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Written by: Adam Taggart For ten long years, the world’s central banks have dragged everyone along for one last attempt at scaling Mount Credit.At several points along the way, in 2011, in 2013 and then again in 2016 it seemed all but certain that the wrong route had been picked and all was lost. We warned people then about the risks, but to no avail. They found a way to navigate even higher from there.And here we are again in 2018, warning everyone of the same risks. Starting back in August of 2018 we were questioning whether “it” had arrived and then were declaring that it had throughout October and November.“Until and unless” the central banks reverse course 2019 will see even more of the same. More stock market volatility, more bond losses, and falling real estate. Eventually these credit stresses will impact those portions of the economy dependent on continued access to more dumb money.Weak companies that cannot sustain themselves without borrowing more will go out of business and lay people off. Major corporations seeing that writing on the wall will reel in their own hiring and expansion plans.Eventually all the of the highly leveraged trading strategies have to pack up shop and go home and that’s when we discover that these “markets” are as fake as a spray on sun tan. No actual liquidity, only the appearance of such as temporarily afforded by all the computer algos out there.In a very successful attempt at holiday season humor, the Wall Street Journal finally noted that the equity markets had become dominated by computer algos, a fact we noted – oh – 7 years ago: Behind the Market Swoon: The Herdlike Behavior of Computerized Trading Dec 25 th , 2018 Behind the broad, swift market slide of 2018 is an underlying new reality: Roughly 85% of all trading is on autopilot—controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast. “Electronic traders are wreaking havoc in the markets,” says Leon Cooperman, the billionaire stock picker who founded hedge fund Omega Advisors.Behind the models employed by quants are algorithms, or investment recipes, that automatically buy and sell based on pre-set inputs. Lately, they’re dumping stocks, traders and investors say. “The speed and magnitude of the move probably are being exacerbated by the machines and model-driven trading,” says Neal Berger, who runs Eagle’s View Asset Management, which invests in hedge funds and other vehicles. “Human beings tend not to react this fast and violently.” ( Source )That’s funny! 10 years of steadily rising “markets" driven by these algos and the WSJ was entirely unconcerned. Now that stocks have been shown to also go down , suddenly the impact of these algos is very concerning to the WSJ. No worries as long as these programs are whipping prices higher, but a lot of concern when they amplify the moves down.Well, better late than never.Our concerns about “markets” so dominated by trading programs are that they are too easily subject to (1) manipulation and (2) sharp sudden movements that could, someday, result in markets being shut down due to lack of participation because the algos found conditions “out of parameter” and they up and left in the literal blink of an eye.If we needed any further confirmation of just how dangerously volatile the markets can be when driven by these automatic trading routines, then Christmas week certainly provided it.On Christmas Eve the US stock markets dropped more than they ever had. Then the day after Christmas the Dow went up more points than it ever had. The next day it swung an additional 900 points, and rather violently upwards mainly in the last 1.5 hours of trading.
From oversold to overbought to oversold to overbought all in 48 hours.
This is akin to what happens to a car that enters a skid and an inexperienced driver first over-corrects one way and then another with each oscillation become larger and less controllable. Eventually the car lands in a ditch and the ride is over.Is this happening now? We think so.
And it’s the perfectly natural and expected outcome of too many years of increasing central bank intervention aimed at preventing the very thing we now face.Again, this chart explains everything we have been experiencing in financial “markets” (now so grotesquely distorted by such interventions that price discovery has been almost entirely destroyed):
In every case so far, every attempt to halt QE has resulted in a Wall Street hissy fit and a lot of crybabies in the investing world demanding that the central banks reverse course. And each time they did, and it worked for a little bit longer.So here we are, and everybody wants to know what comes next.That’s easy. Until and unless the central banks reverse course, once again, and make the next round of QE even larger and more bigly than any previously, we’ll see lots of declines in financial asset prices. Only this time? It won’t be constrained to falling stocks – it will envelop everything.A Fed Too Far
Crass, and vulgar, and utterly indefensible. That’s the only way to describe the combined “leadership” of Ben Bernanke and Janet Yellen who conspired to throw an entire generation under the bus, along with the elderly on fixed incomes and savers too.Millennials were locked out of first time homebuying by an interventionist Fed that decided all on their own that those already living in houses should be made to feel wealthier by virtue of rising home prices.Instead of noting that the 2001 – 2007 housing bubble was a very bad idea, the Fed printed up $1.75 trillion of fresh money to buy mortgage paper and help drive house prices right back up towards their silly, ill-advised peak.
