US stocks fell yesterday. The Dow dropped 85 points, or 0.5%. No biggie.
The biggie is still ahead…
Our guess is the smart money is selling to the dumb money. The people who take the trouble to figure out what something is really worth are unloading. People who just think they should be “in the stock market” are buying.
The “big three” US stock market benchmarks – the S&P 500, the Dow and the Nasdaq – are at near record levels.
Why? Because they represent good value for money? Or because they are propped up by near-zero interest rates and a flood of QE liquidity, now coming from Japan and Europe?
Don’t forget: Global growth is slowing. US corporate earnings are falling. Europe is in danger of coming unstuck in June, when the Greeks have to face up to making a big payment on their debt. And China looks more and more like a massive case of malinvestment on the verge of going bad.
A Time for Modesty
Economic researcher Chris Martenson recently interviewed former investment banker and broker Grant Williams of the Things That Make You Go Hmmm blog for some insight:
We don’t know how it will end, but something has to give. It’s a question of what it will be. Because when you start playing with the forces of nature, you can suppress them for a while, but they will eventually overwhelm you. We’ve seen this constantly throughout history.
Stocks can… and will… fall. They always do.
And newsletter veteran Richard Russell, of Dow Theory Letters, gives more detail:
Many an investor will be wiped out if he insists on waiting to find out if the bull market has topped out in hindsight. The way around this is to limit yourself to conservative positions in the market.
The bearish nightmare could be as follows: One day the market opens with the Dow gapping down 1,000 points. The exchange decides to close for three days. Bearish rumors and fantasies flood the media.
With the market closed, there is no liquidity, and stockholders are locked into positions that are unknown in terms of what their positions are worth. Fear takes over, and when the market opens again, it gaps down in an erratic series of crashes.
This is a bearish scenario but one that has occurred to me. It also makes the case for subscribers holding very conservative positions in stocks or ETFs. This is not a time for genius. It’s a time for modesty, small or no positions in stocks, and peace of mind.
When the crash comes, everybody rushes for the door. The sellers are all there. But where are the buyers?
The other thing that disappears is credit… then cash.
The Fed Is Not “Printing Money”
One of the great mysteries of the post-crisis world is why consumer prices have failed to take off. After all, the Fed was “printing money” by the trillions.
According to classic theory, a larger volume of money should lead to higher consumer prices.
It took a long time for us to figure it out: The Fed is not “printing money” at all. It is lowering the cost of credit.
ZIRP (zero-interest-rate policy) and QE (quantitative easing) accomplish the same thing by different means. They make credit – and speculation – cheaper by lowering borrowing costs.
Since 1971, cash and credit have been indistinguishable. You can buy a steak dinner with a credit card or with cash. And as long as credit continues to expand, your credit card will be as good as cash.
Adding credit to the system, rather than cash, is how Wall Street got rich. It sold credit!
And it is why the rich got richer, too: They were creditworthy! They could take the Fed’s cheap credit and bid for stocks and bonds – driving up asset prices.
All the plain people could do was to borrow money to buy a car or, if they couldn’t find a job, get a student loan.
They could go deeper into debt. But they couldn’t benefit from the rise in asset prices – because they didn’t have any assets. The top 5% of the population owns 75% of financial assets. The bottom 80% owns less than 5%.
But there’s one big difference between cash and credit: In a crisis, credit collapses.
Cash – even cash backed by nothing – nevertheless has a physical, tangible presence. If the stock market gets cut in half, those Jacksons and Lincolns are still there. You can still use them to buy beer and cigarettes.
But what happens in a real credit crisis? What happened in 2008? Every bank on Wall Street would have gone broke had the feds not intervened so vigorously.
Credit works on trust. A friend had a huge line of credit at Lehman Brothers in 2008. In 2009 he was out of business; his credit had vanished.
Now, imagine the next crisis. We’ve already seen what happened to dot-coms, housing and energy. What would happen if all asset classes were affected at once?
The collateral of the banking industry would fall. The banks would look at each other and wonder whose credit was still good. Merchants would look at your credit card and wonder if its issuer was still in business. House sellers would check your mortgage company to see if it was still solvent.
Trust would disappear. And along with it, credit. The economy would go into free fall.
Then the big surprise: Instead of the inflation or hyperinflation that we expected, suddenly the dollar – the almighty dollar… the old-fashioned, paper, greenback buck – would become more valuable.
That is not the end of the story. It is just the beginning.
A New Record for Buybacks
by Chris Hunter, Editor-in-Chief, Bonner & Partners
One side effect of the Fed’s cheap credit is that US corporations get to borrow money at almost no cost… and plow it back into their own shares.
According to TrimTabs Investment Research, US corporations spent $104 billion on their own shares in February.
That’s the most since TrimTabs started collecting data on buybacks in 1995… and almost twice the $55 billion bought a year earlier.
That’s more than $5 billion in share buybacks every day. And more than $2 trillion since 2009.
Don’t get me wrong: This is good news for shareholders over the short term. When a company buys back its shares, it cancels them. This means each outstanding share represents a higher percentage of earnings, which makes them more valuable.
But over the longer term, the problem with this kind of financial engineering is threefold:
1) Companies are spending record amounts on buybacks, when stock market valuations are at one of the highest levels in the last 100 years – hardly a value proposition.
2) Every dollar companies spend on buybacks is a dollar not spent on growing their core businesses. This suggests businesses are struggling to find worthwhile investments.
3) Companies have a habit of spending most on buybacks near market tops. The last time buybacks reached a monthly record of $100 billion was in July 2006. The stock market peaked the following October.