Cheering on bad data

Posted By Darren Winters on Nov 18, 2019


Cheering on bad data

Cheering on bad data because it will bring more central bank easing is again the market’s narrative.

The Fed has reverted to more quantitative easing or QE4, but would rather refer to it as balance sheet expansion. Moreover, the Fed’s rate cut trio has convinced traders that central bank easing is yet again underwriting the risk-on trade. The Fed’s rate-setting committee, known as the FOMC committee cut rates a third time this year by another 25 bps to 1.5% on October 30.

Cheering on bad data means that bad news is good news because more central bank stimulus is in the pipeline

So a stock market melt-up is underway, irrespective of the fundamentals.

Stocks continue to make new highs based on warped logic. If it is bad news stocks rally since it implies more central bank stimulus is coming to the rescue. Moreover, if it is good news stocks rally.

But does cheering on the bad data mean that it is a one-way bet, bearing in mind that the Fed’s policy of QE to infinity has engineered a perpetual bull market?

Here is the caveat to cheering on bad data and buying the dip when even the dip is pricey

Central bank easing is widening the divergence between asset prices and almost any technical or fundamental indicator or data. 

So what does this negative divergence mean for future prices?

Negative divergence points to lower future prices. 

Put simply cheering on the bad data is buying into a Fed-induced stock bubble

Asset bubbles eventually burst, everyone knows that. The million-dollar question is what will be the trigger that bursts the greatest asset bubble in history and when is it likely to happen?

Poor returns over the next 12 months are one reason why investors should be wary of cheering on the bad data with heavily exposed positions, according to investment bank Morgan Stanley

Cheering on bad data

“Bad data should be feared rather than cheered,” said the bank in its latest investors’ report.

“The market is too optimistic on 2019 earnings and is underestimating the pressure from inventories, labor costs and trade uncertainty,” the bank added. 

Moreover, Business Conditions Index, a set of forwarding looking indices, has recently collapsed to the lowest level on record, noted the bank. The MSBCI chart shows the extent of the fall.

Despite the bearish fundamentals the investment bank has not written off cheering on the bad data with risk on exposure, albeit in European and Japanese equities and EM credit

“There comes a point for every analyst where you need to change your forecast or change your view. We’re doing the latter,” said Morgan Stanley.

In other words, the bank remains bearish on the fundamentals but it is upgrading its view to neutral on the global market. This suggests that US Dollar topped has played out, bearing in mind that the Fed’s policy of easing, which entails lowering the Fed fund rates and QE4 is likely to weaken the USD going forwarding. If this is the case, then a weaker US dollar would provide tailwinds for Emerging markets (EMs),EM credit and US exports.

But here is the zinger, “Our economic forecasts assume no further escalation in US-China tariffs”.

Meanwhile, the bank still retains its bearish positioning in the US. The investment bank’s asset allocation chart shows a bearish stance on USD, US equities, US credit, and European Government bonds and commodities.

So are the insiders cheering on bad data with large positions?

Insider stock sales are up this year. While insiders cashing out should not be interpreted as bad news for a company’s stock. 

For example, a director could be selling stocks raising capital to finance a luxury yacht, a holiday home or a divorce settlement agreement. Conversely, a company director could be selling shares in the company because he sees treacherous waters ahead and is eager to lock in profits now before stock prices fall. 

Big money insider sales have been reported.

The number of months where insider sales topped $10 billion in the first nine months of this year, the highest since 2006, according to TrimTabs Investment Research. 

“It signals a definite lack of confidence if insiders are not willing to hold onto their shares,” said Trim Tabs. 

What’s more, the grand masters of the investment world don’t appear to be cheering on bad data with their large cash pile positions

Indeed, Warren Buffett’s Berkshire Hathaway reported a $128 billion cash balance for the third quarter, up from $122.4 billion in the prior quarter. 

Despite, the era of global bubblenomics where the world’s central banks have got investor’s backs covered with QE to infinity major investors have been raising their cash pile positions. 

So we have a stock market rally without investors

Mutual funds and investors are sitting on their hands despite the central bank’s easy money policy for the upper echelon which has aided and abetted stock buybacks, thereby propelling prices higher. 

But Cheering on bad data, buying the dip was how to play it post 2008 financial crisis. The greatest monetary experiment in the history of finance spurred on a bull market that just keeps running.

Central banks have gone back to accommodative monetary policy so why aren’t we seeing the mother of all stock market rallies? Why are insiders selling? Why is Warren Buffett maintaining a large cash pile?

Perhaps markets are in the next phase where monetary easy has lost its mojo

The laws of diminishing returns may have finally caught up with the central bank’s monetary easing policy. 

The Bank for International Settlements (BIS) warned back in July of diminishing returns of monetary policy.

Monetary policy cannot be an engine of growth, warned the BIS in its 78-page annual report.

“What is good for today need not necessarily be good for tomorrow. More fundamentally, monetary policy cannot be the engine of growth” wrote the BIS.

In short, perhaps it would be prudent to be cautious cheering on bad data as price discovery with a thump could come next.

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