Whoever is holding the Fed's proxy spent one hell of a lot of money on Friday to prevent a "flash crash". Of late I have been making the point that the only thing keeping the markets in a multiple week horizontal trading range is the Fed's commitment to absorb any and all selling pressure. That resolve was put to the test on Friday as the markets moved sharply lower when an email from Wal-Mart's (NYSE:WMT) Jerry Murray was leaked by Bloomberg News. Here is an excerpt from the Bloomberg article that set off the mini firestorm:
"In case you haven't seen a sales report these days, February MTD sales are a total disaster," Jerry Murray, Wal- Mart's vice president of finance and logistics, said in a Feb. 12 e-mail to other executives, referring to month-to-date sales. "The worst start to a month I have seen in my ~7 years with the company."
The market responded logically with a steep sell-off on the Dow (NYSEARCA:DIA) starting from 13,984 at 2:01 and hitting bottom at 13,908 by 2:29. As the chart below reflects, the market then began to stabilize as buy orders began flooding in pushing the market back up, eventually settling 8 points higher on the day at 13,981.
The sharp sell-off makes sense but a market close 8 points higher on this news seems suspect. Should we just conclude that traders finally got that pull back they've been looking for to buy on and just couldn't resist that .5% drop in price? Or would it seem a little more logical to conclude that somebody stepped in and absorbed the sell orders and continued buying into the close to keep the contagion from spreading and creating a real sell-off?
The second scenario seems a little more logical to me as I doubt too many traders saw the very modest sell-off as a buying opportunity - especially in light of the rather dire report from Wal-Mart on sales numbers. A look at Wal-Mart volume on Friday supports the thesis that the rally from session lows wasn't the result of "buy the dip" traders seeing this sell-off as a buying opportunity.
Breaking down the sell-off in Wal-Mart
Wal-Mart stock was under selling pressure from the start with volumes running well above the recent average volume number of 8,795,240. By 2:01 the volume in Wal-Mart stock was already at 12,294,270 - about 40% above the recent volume average.
From 2:01 until 2:19 - the low for the day - an additional 3,541,300 shares changed hands as the market sold off sharply. Then from 2:19 until the close the market rallied on very heavy volume. An additional 9,854,400 shares changed hands from the 2:19 low into the close.
In total approximately $1,772,608,344 in Wal-Mart shares changed hands on Friday. As the sell side bias in the stock was apparent from the opening bell it seems obvious that the buy side of the trade wasn't the "dip buyers". As the sell-off accelerated to the down side after the release of the email the buy side became much more aggressive in defense of the stock spending $924,303,714 from 2:01 until the market closed - 52% of the day's total volume.
It should be obvious to everyone that the buy side of this trade wasn't normal investor activity. Consider that the stock was under selling pressure from the start of the day and on heavy volume. That is not the kind of situation that attracts traders and investors.
More significant was the magnitude of the sell-off after the email was revealed. Keep in mind this stock is a bellwether measure of economic conditions. One can believe what they want but it seems rather apparent to me that the very aggressive and expensive defense of this stock and the broader market in general was the result of very heavy buying activity to defend the market and initiated by whoever is holding the Fed's proxy.
Desperate times call for desperate measures
In recent weeks I have argued that the only thing keeping the market aloft is the very, very aggressive money printing of the Fed that is flowing directly into the stock market by way of a very contrived arrangement with the Fed's surrogates. You can read more on my thesis and the reasons I believe this to be true in a series of 3 articles I have written in recent weeks (here, here and here) but suffice it to say that the correlation to Fed balance sheet expansions and the Dow are so high that no other explanation is plausible.
As I watched Friday's action after the email leak an old adage came to mind - "Desperate times call for desperate measures." I "Googled" the phrase to see how others defined its meaning and got the following explanation:
"It means that when people get into trouble, for example financial trouble, they may be "backed into a corner" and feel forced to do things they wouldn't normally do in terms of survival."
I received this email from an economics professor and CEO of a capital management firm in NYC back in September. He will remain anonymous as I doubt he intended for me to share it:
"I was never a conspiracy believer, but it's clear to me that major central banks are now in a conspiracy to manipulate the markets higher.
