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Not even close to transitory. After giving its turkey advice for Thanksgiving, the Federal Reserve finally gave up completely on the “Inflation is transitory” chorus it has been singing all year. Chairman Powell of the People’s Bank of Amerika stated outright today that inflation is not transitory after all, confirming what I have been preaching all year, and he stated that inflation may likely force the Fed onto an even faster tapering path than the it already laid out, confirming the second part of what I have said all year:
Wall Street’s main indexes closed lower on Tuesday after Federal Reserve Chair Jerome Powell signaled that the U.S. central bank would consider speeding up its withdrawal of bond purchases as inflation risks increase, piling pressure onto a market already nervous about the latest COVID-19 variant. In a testimony before the Senate Banking Committee, Powell indicated that he no longer considers high inflation as “transitory” and that the Fed would revisit the timeline for scaling back its bond buying program at its next meeting in two weeksReuters
And, so, with that the stock market also responded in the manner I have said it will when the Fed actually starts tapering and speeds up its tapering because inflation grows to be so searingly hot the Fed cannot avoid speeding up its tapering of QE. Just talk that the Fed will be thinking about picking up the pace at its next meeting, sent the Dow down more than 600 points today, after having plunged more than 800 on what I’ll call Dark Friday. While the market recovered a mere third of its losses on Monday, it lost more than double what it recovered today, putting it already halfway into a correction (down 10% from a previous high).
“Powell’s comments threw a monkey in the wrench in market thinking in terms of potential taper timing. You’re seeing as a result of that, risk-off across the board,” said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles…. Whether … more headline risk or reality risk … it’s having a significant impact on oil, and everything that’s tied to economic growth.
“The principal contributor to the decline in stock prices today is the Powell commentary, regarding the upcoming Fed meeting, about accelerating the tapering of their bond buying program, which obviously leads to the prospect that rate hikes come sooner next year,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia. “That somewhat hawkish shift in tone caught the market flatfooted,” Luschini said.
It wouldn’t have if the market listened to me, but for some reason some people — a great many in fact — found this readily predictable news entirely surprising. So, some of the market’s denial broke today. Whether that is a significant break that sets in the market’s demise that I have been predicting inflation will cause or just another shiver, remains to be seen. Denial dies hard, but it was a pretty deep shiver:
The declines were broad-based, with all the 11 major S&P sectors down…. “The market is clearly in some treacherous waters right now. You’ve had two significant pullbacks out of the last three trading days. This is certainly shaking some of the complacent longs in the market,” said Wedbush’s James.
Powell explained in his warning,
I think you what you’ve seen, is you’ve seen our policy adapt and you’ll see it continue to adapt to we will use our tools to make sure that higher inflation does not become entrenched.Fox
Yes, they will because, as I’ve recently started claiming, inflation has reached the point where it is now burning up the Fed’s backside, leaving the Fed no room to retreat on the tapering if things go bad and pressing it to even pick up the pace, in spite of the fact that it risks all the more that things do go bad.
“The reality is hotter inflation coupled with a strong economic backdrop could end the Fed’s bond buying program as early as the first quarter of next year,” says Charlie Ripley, senior investment strategist for Allianz Investment Management. “Ultimately, the transitory view on inflation has officially come to an end as Powell’s comments reinforced the notion that elevated prices are likely to persist well into next year. With potential changes in policy on the horizon, market participants should expect additional market volatility in this uncharted territory.”Kiplinger
Well, it’s not exactly uncharted because I’ve been charting this path and saying what the turning points would be (the causes to look for) for more than a year. But, I guess it is uncharted if you don’t read here … or do, but don’t believe me. So, let me tell you for clarification how that chart goes from here:
The Fed will pick up the pace of its tightening. The market will strongly revolt, and the Fed, badly as it wants to slow tapering down to save the market will have its back up to the wall, making that very difficult if not impossible to do because the price tag of that choice is even hotter inflation for longer, forcing much more intense tightening further down the path.
The Fed’s last experience with inflation of this kind when it let inflation run this far out of control back in the seventies was painful for the entire nation for a few years. I can guarantee you the Fed well remembers the incident. Most of them were around back then, so muscle memory will make it hard for them to do their usual reflexive withdrawal of tightening when the market revolts.
Thus, the waters ahead are more treacherous even than the articles above indicate. What they respresent is more like the best-case scenario if all goes well. In this fearful new Covid-plagued world, does that seem likely to you? It does not to me.
We have just entered those days of heady inflation that I have said will kill the stock market and bond funds. There is a tipping point at which inflation and the interest changes that respond to inflation matter, but it has never been a clearly defined point.Read the remainder of this entry »
In an effort to prove the Fed’s tapering won’t matter, I recently saw one stock advisor claim that, when the Fed tapered its QE from late 2015 into 2016, “the stock market rallied 60% in an almost straight line higher.”
