ZT: The Real Cause of Stocks’ Big Stumble

holycow

By Randall W. Forsyth
February 10, 2018

这是今天出版的巴伦氏周刊上的评论，虽然我同意他文章中的观点，不过我要指出这位作者一向偏熊~~

Welcome to the department of corrections. Leave your weapons or other instruments of destruction outside.

For traders, the latter would include exchange-traded products to bet against volatility in the stock market, which backfired spectacularly and caused untold injury to those who lost that can’t-lose bet. (For more on this, see “Where Volatility Goes to Die.”) But that was a sideshow to the real reason that equity markets around the globe were rocked last week.

We are witnessing the beginning of the end of the radical monetary policies that brought interest rates down to zero—and in some cases, below zero—and flooded the global financial system with excess liquidity. That has resulted in the inflation of asset values and the subduing of market volatility. That, in turn, enriched investors and speculators. Until it didn’t.

For the U.S. stock market, last week’s drop of just over 5% in the major averages was the worst since early 2016, when global markets were rocked by the plunge in crude oil and other commodities. This time, the precipitating factor appeared to be relatively benign: an uptick in wage gains in a strengthening labor market.

News the week before that average hourly earnings were growing at a nearly 3% annual clip in January caused great consternation that good news for working people was suddenly bad news for the financial markets. “In the ‘old days,’ when good news was reported, the Stock Market would go up,” President Donald Trump tweeted after the market reeled early last week. “Today, when good news is reported, the Stock Market goes down. Big mistake, and we have so much good (great) news about the economy!”

And that’s the problem, to which the markets are reacting, belatedly. With the economy at full employment by conventional measures and the expansion about to mark its ninth birthday in June, interest rates are still near Depression-era levels. At the same time, fiscal policy is turning ultrastimulative to a degree appropriate for recessions, not times of heady growth.

On the latter point, former Vice President Dick Cheney’s dictum that “deficits don’t matter” appears to have become the one verity on which Washington can agree. On top of a tax cut that will boost budget deficits by $1.5 trillion over the next decade, Congress last week passed a spending bill that could add an additional $300 billion in red ink. But according to the Committee for a Responsible Federal Budget, the spending deal and the tax bill could add some $4 trillion to the national debt in the next 10 years. By 2027, federal debt will total 105% of gross domestic product, the budget watchdog group warns.


“We know of no economic theory that prescribes adding to the fiscal deficit when the economy is at full employment,” caution John Ryding and Conrad DeQuadros of RDQ Economics. The best outcome would be if consumers were to boost their savings, in anticipation of having to pay higher future taxes, as predicted by classical economist David Ricardo, they write. The worst would be an expansion in the trade deficit, a falling dollar, and higher inflation, as suggested by Keynesian models.

The latter outcome appears more likely. The specter of twin deficits—on trade and the budget—has begun to stir the long-dormant bond vigilantes, who had little appetite for the Treasury’s auctions of 10- and 30-year paper last week. Indeed, the striking aspect of the market’s turmoil was the lack of a rally in government bonds, which failed to see a flight to quality from investors fleeing riskier assets.

Meanwhile, Jerome Powell formally took over the chairmanship of the Federal Reserve, just in time for the week’s first 1,000-plus point drop in the Dow Jones Industrial Average.

And he is no clone of Janet Yellen, the recently retired chair, contends David Rosenberg, chief economist and strategist at Gluskin Sheff. “He is sensitive to the criticism of the Fed, that it is a serial asset-bubble blower. He is no fan of [quantitative easing] or ultralow interest rates. At his recent Senate confirmation hearing, he made it clear that it is time to normalize rates,” Rosenberg writes.

Normalizing means a 2.75% rate for federal funds, which he notes is twice the midpoint of the current 1.25% to 1.5% target range for the Fed’s key interest-rate target. “This spells something more than two or three hikes this year, something I don’t think the stock market fully appreciates, but has begun to at least contemplate in recent weeks (which is why we have begun to see this intense volatility).” Reduced liquidity more than offset strong fundamentals in 1987, 1994, 1998, and 2007, which saw steep market drops.

If so, the market seems to be calling Powell’s bluff. Since stocks have slid from their peak on Jan. 26 (erasing $2.9 trillion in paper profits, according to Wilshire Associates), the fed-funds futures market has begun to dial back the probabilities of a third rate hike in 2018. While the market is pricing in an 87% probability of a quarter-point increase at the March 21 Fed meeting, the next quarter-point hike isn’t forecast until Sept. 26, with a 69% probability. As for a third rate boost in 2018, it’s less than even money by the Dec. 19 confab.

For whatever reason, the steep selling abated on Friday afternoon, when the Standard & Poor’s 500 index fell to its 200-day moving average, a technical indicator watched by traders, both human and computer. Moreover, JPMorgan global markets strategist Nikolaof Panigirtzoglou writes that two of the types of investment accounts that had figured prominently in the market maelstrom—commodity trading advisors and risk-parity funds—might have already seen such severe liquidations “that further position unwinding by these investors should be limited from here.”

Is the worst of the selling really over? Perhaps in the short term. Equity mutual funds also saw massive outflows exceeding $30 billion in the past week, suggesting that some weaker hands have folded. But while one short-volatility exchange-traded product blew up last week, another was reported to be attracting heavy inflows. Bottoms are rarely made while there are still punters looking to play…or at least get even.