It’s Too Early To Turn Bearish On The Stock Market

I love Rick Santelli and the opportunity I had to be with him on CNBC Monday. However, during the four-minute segment, I didn’t have the opportunity to say that it probably is too early to turn bearish on the stock market.

TrimTabs tracks in real time new inflows into US equity mutual funds and ETFs. Historically January and April are the two biggest months for equity fund inflows. January is important because many people make once a year investment decisions. April sees big inflows because of tax avoidance investing.

This January was a real whopper in terms of inflows. In addition to the usual start of the year new money, there have been two other sources of cash. And by the way, money is not leaving bonds for stocks. Bonds funds are still attracting lots of new cash.

I believe the major source of new funds this January came from stocks sold before year end 2012 to avoid higher capital gains taxes that was then reinvested. There is no way of knowing how many billions of dollars in stocks were sold before year end to avoid higher capital gains, but I think it was a lot.

The other new cash that went into the equity markets was part of the $60 billion of this year’s income taken in December 2012 to avoid higher tax rates. Since those who recognized this year’s income tax last year were obviously wealthy, a good portion of that income probably went into risk assets. Hence we had a record flow.

I firmly believe that this inflow will subside as we move into February. However, I will not increase my short positions until the inflows end. Once the inflows end, the key metric to watch is whether the trading float of shares grows or shrinks. As I said on CNBC, January was the first month since last September that new share sales by public companies were greater than buybacks. But the total dollar amount of selling was not huge. So while corporate selling should be picking up starting this week, it will take a sustained bout of new share sales to turn this market south.

What I did mention on the air is that higher 10-year interest rates are already creating a slump in mortgage activity. Remember that last year as mortgage rates dropped, real estate activity picked up. That enhanced both income and GDP. This year, as interest rates on the 10-year notes approach 2% — the level from which it dropped last year — real estate activity is likely to contract, making for a big year over year negative comparison.

On the other hand, one thing that I did not take into consideration enough in the past is that the Federal Reserve each day now creates $4 billion of new money and uses that new money to buy mortgage bonds and longer term treasuries. Those who sold their bonds to the government got newly created money with which to buy other risk assets. Which means that some of that new money has probably gone into equities as the new money moves down the chain of risk assets. In other words, the Fed is investing in US stocks and in essence is rigging the equity markets.

Therefore until inflows into US equity funds stop and corporate America overwhelms the market with new shares I will not increase my short position.

Rigged markets never end well, but staying solvent until the market does crack is essential to financial survival.

Below you may find the video.