Wow! Let’s take a look at that! Here is what the stock market actually did from the last of half of 2015 through the first half 2016:
Apparently, any misrepresentation of history will do in order to try to maintain a long-lost argument. When the Fed tapered its stimulus, the bull was lying on the ground, panting and dripping with blood like it had faced a great Spanish matador. A look at the facts above will show you that from the latter half of 2015 through the middle of 2016, the market went absolutely nowhere! In fact, it went nowhere throughout the Fed’s full tapering period (assets and ZIRP stimulus) with a great deal of lunging and stumbling just to get to nowhere.
I presented only the part of that “tapering” period shown in the graph above because I wanted to focus the graph specifically on the false claim made above. A broader view would show that in late October of 2016, you could have bought in at the same price you sold out for at the start of 2015.
Only the Trump Rally brought life back into the wasting bull. When Trump got elected in early November, 2016, everything changed because of his promised massive corporate tax cuts that would put enough cash back on the corporate board-room tables to offset all of the Fed’s tapering. (But this time Biden is promising to take most of that bottom-line cash back off the table at the same time the Fed tapers! Not a good combo for the market.)
It’s a shame when narratives that are proffered to support positions that have been wrongly argued have no basis in truth to the point of even trying to rewrite obvious historic facts.
Now, maybe you are generously thinking, “Perhaps it was much better for the roaring NASDAQ.”
It was much worse! The NASDAQ crashed almost 20% from its last high. In fact, it came within a hair of being an official bear market, and it didn’t recover from its deepest low for more than half a year (when the promise of the Trump Tax Cuts changed the calculus for the anticipatory stock market.)
This is an example of how writers who don’t care about full truth can cherry-pick one little part out of a period to say the market did fantastic during the Fed’s tapering. Clearly, there are some steep slopes of short duration during the period the writer defined where the market did rise a lot. However, when you see those rises in context, you can immediately tell the market was merely rising out of an equally large hole it had just plunged into, and it didn’t even make it all the way out! In fact, it rose from one crash only to plunge back to a deeper level and then partially recover to a lower high from which it continued downward. In fact, the market was a train wreck for the entire QE/ZIRP wind-down period, and the worst of that period happened in late 2015 and then again in early 2016!
At no point, however, did any of the major indices show a rise — even during those short recoveries from bearlike plunges — that came anywhere near 60% or a straight line! (More like a 20% rise, but only to fall again.) So, the writer above went far from just playing loose with the truth, and that was tapering (of asset purchases in 2014 and ZIRP at the end of 2015), not tightening.
The entire period (red arc) after the fed finished tapering its asset purchases through its move out of zero-interest-rate policy, looks like this:
That is what HISTORY says you can expect from Fed tapering — a train wreck! But, today, the Fed is talking about speeding up tightening, too, with interest hikes to immediately follow the tapering. (They’ll never get that far, of course, but the Fed will wreck a lot of damage trying.) During actual tightening in 2018 the market did much worse, even with the help of those tax cuts because the tax cuts could not overcome the new downdraft from the Fed to such a point that Trump kept harping at the Fed to stop tightening. This is what history says you can expect from actual tightening:
Not a pretty year. From the time the Fed doubled down on its initial slow tightening rate near the end of January, 2018, to the the end of that year, the market experienced nothing but peril to end the year well below both its January high and its 2018 start.
Those who want to maintain their denial about where Fed actions will take us might try to counter these historic patterns by pulling out the tired mantra “but this time is different.” To which I will respond, “Yes it most certainly is! This time is FAR more fragile and far more likely to face great disruption due to the severe global disruptions I laid out in my last two articles that are already happening (“Shortages and Inflation Are Ripping the World’s Face Off” and “Stocks and Bonds Starting to Tussle“).
In my next article, I will be laying out greater dangers that are developing just as the Fed plans to start to taper. In essence, the last time the Fed was tapering it was because it appeared its Great Recovery had been a success. This time the Fed is advancing its tapering timeline because it is being forced by soaring inflation, not because recovery is complete. That means the Fed will start to taper during a time when an incomplete recovery has left us with high unemployment and as the recovery is already rapidly falling apart under the ravages of inflation and shortages and a continuing pandemic, and when economic damage from the COVIDcrisis remains splattered like blood all over the globe during the onset of a global energy crisis at a time when other central banked are also starting to taper or tighten! And then there are those added pressures governments are putting in place, which I’ll be covering.
And some people think that’s going to go better??? It looks more like planned destruction to me. In fact, I now think the most recent actions and plans of governments and of central banks in the present environment are leading us into global economic collapse.
