Small caps drop over 15% in 4 days only to rally over 10% in less than 24 hours. A rally was not a surprise after such a steep and fast drop. What probably shouldn’t have been a surprise, but still ended up being one was how quickly the Fed felt pressured to announce the immediate implementation of its corporate bond program (which was announced a couple of months ago) but now they actually implemented it with effect today. The timing is obvious. They can’t, won’t tolerate any market downside, so scared they are of losing control of the asset bubble they have created. Which begs the question: How scared are they of these markets that they have to intervene at every down turn?
The amounts of money thrown at this entire construct is obscene. What took hundreds of billions during the financial crisis is now taking thousands of billions, commonly known as trillions. The lengths and depths of their interventions indirectly into equity markets by directly buying high yield and now corporate bonds is a perversion of the financial system. No red line shall remain uncrossed. Along with monetizing Treasury debt the Fed is now in effect the nation’s piggy bank:
The lender of last resort has become the lender of the entire resort.
— Sven Henrich (@NorthmanTrader) June 16, 2020
But it’s not just the Fed. Yesterday’s announcement was apparently not enough as the Trump administration suddenly tossed a trillion dollar infrastructure plan soundbite on top of the liquidity fire. Also on the heels of a 10% correction. How convenient. Whether that plan ultimately materializes or not is besides the point, futures reacted and squeezed vertically even higher. What a circus. Not a stable market and my mantra of the extremes getting ever more extremes continues to hold true.
Last Monday, as $SPX was putting in the highs for this historic rally, I put out Crash 2 talking above a coming volatility move. I’m not pointing this out to pat myself on the back. In fact I had openly acknowledged that this move went higher than even I expected when I highlighted an awe inspiriting rally to come at the March 23 lows.
But for what it’s worth it was a well timed article as $ES dropped 300 handles and $VIX rallied over 70% after I posted the article.
No, the reason I mention it is because I want to highlight a few larger points that lead me to the conclusion that these markets are really just circling the drain, repeating the same pattern over and over again in the past few years.
Take this simple chart of the S&P 500 and the $VIX below and let me give you my perspective of what’s been going on here:
The first big structural point to note is this: The moves are getting ever more extreme. To the upside and to the downside. This is not a stable bull market at all. It’s a mess.
All rallies have come on artificial liquidity injections of either the fiscal or the monetary variety. All sell offs have come on fundamental reality asserting itself.
All rallies have built tightening channel patterns amid volatility compression and have run from one wedge pattern breaking to another other breaking down. Last week $VIX and $SPX once again broke their wedge patterns. The larger trend: Vast prices ranges and increasing volatility while growth remains entirely absent from the equation and nothing but liquidity driven multiple expansion is the market’s upside price discovery path.
The 2017 rally topping in January 2018 was driven by free money in the form of tax cuts. The promise was for 4%-5% GDP growth to come. No such growth ever came. There was a one quarter spike in GDP growth and that was it. Why? Because much of the money went into buybacks and financial engineering and not into capital investment with the expectation of coming growth. That’s what boosted stock prices in 2018 (before reality sunk in).
No, reality is this: Corporate tax cuts have done exactly squat for economic growth, nothing. Corporate tax receipts plummeted and real GDP growth stayed on its meager path:
GDP couldn’t even reach the 2015 peak of this cycle. But there was another $1.5 trillion down the drain.
The Fed tried to use the backwind of the tax cuts to try to normalize its balance sheet. Autopilot roll-off they called it. It failed miserably and market dropped nearly 20% into Q4 2018 before the Fed was forced to flip flop.
So 4%-5% GDP growth didn’t materialize.
Then the promise was for all this earnings growth in 2019 as tax cuts and buybacks were to at least give the illusion of growth. No such earnings growth materialized. None. Yet markets rallied 30% in 2019 on no earnings growth. Why? Because the Fed implemented its largest liquidity program since 2009 in Q4 of 2019. Over $400B in balance sheet expansion to deal with the Repo crisis that emerged in September of 2019.
