Waiting for the blow-off top

Nick Hubble

The American stockmarket chalked up the longest rally in history yesterday. The former record bull market, from 1990 to 2000, delivered 417% in returns compared to today’s 323%.

But we’re not finished yet.

Market peaks tend to feature blow-off tops. That’s a sudden surge in price before the crash. It’s the parabolic final increase that is the real warning signal.

Minds have already turned to what triggers the crash. You know my prediction by now.

But my mind is still wrestling with what I told attendees at our October 2017 conference. What problems can the world throw up that money printing can’t solve?

With central banks and government plunge protection teams around the world increasingly buying shares, can there be a crash in the stockmarket?

The same goes for sovereign bonds, of course. And corporate bonds too.

Crashes in asset markets seem to have become a policy decision. How bad do policymakers let things get before they step in?

To the point of Bear Stearns, Lehman Brothers or Wells Fargo?

Do they allow a 20-year bear market like in Japan before buying up stocks?

Which countries get a bailout, and when? Greece may be too big to fail but small enough to rescue. Is Turkey? Italy?

How far do European Central Bank (ECB) policymakers let Italian bonds tumble to bring the populist government into line?

How stressed do banks need to become for bailouts?

And when do voters signal they’ve had enough, forcing a change in policy? Is it at the point they vote to leave the EU? At the point they elect anti-immigrant parties like in eastern Europe? Anti-euro parties like in Italy? Parties with very nasty histories like next month in Sweden? Perhaps at the EU parliamentary elections in May?

I can’t wait to see how the Italians vote in May…

The policymakers deciding the future of financial markets must be petrified by their responsibility.

Imagine the consequences of another rout like 2000, 2008 or 2011. Would pensions hold up? Would banks stay solvent? Could sovereign bonds remain a risk-free asset under their debt loads? Could people afford homes and basic spending if interest rates jump? What would happen to property prices if they can’t?

Where would politics take us if any of these things happened?

Clearly, a crash is not politically permissible. Bailouts, stimulus, quantitative easing and negative interest rates are very much on the table. Everything is. Anything else is too.

The more power given to central banks and politicians, the more we seem to look to them when things go wrong. But our problems only grow under their solutions.

Countries with too much debt are increasing their debt loads. Our dependence on stockmarkets for retirement is only increasing around the world. Low interest rates may rescue borrowers, but they sacrifice savers. Inequality is increasing as asset values explode with central bank inflation.

The posterchild of policymaking failure is Greece. Ambrose Evans-Pritchard has an absolutely devastating discussion of Greece and its bailout in the Telegraph today. The prospects look worse than ever.

The half-hearted claims of victory at the International Monetary Fund (IMF) and EU must be making Greek political blood boil. And the rest of Europe is watching whether the next debt victim will line up for the same treatment.

Old policies for new problems

The Greek tragedy puts on display that the world has changed deeply in several important ways.

With workforces from China to Europe shrinking, economic growth will be hard to come by. The confusion of a stock and a flow is crucial here. It’s a typical mistake for non-economists that leads to misunderstandings.

GDP is not a stock. We don’t have it each year and then build upon that. If the workforce stopped working, our GDP wouldn’t flatline, it’d fall to zero.

GDP is a flow, which we must regenerate each year. GDP growth is a misleading term because it’s a higher total level of activity, not an increase of something fixed.

Debt is a stock. We have it. It’s fixed. The debt load would still be there tomorrow if 30% of the workforce disappeared. As it will in Greece from 2020 to 2060.

So think about the debt-to-GDP ratio in a world where the working population is shrinking. The debt stock is fixed in the sense that the past amount of debt is still there at the end of each financial year.

Meanwhile, the GDP used to pay that debt is getting harder and harder to regenerate, let alone grow, for the smaller and smaller workforce.

In a world where GDP growth is hard to come by, for whatever reason, debt is a far bigger problem than before.

But the key point is that waiting it out isn’t going to work like it used to. The economy will not just inherently grow in the end thanks to population growth. Keeping the debt stock steady and waiting for the problem to fix itself isn’t going to deliver the result we expect.

These are the sorts of things that the Troika’s models would not have taken into account. Because it’s a new problem to every country except Japan.

Evans-Pritchard has an extraordinary quote where the IMF’s own economist explains the result of all this:

“It has been an enormous policy disaster,” said Professor Charles Wyplosz, the expert brought in by the IMF’s watchdog to review the sorry episode. “People compare this to the Great Depression in the Thirties but that was a nice walk in a beautiful forest by comparison. Nothing like this has ever happened before to a developed economy.

“When the crisis began in 2010 the debt ratio was 120pc of GDP. Eight years later it is 180pc and the Greek economy has shrunk by a quarter. The outcome is as a bad as it could possibly have been, and the problem is certainly not solved. If you cook the assumptions, you can claim anything is sustainable.

“What the Europeans have now done is put Greece to sleep under anaesthesia but when the people wake up and feel the pain they are going to be very angry. Economically it is nonsense, and politically it is shameful.”

Which way will the anger flow?

So far, the political backlash to the economic problems has focused on things like immigration.

In Greece and Italy, it also focused on the EU, ECB and euro. The IMF was harshly criticised in its own internal review for failing to address this. The 2016 Telegraph headline read: “IMF admits disastrous love affair with the euro and apologises for the immolation of Greece”.

You might’ve noticed that European nations are at the centre of this whole discussion. The reasons are simple. Demographic change is playing out there.

But, more importantly, the ECB faces much tighter legal limits on monetary policy than other central banks. Combine that with the euro’s one size fits all exchange rate and monetary policy and you can see why the single currency gets so much blame.

I think the blame is justified. But it doesn’t matter what I think. It matters what Italy’s politicians think. Because they’re the next to test the IMF, EU and ECB’s metal.

Starting this October. Which is why I’ve called an emergency investors broadcast next Wednesday. I’m going to explain why I’m worried the next financial crisis is about to begin… and no one is warning investors about it.

It’ll be free to view. But you’ll need to register. Watch out for more information about that over the weekend.

Until next time,

Nick Hubble
Capital & Conflict

Category: Market updates

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