See you on that in my next article.
As I’ve written about extensively, we know the Federal Reserve has painted itself into a corner where it is now pressured to start tapering its quantitative easing earlier than it had been indicating. Now we are seeing signs that the bond market isn’t liking the news out of the last FOMC meeting, which hinted strongly that the Fed will start to taper its massive purchases of US treasuries this year.
US bonds soon to be released from Fed bondage
US treasury auctions roiled with signs of trouble today. The 30YR UST spiked above 2%, it’s highest yield since mid-summer; but, more importantly, the 10YR did a similar move, rising to its mid-summer high above 1.50%, while the 2YR hit its highest level since March of 2020 when the COVIDcrash began.
At 1.5%, you can see (in the top graph below from three days) that 10YR treasuries have today just poked their head above the upper bound of their recent trading range, indicating a possible breakout:
These bits of bond turmoil are minor foreshocks of what will come in the months ahead. While they are not the real bad news that my next article will be laying out. the biggest bit is that bid-to-cover in the 2YR auction crashed from 2.649 to 2.28, which is the lowest it’s been since the Lehman collapse in December of 2008! (The ratio by which the number of bonds bid exceeded the number of bonds issued.)
As a result, primary bond dealers were left holding a third of the whole issue, which is the worst in almost a year for dealers. This sudden flight in demand suggests fears are setting in about Fed tapering (not even tightening yet), which will cause bond yields to rise more, making today’s bonds worth less down the road.
While bonds already have a long way to move just to properly price in today’s inflation, they have much further to move to price in tomorrow’s. However, as I’ve pointed out before, the Federal Reserve currently owns (as in controls) the yield curve of bonds (the curve along which treasuries of different maturity dates price their yields) because it has been soaking up more than half of all US treasury issuances as soon as the primary dealers buy them.
That, however, will slowly change as the Fed starts to taper back its purchases, leaving it with less and less control over yields with each targeted reduction in purchases until it has none (if it gets to the point of fulfilling its taper promises). The Fed has hinted it intends to be out of purchasing bonds by the middle of next year. So, you can expect bonds to become more realistic in what they telegraph about inflation expectations as pricing starts to become market driven and not entirely Fed controlled (in that he who continually buys and holds half of any market is the market price setter).
In other words, bonds (especially US treasuries) in the months ahead are about to escape their Fed bondage. That untethering will leave them increasingly free to price to real market concerns. Currently, that means old-school analysts who try to gauge inflation based on what bonds are doing have completely missed the train because the bond market currently allows zero price discovery so contains no inflation pricing information at all. (I explained all this here back in July for those who have no idea how the Fed has erased all price information from the US treasury market.)
The US treasury market prices wherever the Fed decides it will at each point along the maturity curve because the Fed controls how much of each maturity it will buy and is buying full-spectrum. When you are soaking up half of all government issuance, that’s a lot of price control. Want lower yields at one part of the curve? Buy more at that maturity date and less along other parts of the bond maturity spectrum.
Therefore, even the idea that the yield curve has to flatten to reveal a coming recession has nothing to do anymore with current or even future reality due to the Fed’s intense yield-curve-control, which I warned my patrons more than a year ago we’d see coming as part of the COVID interventions. You have to learn how to think outside the box when the Fed is taking actions that are completely outside the range of anything ever seen. Yield-curve control has been here since COVID was just getting started, and still no one is talking about it. It’s actually impossible that a single entity can buy up half of all treasuries issued and not have a major suppressing effect on treasury yields. So, where you buy along the curve sets the curve.
The market appears to be trying to price the inevitable asset adjustments in ahead of the Fed’s moves, but keep in, mind, the Fed is still wrestling the treasury market to where it wants it to be, and will only gradually release its grip. No actual change in Fed actions has happened, but the market appears to be starting to anticipate the moves … maybe (as everyone seems a little slow to figure this out).
Stocks may enter bondage to the bond market
As the Fed does start relaxing its white-knuckle grip on the treasury market, you can expect to see stocks struggle more against the current of money that will eventually flow into bonds with higher yields. We may be seeing a hint of those worries pricing in now, too. That’s just one way inflation will eat into the stock market this time by forcing the Fed’s hand. We haven’t seen anything like this because we have not seen any situations where the Fed was already engaged in massive easing as the economy began to collapse and the Fed began to withdraw support from a dependent market just as the collapse began because its hand was forced by relentless (and growing) inflation. (My next article will deal with how the shortages that are part of the inflation equation are about to get MUCH worse. They are not transitory by any means.)
