Central Bank Data Predicts Market Drop

Written by Dennis Slothower
Posted February 3, 2018

We have long been preaching that investors and even speculative traders ought to be paying attention to what the central banks are doing, in particular the Federal Reserve. Our own central bank was the first to initiate massive quantitative easing on the heels of the market crash in 2008. As the years went on, the Bank of Japan and the European Central Bank followed suit.

Now the Federal Reserve has begun shrinking its balance sheet along with multiple hikes in the interest rate, scheduled through 2017 to 2020. By the end of the first quarter 2018, the Federal Reserve will be in a significant quantitative tightening cycle, with the ECB and the Bank of Japan right on its heels.

When the major central banks are committed and acting on tightening liquidity it has an effect on the world economies and on the equity markets throughout the world.

Note the global market historical action compared to direction taken by global central banks with regard to expansion (quantitative easing) and contraction (quantitative tightening). The following chart is a rolling twelve-month change for the central bank actions compared to changes in the world market index:

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This chart shows that the equity markets around the world for years have followed the direction taken by the central banks with regard to expansion and contraction. The largest change in central bank purchases (black line) was just following the 2008 market crash / Great Recession. Note how the change in the world asset index (blue line) grew proportionately.

And while the level of expansion has not been as great as it was in 2009 and 2010, it has still been significant up until the early part of 2017 when the central banks collectively began to tighten, rather than expand. Beginning in 2018 the effect will be negative liquidity, not just lowered liquidity. The coming years will see a dramatic contraction in liquidity from the central banks. In fact, they are all scheduled for an end to bond purchases and actually proffering up their cache of securities in the open market, which will shrink liquidity even further.

This tightening effect will significantly vacuum liquidity from the equity markets and represents a 180-degree change from the expansive actions they have taken for over a decade now. The black dashed line shows the scheduled tightening effect from 2018 onward. At the present time, the blue line (i.e., world equity markets) is diverging from the black line (central bank contraction) — though recently it is just beginning to turn down.

But what direction do you think the blue line will eventually take? It is only a matter of time before the equity markets react negatively to the deeper and deeper central bank contraction — the equity markets will naturally contract due to shrinking and disappearing liquidity on behalf of new central bank actions.

Federal Reserve Stays Put

On Wednesday the late January FOMC meeting of the Federal Reserve was held, and it stayed put on interest rates this time. The statement released by the Fed suggested a Fed that was even more hawkish than it has been over the last year or so, reinforcing the probability of another rate hike at the next FOMC meeting in March.

In Trump’s speech he reminded America that the unemployment rate is at historic lows, with black and Hispanic unemployment at the lowest ever since records have been kept. The Fed confirmed this stance, indicating that the labor market has continued to strengthen and that the economy has been getting stronger. While our analysis shows much to counter this position, it certainly backs up the position of the Fed maintaining a cycle of liquidity tightening. So, expect continued rate hikes and even more of its balance sheet being sold off and taking additional liquidity out of the markets.

"Janet Yellen's final policy meeting as Fed Chair pretty much summed up her entire tenure; policy was left accommodative but there were hints it will be tightened gradually in the future," said Michael Pearce, Senior U.S. Economist at Capital Economics.

He added, "The slightly more hawkish language in the statement is enough to confirm expectations of a March hike and adds weight to our view that the Fed will raise rates four times this year."

It is no small thing that the Fed will raise rates four times this year, following the five rate hikes over the last year or so. This is a distinctly combative Fed, working to tamper down an economy that is theoretically getting too hot for its own good.

This is how the Fed works. It pumps liquidity into the markets for a decade and then, when markets are stretched like we have never seen before, it engineers a recession to cool things down. They are probably clinking champagne glasses knowing that they have a market top even while they are engaged in war against the economy. It won’t last, and they know it... and they don’t care that things will get tough for all of us. After all, it is the only thing they can do to help democrats get back into power. It has happened before... it is happening again.

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

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