“Close the Whole Thing Up”

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“If this doesn’t work,” wonders Seema Shah, Principal Global Investors central strategist…

“What will?”

“This” is of course the Federal Reserve’s desperate harum-scarum yesterday afternoon.

Mr. Powell and crew knocked down rates one entire percentage point. The federal funds rate now squats between 0% and 0.25% — zero essentially.

And so as a dog returneth to its vomit… the Federal Reserve returneth to zero.

The scoundrels of Zero Hedge label it part of the “the biggest emergency ‘shock and awe’ bazooka in Fed history.”

But we are not shocked. Nor are we awed.

Our only surprise is the scheduling — our hazard was a return to zero later this week.

Yet the business was so urgent, all hanging in balance… it could not even wait for this week’s formal FOMC confabulation (now canceled).

Not Just Rate Cuts

We were further informed yesterday that quantitative easing (QE) is commencing anew.

The Federal Reserve will purchase “at least” $500 billion of United States Treasuries — and $200 billion of mortgage-backed securities — $700 billion in all.

We are betting high on “at least.” This merely represents the opening installment.

The Federal Reserve is also extending fresh ratlines — our apologies, swap lines — to foreign central banks.

That is intended to maintain dollar liquidity against the global coronavirus delirium presently obtaining.

Greg McBride, Bankrate chief financial analyst, in summary:

The Fed is dusting off the financial crisis playbook, returning to bond buying, coordinating with other global central banks to provide access to U.S. dollar liquidity, cutting interest rates to zero and opening the Fed’s discount window to ensure the flow of credit through banks to consumers and businesses.

“It’s really great for our country,” gushed the president.

But is it? Did yesterday’s “shock and awe” bazooka blast score a hit?

It did, yes. A direct hit — to the wrong side.

Shocked and Awed…

Stock futures went careening last evening, so shocked, so awed were they. They promptly went “limit down.”

The future arrived this morning at 9:30 Eastern. And markets remained shocked and awed…

The Dow Jones plunged nearly 10% from the opening whistle. The S&P and Nasdaq followed in lockstep.

Once again the breakers tripped… and trading was suspended 15 minutes.

“The central banks threw the kitchen sink at it yesterday evening, yet here we are (with deep falls in stock markets),” yelled Societe Generale strategist Kit Juckes.

“This is what panic looks like,” hollered Patrick Healey, president of Caliber Financial Partners.

Yet we are not surprised. Markets can see the beads of perspiration forming about Mr. Powell’s forehead. Markets are flighty birds easily frightened.

And what telegraphs fear more than a “shock-and-awe bazooka”?

The shock and awe deepened throughout the day…

Another “Worst Day Since Black Monday”

We grow weary of repeating it. But the Dow Jones once again suffered its mightiest whaling since Black Monday, 1987.

The index gushed another 2,997 points today to close at 20,188 — giving back another 12.93%.

The S&P lost 325 points, or 11.98%. The Nasdaq, 970 points and 12.32%

And so additional trillions of stock market wealth vanish into the electricity, lost.

Losses accelerated towards day’s end. Why?

Late this afternoon the president said the “worst of the outbreak” could stretch into August.

Fear gauge VIX went skyshooting to 83 today — within shouting distance of its record 90 from October 2008.

And so we return to our opening question:

“If this doesn’t work… what will?”

Alas, the question is easier asked than answered…

“Just Close the Whole Thing up”

One CNBC host even suggests shuttering Wall Street. Shrieks Mr. Scott Wapner:

How are folks supposed to focus on trading stocks when they’re dealing with nervous kids out of school, spouses working from home and scrambling to keep up, all while managing their own anxieties? Just close the whole thing up and start again later. It’s the right thing to do.

It may be the right thing to do or the wrong thing to do. Regardless, it has been done before.

The stock market was suspended 10 days during the panic of 1873 — and four entire months at the outset of the First World War.

Examples abound. Most recently in October 2012 when a hurricane, Sandy by name, closed the market two days.

But now the Federal Reserve confronts a different variety of hurricane…

“Very Serious Trouble”

“The Fed is now in very serious trouble,” gulps Graham Summers of Phoenix Capital — whom we recently introduced to you, our reader.

“Put another way,” he continues…

The Fed has gone truly NUCLEAR with monetary policy… and the market is STILL imploding…

The Fed can do NOTHING to stop this. No amount of rate cuts or stimulus from the Fed will make people want to go out and spend money if the country is on lockdown/facing a health crisis triggered by a pandemic.

The country is indeed verging upon a lockdown of sorts…

National Lockdown

The Centers for Disease Control and Prevention has recommended that all sizable gatherings and events be “postponed” for the following eight weeks.

New York, New Jersey and Connecticut — home to a fair number of Americans — have taken aboard its counsel.

All gatherings of 50 persons or greater thus are banned.

We remind you that restaurants frequently entertain crowds exceeding 50. As do other dens of vice including drinking establishments, casinos, theaters, concert halls, ballparks, gymnasiums and houses of worship — to name some.

Houses of ill repute, we assume, must ration admission ruthlessly… else court the wrath of the law.

New Jersey residents are now confined to barracks between 8 p.m. and 5 a.m. All travel is “strongly discouraged,” save in emergency.

Other States Follow

Meantime, Illinois bars and restaurants will close to the public beginning tonight. Their doors will not reopen until March 30.

Delivery and takeout services are available, however, as they are in New York, New Jersey and Connecticut.

Washington state has followed their example. As has the great state of Michigan. As has our own state of Maryland.

Massachusetts has exceeded even CDC’s draconian limit of 50. Gatherings of 25 or more are presently forbidden in this, the cradle of American liberty.

Meantime, over 30 million students in at least 31 states are exiled from the classroom. The Ohio governor has suggested his state’s may not come back until autumn.

Even the Supreme Court of the United States will no longer hear arguments — until early April at the earliest.

Do not forget, six of nine justices are aged 65 or above. And the coronavirus harbors a savage antagonism toward the elderly.

Thus a grateful nation is insured against a potential holocaust of justices.

A Ban on All Air Travel?

And now… rumors are on foot that a complete ban on domestic air travel is under active consideration.

We have assigned our men to investigate.

Regardless, the airlines are suffering damnably. Delta Air Lines claims conditions are worse than even the Sept. 11 afterblow.

“The speed of the demand fall-off is unlike anything we’ve seen,” laments Chief Executive Officer Ed Bastian.

The airline has gutted operations some 40%. And 300 planes are tied down to the tarmacs.

Meantime, all American cruise liners will remain tied up to the piers for 60 days.

A bailout of the air and cruise lines is on the way — depend on it.

So too, perhaps, is a bailout of the American citizen…

$1,000 Check Every Month

Sen. Mitt Romney (R-Utah) proposes to hand every American adult $1,000 per month so long as the coronavirus rages.

Reads a press release under his name:

Every American adult should immediately receive $1,000 to help ensure families and workers can meet their short-term obligations and increase spending in the economy.

Of course, the money must originate somewhere… as the government has none of its own.

In many cases it would amount to lifting money out of a fellow’s back pocket and lowering it into his front pocket.

But crises bring forth ideas that would never get a hearing otherwise. Many are of course lunatic.