Stocks did better last week than ignore the Fed’s gentle bond tapering hint, but the bliss that comes from momentary relief seems to have been short-lived. Today, the market began to struggle as bonds began to show an attempt at wresting themselves free of Fed control. No big action, and this isn’t the big news of the day or the disintegration of the stock market I said inflation would eventually bring, but market breadth (number of stocks moving upward v. downward) has been deteriorating for months as concerns gnawed away at the market over how inflation might not prove so transitory (it hasn’t) and might push the Fed’s tapering forward (it has). Likewise if you measure breadth by the number of stocks still trading above their 50-day moving average versus those trading below:
The picture of where stocks are trading relative to their 200-day-moving average looks much worse:
That continually decreasing breadth indicates fewer and fewer investors are participating in or believing in the bull, and that makes each attempt at a new climb more difficult. While there has been a lot of bull in the market over the past year, the misguided optimism is finally fading.
Stocks made another slight dip again today.
The S&P has been struggling throughout September with worries appearing in frequent headlines from analysts about how inflation will force faster Fed tapering. So the market was worried something worse than the Fed actually announced might be forthcoming. As you can see, it struggling two weeks ago to find its way back toward 4550, and failed, and it looks like its latest attempt last week failed at a slightly lower level:
Put another way, that looks like this:
Because the Fed was as dovish as it could possibly be in how it presented its tapering news, the market, at first, appeared calm and took some lift from the fact there were absolutely no surprises from the Fed. However, a little reality may be denting delusional sentiment, and there is a whole LOT of bad reality to come in the month’s ahead, as I am writing starting to write about now.
Again, to be clear, I am not saying this it the point at which the market will fail due to inflation forcing the Fed to tighten, as tapering is still a long way short of tightening. However, we continue to have clandestine tightening going on in the background.
Reverse Repo Crisis Building
Because the Fed is injecting too much liquidity into financial markets in order to keep funding the government’s extraordinary stimulus, such as those checks now going out to families with children, it has had to secretly suck money back out of the system via reverse repos on the banking reserve side where “money” was forming a logjam. (See where I wrote about this secret sucking here.) This is the exact opposite of the Repo Crisis that I warned of in early 2019 and covered extensively when it finally started to unfold in the second half of 2019.
I don’t think the risks from the Reverse Repo Crisis are as crisis-like as what we saw in 2019 in that the historically extraordinary level of reverse repos should start to back down when the Fed finally starts backing off its tapering. Rather, I present them as solid evidence of just how much the Fed’s money printing is not needed in the financial system and has nothing to do with setting financial policy, and how the Fed is being forced to tighten (even if out the back door through Reverse Repos). The Fed is having to mitigate the negative side effects of “financial policy” that has been running way too loose for way too long because the Fed fears backing off, lest it crash stocks, bonds and, as a result, the economy and the everything bubble and causes the government to pay more interest than it can manage.
Think of reverse repos as back pressure. The Reverse Repo Crisis is one of the ways in which we can see the Fed is being forced to taper, and here what that evidence now looks like:
That mountain that is pushing rapidly toward 1.5 TRILLION dollars that the Fed is sucking out of the financial system EVERY DAY (as in rolling it over and seeing it build) is a good proxy for how much extra liquidity they have sloshed into the system. These are funds banks don’t want to keep in reserves. You can see there were almost none of these operations happening when the system was too tight in 2019 and were only a small amount by comparison in prior years, but I suspect we’ll easily hit 2 trillion dollars in overnight money-sucking by the end of the year before tapering begins to dwindle this back down sometime in 2022.
Those overnight repos are, in essence, tightening that is happening down in the Fed basement (see referenced article) as the Fed keeps adding in money at the other end of the system. It is money banks can’t even find a way to loan out at today’s extremely low interest rates. If the Fed didn’t suck it out, the Fed’s primary interest rate would actually go negative, something the Fed wants to avoid.)
They may also be a way the Fed is preparing to ease the shock of tapering, as it can reduce its reverse repos as it tapers the liquidity injections of its bond purchases, keeping net liquidity constant for awhile, but I am not counting on that being as “boring as watching paint dry.” Not in this acid environment that I will be describing later this week.
Stagflation is showing up in data points and articles everywhere now.
Delta worries, labor shortages and fading Washington stimulus — it’s enough to cast a chill on the U.S. economy this fall.
A bevy of Wall Street forecasters chopped their targets for U.S. growth after a poor U.S. jobs report for August. The government on Friday said the economy gained 235,000 new jobs last month — just one-third of what investors were expecting.
Goldman Sachs, Morgan Stanley, BMO Capital Markets, TD Securities and other firms cut their forecasts — some by more than half.
An economy that was expected to grow at a sizzling 7% annual pace from July through September is now seen expanding at a more modest 3% to 3.5% clip….
