Trust is falling - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 16 August 2013
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Poitou, France

We expected the summer trading to drag on...and then the markets to set off on their new trends after September 1st: Stocks down. Bonds down. Gold up.

Looks like they've decided to steal a march on investors. Yesterday, stocks and bonds fell hard. Gold up $27.

The New York Times reports:

    The stock market was pummeled on Thursday after two big companies issued grim sales forecasts and economic data added to investors' concerns that the Federal Reserve would soon start winding down its economic stimulus program.

    The Dow Jones industrial average fell more than 225 points, its worst day in nearly two months. Investors also sold off bonds, driving the yield on the 10- year Treasury note to its highest level in more than two years.

    Before the start of trading, Wal-Mart Stores cut its estimates for annual revenue and profit, warning that cautious shoppers are spending less. The news followed a disappointing revenue forecast from Cisco Systems late on Wednesday.

    In a twist, more signs of resilience in the nation's economy weighed on the stock market. Reports on inflation and the job market appeared to raise the odds that the Fed would begin winding down its $85 billion monthly program of buying Treasury and mortgage-backed securities as early as next month. Many investors think that the Fed's effort to keep interest rates extremely low has underpinned the stock market's record run.
Stocks are now as expensive as they were in 2007, says our old friend Mark Hulbert.

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As for bonds, they are at the top of a 30-year bull market.

And gold? The metal bottomed out in 1998. It's gone up ever since, with a textbook correction over the last year or so.

What's happening now? Slowly, gradually, like draining a huge lock on a canal, the bond market is dropping. Bonds rise on trust. They fall when trust ebbs away.

Why should trust fall now? The simple answer is because it has run its course. Trust is cyclical. As it grows, people become more confident, more sure, and more reckless. Why hold back when there is nothing to fear?

When trust is low, they are reluctant to lend to anyone. The marginal borrower can go fish. When it is high, they give him all the money he wants and throw in a toaster oven.

But as debt rises, the income streams that support the debt becomes, relatively, smaller. Or, to put it another way, trust is naturally self-limiting. It reaches its peak at the exact moment that the system becomes most untrustworthy. This prompts the inevitable correction. Which is what began in 2007, with the collapse of the subprime sector.

But you know all this, don't you?

And for the last five years, the feds have been trying to keep the lock open -- quadrupling the monetary base, adding $5 trillion to the national debt, twisting every price and trifling with every number, and putting more and more of the nation's real wealth in the pockets of the rich. In other words, the feds have been making the system even more untrustworthy!

Behind yesterday's sell-off was, apparently, fear that they would stop fighting it. The economic news is positive, we're told. The Fed will soon begin to 'taper off.' We doubt that will happen.

First, as the report from Wal-Mart shows, the 'recovery' has yet to make a reliable appearance. Household income is weak. And without more income, consumers can't consume.

Second, this is not the first time we've seen what happens when rumors of 'tapering off' are heard. Investors panic. They understand that QE and ZIRP are responsible for current prices of stocks and bonds. They know, too, that if the Fed backs off, lower prices will be guaranteed.

The last time the markets sold off on 'tapering off' rumors, the Fed quickly reassured investors that it had no intention of backing away anytime soon. It will do so again...and again.

In a panic, the feds might even intervene much more aggressively to keep stocks and bonds from falling. And who knows? They might even be able to pull of a pyrrhic victory...sending stocks into the stratosphere...where they get blown to bits!

But that will be a gambler's market. Not our kind of market. Whether the feds like it or not, the trust that keeps stocks and bonds high is flooding out the drains and spittlecocks. Now, it is just a matter of time until the whole kit and caboodle sinks.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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