Americans would acclimate rapidly to the monthly stipend. Who would take it away from them once the all clear signal goes out?

This is an election year, do not forget, when votes go up for sale. A monthly check can purchase many.

“The Worst Is yet Ahead for Us”

But just when might the coronavirus lose its stranglehold on American life?

“The worst is yet ahead for us,” warns Dr. Anthony Fauci of the National Institutes of Health.

We hope the fellow is mistaken.

We further hope the worst is behind for markets.

But we fear the worst is ahead for the economy.

And so again we ask:

“If this doesn’t work… what will?”

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Will Coronavirus Usher in the “Reign of Saturn?”

This post Will Coronavirus Usher in the “Reign of Saturn?” appeared first on Daily Reckoning.

“There are decades where nothing happens; and there are weeks where decades happen” — said a man named Lenin.

This week has the color of a week where decades happen.

The stock market has withstood its lightningest plunge in history…

The aerial ways to Europe are closed…

Hand sanitizer is more precious than oil…

Disney World has locked its gates…

Universities, high schools, grammar schools and grade schools have locked their doors…

Broadway is dark…

Professional sports leagues have put the balls away…

“March Madness” has been canceled.

Instead, an alien madness stalks the land — the coronavirus madness.

North to south, east to west… even to ships asea… the fever builds.

And today the president declared a national “state of emergency.”

Forty-seven states and the District of Columbia have now reported coronavirus infections. Each day brings fresh cases.

How many Americans might it ultimately hook? The possible answer shortly.

Ironic, it is, that America’s biggest monster is visible only through a microscope.

Yet we fear the unseen greater than the seen…

The enemy bomber turns up on radar. The plunging barometer alerts you to the storm. The onrushing train does not approach in silence.

These are observable menaces. Since observable, defensible.

But the black bugaboos of night, the phantom-haunted shadows, the stealthy spirits of the air…

These unseen terrors fetch us most.

And an invisible fee-fi-fo-fum — like a lethal virus — is potentially everywhere at once.

Every person you encounter is a potential executioner, every surface you touch may harbor a plague.

The air itself may carry you to your grave.

Communists lurked beneath every bed once upon a time in America. The “Red Scare,” it was called.

Today we verge upon the “Invisible Scare.” But is it unjustified?

We know nothing of epidemiology… and would prefer to know even less.

But we have had our best men look into it. And they report that medical professionals — of highly sober aspect — give ominous warnings.

A certain Dr. Brian Monahan is the attending physician of Congress. This fellow has informed the Senate that 70–150 million Americans — one-third of the population — may potentially come down with the coronavirus.

If fatality rates run as low as 1%… the pathogen could claim 1.5 million American souls.

Yet our agents report scenarios suggesting the virus may invade up to 214 million Americans.

The variables are many. Much depends upon preparation.

The final death roster may run anywhere from 5,000… to 5 million… depending.

But assume for the moment the virus slips its leash…

Workplaces shutter, the truckers stay home, supply chains snap and the shelves go bare in the supermarkets.

Perhaps one month of shattered commerce could result in a general discombobulation.

What might happen?

Writer Brandon Smith sketches the scene in dark colors:

When the public can’t find an open grocery store, then you will see panic. When there are checkpoints in and out of major metropolitan areas stopping people from leaving if they have any symptoms of illness, then you will see panic. When COVID-19 continues to circulate through the population for a year or more and does not disappear during the summer months as some people theorize, get ready for anger and panic.

When your local banks announce a financial “holiday” for an unspecified amount of time because of a credit crisis and lack of liquidity, and all the ATMs are shut down, then you will see panic. When crime rates explode because of lack of supplies and people start fighting over access to the meager food lines… THAT will be panic.

And don’t think for a second that this is not possible in this country, because it absolutely is. All it takes is for the global supply chain to break down for one month and there will be chaos like nothing the average person has seen in their lives.

Alarmist? Perhaps it is.

And we do not believe the virus will rout us in the manner suggested. Yet…

How many truly anticipated 1987’s Black Monday? Or 1929’s Black Tuesday?

How many anticipated Donald Trump’s presidency of the United States?

Indeed… how many anticipated the coronavirus… or that the United States would fall under a state of emergency today?

“You think that a wall as solid as the Earth separates civilization from barbarism,” writes author John Buchan...

“I tell you the division is a thread, a sheet of glass. A touch here, a push there, and you bring back the reign of Saturn.”

Who is prepared for the reign of Saturn?

Below, Jim Rickards takes you to the year 2026. He reflects upon the great Panic of 2024… and a world drastically changed. Could it happen? You be the judge. Read on.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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R.I.P.: Requiem for a Bull

This post R.I.P.: Requiem for a Bull appeared first on Daily Reckoning.

For the longest bull market in history… it is a time to die.

For the Dow Jones, aged 11 years and two days, the soul quit the body yesterday afternoon.

Immediate cause of death: coronavirus disease (COVID-19).

Underlying cause of death: irrational exuberance.

The sickness was brief, acutely brief — a mere 19 days.

Only in November 1931… in the teeth of the Great Depression… did the index plunge from record heights to bear market depths in so short a space. Such was the violence of the death spasm.

Both S&P and Nasdaq joined it in the morgue this afternoon.

And so the flags over Wall Street flap at half mast today… and the black crepe is up.

Yet as we have argued previously:

The stock market is an ingenious device constructed to inflict the greatest suffering upon the most people… within the least amount of time.

In Memoriam…

The eulogies have already come issuiwwng…

Linda Zhang is chief executive officer of Purview Investments. Says she, a pearl of sorrow coursing down her cheek:

This bull market will go down in history as the one that nobody believed would last this long… What destroyed us in 2008 was overleverage. What brought us to where we are in 2020 is too much hope, sky-high valuations.

Doug Ramsey is chief investment officer of Leuthold Group. This fellow labels the late lamented decade the “steroid era” of the stock market — and identifies the supplier:

It was the most hated bull market — people said that early on. I think in the middle of the decade people [got] on board. Certainly in the last year they became believers. I’d also call the whole decade the steroids era because of all the help out of the Federal Reserve. I think it certainly did get a lot of help from the Federal Reserve. This was the steroids era of the stock market — the Fed propped it up.

Will the Federal Reserve attempt to blow life into the deceased? And how long can you expect the bear’s market to run?

Possible answers below.

But the exuberant, marauding bears desecrated the corpse this morning — before the Dow’s body was cold…

Another 15-minute Trading Halt

Within minutes of the opening whistle… the poor Dow Jones plunged another 1,700 points into eternity.

The S&P plummeted 7%, overloading the circuits and tripping the breakers — for the second instance this week.

For another 15 minutes the markets suspended breath.

Why this morning’s fresh stampede out?

The President Fails to Inspire Confidence

Apparently the president’s fireside chat last evening inspired little confidence. It failed to indicate a government response equal to the crying need.

Fifteen minutes after this morning’s halt, markets reopened for business. They should have remained closed…

The rout promptly resumed.

The market — meantime — places 83.4% odds the Federal Reserve will hatchet rates to between 0% and 0.25% next week.

That is, to financial crisis levels.

But dare we ask… is the worst over?

