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Red Screen At Morning, Investor Take Warning

It's time for safety. And it's beginning to pay better, too
Friday, February 9, 2018, 9:12 PM

Growing up as I did in coastal New England, this old rhyme was drilled into us as children:

Red sky at night, sailor's delight;

Red sky at morning, sailor take warning.

Because many of the people in town still made their living on the sea, the safety of person and property depended on being able to recognize the signs of approaching danger.

A notably red sky at morning is usually due to sunrise reflection off of moisture-bearing clouds, signifying an arriving a storm system bringing rain, wind and rough seas. Those who ignored a red sky warning often did so at their peril.

Red Sky In The Markets

I'm reminded of that childhood rhyme because the markets are giving us a clear "red sky" warning right now. One that comes after (too) many years of uninterrupted fair winds and smooth sailing.

The markets have plunged nearly 8% over just a single week. And the losses are across the board. Nearly every asset class from stocks to bonds to commodities to real estate are participating in the pain. Market displays are a sea of red.

We've written so often and recently of the dangerous level of over-valuation in asset prices (caused by years of central bank intervention) that to re-hash the premise again feels unnecessary.

But the chart below is worth our attention now, as it really drives home just how dangerously over-extended the markets have become. It's a 20-year chart of the S&P 500, showing how it has traded vs its 50-month moving average (the thin green line).

Importantly, the chart also plots the Bollinger bands for this moving average. These are the thin red (upper) and purple (lower) lines above and below the green one.

The simple definition of Bollinger bands is that they are measurements of volatility, and serve as indicators of "highness" or "lowness" of price relative to trading history (a more complex explanation can be found here).

What that means is, when the price of the S&P 500 trades near the upper (red) Bollinger band, that's an indication it's over-priced vs its historic trading behavior. And vice-versa when it trades near the lower (purple) band.

Now, the chart below is important because it shows that over the past 20-years, the S&P 500 has *never* traded above the its 50-month upper Bollinger band -- EXCEPT for the 7 months preceding this one. Simply put, the market had not been more overvalued in (at least) the past 20 years as it was last month:

Bollinger band chart

(click here for an expanded view)

But just as frightening, though, is how the 7% drop the S&P has experienced over the past week has only brought it back to just touch the upper Bollinger band. Despite its recent losses, the S&P is still wildly over-valued.

Said another way: it still has further to fall. A LOT further.

If indeed this is the start of a major correction, one that clears out all  "excessive exuberance" as happened in 2001 and 2008, we could well see a retracement down past the 50-month moving average, all the way to (and possibly, briefly, below) the lower Bollinger band.

That would put the S&P somewhere around 1,500-1,600 -- a drop of around 40% from where it closed today.

And as we made the case earlier this week when looking at classic asset price bubble curves, a return of the S&P to a price level below 1,000 can't be ruled out.

Time To Batten Down The Hatches

When a storm arrives at sea, sailors hunker down. They strip, tie fast, and stow everything they can -- then they ride out the storm and re-emerge once it has passed.

This is an excellent model for today's investor. If this week's plunge indeed accelerates into a bear market, simply surviving the carnage with a substantial percentage of your capital intact will constitute "winning".

So, if you still have long positions in your personal or retirement portfolios, what should you be doing at this point?

1) Move To Cash

Get your money to the sidelines. Remember that everything is relative during periods of extreme volatility like now. When everything around you is dropping in value, the relative value of your cash position rises.

Those who had already moved to cash now find they can buy 7% more of the S&P with it than they could a mere week ago. That relative rise in purchasing power will only increase should the markets fall farther from here.

Cash is also offering an improving absolute return as well these days, as interest rates rise. Not that you'd know it from what your bank is offering you (surprising no one, banks have kept depositor rates near 0% despite receiving higher interest payments themselves from the Federal Reserve).

But holding your cash in short-term T-Bills (durations of less than 1 year) through a program like TreasuryDirect is now returning yields of close to 1.5%. That's 25-50 times(!) more than what the average bank savings account interest rate is right now.

