Recently, there has been a parade of central bankers along with their lackeys on Wall Street coming on the financial news networks and desperately trying to convince investors that there are no bubbles extant in the world today. Indeed, the Fed sees no economic or market imbalances anywhere that should give perma-bulls cause for concern. You can listen to Jerome Powell’s upbeat assessment of the situation in his own words during the latest FOMC press conference here. The Fed Chair did, however, manage to acknowledge that corporate debt levels are in fact a bit on the high side. But he added that “we have been monitoring it carefully and taken appropriate steps.” By taking appropriate steps to reduce debt levels Powell must mean slashing interest rates and going back into QE. The problem with that strategy being that is exactly what caused the debt binge and overleveraged condition of corporations in the first place.
The US stock markets have surged to all-time-record highs, fueled by extreme Fed easing. It jawboned about rate cutting, slashed rates, and birthed a new large-scale Treasury monetization campaign! All this has left traders hyper-complacent, assuming the upside will continue indefinitely. But are these lofty stock levels fundamentally-justified? The big US stocks’ just-reported Q3’19 results illuminate this key question.
Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Required by the US Securities and Exchange Commission, these 10-Qs and 10-Ks contain the best fundamental data available to traders. They dispel all the sentiment distortions inevitably surrounding prevailing stock-price levels, revealing corporations’ underlying hard fundamental realities.
The deadline for filing 10-Qs for “large accelerated filers” is 40 days after fiscal quarter-ends. The SEC defines this as companies with market capitalizations over $700m. That easily includes every stock in the flagship S&P 500 stock index (SPX), which contains the biggest and best American companies. The middle of this week marked 37 days since the end of Q3, so almost all the big US stocks have reported.
What are we to make of Wall Street’s exuberance on Friday over news concerning a U.S. economic expansion that refuses to die? Employers are hiring, consumers are spending and business is humming despite a dramatic economic slowdown in Asia, Europe, South America and elsewhere. Perhaps America really is an economic island, one blessed with unstinting support from a central bank that has finally succeeded in taming the business cycle? If you are too young to remember the last three or four recessions, you might actually believe that things are different this time.
Wall Street Journal columnist David Harrison evidently does. Judging from his picture, Harrison appears to be no older than 30, so we can perhaps forgive him for suggesting, to borrow Prof. Irving Fisher’s immortal declaration, that economic equilibrium appears to have reached a permanently high plateau.
This ageing bull market may soon face the third market collapse since the year 2000. Nobody can predict the exact starting date of its decline—but either a recession or stagflation will surely be its catalyst. During the next debacle, the typical balanced portfolio designed by Wall Street, which consists of approximately 60% stocks and 40% bonds, will no longer provide much protection at all. In fact, that type of portfolio construct has become downright dangerous.
The simple reason for this is that for the first time ever both stocks and bonds are in a massive and unprecedented bubble; and are therefore both vulnerable to significant selloffs. Bonds will no longer provide a ballast or offset to your stock portfolio once reality hits both of those asset classes. If a bond has a 5% yield and has 30 years left to maturity; that holder would lose 25% of his principal if interest rates rise by just 2%. Given the fact that bond yields are the lowest in history, an increase of 2% is certainly not out of the question; and is in fact most likely inevitable.
We talk a lot about the falling interest rate, the too-low interest rate, the near-zero interest rate, the zero interest rate, and the negative interest rate. Hat Tip to Switzerland, where Credit Suisse is now going to pay depositors -0.85%. That is, if you lend your francs to this bank, they take some of them every year. Almost 1% of them.
A bank deposit comes with a risk. But instead of compensating you for the risk, the bank pays you nothing. So it’s a return-free risk. And worse than that, a negative rate means that you are paying the bank in order to take the risk of lending to them.
The music died many times in the past. To name a few:
- 1929 Market crash
- 1933 President Roosevelt confiscates citizen gold and declares it illegal to own more than a few ounces.
- 1971 President Nixon “closed the gold window” and severed the last link between the devaluing dollar and gold.
- 1987 Stock market crash
- 2000 Stock market and “dot-com” crash
- 2008 Stock market and housing crash
- 2019? Stock market and “everything bubble” correction/crash
- 2020-2025? “Inflate or Die” QE, bond monetization, helicopter dollars etc.
The main stream financial media is absolutely ebullient about global central banks’ renewed enthusiasm to cut interest rates to a level that is even lower than they already are. And, most importantly, Wall Street is completely confident that theses marginally-lower borrowing costs will not only be enough to pull the global economy out of its malaise; but will also be sufficient to provide enough monetary thrust to blow asset bubbles into the thermosphere.
However, the truth is Fed stimulus does not always work. This was the case during both 2000 and 2008. A significant amount of rate cuts was not enough to avert a recession and also did nothing in the way of preventing the stock market from collapsing.