Tuesday, August 9, 2016

Flash Crash On Steroids Makes An Interesting Scenario!

Market Could Fall And Not Come Back!
Time and time again I hear how many investors think that even if things go downhill fast they will be smart enough to get out of the markets, others simply think no way exists for these markets to fall sighting a lack of investment alternatives. After the debacle in 2008 where they saw the market take nasty and violent swings they claimed, they have learned a few things that will enable them to make the right moves before it is too late. After years of moving upward, this bull market is long in the tooth. While the economy is mired in slow growth and across the world debt is exploding market bulls have embraced a "Buy the Dip" mantra exploiting a market that moves ever higher pushing aside the market's ability for true price discovery. It is against this backdrop that one such optimist fella wrote the following;
Yes indeed 'this time it actually is different'. There simply are not any good alternatives this time.   Although the FRB increased rates slightly in Dec. 2015 the interest rates being paid out on Treasury Notes, Savings Bonds and CD's have all continued to fall. As have mortgage loan rates continued to fall.   80 to 90% of all wealth is in the hands of the 10% at the top. They grow wealthier each year and THIS TIME, they do not have any good alternatives to the stock markets.   This time, it is different because we as investors can not say I don't like the risks because when you are sitting on millions of dollars worth of liquid assets you Have To put it somewhere. 

This time is different because far more of the wealth is consolidated at the top.  Many top tier stocks are paying dividends of 4+%  compared to 1% to 1.5% on Treasury notes and CD's where the money has to be tied in longer to even get those lower rates.  Imagine you had $5 million of liquid assets you had to invest today.  Would you buy 10 year Treasury Notes and settle for a 1.5% return which amounts to $50 thousand dollars worth of T-note gains each year at 1.5%.  or would you put your money into top tier stocks for a 4+% dividend or a $200 Thousand dollar dividend gain each year. Yes, the stock market risks are higher but the rewards are 4 times higher.   And another game changer is: don't forget that today we have the added bonus of lower federal tax rates on dividend income. Times and condition have indeed changed, making this time indeed different.  ALL IN. Up, up and away. The best gains lie ahead.

His thoughts seem to reflect what many investors are thinking. But what is not being taken into consideration is that if the market falls like a flash crash on steroids they are trapped. We have been assured that can't happen because circuit breakers have been put in place to arrest panic style moves, however, imagine a market that falls, trade is halted, and the market simply does not reopen for days or even weeks. As remote as this might seem please take a moment to consider the possibility and the far-reaching ramifications. While you are imagining this scenario realize that America's stock market is the gold standard and consider how less stable global markets would react in countries like China and Brazil.

For a long time, I have been trying to develop a scenario for a market "super crash" and a reasonable map that would arrive at such a situation. To say I'm negative about this economy is a gross understatement. I saw the last housing bubble coming and predicted the crash in my book Advancing Time. I continue to contend that we have never recovered from the Great Recession or corrected the many problems that haunt our financial systems such as derivatives and collateralized debt obligations. By printing money, imploding interest rates, and exploding the Federal Governments deficit we have only delayed the "big one."

I recently came upon these two quotes on macroeconomic stabilization and crisis. First, from Macresilience;

    "As Minsky has documented, the history of macroeconomic interventions post-WW2 has been the history of prevention of even the smallest snapbacks that are inherent to the process of creative destruction. The result is our current financial system which is as taut as it can be, in a state of fragility where any snap-back will be catastrophic."

And next from Nassim Taleb (author of The Black Swan);

    "Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite."

These quotes suggest an analogy with ideas about forest management when natural fires are suppressed. If random fires do not periodically clear away forest underbrush, we see a build-up of flammable material sufficient to power a massive conflagration. I certainly think an equivalent truth applies to financial markets. The longer it has been since a painful collapse, the greater the willingness to pile on leverage and complexity, such that the next crisis becomes unmanageable. The "Too Big To Fail" and other policies implemented since 2008 have distorted markets across the globe and laid the groundwork for "The Big One", or what we will someday look back on as the mother of all sell-offs.

What happened in Cyprus a few years back should serve as a warning to anyone who thinks money in the bank is safe. A bad haircut, in this case, means you have been robbed. That may be the case if the government reaches in over a long weekend and steals money from your bank account. This is a horrible precedent to set, and the worst part may be how many people accept it saying it is ok as long as it is only on the larger accounts and only impacts the savings of someone else! It is very important to remember these low-interest rates come at a price, a dark side exists to current economic policy. In the long run, the benefits they bring may be outweighed by the distortions they cause.

By not taking steps to correct many of our ills in a way we have made things worse. We have not made the structural changes necessary for our economy to become sustainable. We have put band-aid upon band-aid, upon band-aid while what was necessary was the amputation of a diseased limb. After all the threats that this market has avoided, and sidestepped, it is possible that many now think of it as invincible. This market has overcome the death of the euro, the financial cliff, and the end of Greece as we knew it. My studies in "microeconomics," and observations in the current real-estate market, both as an owner and hands-on landlord allows me to predict, we ain't seen nothing yet!


  1. Bruce, I have commented a few times, but its been a while. I own 3 houses and 22 apartments in a medium sized (75k ) college town. Things are completely nuts! The mayor and the CC sold out to the builders, and it was off to the races. I had a guy hound me to sell a building to him, so I finally did. He bought it will all borrowed money. Man he got hosed, as it was in terrible shape, and he way overpaid. The Cap Rate was about 2%. Just totally nuts, but it looks like its coming to an end. They just cancelled the construction of a grocery store they were going to put right down town. It was an insane idea. ZIRP is doing so much damage its incredible. I just found out that the high school was built on land the city bought from the mayor. You know he got a juicy deal, and we taxpayers got hosed. I think I'll try to jettison something else.
    My tenants are getting to be non students-most older males-with crappy jobs, debt, and thus can't afford to buy a house. Now they can hardly pay their rent.So I am scraping the bottom of the barrel.Five years ago I had all students. I can't figure out what they are going to do with all these apartments. There's hundreds of them. This is way worse than '08. I just can't figure out how people think that an economy that requires 8 years of ZIRP isn't a disaster waiting to happen, but some people think everything is just great. Man some people are so f'ing stupid, and totally economically illiterate on top of that. Just freakin zombies.

    1. Chazz, I very much appreciate your comment. I think either of us would gladly meet with, then take on tour, any of the know it all economist or politicians that think the economy is on the mend. I hope you got a chance to read my article titled, "An Example Of Local Government Run Amuck!" It highlights the totally frightening trend that is overtaking us. Bottom-line, none of the numbers work and the trend is getting worse not better. Thanks again and stay safe.

  2. Absolutely agree with article.

    Here is company www.jetta-talo.fi you should check. It could be useful to understand european real-estate market.

  3. I just came across an interesting piece on the site, Seeking Alpha" that occasionally picks up some of my articles. It is a transcript of an interview conducted on Mises Weekends about a new book, The Road to Ruin: the Global Elite's Secret Plan for the Next Financial Crisis. The link is below.