They've even admitted it in the Fed transcripts! The only thing they still haven't done is go to the NYSE and buy shares directly. That might be the end game in dire circumstances, but then it would be legally and morally questionable...and probably signal the end of the Fed."
This statement is probably not as prophetic as it seems. The work I have done in recent weeks to compare Fed balance sheet expansion and the stock market suggest that the Fed was more directly involved in buying stocks than most of us realized back in September. Many of us -- including me -- tend to reject "conspiracy theories" attributing them to the overactive paranoid minds of irrational individuals.
On the other hand, to summarily reject this thesis could be a little naïve. Recent stock market action is inexplicable if one rejects the idea that the Fed - through their appointed surrogates - is in fact directly manipulating stock prices. Friday's price action seems to be a compelling case in point.
Evidence in support of the thesis that the Fed is engaged in market manipulation
In recent weeks, I have come to the conclusion that the only way to predict with any degree of accuracy where the market is headed is to closely monitor the relationship between the Fed balance sheet and the Dow. I have presented the following charts in recent articles and the charts below reflect the most recent updates as of last Friday.
The charts above show the beginning of a breakdown in the correlation between stocks and the Fed's balance sheet but more on that in a moment. For now, let's consider the long litany of negatives in economic metrics that have surfaced in the last 60 days. Consider that we printed negative on GDP in the last quarter of 2012. Here are a few more negatives to ponder:
- Payroll tax hikes are likely to have a minimum negative impact to GDP of $125 billion -- roughly .75% of GDP.
- Sequestration cuts are expected to add another $109 billion to GDP reduction - roughly .70% of GDP.
- Unemployment spiked higher in the last reporting period indicating a real possibility that unemployment will begin to trend higher once again.
- Obamacare is likely to have a significant impact on unemployment as small companies attempt to keep a lid on costs by tampering with hours worked and employee numbers.
- The recessions in the eurozone and Japan are worsening and China's sharp decline in crude oil imports suggests a serious slowdown there as well.
- The recent improvements in the U.S. trade balance is decidedly negative for reasons most don't fully understand (an explanation is beyond the scope of this article but can be found here.)
- Top line sales figures are starting to flatten and roll over and margins are shrinking for the first time in years.
- Structural GDP is in the cellar at around 7% to 8% negative and the consensus belief that deficit spending has reached crisis levels suggests that the economy can no longer rely on ever increasing fiscal stimulus to prop GDP.
- Despite modest improvements in housing metrics the facts are that approximately 20% of the nation's mortgages remain underwater and represent a huge threat to the economy if we move into recession at the end of the 1st quarter of 2013. If this occurs, foreclosures will accelerate and force the holders of these mortgages to mark them to market and in so doing reveal the real impact a mark to market will have on those holding these instruments.
- The trajectory of inflation is down and suggests we are moving precariously close to deflation -- a huge concern of the Bernanke Fed. Recent gold price action suggests that smart money is dumping gold to the ill informed public in anticipation of deflation - not inflation as so many believe.
Most of us know these things and therefore we are becoming very concerned that the market just won't price in all these negatives. This kind of market action does little to instill confidence and suggests the very thing I am asserting here - a blatant attempt on the part of the Fed to keep a floor under the stock market through manipulation. If a private sector actor were to engage in such tactics they would be in violation of Section 9 of the Securities and Exchange Act. Consider the following language relating to manipulative practices:
"(2) To effect, alone or with 1 or more other persons, a series of transactions in any security other than a government security, any security not so registered, or in connection with any securitybased swap or security-based swap agreement with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others..."
The truth is markets - in normal circumstances - move up and down. They certainly don't discount all negatives and cling to all-time highs in a very narrow trading range for several weeks. An argument can be made that these corrections are both necessary and healthy. Even if we were going to move higher it would be a good thing if we could back off a little - at least 5% or so - to a level where investors would feel a little more comfortable with the idea of buying.
If I were going to jump over a creek, I wouldn't stand at the edge and attempt to propel myself across from a standing position. To the contrary, I would back up a ways and get a good running start. The fact that the markets won't back up and get a running start at the all-time highs suggests - to me at least - that the Fed is deeply concerned that any retracement at all will result in a significant sell-off that attempts to price in the real economic metrics that reflect an economy -- on a global scale -- that is in dire straits.
