A Falling Market Cannot be Allowed - at any cost!
The Central Bankers have clearly painted themselves into a corner as
a result of their self-inflicted, extended period of "cheap money".
Their policies have fostered mal-investment, excessive leverage and a
speculative casino approach to investments. Investors forced to take on
excess risk for yield and scalp speculative investment returns, must
operate in an unstable financial environment ripe for a major
correction. A correction because of the high degree of
market correlation that likely would be instantaneously contagious
across all global financial markets.
Any correction more than 10% must be stopped. As a result of the
level of instability, even a 10% corrective consolidation could get
quickly out of control, so any correction becomes a major risk. What the
central bankers are acutely aware of is:
·
If Collateral Values were to fall with the excess financial
leverage currently in place, it would create a domino effect of margin calls,
counter-party risk and immediate withdrawals and flight to areas of perceived
safety.
·
The already massively underfunded pension sector (which is now
beginning to experience the onslaught of baby boomers retiring) would
see their remaining assets impaired. This could lead to social and political
pressures that would be simply unmanageable for our policy leaders.
·
A falling stock market is the surest way of alarming consumers
and signalling that things are not as "OK" as the media
mantra has continuously brain washed them into believing. In a 70%
consumption economy, a worried consumer almost guarantees a further
economic slowdown and a potential recession.
As our western society continues to consume more than it consumes,
productivity is not increasing at the rate that justifies the developed
nations standard of living as well as the current levels of
equity markets. A possible corrective draw-down to the degree shown in
this chart is simply "out of the question"! The central bankers
acutely aware of this.
Markets Temporarily Held Up
The markets are presently, temporarily held up due primarily to three
factors:
·
Historic levels of Corporate Stock Buybacks,
·
The chasing of dividend paying stocks for investment yield
in a NIRP environment,
·
Unusual Foreign Central Bank buying (example: SNB)
Professionals, institutions, hedge funds etc have been steadily lightening
up on equity markets (or simply leaving completely) leaving the public
holding the back.
It is estimated that the $325B that will leave the US equity markets in
2017 will be replaced by an artificial $450B of corporations
buying their stocks. With corporate cash flows now falling and debt
burdens triggering potential credit rating downgrades, this game is
quickly slowing. The central bankers are aware of this.
Technicals Indicating an End to The Debt Super Cycle
The Market Technicians of all persuasions are almost unanimously calling
for a major correction. What is most troubling here is that their indicators
are not just short and intermediate term measures but critical long term
indicators.
·
Kondratieff Cycle: The 55 Year generational
Kondratieff Cycle shows an overdue major downturn with a cleansing of debt as
part of the end to what has been termed the "Debt Supper
Cycle",
·
Demographic Cycles: Harry Dent has done some
major work on Demographic Cycles and cycles overall. I interviewed him
for the Financial Repression Authority where you can find the video and he
lays out the seriousness of the shifting demographics and how it overlays of
many different types of cycles he has studied.
The technicians who study Elliott Wave see clear evidence that we are now
completing a multi-decade topping pattern in the form of a classic megaphone
top.
The central bankers are aware of this.
I could keep on illustrating the types of warnings we are seeing, but
let me share what the central bankers likely most concerned
about regarding Correlation, Liquidity and Volatility ETPs.
The markets have become so correlated (think of this as everyone on the
same side of the boat) with asset correlations not only being higher, but the
correlations themselves are becoming more correlated. While traditionally
rising cross-asset volatility has resulted in volatility spikes, that
is no longer the case due to outright vol suppression by central banks.
While central banks may have given the superficial impression of stability by
pressuring volatility, they have also collapsed liquidity in the process,
leading to less liquid markets, a surge in "gaps", and "jerky
moves" that are typical of penny stocks.
The greater the cross asset correlation, the lower the vol, the greater
the repression, the more trading illiquidity and wider bid ask-spreads, and
ultimately increased "gap risk", which becomes a feedback loop of
its own. Global central banks are now injecting a record $2.5 trillion in
fungible liquidity every year - in the process further fragmenting and
fracturing an illiquid market which is only fit for notoriously
dangerous "penny stocks."
