No rate increase in September...

Aug 28, 2015

- By Bill Bonner

Bill Bonner
Delray Beach, Florida

Dear Diary,

It's hot in Florida. Steamy hot. Hair curls and bodies go limp.

The "relief rally" continued yesterday. All over the world, equities gained. So did oil and commodities. The Dow was up 369 points. Chinese stocks were up 5%.

Why? GDP numbers came out higher than expected. And New York Fed chief William Dudley said the argument for a rate increase in September was "less compelling."

Oh ye of little faith...fear not! Things are happening just as they should.

It is the end of summer. Markets are giving strong hints of things to come in the fall. Like Vesuvius, a plume of smoke rises...and a cloud of dust hangs over the markets. The economic earth rumbles and animals take flight.

But in come the cronies to tell us not to worry about it.

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And who knows what happens next? When it comes to market forecasting your editor is a fairly good plumber. He can put the pipes together and unclog the toilet. Alas, his record as a soothsayer is spotty. He is rarely wrong, but often so early that by the time the event occurs even he has forgotten that he ever predicted it.

But today we are encouraged and emboldened. We swagger ahead, like a reedy poet into a rough bar, confident in the knowledge that there are giants behind us. Yes, John Hussman's forecast is very similar to our own.

    Last week's decline, while seemingly significant, was actually a rather run-of-the-mill example of "unpleasant skew" that has regularly followed similar market conditions throughout history.

    We should distinguish between causes and triggers here. If you roll a wheelbarrow of dynamite into a crowd of fire jugglers, there's not much chance things will end well. The cause of the inevitable wreckage is the dynamite, but the trigger is the guy who drops his torch. Likewise, once extreme valuations are established as a result of yield-seeking speculation that is enabled (1997-2000), encouraged (2004-2007), or actively promoted (2010-2014) by the Federal Reserve, an eventual collapse is inevitable. By starving investors of safe return, activist Fed policy has promoted repeated valuation bubbles, and inevitable collapses, in risky assets. On the basis of valuation measures having the strongest correlation with actual subsequent market returns, we fully expect the S&P 500 to decline by 40-55% over the completion of the current market cycle. The only uncertainty has been the triggers
A 50% decline over the next 10 years is our forecast. We will stick with it hoping to live long enough to see it proven correct, or in any case hoping to live long enough to see how it turns out.

But this forecast is for real prices, not nominal prices. Because we have a feeling that the feds will not stay in their seats as the government loses revenues, zombies rise in rebellion, and cronies and campaign contributors lose much of their net worth.

As of June, the US public held $84 trillion in net assets. A 50% decline in stock prices would wipe out $12 trillion. Real estate would most likely go down too - especially at the upper end. That super-expensive house in Florida, for example, on the market for $139 million, would have to be sold at auction. How much would it bring? $10 million? $50 million. Who knows?

The junkiest, riskiest part of the bond market would also be destroyed. When the going gets tough the spreads between junk bonds and the safest (US government) bonds widens. Whole sectors go broke.

For example, here's Bloomberg with a report on debt in the oil patch:

    At a time when the oil price is languishing at its lowest level in six years, producers need to find half a trillion dollars to repay debt. Some might not make it.

    The number of oil and gas company bonds with yields of 10 percent or more, a sign of distress, tripled in the past year, leaving 168 firms in North America, Europe and Asia holding this debt, data compiled by Bloomberg show. The ratio of net debt to earnings is the highest in two decades.

    If oil stays at about $40 a barrel, the shakeout could be profound, according to Kimberley Wood, a partner for oil mergers and acquisitions at Norton Rose Fulbright LLP in London. West Texas Intermediate crude was up 4.5 percent to $40.32 a barrel at 10:51 a.m. in London.
Easy come. Easy go. It doesn't take too much imagination to see the EZ money of the last 7 years going back where it came from -- that is, to nowhere.

And then, what would St. Janet do?

Even now, under less stressful conditions...let us assume that markets stay calm...will she raise rates next month as expected? Probably not.

Money growth rates are actually falling. Consumer prices are stable, not rising, while inflation expectations are dropping. Unemployment and GDP numbers make it look as though the economy is running okay, but don't look under the hood!

And with the stock markets so fragile, would St. Janet risk being the one to cause a worldwide panic?

Nah. No rate increase in September. Instead, when the crash resumes, we will see even EZ-er money, not tighter money. We are on course for a Hormegeddon-style outcome. Backing up is not an option. We must go forward - to disaster.

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

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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