End of the Road

The confluence of factors that influence market prices are vast and variable.  One moment patterns and relationships are so pronounced you can set a cornerstone by them.  The next moment they vanish like smoke in the wind. One thing that makes trading stocks so confounding is that the buy and sell points appear so obvious in hindsight.  When examining a stock’s price chart over a multi-year duration the wave movements appear to be almost predictable.

 

The fascinating obviousness of hindsight – it is now perfectly clear when one should have bought AMZN. Unfortunately it wasn’t quite as clear in real time. [PT]

 

Trend lines matching interim highs and lows, and bounded price movements within this range, display what, in retrospect, are the precise moments to buy and sell. In practice, the stock market dishes out hefty doses of humility with impartial judgment. What’s more, being right does not always translate to success.  Sometimes it is more costly to be right at the wrong time than wrong at the right time.

One fallacy that has gained popularity over the last decade is the zealot belief that the Fed disappears risk from markets.  That by expanding and moderating the money supply by just the right amount, and at just the right time, markets can grow within a pleasant setting of near nonexistent volatility.  Some even trust that when there is a major stock market crash, the Fed, having the courage to act, will soften the landing and quickly put things back upon a path of righteous growth.

Believers in the all-powerful controls of the Fed have a 30 year track record they can point to with conviction.  Over this period, the Fed has put a lamp unto the feet and a light unto the path of the stock and bond market.  But what if the Fed’s adventures in fabricating a market without risk are approaching the end of the road?  Let’s explore…

 

Sometimes the road just ends… and you either hit a wall or fall right off a cliff. [PT]

 

White On Rice

When Alan Greenspan first executed the “Greenspan put” following the 1987 Black Monday crash, markets were well positioned for this centrally coordinated intervention.  Interest rates, after peaking out in 1981, were still high.  The yield on the 10-Year Treasury note was about 10 percent.  There was plenty of room for borrowing costs to fall.

The mechanics of the Greenspan put are extraordinarily simple.  When the stock market drops by about 20 percent, the Fed intervenes by lowering the federal funds rate.  This typically results in a real negative yield, and an abundance of cheap credit.

This gimmick has a twofold effect of seen and observable market distortions.  First, the burst of liquidity puts an elevated floor under how far the stock market falls.  Hence, the put option effect.  Second, the interest rate cuts inflate bond prices, as bond prices move inverse to interest rates.

Of course, Wall Street money managers took to the symbiotic forgiveness of the Greenspan put like white on rice.  With this new brand of central planning firmly in place, market uncertainty was largely mitigated. The workings of the Greenspan put made markets behave in more or less predictable ways.

A portfolio manager could smile in the face of the occasional and inevitable stock market crash because it meant their bond holdings were rising.  Then, after a pleasant dip buying opportunity, their stocks would be running back up to new highs.  This was the story of U.S. financial markets and money management from 1987 to 2016.

 

The infamous crash of 1987 – when the „Greenspan put“ was born. Ten year note yields fell from more then 10.2% to 8.8% within days of the crash. The punters didn’t know it yet at the time, but yields would keep falling for years to come… [PT]

 

No doubt, there were several gut wrenching sell offs during this period – like 1987, 2001, and 2008.  But every time, the Fed came to the rescue by cutting interest rates, bumping up bond values, and engineering an extended stock market rally.  Few questioned whether this Fed intervention would ever cease to be available.

 

Why You Should Expect the Unexpected

Over the decades, risk management strategies were invented that advocated the virtues of a 60/40 stock-to-bond allocation portfolio.  And why not?  The Greenspan put brought a comforting certainty to the market.  When stocks go down, bonds go up. Somewhere along the lines the flow of funds from stocks to bonds during a market panic became regarded as a flight to safety.  But what if, in the year 2018, this flight is no longer to safety; but, to danger?

What may come as a great big surprise in the next market downturn is that this relationship between stocks and bonds is not set in stone.  In fact, over the next decade we suspect this relationship will be revealed to have been an aberration.  An artifact of a now defunct disinflationary world.

We haven’t done a thorough analysis.  But we have an inkling that prior to the Greenspan put, the ‘stocks down bonds up’ relationship of the last 30 years was far less certain.  What we mean is that during the prior decade, the 1970s, there were occurrences where both stocks and bonds went down in unison.  Such occurrences could happen again.

