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1.25.2017 - Financial Intelligence Report Bookmark

Until It Can’t?

Over the years, we’ve talked many times about the fact that Central banks are now enormous buyers of actual stocks. We’ve mentioned how the Bank of Japan owns almost ¾ of all their market ETF’s. How the Swiss national bank has bought literally billions of dollars worth of AAPl,  and MSFT and XOM.  We’ve talked about how companies have borrowed money at virtually zero interest rates and used the money to buy up their own shares of stock.

This week Zero Hedge ran a story about how in this coming year, Central banks plan on buying even MORE stocks. Which poses the perfectly logical question : If Central banks can print money out of thin air, and then use that money to buy something “real” such as a stock, Can stocks ever really go down again?
Think of the ponzi that we’re talking about here. If  a central bank whips up 500 million and buys XYZ stock, in the abstract  - a lot of people have been the beneficiary of that. The selling broker gets paid, XYZ takes in money, the stock will probably rise, enriching those that hold it, etc. Yet if XYZ begins to fall, the Central bank has virtually no risk. How can you take a beating if you own the stock with money that never existed?
Again, you have to think about this a bit deeper than just on the surface. If YOU want to buy XYZ, you first have to do some form of productive labor, for which you exchange that labor for currency.  It’s called wages. Then you pay your bills with those wages and if you have something left over, you can then “invest” in the stock XYZ.  But with the Central banks, they don’t need that pesky “labor” portion of the equation. They contribute nothing in the way of productivity to society. One day they don’t have 500 million to spend, and then the next day...they simply do. They pushed a keyboard button and “presto” the screen says 500 million dollars/franc’s/pounds/ just showed up.
They take that fake money, but they exchange it for a “real” good. If XYZ is a real company, then it has buildings and inventory and equipment; it has employees and hopefully accounts receivable. Yet the Central bank has been able to invest in that production stream, with NO sacrifice. No time, no employees, no labor. Can’t this simply go on for ever? It would seem so, right? Like what’s going to stop it? Why can’t they just continue to print and buy up everything for ever and ever amen, and thus the economy could piggy back off of it and we have entered nirvana?  Because the investment was made with NO corresponding “work”.
Take it to the extreme. Say that indeed they just continue printing and buying stock ( and toss corporate bonds in there too such as Draghi has been doing with the ECB)  They buy more and more stocks and more and more people are getting richer because of it. More and more people at the companies are taking in more, they might hire more and then even more people are getting richer. Soon enough  people come to realize that stocks only go up and folks that have never bought one jump in and soon they’re making money. What’s the issue?

The issue circles back to where the money came from. In a “normal” time, remember that to buy that stock you needed money. You got that money by doing something. Work. Labor. You either labored to create something, or to service something. So, with the amount of money that was in circulation at the time, you exchanged your labor into the global “economy” creating product. This kept production/services in line with demand.  It kept a lid on pricing.
But if the Central banks are whipping up billions and buying stocks, a whole procession of people are getting “richer” and giving them the ability to consume more products and services, but there were no more products and services created to “make” the money to buy the stock. What you then have is the absolute text book description of “inflation”.
Most people define inflation as “rising prices”. But in a technical way that’s simply the result. The true definition is “an increase in the money supply”. Well what better example of increasing the money supply can you think of than Central banks whipping money out of thin air, and using it to instantly buy stocks? They are by the very definition “increasing the money supply”.  Yet they are doing it without any productive input into the global economic machinery.
In the short term, schemes like this work. But in the long run, they usually go awry, as some event kicks off the last chapter and monetary velocity picks up and instantly you see the price spiral higher. Monetary velocity is simply how fast a dollar changes hands. In a hot economy, velocity is high as everyone is out spending all they can. In a sluggish economy, velocity slows. Well monetary velocity over the past few years has been very low. At some point it will pick up and that will probably be the start of a price inflation that we haven’t seen in a long time.
Printing money has never worked. It’s been tried throughout history and it works...until it doesn’t. We’re in that very time right now. It’s working, but one day it won’t. While the injection of money during periods of economic contraction has at times been able to keep the wheels from coming off, continued injections almost always lead to a runaway inflation.  
Oh and by the way, this is a relatively new phenomena. Central banks were never supposed to be in the equity market, distorting price discovery.  Tell me dear investor, what exactly is the proper price of XYZ, when the SNB can come in and buy 200K shares with NO care what so ever what it’s price to sales is? You cannot tell me what it is truly worth. If it was expensive at say 20 times earnings, but the Central banks buy it to the point where it is now at 24 times earnings, is it still expensive? Only until they buy more and take it to 30X earnings. The mechanics of a fundamentally functioning market have been blown to hell. Call me skeptical, but I think this functions...until it can’t. Hey just my two cents.
The Market...

Tuesday was your normal run of the mill Tuesday. That was until about 1 pm when we started to see them moving stock prices higher. When I put out my last update of the day at about 1:20 I mentioned that things were looking better but that the volume wasn’t following the plot. We still had very low market volumes. 

As the afternoon wore on the volume remained sickly, but prices were indeed moving up. We latched onto two of the 3 stocks that we had mentioned to our subscribers as having nice charts. By the last hour of the day things were looking pretty good and volume had gotten “better”. We ended with the DOW up over 100. It looked to me like the attack on DOW 20K was finally on again.
This morning the futures were bright green. By 9 am they had risen to the point where it looked like the market might open over 20K. The bell rang and sure enough, there it was. DOW 2030. They’d done it. Of course the question early on was “would it close over 20K?”   Or better yet, even if it did, what does it mean? Are we simply headed to DOW 21K now? Or is this some form of last hurrah push that sucks in the last of the hold outs and then the market goes into a funk and corrects?
The market’s participants are watching Trump do all the things he said he’d do in his first few days and they’re thinking “hey, this guy’s really doing it! If this works this market could be up a whole lot more, so let’s buy and hope!”  That’s pretty much what is driving the “animal spirits” here.  It will be interesting to see what happens when these plans hit the inevitable bumps in the road.

I usually wait to send the letters out after the market closes, so it is a form of a market wrap. But today I have to leave and attend a function, so I’ll be missing the actual close.   However, that said, it’s 3 pm and the DOW is still up 144 and the S&P is up 15. So even if they take some profits in the last hour, I don’t suppose anything untoward is going to happen.
For Thursday, what I’d expect is a bounce up out of the gate, followed by a small pull back that brings us down closer to the 20K level. Like any breakout, it often has to be tested, and I figure they’ll want to get the test behind them quickly. So I’d expect a pop, a drop and then maybe a move back up.

But it is the longer term question that lingers. Again, all this is borne of the hope that lower taxes and regulations passes and that we seen results. The longer they have to wait on those results the sooner they might just want to cash out and “see what happens.” So we’ll have to see where things go.
Have a great evening, I’ll see you all on Sunday. 

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