Given this high relative payout and the extreme safety of Treasurys (the last financial instrument in the world likely to default, as the US will simply print the money to repay, if necessary), this strategy is a clear no-brainer for those with a material amount of cash.

Those looking to learn more about the TreasuryDirect program, including how to open an account there, can read this primer we created.

2) Prepare Your Action Plan

We have long been loud advocates of working with a professional financial advisor. Now, more than ever, you want to review your action plan with him/her.

If you have remaining long positions, battle test them. How do you expect them to perform in a bear market? If the market falls another 10% from here, what will be the expected impact to your overall portfolio? What if the market falls 25%?

Does hedging make sense as a risk management strategy for you? How about building up a short position with a minority percentage of your portfolio?

Now is the time to address and answer these questions, because if indeed a major correction is nigh, it very well may happen so fast you don't have time to act. (Just ask those holding Bitcoin in January how quickly 50% of your position can vaporize.)

As always, if you're having difficulty finding a firm willing or able to engage in the above with you, consider scheduling a free consultation with Peak Prosperity's endorsed financial advisor.

Also, folks frequently underestimate the effort and time it takes to set up accounts, get funds transferred, etc. Don't set yourself up for the frustration and disappointment of delays should you wait until the midst of a market melt-down to get all this in place. The market may be moving so fast at that point as to make your efforts moot. (Again, talk to the crypto crowd here about their challenges funding accounts and trading through the exchanges last month.) 

Instead, get everything set up and prepared now. You don't need to necessarily transfer any funds at this point. But do yourself the service of getting all the administrative hurdles behind you today.

3) Track The Risks & Opportunities Closely

As we've warned for years, we've been living through The Mother Of All Financial Bubbles. When it bursts, the damage is going to be truly horrific.

The ride down in the markets is going to be painful and scary. There are going to be many knock-on effects that are impossible to forecast with precision -- or even to identify -- right now. What will happen with housing, jobs, pensions, entitlement programs, social services, the banking system? All could be impacted.

To what degree? We don't know at this point. Which is why tracking developments in real-time and assessing their likely impacts will be critical.

Similarly, in crisis there is opportunity. There will be speculative opportunities that present themselves during a melt-down (e.g., shorting mortgage insurers during the 2008 crash). And once markets find their bottom and stabilize, there will be the chance to invest in quality assets at fire-sale values compared to today's prices.

Knowing when to deploy your dry powder, and what to deploy it into, will be key.

We'll be doing our best here at PeakProsperity.com every week to offer essential insights to help you stay well-informed and on top of these fast-moving events.

To that mission, we've swiftly assembled a webinar on this coming Tuesday, February 13, 2018 at 8pm EST with Chris Martenson, Axel Merk and several other financial experts to provide in-depth context into the recent market plunge, as well as their best assessment of what to expect from here in the near term. (To learn more about the webinar, click here)

Markets are warning us that even stormier seas lie ahead. Heed that warning, sailor, and hold fast!

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25 Comments

Grover's picture
Grover
Status: Platinum Member (Online)
Joined: Feb 16 2011
Posts: 871
Safety First

Good and timely article, Adam. I've been frustrated with the interest that my bank provides. I've been thinking of opening a Treasury Direct account but just haven't done it yet. That will change next week. The interest rate differential is quite large, but a bigger concern for me is the safety. My deposit in the bank is a short term loan to the bank and essentially unsecured. If the bank goes bankrupt, I'll be in the group at the end of a long line of creditors. As much as I hate funding the government, it appears to be a safer as well as a more lucrative option.

The federal reserve has signaled that they intend to raise interest rates further. They've also embarked on plans of quantitative tightening. At the same time, we've got federal deficits baked into the cake for a long time. The recent budget compromise fiasco will spend more than was originally planned to fund the tax cuts. That money has to come from somewhere. Competition for funds should get noticeably stronger going forward.

