A nightmare scenario we can help you pr epare for…

Friday, 16 September 2022 — Melbourne, Australia

[6 min read]

Dear Reader,

How many of you are tired of the schizophrenia in the markets?

Barely is the market in rally mode before a sell-off causes investors to head for the exit.

It’s a cycle.

You have the central bankers announce their rate rises and economic outlook. People hang onto every word they say, dissecting it and interpreting it the same way Roman augurs read into the future by studying the entrails of a sacrificed animal.

Then the media weighs in on daily movements, adding to the momentum.

It’d be worthwhile if they could steer the ship properly.

But you’re well aware of the central bankers’ track record with managing the economy.

The inflation that they said was transitory is still roaring — the US Consumer Price Index (CPI) data for last month came out on Tuesday night. Prices were up 0.1% relative to the prior month and 8.3% higher than the same time over the last year.

Though you don’t need the official data to tell you that inflation is overstaying its welcome. The only issue I have with these official data readings is that the reality we are living in feels much worse than the data suggests.

Think about it, are your weekly bills rising more than 8% from last year? Mine are.

Sure, this is US data, but I reckon the Australian CPI data would give a similar reading when the Australian Bureau of Statistics releases it.

That’s why I believe ignoring the central bank chatter will do you a lot of good.

But clearly, that didn’t happen this week.

How low can it go?

The US markets on Tuesday trading saw the biggest slump since June 2020. The Dow Jones and S&P 500 indices fell around 4%, while the NASDAQ Index fell more than 5%.

The carnage in the Australian markets was more subdued, with the ASX 200 Index falling around 2.5%. Part of that was because the damage to the resources and mining companies, which comprise a significant proportion of our markets, was less brutal.

Nevertheless, it wasn’t a pretty sight for those hoping for some relief. After all, a small win in your portfolio could help offset rising bills.

With costs remaining high, we expect businesses and households to experience significant pressures. Many businesses are now seeing profit margins take a turn for the worse in the most recent reporting period. Hiring freezes and reduced staff counts are accelerating.

Add to this rising household mortgage repayments and petrol prices, and you have a lot of headwinds on economic growth.

So, if you are hoping for a quick dip in the markets before things become rosy again, I reckon you need to readjust your expectations.

As for how far things can fall, this is not as clear-cut.

On one hand, the argument for the stock markets to drop sharply (30% or more) is that many companies are trading at high multiples to earnings relative to the bleaker outlook on business conditions and the general economy.

But then you have the governments on the other side that have to keep a watchful eye on the official data. Governments worldwide don’t want their economies to collapse as it would ruin their chances of re-election or, worse still, face the prospect of riots (see Sri Lanka, Canada, and the Netherlands).

Their preferred strategy in recent times has been to borrow from the central bank and then pump the economy with trillions of dollars in stimulus payments.

Not to mention that fund managers and algo traders have been playing the game of buying the largest companies to keep the indices up.

That’s why we saw the markets remain levitated for so long. In fact, if you search ‘the most hated bull market’ online, you’ll see articles with this heading at different times over the last decade.

While it created an illusion of rising wealth for many as markets headed up, it could turn really bad on the way down…

How bad?

Let me indulge you with this…and we aren’t just talking about falling prices.

A fearsome scenario…potential reality or conspiracy theory?

There’s an expectation that the government will come to the rescue should the markets tank heavily because of these coordinated rate rises by the central banks.

But what if it’s different this time around?

What if central banks continue to raise rates to tip the market over and governments don’t come to the rescue with stimulus payments?

It’d be a real disaster, wouldn’t it?

Higher cost of living, ballooning debt, falling asset prices, and failing businesses…

There’d be blood on the streets, with no bandages to dress the wound.

And what if governments come to the rescue by offering to take a stake of ownership of your assets to keep you from going bankrupt? So they have a foot in the door, and you don’t need to lose your house…

And what if (just what if) the central banks take this opportunity to transition into an alternative financial system? One that’s digital so that keeping records of transactions will be easier. One that is programmable, so someone could, theoretically, add or subtract wealth in people’s accounts or even shut them out of the system.

These things sound unbelievable and unfathomable, right?

