Reason why people whisper "stock prices rise until autumn, then crash severely afterward"
Hello, this is Gesō Yamashita.
“2020 is going to be dangerous. A big financial shock will occur!”
Such voices are somewhat audible.
On the other hand there are voices saying,
“The upward trend will continue until autumn.”There are also voices that say so.
Why is it assumed thus?
Today I will explain the reasons.
“I don’t really understand economics, and I don’t like difficult stories.”
So that even such people can understand,
I will explain as clearly as possible.
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Recap from last time; the surge in repo rates
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In the last newsletter
we informed that the US Federal Reserve’s balance sheet
is quietly expanding.
Although not heavily reported by the media,
the Fed’s balance sheet is actually expanding at the largest pace ever.
It is pumping liquidity into the markets and effectively supporting prices.
What triggered this was the U.S. “repo rate spike” last September.
There is a market where financial institutions can borrow money for a short period,
starting from as little as one day,
and that market is called the “repo market.”
“We absolutely need a large sum of money by this date.”
Situations like this can happen to anyone,
and financial institutions are no exception; when that happens,
the market where funds flow in until funds arrive
is the repo market.
And in that market the interest rate at which institutions borrow
is called the “repo rate.”
Repo rates usually stay at a relatively low level,
but in September last year, they suddenly spiked.
If repo rates stay at elevated levels,
financial institutions may not be able to borrow,
which could cause severe damage to the economy.
Therefore, the Fed stepped in to stabilize the situation.
It pumped funds into the repo market and worked to normalize the repo rate.
That was the story up to last time.
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The balance sheet expansion resumes
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The Fed will continue to inject funds into the repo market after last year’s liquidity injections.
Also, as is not explained in detail here,
the Treasury’s short-term securities, known as T-bills, are also being purchased.
Because of this the Fed’s balance sheet has expanded rapidly.
For reference we will look back to 2008 and
the progression of the Fed balance sheet. I will explain.
Going back to 2008, before Lehman Brothers collapsed,
the Fed balance sheet was under $1 trillion.
However, after Lehman Brothers’ collapse,
from November 2008 to June 2010,
the Fed conducted quantitative easing,
and the balance sheet expanded rapidly.
By June 2010 it exceeded $2.3 trillion.
More than double the pre-crisis level.
By the way in English, “quantitative easing”
is called
“Quantitative Easing,”
and its initials are taken to refer to QE.
The QE conducted from November 2008 to June 2010 is commonly called “QE1.”
After that, QE2 and QE3
were implemented in the following periods.
QE2: 2010-2011
QE3: 2012-2014
As a result,
by 2015, after QE3 ended,
the Fed’s balance sheet had surpassed $4.4 trillion.
However, after QE3 ended,
the balance sheet began to shrink,
and by the end of August 2019 it was about $3.76 trillion.
Pre-crisis: about $1 trillion
↓
After QE3: about $4.4 trillion
↓
End of August 2019: about $3.76 trillion
This is the trajectory.
Until last summer, the stock market had been climbing nicely down the mountain.
However,
in September last year,
as the repo rates surged,the trend changed, and the Fed’s balance sheet began to expand again.
Every month, the balance sheet continued to grow,
and as of the end of January last month it surpassed $4.15 trillion.
It has started climbing again.
And here is one puzzling point.
Regarding the balance sheet expansion since September last year,
given the scale, it is natural to think
that “QE4 started in September 2019.”
Indeed, market participants have been saying,
“It’s QE4!”
But the Fed insists,“This is not QE.”
In other words,
“The balance sheet is expanding, but this is not QE.”
It is hard to accept, but whether it is QE or not,
the fact remains that the Fed is currently supplying funds on an unprecedented scale.
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Stock prices may rise until autumn, then fall sharply
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Last year, the Dow Jones Industrial Average reached record highs,
and behind that, there was no doubt that the Fed was buying support.
There is no doubt that
the rise in the Dow was artificially created.
And now, as long as the Fed continues to inject funds,
the stock market is likely to be supported,
keeping the upward trend alive.
So, how long can the stock-up trend be expected to continue?
A hint is the autumn’s U.S. presidential election.
One view is that President Trump will keep the stock market rising until the election
so, until then, the chances of a sharp decline in stock prices are low
as well.
Instead, after the election or after the Fed ends its support,
the gloss may come off and stock prices could crash rapidly.
If the Fed mishandles the taps,
the stock market could experience a powerful backlash.
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But the situation is already dangerous.
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Of course, there is no guaranteed outcome in markets,
so what I’ve shared is
only one possible scenario.
Already, we are at a point where the Fed may need to provide support,
which is also a fact.
There are market participants who worry“When will it explode?”
There are financial instruments that imply such concerns.
If those instruments explode,
a crisis larger than Lehman Brothers could occur.
(I will cover this topic again separately.)
“One should not jump to conclusions,
and should be prepared for a crisis that could exceed Lehman’s any time,
to be safe.”
That is the professional mindset.
Please make sure that your carefully saved funds
are not lost in one fell swoop
this year in particular.
With that, thank you for reading until the very end today.
Keizo Dozan
