. Since government borrow with no intention of repaying, it is tantamount to printing more. This accelerates the sovereign debt crisis, and is good for the great rotation out of bonds into the stock market.
On the other hand, on the quantity of money, shrinking of Fed balance sheets are recessionary because government is a big part of GDP. Shrinking the Fed’s balance sheet and hiking US rates at the same time are recipes for recessions. US rate hikes will force foreign central bankers to dig into their savings, thus selling US Treasuries. If the Federal Reserve does not step up and buy these sold US Treasuries, then the private sector must buy them. If the private sector is unable to do so because of the likes of Basel III, then no one else would. Perhaps there will not be market confusion. However, yours truly believes that there must be further dilution of regulatory reforms before the Fed attempts to shrink the balance sheet. Failing to do so will almost certainly guarantee a recession in the short term.
Lastly, the French elections (Macron spring) had eased short-term fears about Europe. The German elections in the fall (Merkel fall) is probably going to matter much more. On balance, it is very difficult to see how the hubris in the American stock market can be maintained for much longer as we head into summer.
Good luck in the markets.