Taper Time

It was a pivotal week for the markets as the Fed minutes last week revealed discussions about downsizing the amount of quantitative easing by tapering bond purchases (Treasuries and mortgage backed securities). Several Fed governors gave interviews this week leading up to a speech by Chair Powell on Friday that confirmed the sentiment was to reduce bond purchases in the coming months. The speech on Friday echoed what the Fed Governors had been saying and we should get more detail on September 22nd at the next committee meeting. There should be a good deal of anxiety in September as the sentiment from the Fed was that they have no choice in the matter and that the tapering is going to happen. The last time the Fed tried this was Q3 of 2018 which put the S&P into a 22% correction that stopped when the high-yield market locked-up which caused the Fed to reverse course. Things are different now and I think the messaging this week solidifies the Fed’s steadfastness in their conviction regarding inflationary pressures. Don’t fight the Fed.

So, how big is the Fed’s balance sheet? The chart below shows the size of their holdings since the financial crisis. For perspective, prior to the financial crisis, anything near $1T was considered getting “too big”. With holdings currently above $7T that should put in perspective how far above normal this has become over the years. Let’s not forget all the debt that has been created by corporations in this time period but that is a discussion for another time. The pandemic has caused a dramatic rise in holdings so that begs the question as to how much tapering is needed to get inflation to cool off? The markets will wrestle with this question in the coming months – I don’t think the Fed knows, either. Will other central banks follow the Fed? If they do, there will be a massive drain in global liquidity but that would only happen if inflation accelerates in the coming months.

Assets Owned by the Federal Reserve Bank of the United States

How is the stock market holding up? Good but certain technical indicators like the McClellan Summation Index is sending a warning signal as shown in the chart below by Sentiment Trader. The worst possible combination for this indicator is when it is below zero and declining which is what the S&P 500 is showing now despite making new all-time highs this week. A negative divergence that can’t be ignored. I would also like to point out that this tool is not great for timing purposes so this divergence can continue longer than you would expect but it is definitely worth watching.

McLellan Summation Index by Sentiment Trader

The chart below is from Friday morning so it does not show the slight new highs made in Friday’s session (system maintenance this weekend). The main thing to take away from this chart is that a break of the 4400 area would warn of a 10%+ correction down to the 4000 area. Upside looks limited from here but a move up to 4550/4600 is not out of the question in the short-term. The next Fed meeting will be significant and how the market begins to digest the tapering news will likely show up in next week’s trading.

Chart of the Week!

The number of job openings exceeded the number of unemployed Americans in June, signaling excess demand in the labor market. The following chart, based on data from the latest Job Openings and Labor Turnover Survey (JOLTS), shows which industries had the highest job openings rate at the end of June. The job openings rate is the number of job openings divided by all jobs, filled or unfilled, in a given industry. (Statistica)


Economic & Central Banking Snippets 

Durables Goods Orders
  • Orders for cars, appliances and other durable goods decreased slightly in July, as manufacturers continued to grapple with shortages in parts and labor and confront higher material costs. The 0.1% decline follows gains in 13 of the past 15 months.
  • Existing home sales in July totaled 5.99mm while supply is at 2.6 months which is below the long term average of six. The median home prices continue to rise and are 18% higher compared to last year.
  • Central banks are beginning to raise interest rates as the Bank of Korea decided to prioritize concerns over inflation and raised interest rates by 25 bps to 0.75%. 
  • The US Markit August manufacturing and services composite index fell to 55.4 from 59.9 as both sub-components came in lower. The service side reported a “slowdown in activity growth that was often linked to labor shortages, the spread of the Delta variant and some instances of supply chain disruption” according to Markit.
  • Core durable goods orders in July came in flat but the June number was revised slightly higher.

Macro Snippets

  • Taiwan Semiconductor Manufacturing plans to increase the prices of its most advanced chips by roughly 10%, while less advanced chips used by customers like auto makers will cost about 20% more. The higher prices will take effect later this year.
COVID-19 Hospitalizations
  • U.S. Covid-19 hospitalizations have surpassed 100,000 for the first time since January, nearly doubling since the start of August. While the figure remains below the country’s winter peak, hospitals in some parts of the U.S. are straining under the load, and officials in states including Georgia, Kentucky, Tennessee and Idaho have requested extra personnel and resources. (WSJ)
  • U.K. car production sank to a new low last month, marking the worst July performance for the industry since 1956, according to The Society of Motor Manufacturers and Traders. U.K. manufacturers built just 53,438 vehicles in July, a 37.6% drop from July 2020 amid the global microchip shortage and factory shutdowns. (WSJ)
  • There have been 556 follow-on offerings (stock sales by companies) so far this year. It’s the most since 1996, according to Dealogic, and those offerings have raised a total of $133 billion so far. 
Follow-on equity offerings 2021.
Paul J. McCarthy III

That is all for now and thank you for being a subscriber!


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.