“You Likely Have not Seen Anything Yet”

“You likely have not seen anything yet,” wails Eric Parnell of Global Macro Research:

A potentially great fall lies ahead. Unfortunately for investors, conditions for the stock market have the potential to get worse, much worse, in the intermediate term. And all of the king’s policy horses and all of the king’s policy men may not be able to put this market back together again when it’s all said and done…

In short, you likely have not seen anything yet when it comes to today’s stock market.

After years of policy stimulus, stocks are trading at record-high valuations and bond yields are at historic lows. It is only a matter of time before reality returns to global capital markets.

But the coronavirus may merely be the tip of the berg that has gashed this Titanic down deep…

Think Lehman Bros.!

Phoenix Capital’s Graham Summers, introduced here this week, argues the bulk of the berg is invisible:

Now, let’s talk about the REAL crisis that is hitting the financial system…

[Global] debt-to-GDP is north of 200%. Leverage is higher today than it was in 2007. And the world is absolutely saturated in debt on a sovereign, state, municipal, corporate and personal level.

However, everything was running smoothly as long as nothing began to blow up in the debt markets [or] credit markets.

And despite a few hiccups here and there, the debt markets have been relatively quiet for the last few years…

Not anymore.

Someone or something is blowing up in a horrific way “behind the scenes.”

The Fed was FORCED to start providing over $100 BILLION in free money overnight back in September 2019. And even that massive amount is proving inadequate…

[Two nights ago], the Fed was forced to pump another $216 BILLION into the system.

You don’t get those kinds of demands for liquidity unless something is truly, horrifically wrong.

Think: LEHMAN BROS.

But we suppose that is why the Federal Reserve answered the klaxons this afternoon, dripping icy sweat…and rounded into action…

QE4 Is Here

Shortly after 1 p.m., it announced it is hosing in a staggering $1.5 trillion of liquidity today and tomorrow.

Between September and December it expanded its balance sheet at a rate unseen even during the financial crisis.

But the flow was but a trickle compared to the torrent on tap:

IMG 1

What is more, the Federal Reserve will conduct purchases across a “range of maturities.”

A full range of maturities includes longer-dated Treasuries. Thus it can no longer deny it has resumed quantitative easing…

Its purchases since September centered exclusively upon shorter-term Treasuries. Since QE targeted long-term Treasuries, it could throw out a smokescreen of deniability.

But no longer. Thus today we declare the onset of “QE4.”

The Rescue Doesn’t Hold

The drowning stock market seized upon the life ring thrown its way. And it rapidly made good half its losses on the day.

But it began to lose its purchase on the ring, on life… and resumed its slide into depths.

The Dow Jones finally settled at 21,200 by closing whistle — a 10% loss on the day — its worst since Black Monday, 1987.

Perhaps history will label this date “Gray Thursday.”

The S&P hemorrhaged an additional 9.51% on the day; the Nasdaq 9.43%.

The Leaders up Are Leading the Way Down

Are ruptures within the credit markets why stocks continue plunging, Mr. Summers?

This is why the markets are failing to rally. It is why every major central bank is out talking about launching new aggressive monetary policies. And it is why the Fed is privately freaking out.

Below is a chart showing [a proxy for] the credit markets (black line) relative to the stock market (red line).

As you can see, the credit market led stocks to the upside during the bull market. And it is now leading stocks to the downside. Credit is already telling us that stocks should be trading at 2,600 or even lower.

IMG 1

This is a real crisis. And from what I can see, the Fed can’t stop it anytime soon.

The Fed’s One Option

But if the prospect of rate cuts and additional QE cannot hold the line… does the Federal Reserve wield any options at all?

So what could stop this?

A globally mandated intervention in which the Fed and other central banks start buying corporate debt.

However, in the U.S., the Fed CANNOT buy corporate debt…

It would need authorization from Congress to do so. And from what I can tell, no one is even suggesting this.

I don’t mean to be a fear-monger, but this is a very dangerous situation.

We would have to agree. It appears a very dangerous situation.

But how long can you expect the bear’s market to endure? The answer in one moment.

But first… will the Federal Reserve actually attempt to reanimate the corpse?

Perhaps not.

The Fed Wants to End the Market’s Dependency

As our own Charles Hugh Smith claimed in a recent reckoning, it has grown fearful of the monstrous bubble it inflated.

But it did not wish to shoulder blame for draining the air out.

Thus the coronavirus has done it a great service by seizing the sharpened pin.

And it may not wish to risk blowing another bubble. Do we speculate?

No. Here former Dallas Federal Reserve President Richard Fisher speaks for himself:

The Fed has created this dependency…

The question is do you want to feed that hunger? Keep applying that opioid of cheap and abundant money? The market is dependent on Fed largesse… and we made it that way…

But we have to consider… that we must wean the market off its dependency on a Fed put.

The question is worth considering. But how long can you expect this bear to run amok?

Here is the answer, says history:

Roughly seven months for the S&P… and perhaps nine months for the Dow Jones.

Of course it could end sooner. But it could also end later.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Complex Systems Collide, Markets Crash

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At some point, systems flip from being complicated, which is a challenge to manage, to being complex. Complexity is more than a challenge because it opens the door to all kinds of unexpected crashes and events.

Their behavior cannot be reduced to their component parts. It’s as if they take on a life of their own.

Complexity theory has four main pillars. The first is the diversity of actors. You’ve got to account for all of the actors in the marketplace. When you consider the size of global markets, that number is obviously vast.

The second pillar is interconnectedness. Today’s world is massively interconnected through the internet, through social media and other forms of communications technology.

The third pillar of complexity theory is interaction. Markets interact on a massive scale. Trillions of dollars of financial transactions occur every single day.

The fourth pillar, and this is the hardest for people to understand, is adaptive behavior. Adaptive behavior just means that your behavior affects my behavior and my behavior affects yours. That in turn affects someone else’s behavior, and so on.

If you look out the window and see people bundled up in heavy jackets, for example, you’re probably not going to go out in a T-shirt. Applied to capital markets, adaptive behavior is sometimes called herding.

Assume you have a room with 100 people. If two people suddenly sprinted out of the room, most of the others probably wouldn’t make much of it. But if half the people in the room suddenly ran outside, the other half will probably do the same thing.

They might not know why the first 50 people left, but the second half will just assume something major has happened. That could be a fire or a bomb threat or something along these lines.

The key is to determine the tipping point that compels people to act. Two people fleeing isn’t enough. 50 certainly is. But, maybe 20 people leaving could trigger the panic. Or maybe the number is 30, or 40. You just can’t be sure. But the point is, 20 people out of 100 could trigger a chain reaction.

And that’s how easily a total collapse of the capital markets can be triggered.

Understanding the four main pillars of complexity gives you a window into the inner workings of markets in a way the Fed’s antiquated equilibrium models can’t. They let you see the world with better eyes.

People assume that if you had perfect knowledge of the economy, which nobody does, that you could conceivably plan an economy. You’d have all the information you needed to determine what should be produced and in what number.

But complexity theory says that even if you had that perfect knowledge, you still couldn’t predict financial and economic events. They can come seemingly out of nowhere.

For example, it was bright and sunny one day out in the eastern Atlantic in 2005. Then it suddenly got cloudy. The winds began to pick up. Then a hurricane formed. That hurricane went on to wipe out New Orleans a short time later.

