At present, we have what might best be characterized as a broken speculative peak, in that market internals (particularly interest-sensitive groups), breadth and leadership have broken down uniformly following an extreme overvalued, overbought, overbullish syndrome. If you recall, the market also recovered to new highs in October 2007, weeks after the initial, decisive break in market internals at that time. Presently, we're looking at the same set of circumstances. On some event related to tapering or the Fed Chair nomination, we may even see another push higher. It isn't simply short-term risk, but deep cyclical risk that is of concern.
This leads us to do something we do rarely: today, we're hoisting our black and blue, tattered 'Crash Alert' flag over our Diary headquarters here in Baltimore. Watch out.
Not that we know anything you don't know. We gave up trying to predict the future long ago, after we realized we were no good at it. Our 'Crash Alert' flag is not a forecast. It is a like a tornado warning: market conditions are exceptionally ripe for a bad storm.
Yesterday, the Dow fell 105 points. Gold barely moved. Bonds kept going down.
Markets move in long cycles of trust. They begin tentatively, with investors unwilling to pay more than 8 or 9 times for a dollar's worth of corporate earnings...and too scared to lend money without at least 10% interest coming their way.
Gradually, as things improve, they become more confident. Soon, they are buying stocks with P/E ratios of 12 to 15...and borrowing at only 5% interest.
Then they become convinced that the good times will last forever. Doubts are put aside as they find reasons to believe that what never happened before is now guaranteed forever. Ordinary people come to think that Wall Street is there to help them make money. Progress, prosperity, and rising asset prices...now and everlasting. Amen.
These beliefs are tested. There are setbacks. Shocks. Brief corrections. But if these are overcome quickly enough, a kind of blind faith takes hold. Investors begin to believe the impossible. Now, for example, investors think the Fed 'will not allow' a serious correction.
It should be pointed out, tout de suite, that the Fed can influence the markets. It cannot control them. And the more it influences them, the harder they are to control. Why? Investors test the Fed to protect their money...just as the Fed makes their investments less trustworthy. Because the more influence it exerts, the farther they go away from where they ought to be. If the Fed offers too much credit, for example, stock prices adjust...and soon become higher than they should be. At some point, they are so high...and so far removed from solid values...that the proud tower wobbles...and then collapses, regardless of what the Fed is doing.
And based on what's happening in the bond market, it appears that the Fed has already lost control.
Ah yes, dear reader, that is one of the curious, always-fascinating feedback loops that keeps life on planet earth 'normal.' Whenever things get too weird, something intervenes to make them less weird. And one of those things is a certain Mr. Market.
It's all very well for investors to believe the Fed won't allow them to lose money. That's what makes it possible for non-delusional investors to make a lot of money. Again, John Hussman:
But at some point, Mr. Market gets tired of watching people make money. He likes to see them all lose money too.
This could be one of those times.
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.