The following article by David Haggith is from The Great Recession Blog:
The Big Bear is back. Ursa Major is in the house of the rising sun, and Taurus is in the house of the setting sun. Those are bad signs for investors who are now daily diving into their horoscopes. The market is pouring out of an inverted Big Dipper, otherwise known as the Big Bear (Ursa Major), and no one (not even the Fed chair) nor any positive event seems able to stop it. I can easily tell you why.
But first, even Goldman Sachs now says that the stock market’s twin peaks this summer were actually a strong indicator back then that the market was crashing into a full-blown bear market, not just a correction, making my prediction that the big change would come in early summer pretty darn close to right even if the tailing action waited until fall. Entering a brutal bearish mood, Goldman has joined numerous others in saying the present market troubles in the US look worse than many people realize:
Two months ago we reported that according to Goldman’s bear market indicator, the risk of a market crash dead ahead was higher than before the dot com bubble burst in 2000 and ahead of the 2008 global financial crisis, or as Goldman puts it, “our Bull/Bear market indicator is flashing red.” (Zero Hedge)
In fact, Goldman’s “Bear Market Indicator” just hit a higher zenith than it did right before the Great Recession and right before the dot-com crash. It has not been this high for almost half a century:
Fast forward two months, and one market correction later, and Goldman’s mood has only gotten worse, not helped by the brutal market action of October, which saw many assets hitting a bear market, and the S&P falling on 16 of the 23 trading days while, collectively, equity markets across the world shed around $5tn of market cap.
To Goldman strategist Peter Oppenheimer, “the obvious question now is whether this has marked the start of a bear market more broadly, or if it is a less entrenched, albeit sharp, correction from which markets will quickly recover.” And, as he concedes, “things do not look encouraging” as three factors suggest that “equities could be about to enter a sustained bear market”:
- First, the growth/inflation mix is turning against equity returns.
- Second, a sharp decline is often followed by a bounce.
- Third, the GS Bear Market Risk Indicator is at elevated levels
Goldman notes that the kind of rounded double top I’ve often talked about typically results in a decline (on average) of 34%. Rarely, they say, does the decline happen without some bear-market rallies along the way down. These are traps if you fall for them and think the worst is over and the bull is back.
Central banks are the central reason the stock market’s stars are crossed
Bank of America says, if there is anything they learned from 2018, it is the following:
That central banks trump everything…when global liquidity peaked in Q1, markets peaked
That we remain in a deflationary world which cannot handle a 10-year Treasury yield above 3%
That investors have no satisfactory answers to the existential questions of “If not stocks, what?”, “If not tech, what?” (Zero Hedge)
So, even BofA thinks the stock market peaked this year because central banks are reeling back their decade of money printing, which is exactly why I predicted it would peak this year. It is predictable because “central banks trump everything.” BofA finally figured that out because 2018 taught them this lesson. I think it was self-evident that CBs trump everything for the obvious reason that they can create an infinite amount of money and direct it where they want it (and it costs them nothing to make this money).
The US stock market’s doom was, in other words, written in the stars for this year well before the year began. If you didn’t see this coming, you weren’t reading in the right places or you were reading but in denial.
It is all wrapped up in that centerpiece nugget above: the world cannot handle 10-year treasury yields above 3%. The Fed’s Great Rewind has kicked long-term interest over that level, as I stated it would because their refusal now to roll over all their government debt into new issuances forces the federal government of refinance on the open market. Attracting busloads of new buyers for all that debt requires higher interest. At the same time, the government has chosen to greatly expand its debt.
The other thing that I said would happen is that bond yields and the stock market would enter seesawing relationship where bond interest rises, which entices money out of stocks, which pulls interest back down some. Then the next step in the Fed’s unwind floods the market with more bonds, tending to push bond yields back up, which sucks more money out stocks. It’s a pump. Every time bond yields rise, they pump money out of the stock market. The handle on the pump goes down. The Fed lifts it up again with another roll-off of bonds, and then it goes down again and pumps more money out of stocks. The stocks that get hit the worst by this pump are banking stocks.
Banks are bears
While the FAANG stocks led the bull market up the mountain for a decade, they are joined in their downhill run by bank stocks, which are going bust faster than all others. The S&P Financials became a bear market last week, down 20.3% from their peak. The S&P Bank Index is down 24%:
This banking bear isn’t just in the US. Since the US bull market started breaking up last January, exactly when I said it would, global banks have erased the entire Trump Rally: (Pardon the victory laps, but I took a bit of a beating for staking everything on that claim, which was seen as a foolish bet, so I’m going to make it abundantly clear that you can see something like this coming because it is foreordained by the central banks’ actions.)
Why did I say January would be the turning point? Because the end of January is when the Federal Reserve’s Great Recovery Rewind would start to get serious. (Central banks trump everything, remember?) That’s why I say this year’s market action was written in the stars.
Naturally a reversal in money supply would hit banks the hardest for many reasons, not the least of which would be the fact that our money supply channels through the banks. When the Fed was creating money out of thin air, it was doing it in the reserve accounts of national banks. Anyone but a modern economist could figure the reverse cause-and-effect out! If creating the money pumped up the stock market, pumping it out is going to lower the market. After all, the whole affair is floating on this bubble of money.
