Stock Prices Vulnerable - Even Before Taper Time Starts

Most who follow markets now know that the US Federal Reserve wants to “taper” the amount of new money printed daily. But nobody seems to now when. And the real question is: what does that mean to the markets if the Fed does or doesn’t taper?

My numbers tell me that stocks are vulnerable even before the Fed starts to Taper. The financial world altered back on May 21 when Fed Chairman Ben Bernanke said the free money drug will stop flowing at some point. Since then over $110 billion has flowed out of bond funds. Why? Interest rates have surged. A 10 year Treasury was 1.6 percent on May 21 and is closing in on three precent today.

Remember flow follows performance. The average supposedly safe bond fund has lost 7 percent in price since May, therefore outflows have surged.

On the other hand, the stock market has been pretty much flat since May 20. So what does a stock investor do now?

Most important to me as an investor is what is really going on in the US economy as well as the supply and demand of cash and shares. What I do not care about are Wall Street’s opinions, guesses and fantasies.

And what is going on is a continuing supply of the free money drug by Fed, and a bearish trend by Corporate America on top of a slowdown in the overall economy.

Let us start first with the underlying economy. Wage and salary growth is puny to non-existent based upon our analysis of the US Treasury’s daily withheld income and employment taxes. Currently wages and salaries are growing at less than 3% year over year before inflation, and the growth rate has been slowing since mid July. The recent slowdown trails the surge in interest rates by six weeks.

All that means is that the housing market has started to slow but the numbers do not yet show that slowdown. Remember mortgage rates spiked early in June. Since closings take place six to 10 weeks after the contract signing, July existing home sales were based on May to early June contracts.

Yes, many Wall Street types are saying that housing will stay strong even if mortgage rates average five percent. After all, five percent is still close to all time lows. Really? That ignores the fact that at today’s 4.9 percent mortgage rate, you need to be making 40 percent more to qualify for the same dollar amount of mortgage then when rates were 3.5 percent. In other words, home affordability has dropped by 40 percent! A 40 percent spike in home costs has to hurt future home sales. And as we get into September, the home sale numbers will be horrendous.

So while higher interest rates are slowing an already slowly growing US economy, stock prices today are virtually unchanged from when Taper Time started May 21. Why are stock prices doing so well as bond plunge in price? Simple. The Fed is still dispensing $4 billion daily in free drug money, $85 billion monthly.

Therefore, the market is unlikely to plunge until the Fed actually starts creating less new money. But any upside growth could be limited as corporate America has turned bearish over the past three weeks. IPOs and new share sales have swamped announced buybacks and cash takeovers since early August. In addition insider selling not only is more than 12 times insider buying but total August insider selling could be the most for any month this year.

Bottom line: Higher interest rates are slowing the US economy. If corporate America remains a seller, then the downside risks to stock prices seem to be much greater than any upside potential. And if the Fed does Taper in September on top of all of the above, watch out below.

Below you may find the video.