We have been
discussing (in the most critical way possible) the Central Banks all over the world for the past 16 years. In fact, a journalist called us this past
January and asked what we thought of the stock market? We responded that we expected the stock
market to decline sharply during the year 2016 as the Fed raised rates.
The journalist countered that every time the Fed raised rates in the
past the stock market still did quite well.
So far the journalist has been correct and we have been wrong. We believe this will change again within the
next few months since the Fed will be forced to finally reverse the damage done over the past 8 years.
We tried to
explain to the journalist that we are presently in a completely different
situation than we were in the past, when the stock market rose as the Fed
raised rates because the economy was doing well and/or there were inflationary
risks. Now we have gone through QE1,
QE2, QE3, and “Operation-Twist” where we drove rates down to zero (ZIRP), or
close to it for the past 8 years. This
time the Fed has grown its balance sheet from about $800 bn. to over $4.5
tn. This enormous amount of money has to
be eventually wound down. This injection
of money printed by the Fed has not driven us into an inflationary bubble
because there is very little “velocity” (the pick-up of transactions). The injection of money does not lead to
inflation since the money printed by the government or Fed does not get the
public to spend the money and they save it instead. This is called a “liquidity trap”, which is what
Japan went through for the past 27 years.
The high debt that we have generated, as well as Japan, has caused a
deflationary environment, which neither one of us seems able to achieve any
type of “escape velocity”.
This time is
also different from the past rate hikes since now our Fed is about to raise Fed
Funds right into the face of a manufacturing recession (down for over 6
quarters in a row). We also are
threatening to raise rates right into the face of virtually every other central
bank that is still in the loosening phase of printing more money and lowering interest
rates. All this while we are about to
tighten by increasing rates and raising the value of the US dollar. And because of the US dollars rise and
continued rise as we raise rates, it will be more difficult to compete with our
trading partners and lower our exports.
Most of our trading partners are participating in a race to the bottom,
as they do whatever they can to lower their currency in order to sell more
goods and services to the US.
given this journalist at least 4 more reasons why we believe the increase in
rates will lead to a bear market for US stocks.
Right now, we would have to admit it looks like the journalist was right
this past January. At first, we looked
like geniuses as the US stock market dropped sharply in January. However, we
still think we will win the prediction contest with the journalist (but maybe a
little later this year or early next year).
The reason we haven’t been accurate is because there were no interest
rate increases since we essentially made the challenge to whether the US market
would rise or fall with the interest rate hike that was expected. Remember, in December of 2015 Stanley Fischer
predicted that there would be at least four interest rate hikes in 2016. So far, there were frequent predictions by
voting members of the Fed that they would be voting for increases. In fact, at the latest meeting there were 3 dissenters
who voted against passing up the increase in rates. We do believe there will be enough votes to
raise rates this December, and that is when we will reverse our losing ways
with the journalist. This past month 3
Fed officials stated that we should hike the rates because they are worried
about already keeping the rates far too low for too long. They were all worried about the risk of
financial instability. We will have to
see how it works out, and will let you know as we continue to believe we will
win the so called “bet” with the journalist as soon as we start tightening,
while every other central bank is driving rates lower or even into negative
territory. As we stated before, we
believe all the central banks are guessing at the new made up remedies, that
have never been tried before, and will result in “unintended consequences” that
could be disastrous.
Our debt (helped by the central banks), as
well as Japan and the rest of the world, will eventually drive us into a global
deflationary debacle. We would put the
probability of inflating our way out of this mess at about 30 % and continuing
to fall into a deflationary global bear market at about 70%. Please keep in mind the debt is not just our
national debt of $20 tn. but the total debt of over $100 tn. if you include the
promises made by the government of Social Security, Medicare, Medicaid, and the
promises of pensions to Federal employees.
Our Fed and
other Central Bankers have been propping up financial markets all over the
world. But now that there are record
outflows of equity mutual funds, all bond funds, and other actively managed
funds, there will be nobody (including the Central Banks) remaining to buy the
financial assets as the money is going into ETF’s, savings accounts, and under
their mattresses. There is no one left to buy as the selling increases and
there are record low amounts of insider buying and corporate borrowing to buy
shares to increase earnings per share by lowering the number of shares
outstanding. This could turn out to be a
bear market worse than 2000-2001 and 2007-2008.