Has the Dow Peaked? No Way.
The same people who have been calling for a dollar crash for over half a decade are now yelling from the rooftops that the Dow — and all major U.S. stock indices — are due for a crash of epic proportions.
Many of the ivory tower academics confuse the economy with the stock market, ignoring the lack of correlation.
I’ve written several times that the bond market is where the largest pools of capital are and that understanding the rotation out of bonds here in the U.S., and in Japan and Europe, would provide the catalysts for higher stock prices, a higher dollar, and eventually much higher precious metals prices.
A recent CNBC article by Michael Santoli stated that Bank of America Merrill Lynch calculated that the first week following Donald Trump's election saw the largest rush into equity funds in two years, the biggest withdrawals from fixed-income funds since the early 2013 "taper tantrum" in bonds, and the widest spread between stock and bond flows on record.
The result has been record-high closes in the major U.S. stock indices, the dollar at 13-year highs and, not so coincidentally, treasuries selling off at a pace that left benchmark yields on track to post their steepest two-week increase in 13 years.
The simple explanation is that the rally is due to a perception that a Donald Trump presidency will translate into less regulation, infrastructure spending, and tax cuts that will have an inflationary effect.
While these factors have contributed to the rally, the global chase for yield is as important a factor as any. In a negative-interest-rate world, the U.S. indices are able to provide a nearly 3% return on capital and the potential for capital gains.
These returns will become increasingly attractive to large funds on a global scale as the rotation out of bonds continues.
Bull market tops like the one the gloom and doom crowd is calling for are typically telegraphed by high levels of retail participation. Retail participation in this rally is still near historic lows.
Martin Armstrong recently commented that a Gallup poll on American retail participation shows that participation is 55% at best, down from 65% in 2007.
The rotation out of bonds is playing out exactly as it should, which is why I’ve called for one last pullback in gold and the related equities. A pullback I believe we are in the midst of but is not over yet.
The rotation into stocks and daily new highs should be considered a preview of what will happen to the gold price and the related equities when some of that money rotates into the gold market.
In Japan the BoJ has promised to buy enough Japanese government bonds so that 10-year yields remain around zero.
Taking a page from Ben Bernanke, Bank of Japan Governor Haruhiko Kuroda decided to steepen the yield curve by raising long-term interest rates.
The problem with that policy is that it’s not sustainable. Bond trading volumes in the secondary market are declining rapidly. Monthly trading of Japanese government bonds by lenders and insurers has declined from a peak of 123 trillion yen in April 2012 to 16.1 trillion in October.
By pledging to keep 10-year rates at zero Kuroda has put himself in a box. Just last week yields rose above zero for the first time since Kuroda announced his plan in September. One of two things will happen now:
Either the BoJ increases its bond purchases and makes good on its pledge to keep rates at or near zero or the BoJ changes its target, which could provide the catalyst for a significant weakening of the yen that kills whatever remaining credibility the BoJ is clinging on to.
Japan’s monetary base has tripled from 135 trillion yen, or 28% of gross domestic product in March 2013, when Kuroda became BoJ governor, to 414 trillion yen, or 82% of GDP as of October.
It is frighteningly ironic that the one goal that the BoJ has been unable to achieve for nearly two decades — engineered 2% inflation — may be the straw that breaks the camel’s back.
What happens if the BoJ is finally successful but overshoots its inflation target and then is unable to put the genie back in the lamp?
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A combination of global infrastructure spending — leading to higher inflation — and unlimited bond purchases — which fail to keep rates at the target level — could lead to a collapse in central bank credibility that sees a tidal wave of capital desperately seeking a home.
Substantially higher inflation would likely lead to higher interest rates. Higher interest rates aren’t sustainable in an economy where government debt to GDP was approximately 229% at the end of 2015 (using conservative government estimates) and forecast to hit approximately 243% by 2020.
Time is ticking in Japan and Europe. Central Banks are no longer able to deliver financial outcomes and the bond.
How does Japan pay off a public debt 2½ times the size of gross domestic product with a shrinking population and stagnant growth while also keeping bond yields below 1%?
Between unsustainable debt levels, a likely Fed rate hike in December, and elections in France and Germany next year that will likely be as polarizing as the most recent election here in the U.S., 2017 will be a year to remember.
I haven’t even touched on Europe but the takeaway is the same. U.S. stock markets will continue higher because the U.S. is the cleanest dirty shirt.
Until that changes U.S. assets will continue to catch a bid.
Corporate balance sheets are strong, retail participation is still historically low and consider this; the top 14 dividend-yielding stocks on the Dow each pay an annual dividend of over 3% and the average dividend yield of all Dow Jones Industrial stocks is 2.81%.
If yields persist lower in emerging markets the yield that indices like the Dow provide will be too good to pass up. If yields increase overseas, it’ll likely lead to debt levels that will be increasingly harder to sustain, which will lead to volatility.
U.S. equities are simply better positioned to absorb whatever surprises the markets have in store in 2017.
To your wealth,
Gerardo Del Real
Editor, Resource Stock Digest Premium
For the past decade, Gerardo Del Real has worked behind-the-scenes providing research, due diligence and advice to large institutional players, fund managers, newsletter writers and some of the most active high net worth investors in the resource space. Now, he is bringing his extensive experience to the public through Outsider Club and Resource Stock Digest Premium. For more about Gerardo, check out his editor page.