‘Not QE’ the Fed called it. A lie. Markets took it to be QE and ran market valuations to the highest ever: 157% market cap to GDP. No worries they said, there will be 5% to 8% earnings growth in 2020, and that will justify the valuations.
No such earnings growth materialized as Covid-19 trigged the global economy into a recession. That’s 3 years in a row of failed promises of economic and earnings growth. And now a rally that took $3 trillion in Fed intervention and a US deficit of $4 trillion to manufacture.
A market that once again rallied on multiple expansion alone and doesn’t have an earnings growth story to back it up is by definition a bubble. Especially now that last week markets rallied again back to 152% market cap to GDP before dropping 10% to 142% market cap to GDP.
Many are insistent on a V shaped recovery. Many of the same people also made bold projections about earnings and economic growth over the past 3 years, growth that never materialized. Fact is unemployment will remain high for years to come. That’s why the Fed is insisting on zero rates until 2022.
No, my larger concern is that we are circling the drain.
Let’s face reality a bit shall we? This economy has not been able to produce above trend GDP growth in many years. It couldn’t do so with 10 years of easy money, it couldn’t do so with a $1.5 trillion tax cut, it couldn’t do so with 3 rate cuts in 2019 and a $400B+ balance sheet expansion and it can’t do it right now with a combined effort of $7 trillion in intervention this year.
Why? Because we are in a structural depression. All growth is financed by debt. All of it. This market and economy has been pumped with artificial stimulus and liquidity to the hilt and what’s it all produced? The US will hit $30 trillion in debt perhaps perhaps as soon as next year.
We are in a depression. Why? Because an economy that requires $7 trillion in intervention is in a depression, don’t fool yourself. An economy that can’t grow with a $1.5 trillion tax cut, rates at zero and non stop intervention is in a depression.
Now the question is how you get out of it and what conditions are in place for future growth.
In the olden days future growth came about because the system was allowed to cleans itself and new business models sprung to fruition from the ashes. Inefficient businesses went bust, new businesses were formed. Corporate debt was reduced. That’s called a cleansing and new innovation.
But that’s not what’s happening here. The opposite is happening. Debt is exploding and by next year US debt to GDP will be perhaps as 135%-140% and corporate debt north of 50% debt to GDP:
A zombified economy:
So let me get this straight: Cheap money, low rates and QE produced the slowest recovery in history. Markets and the economy can’t handle any disturbance without intervention, both are entirely debt dependent and to this day have not been able to either grow organically or stay on their own feet without artificial help.
And note: The size of interventions required is ever increasing. It takes more and more money to keep things afloat. In the meantime every single big rally in the last couple of years, sold to the public on the promise “forward looking” and “optimism” (rate cuts, tax cuts, trade deal, blah, blah, blah) all of them have turned out be wrong.
No 4%-5% GDP growth, no earnings growth in 2019, no earnings growth in 2020. But now the biggest asset bubble inside of a recession ever, a recession from which we will emerge not cleansed and rejuvenated, but zombified, ever more indebted, with an even larger wealth gap than ever before. And if that backdrop doesn’t justify 150% market cap to GDP valuations I don’t know what does.
The Fed has created a full on gambling casino and the gamblers have moved in and are pulling the ‘buy’ triggers non stop. The Fed is not saving the economy, it’s zombifying it and in process of inserting itself ever deeper into markets the Fed itself is becoming too big to fail. The Fed losing control over the asset bubble is now the biggest risk factor to the economy. A rescue model that relies solely on ever higher stock prices ever more divergent from the underlying economy creating an ever larger wealth gap in the process. It’s a spiral out of control that is masking what is really going on: The structural economy is circling the drain and zombifying the economy will only clog it up with dire consequences to come, consequences masked for now as markets are still busy chasing every liquidity headline.
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