The companies that have been hurt the worst during the pandemic — restaurants, hotels, theaters and so forth — added zero new jobs in August. They had created an average of 364,000 new jobs a month since May….
A possibly even bigger factor in the U.S. employment report is a lack of people willing to go back to work….
It’s not just labor shortages, either.
Companies are struggling to obtain the parts and materials they need to produce enough goods and services to satisfy the surge in demand….
Fading government stimulus could also weigh more heavily on the economy in the second half of the year….MarketWatch
As Chris Williamson, Chief Business Economist at IHS Markit, noted after the latest IHS survey of US business activity:
Growth slowed sharply in the US service sector in August, joining the manufacturing sector in reporting a marked cooling in demand and encountering growing problems finding staff and supplies. Jobs growth almost stalled among the surveyed companies in August and supplier lead times are lengthening at a near record rate.
While the resulting overall pace of economic growth signalled is the weakest seen so far this year, backlogs of uncompleted work are rising at a rate unprecedented in at least 12 years, underscoring how supply and labor shortages are putting the brakes on the recovery. The inevitable upshot is higher prices, with firms’ input costs and selling prices rising at increased rates again in August, continuing the steepest period of price growth yet recorded by the survey by a wide margin.Market Economics
Here is what the IHS survey showed for rapidly stalling business activity:
Stalling growth, accompanied by “the steepest period of price growth yet recorded by the survey by a wide margin.“
That translates “STAGFLATION” in stark terms.
The gaping jaws of stagflation, capable of consuming any economy, now look like this:
Rapidly soaring surprises to the high side on prices accompanied by a steeply deepening downside to surprises for the economy.
Can stocks survive this monster?
In light of stagflation reality …
The big question overhanging the market is about how much longer can the Federal Reserve continue to support the stock market?
The answer seems to be, “Not much longer….”
The connection of the Federal Reserve and the stock market goes back to the time that Ben Bernanke was the Chair of the Fed. Mr. Bernanke, during the Great Recession, set off to generate an economic recovery based upon creating a wealth effect that would spur on consumer spending….
The Fed continued to pursue a rising stock market to fuel the economy and the economy responded, through the change in Fed chairs, up until the Covid-19 pandemic hit the U.S. Both Janet Yellen and Jerome Powell, who followed Mr. Bernanke as Federal Reserve chairs, continued the policy….
The big cloud hanging over this picture is the one pertaining to the need for Mr. Powell and the Federal Reserve to “back off” from purchasing $120.0 billion in securities every month and begin to “taper” the purchases….
What will investors do when they actually see the Fed easing off and the liquidity in the banking system begins to decline?
There is more than $4.0 trillion in reserve balances now sitting in commercial banks in the U.S. This is the foundation for all the market liquidity and confidence that now exists within the financial markets in the country.
The question that is being asked is “what happens when reserve balances begin to decline?”Seeking Alpha
The last time what happened was what I called “The Repocalypse: The Little Crisis That Roared.”
Let me answer John Mason’s question in the article I just quoted with a little history lesson, which I covered in much more detail in my last Patron Post.
As you can see in the following graph, when the Fed first tapered from late 2014 – 2016, the stock market went absolutely nowhere for two years. You could have sold out of stocks in 2014 and bought back in the middle of 2016 at exactly the same level. You missed nothing in terms of stock values, except the roller coaster ride of late 2015 through early 2016. (Of course, if you’re good at riding roller coasters, buying low and selling high and then repeating that, you could have done well selling at the top of each plunge and buying back in at the bottom.)
Then, in 2018-2019, when the Fed tried actually tightening by raising interest rates and reducing the size of its balance sheet (effectively money supply), stocks, again, went nowhere for almost two years. You could have sold all your stocks at the January peak in 2018 and bought back in at the same level late in the summer of 2019.
All along the way of the “longest bull market in history” and even into the present bull market (the final oval), the periods of phenomenal stock gains were fueled when the Fed was easing, with the greatest gains happening during the present bull because of the most extreme QE ever and joint federal-government money-doling during the COVIDcrisis period.
So, based on some pretty clear history, what will happen to stocks when stagflation forces the Fed to either taper, as it did in the first period of stock troubles on the chart, or actually tighten, as it did in the second period of more extreme stock troubles? You do the math. It’s not hard.
All the increases of the Great Bull Market can be accounted for by the long stretches where the Fed was actually easing and by the Trump Rally of 2017, which happened because of the promised Trump Tax Cuts (and their eventual fulfillment). Those huge cash flows into stocks fueled massive stock buybacks and huge increases to corporate bottom lines (earnings) to somewhat justify those rising stock valuations. The tax cuts provided as much available cash to stock buyers (especially those running corporate boards) as anything the Fed had done. Even the rise at the end of 2019 happened because the Fed returned to QE because of the Repo Crisis, though it denied it was doing so. At first, the Fed tried to resolve the crisis, which had been caused by its tightening, by adding hundreds of billions of dollars to the money supply through Repo loans then through outright QE during the last couple of months of 2019.
