With the recent plunge in the S&P 500 of over 5%, has the
long-anticipated (and long-overdue) market correction finally begun?
It’s hard to say for certain. But the systemic cracks we've been closely
monitoring definitely got an awful lot wider this week.
After nearly a decade of endless market boosting, manipulation and
regulatory neglect, all of the trading professionals I personally know are
watching with held breath at this stage. The central banks have distorted the
processes of price discovery and market structure for so many years now, that
it’s difficult to know yet whether their grip on the markets has indeed
failed.
But what we know for certain is that bubbles always burst. Inevitably.
Each is built upon a fallacy; and when that finally becomes apparent to
enough people, the mania ends.
And today, there are currently massive bubbles in stocks, bonds and real
estate. Every one courtesy of the central banks (as we have written about in
great detail here at PeakProsperity.com over the years).
And with no Plan B in place to gracefully exit the corner they have
painted themselves -- and thereby the global economy -- into, the only option
available to them is to double-down on the pretense that we'd all be screwed
without their stewardship. They have to do this I suppose. To admit the truth
would throw the world into panic and themselves out of a job.
Who knows what they think privately? But in public, they give us real gems
like these:
Williams Says Fed Rate Hikes Helping Curb Financial Risk-Taking
U.S. interest-rate increases will help reduce risk-taking in
financial markets, Federal Reserve Bank of New York President John
Williams said.
"The primary driver of us raising interest rates is just the fact
that the U.S. economy is doing so well in terms of our goals,” Williams said
Wednesday in a reply to questions after a speech in Bali, where the annual
meetings of the International Monetary Fund and World Bank are taking place. “But
I would also add that the normalization of monetary policy in terms of
interest rates does have an added benefit in terms of financial risks.”
"A very-low interest-rate environment for a long time does,
at least in some dimension, probably add to financial risks, or risk-taking,
reach for yield, things like that," he said.
"Normalization of the monetary policy, I think, has the added
benefit of reducing somewhat, on the margin, some of the risk of imbalances
in financial markets."
(Source)
And with that, our award for “Finally closing the barn door after the
horse left 8 years ago,” goes to John Williams of the US Federal
Reserve.
Come on, Mr. Williams. Your historic 'very-low interest-rate environment'
didn't merely lead to a slight degree of higher risk at the margins here.
Instead, it has lead to an explosion of excessive risk everywhere
today, including:
- Junk bonds trading near their most expensive prices ever
- Covenant lite loans out the wazoo
- The highest levels of corporate debt ever
- The most expensive stock markets ever, by several
measures
- The highest margin debt on record
- Real estate bubbles across the globe
- Pensions highly exposed to the stock market
And the central banks' policy over the past decade hasn't merely been to
create a “very low interest rate environment”. It has been nine long
years of intense and deliberate financial repression.
The resultant risk-taking didn’t happen “in some dimension”. It
happened right here on Planet Earth, in real time, and in public and private
portfolios alike, across the globe.
Pensions have been monkey-hammered by this policy, forced to throw away
100 years of accumulated investment wisdom and flip from traditional
allocations of 60/40 bonds-to-stocks to the opposite in a desperate chase for
yield.
The mathematically-certain insolvency of much of the pension system lies
on your shoulders Mr. Williams. And those of your other Fed colleagues.
Moreover, the other malignant market responses to the Fed’s distorting
policies didn’t “probably add to financial risks”. It
absolutely guaranteed a future crisis -- one that will dwarf any prior.
In my assessment, the biggest crime of the Fed was the decision under
Greenspan to try to eliminate the business cycle by replacing it with a
credit cycle. Here’s what that looks like in chart form:
If you can't clearly spot the absurd Fed-blown asset bubbles in the above
chart, you may as well stop reading here. With that kind of blindness,
nothing can help you plan for what's coming next.
Now, why would central banks prefer credit cycles? Easy! They're a lot
more fun. When they're expanding, everybody loves you. You get invited to
Davos and people love celebrating you at parties.
Just as good, when the bubbles burst, as they always must, you get to ride
to the rescue and play the role of savoir. And when the dust settles, you get
feted as a “hero” by the mainstream media (even though you were no better
than an arsonist putting out his own fire).
Case in point:
Yes, I blame the central banks for the breakdown about to come. They are
the villain to blame for their horse-whipping of stocks, bonds and real
estate into dangerously over-valued asset price bubbles. Nobody else.
Former Fed chairs Greenspan, Yellen and Bernanke have to shoulder nearly
all of the culpability. It remains to be seen what Powell does, but so far he
seems less interested in bailing out stock market declines than his
predecessors. If indeed so, he’s an enormous improvement.
Already, under Powell, for the first time in a decade, we are emerging out
from underneath the miserable thumb of financial repression, the key
cornerstone of which is having to accept negative real yields on saved
money. Today the rate of interest on a 3-Mo T-bill is higher than the
(stated) rate of inflation. It’s also higher than the dividend yield on US
equities. So savers finally have an option that doesn't unjustly punish them.
If we can thank Powell for that, then he’s already done more good than all
three of his predecessors combined. And if he allows this last ill-conceived
credit cycle to finally die of its own accord, he'll actually deserve that
"hero" accolade. Especially because doing so will not only be the
right thing to do, it will be deeply unpopular with the Powers That Be, and
require an inordinate amount of courage to effect.