I’m talking about Hurricane Katrina. You never could have predicted New Orleans would be struck on that bright sunny day. You could look back and track it afterwards. It would seem rational in hindsight. But on that sunny day in the eastern Atlantic, there was simply no way of predicting that New Orleans was going to be devastated.

Any number of variables could have diverted the storm at some point along the way. And they cannot be known in advance, no matter how much information you have initially.

Another example is the Fukushima nuclear incident in Japan a few years back. You had a number of complex systems coming together at once to produce a disaster.

An underwater earthquake triggered a tsunami that just happened to wash up on a nuclear power plant. Each one of these are highly complex systems — plate tectonics, hydrodynamics and the nuclear plant itself.

There was no way traditional models could have predicted when or where the tectonic plates were going to slip. Therefore, they couldn’t tell you where the tsunami was heading.

And the same applies to financial panics. They seem to come out of nowhere. Traditional forecasting models have no way of detecting them. But complexity theory allows for them.

I make the point that a snowflake can cause an avalanche. But of course not every snowflake does. Most snowflakes fall harmlessly, except that they make the ultimate avalanche worse because they’re building up the snowpack. And when one of them hits the wrong way, it could spin out of control.

The way to think about it is that the triggering snowflake might not look much different from the harmless snowflake that preceded it. It’s just that it hit the system at the wrong time, at the wrong place.

Only the exact time and the specific snowflake that starts the avalanche remain to be seen. This kind of systemic analysis is the primary tool I use to keep investors ahead of the catastrophe curve.

The system is getting more and more unstable, and it might not take that much to trigger the avalanche.

To switch metaphors, it’s like the straw that breaks the camel’s back. You can’t tell in advance which straw will trigger the collapse. It only becomes obvious afterwards. But that doesn’t mean you can’t have a good idea when the threat can no longer be ignored.

Let’s say I’ve got a 35-pound block of enriched uranium sitting in front of me that’s shaped like a big cube. That’s a complex system. There’s a lot going on behind the scenes. At the subatomic level, neutrons are firing off. But it’s not dangerous. You’d actually have to eat it to get sick.

But, now, I take the same 35 pounds, I shape part of it into a sphere, I take the rest of it and shape it into a bat. I put it in the tube, and I fire it together with high explosives, I kill 300,000 people. I just engineered an atomic bomb. It’s the same uranium, but under different conditions.

The point is, the same basic conditions arrayed in a different way, what physicists call self-organized criticality, can go critical, blow up, and destroy the world or destroy the financial system.

That dynamic, which is the way the world works, is not understood by central bankers. They don’t understand complexity theory. They do not see the critical state dynamics going on behind the scenes because they’re using obsolete equilibrium models.

In complexity theory and complex dynamics, you can go into the critical state. What look like unconnected distant events are actually indications and warnings of something much more dangerous to come.

So what happens when complex dynamic systems crash into each other? We’re seeing that right now.

We’re seeing two complex systems colliding into each other, the complex system of markets combined with the complex system of epidemiology.

The coronavirus spread is a complex dynamic system. It encompass virology, meteorology, migratory patterns, mass psychology, etc. Markets are highly complex, dynamic systems.

Financial professionals will use the word “contagion” to describe a financial panic. But that’s not just a metaphor. The same complexity that applies to disease epidemics also apply to financial markets. They follow the same principles.

And they’ve come together to create a panic that traditional modeling could not foresee.

The time scale of global financial contagion is not necessarily limited to days or weeks. These panics can play out over months and years. So could the effects of the coronavirus.

Just don’t expect the Fed to warn you.

Regards,

Jim Rickards
for The Daily Reckoning

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Why the Fed Can’t Get It Right

This post Why the Fed Can’t Get It Right appeared first on Daily Reckoning.

The World Health Organization declared the coronavirus a pandemic today. The virus has now spread to over 100 countries and infected well over 100,000 people.

After Monday’s 2,000-point collapse of the Dow and yesterday’s 1,100-point gain, stocks broke down again today. The Dow puked another 1,465 points on further fears.

What we’re seeing now is the very definition of volatility. The market’s in a highly unstable state right now.

These violent swings show the inadequacy of the standard models that the Fed and other mainstream analysts use.

The Fed assumes so many things about markets that are simply false, like that markets are always efficient, for example. They’re not.

Under volatile conditions like these they gap up and down — they don’t move in rational, predictable increments like the “efficient-market hypothesis” supposes.

The problem is that the Fed’s models are empirically false. Studies have proven how faulty their models are.

The Fed has the worst forecasting record in the world. It’s basically been wrong every year since 2009.

Equilibrium models like the Fed uses basically say the world runs like a clock and occasionally it gets knocked out of equilibrium. And all you have to do is tweak policy or manipulate some variable to push it back into equilibrium.

It’s like resetting a clock. That’s a shorthand way of describing what an equilibrium model is. They treat markets like they’re some kind of machine. It’s a 19th-century, mechanistic approach.

But traditional approaches that rely on static models bear little relationship to reality. Twenty-first-century markets aren’t machines and they don’t work in this clockwork fashion.

On the other hand, complexity theory explains financial panics much better than the Fed’s old-fashioned models. Complexity theory accounts for market shocks that seem to come out of nowhere, like the one we’re seeing now.

It also lends you greater insight into where markets are going next, unlike traditional models.

And I promise you, because I know firsthand, the Fed doesn’t use complexity theory. I’ve discussed it with them and they know nothing about it.

But it’s not just the Fed. I’ve talked to monetary economists. I’ve talked to staff people. They just stare at me blankly. They can’t even process what I’m saying.

Complexity theory has had great success explaining phenomena in fields such as climatology, seismology and many other dynamic systems.

And I’ve taken the insights of complexity theory and applied them to financial markets, which are perfect models of complex systems.

I’m happy to say I’m one of a few pioneers who have applied the insights of complexity theory to financial markets.

That’s how I analyze risk in financial markets, and it’s very powerful. Applying complexity theory to markets sets my analysis apart from the mainstream. The evidence for its effectiveness is very, very strong.

What led me to start studying complexity theory? And what exactly is it?

Back in 1997, I was a lawyer for Long Term Capital Management (LTCM). We had two Nobel Prize winners on our staff. We had a team of Ph.D.s from MIT, Harvard, Yale, Stanford, etc. We had some of the best brains in finance working for us, in other words.

I trusted all those Ph.D.s and Nobel Prize winners because they had made us a lot of money. I had no reason to doubt them.

Then the Asian financial crisis came along. By the time the crisis was over, I lost 92% of my own money.

I was only their lawyer, so I wasn’t making these deals. And I didn’t understand the deeper complexities of the financial system at the time. I’ve since learned the truth.

The truth is that their models had nothing to do with the real world. If their models were right, the crisis never would have happened.

I began studying the dynamics of capital markets on my own. I took some university courses, but I did most of the research on my own.

I studied physics, network theory, complexity theory, applied mathematics, behavioral psychology and so on. I took all that learning and applied it to the markets, which the Fed does not do.

So I’ve studied complexity theory intensively for over two decades now. And I’m more convinced than ever of its effectiveness in understanding markets.

Regards,

Jim Rickards
for The Daily Reckoning

The post Why the Fed Can’t Get It Right appeared first on Daily Reckoning.

