A couple weeks ago I wrote about the TRUMP PUT and the impact it's having on the markets, but in case you don't subscribe to my newsletter, here is a brief explanation.
In options trading, a PUT gives an option buyer the ability to require that the option seller purchase their shares if the market drops below the agreed upon price (the strike price). If the market drops below the strike price, the option seller must buy the shares from the option holder.
The Trump PUT is a new term on Wall Street and it refers to the belief that Trump will tweet his way out of a stock sell off. I have NEVER seen a president so obsessed with market conditions. A single tweet from Trump, and a comment by our Treasury, Secretary Mnuchin, reversed three market sell offs last week.
What happens when the market no longer buys into "The Trump Tweet"? The markets have a natural flow, and like water it will always seek its own level. Sure, you can stop water for awhile and you can redirect its path, but ultimately, water will end up where water needs to end up. I believe the same is true for the bond and equity markets which is why I have long held a negative view of the FED. Not the person running the FED, but the entire notion that FED is necessary. In my opinion, which I will prove out with facts over time, is that the FED has only built temporary dams to redirect the flow of the market for now. Just as water must end where it ends, so must the markets. In fact, like water, the longer you attempt to stop the flow, the more treacherous the water will become once the dam breaks, and it will always break! Let's consider this my first concern!
The second reason I think it is a bad idea to push the FED, or for the FED to intervene is that often times, success breeds failure. What I mean by this is that if the FED gives in, or if the FED by their own conclusion decides to push rates down and the market does not agree, we will suffer unintended consequences. In fact, we are already beginning to witness what those could look like. We call them asset bubbles. With too much fuel comes too much fire, and with too much fire retirement accounts and home equity can go up in flames.
I have written in prior weeks about the damage caused by companies that borrower cheap money from the FED and then invest those funds into buying back their own stocks. It artificially increases their share prices and hence their market value. Warren Buffet (previously a huge fan of corporate stock buybacks), recently was quoted stating "I have found new religion with regard to stock buybacks." Buffet is now acknowledging the damage this is having on the market. Corporate debt just hit another all time high, while at the same time, the total number of shares outstanding has dropped to long term lows. See chart below.
All Time Corporate Debt Used for Deadly Purposes
When a company borrows money, it should be used to create and/or sell new and better products. It should also be used to retool their infrastructure so they can become more efficient. I want companies I investment in to grow their share price because they grew their revenue and/or decreased their cost structure. Unfortunately, this is not happening and the impact will be ugly. See the chart below:
What will happen when the FED runs out of fuel, or the fire begins burning too hot and the FED decides to just let the flame die down? This will be done by raising rates, which in turn slows the economy and reduces corporate profits. Not only will companies have much higher debt to service, but they will also not have the cash needed to sustain their company. They spent their cash on artificially propping up their share price as opposed to building a better and more sustainable business. The FED can only control the shortest term interest rates, and the market controls all else. When the FED pushes down too hard on short term borrowing rates, the long-term bond buyers grow nervous and begin selling their bonds. So while short term rates get lower, long term rates will rise much faster than they would have had the FED stayed out. The yield curve steepens, inflation potentially rises, and the FED douses the flame leaving the giant asset bubble they built with abnormally low rates to POP! Think 2008.
"Whatever Cannot Continue Must End"
There are two primary points to this article. The first is that the effectiveness of Trumps Tariff related tweets are wearing off, and soon the market will take its natural course (which in my opinion only leads downward).
The second point is that you cannot ride two ponies at the same time. Either the market and economy are doing great or they're not. If things are great, it would be insane for the FED to add fuel to the fire. If things are not great, let the market do its thing (drop) and then let the FED add some fuel.
I hope I have proven to you that you cannot have a stock market on fire AND low rates for a sustained period so a wish for lower FED rates is also a wish for a stock market downturn. The tea leaves have spoken to me, and the best the FED or Trump can do right now is delay the pain, but the longer they delay pain, the more pain we will endure when the dam breaks.
For now, I would bet on bonds and lower rates over a higher stock market. If you stay in stocks, stay in high quality companies with solid growth and strong balance sheets. Look for dividends and understand that dividends are one of only two ways to see positive returns in the stock market over the next several years.
The second way to see returns is by selling call options against the stocks you own, and then using the income from those options to protect your portfolio by buying put options.
It is MUCH easier than you think. Checkout www.universityofoptions.com/supercharge to see how we can help you protect your retirement.
If you'd like to learn more about what we are doing at University of Options you can email me directly at [email protected] or visit our website at www.universityofoptions.com I hope to connect with you soon!