The U.S. stock market, the U.S. economy and virtually the entire world are now vulnerable to a series of black swans — powerful forces that strike out of the blue and swoop down on the financial markets with potentially devastating impact.
By definition, the actual events themselves are unpredictable: If we could somehow know they were coming ahead of time, they wouldn’t be true black swans in the first place.
But the setup — the conditions that give rise to black swan events — are visible in plain sight.
Here are just five prime examples …
Black Swan #1
Collapse of the Fed’s QE
The Fed’s quantitative easing (QE) — newspeak for money printing — has, without a doubt, been the single most powerful force behind the post-debt crisis recovery.
No other government rescue operation, not even the giant bank bailouts under Bush or the economic stimulus plans under Obama, came close to the Fed’s QE in terms of sheer impact on our world.
No other country or region in the world, not even Japan or the European Union, printed money in greater amounts.
And as I explained here in “The Eight Trillion-Dollar Trap,” in the wake of the Lehman Brothers failure in September 2008, the U.S. Federal Reserve went stark, raving mad, abandoning any semblance of restraint, and expanding its assets by a mammoth $3.6 trillion. All while shoving interest rates to the mat and holding them at or near zero for seven long years.
As long as QE continued, the U.S. stock market rose. But as soon as it was discontinued, the stock market froze in its tracks, going virtually nowhere ever since.
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The big remaining questions:
What happens when investors and corporate decision-makers suddenly realize that QE and zero interest rates aren’t working anymore?
What happens when the music stops and this free-money party comes to an end?
We can’t predict how or when the QE bubble will collapse. But we do know two things:
No nation in history — let alone the United States — has ever experienced anything like this before.
And ultimately, all the free or cheap money in the world cannot buy the essential ingredients every modern economy must have to sustain itself: Confidence. Savings. And Capital … which leads us to …
Black Swan #2
Disappearing Capital Expenditures
Put yourself in Fed Chairman Janet Yellen’s shoes.
Ever since Economics 101, you’ve learned a thing or two about capitalist economies.
You’ve learned that they cannot survive without capital investment. In other words, unless businesses invest in new plants, new equipment and new technology, there can be no future growth.
You’ve also learned that, as soon as corporations begin to cut back on those investments sharply, a major economic decline could be near.
Just something to worry about another day? Heck no!
Last week, soon after you held your latest monthly meeting with the Fed Open Market Committee, you learned one more thing:
In the just-ended first quarter, capital expenditures by U.S. corporations suffered their first major plunge since the Great Recession.
“How is that possible?” you ask. “Didn’t we give the big banks tons of money practically for free?”
“Yes, we did,” your cohorts respond in unison.
“Didn’t we get businesses to finally start borrowing that money?”
“Yes, we did,” says the chorus.
“Then what in the hell went wrong?” you query with growing frustration.
The answer: Instead of investing that money, many companies decided to simply recycle it. Specifically, …
They used it to buy back their own shares, artificially goosing up their prices.
(Mike Larson was one of the first to warn of this danger. See, for example, “Individual Investors Flee, Companies Go on Buyback Spree.”)
The bigger question:
If capital expenditures are already falling with dirt-cheap borrowing costs, what happens when it actually costs real money to borrow?
What happens when corporations begin to anticipate falling consumer demand?
Worst of all, what happens if corporate bankruptcies begin to loom large again?
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Black Swan #3
Throughout history, black swans have been most likely when social imbalances are most extreme. And right now, the U.S. suffers from the biggest concentration of wealth in 100 years.
The richest one-thousandth (0.1%) of America’s households have more than tripled their share of the nation’s assets. And the richest one-ten-thousandth (0.01%) have increased their share six-fold.
So this is not just a problem for the poor. Nor is it an issue limited to the nation’s middle class. It also may be hindering hundreds of thousands of higher-net-worth investors from growing their portfolios.
With their controlling interests of the nation’s big corporations, with the companies’ massive stock buybacks that crowd out dividends … the super-rich are now squeezing the rich!
The chart below tells the story in a nutshell.
The black bars show how the wealth concentration has reached such an extreme, it’s now worse than it was in 1929.
Meanwhile, the red line shows the political polarization in the United States. Again, the last time it peaked was in 1929. And now it’s even worse.
These are two dark clouds hovering over America today — the preconditions for massive social and political battles that can disrupt the economy, causing financial markets to go haywire.
They are the plainly visible preludes to black swan events in American politics.
It could be mass street protests surrounding the Republican and Democratic national conventions this summer … a decision by the Justice Department to indict Hillary Clinton … perhaps the emergence of a stronger third party in America … or more likely, something that no one can predict. No matter what, it will be a shock.
Black Swan #4
Chaos in China
When U.S. analysts look at China, they focus almost entirely on the economic numbers, and those are indeed getting worse.
But if a major black swan event emerges from the Middle Kingdom, it’s likely to be driven primarily by something that’s mostly off their radar screen, such as widespread popular revolts.
Two of the major causes: (1) mass forced evictions, disrupting millions of households, and (2) crippling pollution, a daily nightmare in the lives of hundreds of millions.
The ensuing black swan events could cause a collapse not just in the Shanghai stock market, not just in the Chinese economy, but also in China’s social order.
The impact on global financial markets? Largely unpredictable but potentially enormous.
(For more on this, read my recent column “The Biggest Global Risk Right Now.”)
Black Swan #5
In March, the Harvard Kennedy School published a landmark study on nuclear terror, delivering good news and bad news.
The good news is that major progress has been made in safeguarding nuclear warheads. The bad news is that massive amounts of radioactive material are widely available in hospitals, research centers, and nuclear plants, which are not yet secured.
Moreover, according to this same study, the Islamic State is the first terrorist group in history with both the resources and the desperation to embark on such an attack. (See my column “Nuclear terror predicted by 3 major studies. Here’s how it can impact your investments.”)
There are three ways to protect your investments from black swan shocks, and none of them are rocket science:
First, invest less and save more. Reduce your risk exposure and build more cash.
Second, when you do invest, insist on extreme quality — investments that have a proven track record of performing in good times or bad … and … that have demonstrated the most resistance to unexpected shocks.
Third, seriously consider hedges — investments designed to help you profit from precipitous market declines, whether caused by black swans or not.
Good luck and God bless!