The stock market is frothy. The great gains that investors experienced last year are extending into this year. As the indexes climb, more and more of those on the sidelines are jumping in. Is this a good sign?

 

No, it isn't. "The Fear of Missing Out," or FOMO is rearing its greedy head on Wall Street. Those who may have raised some cash in the past few months, fearing a trade war, or the impeachment proceedings, have watched the portfolios underperform the averages, ignore all the negative news and climb higher.

 

On the geopolitical front, we have seen the same thing. Selling on fear of an Iranian response to the killing of one of their heroes was the wrong move and, evidently, so was taking profits on this week's fears that the China-based coronavirus would spread, denting world economic growth.

 

Anecdotally, I have been getting requests from some of my tell-tale clients (those who want to buy at the top and sell at the bottom) to buy stocks at historic highs, where their prices exceed all rational measures of valuations. They are usually a good contrary indicator.

 

As is the U.S. Advisors Sentiment Indicator. This week's numbers underscore the gathering bullishness of market participants Those professionals who are positive on the market's future moved even higher to 59.4 percent. That is the highest it has been since September 2018.  And as the present rally broadens, we can expect that next week the bulls should top 60 percent.

 

In the past, a 60 percent bullish read would have had most who follow this indicator running for the hills, in the short-term. But so far, the opposite has occurred. Granted, investor sentiment, as a contrary indicator, is not the only variable used in trying to discern the stock market's next move. I believe that the actions by the Federal Reserve Bank will almost always trump sentiment as a determining factor. So, let's look at the Fed.

 

As I have predicted throughout the last several months, as long as the Fed keeps pumping money into the financial markets, I believed stocks would continue to rise. Since the beginning of December, the combined reserve management purchases, plus repo injections by the central bank, has been about $400 billion. The Fed argues that since they have only been purchasing notes (and not bonds with a coupon), their purchases do not qualify as quantitative easing (QE). The market doesn't care. To them QE is QE.

 

These "Not QE" purchases, however, have been so huge that the central bank is approaching the limit of purchases it can make of these short-dated securities without disrupting the market. At the present rate, there will be no notes left to buy in a month or two. As a result, traders are now betting (75 percent probability) that by mid-March, the Fed will have to expand their purchases to include longer-dated Treasury bonds.

 

The logical question to ask is why doesn't the Fed simply stop these purchases? It could be because the Fed has created its own version of "Frankenstein's Monster."  As I have written before, the Fed has dumped such an enormous amount of money into this market that by stepping back from more purchases (no matter how small), the Fed could disrupt the whole market.

 

The bet is that rather than risk that, the Fed might simply begin to expand its bond purchases to include longer-dated debt maturities with coupons. Of course, once that happens, the Fed would have to admit that, yes, they have embarked on yet another QE program. You might ask, "so what's wrong with that?"

 

The first question investors might ask is why? The stock market is assuming that everything is right with their world. Jerome Powell, the Fed's chairman, has said so over and over again. The president has said so even more times than the Fed. So why do we need another QE program after cutting interest rates three times last year? What's wrong? The Fed's actions, far more than anything else, have driven the stock market to its present record highs. Investors will demand an explanation — and soon.

 

The second, darker explanation may be that the Fed is no longer the independent body it claims to be. After all, Powell was appointed by the president. The president has voiced his unhappiness with his man's actions since he got the job. Trump is a staunch believer in easy monetary policy and wants the economy to grow as fast as it can to cement his election chances.

 

What better way to do that than by getting the Fed to pump money into the system via "Not QE," since few of us understand something as arcane as the "repo market." Whereas, cutting interest rates to zero at the president's request would be an extremely optic moment for all involved. Whatever the answer, the Fed's future actions should be watched closely.

 

America's intellectual property (IP) is worth more than $6.6 trillion and employs 45 million Americans and hundreds of millions more worldwide. It is estimated that IP-intensive industries account for one-third of the country's total Gross Domestic Product and 52 percent of U.S. merchandise exports. It is why we, as a country, are fighting so hard to protect these rights today.

 

The figures above come from the U.S. Chamber of Commerce. If anything, they understate the value of IP to all of us. So what, exactly is IP? Generally, it is any product of the human intellect that the law protects from unauthorized use by others. Inventions, literary and artistic works, symbols, names, and images used in commerce, really; just an endless list of things that people created that makes the world what it is today.

 

It is usually divided into two categories: industrial property, which includes patents for things like inventions, trademarks, designs, etc. and copyrights that cover most of the artistic world, including everything from television shows to the latest bestselling books.

 

Our founding fathers thought that IP was so important to the future of this country that they made it a point to protect the rights of authors and inventors in the U.S. Constitution. However, protecting these property rights has not always been the priority it should have been in our nation's history. The most recent example is the on-going trade dispute we are having with China over intellectual property and technology transfers.

 

A cynical investor might ask why, after over two decades of accelerating trade between our two countries, are these issues only coming up now? If IP is such a vital component of our national wealth, why did it take Donald Trump to shine a spotlight on a business practice that has been going on for more than 20 years, not only in China, but in a good part of the rest of the world as well?

