What happens when the music stops? - stock market crash 2017
Central banks have been stopping stock market crashes and crash initiations repeatedly over the past 18 years. You’re probably only aware of the crash of 2000-2003 and 2007-2009 –and that both were stopped by the biggest fiscal and monetary policy support actions ever. My proprietary algorithms show there have been 9 major attempts and 3 minor attempts from the top 4 central banks to stop a stock market crash in the past 18 years. All 12 of these attempts have succeeded at stoping a crash from continuing. In 8 of 12 cases the market was down 10% or less before at least one major central bank (Fed, ECB, BoJ, PBoC) took action to spike the punch bowl and keep the party going. What happens when central bank tools become ineffective or too unpopular to use? What happens when central banks can no longer keep the party going? Let me suggest we will be there next week.
The Fed has repeatedly taken actions to stop the stock market from crashing. Each time it did so it bought a reprieve and we had a risk-on party. Via my algorithms I know the amount of time spent in these risk-on parties has followed an exponential decay. These periods have dropped from years to months to weeks to less than a week (that’s as tight as my algorithms can measure).
You are probably much more aware that there is a central bank in Europe (ECB), Japan (BoJ), China (PBoC), and England (BoE), than you were 5 years ago. These central banks have been doing everything they can to stop stock markets from crashing. Virtually everyone -in the U.S., Europe, Japan, and everywhere else- is aware of central banks keeping the economy and stock market afloat. This result has been slow to arrive, but arrive it has over the past few years. I suspect 5 years ago most Americans were not aware that there were central banks in other countries , much less that those central banks were supporting the U.S. stock market in a similar way as the Fed. Now that everyone knows this it will be all but impossible for central banks to unwind their supportive positions without initiating a panic. The Fed and the other top central banks have painted themselves into a corner.
There is a lie told by central banks -especially the Fed- that they have been taking actions to meet their objectives: stable inflation and full employment. According to the government (BLS), core inflation has been running in excess of 2% for a while now (essentially the Fed’s inflation target), and unemployment is spectacularly low (call it 5%). Never mind that both of these measures are deeply flawed and do not present an accurate portrayal of inflation nor labor markets. These flawed overoptimistic measures have been used by the government to make an ugly reality appear less ugly. Now the government’s own intentionally massaged statistical measures are going to make it difficult / impossible to keep supplying new rounds of supportive policy. You can’t have it both ways. Either everything is great –according to your statistics– and therefore the existing accommodative measures need to be withdrawn to avoid an inflation spike — OR — things are not great at all, your stats are a fraud, and you will need to spike the punch bowl again to keep the party going. Which is it?
For the first time I can recall, the most recent FOMC minutes reflected concern among Feddies that the credibility of the Federal Reserve as an institution is being eroded. This is a long way from the Fed being viewed as savior.
Several years ago (2013 I think) I wrote that there are two potential endings to this story:
Worst case scenario. The Fed is seen to be all-in / out of tricks. The economy rolls into recession. The Fed has nothing left to stop it -and more importantly nothing left to stop a stock market crash. Everyone is aware of this because Fed watching becomes more important than anything else to investors. The largest crash since 1929 ensues.
Second to worst case scenario. Same as above -with one twist. The Fed maintains it has more tricks but things are so good (a lie/bluff) it does not want to use them. The stock market crashes and the Fed does nothing to stop it because it expects the problem to be short lived –or of origin outside its scope.
If no major central bank manages to find something new to pull out if its bag of tricks we will see the largest stock market crash since 1929 over the next 12 months. A down payment in this crash will be seen in November. It does not matter who wins on November 8th.