The Federal Reserve’s Great Recovery Rewind is bound to hit banks globally because the currency the Fed is playing with is the global trade currency. That is partially why it is a race to the bottom now for European banks, though they have all kinds of problems that are of their own making. Thus, eurobanks have also seen a full quarter of their value shredded in 2018.
How could anyone continue to think that 2018 hasn’t already proven to be a financial disaster? I mean think of that: Institutions that have been building value for over a hundred years have lost a quarter of their financial worth in one year! And look at where that leaves them:
Almost back to where they were by the end of the Great Recession. “By the end,” I say. Almost right back also to where Brexit and the Euro Crisis took them. That’s right: back to where banks ended up after years of the greatest financial collapse in modern history. Only this is before any financial crisis has even begun! How can that not be horrible as the starting place for your next financial crisis? You think this is not going to become the Epocalypse when banks are starting from the bottom they ended up in last time around?
Nick Colas of Datatrek refers to US financials right now as the “death trade” or a “train wreck.”
US large cap Financials trade like death itself…. They are back to trading at their June 2000 low. (Zero Hedge)
Colas believes the market may be anticipating something worse than a slowdown.
At their current weighting of 13.1%, Financials are at their lowest percentage of the S&P 500 since May 2009…. The bottom line here: either US large cap Financials are near a bottom relative to the S&P 500 (like June 2000) or markets are still in the midst of discounting something much worse (like 2009)…. The recent coupling of US to European Financials is troubling, because the American financial system is nominally better capitalized than the Eurozone’s. Markets don’t seem to care…. We will be closely watching how US large cap Financials trade into year-end…. If Financials continue to break down, that is very bad news indeed. And judging by the slew of analyst downgrades, the suffering is far from over.
- Atlantic Equities downgraded Goldman Sachs Group, slashing its price target.
- Keefe Bruyette & Woods downgraded Bank of America Corp. and Morgan Stanley.
- Morgan Stanley analyst Ken Zerbe wrote that the sector is prone to further weakness if economic fundamentals don’t improve. “The carefree days of rising rates and pristine credit quality could be coming to an end. We cannot ignore the growing risk of a bear credit market next year preceding a recession as well as the negative impact of weaker economic growth.”
When the bankers, themselves, are telling you, “It looks dismal for us,” you know the prognosis isn’t good! Joining the above chorus, Bank of America’s head of global rates says,
I Have Not Been This Worried Since 2008…. “We’ll have a $1 trillion budget deficit, a big fight over the debt ceiling, gridlock and the U.S. economy will be slowing at the same time…. That makes me very nervous.” (Zero Hedge)
The BofA head also notes that the big presidential 2020 election cycle will begin later in 2019 to where Democrats will be glad to let Trump take the blame upon himself (as he already did) for shutting down government. The tariff war could get worse. He “wouldn’t touch” his own area of specialty — emerging markets — “with a ten-foot pole.”
Eurobanks gone bonkers
This is what a race to the bottom looks like, and it is why the European Central Bank has decided all interest rate hikes are off the table … in the very least until next summer. (As if next summer is going to prove any better for them, but they continue to believe in themselves. You’d be a fool taken for the downhill ride if you believed in them. They may have infinite money supply, but they have very finite intelligence that measures out on the short end of the stick. If you poked a central banker’s brain up a gnat’s nostril, it’d rattle around like a bb in a box car.)
Here’s how bad it is for the Europeans. Credit Suisse, whose stock isn’t much better than a penny stock, announced stock buybacks and dividends on Wednesday, and its stock price didn’t even budge. That’s even though their stock has almost nowhere left to go but up. They just can’t catch a bid to save their broken bankster souls. Ah well, may banking stocks become the toilet paper used in hell where it can remind all the banking barrons in the subbasement of their former lives on earth. What could be more fitting?
The silver lining for the Stoxx 600 is that, with European banking stocks now so low in value, they can no longer budge the needle on the stock index when they fall! They haven’t got any weight to throw around. (Maybe that is because all their money was printed out of thin air to begin with. Not a lot of weight in air, especially upper-stratosphere thin air.)
Here is the portion of total market value they occupied in the last collapse compared to the portion they have today:
So, in one respect, if they all went bankrupt and lost 100% of their value, the fall in total market value would hardly be a blip. Of course, we know their collapse would have a huge impact for reasons outside of their market value. They are the spine of the financial system. When it shuts down, as we saw in the Great Recession, the whole system shuts down. Yet, if their value is so low after years’ of central banks creating all the world’s new money through them, are they not nearly bankrupt already in terms of their worth? The above chart is a rather grim looking picture.
Ever seen a herd of billionaires running downhill hand-in-hand? (Don’t worry. No matter what they do to their institutions and no matter how much that impacts the world, politicians will bail them out again … unless you stop it from happening now.)
Oh, but they are going to save themselves with mergers. Deutsche Bank and Commerzbank — the lowest and third-lowest banks in stock value in Europe — are trying to merge, which is about as gross as watching slugs mate. What do megabank mergers get you but more slime? How can anyone think that, if you take two corrupt institutions that are already deemed way too big to fail and that have lost control of themselves and combine them into a larger monstrosity, this is going to turn out well?