Quoting my last Patron Post,
My big prediction for 2019 was that Fed tightening would end in a massive repo crisis in the latter half of 2019 because bank reserves were being drawn down too far due to the Fed’s reluctance to give up tightening soon enough. That would only end, I said, by the Fed going back to QE to actually reverse its tightening….
The Fed had to rush back into QE during the final quarter of 2019, though, of course, Powell maintained that it wasn’t really QE because, again it was just temporary and did not involve long-term bonds. (Any excuse will do to avoid saying they have permanently monetized the US debt and its economy.)“Fed-up and Failing: How FedMed Killed the Patient“
As Mason goes on to say in his Seeking Alpha article,
There are plenty of reasons for the Fed to reduce purchases. Even stop them.
The most important one to me is the fact that all the liquidity in the banking system is forcing short-term interest rates toward negative territory….
Mr. Powell and the Fed say that they do not want the federal funds rate to become negative. But, it looks like the Fed needs to stop purchasing all those securities if the federal funds rate is to stay in positive territory.
And then there is the looming threat of higher rates of inflation.
The Fed is going to have to make a move this fall….
Investors have been betting on the Federal Reserve support going back to 2009. The Fed has not let them down. Yet….
Mr. Powell kept the Fed excessively loose during his first months as Fed chair. Rather err on the side of monetary ease than be a part of a market collapse. Then the pandemic came along and Mr. Powell oversaw a massive injection of reserves into the banking system.
Now, it seems as if we have reached the point where all the “ease” in the past is catching up with us and we are reaching a spot when the Fed will have to catch up for all the trillions of dollars it has pumped into the economy.
And, what, then, are investors supposed to do?
Investors have, for the past twelve years or so, “followed the Fed.” And, this has made them billions and billions of dollars of profits.
But, all good things must come to an end….
The Fed is going to have to change its policy stance. Investors beware.Seeking Alpha
And that way of seeing things is why I bet my blog on the present inflation train continuing until it forces the Fed to tighten and, thereby, kill the stock market (based on historic precedent that is pretty clear about how the market responds). The market has risen higher on greater easing than ever before, so it has further to fall. The alternative, I said, is that the Fed refuses to tighten because it fears the market carnage its tightening will create (or because the government demands Fed funding), and so we move into even worse inflation than the present inflation, which will rip the economy apart even more than the present stagflation already appears to be doing. That kind of carnage, too, is not likely to end well for stocks. Tends to be the kind of thing that flips sentiment on its head.
How high is too high?
The proverbial Buffet Indicator, which the Oracle of Omaha goes by for assessing whether stocks are overvalued, is further into the nosebleed section of stock valuations than it has ever been … by far:
And, if GDP continues to fall as is being widely predicted now, this gauge of stock values will look even worse.
Price-Earnings ratios also look extreme:
As Lance Roberts notes,
Corporate earnings and profits ultimately get derived from economic activity (personal consumption and business investment). Therefore, it is unlikely the currently lofty expectations will get met…. Through the end of this year, companies will guide down earnings estimates for a variety of reasons: Economic growth won’t be as robust as anticipated. Potentially higher corporate tax rates could reduce earnings…. Higher interest rates increasing borrowing costs which impact earnings….Seeking Alpha
In other words, the Price/Earnings ratio for stocks will become even further overvalued because earnings will decline.
The problem for investors currently is that analysts’ assumptions are always high, and markets are trading at more extreme valuations, which leaves little room for disappointment.
However, the price/sales ratio looks more stretched than at any time in the past:
Historic CAPE valuation also shows stocks are more overvalued than anytime other than just before the great crash of 1929 and the dot-com bust of the early 2000’s:
However, the timing for the rise and fall of stocks is based on turns in the tide of investor sentiment. Although, the level to which they fall is likely to be a much deeper plunge when they are this highly overvalued historically.
Unfortunately, the early aught years offered far better economic growth prospects due to the burgeoning internet economy than the present COVID economy offers after decimating industries all over the globe, a ravaging that continues to broaden like ripples across the oceans of this world. If stocks were overvalued during the dot-com era with plenty of room to fall, how much more so now with the entire global economy in tatters?
