Not too long ago I was chatting with an Australian vineyard owner near Solvang, California.
He asked what I did for work. I told him.
Then he looked at me and said: “It’s all gonna blow soon, ain’t it?”
I drank his wine and said: “Yep.”
Then again, I’ve been saying that for years…
For now, let’s take a step back and consider our “interesting” economic landscape as we come up to our 120th month of an entirely debt-driven and central-bank created “market cycle.”
Toward that end, I’ll open with a metaphor -a device I do so enjoy…and it’s the same one I offered to my wine owner.
The image I have is a beautiful little desert village with fruit stands in the streets, children running through sun-bathed flower beds, and yuppies driving blissfully about in convertibles listening to Michael Bolton’s Greatest Hits.
The sun is shining, not a cloud in the sky. All is well, as far as the eye can see. And up there, on the distant horizon, sits a massive dam, behind which millions upon millions of gallons of deadly river water are pushing.
And somewhere, hidden among the walls of that great dam, is a group of very nervous folks – dangling from repelling ropes, with their stubby little fingers desperately plugging holes which are now appearing with increasing frequency.
The image I like to use includes Ben Bernanke, Alan Greenspan, Mario Draghi, and Janet Yellen scurrying from hole to hole to hole, shouting for more corks, fingers, or even silly putty to keep the great dam from, well, crushing them (and the village below) to death…
So where am I going with this?
Well, think of that blissfully naive village as the global market economy, that slowly decaying dam as central-bank “magic,” and those ever-rising water levels as the current debt market, stock bubble, and totally ignored fear-index.
Global Markets: The Blissfully Ignorant Village Square
Now, let’s look at each aspect of my silly metaphor, starting with the naive little village.
Today, the global markets have become quite complacent. There is very little fear as the main stream media and Wall Street’s sell-side cheerleaders pump out earnings and “synchronized global growth” memes with all the positive fervor of a Michael Bolton solo…
Don’t worry, be happy. And why not, right?
Since that unfortunate little sub-prime banking crime and bailout in 2008 (aka the “Great Recession”), the Nasdaq 100 is up 220%, and the Russel 2000 (RUT) has climbed by 105% (and counting).
Earnings projections out of the Street are promising double-digit percentage growth, balance sheets are heralded as “strong,” and the S&P is expected to easily hit 3,000 – which it very well may.
In fact, things are looking so good in this perfect village that insurance salesmen are making a fortune taking in premiums for selling flood insurance to homeowners they know will never need it.
So, there you have it…
The markets and the world are like gleeful children laughing and running through fields of flowers and cotton candy.
All is well.
The Central Bank Miracle Dam
And why shouldn’t all be well?
After all, privately owned banks disguised as something “federal” (i.e. like the Fed and its cadres of PhD-carrying supermen) and departments like the U.S. Treasury (and its cadres of bureaucratic yes-sayers) discovered the miracle cure for all market risk in 2008.
Namely, if markets ever go dramatically down, just print trillions of dollars, crank rates to zero, and let the smart central bankers rather than natural market-demand “buy” good times. In fact, it’s such a great plan that central banks all over the world are doing it too! Yippee-Yay!
What about all that water pushing against that dam? And what about all those holes popping up on its walls?
Millions of Gallons of Dangerous River Water…
Here’s where the idyllic picture above turns a bit darker.
You see, market forces, like raging rivers, can only be contained for so long.
If the dam is made out of clay (or PhD’s), it just might burst despite its impressive surface shine.
And market forces are telling us loud and clear that this raging river water is about to burst through that miracle dam.
What are the signs?
Well, first, even those great minds at the magical central banks know that if you print trillions of dollars out of thin air to “support” or “stimulate” markets, you run the risk of a few (and often unmentioned) “side-effects.”
If you support a market artificially for too long, you run the risk of market addiction to the “stimulus.”
Markets become overly reliant on good times, low rates, continued “risk-free” borrowing and continued “buy at any price” investing.
This kind of addiction might explain why the S&P since 2008 looks like this:
When markets believe in miracles and memes (like the “Fed has our back,” “earnings are strong” or “global synchronized growth” will save us), money flows too quickly and thickly into over-valued securities.
Add to this dangerous market wave the countless number of bond traders front-running the central-bank-created (and grossly distorted) bond and rate markets, one quickly sees that the size and speed of this dangerous flow only increases-thereby creating more holes in that market “dam.”
And lest we forget, artificial low rates (nod to the central banks) also makes borrowing so easy that publicly traded companies are buying buy back their own stock at record levels and at peak valuations, thereby momentarily boosting the markets even more.
Of course, the moment rates rise, this shortsighted boost will become a fatal head wound.
Now, holes are appearing all over the walls of the magical dam, and the central bankers are running out of fingers to plug them.
In a debt driven “recovery” -like the one the Fed gave us in 2008- the experiment fails if GDP and Main Street growth are not rising. Sadly, since 2008, neither GDP (annualizing at 2%) or Main Street have grown.
What has grown (or “inflated”) is the stock and bond market. Unfortunately, they’ve grown to historical “bubble” levels by every metric. Every metric.
The Fed also knows that they can’t print money forever to buoy up bonds and keep borrowing costs (rates) down. To do so would risk destroying their currency and flirting with the inflation elephant in the room.
In a post-08 “recovery” driven by QE, low rates, and debt a rising yield/rate environment is the end of the party, the end of the “magic,” and the end of the happy village meme.
In short, rising rates represent the proverbial “Oh Sh!#” moment in the life of our “magical dam.”
And there won’t be enough fingers in the dam to prevent a long-repressed market river from drowning the village below…
As always: Be careful out there.
April 21 2019