Here’s Why the Stock Market Is Tanking
Friday, October 5, 2018 16:17
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“Here’s Why the Stock Market Is Tanking”
by Brian Maher
“The Dow Jones shed some 300 points between Wednesday afternoon and yesterday’s close. The rout was on again today – down another 180 points. What sudden noise has startled the horses – a new salvo in the trade war? The latest ‘scandale politique?’ A fresh outburst of geopolitics? No, no and no again. Then what?
The answer arrives by way of the bond market – specifically the Treasury market. Yields on the bellwether 10-year Treasury note have broken out since Wednesday, like an army that has broken the enemy’s center after a long stalemate. From 3.05% Tuesday afternoon, yields have galloped ahead to a current 3.22% – their highest point since 2011.
Not much difference between the two figures, you say. The big deal is what? In nominal terms, little. But this is a market that generally moves by the millimeter rather than the inch or the foot. The recent activity is a pandemonium. But why now?
Bedazzling private-sector unemployment data and record service-sector numbers came out Wednesday. The extravagant numbers feed the predominant narrative of an “overheating” economy. Record-low unemployment also suggests inflation is finally coming to its legs – according to mainstream analysis anyway. Rising inflationary expectations mean the market in turn expects the Fed to respond with further rate hikes.
But why should rising rates flabbergast the stock market? If the Federal Reserve must raise interest rates to throttle an overheating economic engine, so much the better. It keeps the engine humming at a nice, pleasant purr… and the economy at a safe speed. The stock market should jump – not fall backward.
Ah, but as with much pertaining to the dismal science of economics, the business is… complicated. The field is a bedlam of half-truths, conditional truths, on-the-other-hands, maybes and maybe nots, sometimes yeses and sometime nos. No iron linkage joins the stock market and the bond market. They may rise or fall in unison, or individually – depending.
Rising 10-year rates are generally bullish for the economy, as stated. But comes a point when the bull tail wind turns to bearish head wind. For an economy fattened on cheap debt, rates above a certain point begin to tug. Rising interest rates elevate the cost of debt. Loan repayments overburden corporate shoulders. Earnings suffer.
Rising rates also put drag on the overall economy. Mortgages become dearer, new loans wither, auto sales slip, credit card rates sting that much harder. Rising Treasury yields also take the legs from beneath the stock market. They draw investors away from stocks into the safer waters of the bond market.
Explains Tim Ghriskey, managing director at Solaris Asset Management: “What it says, in general, is that higher interest rates make stocks look more expensive, especially relative to a fixed-income alternative. Once yields rise to a certain level, stock investors begin to get attracted to low-risk bond yields instead of higher-volatility stock investments.”
But at issue is not so much the rising Treasury yields in themselves… but the pace. The stock market seems at peace with a gradually rising yield. But a sudden jump its stomach cannot hold down. As explains “The Heisenberg” of the eponymous Heisenberg Report: “The problem, as ever, is that there’s a fine line between “good” rate rise and “bad” rate rise, where the latter is indicative of an inflation shock, sharply tighter financial conditions and/or both. When it comes to delineating between “good” and “bad,” there’s obviously no set rule, but the pace matters. Rapidly rising yields over a short time frame [could lead to] a simultaneous sell-off in stocks and bonds.”
February’s “correction” is instructive in this regard. Ten-year Treasury yields had been on a steady march in the space prior. The stock market shrugged its shoulders. Then a gangbusters jobs report came out indicating surging wages. Markets glimpsed the specter of approaching inflation. Treasury yields went skyshooting. Too much, too fast, said the market. And the thumping 11% correction was underweigh.
So the question becomes: Will the latest spike lead to another correction? At this point the current yield spike almost perfectly matches the jump that led to February’s fireworks. Deutsche Bank’s Aleksandar Kocic estimates the “red zone” – where surging 10-year yields threaten stocks – ranges between 3.20-3.70%. In reminder, the 10-year rate is presently 3.22%. In the danger zone, that is. Slow down, says the stock market. Will the bond market listen? To be determined…
Below, Jim Rickards shows you how trade wars, currency wars and interest rates are all related. He also shows you that so many credit crises are brewing “it’s hard to keep track without a scorecard.” Read on.”
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“Trade Wars, Currency Wars and Interest Rates Are All Related”
By Jim Rickards
“The currency wars began in January 2010 with President Obama’s State of the Union address and his declaration of a National Export Initiative. The trade wars began in January 2018 with President Trump’s imposition of tariffs on solar panels, appliances and aluminum, mostly from China and South Korea. The tightening of monetary policy began in December 2015 with Janet Yellen’s “liftoff” in interest rates and October 2017 with the start of Fed balance sheet reduction called “quantitative tightening,” or QT. All three policies have important implications for global investors. But what do they have to do with each other?
