Providence Is With Us

Yesterday European Central Bank President Mario Draghi announced what could be an unlimited bond buying program to save the euro.  Later in the day, after running up 28 points, the S&P 500 closed at its highest level since before Lehman Brothers vanished from the face of the earth.  You can make of it what you want.  But from our perch, we see another disaster in the making.

A broken clock is right twice per day.  What we mean is, any day now, the stock market could crash.  That’s our story, at least…and we’re sticking to it.

On July 20th we published an article titled, Get Ready for a Massive Stock Market Selloff.  In summary, the article warned that the lack of monetary easing, an economy on the verge of recession, and a Congressional stalemate as the country drives full speed ahead toward the fiscal cliff would result in a massive stock market selloff.

Quite frankly, we thought the stock market would reverse course by now.  That it would no longer continue going up…it would go down.  Yet since July 20th the stock market has not gone down; it has gone up.  In fact, as measured by the S&P 500, it has gone up over 5 percent.

Based on the market’s pleasant upward movement of late, does this mean we are now buying stocks?  No way.  Moreover, that the S&P 500’s gone up 5 percent over the past 54 trading days and 30 percent since the October 3, 2011 interim low only reinforces our bearish sentiments.

Why Something Bad Will Happen before the Year is Through

No doubt, markets are irrational.  In the words of Keynes, “Markets can remain irrational longer than you can stay solvent.”  Nonetheless, sooner or later, something must give.

Here at the Economic Prism we believe something big – and bad – will happen before the year is through.  Each day, as the stock market rises, we become all the more sure of it: A massive stock market selloff is coming.

Here’s why…

The market’s a forward looking animal, say the old timers.  It looks out into the future and prices in future events before they come to pass.  But what happens when the market prices in certain, bullish events and then they don’t happen?

You see, Wall Street’s been operating under the assumption that additional quantitative easing will be executed before the year’s end.  So, too, Wall Street’s been operating under the assumption that Congress will come up with a plan, at the 11th hour, to freeze the automatic tax hikes and spending cuts that will kick in on January 1st.

We believe both these assumptions are false for a few simple reasons.  (1) Federal Reserve Chairman Ben Bernanke cannot print more money when stocks are near all-time highs and oil is at $100 per barrel.  He needs these asset prices to deflate before he can pump more money into the financial system.  (2) Congress is too dysfunctional, and election year politics are too polarizing, for any compromise to occur before the end of the year.

When Wall Street finally figures either one of these out there will be a great panic.  But that’s not all that’s coming…

Providence Is With Us

When the country drives off the fiscal cliff, and simultaneous tax hikes and spending cuts are triggered, unemployment will again spike up, corporate profits will crash, businesses will go bankrupt, and consumer cash flow will slow to a trickle.  The economy will quickly fall to ruin.

At that point, there won’t be anything a politician, the government, or the Fed will be able to do to stop it.  Once the economy stagnates, a new recession will have to take its course.  Plus, when it comes down to it, a recession is what’s needed to purge all the bad debt and misallocated capital from the economy…and return assets to their real – non government stimulated – market price.

Remember, the Fed was not able to stop the dot com market crash.  Nor was it able to stop the housing market crash.  All the Fed can do is create massive amounts of credit and pump it into the financial system.  Where the money goes once it’s created is beyond the Fed’s control.

Sometimes it goes into stock prices, or house prices.  People generally like this type of asset inflation…it makes them feel richer, smarter, and younger too.  Before long they take their inflated wealth and they spend it; the economy booms.  Alan Greenspan calls this the ‘wealth effect.’

Other times the Fed’s funny money goes into oil prices, food prices, and consumer prices.  People especially dislike this type of inflation…particularly when economic stagnation has already bankrupted them, and they’ve lost their job and their house.  Alas, with all the debt and bogus money already floating around out there, further fiscal and monetary stimulus may successfully debase what little is left of the dollar.

“Providence is with us,” said President Obama last night during his Democratic National Convention speech.

We nearly cracked a rib in laughter.

Sincerely,

MN Gordon
for Economic Prism

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