Unwinding the everything bubble
Unwinding the everything bubble began in the final quarter of 2018 and it is likely to be a big story in 2019.
The central bank’s bubble of everything was financially engineered with nearly a decade of experimental monetary policy. Through a policy known as quantitative easing QE, the major central banks purchased approximately 15 trillion dollars of assets in the market to create the so-called “wealth effect”. The idea, albeit in theory was to keep asset prices buoyant and make asset holds feel wealthier so that households would consume more which was also intended to boost business investments.
But these policies created the everything bubble in the financial world, massive wealth inequality and the rise of political instability.
In an attempt to prevent a systemic crisis, the main central banks are now attempting to unwinding the everything bubble
Put another way, the central banks are now tackling the negative effects of their own monetary policy.
With the exception of precious metals, 2018 was the year of peak bubble of everything from stocks, to government and corporate bonds, junk bonds to real estate and start-up valuations all surged Even alternative investment such as classic cars, fine whisky all entered the price bubble stratosphere.
Then came in 2018 the central bank’s monetary policy transition from accommodative to tightening and the beginning of unwinding the everything bubble.
But let’s zero in on the peculiar look and feel of the bubble of everything which broke the mechanics of the market.
During the central bank’s accommodative policy which entailed QE and near-zero interest rate policy ZIRP something unusual occurred, all asset prices rose in tandem. The correlation between rising stock prices and falling bond prices was broken, everything rose. Bonds rose stocks rose with the exception of gold and silver valued together. Portfolio diversification became almost impossible in the central bank’s artificial everything bubble.
All assets went sky-high and a bull market by default had been engineered by unprecedented amount of central bank easing. Moreover, the asset bubble was global as all assets in the portfolio kept going up year after year.
In the pre unwinding the everything bubble, the risk on trade was rewarded, buying the dip made asset managers look like Superman. But it was a surreal market propped up by the central bank’s massive liquidity. Those that shorted the market, or scrambled to safety by piling into precious metals or stayed on the sidelines in cash accounts didn’t do so well.
Unwinding the everything bubble had to come next alternatively the central bank risked creating a systemic crisis, a monetary crisis
Creating a perpetual bull market in risk assets is not the central bank’s main priority. The fact that the Fed is unwinding the everything bubble by raising interest rates 9 times so far in this cycle which started in 2015 suggests that the bull market is being sacrificed to prevent a systemic crisis (a crisis of confidence in fiat debt money).
The central bank’s transition of monetary policy from accommodative to tightening is causing the unwinding of the everything bubble
Quantitative tightening QT (the inverse of QE) is accelerating the unwinding of the everything bubble. The Fed has already started shedding assets it had acquired under QE.
It ramped up selling its balance sheet assets (QT) as of October 2017 and it is now operating at “cruising speed” with 370 billion dollars of assets already being dumped onto the market.
Moreover, the ECB is in cahoots with the Fed’s monetary tightening policy. The ECB has already abandoned its negative interest rate policy and a first rate hike is expected to occur in 2019. BoJ also pursued a massive QE program which included a wide range of assets. In 2017 it started tapering, there have been four months were its assets actually fell from the prior month. Over the past 12 months, its total assets rose by only 4.6% compared to annual increases from 2013-2016 which reach 45%.
The BoJ owns half of all government securities and almost the entire bond market.
The three main central banks ( Fed, BoJ, and ECB) have started unwinding the everything bubble
Global interest rates are also rising around the world. 2018 marks the end of an era and the beginning of the unwinding of the everything bubble.
Consequently, the S&P index is down 2.8% YTD and down 11.6% from its peak. So far this year it looks like the Santa rally is dead on arrival. S&P 500, Dow, NASDAQ are all down by approximately five and a half percent in December.
Unwinding the everything bubble already started in 2018
Market watch writes, “it was the worse beginning of December since 1980.” Dax is down 16% to date and 20% from its peak which means it is now in a bear market. FTSE 100 down 11% since 2018 and 13% from its peak, Italian index is down 23% YTD and down 30% from its peak, Spain’s IBEX is down 12% YTD, down 16% from its 52 weeks high and down 40% from its 2007 peak. Asian stock indexes are all down.
EMCI in those countries in USD has plunged by 22% from its peak in January. In term of US bonds, yields have been rising and their price has been falling and US banks just disclose the largest unrealized losses on US investment since Q1 2009 according to the FDIC.
For the first quarter of 2018 combined these unrealized losses amounted to 200 billion dollars. The Declining value of the bond portfolio in tight liquidity conditions could be a big problem in 2019.
Real estate prices are also declining everywhere.
As unwinding the everything bubble get underway which assets are likely to do well in 2019?
Cash investments, short-term treasury bills, high yield saving accounts that returned 1.5 and 3 % might start to look attractive as investors conclude that those meager returns are better than losing 20% in a bubble of everything.