 

Well, in the case of China, it was the price of doing business. There was nothing sneaky or underhanded about it. The Chinese were straightforward in what they wanted when they first opened the doors to their economy in the Nixon/Kissinger era. The message was clear — if you want to do business in China and sell to our billions of consumers, in exchange, we want to understand, learn, and license the intellectual property behind your products.

 

So why did we agree to those conditions? During those days, the markets were rewarding companies that managed to plant the first flag on Chinese soil. It was considered a "strategic advantage" to beat your competitors into China. Every company in the world wanted a piece of the action and to be first to crow over a foothold in the country. It was (and still is) the fastest-growing consumer market in the world. Visions of billions of additional hamburger or DVD sales filled the trade journals of the day.

 

The uncomfortable truth is that our U.S. corporations gladly transferred their secrets to Chinese companies in exchange for that new business.

 

And don't think our government was not complicit in helping U.S. companies gain an advantage in China. They knew exactly what was going on, in my opinion. And now, only after the horse has already left the barn, are we trying to slam the stable door shut. In hindsight, we have to ask ourselves this question:

 

"Was giving away our industrial property and looking the other way as our technology was pilfered worth the additional sales we received from the Chinese?"

 

Evidently not, if you listen to the rhetoric. The media, the public and of course, the outrage of politicians on both sides of the aisle are well known. The inconvenient truth is that we always had the opportunity to "just say no," but we didn't. We said nothing.

 

Sure, you can blame China for being unfair in the first place, as if business is ever fair or unfair (unless you lose). But from the Chinese point of view, as a country striving to raise itself up by its bootstraps 30 years ago, was it unreasonable or unfair? To me, it was simply a smart business tactic. They recognized the greed and profit motive of capitalistic societies and exploited it for their own benefit.

 

When asked, the members of the Federal Reserve Board continue to argue that the almost $500 million they have pumped into the overnight repurchase market since September is not quantitative easing. The stock market disagrees.

 

"Not QE" is the term most often used by the Street in describing this fairly hefty expansion of the central bank's balance sheet. Because the purchases that the Fed is making are categorized as debt instruments that mature in 12 months or less, they escape the hard and fast definition of what the Fed labels as quantitative easing. QE is the purchase of longer-dated maturities of debt instruments, so the Fed is technically correct.

 

However, traders are folks who like things simple. Over the past decade or so, when the Fed expanded its balance sheet (bought bonds) the stock market climbed. As far as the Street is concerned, it has happened again starting in September, and so far, there is no end in sight.

 

There are various explanations (none proven) for exactly why the Fed is making these purchases. Officially, the Fed argues the entire exercise is simply technical in nature. The Fed explained that for various reasons — quarterly tax payments, bonuses, etc. — corporations need more cash to make ends meet, but this trend will soon fade. The problem is they have been saying that for over four months.

 

Others worry that some big bank is in trouble, or that this is a new strategy by the central bank to ensure a soft landing in the economy by graduating over time from purchasing short dated debt to full-fledged QE purchases of longer majorities somewhere down the road.

 

I ask myself what could the Fed be worrying about that the market doesn't see quite yet? It is fairly obvious to most economists that the manufacturing sector in this country is in recession. We are also in our third quarter of falling industrial production. The good news is that the manufacturing sector represents less than 8.5 percent of overall jobs and less than 10 percent of the economy. So far, none of the woes in that area has spread to the overall economy.

 

There is a chance that if the downturn in manufacturing persists, it might at some point start to impact consumer spending, which is the locomotive that drives the U.S. economy. However, there is no evidence of that as of yet. In the meantime, the stock market continues to make record highs. And as long as the Fed keeps the spigot in the "on" position, the stock market's cup should continue to runneth over.

 

The signing of the Phase One China trade deal also cheered investors this week. The vast majority of Wall Streeters have not been fooled by the hours-long signing and celebration of the event by the administration. The deal, if one can call it that, is a win for China and not the United States. The fact that the really difficult issues remain and will not be resolved until after the election (if ever) reduces the upside from this event.

 

About the best that can be said for the deal is that it does reduce tensions somewhat going forward. It also gives the president a chance to claim another success (no matter how lame) among his followers.

 

The Phase One trade deal with China was signed with a great deal of pomp and circumstance this week. While happy that trade tensions on both sides have been reduced, the vast majority of Wall Street players saw the deal as a win for China.

 

After almost three years of threats, bluster and on-again-off-again tariffs, we are right back where we were before Donald Trump was elected. Yes, China has agreed to purchase an additional $200 billion in U.S. goods over the next two years, but the trade deficit was always the wrong metric when comparing our overall trade with China.

 

Trade imbalances are caused by capital flows. Don't take my word for it, just ask any economist in the world. In addition, the U.S. dollar is the currency of choice around the world and our U.S. Treasury debt is also considered the safest in the world. Those two factors create an environment where foreign investors use dollars earned from exports to purchase U.S. assets and not U.S. goods.

 

The president's entire focus on trade imbalances has been bogus from the start. One can only assume that either he does not understand that key point, or that his political base can't grasp anything more than a simplified and erroneous concept of trade imbalance as the source of all our problems with China.

