Everything bubble ripe

Posted By Darren Winters on Aug 16, 2019


Everything bubble ripe

Is the everything bubble ripe?

The global stock market rout is underway with red flags in abundance.

The inverted yield curve warning, which is now making mainstream headlines, has become even more inverted. That typically is not what happens when investors are bullish.

Historic data suggests that the inverted yield curve is a reliable recession indicator, so the latest stock sell-off could be signal that the everything bubble is ripe

Typically, when investors lend out long term they demand higher yields than when they lend in a short time frame. Why?

Investors are taking on higher risks when they buy long term bonds than bonds with a shorter maturity date. So investors expect higher yields for bonds with long term maturity dates.

In a few words, the yield on a 10-year Treasury note in a benign market should be above that of the three-month bill.

When 10-year Treasury yield falls below the three-month bill, then the yield curve has inverted.

So why is an inverted yield curve a red flag for the economy and a potential warning that the everything bubble is ripe?

Everything bubble ripe

If investors were optimistic about the future they would be piling into stocks for capital appreciation and dividends and not 10-year Treasury with such dismal yields.

Capital flows are the holy grail of investing, so as the price of the 10-year Treasury goes up, due to buoyant investor demand its corresponding yield falls.

So the inverted yield curve suggests that the everything bubble is ripe.

But a recent piece in the market watch is playing devil’s advocate. It argues investors should not worry about an inverted yield curve, based on the stock market performance since 1978.

“On average, the S&P 500 has returned 2.5% after a yield-curve inversion in the three months after the episode, while it has gained 4.87% in the following six months, 13.48% a year after, 14.73% in the following two years, and 16.41% three years out, according to Dow Jones Market Data,”writes MarketWatch.

But surely 1978 to 2008 period is a very different world from today.

In the last decade, since the financial crisis of 2008, the world’s central banks have embarked on the greatest monetary easing experiment in the history of finance.

We have witnessed a debt-fuelled asset bubble in stocks, courtesy of the central bank’s asset purchase program. Moreover, today, the Fed’s base rates are already near record lows. 

In 1978 interest rates were a lot higher.

So the everything bubble is ripe for those who believe that the Fed’s monetary policy is exhausted

That’s a sound view, bearing in mind that the Fed fund rate is already near record lows, which means the Fed can’t make any meaningful cuts to stimulate the market.

July’s Fed cut rates by a 25bps was the first-rate cut in 11 years and stock sold off. Moreover, the Fed’s bond purchase program known as quantitative easing QE is exhausted, how much more debt can the Fed monetize, without debasing its fiat currency into oblivion.

The everything bubble is ripe because the Fed’s monetary policy doesn’t have many rounds left in its chamber to combat the next recession, unlike previous recessions.

Fed impotence will eventually be the catalyst for a panic, where everything bubble is ripe to burst

The 2008 financial crisis ushered in a decade of unprecedented monetary easing, it created the bubble of everything. Real estate prices, particularly in the metropolis, are now not affordable for most workers, stock price and earning relationship is broken. In a warped world, even junk high-risk bonds have fallen into negative yield.

Put simply, the solution to the 2008 financial crisis, a debt crisis was erroneously even more debt

The post-2008 financial crisis was the decade of a debt-fuelled economic recovery, it rewarded speculators, diverting capital away from productive endeavors and thereby aided and abetted the greatest wealth-income inequality of our time.

The financial market became the Fed’s perpetual motion machine to keep the bull market running all the Fed had to do was injected the bull with more QE, then pretend on stage that all was fine and dandy with the economy. 

So the 2008 financial crisis has not been fixed, and the Fed could have made it worse with massive monetary easing. 

How can a debt problem be resolved with more debt?

When the Fed loses critical mass trust in its handling of monetary policy, then the everything bubble is ripe to burst.

The Fed’s 25bps July rate cut sent stocks tumbling and different reasons were given for why.

Some commentators have argued that the Fed didn’t cut its base rates aggressively enough and where anticipating at least 50bps.

But at this late stage of the game, with rates were near zero, what counts more than rate cuts is confidence from the Fed that it has a handle on the state of the economy and monetary policy.

A hawkish rate cut is an oxymoron, the economy is either ticking over nicely or it isn’t.

The poker face doesn’t work when the cards are on the table and the Fed Chair Powell has shown his cards with a rate cut.

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