Ever since the big crash of 2007 – 2009, I have been forecasting a deflationary depression for the global economy. I realise this is a very bold call. Some would even say it is totally nuts given today’s ‘Goldilocks’ economy.. What could possibly go wrong? But I believe the stage is now set for this monumental event to occur in the next few years – and the process is now starting.
What came to the rescue for markets in March 2009 was, of course, the central banks who bailed out the commercial banks – and created the veritable Everest of debt and asset bubbles we see today. Much of that debt will be liquidated in the weeks ahead as the Great Bond Rout intensifies.
By March 2009, the collapse in the S&P took it to a low at the notorious number of 666 – the number of the beast with seven heads and ten horns that emerges from the sea (Revelations 13:1). Hmm. I believe when the bear has had its fill, the S&P will trade below this number.
So why do I see a deflationary depression? For the simple reason that I outlined all those years ago – that the growing bubbles of debt through all levels of the economy and governments would implode once short term interest rates start to rise off the floor that the QE/ZIRP/NIRP operations had engendered. This is the chart of my favourite short term US rate which the Fed always follows
This is a market-driven rate (not Fed-imposed) and it is now yielding 1.5% – a 50% increase in five months – and climbing. This is the only chart you need to understand why 30-yr Treasuries yields are rising (it hit a new high at over 3% level yesterday) – and why shares are falling now.
Companies have been borrowing massively at ultra-low rates to buy back their own shares – and now not only is the cost to purchase more shares rising, but their shares are falling – a double whammy. The taps are rapidly being turned off. I smell the first whiffs of panic.
Yesterday’s 660 point fall in the Dow is the direct result – and that is the biggest one-day fall since December 2008. Yes folks, last week the market turned on a dime from super-bullish to the most fearful in nine years.
Ar Davos, I noted Mnuchin’s speech where he bragged about the wonderful US economy that was ‘firing on all cylinders’. I took that to be the moment where extreme complacency reached its zenith – and the only way for it was down. In fact, he was my ‘tell’ to help me pick the to top in the stock market.
So what about the dangerous levels of US debt? Here is the trajectory of US Federal debt
In six years it will have grown by a staggering 35% – and counting. By March the government will run out of cash if the debt ceiling is not raised substantially (which of course they will). That means they will run the debt way above the $21 trillion level. And with yields rising fast, the negative impact on the budget will not be chicken feed. Incidentally, the expression ‘out the wazoo’ is a purely technical term.
The ‘Cash is Trash’ era is coming to and end and we are entering a new ‘Cash is King‘ phase. Investors who liquidate assets and get liquid will the the big winners hence. And US dollars is the preferred currency to hold.
Is a depression really on the cards?
So what is a deflationary depression? To me, it means money and debt in the economy are falling (this is the proper definition of deflation. Consumer prices may rise or fall, but usually fall overall). Rising short term rates produce a drop-off in the amount of new debt desired by borrowers and hence the amount of money in the system (that is how money is created). And with a reduced appetite to take on more debt, consumer and producer prices must fall with reduced demand. And that is a measure of how far social mood (or sentiment) falls – and that is what drives the stock market.
That will put pressure on industrial commodity prices (ags are somewhat different) and the downward pressure on the economy intensifies. Industrial commodity prices (including crude oil) will take some big hits in the weeks/months to come.
One other very significant reason I am bringing up the idea of a depression is simple – virtually nobody else is (that always occurs at tops). If you read the media, the pundits on seekingalpha and on Bloomberg, I have yet to find a single person that mentions the D word. Yes, everyone is on board the standard narrative: “The pull-back is to be welcomed, it is a sign of a healthy market – and we’ll just keep buying the dips”.
The most bearish pundit I have come across (and there really aren’t that many) will only admit to a 3%- 5% dip which would represent a terrific buying opportunity, so they maintain. That is as bad as anyone can conceive. All projections for GDP point to renewed growth globally.
As I have said many times, this strategy has worked wonders for a few years, but one day, it won’t. And maybe that day has finally arrived. Yesterday, the dip-buyers were crucified. There was no buying into the close which is normal. Far from it, it seemed there was panic selling in the last hour.
One other sign we have a top is the performance of junk bonds which is a bellwether for sentiment and the markets as a whole. Junk bonds behave more like equities than bonds. These are high-yield bonds issued by the most speculative companies and recently, the spread with Treasuries has been at its narrowest ever. Investors are happy to accept a few point of yield for a dodgy bond over a dead cert Treasury. The fear of default is totally absent. That will change.
But that’s what junk bonds do when times get a little tough – they default en masse. The biggest issuers are US shale oil companies. If perhaps crude prices fall from the recent $66 to say the mid-to-low $50s, you can bet some will be in difficulty. Hmm. Here is the chart
With Treasury yields zooming up, junk yields must follow suit to attract investors – and the price is falling. The key level is the 86.4 low. Breaking hard below that would set off a run.