But that is the lunacy of our world. That is all we’ve done with banks since the Great Recession — take banks that we were all told were “too big to fail” and make them twice as big by smashing them together. The general populace has let it happen because they’ve chosen to believe their leaders know how to get them through this, but their leaders do not even have their best interest at heart. They love bankers.
From “buy the dip” to “sell the rip,” sentiment has flipped
Buy the dip as a strategy is no longer working:
When ten years of something works and then it doesn’t, it makes investors feel like they are coming out hibernation into a frosty world.
How bad is mood? Well, even the Powell Put last month, when the Fed implied it is nearing the end of its interest-rate increases, didn’t stop the market from falling for more than a few days. Of course, that is because their interest-rate targets are irrelevant so long as they are unwinding their balance sheet in order to suck money out of the system. With that huge vacuum pump running, the Fed’s stated interest targets merely keep their stated goals up with where the market is naturally taking interest anyway, and the Fed has made no mention of stopping the Great Recovery Rewind.
With a growing chorus of investors and analysts arguing that the Fed as [Sic.] already made financial conditions too restrictive, its policy of reducing its balance sheet month after month may become of increasing concern…. “When the Fed announced QT, they very effectively communicated to the market that this would be a program on autopilot…. But that doesn’t mean we wouldn’t hit a level where QT has a real, negative impact” on both the stock market and the economy, he said. “We may have reached that point already.” (MarketWatch)
No kidding. I said we would by this fall, and here we are. But I don’t think the Fed has figured this out yet. It still thinks it can simply stop raising its interest target if the economy slows too much while it continues reducing money supply. It seems to have forgotten that it originally bought bonds in order to drive down long-term interest rates, so naturally rolling them off, is going to drive up long-term interest. (Someone needs to knock on their wooden heads to see if they are hollow.)
One of the factors that I have said will make this a crash and not just a correction is that momentum of a falling market will get ahead of the Fed. If the Fed responds to an economic downturn, it’s likely to keep its rewind running and just back off its stated interest targets. That will be a huge operating error. (So far nothing in any Fed speech sounds like the Fed is even thinking of stopping the unwinding of their balance sheet.) Moreover, changes the Fed makes have about a half-year lag time in how they affect the overall economy. So, the whole economy can be off a cliff before the Fed even knows what it has caused. (As the Fed says, it has no crystal ball and is data dependent. With a half year lag time on the data it uses to make its decision, it is usually late in acting.)
Bear in mind, also, that a rise in bond interest does not just impact stock values by making bonds more competitive with stocks, it also lowers corporate earnings, one of the main benchmarks by which stock valuations are measured as to whether they are too high or too low. Higher interest on corporate bonds for highly leveraged corporations (and they are almost all levered up) quickly eats away at earnings.
That is why investors are worried about a Fed policy error; but a data-dependent Fed (if the Fed is what it always claims to be), is not going to respond to market sentiment because sentiment is not data. So, panic will run way out ahead of the Fed’s reaction time.
MarketWatch reports that individual stock investors haven’t felt this bearish since 2013 when the US government got its credit rating downgraded because Republicans under John Boehner decided to play games of brinksmanship with the US debt. (I said two weeks ahead of the downgrade their game would certainly cause a downgrade.) Some analysts now see signs of panic in sentiment readings:
Expectations that stock prices will fall over the next six months, jumped 18.4 percentage points to 48.9% in the seven-day period ended Wednesday…. That’s the highest since … April 11, 2013, and marks the 10th straight week bearish sentiment was above the survey’s historical average of 30.5%.
“Fund-flow” data proves this sentiment is operative; that is to say, money is moving at a fearsome rate out of stocks and into cash — not just bonds, but even lower-interest, safer “cash.” Some fools will tell you that panic is the most bullish sign there is. That’s utter nonsense. Panic is panic. It is what makes markets crash in the first place, and this drop is barely getting started. Panic is not a bullish indicator until it has run its course. Permabulls look for excuses to entice you into buying stocks, so they point out that markets only turn bullish when panic rules the day. Well, of course! What they don’t say is that being bearish means panic is ruling the day!
Their fake wisdom is like saying, “Markets only recover when bear markets have reached their lowest point (exhaustion of highest panic).” True, but they can fall in panic a long way before panic is exhausted. Everyone talking bearish doesn’t mean the market is likely to rise. Everyone talks bearish anytime the market is falling off a cliff. This one hasn’t even gotten to panic level yet. That’s why bull markets are typically long and bear markets typically shorter. Fear is faster than hope. It gets the job done.
That said, the weekly outflows from US stock funds are already the fastest ever! ($46 billion in one week. Whoohoo!) We’ve just crested the top into fear, but look at what waits on the other side:
That’s going to be fun!
To put that roller coaster in graph form, here are the likely stopping points for the market’s bear run:
Whether the market just reverts to the mean or drops to the last highs, that’s a long way to fall. And, then, what if it does like it did in the Great Recession and drops to the previous floor? Oh my gosh!