The mortgage interest rates are starting to creep up as well. These are based off US 10 year yields. MarketWatch.com shows the 30 year fixed rate at 4.31% (because the US 10 year yield is now 2.85%.) Although still low by historical standards, it is about 1% higher than the recent lows. If it goes up much higher, it will start affecting home buyers, which will force sellers to take a reduced price. That might prick the current housing bubble. That has many knock-on effects throughout the economy. Will that cause or exacerbate a recession? Can the banks withstand a shock to their bottom lines? How long can they? I expect the answers will come with time.

Grover

Jeffleonard90@gmail.com's picture
Status: Bronze Member (Offline)
Joined: Aug 17 2012
Posts: 36
February 9?

Do you think today’s rebound was:

1.  Central bank intervention 

2.  Dip buying

3.  Both

4.  Something else

I was talking with someone in the airport today, her first question to me was “are you going to buy the dip?”  I plainly stated “I don’t think this is a dip”, strange look ensued.

Mark_BC's picture
Mark_BC
Status: Platinum Member (Offline)
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Posts: 509
For years I've been lamenting

For years I've been lamenting the poor performance of gold, well finally that is "somewhat" paying off as it rides out the storm for us. Here's hoping this is the beginning of the end of the gold suppression scheme!! (or maybe we shouldn't, seeing what's on the other side).

Jeffleonard90@gmail.com's picture
Status: Bronze Member (Offline)
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Posts: 36
Gratitude

Thank you Adam and Chris for working hard and keeping us updated.  The markets and finance are not in my wheelhouse and it’s great to have information even I can digest.

thank you,

jeff

KugsCheese's picture
KugsCheese
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Posts: 1464
Something Went Wrong

 

charleshughsmith's picture
charleshughsmith
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Posts: 722
door # 3 (and OEX)

Jeff, many of us are asking the same question. I suspect it's #3, some buying by central banks (that is, a bump higher in the buying they're already doing as policy) and "buy the dip," which is now a deeply engrained behavior that will take repeated losses to modify.

If we look at indicator such as NYMO (McClellan Oscillator), CPC (put-call ratio), etc., these sank to extremes, suggesting a relief rally is on tap, Technically, declines tend to stairstep down: a big drop, then a relief rally that rolls over into another decline,and so on. Given the rewards that have been showered on those who bought every dip for 9 years, that behavior will cause dips to be bought for quite some time.

We can also expect TPTB to push markets to new nominal highs, just to scorch Bears and "prove" (since the stock market is now a signaling device) that everything is back on track.

Lastly, it's options expiration next Friday, and market-makers hate to hand Bears big profits for being short/holding puts. Typically, markets rally into Wed. of OEX week and it usually doesn't pay to bet against that.

Snydeman's picture
Snydeman
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Posts: 539
Settle your...

I forget right now who it is that always says it, but if things don’t play out that way and next week is carnage in the markets again, it’s probably fair to say you’ll need to do more then settle your mare- you’ll need to bring the whole herd into the barn and lock up for a while...

 

Speaking psychologically, the question is whether non-institutional buyers see this Friday’s bump up as a sign they should BTFD, or whether it’s an opportunity to sell at a higher price than they could have on Thursday.

 

At least it wasn’t a boring week, eh?

Jeffleonard90@gmail.com's picture
Status: Bronze Member (Offline)
Joined: Aug 17 2012
Posts: 36
Thank You

Thanks for that information Charles.  Trying to educate myself, this is very helpful.  

Jeff

MKI's picture
MKI
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Posts: 77
Stocks vs Market & Fear vs Life

No matter what the stock market does, many companies are 1) making LOTS of money (ROIC), 2) sharing this money with their investors (dividend PO), & 3) too big to fail (in modern bailout culture).

I find the whole bear market-hate bemusing. Sheese, haven't we lived through a bear market or to since 1929? We haven't even started this bear market yet and everyone is crying foul. Lots of money to be made here if we can get a real collapse going like 2008 and the government stops bailing everyone out for just a year or two. One just watches the market dividend yield never holding more than 50% of one's NW in stocks when the yield falls below 2.2% (and of course buy only undervalued blue-chip stocks to protect capital (bailout culture wont' let those stocks fail).