But surely, US economic conditions have rarely been better. Unemployment rate is low, interest rates are still very low, wages are rising and yesterday, consumer confidence was reported much better than expected. Also yesterday, there were a huge 200,000 non-farm jobs added with wages growing rising at the fastest annual pace since 2009.
How can there be a depression ahead? One reason is the debt issue (see above) and another is that markets never top out when conditions are poor – they do so when times are great and complacency is rampant. And a falling market always precedes an economic contraction several months afterwards. And all that data referred to past performance and in no way can foretell the future – only the stock market can do that in real time.
Most use the straight line method of forecasting – and project into the future the current trends. But a glance at any price chart will show that there are times when major trend changes occur – these create the Elliott waves – those holding the bag then are those using that straight-line approach. They then hold on hoping for a turn but when all seems lost, they sell and that creates the bottom.
Assets will take some big hits
We already know cryptos are in bear trends with Bitcoin down a Fibonacci 62% from a year ago. These markets were the final magnificent flourish in the speculative mania that had gripped mankind for so long (and especially since 2009). But with the air escaping from this bubble, they are leading the way down. Or rather, they are second to the bursting of the Bond Bubble, which blew in June 2016 as US 30-yr Treasuries topped at 178 (they now trade at 145 – and falling).
Stocks have remained in strong bullish mode as the single hold-out in the mania – until last week.
Gold has been in a complex wave pattern but I believe will also join the bear trend. Crucially yesterday, gold fell hard in line with stocks – and broke any link between weak stocks and the common ‘gold as safe haven’ theory. Normal expectations when the Dow falls the most in nine years is for at least some move into gold. But the opposite occurred – and that is significant for the outlook for assets in general.
Here is the chart showing the waves and my outlook:
There is plenty of room on the downside since DSI bullish reading reached the 91% extreme recently.
And here is silver, which normally trades in line with gold – but not this time
Note the recent high did not exceed the A wave high, but on the gold chart, it did. That non-confirmation of the bull trend gave the game away. The decline yesterday was sharper in silver to confirm its relative weakness.
I believe the major trend has changed to down in both.
FTSE also hard down
As US markets continued their heady climb, our plucky FTSE tagged along but when the Dow dam burst, the FTSE could hold out no longer and the bears took total charge. This is how the damage looks on the 4-hr
Yesterday, all reasonable support levels were swept aside in the panic to sell and is creating a textbook third wave. The break of the lower tramline was a good sell signal.
Mark Carney – has he given us a wonderful contrary indicator?
I believe I may have a signal of some kind that the proposal by BoE Governor, Mr Carney, that RPI (which includes housing costs) should be scrapped as a yardstick to adjust many of the payments the government undertakes. With housing costs going through the roof (sorry), this data series has been running consistently higher than the CPI (Consumer Price Index) which ignores housing.
And because housing costs are now a huge proportion of household budgets, could this desire by government to abandon RPI be an attempt to reduce their costs – as they finally acknowledge housing costs are rising into what they see as forever? They would save a lot by switching to the RPI =provided house prices continue their upward spiral. But what if they don’t?
So, after going through innumerable committees, panels, industry consultations, focus groups and so on for the last many months/years, is this a subtle hint that this new policy that finally sees the light of day is emerging just when the housing trend is about to change? Will housing prices start declining and reduce the level of RPI below that of the CPI in the months ahead? What irony!
If so, it would not be the first time that a major government policy announcement has provided a beautiful contrary signal. Remember when our Prime Minister announced he would sell much of the UK’s gold reserves as the price had been in a severe bear trend for many months? That was a perfect signal to buy and it then climbed in a huge bull run taking it to the famous all-time high of $1920. That was the notorious Brown Bottom.
Incidentally, we have seen house prices rise by over 10% in some markets. Do you believe that can be sustained for years to come? Many people believe it can (or at least keep rising at a decent clip). Projecting say ten years hence, a house selling for a relatively modest £400k today would we ‘worth’ over a million. With interest rates then surely well above the current near-zero, how much would the monthly payments be on a 90% mortgage?
And if we really are even in a mild recession, how many young people could afford these payments? Of course, that is fanciful. Houses have to be sold to those that can afford the carrying costs so what will give? House prices will fall, as unbelievable that is for most people to imagine.
What’s in store next week?
Yes, that’s what everyone wants to know! It will certainly be more than normally eventful, I am sure.
If shares open Monday down, we should see a counter-trend bounce by mid-week. If not, then the downtrend should resume until the third waves exhaust. Already, wave 3 in the Dow has already exceeded the length of the first wave so it has done enough to justify the label but in a selling panic, all bets for targets are off.
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