When political leadership is wanting, one would expect respected leaders in the private sector to pick up the slack, providing a guiding hand through tectonic changes such as collapsing commodity prices, sliding emerging markets currencies, interest rate uncertainty, and stock market volatility that have lowered stock prices by 10% in short order. Instead, our financial experts are talking down the market with warnings of recession, and another 10% decline, at a time when lower import prices, higher employment trends, and robust consumer confidence point toward continued growth in the economy. Today is a buy-the-dip opportunity for investors who ignore the spin.
Donald Luskin is calling for low oil prices to cause a recession. George Soros says the pending Chinese devaluation will be the cause. Kyle Bass says it will be a debt implosion in China. Raoul Pal says the ISM falling below 50 historically correlates with a recession. Mohamed El-Erian says that the markets are likely to fall 20% because the Fed is no longer repressing volatility.
America consumes 20 million barrels of oil per day but only produces 10. The net impact of lower oil prices is therefore highly beneficial to the American economy. Near-term dislocations such as dramatic reductions in oil capex and loans to the sector going bad have caused markets near-term to correlate closely with oil prices, but this link will soon break as the longer-term benefits to the consumer outweigh the near-term costs. With rig counts down by 2/3, how much more is there left to cut?
America is likewise a net importer of goods from China and other emerging market countries. A devaluation in the yuan, while it would reduce the exports to China by US-listed international companies, would on balance be more beneficial to the economy by its boost to American consumers and reduction in cost of goods for companies.
Unlike the initial stage of the euro crisis, when US bank loans to Greece were large enough to have caused a global depression if they had been defaulted on, the vast majority of Chinese debt is owed by the Chinese to the Chinese. American and global bank exposure to Chinese debt is minimal. The ripple effects in the unlikely event of a Chinese debt implosion would be contained.
An ISM reading below parity is not the kiss of death to the American economy, particularly when it is driven by falling capex in the oil and commodity space.
Finally, El-Erian's argument that the US government is out of ammunition to prop up the American economy is not exactly supported by the facts. Given an average maturity of 5 years on their Treasury portfolio, the Fed continues to purchase $500 billion of Treasuries per year just to stick to their commitment to retain $2.5 trillion of Treasuries on their balance sheet. That makes the Fed the largest buyer in Treasury auctions even today. That's not exactly a Fed out of ammo. Not until the Fed engages in Quantitative Tightening, i.e., cashing in their Treasury portfolio as it matures, will they have ended artificial support of low interest rates.
The Fed's recent increase in the Fed Funds rate was achieved, ironically, by increasing bank subsidies, not decreasing them, to a banking system awash with liquidity from Treasury purchases. Specifically, the Fed's "rate hike" consisted of two actions: 1) They increased the annual interest rate paid on the $2.5 trillion in excess bank reserves from .25% to .5%. That is an increase in a de facto bank subsidy from $6.25 billion per year to $12.5 billion per year paid on banks' $2.5 trillion in "found money," and 2) They increased the amount of Treasuries they lend out to money market funds via "reverse repos" to $2 trillion from $300 billion and boosted the rate paid from .05% to .25%. (Now we know why the Fed accumulated an extra $2 trillion of Treasuries over the past six years and is not allowing them to mature). The Fed hands out Treasury bills as collateral for borrowing up to $2 trillion from money market funds and pays the funds an annual interest rate of .25% for the privilege. This amounts to $5 billion per year in new taxpayer subsidies to money market funds, who would otherwise not have been eligible to receive interest on their excess reserves. Item 1 plus item 2 equals $11.25 billion per year in new government subsidies to the financial system via banks and money-market funds.
Like jazz musicians playing cacophonous tunes because they have played harmony so much they have grown tired of it, our economic leaders are focusing on esoteric issues that may challenge their minds but unfortunately fail to communicate simple over-riding data points that investors need to focus on to make it through times of uncertainty like today. Don't listen to the noise. Buy the dip. Buy SPY.
From a technical point of view, the stock market has just achieved a triple bottom from August 2015 through January 2016. The pattern looks like a re-play of the triple bottom hit in December of 1987 following Black Monday, which marked the bottom of stock prices for that generation.
This technical pattern supports the more fundamental conclusion reached above, i.e., now is a good time to buy the dip through the S&P 500 ETF (NYSEARCA:SPY). A recession, and therefore a further 10% decline in stocks, is not on the horizon.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.