S&P500 down 10% on the week, it would take another 10% to call it a bear market

Outlook:

The WSJ reports its most recent survey of economists show GDP should rise by 2.8% this year, the best in a decade. The Fed will raise rates three or perhaps four times. Golly, how normal that sounds. We also get wholesale trade and the rig count, and Canada reports employ-ment data, often to CAD bull dismay.

The chart of the week is surely the S&P and its 10% drop that puts it into "correction" territory. It would take another 10% for a total of 20% for the stock mavens to name it a bear market. So far we have been feeling fairly calm about the equity drop—it was overdue, it was justified on the Shiller rea-soning to get P/E's back in line, and once it had gone so far on the first day, herd behavior was sure to follow, algos and all. Lipper reports the exodus from equities is $23.9 billion this week alone. We con-tinue to think it won't reach 20% because of the absence of an authentic trigger, but nobody really can ever forecast the stock market and mostly we shouldn't try. However, note the fine print in the chart—the last full bear market ended down 57%. Yikes.

The Fed is being named the villain because it intends to hike rates at the March meeting, something expected by the money and fixed income markets for eons (in financial market terms). It's ridiculous on the face of it. A 25 bp hike will no more stress the financial conditions of companies than it will impoverish household debtors with credit card bills. In the absence of any real inflation—see yesterday's chart—the Fed is hardly on a rip-tide of ever-higher interest rates. As for the benchmark 10-year at 3% or a little higher, say 3.25%, in the grand sweep of history, that's really very cheap. See the long-term trend chart (from macrotrends.net).

The real threat to yields is not the Fed and not inflation, but rather fiscal irresponsibility in Congress that is allowing the national debt to reach and soon surpass 100% of GDP. The US has the "exorbitant privilege" of possessing the reserve currency and so can get away with lower rates than non-reserve countries, but patience will likely wear thin and some increase in longer tenors will get attributed to excessive debt. By now everyone has read Rogoff and Reinhart.

But the US is not Greece. In fact, Greece is not Greece. Today, after a stock market turmoil delay, Greece issued a 7-year note for €3 billion at a yield of 3.5%, the first new issue since 2014, with two more planned this year. See the next chart of the Greek 10-year yield.

It doesn't get any worse than it got in Greece during the 2010-2012 crisis. The economy was tanking, the government was tanking, the stock market was tanking, some important members of the eurozone wanted to boot Greece out, and the spillover to Cyprus caused a banking/liquidity crisis that persists to this day. But aside from those few years of massive crisis, Greek yields have mostly been around 5% for nearly two decades. This is not to minimize the misery of the Greek crisis. But hard-hearted finan-cial types like to note that Greece adapted to eurozone-imposed austerity and the drop in yields (and return to the market) looks "normal." The IMF still calls for debt relief and the Greek saga is probably not fully over yet, but see the chart again.

So, with a fairly booming economy, nearly full employment, low inflation, a stable banking sector, a sane and pragmatic new Fed chief, and hardly any gloomsters predicting recession, what can go wrong? What we mean is what can go wrong that should freak out the stock market?

Top of the list is an institutional failure. The last big US financial crisis was caused by banks creating sub-prime mortgages that never should have been issued in the first place to un-creditworthy borrow-ers. Then they compounded the problem by bundling them into "securities." Then the rating agencies gave the securities high ratings they never deserved. Then some institutions overdosed on them and had such high leverage themselves that when the asset prices fell, they had no more borrowing capability. Who is to blame? The banks, the rating agencies, and the buyers of bogus securities.

Gee, where do we have a bogus security these days? One obvious candidate is cryptocurrencies. But here the narrative changes horses, because the whole point of cryptocurrencies is to escape the hide-bound, bureaucratic, rule-ridden, government-regulated financial system. Everyone appreciates crypto-currencies sticking it to The Man, and their very existence is a validation of public dissatisfaction with the financial system, but in the end, The Man is the one who saves the day. Those who dislike the fi-nancial system so much know almost nothing about it. And the financial Establishment has no respon-sibility when it comes to cryptos. Maybe it should, as in South Korea, but you play in that sandbox at your own peril. Bitcoin is down 42% year-to-date and you don't hear cries of distress for the govern-ment to come rescue the "investors." Governments don't rescue you at the race track, either.