“The Most Critical Time Since the Financial Crisis”

This post “The Most Critical Time Since the Financial Crisis” appeared first on Daily Reckoning.

“We’re faced with the most critical time since the financial crisis.”

This we have on the grim authority of money man Sven Henrich.

Last evening prepared us for this morning’s hells…

In overnight trading, S&P futures plunged 5% in four hours. The selling frenzy tripped the “circuit breakers.”

These fail-safes were installed after 1987’s “Black Monday” to prevent encores.

Thus S&P futures trading screeched to a halt, suspended… lest the fever deepen.

But the opening whistle blew this morning. And the delirium resumed precisely where it had ended…

A Trading Halt

The S&P went instantly careening. It shortly sank 7%.

Once again the violence tripped the circuits (the threshold for regular-session trading is higher than after-hours trading).

The referee called a halt at 9:34 — the first ever under existing rules — and administered a 15-minute standing count.

For 15 minutes the market fought to recapture its legs… and its wits.

At 9:49 the ban came off. Though woozied, the market “stabilized.”

But the battened and bludgeoned market could scarcely maintain the vertical.

The Worst Day Since “Black Monday”

Both S&P and Dow Jones went along, 5% down through noon. The remainder of the afternoon worked little improvement.

The Dow Jones tumbled 8% at one point this afternoon — the most since another Monday, long distant — “Black Monday” in 1987.

It closed the day down 7.79% to 23,851, a 2,014-point waylaying.

The S&P gave back 226 points on the day, for a 7.60% loss.

The Nasdaq similarly absorbed a 625-point trouncing, losing 7.29% on the day.

Thus the three major averages presently camp upon the doorstep of a bear market. One more slip… and they go in.

A bear market is a 20% plunging from recent peaks.

European stocks officially crossed over today — down over 22%. Not three weeks ago they traded at record heights.

Meantime, 10-year Treasury yields plunged to a starvation-level 0.318% this morning.

Words fail us.

“The Path of Least Resistance is Still Down”

Is the worst over?

“The path of least resistance is still down,” shouts Liz Ann Sonders, chief investment strategist at Charles Schwab.

Once again we must point our accusing finger at “passive investing.” The computers caught a fever, unloading positions at electronic speeds.

But there are few buyers on the other end to take them in.

That is why — we theorize — “corrections” have attained great ferocity in recent years.

That is also why markets have gone from record heights to bear market’s doorstep within three weeks.

But what happened this morning? Why did the bottom drop away?

Oil Collapses

Oil is the explanation most widely on offer. Investors Business Daily:

Oil prices began to collapse on Saturday as negotiations between Saudi Arabia, the de facto leader of the Organization of the Petroleum Exporting Countries, and Russia over production quotas failed. The breakdown in talks led the Saudis to sharply slash prices in the onset of another price war. The Saudis also said they would abandon OPEC’s current production curb, a move that opens the same door to other OPEC members, threatening to flood the already-oversupplied oil market with possibly more than 3 million barrels per day in additional production.

Oil prices had already sold off for three straight weeks, losing more than 37% as global markets grappled with the potential impact upon demand of the coronavirus outbreak begun late last year in China.

Crude oil hemorrhaged 25% today — its heaviest rout since 1991. It has come all the way down to $30.93. And oil stocks took a savaging today.

Two “Black Swans” Converge

Thus two “Black Swans” pooled their mischiefs… and came swooping in this morning.

These nightmare birds are the coronavirus and oil. Combined they account for this sudden terror.

So argues Seabreeze Partners Management president Doug Kass:

Over the weekend one old Black Swan (coronavirus) and a new Black Swan (substantially lower energy prices) joined forces in the pond as the collapse in yields and energy prices is serving to crater global equity markets this morning. In scope and rapidity, the accumulated declines in bond yields and stock prices are unprecedented…

There will be enormous fallout where large bets have gone wrong — ranging from bond, equity, commodity and VIX positioning.

Adds one Chris Rupkey, chief financial economist at MUFG Union Bank:

[Stock market investors] want out. Big-time. The sky is falling. Get out, get out while you can. Wall Street’s woes have to eventually hit Main Street’s economy hard.

A Minefield of Debt

The energy sector is soaked through with debt. A fair portion is “high yield.” That is because it is, as the professionals say… risky.

Many of the big banks hang on the other end of it. Bank stocks absorbed some of the heaviest slatings today — not coincidentally, we hazard.

What if losses pile up in the energy sector? Defaults could go barreling through the credit markets.

And woe to ye of earth and sea once they do…

Nordea’s global chief foreign exchange strategist Martin Enlund:

If “unforeseen losses” show up in the high-yield sector (very energy-heavy), it might damage the credit cycle… and if the credit cycle cracks, forget about buybacks, mergers and acquisitions and the S&P’s current valuation.

Buybacks are the chief gimmick behind the market’s gorgeous multiyear spree.

Who will buy if the corporations do not? Who will pick up the standard… and carry forward?

The questions nearly answer themselves.

Next we come to a central actor in the drama unfolding before us — the central bank.

Heading Back to Zero

What can you expect from the Federal Reserve in the days and weeks ahead?

Its recent “emergency” 50-basis point rate cut came thudding down… like a zeppelin of lead.

But of this you can be certain: More is ahead.

Goldman Sachs chief economist Jan Hatzius is convinced the Federal Reserve will hatchet another 50 basis points at this month’s FOMC meeting.

It will proceed to another cut in April, says he:

We now expect a 50bp cut, in part because the bond market is already priced for a large move and the FOMC will likely be reluctant to risk further tightening in financial conditions by refusing to deliver. We are also penciling in a final 50bp cut at the April 28-29 meeting.

At which point rates would hover between 0–0.25% — all the way back to post-crisis lows.

Remember “Normalization?”

And so Mr. Powell’s previous designs to “normalize” rates now appear a cruel, cruel jest.

We never believed he would succeed. The market is so entirely dependent on abnormal interest rates… it would collapse without the backstop.

He attempted to pull it out gradually after he came on duty. But he put it back after December 2018, when the market wobbled badly.

Now it is riveted into place and reinforced with cement.

But recession menaces — greater than at any point in years.

And like a blunderbuss artillery man who squanders his ammunition ahead of the main action… the Federal Reserve is blasting its remaining “dry powder” ahead of time.

As we razzed last week:

The Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

Monetary policy is a spent cartridge, an empty shell casing.

Central banks will be forced ultimately to surrender command to the fiscal authorities.

Prepare for Fiscal Policy

“Helicopter money,” Modern Monetary Theory, some variant of the two, these we will see.

Depend on it.

We opened today’s reckoning with a lament from analyst Sven Henrich:

“We’re faced with the most critical time since the financial crisis.”

And so we conclude with Mr. Henrich:

The constant subsidy of markets and the economy has led us to the largest credit and asset bubble in our lifetimes and the architects of the monstrosity have left themselves weak and depleted. They are now begging for fiscal stimulus from governments that are traditionally slow to react. The big bazookas will come, the question is whether it will be too late.

That is our question as well.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post “The Most Critical Time Since the Financial Crisis” appeared first on Daily Reckoning.

Did the Fed Bail out the Market Today?