As Michael Lebowitz noted on Lance Roberts’ Real Investment Advice site,
If the market falls to the average of the last ten years (0 sigmas), we should prepare for losses of over 30%. If it falls below zero, as is typical, more significant losses are likely in store.Real Investment Advice
As Lance Roberts of Real Investment Advice writes,
Significantly, investors never realize they are in a “melt-up” until after it is over…. However, there are clear signs the advance is beginning to narrow markedly, which has historically served as a warning to investors….
“Relative to their 200-day moving averages (DMA), all three indexes have been generally trending lower since April, as shown in the second chart below.” – Charles SchwabSeeking Alpha
That could be a sign the tide is turning.
The Fed is now getting pushed into needing to tighten monetary policy to quell inflationary pressures. However, a rising risk suggests they may be “trapped” in continuing their bond purchases and risking both an inflationary surge and creating market instability.
We know what the market historically does when the Fed either tapers or tightens. We don’t know if the Fed will taper or tighten since it, too, knows from experience it will crash the market if it does that, and it has the government debt pressing it toward endless money printing. Still, we do know the pressure to tighten has continued to build all year long, just as I’ve said it would, and we know it shows no signs of letting up, and we know current stagflation certainly isn’t helping the economy any. So, something is going to crack, even if the Fed doesn’t.
In the face of great inflationary pressure, the Fed has its back to the wall:
The scale and scope of government spending expansion in the last year are unprecedented. Because Uncle Sam doesn’t have the money, lots of it went on the government’s credit card. The deficit and debt skyrocketed. But this is only the beginning. The Biden administration recently proposed a $6 trillion budget for fiscal 2022, two-thirds of which would be borrowed.” – Reason
Exploding government debt will not let the Fed tighten. What is it going to do?
The problem, of course, is that the Fed must continue monetizing 30% of debt issuance to keep interest rates from surging and wrecking the economy.
That was also John Mason’s concern. Without continued Fed largesse, interest rates will certainly rise, as the government has to replace the Fed as chief financier. Fed bond buying is the only thing holding rates down, in spite of inflation, and rising interest will crash the bond market, as Bond King Bill Gross argues:
Bill Gross, the “bond king” believes that bond prices are at their peak with no place else to go but down…. Gross … is attracting more attention these days referring to bonds as “trash” and arguing that if one buys U.S. government debt, one is almost assured of losing money….
To Mr. Gross, the Federal Reserve must start reducing the amount of securities it is adding to its portfolio every month.
This past year the monetary authorities bought 60 percent of the “net issuance” of the federal government debt. If the Fed “backs off” from its current level of purchases, the question becomes, how much will the private markets be able to absorb in 2022 and beyond.Seeking Alpha
This has skewed the entire bond market to where now even high-risk, high-yield corporate bonds are mostly pricing with negative yields. (Negative yields equal premium prices, making it likely prices have a long way to fall if they even try to match up to current actual inflation, much less wherever inflation is going to wind up.) Whereas never has more than about 8% of the HY market priced with negative real (inflation-adjusted) yields, about 85% now has negative real yields:
So, Fed policy will cause either a stock crash, a bond crash, or both. Gross says the 10-year must rise from its current yield around 1.35% to 2% or more just to track with inflation and to make up for the lack of demand for government bonds if the Fed backs away from being the main buyer in order to fight inflation — the buyer of last resort for government bonds. That, John Mason points out, would lead to substantial losses for current bond investors holding 10-year government bonds at the lower yield.
Bank of America, gives the following yield guidance for the remainder of the year:
Of course, if the Fed doesn’t tighten and keeps forcing bond yields to remain down by soaking up all government bond issuances at that 60% rate of consumption, stagflation will become a roaring inferno, the likes of which we haven’t seen in the US. I find it highly improbable that investor sentiment will survive that kind of upward surprise in prices and the downward surprises in the economy that those soaring prices will bring about.
Danged if you do and danged if you don’t
That’s to put it politely, of course. Sounds to me like, either way, the economy is going to collapse and markets with it. Either the stock market gives way because the Fed tapers its bond purchases or even tightens, which raises interest rates, in order to curb inflation, and the bond market fails simultaneously because yields rise as the market fills the gap in government funding as the Fed tightens, or soaring prices ravage corporate profits and consumer ability, destroying the economy, and stock investors will like that garden of horrors no better.
What I am seeing is the everything bubble bursting as anything the Fed tries to do to save one thing now now only makes something else worse.
Since the days when the Fed first started its “Great Recovery” program, as I call it, the economy, and often the stock market, has fallen every time the Fed has tried backing away from its quantitative-easing strategy. In one of my first articles written on this blog back in 2011, I wrote
I predicted that the government [its puppet or agent, depending on how you look at it, being the Fed] would try a second round of quantitative easing as soon as the first one they approved ended and downward reality began to reappear of a hard road in front of us. I have even stated the government would be strongly tempted to try a third round when the second ended and the ugly reality, again, began to reappear. Anything to avoid this austere reality. Stark realities mean angry voters….
