Getting into a sports stadium is always easier than getting out. Unless you leave early.
The stockmarket is much the same. Up the escalator and down the elevator is the mantra describing the nature of the stockmarket’s booms and busts. Slow and steady bull markets followed by sudden crashing bear markets. And that’s what’s happening right now.
The FTSE 100 is down about 10% for the year so far. We’ve lost all the gains of 2017 in the space of a two-month dip. But if you take a longer view, there have been plenty of similar tumbles since 2009.
So is this just another test? Or a real bear market?
But why are markets crashing? Is it trade wars? Brexit? Perhaps stocks just got too expensive and they’re due for a correction. Bearish fund manager David Rosenberg summed up the list of problems and where he thinks they leave us on Twitter:
Hmmm. Let’s see. Tariffs. Sharp bond selloff. Weak dollar policy. Massive twin deficits. New Fed Chairman. Cyclical inflationary pressures. Overvalued stock markets. Heightened volatility. Sounds eerily familiar (from someone who started his career on October 19th, 1987!).
1987 saw an epic crash in stockmarkets.
But which of those factors is causing stocks to decline now? The answer is, who cares? Only one of those factors really matters in the end. And not because it could cause a stockmarket crash. But because it’s the only one preventing such a crash.
The cause of stockmarket crashes used to be important. They’d tell you a lot about how bad things would get. And which assets are due for the biggest falls.
But these days, the crash potential isn’t measured by the problem. It’s measured by the solution. How and when will central banks and governments act?
Back when Alan Greenspan, Ben Bernanke and Janet Yellen were in charge, the market needed to establish the strike price of their put too. Let me explain…
A put option is a bit like insurance on the stockmarket. It pays out if markets fall beyond a certain level. Central bankers have a habit of behaving in much the same way as a put option. They’re willing to tolerate stockmarket plunges. Up to a point. Then they start to interfere to prevent them.
The Greenspan Put was uncovered in 2000. The Bernanke Put in 2008. The Yellen Put pushed the market up countless times. But now that there’s a new chairman at the Fed, we have a new put – the Powell Put. The problem is, we don’t know where the strike price is – the point at which the put becomes active.
If the market is testing Jerome Powell’s patience, the question about how bad the crash will get comes down to his personal preference. It sounds ridiculous, but that’s always the nature of central planning. The whims of our Dear Leader determine stockmarket returns.
QE still drives the stockmarket
Actually, I have it backwards. The stockmarket drives quantitative easing (QE).
Central banks around the world are still printing money like mad. They know the façade of recovery rests on them.
And they’ve declared themselves “data dependent”. This means they’re reacting to information, not being proactive. Economic data will determine monetary policy.
The trouble is, most economic data takes a long time to filter through. We didn’t know the US was in a recession until about a year into it in 2007. Monetary policy played catch-up.
But the stockmarket is supposedly forward-looking. And so is the yield curve. Are they signalling recessions by taking a turn for the worse? And will central bankers respond to their predictions by delaying the end of QE?
If central bankers act now by extending QE, they’re fighting the symptoms instead of the cause of the problem. So that’s a bad idea too. An idea which delivers stockmarket bubbles.
The inherent problems with monetary policy are a long list. But right now, they’re all that’s keeping the economic and financial world together. That’s not a good foundation.
So what are the risks?
In a world where an institution with an infinite budget can buy financial assets to try and achieve market stability, how can a crash happen?
The answer is, it’ll happen in the currency instead. And that’s code for the bond market.
If a nation is simply going to print enough money to float stockmarkets and bond markets, then the value of the money that will repay those bonds will fall. Investors will flee. Especially because bonds are a promise to pay back devalued money in the future.
For now, bonds remain bid. The world still fears the old style of reckoning. Corporate defaults, stockmarket crashes and more. Bonds seem like the safe place to be in that environment.
The irony here is that a crashing bond market may well sink stocks too. That’s what happened in southern Europe. Companies have leveraged up as much as mortgage borrowers in 2006 alongside nations.
That’s why, in the end, no market is safe. And least of all, this one.
Until next time,
Capital & Conflict
“Nothing shocks this market…”
Category: Central Banks