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Central Bank Balance Sheets

December 07, 2020

Worldwide stock and bond markets continue to defy gravity in the wake of a resurgence of the Corona virus. Economic numbers are mixed to weak and as government stimulus has waned in recent months – but the stock indexes are full steam ahead. Interest rates remain very low and mortgage rates are keeping bids under a rocketing residential real estate market. Markets are very optimistic about the vaccine possibilities for the first part of the year as well and appear to be ignoring any of the political turmoil that is still plaguing the headlines.

One of the developments of the last month that is concerning to us is the weakness of the U.S. dollar. Many of the pundits are attributing this to a removal of the risk premium that was built in to the dollar as the pandemic ravaged the globe. That doesn’t pass the smell test with us – first and foremost because the selloff has gone way further down than where the rally started – and the pandemic is still setting records. Also, the way stocks are rallying does not imply that people worldwide are pulling their assets back out of our markets. This dollar weakness hasn’t gotten to disaster levels by any stretch – but with our interest rates higher than much of the developed world the selloff is counterintuitive. This needs to stay on the radar…

One thing that concerns us about the rally in the stock market is the one-sidedness of the market. Meaning, money managers across the board are confident and bullish. It is very reminiscent of late 2018 when the bullish sentiment was extremely high as well. We are certainly not predicting the Christmas meltdown in the markets that we had that year, but there are parallels that raise concern. One thing that is even more extreme now is that the volatility- trading hedge funds have pared back their short positions to effectively an all-time low.  This is by some measures as collectively bullish as an investing community as we ever have ever been…

That certainly doesn’t mean that the market is going to sell off tomorrow, but it does make you wonder how smart it is to pile a bunch of new money into the market from this level. One thing that many of the investors with heavy stock overweighing their portfolios are reiterating right now is the backstop of central bank asset buying they expect to protect their downside risk. In fact, asset managers all over the globe have taken this from the don’t-ask-don’t-tell expectation behind the scenes (probably originated as “The Greenspan put from 1987”,) to a verbally stated rationalization. Valentijn van Nieuwenhuijzen, who helps to manage NN IP’s 295 billion euros ($356.09 billion) of assets, told Reuters Global Investment Outlook Summit, 2021 “Central banks will be super committed,” he said. "With massive output gaps, I doubt that over a 3-5 year horizon there will be any change in the picture of debt levels or inflation."

Courtesy of Morgan Stanley we see a chart of the expectations of the balance sheets of the major world central banks going forward. We will be surprised if by Dec-22 their position isn’t MUCH larger…

We are not the only ones that can see the over extension of near-term bullishness, but most expecting a pullback consider it a buying opportunity.  Morgan Stanley and JPMorgan's advice is to mind the sharp imminent correction but to promptly buy the dip, i.e., "any equity correction in the near term would represent a buying opportunity as in our opinion we are only in the middle of the current bull market."

The trend is your friend and at this point the trend is toward a Santa Claus rally. But much of this rally is on the central bank policies on the front end and expectations of a central bank safety net if anything goes wrong. Keep in mind, our fearless leaders in Washington DC are negotiating dumping another $1 trillion or so in “stimulus” when the market is pinned to an all-time high. These highs could certainly get higher. That seems like fiscal madness from a historical perspective, but so many of the historical measuring sticks of asset valuation are relatively useless with so much government/central bank meddling in asset markets.  As Mark Twain so famously said – history doesn’t repeat but it often rhymes. Don’t expect this time to be exactly the same as historical bubbles – but also don’t think the piper will never have to be paid.

Regards and good investing!

Greyson Geiler