Houses, over the long term, should appreciate in line with inflation, no more no less. Anything above that green box means house prices have gotten ahead of themselves, and below means they’ve fallen too far.But the Fed decided, all on its own, that the prior peak was a good thing and needed to be replicated as soon as possible.The idea here was morally bankrupt as it was illogical. The Fed thought that people living in houses with rising prices would experience a “wealth effect” and therefore both borrow and spend more, which would somehow be a good thing.The illogical part is not hard to work out. If you are already living in a house, and you have to live in one anyway, are you truly wealthier if it goes up in price? Obviously the answer is no, and a tiny bit of thought reveals the opposite.The only way to tap that wealth, without borrowing against it, would be to sell your expensive house and downsize or move away to a cheaper location. Moving nearby to an equivalent house does nothing for you expect waste realtor and other transaction fees. A more expensive house defeats the strategy entirely.Otherwise, living in a more expensive house costs you more in terms of insurance and property taxes. That is, it makes you poorer, not wealthier.Only in stupid-banker land does a liability that drains more cash from your pocket count as an asset. As Robert Kiyosaki has stressed in every lecture he’s given over the past 25 years, the house you live in is not an asset.Roofs need replacing, electricity and oil are consumed, painting and mowing and plowing are all part of simply preventing this thing from rotting straight away into the ground. Mortgage interest, insurance and property taxes have to be paid or you will quickly lose ‘your’ house to some authority or another.You see any cash flying into your pockets during any of that? Me neither.Therefore your house is a liability. Assets are things that put cash in your pocket, liabilities take cash out. I don’t know about you, but my house is far from perfect except when it comes to taking cash out of my pocket. There it’s batting 1.000Hence, Robert Kiyosaki is right; the house you live in is a liability, not an asset. How does someone become richer if they borrow more against their money pit? Well, that’s the entire centerpiece of the Fed’s decision to drive house prices up. It makes you richer. That’s their whole plan, laid bare.Now a cash flowing rental property, either residential or commercial, is another matter entirely. Those areassets. Lever up for those! Borrow away. We’ll be holding a Real Estate investing webinar in January so keep an eye out for that and be sure to sign up.The immoral part of the Fed’s decision to drive up house prices has two parts. The smaller part concerns the immorality of encouraging people to go deeper into debt (refi’s, HELOCS, etc.) by leveraging a liability. Bankers not should but do know better.The larger part centers on forcing an entire generation (e.g. Millennials) to either skip buying a house because they can’t afford one, or to buy a more expensive house than they can reasonably or comfortable afford.Put simply, the Fed threw an entire generation under the housing bus just so that the older folks could feel a little better about the price of their already purchased and lived-in home and maybe spend a little more. It’s no different than setting your house on fire because you are a tiny bit cold.This was crass, and vulgar, and utterly indefensible.It’s Over
After ten long years of steadily rising equity markets, or ““markets”” as we like to call them to denote their fictitious and often fraudulent nature, something approximating volatility has returned here very late in 2018.As we head into 2019, we’re expecting to see a lot more volatility and even more losses as reality once again steps back into vogue. It never really left, of course, only was kept away for a while with monetary Botox administered by self-delusional bankers and politicians unable to face their many failures directly.Every recovery eventually ends and this one is no different.In our view, however, any recovery built on a foundation of cheap credit will not only end but end badly. This is easy to understand in neighborhood terms.Suppose you and your neighbor both earn $100,000. Next year you both still earn $100,000 but your neighbor borrows an additional $25,000 on their credit card to spend on things like a gardener, a boat, and a couple of trips.The way the government records things your neighbor had their personal economy expand by 25% and that's a very good thing. Neither the US government nor the Federal Reserve bother to back out the borrowing when they count up economic activity.Of course, they should, because all borrowing really represents is future consumption taken today. Your neighbor, when they have to pay back that $25,000, plus interest, will have to forego that amount of future consumption to pay back the debts.How dumb is it to not factor out borrowing when considering economic activity? Fantastically dumb.Here’s what happens to US GDP growth when just the increase in the federal debt is taken out:
This is why the ‘recovery’ is not really a recovery. It’s not based on anything organic or healthy. It’s simply borrowed and all borrowing sprees eventually come to an end.Looked at from a stock market perspective, here’s what central bank inspired credit cycles look like:
Or we could rotate it and look at it from the perspective of debt accumulation:
( Source)The above chart is a head scratcher. Whenever that line is moving upwards, it means that debt growth is outpacing economic growth (and remember, debt’s effect on GDP is not factored out, so it’s even worse than what you are seeing here).What’s the plan here? Continue to pile up debt at a faster pace than economic growth forever? What about the idea that economic growth has slowed of late and cannot grow forever for resource related reasons? Is anybody in power paying even the slightest bit of attention?Most importantly, what happens when ~40 years of excessive debt accumulation comes to an end? Do financial systems and institutions even function anymore?Nobody has a good answer to those questions, which is why the Federal Reserve, et al., are terrified to find out what happens when their grand debt bubble experiment comes to an end. Mad max is not out of the question folks. A lot of things very suddenly no longer work when the credit not only dries up, but goes in reverse. Very basic things like food and gasoline distribution networks and public safety payrolls become difficult to maintain. Just ask Venezuela.Until and unless the central banks do something very, very different in the months ahead, it’s over.