Is this the market's breaking point?
I admit: I'm a permabear.
This is no surprise to those who know and have followed me over the years. But I'm publicly proclaiming my 'bearishness' because doing so might open up a needed and long overdue dialog.
Here's my fundamental position: Infinite growth on a finite planet is impossible.
Cutting to the chase, this is why I predict a major crash/collapse across stocks, bonds and real estate is on the way.
The recent market weakness seen over the past two weeks is nothing compared to what's in store. As we’ve been carefully chronicling, bubbles burst from ‘the outside in’, starting at the weaker places at the periphery before progressing to the center.
Emerging market equities are now down -26% from their January highs and -18% year-to-date. China's stock market is down -32%, even with substantial intervention by the government to prop things up.
The periphery has been weakening all year, and the contagion has now spead worldwide.
Taken as a whole, global equities have shed some $13 trillion of market capitalization for a -15% decline:
The rot has spread to the core with surprising speed. Now even the formerly bullet-proof US equity markets are stumbling.
The S&P 500 is now negative on the year:
It’s been obvious for a long time to those who have watched The Crash Course that endless growth is simply not possible. Not for a bacteria colony in a petrie dish, not for an economy, not for any species on the planet. Eventually, when finite resources are involved, limits matter.
But the vast majority of society pretends as if this isn't true.
The US government is (and has been for decades) adding to its massive pile of debt at a rate far faster than it's income (GDP) is growing. Pension managers have a horizon measued in decades, and yet they buy stocks and bonds that can only pay off if endless growth occurs (e.g., 100+ P/E ratios). Much of today's buildings and public works will need to be rebuilt/replaced within the next 50 years, yet no one is certain whether we'll have enough affordable energy to do so.
In regards to the financial markets specifically, history has given us clear lessons to heed. 1929, 1987, 2001 and 2008 each showed us that when the world gets so manic that investors must believe in perpetual perfection/endless growth to justify current asset prices, a painful correction ensues as the limits of reality re-assert themselves.
Bulls vs. Bears
My permabear-ishness is a by-product of peering into the future and not being able to align society's hopes with what I see as the current trajectory of the world.
As a baby boomer, this sets me apart somewhat from my age cohort, many of whom have benefitted as our generation has lived beyond its means. But it’s not all unusual to find young adults, peering ahead into a diminished future, who share my views.
So when I look at today's markets, I ask: What’s the purpose or point of investing in financial assets that, by definition, depend upon a logical fallacy (endless growth) being true? None at all.
Now, in the short term, if you believe yourself to be smarter and more nimble than the rest, maybe you can find advantage in speculating over the short term. (And good luck with that, by the way...)
But for the average person? Is parking money in a 401k in a general index fund(s), crossing one’s fingers and hoping that the next twenty years will behave like the last twenty a good bet? Not if sustained economic growth continues to remain elusive the way it has since the 2008 crisis.
The Bull Trap
By definition, stock market bulls believe in growth, specifically endless growth. They believe, over time, the markets will head ever upwards.
As I’ve said I don’t believe that endless growth is possible. But more than that, I think, were it possible, it would be harmful to humans and planetary life in general.
I used to believe in growth. In my early career as a consultant, I even helped companies chase it. But as I became more familiar with the scientific data and connected a few dots, I realized my views regarding growth were naive. And in some cases entirely backwards.
For instance: In my MBA courses, I was taught that at a high enough price, new supply will always emerge to meet the market demand.
But a tiny bit of inquiry quickly reveals that the economy doesn’t deliver resources, instead we have an economy because there are natural resources to use. No resources, no economy. The economy is a subset of the natural world, not the other way around.
Most people get that intuitively, but it remains a mystery why so many stumble on the idea that ever moreeconomic growth requires ever more resources. They ignore the reality that, at some point, resource limits matter.
And within the resource story, energy is THE master resource. No energy and you can’t have anything else. No economy. Nothing.
Even more precisely, surplus energy (also called "net energy") is what powers everything you and I hold dear about our amazing, just-in-time, global lifestyle. If a Cheetah expends more calories hunting than it actually catches, it dies. Every organism only thrives if it has a surplus of chemical energy compared to what it expends.
Simply put, humans are using up hundreds of millions of years of stored ancient sunlight (via fossil fuels) in the equivalent of a geological microsecond. It's been a one-time-only bonanza for our species. One that is fast approaching it's end.
Hey, it’s been fun. And we’re doing some really cool things with all that surplus fossil energy, like space travel and smart phones. But one thing we haven't done is invest for a future that will function when all that tasty surplus fossil energy is gone.
And as we've often written about, the ramifications are already beginning to be felt, and will only get worse over the coming decades.
A critical factor is that our system for running the world is becoming increasingly unstable. As surplus energy decreases, we are using more and more debt to pull tomorrow's prosperity into today to keep the party going.
