Beyond the Stock Market Run

Dan Carroll, a founder of Kaching, emails:

Hey Robert,

Hope all is well....

M2 is declining...consumer credit is declining at rapid rate and so is commercial lending...all of this is very supportive of debt deflation.

What's your take? I saw your recent post about saying "careers will be made shorting treasuries" I agree at some point, but if as you say that the current equity ridiculous run will run out of steam, then treasuries will become a safe haven again...interested in hearing your take.

--Best Regards,

Dan

My reply:

Hi Dan,

Your points are solid. The slowdown in money supply is deflationary,which in turn, generally, means less lending--although if you look at the growing excess reserves it appears there is something akin to a lenders strike by bankers. The lack of lending (as the monetary base grows) is causing the slowed money growth. The Fed can get around this buy buying even more assets and different types of assets, but it is an unusual situation. Go back to the early summer of 2008 and take a look, the banks hardly held any excess reserves. This is clearly a desire to hold cash--by the banks.

That said, the situation appears to be changing for stock market players.The climb in Treasury interest rates can be partially blamed on a desire to hold less cash and more stocks. We can see this because the money supply is not expanding, yet the stock market is going up--the money has to be coming from somewhere. I think it is coming from the Treasuries.

Thus, my bearish view on the stock market. There is a limited amount of money that will move from cash balances into the market. It is not like the Fed printing, which can be in reality an unlimited source of new funds.

Your point is well taken about a second flight to Treasury securities when the market turns down again. But there are many countervailing trends which make it a very complicated this time around. This time there will be a huge new supply via the Treasury. Secondly, this time, the Chinese will likely see it as a selling opportunity. Finally, this looks in many ways like a Bear Market rally, so when it reverses it won't be the same intensity of flow into Treasury securiyiestas occurred last year--a lot of that money is still there.

However, how all these factors play out on a short term basis is real tough call. On a longer term basis, it's much clearer. U.S. deficits will continue to grow as government grows and with the added money that will eventually be needed to finance medicare. medicaid and Social Security. It's not going to be a pretty picture.

So there are two ways to play the Treasury securities game. You can play just on a long term basis, ignoring short term counter trends, i.e. just stay short with plenty of excess margin. Or you can try to correctly read the short term counter trends, i.e., when are we going into a period of strong or weakening demand for cash? When will the lack of buying out of China impact the market? When will a downturn in the stock market create a flight to T-bills? In other words, watching all the very complex details. I don't think it is an easy thing to do. But, I think half the battle is knowing what trends to monitor and trying various ways of detecting when these trends are influencing the market. That's why I say it is a career versus a part time trading job. There is a lot to be aware of and monitor. But, if somebody is smart and puts the time in, it will mean many, many $$$$.