1,000 Foot View
Is the world coming to an end? It would seem so as we watch the market take a nose dive, only to rebound in what seems nothing more than a “dead cat” bounce. So why all the turmoil, volatility, and radical markets? We can certainly try to point our finger at one thing or another – much like the talking heads on TV trying to explain each day, why on that day, the market is moving. But rather than trying to find scape goats or make sense of each stock tick, stepping back and taking a broader view – the 1,000 foot view – is usually the only way to understand what is going on. There are certainly catalyst events, but the catalyst event may only be triggering a far larger underlying problem.
1,000 foot view
All too frequently we take granular views and try to extrapolate why the market is behaving this way. The problem with making an assumption on such a narrow focus is that you may miss the big picture. A Labor Report, Earnings in a big company, a move in interest rates, or some geo-political announcements are all just catalyst – the proverbial straws if you will. No one single event is the cause, but rather the triggering mechanism that can start a watershed moment. We must understand that the water and the dam have always been there.
Courtesy of FRED
We tend to ignore the dam and the massive amount of water behind it. As long as it holds, we don’t seem to care or even pay attention to its existence. It is not until the dam breaks or the water overflows that we quickly realize the problem.
Courtesy of wikipedia
If you only follow the media or what I like to call “short-sighted blame-game economist” – Keynesians for short, you would think it is someone or somethings fault at that moment. As if the massive dam of water was never to blame. To hear supposed well-respected economist state something along the lines, well it wasn’t a problem until XXXX happened – sounds as idiotic as it is short-sighted. Feel free to read Paul Krugman’s ideological hell-bent blame gaming column in the NYT if you want to know whose fault it is (never a Democrat or Liberal by the way). Yet he would never admit the massive dam trying to hold at bay the trillions of debt and liabilities of the government and Federal Reserve as ever being a culprit.
Courtesy of FRED
The 1,000 foot view?
So what does it look like from the 1,000 foot view? If one were to be objective (admittedly hard to do) we would see a currency war based on the need to spur inflation through devaluation. Nation after nation trying to devalue and inflate their currency against their neighbor in an effort to spur borrowing (debt financing) and boost exports. It is one thing for one nation to do it in a more stable geo-economic environment. Japan has been doing it for decades and become the sole source of cheap money (Carry Trade). However, when more nations pile into the devaluation intervention game – it becomes a problem.
At first – after the crisis – the Western nations (Japan, England, ECB, and U.S.) started with their central bank intervention; zero interest rates, bond buying, mortgage buying, money printing, etc. Japan had already been doing it, but the rest of the West jumped in and thought – hey it worked for Japan and they haven’t blown up, so let’s jump off the Keynesian cliff too. It worked or seemed to and a big thanks was China – who continued to expand from 2008 – 2014. Certainly their expansion slowed, but they were able to take up the slack in growth as the West stalled.
China’s boom and massive growth (thanks to the billions of consumers) became the sole source of floating the rest of the world. In the last few years they have surpassed us in almost every category; computer sales, smart phone sales, car sales, luxury sales, etc. More millionaires and billionaires being created than anywhere in the world. A massive population being introduced for the first time to debt consumption.
Meanwhile the U.S. and the West became reliant on Fed interventionism. Cheap money (low interest rates) and the central banks monetizing their own government deficit spending allowed the governments to continue to spend and consumer’s straddled with debt to increase their leverage.
What many fail to realize is that after the crisis of 2008-2009 the West never really took a loss. We never deleveraged or allowed those that needed to fail, to actually fail. Instead the central banks and governments jumped in and bailed out everyone. The debt was moved from the private to public sector and with zero interest rates, the government did everything to try to spur more borrowing (debt) to create more spending to boost the economy.
Expanding on Debt
Technically for the last almost 8 years we have been expanding on debt financing, not REAL revenue growth. One only has to look at earnings, same store sales, and net growth, couple that with wage growth and consumer debt and it is very clear. The West is not seeing any REAL growth and hasn’t. Any growth has been based on the expansion of MORE debt. Those that were already maxed out in 2008-2009 never recovered and those that didn’t continued to borrow more.
The Class Warfare we hear so much about from Politicians is based solely on debt. The crisis is what created the decline of the middle class. The vast majority of the middle class, were nothing more than the over-leverage debt class. Those that were straddled with too much debt vs. income ended falling out of the middle class, those that had a lower debt to equity ratio and enough income to finance debt, stayed or moved up. Unfortunately the vast part of our middle class population was part of the debtor nation.
So what has changed now?
China can only carry the West’s water for so long. They will continue to grow, but with everything you hit a maximum penetration rate. Once everyone has an iPhone that is going to buy an iPhone, then growth slows and becomes reliant on those iPhone users wanting to upgrade. China over the last decade has started hitting their maximum penetration consumption rate in several categories and continued growth (while strong) is never going to be in that 10+% range.
