Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

Quantitative Easing

Quantitative easing is a monetary policy tool used by a central bank to try and stimulate an economy when the economic cycle is far below optimum levels. Central banks increase the quantity of money in the financial system through quantitative easing by purchasing securities, such as treasury bonds, to increase the price of assets; this will lower prevailing yields and entice investors into other areas that might be more beneficial for an economic rebound. One worry with quantitative easing is that the increase in the supply of money might lead to inflation, or the overall increase in the price of goods.

About That QE4…

By for Profit Confidential

Another Round of Money Printing Coming SoonIt’s widely expected that at the end of this month, the Federal Reserve will end its third round of quantitative easing (that began in September of 2012). This is QE3, where the Federal Reserve was printing $85.0 billion of new money every month and using it to buy U.S. Treasuries and mortgage-backed securities (MBS). In the beginning of 2014, the Fed started reducing the amount of money it was printing each month.

Is there another round of quantitative easing (more commonly known as QE) coming?

Here’s why I ask…

First, U.S. long-term bond yields are collapsing. Back in 2013, when the Federal Reserve hinted that it might move away from quantitative easing, we saw U.S. bond yields soar. Between May and December of 2013, yields on the U.S. 10-year notes almost doubled. But since then the unexpected happened.

10 Year Treasury Note Yield Chart

Chart courtesy of www.StockCharts.com

Since the beginning of 2014, the yields on the same bonds have plunged 30%. Despite the Federal Reserve telling us it expects to raise interest rates in 2015 and 2016 (which would be catastrophic for bonds), bond prices are rising… Odd, to say the least.

Second, I hear hints about QE4 from key members of the Federal Reserve. In an interview with Reuters, the president of the Federal Reserve Bank of San Francisco said, “If we really get a sustained, disinflationary forecast…then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider.” (Source: “Exclusive: Fed’s Williams downplays global risks, eyes U.S. inflation,” Reuters, October 14, 2014.)

In other words, if inflation in the U.S. economy doesn’t meet the … Read More

What the Smart Money Is Doing Now

By for Profit Confidential

Smart MoneyAccording to the Investment Company Institute, assets in institutional money market funds increased $17.19 billion to $1.69 trillion for the week ended on September 24, 2014. This was the biggest weekly increase in these money market funds in the last five months. (Source: Investment Company Institute web site, last accessed October 1, 2014.)

This is critical: when institutional investors sense the risk of a stock market sell-off in key stock indices, they tend to move their assets into highly liquid money market funds.

The sudden rush of institutional money into money market funds correlates with the National Association of Active Investment Mangers (NAAIM) Exposure Index below. It shows a clear decline in the amount of stocks active investment managers are holding in their portfolios.

NAAIM Exposure Index Chart

Chart courtesy of www.StockCharts.com

Since late 2014, we’ve seen investment managers reducing their exposure to key stock indices. While they were fully invested in early 2014, we see investment managers are only 59.76% invested in stocks right now. Is it just an anomaly they are selling stocks when money market funds are seeing an influx of cash? I hardly think so.

Finally, let’s look at small-cap stocks, as they are facing severe scrutiny. Key stock indices like the Russell 2000 that track the performance of small-caps are plunging. The Russell 2000 is now down more than 10% since it made new highs in March of 2014. This small-cap index has now broken down below its long-term uptrend, as illustrated in the chart below.

Russell 2000 Small Cap Index Chart

Chart courtesy of www.StockCharts.com

(Let’s remember that the trend is your friend—until it’s broken.)

Dear reader, all of this should be nothing new … Read More

If the Economy Is Improving, Why Are Investors Pricing in a Slowdown?

By for Profit Confidential

U.S. Economy Slowing Down Here in 2014The Bureau of Economic Analysis (BEA) surprised even the most optimistic of economists when it reported the U.S. economy grew at an annual rate of four percent in the second quarter of 2014.

On the surface, the number—four percent growth—sounds great. But how serious should we take that gross domestic product (GDP) figure?

