Ray Dalio

There’s more than a whiff of 2008 in the air. The sources of systemic financial sector risk are different this time (they always are), but China and the global industrial/commodity complex are even larger tectonic plates than the US housing market, and their shifts are no less destructive. There’s also more than a whiff of 1938 in the air, as we have a Fed that is apparently hell-bent on raising rates even as a Category 5 deflationary hurricane heads our way, even as the yield curve continues to flatten.

“To the intelligent man or woman, life appears infinitely mysterious, but the stupid have an answer for everything.” ~Edward Abbey

"The irony in this year’s batch of outrageous predictions is that some of them are “outrageous” merely because they run counter to overwhelming market consensus. In fact, many would not look particularly outrageous at all in more “normal” times – if there even is such a thing!"

We are talking of course, about the infamous RRR-hike of 1936-1937, which took place smack in the middle of the Great Recession.

"... you can bet that whenever an earthquake like this happens, especially when it’s triggered by two invisible tectonic plates like put gamma and call gamma and then cascades through arcane geologies like options expiration dates and ETF pricing software, both the media and self-interested parties will begin a mad rush to find someone or something a tad bit more obvious to blame. So you end up getting every investment process that uses a computer – from high frequency trading to risk parity allocations to derivative hedges – all lumped together in one big shotgun blast"

For investors, the markets have been sending a fairly clear warning signal. Market topping processes take time to develop fully and, unfortunately, are only fully recognized in hindsight. The problem in waiting for "recognition" is that the destruction of capital is already far larger than previously expected. This leads to a series of "psychological" responses that exacerbate the problem such as "hoping to get back to even." The last point is critically important. In the world of investing, "hope" has never been an investment strategy that one could profit by. It likely won't be successful this time either.

The chart below shows the annual change in 12-month forward S&P 500 EPS expectations. This series is based on forward consensus expectations and therefore excludes many of the write-downs and exceptional items that are currently pushing down actual reported profits. It is more akin to operational profits and has never been this negative outside of a recession!

While the rest of the levered-beta 2 and 20 chasers formerly known as "hedge funds" recently accused risk parity of blowing up their August returns (September is not shaping up much better) the biggest risk-parity fund in the world also found a scapegoat: the global economy, which according to Dalio, is the reason for All Weather's dramatic August slump. Bridgewater's message is simple: absent far more easing, what the charts above signal is that the US economy is about to slam head-on into an economic recession.

When 2-and-20 looks more like 50-50...

The current surge in deflationary pressures is not just due to the recent fall in oil prices, but rather a global epidemic of slowing economic growth. While Janet Yellen addressed this "disinflationary" wave during her post-meeting press conference, the Fed still maintains the illusion of confidence that economic growth will return shortly. Unfortunately, this has been the Fed's "Unicorn" since 2011 as annual hopes of economic recovery have failed to materialize.

The gold market seems to have bifurcated: one market for largely paper speculation and high leverage, and another for the purchase and distribution of actual physical bullion. This is a problem because the attitude towards gold among the status quo in the West has become rigidly dogmatic, supported by years of lazy thinking and a determined the campaign of ridicule and propaganda to try and extend the unsustainable. There is going to be a reconciliation of attitudes and realities at some point, and like vast tectonic plates unable to move but building greater and greater pressure, the longer that the status quo and their courtiers try to maintain their modern aristocracy, the more dramatic that change may be when it finally comes.

The long awaited day is finally here by which we, of course, mean the day when nobody has any idea what the Fed will do, the Fed included. Putting today in perspective, there have been just about 700 rate cuts globally in the 3,367 days since the last Fed rate hike on June 29, 2006, while central banks have bought $15 trillion in assets, and vast portions of the world are now in negative interest rate territory.

Nahhh ... The Problem Is NOT ENOUGH Debt! </sarc>

What Could Possibly Go Wrong?

"there is a sense that policy is being priced to “fail” rather than succeed... why should equities always rise in value? Why should debt holders be expected to afford their debt burden? There are plenty of alternative viable equilibria with SPX half its value, longevity liabilities in default and debt deflation in abundance. In those equilibria traditional QE ceases to work and the only road back to what we think is the current desired equilibrium is via true helicopter money via fiscal stimulus where there are no independent central banks.