 

In theory, under this new deal, U.S. exports should increase to $263 billion this year and as much as $309 billion in 2021. That should provide the president with good optics on the campaign trail. The lion's share of the $200 billion in the deal would be in manufactured goods, followed by energy, services and agricultural goods. If the truth be told, much of what China needs from us is on this list. 

 

They want more oil and LNG from America to counterbalance their energy suppliers in the Middle East. U.S. financial services and insurance have long been on China's shopping list since these are areas they need in order to broaden and add competition to their own sectors. Telecom, cloud computing, and intellectual property are also on the list. As for food imports, all of the goods they have agreed to import are in short supply in their country.

 

Supposedly, some provisions on intellectual property enforcement and protections against forced technology transfers have been included in the Phase One deal. It remains to be seen whether or not these points have any teeth or are just "understandings" between the two countries.

 

As I have written before, the really tough issues have been rolled back and await a Phase Two agreement. The president has already warned that this will take time and probably won't happen before the November elections. Peter Navarro, an assistant to the president and one of the administration's most hawkish on China, wants China to stop subsidizing its state-owned enterprises. He also wants China to halt what he called "cyber intrusions" that hack into American businesses and steal our trade secrets. 

 

Clearly, intellectual property protections and technology transfers, along with state subsidies, are going to mean changing some of the fundamental tenants of the Chinese economic and political system. That could take years to achieve, even if the Chinese were willing to do so.

 

In the meantime, the threat of tariffs and more tariffs remains on both sides and will act as a barrier and a weight not only on both countries' economies, but also on the rest of the world. There is already concern that the president will now turn his sights on Europe and once again threaten tariffs on their imports as well.

 

Fortunately for us, throughout the last few years we have enjoyed moderate economic growth and robust employment. Those factors shielded most of our economy (but not the agricultural or manufacturing sectors) from the worst of Trump's trade tirades. What would happen if, over the next four years, conditions change and/or the economy fell into recession? Could the world and the U.S. economy survive four more years like the last three?

 

It was another up week for the stock market. As we hit record high after record high, investors want more and expect to get it. Forecasts are getting even rosier for this year and, if all goes well, we can expect the signing of the long-awaited Phase One China trade deal next week. What's not to like?

 

Geopolitics for one thing. As I wrote last week, investors should expect a response after the killing of Iran's No. 2 guy, Gen. Qasem Soleimani. I expressed hope that it would be sooner rather than later since the market hates the unknown. That turned out to be the case.

 

The Iranian response, however, was largely symbolic. Several rockets that did little damage and took no lives landed on two military bases in Iraq. Both sides then seemed to dial down the rhetoric and go back to their respective corners — until next time.

 

While the week saw some wild swings in the averages by Friday, it was on to the next thing. That turned out to be the non-farm payrolls report for December. Economists were expecting 160,000 job gains but received only 145,000 instead. Although that still keeps the unemployment rate at a 50-year low of 3.5 percent, wage growth also disappointed. Average hourly earnings grew by 2.9 percent. That is the first time since 2018 that wage gains were below 3 percent on a year-over-year basis.

 

But nothing negative seems to stick to this market. Rockets, impeachment, weak manufacturing data, even the weak job numbers have, at most, provided small dips in stocks at best.  As I mentioned last week, the investor sentiment numbers have been flashing red signals. More and more market strategists are warning of an "imminent" decline of 5-10 percent, but few care.

 

Don't think I am complaining. I enjoy a bull market as much as the next guy. However, the underlying reasons for this uninterrupted march to the clouds may be somewhat troubling to ignorant folk like me. I don't believe the tweets that take credit for all-time highs that are coming out of the White House. Nor would I believe that exercising military muscle against a tiny Middle Eastern country is all that bullish, except in the eyes of the "chosen few." It is still all about the Fed, in my opinion.

 

In several columns last year, I wrote about the sizable sums of money that are being injected into the nation's repo market by the U.S. central bank. It started last year and was supposed to be a temporary measure. The argument was that corporations were facing a cash crunch and needed extra funds to pay quarter-end tax bills. The quarter had come and gone and yet, by Christmas, the Fed had pumped almost $1 trillion into that market.

 

Dumping all this money into the market was like launching a stealth quantitative easing program (QE) that is almost as powerful as cutting interest rates one or two more times. I also predicted in December that the stock market would move higher as a result of an additional $255.95 billion that the Fed planned to dump into repos at year-end. However, that was supposed to be the end of this quiet QE exercise. 

 

Guess what? The Fed injected even more money ($258.9 billion) into repos last Friday. No one actually knows why or what is going on at this stage. All the excuses the central bank has used to explain the market's need for so much cash now sound shallow and certainly less than kosher.

 

I believe the end result has been that this money is being siphoned out of the repo market by enterprising financial institutions. It is then finding its way into the stock market where the arbitrage opportunities of borrowing at next to nothing and investing it in much higher rate of return stocks is going on at a furious rate.

 

The astute reader might ask, "what happens if and when the Fed stops injecting this money into the repo markets?"

 

Well, if I am right, we should get that 5-10 percent pullback everyone is expecting. The question is when does the Fed take away the punch ball?