Let's get a few things straight:
- The Federal Reserve is buying $85 billion a month of Treasuries.
- The budget deficit is shrinking very fast thanks to a combination of a stronger economy, budget cuts, and Fannie Mae and Freddie Mac repaying tens of billions of dollars in bailout funds.
- Over the next six months, the budget deficit will likely be less than $100 billion, while the Fed will buy more than $500 billion of Treasuries.
Hedge fund billionaire David Tepper connects these dots and comes to a firm conclusion: Stocks are going higher. The Dow Jones (^DJI 0.06%) surged on his comments.
Here he is on CNBC this morning:
In My Cousin Vinny there's this moment at the end of the movie where he's making a case and he's summing it up, and he sums it up with so many different things that the prosecution says, "case dismissed." Because the evidence is so overwhelming.
It's kind of like that right now. It's so overwhelming. I mean, the economy is getting better, autos are better, housing is better -- they can't find enough people to work in housing, that's the only thing holding it back right now.
The Fed ... we actually looked at how the numbers run. The numbers are quite amazing -- just truly amazing. The Fed, as you know, is going to purchase $85 billion of Treasuries and mortgages per month ... so over $500 billion in six months.
But what's happened, and what's really amazing, is that over the next six months, because of tax increases, because of budget cuts, because of growth in the economy, and also because of Fannie Mae and Freddie Mac paying back money to the government, the deficit over the next six months is shrinking massively. ... It looks like the next six month's deficit is going to be well under $100 [billion], probably closer to $85 [billion].
Which means -- and this is an important thing -- ... we have over $500 billion we're going to buy over the next six months, and now we only have a deficit that's less than $100 billion over the next six months. ... That means we've got $400 billion -- $400 billion -- that has to be made up.
A lot of that $400 billion will make its way into stocks, Tepper concludes.
Easy enough.
I'm not a fan of short-term trading strategies and predictions, but a few things stick out here. One is that Tepper has probably been more right than any other economist or investor when it comes to how stimulus policies would affect the market over the last five years. He is worth listening to.
And, importantly, I think Tepper has been right about the recovery because he thinks about markets in simple, rational ways. I'm sure the way he invests in his hedge fund is more complicated than how he describes it on CNBC, but you can tell Tepper has a more simplistic viewpoint than most of his peers, who overthink and try to reinvent the wheel -- almost always at the expense of returns. Other investors appear on CNBC and talk about beta and alpha and 200-day moving averages. Tepper basically says, "The Fed prints, buy stocks." And he whips the pants off most of them.
Investor Marty Whitman once said: "Rarely do more than three or four variables really count. Everything else is noise." Tepper seems to have that frame of mind down pat. We can all learn from it.
But I also wonder whether the declining supply of new Treasuries will force the Fed to cut back or alter its QE policies before it wants to. The Fed has vowed to keep easing until the employment market makes significant improvement. But the deficit is now falling much faster than unemployment. If we continue on a path where the Fed is buying multiple times more Treasuries than the Treasury is issuing, something will have to give. Maybe when it does, Tepper will come back on CNBC to make sense of it all.