The modern popularity of the mutual fund has made many believe the "market of individual stocks" & the "stock market" are the same thing. They aren't. You don't have to date every girl, nor buy every stock. There are overvalued and undervalued stocks (based upon what they cost vs pay in dividends). Just because there are more losers than winners at any given time doesn't mean much to me except a buying opportunity if the right, safe, money-making stock gets cheap enough.

Dividends (which is just money earned from the hard, enterprising work of real people slaving 9-5) generates real wealth in the form goods and services which we all use. Owning dividend paying stock allow me to spend this real wealth on my personal consumption then plow back the extra into more stocks, real estate, and 10% gold. So who cares what the "stock market" is doing? I Just care about the dividends.

The future decades of the stock market will be interesting as I'm not sure government bonds will pay much more than inflation plus I doubt the government will let blue-chip stocks fall much via bailouts (see 2008). Remember, the FED has been screwing with the market since 1929 and a lot of real technological wealth has been created since that time. I've certainly benefited playing this game. Besides, government inflation demands we play somehow. Risky? Sure. Just own a house with a hand pump well & garden and hold no debt. The rest is gravy. Risk on!

TechGuy's picture
TechGuy
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Posts: 447
Tracking Stocks values vs economic data

FWIW: I am hestient to put much faith into maket graphs and functions to determine future performance. Corrections are initialated by economic news (or the lack of it). I suspect that this correction was initiated by a combination of CB QE pull backs & the lack of good news to drive investor confidence. I also believe that most of investor capital has been nearly fully invested and there wasn't much more capital sitting on the sidelines needed to push markets higher. Some large investors likely decided to take some profits resulting and no buyers available to sell to.

1. CB's withdrawl of liquidity (ECB tapering QE, & US Fed selling assets purchased during 2009-2012). 

2. US tax cuts fully priced into the economy by the end of January, which caused the"blow off" period when investor enthusiasm probably peaked for 2018.

3. Consumers and Business borrowing likey peaked, as consumers & business are unable to expand debt without running into issues servicing their debt. From ~2009 to current. Most business and consumers used lower interest to increase debt instead of reducing debt (making use of savings from lower rates to paydown debt). Now we may be approcating a simular situation as consumers & business did in 2007-2008 when they ran into issues servicing their debt. The issue is that in 2008-2009 the CB banks had room to lower rates (ie going from ~8% loans to 3-4% loans). Cutting interest rates again is likely not going to work again.

4. Demographics continue to drag money velocity. Boomers probably are entering their peak savings rate as older boomers retire, swtich to a lower fixed income, and younger boomers are saving more for retirement as they grow closer to retirement age. The younger generations (Gen-X is a much smaller generation), and the  Millennials do not earn as much as boomer generation (Lack of career enthusiasm, poor career choices, excessive student\auto loan debt). 

5. Companies are still in cost cutting more as there is little real growth. Business are cutting cost by outsourcing, automating, and consolidating. These are not helpful to employment and wage growth. 

 

Considering demographics, and debt, we are probably on borrowed time before the next recession & crisis begins.

FYI: Some articles of interest

http://www.businessinsider.com/consumer-debt-surges-and-subprime-auto-de...

Mortgage debt surged 4.2% year-over-year, to $9.19 trillion, still shy of the all-time record of $10 trillion in 2008 before it all collapsed.
Student loans surged by 6.25% year-over-year to a record of $1.36 trillion.
Credit card debt surged 8% to $810 billion.
“Other” surged 5.4% to $390 billion.
And auto loans surged 6.1% to a record $1.21 trillion.

https://www.fool.com/investing/2018/01/21/margin-debt-at-record-levels-k...

Like the stock market, margin debt has risen sharply in recent months. According to FINRA's latest margin statistics, borrowing by investors in November 2017 stood at an all-time high of $627.4 billion. This is almost a $100 billion increase over margin borrowing at the end of 2016 -- and more than double the level of borrowing at the end of 2010.