But the rating agencies are not involved, thank goodness. The embrace of cryptocurrencies by the gen-eral population is probably pretty small, and as far as we know, none of the big 20 financial institutions are involved in any substantial way, so a few newbie financial types, truck drivers and factory workers will have lost their savings but there won't be a giant rise in homeless street people. The last time, mil-lions of people were literally left homeless. It's not without meaning that one of the mortgage bankers who made hundred of thousands homeless is now our Treasury Secretary. (Cryptos will come back.)

So, if not cryptos bringing down the roof on all our heads, what? We continue to worry about algo-driven stock trading, but even so, at some point a couple of deep-pocket guys are going to say, "Basta. Let's buy." We don't know when that will be or what the P/E's will be at the time, but it's absolutely, 100% certain to occur. It always does.

The stock market rout is not due to the government shut-down, or fear of the March Fed rate hike, or inflation lurking in the bushes, or any suggestion of institutional failure. And yet the WSJ reports "Investors globally yanked a net $30.6 billion out of equity funds in the week ended Wednesday, the most on record." Why? The madness of crowds.

We saw one analysis that postulates if reallocation out of equities into fixed income (for whatever rea-son) is authentic, the yield should be higher. It's not moving in lockstep with the drop in equities. The deduction is that equity holders are selling just to get out of Dodge. That means they are in cash, and it won't be long before yearning for a return gets a grip.

As for the stock market's effect on the dollar, it's a risk-off play so far and won't go away and allow realistic data-driven FX moves to return until fear and loathing are exhausted. We think that could hap-pen as early as next week. Whatever the timing, the dollar is on a long-lasting downtrend and it's nerve-racking to be forced to be long by the stock market.

Tidbit: Bloomberg has a story on the 6 reasons the stock market is correcting. The MUFG chief econo-mist blames the end of the low-rate era, with the stock market the leading indicator. "There is no way the Federal Reserve is going to raise interest rates at Powell's first meeting as chair in March. They aren't that crazy." We say Powell has no choice and must raise rates at that meeting, not only because it has been so long telegraphed and is justified on the expected data, but also because the Fed does not play hostage to the equity gang.

A Pimco economist told Bloomberg "Equity market behavior is mimicking historical periods of accel-erating inflation, slowing growth." We say there ain't no inflation and all the forecasts are for rising growth.

The Vanda Research analyst blames a shift to risk-off sentiment that has re-set the old correlations and trends. Oakbrook Investments concurs, naming flight-to-safety. Hedgies are herd followers, according to Williams Capital. Washington Crossings Advisors says the Fed has been repressing volatility for 10 years and market players are shocked by its appearance. They "sell first and think about it later."

Is this actually six reasons, or one? More to the point, if this is the standard of analysis at big manage-ment firms, no wonder the market is crashing. There is no guidance here.

Fun Tidbit: All week the story has kept popping up that Trump's personal lawyers are advising him not to testify to the special prosecutor because Trump is habitually a liar and almost sure to commit perjury. Imagine any national leader being described as such a liar he can't be trusted to give honest testimony to a court in a country whose entire system is built on the Rule of Law.

We can't even compare to Berlusconi, an equally boastful guy but not, evidently, much of a liar. A cheat, maybe, but not a liar. Meanwhile, the White House lawyer thinks he should testify, but then, his job is to protect the prestige and reputation of the presidency, not the current occupant. Poor guy, no-body has the heart to tell him it's too late.

And this week an appellate court found Trump guilty of scamming people who bought worthless "courses" from Trump University and ordered Trump to reimburse them $25 million. Again, imagine any national leader being found guilty of scamming the little guy. At what point do people take to the streets to demand Congress impeach? It's not only the special prosecutor at work. It also takes the pub-lic. Everyone associated with Watergate and Nixon's resignation one step ahead of impeachment acknowledges that public outcry was a critical factor.

 

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