Record Buybacks Offsetting Fed Liquidity Drain

by FS

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We’re likely to see two or three more rate hikes this year and the continuation of quantitative tightening, through which the Fed is on course to drain $420 billion dollars of liquidity from the markets.

Earnings growth has been discounted at current prices, and tech stocks are almost single-handedly holding up this market, Global Money Trends’ Gary Dorsch told Financial Sense Newshour.

Stock buybacks are going on at a record pace of about $150 billion in the first quarter, and are projected at anywhere from a total of $650 to $800 billion this year.

record buybacks
Source: Barron’s

This is largely offsetting the Fed’s liquidity drain, Dorsch stated. We’re also seeing a shrinking market, as the number of companies listed is decreasing due to mergers and acquisitions, and the number of shares listed is shrinking due to buybacks.

“It’s difficult to short a shrinking market,” Dorsch said. “That’s where we get the buoyancy. … Start raising cash and selling positions on rallies, as I think it will become turbulent in the second half of the year. … Quantitative tightening is going to possibly flatten the market and even lead to some minor declines in the second half of the year.”

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Could an Overseas Slowdown Lead to a Fed Pause?

In a speech on May 8th, Federal Reserve Chairman Jay Powell said that quantitative tightening is going to continue and that emerging markets can handle higher interest rates and tighter liquidity.

Powell believes emerging currencies are largely influenced by the direction of commodity prices and have been divorced from Fed policy, Dorsch stated. This will turn out to be incorrect, he added, and we’ve seen massive devaluations in several foreign currencies recently.

turkish lira freefall

There’s been a decoupling, Dorsch added, with emerging stock markets remaining weak and testing their February lows, whereas U.S. and European markets have recovered.

With at least two more rate hikes baked in, Dorsch’s target for the 10-year is between 3.25 and 3.5%

“I’m very worried actually about the bond market,” he said. “It may even get outside of the control of the Fed. … The massive tsunami of debt could ultimately swamp the bond market, and we may even see the 10-year eventually hit 4 percent.”

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Will Buybacks Be Enough to Keep Markets Up?

That is the multi-million dollar question, Dorsch noted. It depends on how much tolerance the markets have for higher interest rates. He estimates that we would need to see the 10-year get closer to 3.5 percent before we will see more than a 5 percent pullback in the S&P 500 index.

At best, we’re in a holding pattern going sideways, Dorsch stated, but if interest rates go higher than anticipated, all bets may be off.

yield curve momentum lei
Source: Bloomberg, Financial Sense® Wealth Management

“The most I see is a 5 percent drop from here, but if I’m wrong and things accelerate to the downside, then we could get a further contraction,” Dorsch said. “If we were to get below 50 basis points closer towards zero (in the 2- and 10-year bond spread), then the Fed would stop tightening and would go on pause.”

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