The single most important item for investors to understand is collateral. Specifically, how there is a huge shortage of high-grade collateral backstopping the trillions in derivatives trades owned by the TBTFs
The senior most assets backstopping the $600 trillion derivatives market are SOVEREIGN BONDS: US Treasuries, Japanese Government Bonds, German Bunds.
By keeping interest rates near zero, and pumping over $10 trillion into the financial system since 2007, the world’s Central Banks have forced investors to misprice the most prized collateral backstopping the entire derivatives system: SOVEREIGN BONDS.
SO what happens when the current bond bubble bursts and we begin to see bonds falling and yields rising?
Another collateral scramble begins… this time with a significant portion of the interest rate derivative market (over 80% of the $600 TRILLION derivative market) blowing up.
At that point, rising yields is the last thing we need to worry about. The assets backstopping a $600 trillion market themselves will be falling in value… which means that the real crisis… the crisis to which 2008 was the warm up, will be upon us.
This is why Central Banks are so committed to keeping rates low. This is also why all Central Bank policy has largely benefitted the large financial institutions (the Too Big To Fails) at the expense of Main Street…
THE CENTRAL BANKS AREN’T TRYING TO GROW THE ECONOMY, THEY’RE TRYING TO PROP UP THE FINANCIAL INSTITUTIONS’ DERIVATIVE TRADES.
To return to our initial question (is this just a temporary top in stocks or THE top?), THE top is what we truly have to watch out for because it will indicated that:
1) The Grand Monetary experiment of the last five years is ending.
2) THE Crisis (the one to which 2008 was just a warm up) is beginning.
Indeed, the chart for the DJIA says it all:
This is an expanding wedge pattern. It predicts an eventual move in the Dow back down to 5,000 or even lower depending on the timing of things.
This will likely be accompanied by:
1) Rampant margins calls and demands for higher grade collateral
2) The yield on the 10-year note hitting 1% or lower.
3) Markets being closed
4) Banks being frozen (similar to what happened in Cyprus)
When will this happen? What will trigger it? I don’t know. No one else does either. But this chart is dangerous. And investors should keep it in mind.
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