But that can't last forever. And as 2008 showed us, when the debt stops growing, even briefly, the whole system shudders to a stop. Our current system of credit/money is either expanding or threatening to collapse. It no longer has a middle ground:
The Social Fabric Is Starting To Rend
This idea of growth being dependent on surplus energy is not a very difficult train of logic to follow. But as I’ve learned the hard way when delivering this message over the years, data and logic rarely changes people's behavoir.
People's actions are governed by their beliefs, which are stubbornly housed in our brain's emotional limbic system, not in the more rational cortex. When beliefs get challenged, emotions flare up. Data is irrelevant. Logic doesn’t matter. The backfire effect mushrooms and takes over.
We are now at the most important inflection point in all of human history, yet practically nobody knows about it. But try to raise people's awareness and – wow – does it ever challenge their belief systems. Fear and anger are the first emotions to get triggered, and listeners quickly search for any reason to reject the information.
This is wack-job conspiracy theory! This is failed Malthusian claptrap! This is fear-mongering! You're underestimating human ingenuity! If this were really true, I'd be reading about it in the media!
Over the years, I've heard thousands of these 'reasons' to reject looking critically at the data. It no longer bothers me, as I recognize it for what it truly is: an attempt to protect oneself from having to grapple with the possibility that the promise of endless growth, which our current prosperity is based on, just might not be real.
And I think many folks are nevertheless becoming aware of this on a subconcious level. It's that feeling in our gut we get when we see the 1% live so much better than the rest of us 99%. When we hear how "great" the employment rate is or the stock market is, yet we see so many households struggling to get by as the middle class get squeezed harder and harder between stagnant wages and the rising cost of living. When we see those who run our country and its corporations live by a different, more preferential, set of rules than the public is held to.
I think this explains why tensions and tempers are so high right now, even though very few seem to understand why. It explains why the country is so divided and increasingly desperate. It explains the hyper-partisanship, the turn to opioids, the pipe bombs.
To my way of thinking, a lot of the emotional energy being expended right now is due to the fact that our entire way of being is busy collapsing all around us. Our main narrative of “how life works” is breaking down. This is resuting in an epidemic of grief, depression, anger and sorrow.
Is The Crash Upon Us?
So with the wipeout of all 2018's market gains this week, is the next crash upon us? Is the financial system in the process of breaking down, as it did in 2008?
There are a number of indicators we watch closely here at Peak Prosperity. While many are showing signs of distress, we're not yet seeing the kind of systemic arrest we'd expect to see preceding a market seisure.
For instance, even as equities have pulled back, the weakest credit element, here represented by the ETF “JNK” that tracks junk bonds, has barely even budged during the current sell-off:
What tipped me off as a pre-indicator of the 2008 crash was the movement in both the credit markets and the financial companies most dependent on them. Remember, "stocks are for show but bonds are for dough". The serious money playing in the bond market typcially seeks safety before the more risk-loving players in the equity markets catch on.
Similarly, the prices for 'safe haven' US Treasury hasn't rallied by all that much. If there were a panic brewing, we'd expect to see these spiking more violently, even with China beginning to sell their stash and the Fed pulling back:
That “bounce” doesn’t even bring US 20-year bonds back to even for the month of October, let alone return them to where they were in September.
Similarly, gold hasn't rallied that much either in US dollar terms (in euros and yuan is another matter):
Add to the above that the US economy is not (yet) in recession, and a full-blown crash looks unlikely to unfold before us right now.
BUT, what we are seeing in the markets is exactly the kind of precusor activity we would expect to see in the final stage leading up to a crash.
In Part 2: How Close?, we lay out the indicators we're watching most closely and what they're currently forecasting about the timing of a major market breakdown, as well as reinforce the importance of prudently preparing yourself *now*.
This equity correction has my full attention. No, I don’t think it’s the big one (yet). But, yes, I think the big one is not far behind
In the immediate here and now, focus on getting yourself prepared as best as you can and remain above the emotional fray that's tormenting so many people. It's only going to get worse from here.
Fonte: qui
Expect A "Lost Decade", Mish Warns Stock Market Rout "Only Just Starting"
October has been a terrible month for equities. Yet, this is only a start of what's to come...
Decline Barely Started
Despite the rout, the S&P is just barely down for the year.
Expect a "Lost Decade"
Why?
The Shiller PE Ratio also known as "CAPE", the Cyclically Adjusted Price-Earnings Ratio, is in the stratosphere. It's not a timing mechanism, rather it's a warning mechanism.
The main idea is that earnings are mean reverting.
On that basis, stocks are more overvalued than any time other than the DotCom era.
But that is misleading. In 2000 there were many sectors that were extremely cheap. Energy was a standout buy then. So were retail and financials.
It's difficult to find any undervalued sectors now other than gold.
