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

TINHIW

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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The coming stock market crash of 2017-2018

Topic: The case for a 50% downside for stocks in the coming 12 months, and then some

Style: Funny, ’cause it’s true (kind of)

Nota bene: this post should be read in conjunction with my previous post on the bull case for stocks


1 The trend has gone too far

I mean, what are the odds of this trend continuing (see chart) without a major hickup?

Trees don’t grow to the sky. Sooner or later, the human psyche will pull the index back to its long term trend (asymptotic to population growth + productivity growth)

Remember that stocks went nowhere between 1996 and 2009, and 2000 and 2012 or was it 2013? That’s a long time going nowhere and it seems to be about time for a re-run of a crash and no returns fro a dozen year or so.

2 Stocks are expensive

Historical peaks in the S&P 500 ratio have only briefly broken above the 20 level. Today we’re at 24.57. And that’s with significant accounting tricks, massive stimulus, zero interest rates and a generally upbeat mood and risk tolerance at highs. Whenever stimulus wanes, reality comes back to bite creative accountants in the derriere, interest rates stop falling or start rising P/E-ratios are bound to explore earlier depths. And that’s even before taking into account a less optimistic sentiment, as well as increasing actual need for funds.

By the way, here is an alternative valuation measure. It’s based on Price/Sales (from Hussman Weekly the previous week) which is an automatically cyclically adjusted valuation measure (more or less) Notice how the valuation measure has increased 4-fold since 2009. That alone carries an inherent risk of a ca. 75% fall in share prices, if sentiment were to fall to 2009 levels.

A permanently higher plateau?

3 Profits are going… where exactly?

Not that fundamentals are that important, except over very long time periods, but the profits have stalled lately. That’s despite historically hysterical monetary stimulus and budget deficits (essentially fiscal stimulus one way or the other). It’s hard to conceive of a new and bigger wave of stimulus on top of the already failing ones. There is no new China, no new India, no hoping for Africa to pull profits higher when the low hanging fruit in the U.S. and Europe have been plucked.

In addition, after 9 years of expansion a profit recession is way overdue. The profits for S&P companies quite often decrease by 30-50%, and the swings have become bigger since 1980, not smaller.

With both lower earnings multiples and stalling or falling earnings in the cards, a 50% decrease in S&P 500 is actually a quite modest expectation. Time for a black Friday soon?

Labor costs recently hit a low (inverted scale) and profit margins a mirroring high. With the magic of debt (that postpones the need for a real living wage) faltering it’s about time wages reflected living costs, and margins came back to earth. Guess what’ll happen to profits… Hint: it’s not positive.

4 Interest rates are about to rise

This chart speaks for itself, I hope. With interest rates this low, the only way is up. Retirees and pension funds can’t live off of a 2.2% return. Nominal!

Look at the chart, can you honestly say you think rates are going even lower? Anyway, rates don’t really matter, at least not fundamentally. If rates are staying low or going lower, then history teaches us that it’s because growth is low. In terms of equity valuations, lower interest rates and lower growth will cancel each other out. No, matter, unless we go completely digital, interest rates are not going negative (for long). A situation where suppliers want to be paid late, where you’re paid to mortgage your house and so on, simply is to perverse for an economy to take.

5. Dividend yields are low, and if they are about to rise, it’s only because stock prices are about to come crashing down

The dividend yield is lower than the interest rate, but rates are fixed and nominal, whereas dividends are risky and contingent of profits and not least cash flow. Dividends can be reduced or cancelled altogether.


Many more and bigger fundamental reasons to worry

There are of course numerous more reasons to expect lower profits, multiples and share prices, such as profit margins mean reverting (or inverting!), increasing churn rate among the top companies in a digital world etc. No need to mention the boomer cohort retiring, thus both reducing their equity portfolios, and cutting back on consumption (due to uncertainty about longevity and investment returns; feeding into lower sales and profits on top of any other adversity or recession trigger). I also don’t want to spoil any bull party with mentions of the debt ceiling and a congress that actually wants to see the president fail.

Finally, there is that minor detail of all too much debt in all sectors of the economy (government, corporate, student, auto, mortgage, credit cards) having already pulled sentiment and consumption forward, and henceforth putting a lid on future growth.

Oh, I almost forgot The Fourth Turning which with impeccable timing is soon upon us with its convenient total solution to small matters such as a failing European Union, currency wars, nuclear bickering with North Korea, unsustainable pension promises and the obese healthcare sector. Maybe a digital World War III, followed by a gold backed cryptocurrency fiat re-set accord could interest you?


And the bad news?

Technicals don’t look good either. Dr Hussman has frequently noted that high valuations alone rarely slow down equities. However, when the appetite for risk eventually recedes, it’s visible in “market internals”.

He theorizes that when risk is in universal demand it makes asset classes, industries, sectors and companies converge. The mirror image of such bull behavior is widening dispersion in a number of respects as a harbinger of more widespread flight to safety. The FANG phenomenon is hardly new, and narrowing markets are but one example of an early risk off signal for equity markets.

FYI: As of August 14, Dr Hussman no longer calls the rising risk aversion subtle.

Ain’t nuthin’ but a FANG!

As a final word: never forget that all securities have to be held until retired. That means that no matter how far a stock price has fallen there is still 100% owners, and thus potential sellers of the stock left. If falling equities means record high NYSE margin debt will trigger forced selling those potential sellers risk becoming increasingly urgent. And then there is the case of Ponzi schemes which have an uncanny knack of being exposed and exacerbating the negativity right when they do the most harm.

Do you still preach dancing while the music is playing, albeit close to the exits (or remaining chairs)? I mean, central banks have no way to go but ever more retard. The same goes for banks and corporations. They’ll push for just one more quarter of play pretend. Maybe they can pull themselves up by their own hair a final time before the ultimate solution. Some even claim it was the earlier downturns that were anomalies and due to very specific one-time issues.


Well I’m peepin’ and I’m creepin’ and I’m creep-in

But I damn near got caught ’cause my beeper kept beepin’

Now it’s time for me to make my impression felt

So sit back, relax and strap on your seatbelt


I wouldn’t bet on it; there’s no reason to. You can always decide to simply pass on this round and see what happens. Or, you just have to ask yourself if you feel lucky.

Well, do ya? (Please read this post in conjunction with my previous ironic post on the bull case for stocks)


Are you afraid yet? You should be.

The fire is lit, and there are very few exits — small and obscure ones.

You should be

Gold is one of those exits. Bitcoin might be another. Soft commodities could also be worth a look.


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BONUS: Check out Ludvig’s write-up in English of our interview with billionaire and hedge fund founder Martin Sandquist here.