This post Did the Fed Bail out the Market Today? appeared first on Daily Reckoning.

The good news first:

We learn by the United States Labor Department this morning that the economy took on 273,000 jobs last month.

Consensus estimates came it at 175,000.

Unemployment slipped from 3.6% to 3.5%… equaling a 50-year low.

Meantime, December and January estimates were upgraded by no less than 85,000 jobs.

Thus there is more joy in heaven.

Now the bad news:

The stock market picked up the news… and heaved it into the paper basket.

“Black Swan-dive”

The Dow Jones hemorrhaged another 800 points by 10 a.m. The other major indexes also gave generously — again.

VIX — Wall Street’s “fear gauge,” exceeded 48 this morning. It had guttered along under 15 until late February.

In all, global equities have surrendered $9 trillion in nine days — $1 trillion each day.

Never before have global equities retreated so swiftly and violently.

Meantime, the 10-year Treasury note achieved something of the miraculous this morning…

Yields collapsed to an eye-popping 0.664%.

Many were flabbergasted when yields sank to a record 1.27% low in July 2016. Yet this morning, they were nearly half.

Well and truly… these are interesting times.

Michael Every of Rabobank shrieks we are witnessing a “Black Swan-dive, as yields and stocks tumble in unison…”

A New Contrarian Indicator

But at least the crackerjacks at Goldman Sachs gave us advance notice of this thundering stampede into Treasuries…

A Bloomberg headline, dated Feb. 10:

“JPMorgan Says Bonds to Slump, Fueling a Return to Cyclicals.”

And this, bearing date of Feb. 23:

“JPMorgan Says Rally in Treasuries May Be Nearing Turning Point.”

May we suggest a new contrarian indicator?

The “JPMorgan Indicator.”

The reference is to the famed 1979 BusinessWeek cover declaring “The Death of Equities.”

Of course equities embarked upon the grandest bull market in history shortly thereafter.

Perhaps JPMorgan can provide a similar service.

As Zero Hedge reminds us, most hedge funds are clients of JPMorgan. Those who took aboard its advice are presently paying. And royally.

They “shorted” longer-term bonds — betting they would fall.

If You Don’t at First Succeed…

We imagine Mr. Jerome Powell is scratching his overlabored head today. His “emergency” rate cut Tuesday failed to fluster the fish.

But that does not mean more bait is not going on his hook…

Markets presently give 50% odds the Federal Reserve will lower rates to between 0.25% and 0.50% by April.

The central bank is already woefully unprepared to tackle the next recession. Yet it appears ready to squander what little ammunition that remains.

And Bank of America is already assuming a global recession is underway:

“[Our] working assumption is that as of March 2020 we are in a global recession.”

A global recession can wash upon these American shores.

What is the Federal Reserve to do in event it does?

Dwindling Options

It has little space to cut interest rates, as established. And purchasing Treasuries has lost its punch. Recall longer-term Treasury yields presently dip below 1%.

Additional purchases could drag yields to zero… and below.

Eric Rosengren presides over the Federal Reserve Bank of Boston.

He moans these conditions “would raise challenges policy makers did not face even during the Great Recession.”

Again, what could they do?

In a situation where both short-term interest rates and 10-year Treasury rates approach the zero lower bound, allowing the Federal Reserve to purchase a broader range of assets could be important.

… We should allow the central bank to purchase a broader range of securities or assets.

Full English translation:

The Federal Reserve should be authorized to purchase stocks.

But Is It Already?

This Tuesday we vented the theory that the Federal Reserve has been sneakily — and illegally — purchasing stocks.

Citing Graham Summers, senior market strategist at Phoenix Capital Research:

For years now, I’ve noted that anytime stocks began to break down, “someone” has suddenly intervened to stop the market from cratering…

[And] a year ago, I noticed that the market was behaving in very strange ways.

The markets would open sharply DOWN. Seeing this, I would begin buying puts (options trades that profit when something falls) on various securities, particularly those that had been experiencing pronounced weakness the day before.

Then, suddenly and without any warning, ALL of those securities would suddenly ERUPT higher.

Mr. Summers theorized that the Federal Reserve was purchasing Microsoft, Apple, Alphabet (Google) and Amazon stock.

Because these behemoths wield such vast heft, they can haul the overall market higher.

Did the Federal Reserve possibly resort to the same skullduggery today?

The Smoking Gun?

At 3:08 we noticed the Dow Jones flashing 25,268 — another whaling to conclude the week.

We next looked in shortly after 4 to tally the final damage.

Yet we were astonished to discover the index had surged to 25,938 in that hour.

For emphasis: That is a 670-point spree in the span of one hour.

It settled down to 25, 864 by closing whistle. But the index closed the day only 256 points in red — a victory of sorts.

What happened?

A quick look at Apple revealed it began rising around 3 o’clock… as if by an invisible hand.

Microsoft displayed a nearly identical pattern. And Amazon. And Google.

All mysteriously jumped at 3 p.m.

We leave you to your own conclusions.

A Record of Mischief

It’s long been argued that the Fed shouldn’t and doesn’t buy stocks.

However, the fact is that the Fed does a lot of things it’s not supposed to do. According to the Fed’s own mandates, it should never monetize the debt by printing money to buy debt securities.

The Fed’s already done that to the tune of over $3.5 TRILLION.

Moreover, we know from Fed minutes that as far back as 2012, the Fed was shorting the Volatility Index (VIX) via futures, or options. Here again, this runs completely contrary to the Fed’s official mandate. And if you think this is conspiracy theory, consider that it was current Fed Chair Jerome Powell who admitted the Fed was doing this!

Simply put, the Fed has been skirting its mandate for years in the name of “maintaining financial stability.” In fact, what usually happens is the Fed does things it shouldn’t, denies it for years and then finally admits the truth years later, by which point no one is outraged.

I believe the Fed is currently engaging in precisely such a practice when it comes to the outright rigging of the stock market today.

The Laws Fall Silent

The Federal Reserve Act does not authorize the central bank to purchase equities.

But financial emergency is akin to wartime emergency.

And as noted, the Federal Reserve took… extreme liberties with the law during the last crisis.

It may be taking additional liberties at present. And it will again if necessary.

“Inter arma enim silent lēgēs,” said Cicero — “In times of war, the law falls silent.”

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Did the Fed Bail out the Market Today? appeared first on Daily Reckoning.

Heading Into Negative (Real) Interest Rates

This post Heading Into Negative (Real) Interest Rates appeared first on Daily Reckoning.

Last July I was in Bretton Woods, New Hampshire, along with a host of monetary elites, to commemorate the 75th anniversary of the Bretton Woods conference that established the post-WWII international monetary system. But I wasn’t just there to commemorate  the past —I was there to seek insight into the future of the monetary system.

One day I was part of a select group in a closed-door “off the record” meeting with top Federal Reserve and European Central Bank (ECB) officials who announced exactly what you can expect with interest rates going forward — and why.

They included a senior official from a regional Federal Reserve bank, a senior official from the Fed’s Board of Governors and a member of the ECB’s Board of Governors.

Chatham House rules apply, so I still can’t reveal the names of anyone present at this particular meeting or quote them directly.

