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May 24, 2018

Discover Who’s Been Swimming Naked as the Tide Is Going Out


YOUGHAL, IRELAND – The Dow turned down a bit. The 10-year Treasury yield held at 3.07%.

As long as neither revisits its recent top and bottom, respectively, we presume the “primary trend” for both the bond market and the stock market is down.

Everything else is just noise.

Bad Guy Syndrome

We have been exploring the “bad guy” syndrome. The U.S. has invaded 70 countries since its founding. Modern Iran: zero.

The U.S. has weapons of mass destruction and has proven that it is ready to use them; it dropped an atomic bomb twice – both times on civilians.

Iran has no atomic weapons. The U.S. has troops in Afghanistan and Iraq, within easy striking distance of Iran… and now makes demands that no self-respecting sovereign nation would ever accept.

Iran has no troops in Mexico or Canada… no way to attack America… and makes no demands of it.

So who’s the bad guy? It doesn’t matter what we think. But what do the gods think?

We’ll come back to that question tomorrow.

Rabble-Roused

In the meantime… let’s stick with the primary trend. If the primary trend for equities really is down… we are unlikely to make any money in stocks for the next 10 or 20 years… at least.

It takes that long for a bear market to run its course. Individual stocks may go up. But, unless you are lucky or very well-advised, they won’t be the stocks you own.

Nominal prices may go up, but after you adjust for inflation, you will see that you have lost money.

And if the primary trend in bonds is also down, you should get out of the credit market… and stay out… for the rest of your life.

It takes a lifetime for the credit market to complete a full cycle. So we are unlikely to see another top. We’ll be lucky if we live to see another bottom; it might come in 10, 20, or 30 years.

Investors take a beating in a primary bear market in stocks. But a primary bear market in bonds is like being a prisoner in Guantanamo – painful, humiliating, and frightening.

A Fed report out yesterday tells us that 40% of households cannot raise $400 for an unexpected emergency. One out of five cannot pay its monthly bills.

What will happen to these people when interest rates rise and easy credit disappears?

Businesses close. Households go broke. The desperate rabble gets roused and the feds panic…

And then, the torturer gets out the torch and pliers.

Swimming Naked

Yesterday came more revealing news. The Financial Times was on the story:
China’s shadow banking sector has been a major source of speculative lending to the global economy. But 2018 has seen it entering its endgame, collapsing by 64 percent in renminbi terms in January to April from the same period last year (by $274 billion in dollar terms)…

Mr. Xi clearly knows he faces a tough battle to rein in leverage, given the creativity that has been shown by the banks in ramping up their lending over the past decade. The stimulus programme has also created its own supporters in the construction and related industries, as large amounts of cash have been washing around China’s property markets, and finding its way into overseas markets.

But Mr. Xi is now China’s most powerful leader since Mao, and it would seem unwise to bet against him succeeding with his deleveraging objective, even if it does create short-term pain for the economy as shadow banking is brought back under control.

Essentially, therefore, China’s lending bubble is now history and the tide of capital flows is reversing. It is therefore no surprise that global interest rates are now on the rise, with the U.S. 10-year rate breaking through 3 percent. Investors and companies might be well advised to prepare for some big shocks ahead. As Warren Buffett once wisely remarked, it is “only when the tide goes out, do you discover who’s been swimming naked.”

Asset prices float on a sea of liquidity… credit pumped into the markets by central bankers.

But now, all of the world’s major central banks – with the exception, possibly, of the Bank of Japan – are taking their hands off the pump handle or actually draining out cash and credit.

The Fed is tightening up… raising its key rates in quarterly 0.25% mini-steps.

The Europeans are preparing to end their quantitative easing program as control of the bank moves to the Germans.

The Bank of England has shifted to a neutral policy.

And China, as seen above, is turning off the cash and credit.

Patrick Artus, an analyst with Natixis, puts the world’s total monetary base at about $24 trillion. It’s been growing for the last 10 years at a double-digit rate.

As of March of this year, it was still increasing at a 13% annual rate over the previous 12 months. This is the money that has kept the Dow riding high and that sent it over 26,000 in January.

But now, the 38-year-old tide has turned.

Over the next 12 months, Artus estimates liquidity growth of only 3%, not nearly enough to sustain financial markets or the economy.

So cover your eyes, Dear Reader. The water is receding. You are about to see some hideous sights.

Courtesy of Bill Bonner, Bonner & Partners (More articles here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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