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The moment of truth for U.S. stocks will take place in the next two weeks
By: MarketWatch | October 17, 2017

Third-quarter corporate earnings and the ECB’s all-important stimulus plans for 2018 will converge

The next two weeks in the U.S. stock market are bound to be more interesting than usual as companies begin reporting third-quarter results and central banks around the world start talking in earnest of draining liquidity from the financial system.

The market could move quickly, so we need to be ready. I have a strategy designed for that, and so should you.

Demand for stocks, bonds and real estate are driven by liquidity. The more money that chases those asset classes, the higher those investments’ prices will rise. That is simple supply and demand, and it works on both sides.

There are two scenarios:

• Assume that supply is constant and demand increases. In an environment like that, we would expect prices to increase. That would happen regardless of news, earnings or any other corporate event.

• The same is true on the other side of the equation. If there’s less money chasing the same supply, prices are going to decline. But in this scenario, prices also can decrease regardless of news, earnings or any other corporate event.

Before we continue, let me say that changes in supply, most notably in the Treasury market, also have a material influence. But the focus of this article is on demand.

Demand for the asset classes listed above comes from two primary sources.

The first is natural flows of money from U.S. investors. This natural flow of money is defined by The Investment Rate, my longer-term macroeconomic model. It defines market cycles dating to 1900 and extending beyond 2060. Using a combination of societal norms and natural lifetime investment patterns, The Investment Rate tells us in advance where current natural demand levels are.

The second source of primary demand comes from stimulus (unnatural). Central bank stimulus has been targeting asset price appreciation since 2012, and since then, the stock market has surged and the price-to-earnings ratio of the S&P 500 Index SPX, -0.08% has increased to 24. That makes this the most expensive bull market in history.

ECB meeting

The relationship between those two primary sources of demand is important. Natural demand levels defined by the Investment Rate are declining, but the fabricated demand coming from stimulus efforts have been consistent.

The European Central Bank (ECB) is currently printing $60 billion a month, but that will soon change.

On Oct. 26, the ECB will meet to discuss changes to its stimulus program. There is a fluid debate on what exactly policy makers will do, and we have our opinions too, but the conclusion is the same no matter how we slice it. The ECB is winding down its stimulus program. Economists expect policy makers to outline its bond-buying program and give guidance for 2018.

The ECB’s meeting may be overshadowed on the same day by earnings from Google GOOG, -0.01% Microsoft MSFT, -0.34% and Intel INTC, -0.80%

It’s not unusual for the market to discount future events in favor of immediate events, and a decision by the ECB to end its stimulus program sometime next year, which seems to be the going consensus, will not change the stimulus monies that are flowing into those asset classes today. If the money is still flowing now, greed-driven investors are not likely to care. The media will be talking about earnings too, so it will be easy to lose focus on what may be the biggest financial news event since 2012.

The demand side of the equation is set to change dramatically, and when it does, the natural demand that is identified by The Investment Rate will again define the demand side of the equation on its own. Natural demographic demand is declining aggressively, and it will compound the adverse impact of the end of stimulus and the lower demand levels.

Protect yourself

The writing is on the wall: Fabricated demand is going away, and investors should protect their portfolios. I have designed a strategy specifically for this called our CORE portfolio strategy, and it is designed to neutralize portfolios against market declines when adverse conditions present themselves.

Everyone should have something like this available to them, given the changes that are coming. Preparing for this in advance is important because, again, the market will seem to forget about what the ECB says next week. But don’t get caught off guard. Smart money knows that demand matters.

http://www.marketwatch.com/story/the-moment-of-truth-for-us-stocks-will-take-place-in-the-next-two-weeks-2017-10-16

• DiscoverGold

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