Dear Diary,
How do you like that Dow? Down 272 on Tuesday. Then back up almost exactly as much on Wednesday.
As we predicted, volatility is rising. Investors are beginning to squirm.
Why?
The Fed is ending QE. And it could hike short-term interest rates as soon as next year. The EZ money is getting scarce.
“We are trapped in a cycle of credit booms,” writes Martin Wolf in the Financial Times.
Wolf is wrong about most things. But he is not wrong about this. “On the whole,” he writes, “there has been no aggregate deleveraging since 2008.”
He does not mention his supporting role in this failure. When the financial world went into a tailspin, caused by too much debt, in 2008, he joined the panic – urging the authorities to take action!
As a faithful and long-suffering reader of the FT, we recall how Wolf howled against “austerity” in all its forms.
His solution to the debt crisis?
Bailouts! Stimulus! Deficits! In short, more debt!
Deleveraging? What Deleveraging?
Since then, only America’s household and financial sectors have deleveraged… and only slightly. Businesses and government have added to their debt.
Overall, the world has much more debt than it did six years ago – more than $100 trillion worth.
Wolf has come to realize where his own misguided policy suggestions lead.
As a recent paper by banking think tank the International Center for Monetary and Banking Studies put it, fighting a debt crisis with more debt leads to a “poisonous combination of higher and higher debt and slow and slowing real growth.”
That is the world we live in. Thanks a lot, Martin.
The future is a blank slate. It whacks us all – but differently, depending on how exposed we are. What can we do but try to protect our backs… and squint, peering through the glass darkly ahead.
“These credit booms did not come out of nowhere,” writes Wolf. “They are the outcome of previous policies adopted to sustain demand as previous bubbles collapsed.”
Why sustain unsustainable demand? Why not just let the bubble collapse?
Under oath in a New York courtroom, two former US secretaries of the Treasury have told us why.
Not bailing out AIG would have been “catastrophic,” said Hank Paulson on Monday. A failure of AIG would have led to “mass panic,” chimed in Timothy Geithner on Tuesday.
At least they had their story straight.
But it is not hard to connect the dots. When a credit bubble pops, it causes fear and panic. The authorities take action to stop it.
What can they do?
Whatever it takes, is their answer.
What does it take to stop a deflating credit bubble?
More money! More credit! More debt!
“We need to escape this grim and apparently relentless cycle,” Wolf concludes.
Meanwhile, “IMF warns of third euro-zone recession since financial crisis,” reports the FT.
The IMF also downgraded its forecast for world GDP growth to 3.3%.
High debt. Slow growth. And another colossal crisis coming.
No wonder investors are nervous.
Regards,
Bill
Small-Cap Weakness Signals Trouble Ahead
If you want to know what’s in store for the Dow and the S&P 500, take a look at what’s happening to small-cap stocks.
Investors see small caps as riskier than their large-cap cousins. That’s why small caps tend to lead the way up in a bull market – as risk appetite grows – and lead the way down in a bear market – as risk appetite wanes.
And right now, risk appetite among US stock market investors is clearly waning.
As I wrote yesterday in The B&P Briefing, our bonus letter for paid-up Bonner & Partners subscribers:
There continues to be a direct link between market cap (which measures the total value of all outstanding shares) and performance.
The S&P 600 SmallCap Index is down -5.4% year to date. The S&P 400 MidCap Index is up 1.1%. The S&P 500 Index of large-cap stocks is up 5%. And the S&P 100 Index – a subset of the S&P 500 that tracks the 100 biggest stocks by market cap – is up 5.5%.
And the S&P SmallCap Index is down -8.6% from its high for the year. That compares with a drop of just -2.6% for the large-cap S&P 500 from its year high.
In other words, investors are staying with this bull market – for now. But they’re getting nervous. Something we also saw happen in the lead-up to the 2008 crash.
This doesn’t mean you should panic. But we recommend you take the necessary steps now to protect your gains.