But I can discuss the main points. They essentially came out and announced that rates are heading lower, and not by just 25 or 50 basis points. Rates were 2.25% at the time. They said they have to cut interest rates by a lot going forward.

Well, that’s already happened. The Fed cut rates last September and October (each 25 basis points), bringing rates down to 1.75%. And now, after Tuesday’s emergency 50-basis point rate cut, rates are down to 1.25%.

That’s a drop of one full percentage point. If the Fed keeps cutting (which is likely), it’ll soon be flirting with the zero bound. And if the economic effects of the coronavirus don’t dissipate (very possible), the Fed could easily hit zero.

But then what?

These officials didn’t officially announce that interest rates will go negative. But they said that when rates are back to zero, they’ll have to take a hard look at negative rates.

Reading between the lines, they will likely resort to negative rates when the time comes.

Normally forecasting interest rate policy can be tricky, and I use a number of sophisticated models to try to determine where it’s heading. But these guys made my job incredibly easy. It’s almost like cheating!

The most interesting part of the meeting was the reason they gave for the coming rate cuts. They were very relaxed about it, almost as if it was too obvious to even point out.

The reason has to do with real interest rates.

The real interest rate is the nominal interest rate minus the inflation rate. You might look at today’s interest rates and think they’re already extremely low. And in nominal terms they certainly are. But when you consider real interest rates, you’ll see that they can be substantially higher than the nominal rate.

That’s why the real rate is so important. If you’re an economist or analyst trying to forecast markets based on the impact of rates on the economy, then you need to focus on real rates.

Assume the nominal rate on a bond is 4%; what you see is what you get. But the real rate is the nominal rate minus inflation. If the nominal rate is 4% and inflation is 2%, then the real rate is 2% (4 – 2 = 2).

That difference between nominal and real rates seems simple until you get into a strange situation where inflation is higher than the nominal rate. Then the real rate is negative.

For example, if the nominal rate is 4% and inflation is 5%, then the real rate of interest is negative 1% (4 – 5 = -1).

The U.S. has never had negative nominal rates (Japan, the eurozone and Switzerland have), but it has had negative real rates.

By the early 1980s, nominal interest rates on long-term Treasury securities hit 13%. But inflation at the time was 15%, so the real rate was negative 2%. The real cost of money was cheap even as nominal rates hit all-time highs.

Nominal rates of 13% when inflation is 15% are actually stimulative. Rates of 3% when inflation is 1% aren’t. In these examples, nominal 2% is a “high” rate and 13% is a “low” rate once inflation is factored in.

What is the real rate today?

The yield to maturity on 10-year Treasury notes is currently at a record low of under 1% (it actually fell to 0.899% today before edging slightly higher). That’s never happened before in history, which is an indication of how unusual these times are.

Meanwhile, inflation as measured by the PCE core deflator (the Fed’s preferred measure) is currently about 1.6% year over year, below the Fed’s 2% target.

Using those metrics, real interest rates are in the neighborhood of -.5%. But believe it or not, that’s actually higher than the early ’80s when nominal rates were 13%, but real rates were -2%.

That’s why it’s critical to understand the significance of real interest rates.

And real rates are important because the central banks want to drive real rates meaningfully negative. That’s why they have to lower the nominal rate substantially, which is what these central bank officials said at Bretton Woods.

So you can expect rates to go to zero, probably sooner or later. Then, nominal negative rates are probably close behind.

The Fed is very concerned about recession, for which it’s presently unprepared. And with the coronavirus, now even more so. It usually takes five percentage points of rate cuts to pull the U.S. out of a recession. During its hiking cycle that ended in December 2018, the Fed was trying to get rates closer to 5% so they could cut them as much as needed in a new recession. But, they failed.

Interest rates only topped out at 2.5%, only halfway to the target. The market reaction and a slowing economy caused the Fed to reverse course and engage in easing. That was good for markets, but terrible in terms of getting ready for the next recession.

The Fed also reduced its balance sheet from $4.5 trillion to $3.8 trillion, but that was still well above the $800 billion level that existed before QE1 (“QE-lite” has since taken the balance sheet up above $4 trillion, and it’s probably going higher since new cracks are forming in the repo market).

In short, the Fed (and other central banks) only partly normalized and are far from being able to cure a new recession or panic if one were to arise tomorrow.

The Fed is therefore trapped in a conundrum that it can’t escape. It needs to rate hikes to prepare for recession, but lower rates to avoid recession. It’s obviously chosen the latter option.

If a recession hit now, the Fed would cut rates by another 1.25% in stages, but then they would be at the zero bound and out of bullets.

Beyond that, the Fed’s only tools are negative rates, more QE, a higher inflation target, or forward guidance guaranteeing no rate hikes without further notice.

Of course, negative nominal interest rates have never worked where they’ve been tried. They only fuel asset bubbles, not economic growth. There’s no reason to believe they’ll work next time.

But the central banks really have no other tools to choose from. When your only tool is a hammer, every problem looks like a nail.

Now’s the time to stock up on gold and other hard assets to protect your wealth.

Regards,

Jim Rickards
for The Daily Reckoning

The post Heading Into Negative (Real) Interest Rates appeared first on Daily Reckoning.

Here’s Where the Stock Market’s Going

This post Here’s Where the Stock Market’s Going appeared first on Daily Reckoning.

The Federal Reserve ordered seven “emergency” rate cuts since 1998. Tuesday’s was its eighth.

Going off the first seven… where will the S&P end the next 12 months?

Your choices are these:

  1. -9.2%
  2. -4.7%
  3. +6.1%
  4. +11.3%

But we are in devilish spirits today.

Let us therefore bewilder you with a fifth option: zero. The S&P will end precisely where it began.

Have you made your selection? You will have your answer shortly, your tour of the horizon.

First to a far more immediate source of bewilderment…

The seesawing market swung again today — down. And we are down with vertigo attempting to follow it one day to the next.

The Dow Jones plunged 600 points to open the day. It gave up another 369 points to end the day — a 969-point slating in all.

The S&P lost another 106 points today; the Nasdaq, 279.

Gold went rampaging again today, up another $29.00.

Meantime, the 10-year Treasury yield slipped to an impossible 0.899% this afternoon.

The mind staggers and reels.

But where does history argue the S&P will trade in one year’s time?

Again — prior to Tuesday — the Federal Reserve mandated seven “emergency” interest rate cuts since 1998.

These transpired in:

October 1998. January 2001. April 2001. September 2001. August 2007. January 2008. And October 2008.

All but two were 50 basis point hatchetings. October 1998 (25 basis points) and January 2008 (75 basis points) form the lone exceptions.

Tuesday’s emergency cut was right at par — the standard 50.

To help instruct your decision and speed you along, let us consider S&P action in the shorter term…

Deutsche Bank’s Jim Reid has ransacked the data in search of light. He first glanced one week out.

Where does the S&P stand one week after an emergency rate cut?

The answer is a 2.8% median gain.

Two trading sessions in, results do not encourage. Yet three are ahead. And time yet remains.

But let us now shimmy up the mainmast… and train our monoscope on the farther horizon.

Where does the S&P stand six months following an alarmed rate cut?

Substantially lower, according to Mr. Reid’s researches.

The answer is -4.3%.

The S&P is up 2.8% after one week, that is — but down 4.3% after six months.

