The shocking reason the market crashed this week

Summary: stocks tumble as investors update their models of policy rates, inflation, buybacks, bond yields, DCF models, refinancing hurdles, italian banks, Emerging Markets worries and trade wars

Thought of the day: how nimble and smart they are, investors!

What the pros are saying

WSJ, CNBC, Reuters and other news outlets have explained in detail the last two days why the stock market is crashing:

-Investors realized inflation is gaining momentum, and that the US Fed and other central banks will have to counter with rate hikes. Higher policy rates and less QE (money printing) feed into higher market yields for bonds, which in turn acts as both an alternative investment in a TINA* world, and a higher discount rate in investors’ Discounted Cash Flow models. The latter is particularly important for tech stocks that are expected to make most of their profits far into the future (if ever).

Not least investors took just 24 hours to realize that with inflation looming and interest rates rising into the low single digit space (the horror!) will become more difficult to finance the outlandish projects that warrant current double digit P/S valuations, as well to re-finance the already hugnormous piles of debt lingering from past stock repurchase programs — not to mention future stock buybacks that might very well have to be cancelled.

Can you imagine a world where corporate investment budgets shrink from year to year, and where dividends and stock purchases have to be financed with free cash flow stemming from profits rather than free bank money?

Finally, many models were swiftly updated with new currency prices and trade tariffs, as well as the endgame result of recursive doom-loops (government-bank insolvency and runaway financing rates), triggered by recent Italian bank bankruptcy jitters.

  • TINA = There Is No Alternative To Stocks


That Is Not How It Works!

No, no, no! No!

That’s emphatically not what happened this week. That’s not how the market works. There are hardly any investors left that take time off their days to think about thing s like that, and certainly not in that manner.

There are but a few fundamentally inclined outfits that do meet once a week to discuss similar things. However, A) they have not had their meetings yet this week, and B) they are quite few compared to passive funds, momentum investors, CTAs, daytraders, index huggers etc.

Ask yourself: Do you know anybody who claims they sold for the reasons listed above? That they updated their models and sold due to inflation gaining steam and all or any of the variables and repurcussions? I didn’t think so. There probably are quite a few talking about why the market sold of, why others sold, whether it’s thoughtful and smart of others to sell for those reasons, but just about nobody went through the calculations above and concluded it was time to sell this week. Nope.

The butterfly effect

If you stretch conditions far enough, e.g., with debt upon debt, derivatives upon derivatives, ever higher valuations on ever higher adjusted, manipulated numbers, based on unsustainably low costs for debt and wages, and resulting unsustainably, historically perverse margins…; then any little flap of the wing can set off an avalanche.

Do you know anybody

who claims they sold for above reasons

I’m not saying the last few days is an avalanche, an earthquake, a tsunami, the beginning of the big one. I mean, the small correction, which isn’t even a correction, let alone a “crash”, is hardly visible in a stock chart.

I’m just saying the conditions are already there for a massive re-set of stock markets and bond markets alike. And that means no other reason is needed for stocks to fall… or crash for that matter.

So, no, investors aren’t cooly and rationally updating their excel models with new assumptions and recent data publications, or discussing said inputs during partner meetings. Nope, they are selling because somewhere in the market someone’s sell order pushed one stock below a level that made somebody else sell – on a hunch, as a stop loss, a machine learning model, some esoteric and spurious correlation between normally unrelated instruments; I don’t know and it doesn’t matter – and that in turn made somebody else sell that or some other instrument.

Enough debt, enough leverage, enough trend following and passive investors, high enough valuations, too few short positions, too little cash reserves in big mutual funds and so on mean at a certain point there are no value based buyers left to mitigate the selling.

Again, whether this proves to be just a two day mini downturn, or the beginning of the worst bear market since the 70’s, doesn’t matter. The point is that nobody really knows what set off the selling. It wasn’t Powell, Trump, treasury yields or cash flow models. It was simply one eager seller too many — and that seller was baked in the cake since several years back, just being temporarily on hold due to increasingly deranged central bank policies.

Happy trading!

P.S. Bookmark my site, subscribe to my newsletter by entering your e-mail address, and finally DO CHECK OUT my recent podcast interview with the one and only Erik Townsend of Macro Voices (you can find the interview and Future Skills podcast on any podcast platform… and here).

The least tempting stock market charts ever

Topic: a negative view of the Swedish stock market chart

Conclusion: not quite a bargain is it? -50% would be more than reasonable.