"More than $50 billion has poured into low-volatility indexed
exchange-traded funds over the past five years or so, in the wake of the
2008-09 market meltdown. There are now 14 "lo-vol" ETFs with assets
exceeding $100 million each, and many more with less. Whenever the market
hits a pothole, these ETFs enjoy a bump-up in assets."
Even more concerning are Volatility ETPs (Exchange Traded
Products) which are derivative of some underlying
asset. Volatility ETFs are particularly strange animals since
you're buying a derivative (ETF) on a derivative (the futures contract) which
itself is based on a derivative (the implied volatility of options) and those
options themselves of course are derivatives which themselves are based on
the S&P 500. Getting the picture? The folks at Capital Exploits warn:
....everyone is on the low volatility side of the boat, because the
central banks have managed to create a sense of calm in the markets exhibited
by record lows in volatility and investor have used linear thinking
extrapolated well into the future assuming ever greater risk ignoring market
cycles and extremes at their peril.
Every time you sell volatility you get paid by the counter-party
who is typically hedging the volatility (going long) of a particular position
and paying you for the privilege. This is not unlike paying a home insurance
premium where the insurer takes the ultimate risk of your house burning down
and you pay them for the privilege. The difference however between
selling volatility in order to protect against an underlying position and
selling volatility in order to receive the yield created is enormous. And
yet this is the game being played.
The central banks have managed to create a sense of calm in the markets
exhibited by record lows in volatility and for their part Joe Sixpack
investor has used linear thinking extrapolated well into the future assuming
ever greater risk ignoring market cycles and extremes at their peril.
Again, none of this is going unnoticed by t increasingly worried
central bankers.
The Next Fed Policy Shift
So what can the central bankers be expected to do? We laid out this
road-map at the Financial Repression Authority well over a year ago. We
anticipated in our macro-prudential research much of what has now become
mainstream discussion:
- Helicopter Money (now openly discussed)
- Fiscal Infrastructure Stimulus (has become part of
all candidates election platforms)
- Collateral Guarantees
- Buying Corporate Bonds - DONE (ECB, BOE)
- PLUS more on Collateral Guarantees
We now believe the Central Bankers and Federal Reserve specifically is
preparing for more in the way of Collateral Guarantees.
We believe it will actually take the form of direct buying the US
stock market similar to what the Bank of Japan is already doing
with ETFs.
The "Minsky Melt-Up"
My long time Macro Analytics Co-Host, John Rubino concludes in his most
recent writing "Flood
Gates Begin to Open":
Individual countries have in the past tried "temporarily higher rates
of inflation," and the result has always and everywhere been a kind of
runaway train that either jumps the tracks or slams into some stationary
object with ugly results. In other words, the higher consumption and
investment that might initially be generated by rising inflation are more
than offset by the greater instability that such a policy guarantees.
But never before has the whole world entered monetary panic mode at the
same time, which implies that little about what's coming can be said with
certainty. It's at least probable that a combination of massive
deficit spending and effectively unlimited money creation will indeed
generate "growth" of some kind. But it's also probable that once
started this process will spin quickly out of control, as everyone realizes
that in a world where governments are actively generating inflation (that is,
actively devaluing their currencies) it makes sense to borrow as much as
possible and spend the proceeds on whatever real things are available, at
whatever price. Whether the result is called a crack-up boom or
runaway demand-pull inflation or some new term economists coin to shift the
blame, it will be an epic mess.
And apparently it's coming soon.
It is our considered opinion that the monetary policy
setters are presently even more worried about the current global
economic situation than we are - if that is possible?
This is evident because over the last 14 days Fed
Chair Janet Yellen, former Treasury
Secretary Lawrence Summers and JP Morgan have
all been out talking openly and publicly about the possible
consideration of policy changes that would allow the Federal Reserve
to buy US equities. These releases must
be seen as trial balloons to condition expectations.
Japan and Switzerland amongst others are already doing it (as we
previously reported), while the ECB is
also floating its own trial balloon on the same subject.
If you want to know what could create a Minsky Melt-up, this is it!
Here is our latest Financial Repression Authority Macro Map
illustrating what we see unfolding. We believe the dye has
been cast!
The US Federal Reserve can soon be expected to get
congressional approval for equity purchases.
Of course this will take a post election scare and a new congress to
receive.
