Now THAT was ugly! The Dow plunged a whopping 531 points, after losing 358 yesterday, while the Nasdaq Composite shed 3.2%. That makes this the worst week for the Dow since 2011. All in all, the Nasdaq 100 Index lost more value in the last two days than at any time since March 2008.
Safe haven investments like Treasuries predictably surged. But most remarkably, the VIX volatility index soared to around 27.6 from 19.1, a shocking one-day gain of 44%. It has now more than doubled just since Monday!
But if you step back from the short-term action, and look at the big picture, I believe something very, very important is happening – a sea change in market thinking the likes of which we haven’t seen in years. Let me explain …
The “Greenspan put.” The “Bernanke put.” The “Yellen put.” The “put” from the heads of the ECB, BOJ, PBOC, etc., etc.
Mainstream pundits and big money Wall Street investors have grown so use to having central bank puts, they don’t know how to function without them. But they better learn fast – because they’re getting torn up now!
For background, a “put” option is a contract that gives you the right, but not the obligation, to sell an asset. It comes with a specified price and expiration date. You can think of puts as hedges – “insurance policies” that guarantee you won’t lose more than a certain amount of money your underlying investments.
For 6-1/2 long years, investors have come to believe that central banks will always and forever be there to draw up a new put every time the markets stumble. And they’ve come to accept those puts will always function as intended – or in plain English, work to drive the markets right back up.
Heck, I can’t blame them. Central bankers have indeed proved time and again they have no spine, can’t handle corrections, and are deathly afraid of their own shadows. So they have stepped in repeatedly – with multiple interest-rate cuts, multiple rounds of quantitative easing (QE), and in the case of Japan, Switzerland, China and others, outright manipulative buying of assets like stocks and ETFs.
Wall Street made a devil’s bargain and accepted this behavior because it saved their bacon. They front-ran central bank purchase programs because it made them money, even if doing so left a bad taste in their mouths. Frankly, I did as well despite my own misgivings (and in some cases, outright disgust with what the Fed and its foreign counterparts did). If you fought it, you got run over.
But you know what? It looks like the days of relying on central bank puts are over. And I think China is the reason.
Look, central bankers and other government policymakers there basically launched an economic war against stock market sellers. They slashed interest rates. They cut bank reserve requirements. They lent hundreds of billions of Chinese yuan to brokers and told them to buy stocks. They froze all initial public offerings to keep new stock supply from hitting the market, and forbade big company officials from selling their shares.
|Are the days of the central bank ‘put’ that served as insurance against market losses at an end?|
But the stock market plunged anyway. Investors fled anyway. They didn’t buy on news of these massive new puts, they sold. And overnight, the Shanghai Composite Index sank back to its 200-day moving average and the key 3,500 level at which central bankers first started panicking and intervening.
Meanwhile, ECB President Mario Draghi’s Euro-QE experiment is failing. The entire post-QE rally in inflation expectations that he sparked this spring has now been given back. That mirrors what is happening here in the U.S., where inflation expectations priced into the 10-year Treasury market are back to half-decade lows. Heck, even the Federal Reserve’s own experts admitted this week that QE doesn’t work.
The St. Louis Fed released an economic paper by VP Stephen Williamson a few days ago, one that contained this damning quote: “There is no work, to my knowledge, that establishes a link from QE to the ultimate goals for the Fed – inflation and real economic activity.”
The paper went on to say QE, so-called “forward guidance” on policy, and zero interest rates have all failed to boost inflation or wages in the U.S., Switzerland, Japan, or anywhere else where massive QE programs have been launched.
Long story short, reality is intervening into the markets. Confidence in the central bank put is fading – and for good reason. Even the policymakers who wrote the puts are admitting they don’t work!
