Why the Bull Market Could End in November

Facebook’s back online and stocks are rising once more.

In short, everything’s back to normal.

Even Facebook whistleblower Frances Haugen’s testimony to Congress (delivered this morning) was unable to keep bulls restrained for long. The market opened for a moderate gain before roaring through noon. Tech led the way with Dow industrials following closely behind.

And bulls can thank Senator Joe Manchin for the late morning rally after saying that he was warming up to President Joe Biden’s “social spending plan,” formerly known as the infrastructure bill.

“I’m not ruling anything out,” Manchin told CNN reporters, referencing Biden’s $1.9-$2.2 trillion price tag on the bill. Manchin previously said he would go no higher than $1.5 trillion. Manchin’s vote is likely to decide whether the bill lives or dies.

It’s no secret that the market has responded very positively to government spending since the start of the pandemic. By telling reporters that there’s a chance of a deal getting done near $2 trillion, Manchin reinvigorated buyers. He also stoked bullish enthusiasm with his comments on the debt ceiling.

“We just can’t let the debt ceiling lapse. We just can’t,” Manchin said.

“We can prevent default, we really can prevent it. And there’s a way to do that, and there’s a couple other tools we have that we can use. Takes a little bit of time, a little bit of – it’s gonna be a little bit of pain, long ‘vote-a-ramas,’ this and that – do what you have to do. But we cannot – and I want people to know – we will not let this country default.”

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Lawmakers have yet to see a debt ceiling they didn’t ultimately end up raising. As we mentioned previously, though, quantitative tightening will result from raising the debt ceiling due to the Treasury’s recent spending spree.

For those that aren’t acquainted with the US debt ceiling, it’s the maximum limit to how much the US government can borrow to pay its debts and obligations. Whenever that limit is reached, the US Treasury can’t issue any more notes, bonds, or bills.

What it can do, however, is pay for debts and obligations with tax revenue or the Treasury’s saved-up cash balance. As of July 31st, that cash balance was just $442 billion. That was a low number, historically speaking. From June to July, it plummeted by $398 billion.

As of October 1st, it sat at a meager $132 billion.

Typically, the US Treasury never needs to draw from its cash balance to pay the bills. It just issues new debt to meet its financial obligations.

For the US economy, the practice of issuing new debt usually doesn’t have any significant impact. The amount of money the Treasury spends (which adds cash to the economy) is offset by the debt issued (which removes cash from the economy).

As a result, no liquidity is added nor removed.

But more recently, the Treasury has run into a bit of a problem with this model due to the debt ceiling. It ended up slowing down debt issuance as the debt ceiling rapidly approached, which forced the Treasury to draw from its cash balance to pay for things instead.

And because less debt was being issued (while the cash balance was being spent), this acted as quantitative easing. Cash was effectively being injected directly into the economy by the Treasury without the issuance of debt to soak it back up. This applied serious pressure to short-term rates and was to blame for the negative rates in the repo market.

Lawmakers are expected to raise the US debt ceiling this month like Manchin said they would. And when they do, the Treasury will issue hundreds of billions of dollars in new debt (which sucks liquidity out of the economy), almost certainly outpacing spending (which injects liquidity into the economy) by a wide margin.

We talked about this last month. Now, though, with a potential $2.2 trillion bill looming overhead, the tightening could get a whole lot worse. Even if the majority of the $2.2 trillion comes from taxes, there’s still likely to be several hundreds of billions of dollars raised by new Treasury debt issuances in addition to what will be issued when the debt ceiling is lifted.

This will result in a significant source of tightening, right around the same time corporate earnings hit. It’s also when Wall Street expects the Fed to finally start tapering asset purchases.

Does that seem like the kind of macroeconomic backdrop that will help extend the bull market? That’s not to say bulls won’t make another attempt to hit new highs.

They most likely will. Every monthly dip this year has been filled by opportunistic buyers.

But the next correction could very well be the final one due to a set of truly “market wrecking” conditions converging, and all at roughly the same time.

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