Financial Crisis Coming
It's been about 10 years since the last financial crisis. FocusEconomics wants to know if another one is due. The short answer is yes.
"Peak QE": This Is What Share Of The Market Central Banks Now Own
After a decade of unprecedented liquidity injections by central banks to preserve the western financial system, global QE has peaked.
First, the aggregate balance sheet of major central banks started to shrink earlier in the year, a reversal that took investors many months to notice but judging by recent market volatility, it is finally being fully appreciated.
Second, beginning this month the Fed's bond portfolio run-offs as part of its QT are roughly offsetting the combined tapered net QE purchases by the ECB and BoJ. Worse, QT is now set to dominate.
Some facts: between mid-2008 and early 2018, the "Big-6" central banks expanded their balance sheets by nearly $15tn, most of it due to explicit targeted purchases of domestic assets (QE) in addition to other forms of liquidity injections (collateralised lending such as the ECB's TLTROs or FX interventions equivalent to foreign-asset QE).
According to Deutsche Bank estimates, the four major central banks involved in QE (Fed, ECB, BoJ and BoE) are now collectively holding $11.3tn of securities accumulated through their asset purchase programs.
Why is the above important? Because as Deutsche strategist Michal Jezek, now that liquidity is contracting makes for a timely moment for looking at the proportion of relevant asset classes owned by central banks and putting the ECB's corporate bond holdings into a wider context.
To begin, as Jezek confirms what we have been saying since the start of 2009, "clearly, QE matters." As central banks reduced the free float of some securities and QE has worked its magic on confidence and growth, asset valuations reached unprecedented levels while volatility became suppressed. A couple of years ago, a quarter of the global bond market was trading with a negative yield. With global QE fading, this proportion has now fallen by half but remains significant.
And the combined valuation of global bonds and stocks has more than doubled since the crisis, led by stocks.
So in light of the recent jump in volatility, and given potentially fragile valuations, QE tapering has been gradual and well telegraphed with the aim to minimize disruptions. Certainly in the case of the ECB CSPP, the market has focused on the taper for quite some time and while many believe it has been largely priced in, Italian bondholders are becoming increasingly uncertain if that is indeed the case.
That said, as DB cautiously admits, "the end of the overall ECB QE and start of global QT may not have been fully internalised by the market yet and the absence of a large, price-insensitive buyer of last resort should keep volatility higher."
To be sure, acquiring a portion (or most) of a securities market over time does not necessarily mean shrinking it. Consider that while the ECB took nearly €175BN of Eurozone corporate bonds out of circulation but net issuance over that period has nearly offset it and broader net issuance from global IG corporates in EUR has well exceeded that volume, as we show in our most recent Issuance and Fund Flows report.
However, QE does shrink the market compared to the counterfactual of no QE because the extra supply response (more issuance because the central bank is buying) should normally be a lot smaller than the net amount bought.
With that in mind, Deutsche Bank presents its estimates of the share of relevant asset classes owned by central banks. The most extreme case is Japan where the BoJ owns almost half of the JGB market, followed by the Eurozone where the ECB holds nearly a third of the relevant covered bond market. Other than that the central banks own 20-25% of their government bond markets and 15-20% of the relevant part of the ABS/MBS market.
As Jezek next notes, compared to all the above numbers, it might seem that there is less scarcity in the Eurozone corporate bond space with the ECB owning "only" about 8.5% of the relevant bond universe (and 20% of the CSPP-eligible subset worth €850bn +). While there is a much greater liquidity constraint than in government bond markets, it is probably true that if healthy net issuance continues, the ECB could carry on conducting meaningful net CSPP purchases well beyond 2018.
Why would they?
According to Deutsche, one reason is that they might decide to put more weight on corporate and less weight on government bonds in their upcoming reinvestment strategy, with zero net QE. Against that, there seems to be limited willingness of the ECB to take unsecured corporate exposures given their recent experience with the troubled Steinhoff and Atlantia credits in the CSPP portfolio. In other words, it now seems more likely that the ownership share will slowly begin to decline as net corporate purchases cease and the IG market keeps growing.
Unless of course the European bond market suffers a cardiac arrest, in which case the ECB will go all out again.
And while the BoE owns about 3% of the UK GBP IG market given its CBPS programme was limited in scale from inception, in bank-based Japan (with a less developed and small corporate bond market) the BoJ has accumulated some 15%, by our estimates.
Looking ahead, Deutsche Bank suggests that as global QT sets in, the turn in the credit cycle still seems relatively distant, with default rates low and still falling, while declining issuance in US high yield has kept spreads supernaturally tight.
The bank forecasts lower but still decent growth at least through 2020 with rate curves bear steepening in the next couple of quarters not only in Europe (consensus) but also in the US (non-consensus) before they start flattening into a slowdown.
