Wednesday 27th March 2018
It won’t be pretty….
Fun and games in the stock market over the last few days….
At Money Truths we make a point of keeping an eye on the American indices – and for good reason….
When the wind blows across the Atlantic, it eventually rattles the doors over here. And to be forewarned is to be forearmed….
- A re-test of investor nerves….
The S&P 500 tested investor nerves on Friday – plunging 2.5% to a 6-week low….
The Dow Jones Industrial Average also lost ground – more than 700 points-worth….
The falling values were attributed to what amounts to naked fear….
Investors were exiting stocks in favor of government bonds – a direct response to concerns that President Donald Trump is intent (via tariffs on steel and aluminum imports) on inciting a potentially dangerous and certainly damaging trade war with China and anybody else who fancies a tear-up….
At closing bell on Friday evening, money managers were gloomy and subdued….
But they needn’t have been. Friday’s emergency was swiftly recast as just another opportunity – the latest in a long line – for the market to profit….
Buying the dip has worked its magic again. Indices were back on the up and up on Monday….
The S&P 500 hasn’t recovered all last week’s losses – not by a measure. But the market is travelling again in the ‘right’ direction – up.
Investor anxieties have been calmed and spirits rejuvenated. Their faith that this market always bounces back has been restored and re-strengthened….
- The truth about parachutes….
There are not too many certainties in this life….
One is that you will never catch me jumping out of a plane with a parachute strapped to my back….
Experts – who know about these things – report that instances of failed parachutes are rare….
Maybe so. But parachutes can and do fail. And when it happens, not too many parachutists walk away to tell the tale….
People I’m acquainted with who enjoy jumping out of planes report that fear is natural – and that it dissipates with experience….
In other words, the more times you jump, the less fear you feel and the more confidence you have in the chute….
But confidence is just confidence. It mustn’t be confused with certainty. The odds haven’t changed. Experience of jumping – and landing safely on firm ground – doesn’t remove or diminish the inherent risks associated with every jump you take….
The parachute might well have opened the last 50 times you relied on it. But it doesn’t follow that it will certainly open the next time you’re plummeting towards solid earth at 600 mph….
Confidence that it will might turn out to be fatally misleading….
- Fearlessness born of experience….
I wonder if what we saw play out in the American stock markets over the last few days is a case of potentially fatal confidence in the parachute….
Sure, there was some trepidation on Friday when the markets plunged….
But it didn’t take long for investors to recover their nerve – buying back into the dip, halting the freefall, recovering some of the altitude that had been lost and successfully arresting a potentially earth-bound plummet….
Is what we observed confidence – or lack of appropriate fear – based on experience?
I believe it might turn out to be so….
We are currently witnessing the second-longest S&P 500 bull market in history. It has been going since 2009 and has lasted some 2281 days….
Only the bull market that ran on between 1987 and 2000 lasted longer. That one never scaled the sheer heights of this one. And that one wasn’t built, as this one is, entirely on monetary policy that was so loose as to be entirely devoid of elasticity….
Throughout the entirety of the current S&P bull market, investors have become accustomed to the parachute opening. Every dip has been followed by a bounce-back and an opportunity to bank a new round of profits….
Perhaps it has happened so frequently and with such reliability that fear has dissipated to a point that severely underplays the potential for disaster….
- Hard landings….
It is reasonable to expect that what has happened with most frequency before is most likely to happen again….
It’s a catchy argument. One that inveterate dip buyers certainly subscribe to. And viewed against the last few years, you can see that the argument has had some merit. Some folk have gotten rich off it….
But measure the argument against a wider expanse of time and we learn that no market grows to the sky….
Pull-backs, corrections and crashes are as necessary and as certain a part of the overall cycle as growth and increasing values….
History is more than 10-years long. One bull market – however lengthy and (up to now) reliable – cannot and does not rewrite the rule book – whatever the dip buyers want to believe….
Sooner or later, the parachute those investors have been relying on for a soft-landing is going to fail. And when it does, the only bounce on offer will be bone-crushingly painful – as man reacquaints himself with solid earth and reality….
Signs are that this very scenario is not too far distant….
- Changing landscapes….
The current S&P 500 bull market – like bull markets elsewhere – has been built almost exclusively on credit supply on a scale never seen before….
The US Federal Reserve (and other central banks) have flooded their economies with mountains of fresh cash via quantitative easing programmes – money-printing or bond-buying….
And they made it easy for consumers and businesses to borrow as much cash as they can carry by holding interest rates at the lowest levels in history – for almost a decade….
Much of that new money – created out of thin air – has been channeled directly into the markets – ensuring they have been both buoyant and rising throughout the entire period….
Loose monetary policy and rising asset values have walked hand in hand for almost a decade – the latter relying on the former for continued robustness….
But things are changing. Slowly but surely. And what has been before cannot be expected to endure indefinitely into the future. The Federal Reserve has begun to unwind its policy of monetary expansion….
Instead of buying bonds, it is now selling them or allowing them to expire at a rate of $600 billion annually….
Interest rates have started to rise too – and further rises are in the pipeline….
- It won’t be pretty….
This new policy is one of monetary tightening rather than the one of monetary easing that the market has become accustomed to (some would say addicted to) over the last decade….
This change of direction turns things on its head….
In a market that has relied almost entirely on easy monetary policy for its continued momentum, a tightening of that policy must – sooner or later – find expression in falling market prices….
At that point dip buyers – and other market players – will find that the parachute they’ve been able to rely on for so long will fail to open….
The market will correct. There won’t be a swift bounce-back just around the corner. There will be no soft landing. Instead, those investors will drop like a stone and hit the deck – at speed – and what is left behind won’t be pretty….
That’s how it looks from here….
All the best,