Readers keep in mind that the most important statement I make below is:
“there are always multiple potential outcomes to any economic/market scenario — and I’ll absolutely keep an open mind“
While I present a sequence of events that may indeed unfold, I am in no way committed to the thesis. The economy and the markets are dynamic and so is our analysis. Conditions change, developments unfold and we adjust accordingly.
3/2/2020
ISM missed expectations this morning. China’s Caixin PMI tanked, of course, per last evening’s release.
Fed rate cuts are a foregone conclusion, the question is will they wait for the March meeting, or do an emergency cut this week? The latter if the market continues to sell off.
The fact that stocks are up this morning in anticipation of intervention has to be calming to the Fed. If they jawbone the market higher, they could hold off till the meeting. Although the news this morning is that G7 central banks are meeting by phone this week; the market is rallying on the prospects for immediate coordinated action.
Unfortunately, the likely results of aggressive stimulus — while they virtually have no choice — in response to the virus essentially puts the Fed in a corner, and serves as a potentially disastrous bull trap for late-coming investors.
While there are always multiple potential outcomes to any economic/market scenario — and I’ll absolutely keep an open mind — here’s how the “potentially disastrous bull trap” could play out over the next few months to, say, two years:
1. Stocks rally hard as folks dive in on news of central bank intervention.
3. Stocks rally hard as folks dive in on news of more intervention.
4. If the rally sticks until the virus gets contained, the central banks (the Fed in particular) will find themselves in a precarious position.
OR:
5. If the rally fades on worsening virus news, etc., central banks intervene further, and (particularly the Fed) have pretty much run out of conventional bullets.
Three possible finales:
1. In the #4 scenario the Fed — already running low on conventional bullets — will be anxious to take back those rate cuts, etc. (read hike rates and possibly balance sheet rolloff). The market will sell off hard on that (fed tightening) news, and, I suspect, end this longest-ever bull market for good.
2. In the #5 scenario, with conventional ammo spent, the fed will be desperate to restock (hike rates, etc.) on any sign of economic recovery. The market will sell off hard on that news, and, I suspect, end this longest-ever bull market for good.
3. The economic data continue to deteriorate to the point where investors finally realize that all the Fed stimulus in the world can’t keep a recession from happening when its time has come. And, thus, this longest-ever bull market ends for good, in epoch fashion. The epochness of the next bear market will be blamed, justifiably so, on late-stage bubble-blowing at the hands of a panicky Fed.
Speaking of the potential epochness of the next bear market, there’s of course that ginormous elephant in the room that we’ve been illustrating herein for months; the massive corporate debt bubble — fueled by a decade+ of easy money policy — that has sucked in pension funds, etc., that can’t capture remotely enough yield on the safe-end of the curve to satisfy their return requirements.
Epoch bear markets are typically accompanied by a credit crisis; the next one, alas — whenever it occurs — has all the makings…