The "Law of Diminishing Returns" and why the Fed's attempt to manipulate the market is doomed to failure
"The law of diminishing returns is a classic economic concept that states that as more investment in an area is made, overall return on that investment increases at a declining rate, assuming that all variables remain fixed. To continue to make an investment after a certain point (which varies from context to context) is to receive a decreasing return on that input."
As that definition is applied to the Fed's aggressive stimulus efforts the charts above comparing the Fed's balance sheet to the Dow are showing signs of faltering. In the last few weeks, the Fed has injected roughly $60 billion into the economy through securities purchases under the provisions of QE3 and QE4.
Consequently, after several weeks of sideways movement on the Fed's balance sheet it is once again moving higher. Paradoxically, the Dow chart remained flat over that same time period. With only one exception since the onset of QE1, stocks have moved in lock step with Fed balance sheet expansion. The correlation coefficient during this period is .90 and the only time the market didn't respond - almost instantly - to the Fed's money printing was during the Summer of 2011 when Congress grappled with the debt ceiling issue and Standard & Poor's issued the first credit downgrade in our country's history.
The magnitude of the selling volume during the summer of 2011 was substantial enough that the Fed didn't have financial resources sufficient to back stop the market collapse. After updating my charts this week and seeing the correlation between Fed asset accumulation and the Dow start to break down it occurred to me that the Fed has taken this as far as they can. The market's stubborn resistance to push through to all-time highs and its proclivity to drift lower in recent weeks suggests that virtually no support from private sector investors has been forthcoming.
A recent article by Tom Armistead tends to reinforce and support my conclusion on this matter as it pertains to private sector support. Tom's statement informs us on the sentiment of at least some investors and traders at this time:
"The more I think about it, the less I like the idea of being fully invested in the market, looking at best for 7% long-term, when a (hopefully temporary) short-term loss of 25% to 40% is logically possible.
Wall Street is not a nice neighborhood. It's high in fraud, abuse and manipulation. There isn't any reason to go there unless low valuations stack the odds in your favor."
I follow Tom as I see him as one of the more logical bulls offering commentary on Seeking Alpha. I have been bearish the market since QE3 was announced in September of last year and find it useful to see how the other side of the trade views things. I admit I was shocked to see Tom taking the position he did in this article but must credit him with a degree of professionalism not demonstrated by many who continue to make the case for the bull side. A professional will always weigh the risk/reward within the context of current pricing and exit a position when that risk/reward ratio turns negative.
I, too, see a 40% downside risk to the markets from these levels - possibly more - as I can see a scenario for a test of the 2009 lows occurring in 2013. When a buy side bull like Tom joins the chorus expressing bearish sentiments, it is time to be concerned.
So, to the point - as I see it the "Law of diminishing returns" is in full play here. The mini sell-off precipitated by the Wal-Mart email cost the Fed's surrogates a lot of money Friday. As already noted, Wal-Mart was under pressure all day long and a total of $1,772,608,344 in Wal-Mart stock exchanged hands Friday. We don't know who was on the buy side for sure but it is hard to imagine that anyone really expected to profit from these buy side orders in the near term. That suggests the market maker's standing in the gap and absorbing the sell orders were carrying out the Fed's agenda.
Consider that Wal-Mart is just one stock. The Fed is printing at the rate of $85 billion a month based on QE3 and QE4 agendas. That is a lot of money but not nearly adequate to back stop a high volume sell-off. There were approximately 25 million shares of Wal-Mart traded on Friday.
The Dow volume on Friday was approximately 637,000,000 shares. Extrapolate this however you want too in order to arrive at the amount of money required to back stop this market in a broad based, high volume sell-off. Despite the opinion of many the Fed is simply not big enough to back stop this market if sentiment shifts as I think it is doing at this point.
Bright red warning lights are flashing at the present and Friday's action that culminates a multi-week period of sideways price action is indicating a market that is literally exhausted. Markets move and the likelihood that this market will simply sit still at these levels has a probability occurrence factor of zero. This market is going to move and it would appear the final building blocks are in place for a significant sell-off.