But what about the entire year? Does the S&P continue to slip? Or does the seesaw swing positive again?

Or does it end flat — an entire year upon the hamster wheel?

Again… here are your choices:

  1. -9.2%
  2. -4.7%
  3. +6.1%
  4. +11.3%
  5. 0%

We have held you suspended in the air long enough. The answer is…

A. The S&P sheds a median 9.2% the year following an emergency rate cut.

And there you are. Thus you can expect the S&P to close March 2, 2021 near 2,760.

But one exception stands prominent… as a diamond stands prominent among the stones… as an honest congressman stands prominent among congressmen.

That lovely exception is October 1998. The S&P roared 24.1% by October 1999.

Yet this capital fact remains: The S&P ended the year down six occasions of the prior seven.

Alas, we have no corresponding data for the Dow Jones. But the two rarely fall much out of step. We can therefore assume similar results.

But comes the inevitable question:

Why doesn’t the market take to the emergency dose of cuts?

The gentlemen of Zero Hedge answer as well as anyone:

Traditionally when the Fed engages in such an unexpected move, it means that the economy (or markets, or both) are already in free fall, and the Fed is far behind the curve.

Who can be surprised?

The Federal Reserve generally lags so far “behind the curve”… it never has to turn the wheel. It goes forever on the straightaway.

But in fairness, we speak today of averages.

As we have noted before, climate is what a fellow can expect. Weather is what he actually gets.

The S&P could well burst upon a wondrous 12-month spree. It has laughed off the odds before.

Yet 22 years of history argues it will not…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Here’s Where the Stock Market’s Going appeared first on Daily Reckoning.

What Really Happened Last Week?

This post What Really Happened Last Week? appeared first on Daily Reckoning.

Yes, but why was last week’s correction so pitiless?

Monday we put our finger on “passive investing.” That is an investing strategy that flows with the tides.

A rising market tide lifts all vessels — even the leaking, decrepit, unseaworthy hulks.

But when a strong gravity pulls the water the other way… all go down with it.

And it was an angry moon last week, exerting a mighty tug.

But passive investing may only tell a portion of last week’s harrowing tale.

We have clawed our way deeper into the facts — and deeper again — to arrive at a fuller explanation.

Details to follow. But here is your hint:

It implicates the Federal Reserve… despite our unshakeable faith in its infallibility.

First, today’s tidal reading…

Stocks Rise on a Surging Tide

We are pleased to report the water rose today. And high…

The Dow Jones rose 1,173 points — its second-highest (point) gain in history.

The S&P gained 127 points. And the Nasdaq, 334.

And so all three indexes have uncorrected. That is, they have all three emerged from correction.

But why?

Explains CNBC:

Stocks surged on Wednesday as major victories from former Vice President Joe Biden during Super Tuesday sparked a massive rally within the health care sector…

Tuesday’s primary results sent health care stocks flying. The S&P health care sector surged 5.8%, posting its best day since 2008. UnitedHealth and Centene jumped 10.7% and 15.6%, respectively. Shares of UnitedHealth had their biggest one-day gain since 2008.

Many investors have applauded Biden for his middle-of-the-road tact in contrast to the more progressive policies of Sanders and Sen. Elizabeth Warren.

Gold shed $6.10 today.

But the somber bond market merely shook its head… and sighed. 10-year Treasury yields remain under 1%.

But to proceed…

If passive investing does not fully explain last week’s fearsome correction… what does?

The Great Liquidity Flood

Our tale begins last September…

A main line ruptured deep within the financial plumbing. And liquidity ran dry in the critical “repo” market.

Pouring icy sweat, panicked, the Federal Reserve rushed in with the hoses… and let the valves out.

It emptied in so much liquidity over the next four months, it inflated its balance sheet $400 billion — a $1.2 trillion annualized rate.

Not even during the lunatic days of the financial crisis did it carry on at such a gait:

IMG 1

The stock market surged on the rising water, nearly perfectly, four months running:

IMG 2

And so the Federal Reserve inflated a bubble — a bubble within a greater bubble.

But here our tale gathers steam…

The Fed Closes the Hoses

In December, the Federal Reserve tightened the valves. And liquidity, formerly flowing in gushes, dwindled to a trickle.

And so the delirious stock market lost its energy… like an airplane that has lost its lift.

The thing went on momentum for a time. But nothing was pushing it along. And so it was vulnerable…

We introduced you to Mr. Graham Summers yesterday. In reminder, he is a senior market strategist at Phoenix Capital Research.

From whom:

From September 2019 to December 2019, the Fed provided some $100 billion in liquidity to the financial system every single month.

The Fed then stopped these policies on a dime in mid-December. From that point onward, the Fed’s balance sheet, which expands when the Fed is providing liquidity to the financial system, completely flatlined…

Lost amidst all the talk of the coronavirus and potential global economic contraction is the fact that the Fed’s balance sheet has been flat to down since early December. This tells us the Fed completely ended the aggressive liquidity pumps it was running from August through the end of the year…

You can see these developments in the chart below:

IMG 3

The “Pin” That Popped the Bubble

Then the coronavirus chewed through its leash… and ultimately through the ticker tape.

But it was merely the “pin” that punctured the bubble, says Summers:

Now, you can see the impact these policies had on the stock market in the chart below.

The Fed created this environment with its monetary policies. The fear of an economic slowdown due to the coronavirus was simply the “pin” that burst this mini-bubble.

IMG 4

What does Mr. Summers conclude?:

The big lesson here is this: The financial system is now completely addicted to Fed liquidity. The Fed can try to talk tough about withdrawing liquidity from the system, but at the end of the day, the market is going to force the Fed’s hands.

In turn, we conclude:

Passive investing — twinned with plateaued liquidity — conspired tp deal markets the swiftest, sharpest correction since 1928.

This fearsome combination sent markets careening from record heights to correction in a mere six days.

But you can be sure the Federal Reserve is preparing to unfurl the hoses yet again…

Liquidity Running Dry Again in the Repo Market

It appears the repo market is entering another drought. And the major banks — primary dealers, so called — have reacquired a panting thirst.

They have requested $111.48 billion in overnight loans from the Federal Reserve.

But the Fed can only dole out $100 billion under existing arrangements.

“Oversubscribed” is the term.

That $111.48 billion comes on top of the $108.6 billion dealers requested the night before — again, oversubscribed.

The Federal Reserve had intended to suspend repo operations next month. But reports The Wall Street Journal, in predictable understatement:

Those plans could change amid the rapidly shifting economic and financial outlook. Some in the market are already wondering if the Fed will increase the size of its temporary operations to accommodate the high level of demand from banks.

We wager high those plans will change. 180 degrees.

Will it reinflate the stock market?

We have no answer. The market faces a mighty foe in a miniature virus.

But little surprises us these days.

Dangerously Low on “Dry Powder”

Meantime, the Federal Reserve squanders what little “dry powder” that remains.

Yesterday’s 50 basis point blast reduced the federal funds rate to between 1% and 1.25%.

Goldman Sachs projects another rate cut when the FOMC huddles in two weeks. And another in April (each 25 basis points).

If true, the Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

And given the global economic outlook…

It will be unable to restock its magazines for years and years — and years.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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