That is the bleak landscape we now face (and are still trying to deny). The artificial recovery made it appear for awhile as if we were just going through another bursting economic bubble and were on our way out. In real fact, ALL of those efforts did nothing to correct the underlying problems of the economy. That is why this is the same recession, not a second recession. It is due to continuation of the same cause. It looks like two recessions or a double-dip only because it was falsely propped up in the middle by the unsustainable effort to create funny money. The worst part of Ben Bernanke’s solution is that he actually perpetuated the problem and even made it worse…. Ben Bernanke sought to prop up the failed housing market by expanding debt once again. Yet it was this highly indebted housing economy that led us into this mess.“Saving Capitalists from Capitalism“
We’ve been kicking this can down the road of reviving the economy every time it fails by exponentially increasing government debt and Fed money printing. In my last Patron Post, I laid out in great detail how the economy has failed every time the Fed has backed away from QE. We’ve now reached the point where inflation is forcing the money printing to end just as the economy is going down again and when stocks are more dependent on Fed support for their extraordinary valuations than ever before.
We all remember how Fed tightening went when it actually tried it back in 2018. It was a disaster, which forced the Fed had to call it off well ahead of the Fed’s stated plans. Now mere tapering could be as big a disaster as tightening was because it happens in a vastly worse economy of rapidly plunging GDP if it happens at all.
As I concluded in that last Patron Post,
The new QE, QE4ever, has already managed to outdo all the previous rounds of QE put together. So, as I said back at the start of tired and endless recovery plan, once we began down the path of QE as a way out of recession, instead of rectifying the real problems that were the cause of the Great Recession, it became QE forever, Baby! We decided to solve a debt problem by piling on more debt in that all Fed money issuance happens through debt issuances.
And that’s why I call this the Great Recession Blog. We’re still on the Great Recession Recovery Plan with no end in sight because we solved nothing! We just bought time — “kicked the can down the road” –at the cost of ever spiraling debt, financed by exponentially growing Fed money printing. And we all know what happens now if the money printing actually stops. This time, however, the Fed has inflation breathing like a dragon down its back to face it to stop moneh printing, and this time the Fed faces that tightening pressure when the economy is already slumping:
“Fed officials themselves expect noticeably slower growth in the years ahead at a time when both monetary and fiscal policy will be tighter. That raises more questions about whether Powell and his cohorts can get the exit right. “Are they exiting at the right place? Are they exiting at the right time, at the right magnitude? Given the slowing of the economy, we have questions around both,” Misra said…. ‘I think people are very worried about the idea that maybe this isn’t going to work out the way we planned….”
It never has. Why would it start to now?“Fed-up and Failing: How FedMed Killed the Patient“
While the Fed’s current tightening is not exactly a well-kept secret, stock and bond markets seem willing to ignore what the Fed’s left hand is taking away as the right hand is giving. Reverse repurchase agreements, which I have been tracking here, have exploded to a trillion dollars in money that the Fed is sucking out of the financial system.Read the remainder of this entry »
It wasn’t just COVID that got us down the road to ruin. Because many think we are in what looks like a post-apocalyptic world of rubble only because of COVID or because of Trump, I decided now would be a good time to summarize how predictably the Fed’s Great Recovery and Great Rewind got us here.Read the remainder of this entry »
I rarely mention anytime I’ve been interviewed. However, I was reviewing a casual conversation I just finished with one of my readers, Bob Unger, and I thought Bob’s questions led to a well-rounded expression of how, over the past two years, our economy got to the collapse we are in now, how predictable the Federal Reserve’s policy changes and failures were, why economic recovery has stalled, and why the stock market was certain to crash twice this year, including why the second crash would likely hit around September.
I’ve found Bob’s interviews with others interesting, so I recommend checking out his YouTube page. I had no idea where the interview below would go, but it wound up encapsulating my main themes for the past two years:
(Other interviews I’ve done are linked in the right side bar where I usually just let people stumble onto them on their own.)
This week’s results in the Fed’s repo-market interventions in one fell swoop proved everything I’ve said about the Fed’s intervention being QE4ever and the problem’s cause.
The following results show the repo market has been fixed:
The instant the Fed returned to full-on, “we-now-call-it-QE” QE, the repo market settled right down to an easy calm.Read the remainder of this entry »
The emphasis has to be on HOG as they squeal for corporate welfare and push their snouts into the trough. One hedge hog says the government needs to bail out all businesses by paying all wages so companies that depleted all cash don’t have to pay to retain all workers:Read the remainder of this entry »