 

tomadkins's picture
tomadkins
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Posts: 33
SAILOR TAKE WARNING

ALL,

 

Thanks for the comments, Adam.

 

Sailor take warning:  in this "market"....warning, to me, is NOT to be taken "in" the market.

Talk about variances and over valuations.

The market, per se, is a total casino.  If you can "trade" faster than an algo/HFT....good for you.  There is fragility EVERYWHERE.

This time is it obviously, NOT different.

As China prepares for the petro-yuan, as the events in Syria attempt to distract the sheeple, as the noise in DC reveals some of the absolute disconnect within "all" of the beltway...there are NO markets.  

There exists illusions:   PPT is a prime example.  It is all about MOPE:  mgt of perceptive economics.  Optics.

For those with the temerity to be "in the market"....more power to you.

Long ago I've committed to be in a physical position.  The premiums are near all time lows.  The amount of physicals are near all time lows.  The pump/dump of the markets is enuf to distract even a seasoned participant.

Cash IS a position.  And given the irritability of the valuations we are seeing...you can NOT catch a falling knife.

Best is to remember the Scouts motto:  "be prepared".

To all on this board:  I wish to each and every one of us all that we are willing to commit to...in an effort to sustain our individuality and collective community.  

Action is required.  If you have NOT taken action...please take heed:  there is obvious blood in the water.  Smell the coffee !

These next few weeks...through the end of March...will be historic.   An ounce of preparation will be worth a lifetime of intentions..

Seize the day.  We are living in extraordinary times.

 

Best,

 

Tom 

Adam Taggart's picture
Adam Taggart
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Posts: 3152
Commodities At Historic Undervaluation vs Stocks
tomadkins wrote:

Long ago I've committed to be in a physical position.  The premiums are near all time lows.  The amount of physicals are near all time lows.  

Tom -

You'll see this chart again in future articles on PP.com:

GSCI/S&P 500 ratio chart

Commodities are at their lowest relative valuation compared to stocks than at any other time in the past half-century. For many reasons, that imbalance can't last. And it will likely be correct by both equities falling AND commodity prices rising.

I do worry that, in the near term, a market melt-down may send commodity prices lower, too, as everything not nailed down gets sold to meet margin calls, etc.

But when they come into their own, I expect the upward re-pricing to be sudden and sharp (meaning: you'll very likely need to have had built your position in advance to participate in it)

davefairtex's picture
davefairtex
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Posts: 5595
equities vs GDP

Here's a long term valuation chart - total market cap of all US equities divided by GDP.  It suggests that, from a valuation standpoint, we haven't exceeded 2000 quite yet.  That's because GDP has doubled from 2000 to today.

But you probably can't call this market cheap either.

dcm's picture
dcm
Status: Silver Member (Offline)
Joined: Apr 14 2009
Posts: 218
the commodity oddity

As Gail the Actuary and other wise people have pointed out, there's commodities, then there's the _____ you can't live without. And it used to be _______ a lot of us knew how to make, or manage, or grow.

I have such a hard time analyzing this stuff anymore because were at such a unique breaking point in our physical world. With that, I suppose, "the markets" have never been such a sick and meaningless shadow play. As Gail reminds us, sure the stuff is cheap and getting scarce but no one can pay for it....because the stuff is actually NOT cheap and getting scarce. But that doesn't mean a broken planet can pay the price. Well...not a price the way we think of it. The real world of real things is broke, really broke..in every meaning of the word. If mis-pricing was our only problem, I suppose rocket stoves and permaculture would be just another fad.  

Sometimes I wonder if its the very nature of the abyss that makes us all wannabe actors in this silly and maybe suicidal thing called modern markets. So the commodities may be ripe for the picking, but there's only so much you can pick.  

As Nate Hagens pointed out years ago on this site, a stock market can be fun and profitable but we actually may not have a stock market soon. Because it runs in my family, I'm probably being over dramatic... but I keep feeling that I should learn how to make, store and ration my commodities before I learn to buy them. 

charleshughsmith's picture
charleshughsmith
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Posts: 722
compared to 2007 or 1966....

if we set 2000 aside as an anomaly then we're looking at the peaks in 1966 and 2007 for comparables, and by those standards, we're clearly in bubble territory.

Empirical Spiritual's picture
Empirical Spiritual
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Posts: 19
Dotcom boom...

Let's not forget just how crazy the DCB was- e.g. Pets.com vaporized $300MM, but IPO to bust in less that a year was some serious snake oil peddling. 

 

dryam2000's picture
dryam2000
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Posts: 293
GDP?

GDP is totally contrived.  A strong argument can be made it’s much lower than what the Fed or other government folks tell us.  Fake news if you ask me.

davefairtex's picture
davefairtex
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Posts: 5595
pick your denominator

What would you like in the denominator, if not GDP?

You may not know that GDP is nominal GDP, as opposed to real GDP (GDPC1) which is deflated by those inflation metrics that we all don't like.

Would you prefer LOANINV?  TCMDO?  Total Wages & Salaries of all non-government workers?  It has to be something in nominal dollars so it matches MVEONWMVBSNNCB.

You pick a denominator that, for you, isn't 'fake news' and I'll be happy to post it.

robie robinson's picture
robie robinson
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Posts: 1203
A settled

mare trained to the lines and a few critters will be worth more than the markets.....someday.

Mark_BC's picture
Mark_BC
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Posts: 509
Where are all the terrorists? On vacation?

I am I the only one who's noticed we haven't had a "terrorist attack" lately? Months ago they were coming at us almost weekly. Either the "terrorists" had a change in heart and gave up attacking us en masse, or our masters are busy with other things for the moment and have put the "terrorist" program on hold. It is 2018, after all; the year we are supposed to get a one-world currency. It must be true. It was on the Cover of the Economist. Here is my take:*

I think they see that we are near the bottom of the treasure chest of gold and / or silver. They know the end is nigh so we are seeing the final stages of the soap opera narrative they are playing. They only hit us with one thing at a time. Before it was terrorist attacks, but now they want us to be scared of market crashes instead, for a while. We have been fully primed to fear and blame terrorists now so they are focussing on other things: blow the stock bubble up high, then remove support so it crashes. Reap profits from the blood on the streets. Instill fear in all market participants; destroy the confident euphoria everyone had.

They might break the markets down some more but I think they will send them back up and the "green shoots" narrative will be used again. Everyone will breathe a hesitant sigh of relief as we get back on to Taking Care of Business and rebuilding the markets after this recent unfortunate correction.

Then the terrorists will make their return... but this time they will be back in combination with more market crashes!!! Nooooo!!!!! The terrorists will have moved beyond Russian meddling in the election, and have figured out how to hack the financial system!!!! This terrorist attack will be so large it will take down the markets even further than we are currently witnessing. So far, in fact, that the fallout will destroy the delicate global financial system and the dollar. We will need a new currency!!! And, thankfully, they will just happen to have one on hand, ready to go! 

Whether China and Russia are on board with that, I don't know. The friction with those countries seems to be more than just a soap opera. I am guessing that our wannabe masters' plans back in the 90's for this one-world currency have hit problems and they aren't going to get the whole world on board in 2018. It will instead be a western world-currency, with no gold to back it. It will be backed with debt-slave labour. The East will be doing its own thing with gold.

Timeline: before the end of 2018.

* I reserve the right to be completely wrong.

Snydeman's picture
Snydeman
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Posts: 539
Tried to explain.

So, I found myself getting so swamped with people asking about last week, I decided to email out to my whole school some basic explanations of what the heck is going on. I'm shocked by how little anyone knows anything around here about basic investing...and all these people are college educated and have 401ks they don't even remotely understand.

 

******************************************************

Greetings Fellow Faculty!

 

I've had a few people stop and ask me about the recent stock market craziness, and since I just taught about investing in my Economics class, I figured I'd put together an email that helps explain things...hopefully in plain and digestible form.

 

The Crib-Note Version: Stocks are going crazy because, in priority order:

 

1. Bond yields- Interest rates on bonds have been going up, making them a more attractive investment option again. Investors often sell stocks to free up money to buy bonds (or visa versa).

 

2. Profit-taking- Stocks were widely considered to be at their highest values ever. Since no one makes money on a stock until they sell it, at some point when prices get high, investors "take profits" by selling stocks.

 

3. Psychology- as stock prices begin to dip, more investors begin to believe it is a good time to sell, which drives prices further down. At some point, panic may set in as too many sellers try to exit the market at the same time. To use a metaphor, the auditorium is big and packed, but the doors are not; in a rush, not everyone gets out in time.   

 

 

The extended cut:

 

While there are a few reasons why the stock markets have been so volatile lately, one fundamental reason comes down to these two illustrations of what I just finished teaching my Econ students today.

 

 

 

 

See, one makes money from investments in two basic ways:

 

First, you make a capital gain by selling an asset (real estate, stocks, bonds, your car, Bitcoin, etc) at a higher price than what you bought it for. The bigger the differential between the two, the more money you can make. However, as the risk-return pyramid shows, the higher the possible rate of return on your investment, the higher a risk it is. This is always true, and anyone telling you otherwise is either ignorant, deluded by promises of easy wealth, or selling you something. The problem here is that its REALLY, REALLY hard to time the market perfectly and sell at the "top," because few of us have such a good handle on the future as to know where things are headed at any given time. The girls learned that the hard way during our simulation, as a few sold stocks at what they thought was an excellent high price, only to have the price go up even more the next turn. The howls were loud and clear...

 

Second, you can make money on the dividends/yields/interest generated by any assets you hold. Assets with higher yields/dividends/interest generally are riskier as well, but that depends on the reasons why dividends are or are not given, so the risk vs return law only applies to a certain degree here. Generally, though, if a bond or stock is giving you a stellar return, it means that they are either a risky business (a junk bond) or they never reinvest profits back into the business, which makes that a stock less likely to experience massive capital growth since the business isn't expanding; this means you are less likely to make money according to #1 above.

 

It's more complicated, of course, but I find these are good general concepts around which to form one's macro investment strategies.

 

One big CAVEAT is that the rate of return you are getting in #2 must be higher than the current rate of inflation (which is a measure of how much value your money is losing each year). If your Savings Bond from the US government is generating 1% interest, but inflation is 2%, you are not making money; you are losing it.

 

So, for the last ten or so years, because of a concerted policy by various central banks around the developed world, interest rates have been so low that NOTHING below the "stocks" line in the risk-return pyramid has been generating a rate of return (interest rate) above the average rate of inflation. So Big Investors, hedge fund managers, and pension fund managers have been funneling money into stocks, commodities, and real estate because there's nowhere else to PUT money that can make any kind of decent money back. 

 

However, as interest rates begin to creep back up - and especially if the interest rates were to actually go back above the inflation rate (which they haven't), things like bonds become more attractive again. This causes moves OUT of stocks and IN to bonds so that investors can "re-diversify" and balance their portfolios with some less-riskier-assets again. That leads to drops in the stock market.

 

 

 

This is a really long way of saying if you want to see whether it's going to be a bad day in the markets, keep an eye on the bond yields, inflation rate, and overall interest rates.

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MKI
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Joined: Jan 12 2009
Posts: 77
Explain...

Thanks for the discussion.

S: Since no one makes money on a stock until they sell it

This depends on the stock. Over the years some stocks have paid double-digit dividend yields, plus had enough book value to cover any potential liquidation, so one holds their worth without selling and keeps some of the dividends (the part that exceeded inflation).

There are is also private equity out there as well. For example, I once pooled some cash for shares to build a house kit for $50M US and built it for $10M. It's now worth over $200M...& rent value is equal to $10M profit annually. So this equity paid for itself in less than a decade and it's  book value has always been only 4X. So I made money on this "stock" even from year 1. 

But for a Dow stock, MCD has fit this pattern over the last decade. The dividend yield has been obscene if you bought 15 yo. It's all about the entry price, plus the divided yeld plus, the book value. Even a crash wouldn't stop the profits from being realized. I do agree there are very few stocks left in the market that haven't gone nuts.

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Mark_BC
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Posts: 509
Quote: Bond yields- Interest
Quote:

Bond yields- Interest rates on bonds have been going up, making them a more attractive investment option again. Investors often sell stocks to free up money to buy bonds (or visa versa)

......

However, as the risk-return pyramid shows, the higher the possible rate of return on your investment, the higher a risk it is. This is always true, and anyone telling you otherwise is either ignorant, deluded by promises of easy wealth, or selling you something.

re: bond yields, aren't they supposed to go down as investors pile into them from stocks? (price going up). I think I recall reading somewhere why they went up when they should have been going down but doesn't it just boil down to central bank meddling?

re: risk-return pyramid, I was just hearing that Greek debt and junk bonds are trading below Treasury yield which makes no sense. Again, the result of central bank meddling?

Dave Kranzler and PCR had a piece out explaining that the Fed and PPT buy stocks to send the market back up, which puts a floor under their price. Entirely stands to reason that they were behind the latest crash (the Fed, not Dave Kranzler and PCR...)

http://investmentresearchdynamics.com/do-bona-fide-financial-markets-still-exist/

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Snydeman
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Posts: 539
Mark_BC wrote: re: bond
Mark_BC wrote:

re: bond yields, aren't they supposed to go down as investors pile into them from stocks? (price going up). I think I recall reading somewhere why they went up when they should have been going down but doesn't it just boil down to central bank meddling?

re: risk-return pyramid, I was just hearing that Greek debt and junk bonds are trading below Treasury yield which makes no sense. Again, the result of central bank meddling?

Dave Kranzler and PCR had a piece out explaining that the Fed and PPT buy stocks to send the market back up, which puts a floor under their price. Entirely stands to reason that they were behind the latest crash (the Fed, not Dave Kranzler and PCR...)

http://investmentresearchdynamics.com/do-bona-fide-financial-markets-still-exist/

 

Mark,

I'm not an expert at the technical level, but in theory yes the yields go down as investors pile into bonds. The question is how many investors are piling in, and how much are they bringing to the table? If large players like China are backing out of buying Treasurys at the same time we're issuing more to cover our debts, the end result will be rising rates overall. 

 

As for Greek bonds/junk bonds, the fact that those rates are so low is the perfect evidence for just how broken the markets are. The risk-reward pyramid is how economics should work, not how it is currently working. I think one of Chris's (Axel, Charles, et al) points is that reversion back to the kind of normalcy represented by that pyramid is where the pain and blood will happen, because the further from reality the markets are now, the harder the return to real markets and economic fundamentals will be. Yet we can't stay here forever, because central bank shenanigans have blown away pensions, destroyed savings, created massive debt loads, and caused massive social inequality. You know, small stuff.

 

As always, I might be wrong. =)

 

-S 

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pinecarr
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Joined: Apr 13 2008
Posts: 2252
CHS podcast

I was happily surprised to see that Greg Hunter's (USAWatchdog's) early Sunday podcast is with Charles Hugh Smith, "Financial Markets Definitely Destabilizing"

"Financial writer and book author Charles Hugh Smith has been watching the extreme movements in financial markets closely. Is he nervous?  Smith says, “Oh yeah, it’s definitely destabilizing.  In other words, it’s becoming not just more volatile, the whole underlying structure of our economy is destabilizing.  What I mean by that is it’s becoming more brittle or fragile.  That is fundamentally why we are seeing these wild swings.  People are swinging between . . . keeping the money machine like it is for another nine years, and the other side of the coin says wait a minute, we have already had a weak expansion for nine years.  It’s almost the longest expansion in U.S. history.  A normal business cycle doesn’t run in one direction forever. . . .If you don’t allow your economy to have a business cycle recession, then you are simply making it more fragile by encouraging really marginal and risky investments, and that’s where we are now.”"

 

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