Does this series of charts look tempting to you?

(The Swedish OMX stock market index)

First, in the very short term, there seems to be a psychological barrier around 1650. After 3 attempts buyers are giving up. The break out in April looks more and more like a false, last hurrah.

Observing the index from a slightly longer distance, the similarities with the last peak are striking. Even more alarming is that we didn’t manage to get above the levels of 18 months ago. If stocks are this weak when US indices are hitting all time highs every day, there’s something rotten in the state of Sweden.

Seen from the beginning of the cyclical bull market, the double top of 2015-2017 looks even more ominous. Maybe there’s room for a third top before normality ensues, maybe we’ll go right through 1250. No matter, I think 1250 is where we’re going to start with. We’ll cross the bridge of “bounce back to the 1600s, or crash trough to triple-digit territory” when we get there.

In a 2-decade perspective, the current formation looks surprisingly tiny, like a “no volatility, great moderation tremble”, rather than a true wash out and re-set of the greatest monetary scandal in history.

My guess is that the latter is what we have before us.

The question is “just” how many more rounds central banks have left before they’re empty. In any case, looking for bargains here when stocks haven’t even visibly corrected in the chart just doesn’t make any sense to me. It’s as if Under Armour first raised prices by 200% and then put up signs with “SALE -5% OFF“. Tempting?

What to do about it? Get out of stocks unless you have insight in some very specific individual companies. Go cash, or buy something that’s currently unloved such as gold, gold mines, uranium or soft commodities.

Read more about the case for a -50% leg on the US stock market here LINK

NB: My next post will NOT be about financials or the stock market.

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Stocks about to rally! Is diversification a four letter word?

Topic: The case for a 25% upside for stocks in the coming 6 months

Style: ironic, humorous, short

1 The trend is your friend

I mean, what are the odds of this trend suddenly reversing?

Some say it’s just getting started.

Remember that stocks went nowhere between 1996 and 2009, and 2000 and 2012 or was it 2013? That’s a long time going nowhere so it’s about time we had a rally, no?

2 Stocks are cheap

We’re not even at a recent bottom in PE ratio, let alone an ocular average PE for the recent history. With zero interest rates, massive stimulus, not to mention the internet and general automation boosting productivity, PE-ratios should be well above average, right?

3 Profits are going up

Not that fundamentals are that important, except over very long time periods, but the trend for profits is up. In addition profits have hit a temporary plateau while they wait for the most recent monetary stimulus to translate into higher profits.

With both higher earnings multiples and higher earnings in the cards, a 25% immediate increase in S&P 500 is actually a quite modest expectation

4 Interest rates are low

This chart speaks for itself, I hope. With interest rates this low, there is no alternative to stocks. Retirees can’t live off of a 2.2% return. Nominal!

True inflation eats up all of that if not more, not least since housing costs are rising. And… look at the chart, can you honestly say you don’t think rates are going lower?

5. Dividend yields are real, and they are at a low point in history and thus likely to rise

OK, admittedly the DIV yield is lower than the interest rate, but rates are fixed and nominal, whereas dividends increase with the economy (if not faster owing to the superior selection of stocks in the top index).

By the way, with rising profits, either dividend yields will increase or stocks will rise. And then there is the potential of multiple expansion as well! Please note that DIV yields are abnormally low. Hence, they are likely to rise.

There are of course numerous more reasons to expect higher profits and share prices, such as increasing automation (robots are way cheaper than humans), solar energy (once expensive oil is out of the way, profit margins can expand), profit margins are at historical highs, digital companies like Alphabet, Netflix, Facebook, Amazon etc are not burdened by production costs, 18tn USD of newly minted money globally over the last few years, the 5tn Chinese One Belt One Road initiative, a permanent shift higher in valuation multiples as we now realize stocks are the superior investment alternative… The list goes on and on.

No matter, in the next post, that I urge you to read in conjunction with the one you have before you, I’ll go through a few highly speculative and hypothetical challenges to the upside case. We’ll talk demographics, pensions, debt, currencies, consumption, inflation, and maybe even throw in some debt ceiling and foreign tax repatriation arguments for good measure.

Check it out here.

Could there actually be an alternative to being all in on the stock market? Isn’t diversification a four letter word? Stay tuned to find out. Subscribe, read my book, check in again, tell a friend.