 

Correlations between bond yields and stock prices have indeed alternated significantly over extended time periods. During the Great Depression, WW2 and the post-war recovery, interest rates and stocks were most of the time positively correlated – they fell and rose in tandem. From around 1969 to 1998 they were mostly negatively correlated, when bond yields declined, stock prices surged and vice versa. After the Russian crisis of 1998, the relationship changed once again to an increasingly positive correlation, with falling stock prices coinciding with falling bond yields and vice versa (even though the larger trend in bond yields remained down because the declining phases were stronger then the rising phases). [PT]

 

You see, the conditions that made the Greenspan put possible are the opposite of the conditions that exist today.  Rates are low and are moving higher.  The world is oversaturated with debt.  Policies of mass money debasement have bubbled stocks and treasuries out to extremes well beyond what was honestly fathomable.

Yes, the doom and gloom of an epic stock and bond market meltdown are approaching.  At the moment, Fed Chair Powell’s even determined to bring it on.  We applaud his efforts.

Yet when push comes to shove, and the Fed lowers the federal funds rate, expect the unexpected to happen.  The Greenspan put – the market savior – will be mowed over like a ground squirrel beneath a tractor rotary tiller.  The market carnage left in its wake will be grotesque and unrecognizable.

 

Charts by: StockCharts

 

Chart and image captions by PT

 

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

6 Responses to “Why You Should Expect the Unexpected”

  • Patrick:

    I can agree with all of the above in the short-term; at leasr until markets fall far enough that the Fed comes back in to directly monetize gov and corporate bonds plus stocks, no different than ECB and BoJ. And, Yes, Congress will green light it faster than you can say ‘excessive liquidity’. And the Dollar Index? Sure it’ll fall but not as much as most believe, because this time every other central bank will be accelerating already active QE programs. Inflation will be the biggest concern but housing bubble 3.0 will see to it that wages don’t lag quite as much.

    My prediction is Powell ‘pauses’ around DOW 20K. And, after a massive rally, finally reverses and prints after DOW falls back down around 17.5K, due to the bond, corporate & housing bubbles popping.

    • TheLege:

      @Patrick. With respect, the dollar’s level relative to other currencies is irrelevant. What matters is what the gold price is doing at the time. Equally the level of the Dow is irrelevant – at least, without being adjusted for by the price of gold.

      • utopiacowboy:

        If the dollar is strong gold will be weak. Same for the stock market. When the market had big drops gold was rallying strongly. It’s going to take an explosion of the debt bomb before gold goes much higher.

        • TheLege:

          I think you misunderstand the argument. The point I was making was that Patrick suggested the dollar would be relatively ‘strong’ versus other currencies and I simply pointed out that he may well be right — except that gold might cost $5,000 per oz at that time, in which case the ‘strength’ of the dollar would be irrelevant i.e. it would be very weak even if it was the strongest of the fiat currencies.

          In the meanwhile you say “if the dollar is strong”. What kind of statement is that? The dollar is only ‘strong’ if it is appreciating against gold — what it does versus other currencies is irrelevant.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Silver “Scarcifies” – Precious Metals Supply and Demand
      On Monday, Silver got Scarcer – and Simpler On 23 July, we said:   “Well, it’s complicated.”   The action on 27 July was not.   Silver spot price vs. September basis   Notice the big drop in the basis starting around midnight (London time). It falls from over 7% to under 2%. To refresh: Basis = Future(bid) - Spot(ask) For the first two and half hours, the spot price is not moving. So, the only way the basis can drop is if the price...
  • Silver Explodes — But Why? Precious Metals Supply and Demand
      Explosive Days in Silver The silver market witnessed another explosive day! At midnight (in London), the price of the metal was $26.90. By 9pm, it had rocketed up to $28.95, a gain of 7.6%. This is not normal. But then, we are not in a normal world.   After several years of going nowhere and a downside fake-out in March this year, silver has come to life rather dramatically... [PT]   The Republicans are spending like drunken Modern Monetary Sailors. And...
  • Best Laid Schemes
      A Really Neat Bridge   But, Mousie, thou art no thy-lane, In proving foresight may be vain; The best-laid schemes o’ mice an’ men Gang aft agley, An’ lea’e us nought but grief an’ pain, For promis’d joy! – Robert Burns, To a Mouse, on Turning Her Up in Her Nest With the Plough (in extract), 1785     Installation of the final cable support pipes on the Gerald Desmond bridge replacement. Here is a drone video of the project. [PT] Photo by...
  • The Dollar Is Dying
      Insulting the Captive Audience This week, while perusing the Federal Reserve’s balance sheet figures, we came across a rather curious note.  We don’t know how long the Fed’s had this note posted to its website.  But we can’t recall ever seeing it.  The note reads as follows:   “The Federal Reserve’s balance sheet has expanded and contracted over time.  During the 2007-08 financial crisis and subsequent recession, total assets increased significantly from $870...

Support Acting Man

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

     
    Buy Silver Now!
     
    Buy Gold Now!