Firstly, I’d like to start by pointing out that the BEA often revises its GDP numbers downward. We saw this happen in the first quarter. First, we saw the BEA say the U.S. economy grew by 0.1% in the first quarter, then after a couple of revisions, they said the economy actually contracted 2.9% in the quarter.

I obviously expect the BEA to lower its initial second-quarter GDP numbers again.

But here’s what really worries me…

If the GDP data suggests the U.S. economy is growing, why are investors pricing in an economic slowdown?

The chart below is of the 10-year U.S. Treasury, the so-called safe haven. Back in 2007 to 2009, investors ran to U.S. Treasuries as a safe haven. As the U.S. economy improved, the yields on the 10-year U.S. Treasury started to rise as interest rates rose with general optimism towards the economy.

10 Year Treasury Note Yield Chart

Chart courtesy of www.StockCharts.com

But since the beginning of this year, yields on the 10-year U.S. notes have declined 18%. This is despite the fact the biggest buyer of these bonds, the Federal Reserve, has stepped away from buying these Treasuries as its quantitative easing program comes to an end.

At the same time, we have the stock market finally starting to give in. So if the stock market is a … Read More

Why We Are Closer to a Recession in 2014 Than You Think

By for Profit Confidential

U.S. Economy to Fall into a Recession This QuarterDon’t buy into the notion that there’s economic growth in America!

We’ve already seen U.S. gross domestic product (GDP) “unexpectedly” decline in the first quarter of 2014, and now there are signs of another contraction in the current quarter. (The technical definition of a recession is two negative quarters of GDP—we’re halfway there!)

As you know, consumer spending is the biggest part of our U.S. economy, accounting for about two-thirds of our GDP. And consumers are pulling back.

Consumer spending in the U.S. economy declined 0.26% in April from March. This was the first monthly decline since December of 2013. (Source: Federal Reserve Bank of St. Louis web site, last accessed June 4, 2014.)

And while consumer spending is one indicator that suggests a recession may soon be coming into play in the U.S. economy, there’s also one very interesting phenomenon occurring that suggests the very same.

The Federal Reserve is serious about pulling back on its quantitative easing program. And in anticipation of the Fed pulling back on money printing (when it first indicated it would start tapering), the yields on bonds shot up.

But since 2014 began, and the Federal Reserve actually started to taper, the yield on the long-term 30-year U.S. bond has declined more than 12%.

 30 Year t Bond Yield Chart

Chart courtesy of www.StockCharts.com

If the Fed is pulling back on printing (it has said it wants to be out of the money printing business by the end of this year), why are bond yields declining?

From a fundamental point of view, it suggests the market anticipates very slow growth for the U.S. economy ahead.

Dear reader, the perfect storm … Read More

The Downside to Dow 20,0000

By for Profit Confidential

Where the Stock Market Could Head NextWith the Dow Jones hitting 17,000 being pretty likely in the not-too-distant future, from there, it’s only another 18% or so until the Dow hits 20,000, which is pretty incredible.

These numbers seemed so unrealistic just a few years ago but now, it’s not too farfetched. The most amazing thing to me is that stocks still haven’t experienced a material price correction since the financial crisis.

Stocks aren’t necessarily stretched in terms of valuation, especially with corporate earnings outlooks holding up for this year and going into 2015. What is stretched is investor determination with a market at its high.

Johnson & Johnson (JNJ) is a great company and a worthy long-term investment (see “Three Blue Chips Set to Drive Higher”), but it’s tough to buy stocks at all-time record-highs. In Johnson & Johnson’s case, the position’s up almost 20 points since the beginning of February, and this is on top of a previous 20-point gain in 2013.

One of these days, stocks are going to get walloped. But there’s got to be some sort of catalyst for it to happen.

The Federal Reserve can be a catalyst if it decides to suddenly change its outlook for interest rate certainty. The catalyst could also be a geopolitical event or something that comes out of nowhere, like a big derivatives trade gone bad.

In any event, there will have to be a shock that is perceived to have a lasting effect on capital markets.

In the lull between earnings seasons, which we’re currently experiencing, stocks reaccelerated on the back of very modest economic news and that in itself is telling about … Read More

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