"Billy Clubs and Water Cannons"
Markets are already black and blue...
but the real pain is yet to come.
by Bill Bonner
Youghal, Ireland - "The beatings will continue until morale improves. Understanding today’s market is very simple. For the last 40 years, the Fed has been rewarding stock holders. Now, it’s punishing them. Investors are beginning to understand. Barrons: "The Stock Market Finally Gets It. FedEx’s Bad News Helped Drive the Point Home." From a certain point onward, there is no turning back. The stock market reached that point this past week.
Oh, the market was hopeful, entering the week, that inflation had reached its peak, that the Federal Reserve would stop raising rates soon, that the bottom was in. But Tuesday’s release of August’s consumer-price-index data showed that inflation hadn’t been tamed and dashed all the goodwill, sending the major indexes to their worst day since 2020.
Fox News tacked into the same wind: "Bank of America strategist Michael Hartnett…warned in an analyst note this week that the "inflation shock ain't over," and that a subsequent earnings recession will precipitate further declines in the market. Hartnett said that past bear markets show an average peak-to-trough decline of about 37% for the S&P 500, the benchmark index, over 289 days. That would suggest the current bear market – which began in early June – will end in October with the gauge around 3,020 points. That would mark a nearly 22% decline from current levels."
Good and Hard: All over the world, with the notable exception of Japan, almost all central banks have brought out their cudgels and tasers. Already, US markets are black and blue. But central banks have only just begun. Investors anticipate another 75-basis point (0.75%) increase this week. But some economists are urging the Fed to strike harder. Larry Summers, for example, the only Democrat to have any idea of what is going on, suggested a 100-basis point hike. And Komal Sri-Kumar, head of Sri-Kumar Global Strategies, told CNBC that the Fed should go for 125 basis points.
But Argentina, always a leader with crackpot financial trends, shows the way forward. Reuters: "Argentina Hikes Interest Rate 550 bps After Inflation Overshoots." "Argentina's central bank hiked the country's benchmark interest rate 550 basis points to 75% on Thursday, a day after inflation overshot forecasts to near 80% on an annual basis. The hike followed a 950 basis points-raise in August of the 28-day Leliq benchmark rate, as the government tries to bring down spiraling prices that are hurting Argentines' savings and salaries and denting the popularity of the Peronist government."
Rates are rising. The economy is slowing. Stocks are falling. The only question is: how long will the beatings go on? “It is clearer by the day that markets were overly lavishly supported by central banks for too long,” writes Katie Martin in the Financial Times. “Correcting this imbalance will keep on sparking the ugly declines and head-fake bear market rallies that characterized the crisis of 2008-2009.”
The Kübler-Ross Model: A real bear market proceeds like a death sentence. First, there is denial. Then, anger and depression… followed by bargaining, and finally, acceptance. Until last week, ‘denial’ was the name of the game. But then, investors began to realize – the Fed is serious. It intends to inflict a lot more pain.
Markets move faster than economies. First, the P gives way. Then the E. Stock Prices are supposed to ‘look ahead,’ anticipating future Earnings. So, in the initial stages, prices drop before the bad recession-era earnings become apparent. Then, the lower prices mislead investors. They think stocks look ‘fairly priced.’ Advisers urge them to ‘buy the dip.’ At current prices, for example, Alphabet almost looks like a value stock.
But then comes more bad news. The recession causes sales and earnings to fall. Soon, it doesn’t look like such a bargain anymore. As of last week, investors are no longer in denial. They’re just trying to understand how bad it will get. Analysts look to the recent past for clues. Will it be like the Nasdaq crash in 2000? Or the mortgage finance crisis after 2007? Or, maybe the Covid Panic selloff of 2020?
In our view, those riots are irrelevant. They’re from a different era, when the Fed was on hand… with warm blankets and hot coffee. Now, the Fed is back on the scene… but with billy clubs and water cannons. More to come…"
Joel’s Note: It’s hard to fathom what an Argentine-style, 550 basis point hike would look like in the U.S., much less the carnage it would unleash on the markets. And yet, with a nominal Fed target rate still below 2.5%… and inflation running at 8.3% (17.1 according to ShadowStats - CP)… such a mammoth hike would still leave real rates floundering in negative territory. (2.5 plus 5.5 still equals 8… even in modern economics classrooms.) And if inflation “hiccuped,” say because energy prices come roaring back after the Strategic Petroleum Reserve release ends next month, we could be off to the races again… with the Feds chasing down 9… 9.5… or even double-digit inflation.
What does all that mean? In a nutshell: more distortion of the most important price of all. Dan explained as much in last Friday’s note to Bonner Private Research members…"In a ‘normal’ financial world, time has a price. That price is the interest rate you earn by loaning or investing your savings. The benchmark interest rate – currently set by central banks – determines the returns for all other asset classes. When you leave it too low for too long, you get diminishing marginal returns. Worse, too much of a good thing becomes a bad thing.
We’re reckoning with many ‘bad things’ and bubbles right now. When you distort that price (lower it to zero) you distort the values of all other assets (making it very difficult to figure out what to pay today for future cash flows). By mis-pricing the cost of capital, you distort capitalism itself.
Which brings us to 2022… and the beginning of the reckoning we’re witnessing across markets right now. “A lot of people made a lot of stupid money in the low interest rate era,” Dan reminded us Friday. “A lot of them are going to lose even more in a grinding, volatile, bear market.”
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