Stock Market Crash 2015: Under the Shadow of Black Swans
Because the stock market hangs tensely in the balance, a single event — called a black swan — could trigger “Stock Market Crash 2015,” and several black swans are flying overhead, looking like they want to land. That does not stop the rosy-eyed optimism of some of the permabulls, who have returned to saying that the worst is behind us. After a brief end-of-summer plunge, the stock market has experienced a good rebound — the longest day-to-day rise the US stock market has seen in months.
Predictably, some of the big, talking heads have grabbed on to that rise to say we’ve weathered the decimation of the Chinese stock market and, so, we can move forward again. On the other hand, the easy unanimity in their ranks that once was … is no more. No longer do the bulls beller with a single voice. So, be wary, if you’re tempted to follow their advice and “buy the dip.” Remember that I warned of this illusion when the market first started its rapid fall. I said it would bounce and it would bounce high because that’s how bear markets roll … then they plunge into the deep beyond.
Just because the bear bounces, that doesn’t mean he’s dead. So, before you buy the rally, consider the following major warning signs and potential black-swan events.
How the rally, itself, is a sign of Stock Market Crash 2015
The first major warning that this rally is a further sign of a stock market crash in 2015 can be seen by dissecting the rally. When a rebound is narrow in terms of the number of stocks that are driving it or when the rebound is led by the same stocks that led the drop, then it is weak and usually gives way. This rebound is both. That’s why Doug Kass, the president of Seabreeze Partners Management, said in a recent tweet that the rally is a warning sign.
Energy and commodity-based companies led the market down; those same industries are leading the charge back up because the price of oil is rising. Goldman Sachs says the rebound in oil prices won’t hold. China’s slow-down is far from over. Nearly all of its industries face weak internal demand and even weaker external demand. So, the components of the rally look like pieces that will readily fall back apart. That, in turn, creates more fear (or realization?) that the market is not stable, so another drop ensues.
Meanwhile stock-market bubbles are starting to burst in other areas like biotech and dot-coms where companies like Twitter are doing significant lay-offs. So, other areas of the market may start to slide at the same time that oil prices go back down and the rally ebbs.
What is the risk of further deflation in commodity prices?
The following article notes that commodity prices may have some major hidden troubles yet to be revealed.
The lucrative practice of using commodities as collateral to make money from interest-rate differentials inside and outside of China, a practice known as the carry trade, could cause significant pressure on commodity markets, were the trade to unravel. The Bank for International Settlements says this trade exceeds $1.2 trillion worth of commodities and could reach $2 trillion. (“Unwinding of carry trade may unmask China’s true metal demand“)
What this means is that commodities have been used in huge quantities as collateral. Once they are collateralized, they cannot be sold for production. Those materials, already produced, are removed from inventories that are for sale because you cannot sell the bank’s inventory. The news has been full of stories about inventories being very high right now due to lack of demand.
So, the question is how much higher would those inventories be if those resources that have already been mined, pumped, grown, whatever, suddenly come back into the market; and how likely is that to happen?
There is also a knock-on effect to consider. When loans that were collateralized with these resources fail and the collateral suddenly gets auctioned on the market, that down the value of that resource market wide if there is a lot of the resource going on auction. That means the value of everyone else’s collateral drops, meaning the value of collateral becomes insufficient to cover the loans. In other words, everything starts to unwind.
So, 1) How big is the problem? The Bank of International Settlements estimates about $1.2 TRILLION worth of resources are sitting on the shelf as collateral in China. To give you an example of the size of this potential unwind, it is estimated that about 70% of the finished copper that China imports may be tied up as collateral. If that started shifting rapidly into production inventories, it could shut out all copper sales to China (or actually just compete against all copper sales, driving the price way down as both the supply from collateral and the supply from importing compete for the same sales.
2) How likely is that to happen? Well, let’s look at steel as just one area where a black-swan event is hovering. Investors wonder if a potential bond default by Sinosteel Co. is an omen of things to come amid slowing demand for the metal used in everything from cars to construction. The Chinese state-owned steel trader, whose parent warned of financial stress last year, may have to honor 2 billion yuan ($315 million) of principal next Tuesday…. China Merchants Securities Co. thinks the firm will struggle to repay…. Steel issuers’ revenue fell about 20 percent in the first half from a year earlier and over half of the firms suffered losses. (“Damping The Blast Furnaces — China’s Steel Industry Next In Line For Defaults“)
You can see from that snapshot of one major company and the condition of the Chinese steel industry that, if there are any steel companies that have collateralized some of their unsold product, a lot of steel could go on the market at fire-sale prices if those loans start to default.