So companies are faced with a problem, where to go to find NEW consumers? It will be a while, but I think South America, India, Indonesia, and more importantly Africa (all large population centers) in the decade to come will be the new growth centers. However, that is not going to happen today or tomorrow, they still need to build infrastructure and create a business friendly welcoming environment. Stability helps as well.
The Fed expectation
The Fed has set the tone that they are Hawkish, raised rates at the end of last year and the media (and market) believe they are going to continue to raise rates this year.
I fall into the minority camp.
First there is not one Hawk that is a President appointed governor, not one. So it is silly to assume that any of these governors, who have lived and breathed Keynesian Dovish ideology all their lives is now all of a sudden a Hawk. Of course we could hope they have had a real coming-to-Jesus moment and realized that massive intervention of trillions of dollars doesn’t solve anything, but creates only bigger bubbles – but I highly doubt that.
Second, the governors are all appointed by President Obama, are all firmly democrats and liberals. They are certainly not going to let the economy and stock market crash heading into the election year. Perhaps they are going to let the market sell-off at the beginning of the year and then step in with more stimulus, lower rates, and more interventionism come the fall into the election – to give the market a big rally and boost economic data headlines. They do have some time.
Lastly, they are mortally afraid of deflation. While I don’t see deflation as a risk at all – in fact I believe that government headline data (primarily the CPI, PPI, and PCE) are masking the real problem and that is the specter of inflation and very high inflation. As I pointed out in the past, M2 money supply continues to grow and the velocity of that money slows. If that money starts flowing and velocity picks up – we could see inflation come on fast, perhaps as fast as the 1970s. The Fed would be in a real jam if that happened. So while they are scared of deflation and glued to monitoring PCE, PPI, and CPI data (all of which do not accurately report inflation to begin with), the real sh#t show is going to be inflation.
Courtesy of FRED
1,000 foot view conclusion
We are running out of debt and leverage – period, end of story, done! The Fed and the West can buy some more time, lower interest rates – even negative. They can, like Japan, actually start buying into the stock market to prop it up. They can, have, and will continue to print more money and offer more stimulus and bailouts. However, there is no one left to carry the water of growth as both the public and private sector is straddled with mounting debt and are having the most difficult time expanding their debt and getting access to credit.
As long as the Keynesians rule the economic engine of the ever growing Socialist movement, we will live in a society in which deficit spending at all costs is used to fuel economic growth (until it can’t). That has never worked throughout history and they have all ended in fire or ice. Of course their mentor, Lord Maynard Keynes, famously said, “In the long run we are all dead!” Just like those that say, “You can’t take it with you!”, Keynes knew that to mean debt as well. A very selfish outlook and one that only punishes the next generation and further breeds socialism.
Every nation in the history of civilization that has tried to devalue (print) their way to prosperity has failed.
As Voltaire said, “All paper money eventually returns to its intrinsic value… zero!”
Courtesy of wikipedia
Note Voltaire lived through the France’s repeated experiments of fiat currency – all of which failed during his life time.
Support & Resistance
Can we hold and close at 16,000. It think it would be hard pressed to look for any real consolidation without extreme volatility at this point. A visit to 15,800 or even down to 15,600 before we find buyers step in is a real consideration.
I am not sure if we can hold there, I would watch the close. Remember we visited 3,800 is rapid succession before we saw any rally. So expect volatility.
I would think the 1860 – 1900 range is a consolidation range, while wide and volatile. However 1860 looks like a critical low support reach mid-last year before support was found. If we can’t hold there, expect a further drop.
My real concern is the Russell which is the best gauge of market order flow. We haven’t been this low since mid-2013. That’s right we are in a bear market when measuring the broad market and 2.5 years of gains are wiped out. If we can hold we could see a step down to 950, 900, 850 – before we see any real money flowing back in. I am not sure how low we can go – but the Russell’s sell off is something to pay attention to. The narrower based indices can only rely on their over-weight stock so much.
As I have mentioned on numerous occasions, it is always better to hedge positions. While it is not a guarantee from loss, it will certainly mitigate loss and allow YOU to sleep at night. Our primary fund (KFYIELD) has been over-hedged since November and has profited, only because we have been over hedged. It is nice to know our partners, including myself, is profiting in this market volatility.
It’s not that I predicted this decline, but we did realize it was possible and decided to over insure.
If your broker, your financial advisor, or you don’t know how to hedge positions – then you need to find someone that does. It is these times, they earn their money. Anyone can make money when you are long in a bull market, only a handful can keep you from losing or make money in a bear market. Seek those people out. Their knowledge will save you money and sleep.