There is a close-knit relationship among trade wars, currency wars and monetary policy that has dire implications for emerging markets and could lead to another global monetary crisis worse than 2008. When countries are losing in the trade wars, they can fight back by cheapening their currencies to reduce unit labor costs to offset the higher prices from tariffs. Countries can also fight the currency wars by tightening or loosening monetary policy as a way to attract or fend off international capital flows into their markets.
The currency wars, trade wars and interest rate wars are all just forms of market manipulation conducted by central banks and finance ministries under the guise of “policy.” The problem is that as big countries like the U.S., China and German duke it out in these financial manipulations, the emerging markets are caught in the crossfire and end up as collateral damage. As the world learned the hard way in 1997–98, what happens in emerging markets does not stay in emerging markets. Through financial contagion, an emerging-markets liquidity crisis can take the world by storm and affect advanced-economy capital markets also.
Crises are never the same twice, but they do have much in common. A replay of the 1998 crisis on a scale larger than 2008 could be starting in front of our eyes in places like Argentina, Turkey and Indonesia.
But in reality, so many credit crises are brewing, it’s hard to keep track without a scorecard. The mother of all credit crises is coming to China with over a quarter trillion dollars owed by insolvent banks and state-owned enterprises, not to mention off-the-books liabilities of provincial governments, wealth management products and developers of white elephant infrastructure projects.
Then we have the U.S. student loan debacle, with over $1.5 trillion in outstanding debts and default rates approaching 20%. Next comes a new warning about so-called “junk bonds.” We’re facing a devastating wave of junk bond defaults. In fact, the next financial collapse, already on our radar screen, will quite possibly come from junk bonds.
Let’s unpack this… Since the great financial crisis, extremely low interest rates allowed the total number of highly speculative corporate bonds, or “junk bonds,” to rise about 60% – a record high. Many businesses became highly leveraged as a result. There’s currently a total of about $3.7 trillion of junk bonds outstanding. And when the next downturn comes, many corporations will be unable to service their debt. Defaults will spread throughout the system like a deadly contagion, and the damage will be enormous.
This is from a report by Mariarosa Verde, Moody’s senior credit officer: “This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default. A number of very weak issuers are living on borrowed time while benign conditions last. These companies are poised to default when credit conditions eventually become more difficult. The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.”
Many will be caught completely unprepared. Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”
The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the over-leveraged banking sector. Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not.
Meanwhile the Fed is raising interest rates. It’s also undertaking QE in reverse by reducing its balance sheet and contracting the base money supply. As you know, this is called quantitative tightening, or QT. Credit conditions are already starting to affect the real economy. New cracks are appearing in emerging markets, as I mentioned. I also mentioned that student loan losses are skyrocketing. That stands in the way of household formation and geographic mobility for recent graduates.
Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch. Now we have a new warning about a market crash from an impeccably credentialed mainstream economist.
Robert J. Shiller is one of the most highly regarded economists in the world today. He’s a winner of the Nobel Prize in economics and co-inventor of the Case-Shiller housing price index that is a widely cited indicator of expansion or distress in the housing market. He is also the inventor of the CAPE ratio (cyclically adjusted price-earnings ratio). The CAPE ratio uses long-term earnings instead of short-term to spot stock market bubbles. It has a much better track record than typical Wall Street analysis at predicting downturns. Most famously, Shiller was one of the few economists who warned of the 2007 mortgage market collapse and the 2008 financial panic.
Shiller is one of my favorite economists because he’s not afraid to throw off conventional models and to develop new models that do a better job of forecasting. His latest warning is one that investors cannot ignore. Shiller is once again warning of the potential for a stock market meltdown. In particular, Shiller shows that any slowdown in earnings could reveal a stock market bubble that will pop suddenly and unexpectedly.
Shiller contends that investors have too much confidence in projections of higher earnings as far as the eye can see and should be more concerned with the cyclicality of earnings and the prospect of a recession or earnings slowdown in the not-distant future. Investors who listened to Shiller in 2007 had time to avoid massive losses. It may be a good idea to listen to him again.
It doesn’t matter where the crisis begins. Once the tsunami hits, no one will be spared. The stock market is going to correct in the face of rising credit losses and tightening credit conditions. No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act.”
Source: http://coyoteprime-runningcauseicantfly.blogspot.com/2018/10/heres-why-stock-market-is-tanking.html
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