Let me create a picture: Let’s say a company called Massive Steel, Inc. produced 100,000 tons of steel that are in its available inventory. It’s inventory has backed up to that amount, which is more than twice what it usually keep on hand to sell. Thus, it easily sees that the market has deteriorated to where it will be lucky to sell 50,000 tons. For the very reason that its inventory is backed up, its revenue is proportionately down. It’s having a hard time covering fixed costs, so it takes the extra 50,ooo tons off the market and puts it up as collateral for a loan to get itself through the tough times. In this scenario the loan seems unrisky on the surface because it is fully collateralized, but it is being made precisely because the company is in a high-risk situation. If things get worse and the company defaults on the loan, that 50,000 tons goes back on the market in an auction, putting a huge squeeze on all the other steel manufacturers, causing the value of their inventories to drop. So, while the first bank found its loan completely covered. All banks down the line find insufficient value in their collateral to cover similar loans, and the likelihood of those similar loans to go into default goes up due to falling steel prices creating a tighter pinch.
Will there be a big unwind in that kind of situation? Who knows? But the possibility is large. Thus, the oversupply situation in Chinese steel and other resources has a lot of potential to get worse because many companies producing or using commodities are already in trouble. The huge collateral of the first to fall could dump a lot into the existing oversupply on the market. That cascades into problems for marginal competitors, putting them in default, and a cascade develops that could be the grand flush.
Or it may not. It’s circling black swan. It may never land.
A little-known sign of stock market crashes reached its highest peak ever in October 2015.
Here’s an anomaly most people have never heard of. ZeroHedge reports that one metric of the stock market that goes up when the market is about to crash has risen to its all-time zenith. Check out their “Crash Risk” graph at (“The SKEW——-Expectations Of A Stock Crash Have Never Been Higher“.
I won’t pretend to know how predictive skew is, as its the first time I’ve seen a skew graph; but if ZeroHedge considers it a bad sign, I think it is worth, at least, noting that it has reached its all-time high. ZeroHedge says this is particularly critical right now because it happens at the same time that volatility in the market has dropped back down. They perceive that coincidence as a sharp rise in risk (skew) accompanied by complacency over risk (VIX). That’s like feeling comfortable while your driving because your not paying attention to the road ahead and didn’t see the “bridge out” sign. The risk of disaster is made greater by your lack of attention. Moreover, complacency in the face of sharply rising risk is exactly the perfect set-up I described last week for panic in the stock market in 2015. That feeling of settling down to relax, just as the stock market drops again, increases the shock value of the fall. The moment people thought things were settling down, WHOOSH!
Debt ceiling anxiety could be the black swan for the US stock market before November 3, 2015
In the summer of 2011, Republicans played a game of brinksmanship with the United States sterling reputation of being the world’s best credit risk by threatening the possibility of not raising congress’s self-imposed debt ceiling. That would force a default on the debt and damage the United State’s credit rating.
I argued that they would never actually vote not to raise the ceiling and, therefore, to default on the debt. Thus, I said, they were not afraid because THEY knew they would vote to raise the limit at the last minute, once they had gotten all they could in negotiation. So, they weren’t worried about the credit rating. What they were completely blind to, I said, was that they didn’t need to default in order to damage the US credit rating. All they needed to do was cause everyone watching to believe they might not vote to raise the ceiling before midnight hit. That would create a perception of risk and dent the US credit rating before default ever happened. It is the job of rating agencies to set credit risks that predict such things before they happen, not after. On that basis, I predicted that a stock-market panic would ensue in August. And that is exactly what happened.
Now we face the same scenario, only it’s worse because the Republican leader, John Boehner, who was carrying out the tough negotiations back in 2011 was also a person who was keeping the most extreme element of his party under control. That element would not have voted to raise the debt ceiling without Boehner’s pressure. Today’s game of brinksmanship happens as Boehner is stepping out, and the Tea Party Republicans are jostling to get a leader who will specifically agree to be a hardliner on this issue.
The clock has three more weeks before the US defaults on its debt, but I doubt Republican have learned anything from last time. They are likely as unaware as they were then that they don’t really have that much time — that credit agencies will, again, lower the US credit rating before that date if they play brinksmanship too close to the edge. That is a black-swan event that would very likely cause the stock market to crash, just as it caused the market to drop off a small cliff in August, 2011. Here’s the clincher: no one knows how close Republicans can dance to the edge before a credit agency acts or public fear becomes panic.
Only this time, Republicans have more seats in the House, and Republicans control both chambers of congress, and there is an unpredictable and angry void in Republican leadership, and the stock market has already recently fallen off a small cliff, and the stock market is a lot more overvalued than it was in 2011, and the entire world is in trembling economic condition with many nations already back in recession. Therefore, this black-swan event is more likely than in 2011 when it did happen, and the damage is likely to be a lot rougher.
The question is will Republicans miss there guess on how far they can push this and how much damage their brinksmanship will cause? They certainly did last time, and I think they can be counted on to do so this time even more spectacularly. Time will tell … but not much time. Might be a lot of telling, though. The actual tipping point will most likely be at an unknowable date somewhat shy of November 3rd. All is dark as to where the brink of this cliff really is, except that it certainly happens by November 3rd.
For further predictions of stock market crash 2015: