Just as I was starting in this business in early 1997, not knowing shit about shit, I heard rumblings from some of the traders about some whacky stuff going on in Asian currency markets that were likely to derail an epic bull market (the S&P 500 was up 37% in 1995 and 22% in 1996). A bull market that just months before then Federal Reserve Chairman Alan Greenspan had already attributed to “irrational exuberance” by investors. What a dope, right? The SPX rallied 33% in 1997, 28% in 1998 and 20% in 1999 before its eventual top in Q1 2000 that would be the start of a protracted bear market that would see the SPX decline more than 50% from its peak to its lows in October of 2002.
In my first few years in the business I saw some very smart people make rational arguments in what was an irrational market. The Asian currency crisis was just a blip amidst a growing mania. So was the demise of Long Term Capital, the multi billion macro hedge fund whose collapse in the Summer / Fall of 1998 caused the SPX to drop 22% from its peak. Just another blip. A year later the SPX was up 50%.
And I haven’t even mentioned the Nasdaq Composite, which was even more volatile than the SPX, If you weren’t focused on the macro, and merely on the emerging technology stock bubble in the U.S. then you were in for one of the wildest rides the world of risk assets had ever seen. From mid 1999 to March 2000, the Nasdaq Composite doubled, and then proceeded to lose nearly 80% of its value over the next two and a half years.
I can tell you from experience that there were far more smart people who saw the bubble for what it was (most people knew it was a bubble), made a very rational arguments why it could not persist but were carried out prior to the turn.
The same holds true for the lead up the financial crisis last decade that brought the global economy to its knees. Without the monetary policies and crisis actions taken to shore up financial institutions, and sovereign nations since, the world would likely be in a depression. Again aside from a handful of outliers like those described in Michael Lewis’s book The Big Short, there were few who profited in a major way from calling the top of the U.S. housing bubble, even though everyone knew there was a bubble.
Once again we find ourselves with U.S. stocks very near the all time highs, up more than 200% from their 2009 financial crisis lows, and the top calling is everywhere. I for one can not make a logical argument why U.S. stocks should be climbing the wall of worry that they appear to be climbing given the growing list of structural headwinds. Heck, George Soros, one of the most successful investors on the planet warned in a speech yesterday:
What’s happening in China “eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fueled by credit growth,” Soros said. “Most of money that banks are supplying is needed to keep bad debts and loss-making enterprises alive.”
But for years, lots of very smart and successful investors have been making the same point, they have all been early. Soros may still be early. Soros will likely be right at some point, but for you it’s nearly impossible to make investment decisions off of that call.
It’s been my view that the bouts of downward volatility that we have seen in risk assets since the fall of 2014 has been a direct response to the U.S. Fed’s end to QE (in Q4 of 2014) which the U.S. dollar anticipated and bottomed in the Spring of that year, causing the collapse of industrial commodities, which in turn put tremendous pressure on emerging market currencies and credit. This was exacerbated by China’s devaluation last August, and reached a near fever pitch in the first 6 weeks of this year. It’s my view that the stabilization of risk assets globally since mid February is merely a function of the easing of the U.S. dollar, the DXY (U.S. Dollar Index), which is down nearly 6% from the start of 2016, now nearing the lower end of the band its has been in between $93 and $100 since the start of 2015:
It’s also been my view that since the U.S. housing bubble burst we have merely seen a rolling credit crisis across the globe, hitting Europe in 2010/11 (still not over) and working its way through emerging markets like China, Brazil and Russia now. The only reason we have not seen the sort of bloodletting that we did in 2008/09 in the U.S is a function of coordinated global monetary policy. And here is the chart in my mind that tells you what is different this time. The U.S. Fed Funds rate was above 5% at the peaks in 2000 and 2007/08, the drop in risk assets caused the powers that be to dramatically lower Fed Funds, and now they appear to have little upward pressure from the zero interest bound:
The main point here is simple, after the Fed’s first rate increase in 9 years back in December, they seem unable to stay the course. They are scared shitless of what lies beneath, and they know that a reversal of the recent declines in the U.S. dollar might cause risk assets to once again go haywire. But committing fresh capital to buying equities because central banks are giving you few other options to seek return, is completely mental in my opinion. They have no other choice to be doing what they are doing, you do, until they go to NIRP, and that’s cash (and hard assets of course).
And if and when the next crisis hits and the Fed is below the zero interest bound that Europe and Japan are now in, the price action in the Euro and the Yen tell us that NIRP is not exactly a slam dunk for weakening your currency and stimulating growth. What that means is that the central bank put that has supported U.S. equities in their 200% plus climb since the financial crisis lows is less becoming and less effective while at the same time feeling more and more desperate. Which leaves this sobering thought, if people are still buying stocks because of the ol’ “don’t fight the Fed” playbook, they need to realize that while The Game’s the same, it just got more fierce.