Most importantly, rallies based on policy expectations are lasting for a shorter and shorter period of time. Just look at the market bounce on Wednesday after the latest Fed meeting minutes were released. It lasted for all of 15 minutes.
|“Even the Fed’s own experts admitted this week that QE doesn’t work.”|
That last one is key. I suggested the “Autopilot Market” may be coming to an end. Everything I’ve seen since then only seems to confirm that a sea change is at hand – that we’re in a new market regime where you can’t just sleepwalk through each day and count on central bank puts to bail you out. So invest accordingly.
Am I right? Wrong? Will the Fed manage to put everyone back to sleep with its next major policy initiative? Or is its bazooka more like a pea-shooter these days? Do you believe a sea change is at hand, or that I’m making too much of recent market action? These are incredibly important questions, so make sure you weigh in at the Money and Markets website.
Judging by the comments I’m seeing over at the website already, it’s clear you are getting increasingly worried about the stock market, global deflation and the worldwide currency wars.
Reader Carla warned of much more damage to come, saying: “I am very much on the same page as you and think the nastiest is still ahead. It’s late in the cycle, but take profits, counter balance with selling losses to offset tax liability, and hold tight. To me, it’s a tsunami in process.”
Reader James C. also sounded an alarming note: “It looks like we are heading for another Great Depression like in 1929, where gold is the last standard of value.”
Reader Frebon added: “This market and the entire world economy has become central bank dependent. They may have the right idea about re-inflation, but are going about it the wrong way. They need to put money into the hands of those that will actually spend it by buying things … not banks to raise their tier levels … or corporations to buy back stock … or even investors who just want to see their portfolios grow.”
And finally, Reader Robert C. said: “These currency devaluations are accelerating. The race to the bottom is accelerating!”
At the same time, not everyone is ready to run for the hills. Reader Bill V. countered that: “A drop of slightly more than 2% in the Dow Jones Industrial Average is hardly worth hyperbole. It is, after all, a marketplace where investor sentiment can oscillate by several percentage points.
“Right now the stock market is like a herd of restless cattle before a big thunderstorm — ready to bolt at the least provocation. But sooner or later, they settle down and go back to grazing when the perceived threat has disappeared.”
Thanks for weighing in. While we could easily see a very short-term bounce given the drubbing we’re seeing here, I still am not seeing signs of true panic – the kind that leads to significant, long-lasting bottoms.
If anything, I believe many Wall Street pundits and mainstream investors have grown wildly complacent thanks to six long years of easy money, moral hazard, and shrinking volatility. They don’t want to accept that this regime may be over, and that a sea change in thinking could be at hand. But that’s just me. If you want to share your thoughts on this important topic, make sure you use this link to do so.
Former tech darling Twitter (TWTR) is continuing its meltdown, with the social media stock dropping below its November 2013 IPO price of $26 this week. All told, its value has been more than cut in half – to $17.6 billion from $41.5 billion.
The wide-ranging commodities decline claimed another victim today, when Deere & Co. (DE) warned that it wouldn’t make as much as expected this year. The world’s biggest maker of farm equipment warned it would earn only $1.8 billion in 2015, $100 million less than it forecast as recently as May. Equipment sales are now expected to plunge 21% for the year.
China’s manufacturing sector is falling fast, according to a just-released purchasing managers’ index for August. The gauge of factory activity slumped to 47.1 this month from 47.8 in July. That was worse than economists expected, and the lowest reading since early 2009.
Everyone’s favorite Greek Prime Minister, Alexis Tsipras, resigned yesterday and said the country would hold snap elections. The move is designed to fight off a rebellion from hard-liners in his Syriza party, but it’s unclear whether it will strengthen his mandate or result in him losing his job permanently.
Lastly, former President Jimmy Carter revealed he is suffering from brain cancer, in addition to the liver cancer that he had already been fighting. He will undergo treatment for the melanoma, but at 90 years old, also said he is willing to accept whatever happens.
So what’s the verdict? Is China falling apart, or just going through a minor downturn? Is the next act in the Greek drama about to play out, with consequences for Europe’s economy? And what do you think about the meltdown at Twitter? Are other social media stocks going to hit a wall next? Share your thoughts over at the website.
Until next time,