Heck, Trump was already gunning for Powell on Wednesday after just the
first -3% decline:
“The Fed is making a mistake, they’re so tight. I think the Fed has
gone crazy.”
~ Donald Trump, 10/10/18
But if Trump was concerend on Wednesday, he must have been spitting nails
on Thursday as the market carnage continued:
Is this really it?
Has the worm really turned? Is it not possible that the authorities
will once again rescue these “markets” driving them ever higher in their
quest for printed-up prosperity?
Again, anything is possible, but our view is that until and unless the
central banks decide to reverse their QE wind-down operations the faux gains
that resulted from the money flood will evaporate as well.
Our view is that things progress from “the outside in” reflecting the fact
that it is always the cash strapped zombie company that fails before the AAA
rated company, and it is the weaker emerging market economy that suffers
before the core OECD economy.
This table of various year to date stock market returns perfectly
illustrates that the “outside in” dynamic has been in place for a while.
It’s not a perfect detection mechanism certainly (Germany is down 4x more
than Portugal?) but the pattern is more than directionally adequate.
The money flood has reversed and we’re seeing that in the losses that have
been mainly concentrated at the periphery -- but are fast rippling into
the strongest "core" markets
Time For Safety
Admittedly, we’ve been mostly out of the markets for a long while,
preferring cash, gold, some core real estate holdings; while slowly building
a small short position.
Our main strategy for surviving bubbles is to not get caught up in them in
the first place. We've long advocated the wisdom of amassing cash, to have
'dry powder' capital to deploy at much better valuations after the bubble's
bursting. In our opinion, everyone should be working on ‘buy list’ for that
day.
Sadly, the expansion of the Everything Bubble has gone on for far too long
as the central banks have all but destroyed true price discovery and
well-informed capital allocation. Heck, most Millenial adults weren't old
enough to experience the 2000 and 2008 episodes -- to them, today's
Frankenmarkets are 'normal'. Most seem to have exactly zero clue of the
role of the central banks have played in fostering the lion’s share of the
stock and bond market gains that have occurred during their short adult
lives.
The investment chat sites I lurk through to gauge the mood are awash with
folks telling each other to “buy the dip” and “stand firm.” Many are
parroting the Wall Street/CNBC mantra that "This time is different!",
so it’s best to just keep putting money in, staying long and fully invested.
We disagree. And we think those blindly marching to Wall Street's tune
will be the first and worst victims when the next major correction hits.
Which is why we encourage everyone reading this to crash-test their
portfolio with their professional financial advisor. If indeed we're entering
another 2008-style correction, how will your current holdings fare? How
risk-managed are your positions? Are your potential losses hedged to the
downside? And once the dust settles, what's your plan for re-entering the
market?
These are critical questions to be asking right now. And the time to
address them may indeed be very scarce (the Dow has dropped another 100
points as I've been writing this).
If you don't have a financial advisor, or are having difficulty finding
one willing to address the risks discussed here, consider scheduling a portfolio
crash-test consultation (it's completely free) with the advisor Peak
Prosperity endorses.
Just please, whatever you do, make sure you've taken prudent steps to
prepare for a major market downturn. Don't leave your hard-earned wealth
exposed, unless that's an intentional decision on your part.
Conclusion
The recent market sell-off was not at all unexpected by us. We began
observing the first tremors at the periphery many weeks ago.
Last week, on October 5th, we sent out a market warning to our
premium subscribers under the banner The Markets Are Suddenly Looking Very Sick.
Whether the central banks blink here and ride to the rescue is the big
question.
While we'll have to wait and see to learn the answer, in all of our
interviews with experts (e.g. Axel Merk) who know the Fed and its
staffers personally, the consensus is that Powell is a different animal from
his predecessors. He'll tolerate quite a lot of stock weakness before he's
moved to act. Is his line in the sand -20%? -30%?
Whatever it is, it’s likely a lot more than the -6% we’ve seen so far.
Further, the ECB is in a bind because it, too, are publicly committed to
tapering its balance sheet expansions to zero by the end of 2018. And as the
EU is also locked in a budget battle with Italy, and it would be very
politically difficult for the ECB to both play dove and hawk at the same time
by bailing out the markets with more QE while also not buying any more
Italian government debt or helping Italian banks.
The Bank of Japan is pretty much done, too. It has recently even (gasp!)
shrunk its balance sheet a few times in recent months.
China is busy fighting its own battles with slowing growth and history's
largest ever-real estate bubble. It's also in very delicate trade
negotiations with the US, complicated enormously recently with the revelation
that the Chinese PLA had a role in inserting hardware hacks (chips) onto high
tech products supplied to the US. So the PBoC is probably not going to
be in the business of doing anything dramatic in terms of balance sheet
expansion right now.
Add it all up, and the “outside in” contagion we’ve been observing over
the past few months seems to have finally reached the core.
In Part 2: Preparing For The 'Big One' we examine what a
true market "crash" would look like. We’ll be looking at
bonds, stocks, gold, the gold miners, currencies as well as discussing
potential candidates to consider for your post-crash 'buy list'.
Ready or not, developments are escalating. Be as ready as you can for
what's coming.
Click here to read Part 2 of this report (free
executive summary, enrollment required for full access
