Is the bull market running on fumes? Warning signs go up

Is the bull market running on fumes? Warning signs go up

In this week’s video insights, I discuss how two seemingly separate developments – Jerome Powell ending quantitative tightening (QT) and rising delinquencies on US subprime auto loans – could combine to warn that the stock bull market is out of steam. Liquidity support could soon become more targeted, banks could tighten lending and high equity valuations could come under pressure. Now is a wise time for investors to rebalance: move profits from high-growth names into defensive stocks, keep some money for volatility, and perhaps explore adding uncorrelated assets like private credit or arbitrage funds to their portfolios.

For more information please call David Buckland or Rhodri Taylor on (02) 8046 5000.

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Hello, I’m Roger Montgomery and welcome to this week’s video insight.

Today I want to connect two threads that at first glance seem unrelated: one from the halls of the US Federal Reserve (the Fed), the other from the cracked asphalt of used car lots in the US. Taken together, I wonder if they form a single, elegant warning: the stock bull market is running on thinning fumes.

Jerome Powell, in his speech to the National Association for Business Economics on October 14, delivered a phrase that shook the algos: Quantitative Tightening (QT) is “in sight” and coming to an end. The reflexive read was more liquidity, higher multiples, party on and lifted the S&P half a percent before the close.

I wonder if more advanced capital has stood still. You see, ending QT is not the same as restarting Quantitative Easing (QE). Since June 2022, the Fed has allowed $95 billion per month to disappear from its balance sheet, reducing it from $9 trillion to $6.6 trillion.

That drain was intended to drain reserves, prompt private buyers to take up government bond supply and tighten financial conditions in parallel with interest rate hikes. Still, shares have continued to rise. Why? Because the Fed never really removed liquidity. Reverse repo facilities, overnight credits and government bond purchases disguised as ‘technical adjustments’ kept the taps open.

But what if those backdoor injections have now run out? Bank reserves amount to 10 to 11 percent of gross domestic product (GDP) – close to the Fed’s “spacious” threshold set by Governor Waller. So Powell’s pivot is not the forgiving gift it appears to be. When QT ends, some analysts expect the Treasury Department to flood the system with short-term bills to finance defense, artificial intelligence capital expenditures (AI capex), strategic resource acquisition and budget priorities. And if they’re right, that’s not market support. Liquidity would be more targeted and not spread all over the place.

And the banks, already in the process of writing down loans — as Zions Bancorp recently fell 13 percent in one session — will hoard reserves instead of lending to indebted companies.

When that happens, the availability of credit decreases. Earnings multiples are shrinking. The price-to-earnings ratio of more than 20 on the S&P is becoming even more difficult to sustain.

And if fiscal spending drives up long-term interest rates while the Fed caps the front end to avoid 2019-style repo spasms, we get a steeper curve at the cost of lower risk appetite. In that case, the recent gold rush isn’t esoteric nostalgia; it’s a stress meter.

The stock market has been climbing a wall of worry for three years thanks to AI euphoria, robust profits and liquidity camouflage. That wall is now vertical, but the Fed is shifting from tightening to targeted support that could bypass support for the most expensive stocks. And meanwhile, as evidenced by the recent bursts in U.S. auto lending, consumer resilience, as measured by 60-day delinquencies, is deteriorating. Delinquencies on subprime auto loans have risen to record levels. PrimaLend Capital Partners – a major player in the buy-here-pay-here car financing market – has filed for bankruptcy protection, veteran short seller Jim Chanos says there are “a lot of red flags” at Carvana, a major online retailer of used cars in the US, and Bank of England Governor Andrew Bailey has drawn parallels with the financial crisis of 2008, citing the resurgence of ‘slicing and dicing’ complex loan structures. in the private credit markets, with the collapse of US companies, First Brands and Tricolor, described as ‘canaries in the coal mine’

Investing is not about ‘all-in’ or ‘all-out’. It’s about rebalancing regularly, looking at the assets in your portfolio that have served you very well over the years, and rebalancing or ‘shaping’ your portfolio to reflect your risk profile and ongoing needs. Rebalancing is not capitulation; it is capital preservation with optionality.”

1. Pivot profits from high-beta growth to defensive cash flow compounders – utilities and healthcare have outperformed last month for good reason. Small caps are starting to perform better.
2. Have some cash or near cash dry powder if volatility produces a few options, and
3. Add uncorrelated private assets or arbitrage funds to your portfolio. We offer you some that are worth considering or that you can ask your advisor.

That’s all we have time for. I’ll see you again next week. In the meantime, follow our daily blogs or follow us on Facebook and X.
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