Well, our recently elected Labor Government campaigned on a platform offering to take a 40% stake on a property to help first homebuyers get into the market.

And the World Economic Forum has been discussing central bank digital currencies.

What could possibly go wrong with these developments?

I don’t know about you, but I want to run in the opposite direction to what they’re doing. And if you’re the same as me, you’d want to check out our strategy to protect yourself from the potential impacts on your wealth.

Things can happen fast, so act now!

God bless,

Brian Chu,
Editor, The Daily Reckoning Australia

Dear Reader,

‘Inflation represents the ultimate negative feedback loop.’

Milton Friedman

The best war is the one you don’t fight. And the best inflation is the kind you never have. Yesterday’s 8.3% inflation print (which is how they describe it in the financial press) disappointed investors. They had their hearts set on a lower print. Because then, they reasoned, the Fed could go back to doing what it does best: inflating the economy.

From Bloomberg: ‘Inflation Surprise Puts Onus on Fed to Hit Brakes Even Harder’:

‘What started as a pandemic-driven supply shock has morphed into widespread inflation rooted just as much in resilient demand, underscored by unexpectedly high numbers that dashed hopes price gains were ebbing.’

We all need editors — at Bloomberg as well as everywhere else. What the writer was trying to say was that inflation may have begun as a pandemic-driven supply shock. But now, consumers keep buying and prices keep going up.

2+2 =?

Investors put two and two together. The Fed will be forced, they realised, to stick with its program of rate hikes. CNBC: ‘Dow tumbles 1,200 points for worst day since June 2020 after hot inflation report’:

‘The Dow Jones Industrial Average slid 1,276.37 points, or 3.94%, to close at 31,104.97. The S&P 500 dropped 4.32% to 3,932.69, and the Nasdaq Composite sank 5.16% to end the day at 11,633.57.’

But so far, the pain is limited. Stocks are down, but not catastrophically. There are few bankruptcies. Mortgage rates are still at less than 6%. And as far as we know, only one corporate CFO has committed suicide. Business Insider: ‘The Bed Bath & Beyond CFO fell from the 18th floor on Friday, the NYPD confirmed to Insider’.

The Fed is expected to raise its key rate by 75 basis points (0.75%) at its meeting next week, putting more pressure on debtors. Some people are urging the Fed to go easy, fearing — correctly — that they might drive the economy into a deeper recession. Others take the contrary view, also correct, that inflation is a bigger danger than recession and that the Fed will have to make the latter worse in order to stop the former. Bloomberg:

‘Jeffrey Gundlach of DoubleLine Capital is worried the Fed will choke off economic growth by raising interest rates too fast. Former Treasury Secretary Larry Summers is among those saying the central bank needs to hike even faster to restore its credibility.’

What to do?

When our phone didn’t ring yesterday, we knew who wasn’t calling; Jerome Powell didn’t want our advice. But had we been asked; we would have given it to him straight:

‘Jay, buddy, you and your bunch of hopeless clowns created this mess. You dropped interest rates way too low and left them there for way too long. But you should never have been interfering with the credit markets in the first place…

‘Jay…Jay…are you still there? Jay? The SOB hung up on me!’

Pobre Jay

The press this morning is showing photos of Jerome Powell. The poor man is under pressure. He thinks the current inflation is demand-driven. If he is to stop it, he will have to suppress demand by raising interest rates and sticking with his QT (quantitative tightening, in which the Fed shrinks its bond holdings).

He knows, too, that he is way behind the inflation curve. He hoped inflation would come down fast, so he could raise rates more gently. He might expect, for example, that inflation would fall to 4%...so that he could slide his rates up to 6% — and all would be hunky dory again.

But inflation isn’t cooperating. It’s not dropping as fast as he had hoped. Normally, the Fed lends at positive rates (about 2% above inflation). To do so today would mean a Fed Funds rate of more than 10%. But the US has a pile of debt US$90 trillion high. And every increase in interest rates shakes the ground on which it stands. It is only a matter of time until it falls over.

The best debt crisis is the one you never have to face. Jerome Powell may not be so lucky.

Regards,

Bill Bonner,
For The Daily Reckoning Australia