Submitted by David Stockman – The Contra Corner Blog
In fact, the S&P 500 had risen by nearly 1000% as of the recent May peak, but that was not owing to a traditional domestic business cycle or booming growth in the main street economy. To the contrary, real median household income in 1989 was $53,000 in constant 2013 dollars—–or exactly where it still sits today.
Instead, the big cap US stock index depicted above floated upwards for more than two decades owing to the great central bank Financial Bubble. On the back of $225 trillion of debt, the world economy got drastically overbuilt—–from the boom’s epicenter in China and throughout the global food chain of Emerging Market (EM) economies which supplied it, the petro-states which powered it, and the Development Market (DM) economies which consumed more than they produced and financed it from borrowings and speculative windfalls.
Now the tide is receding. The global commodity crash and CapEx depression is driving corporate profits lower—-a trend line which will sharply intensify in the year just ahead.
At the same time, the central banks have reached the end of their tether. The EM banks like that of China must now shrink their domestic monetary system and credit in order to prevent monumental capital flight. In the last five quarters alone China has had a $800 billion outflow.
The DM central banks are in an even worse predicament. They have held interest rates at the zero bound for seven years and bought up a fair share of the public debt via the fiat central bank credit of QE. But while drastically inflating financial asset prices, these radical maneuvers haven’t levitated the main street economy. Consequently, central bank credibility is evaporating fast and policy confusion, indecision and incoherence are mounting visibly.
The implication for the stock market is straight forward. Loss of confidence in the central bank money printers will cause valuation multiples to contract. At the same time, the accelerating global commodity crash, capital spending plunge and declining trade volumes will soon bring on worldwide recession——one which the central banks will be powerless to reverse via monetary stimulus.
That means that stock prices will be under pressure from lower multiples and lower earnings for as far as the eye can see. Indeed, the market top is in not just for the so-called recovery cycle since June 2009, but the entire central bank Bubble Finance cycle of the last 20 years.
To be sure, bull markets do not die easily, and especially ones that have been fed a epochal diet of easy money and central bank props, puts and bailouts. So it is probable that the tops will be tested over and over until the last dip-buyer capitulates and the last robo-machine is reprogrammed to sell the increasingly incoherent central bank word clouds rather than buy on hints of more free money.
For that reason there is emerging a market failure zone high in the hills above the recent short-lived tops. The latter represent a kind of monetary rigor mortis of the phony, dying bull market, and not evidence of a new leg higher.
In the case of the S&P 500, those spasmodic tops are in the 2075 to 2125 range. Yet it closed yesterday at the approximate level first achieved in early May 2014. So the market has been chopping sideways for nearly 500 days, and now faces the on-coming headwinds of a intensifying global economic slump and a central bank that is increasingly paralyzed and ineffective.
The world’s equity markets are now especially vulnerable because they constitute the volatile cherry atop the global financial bubble. Back in 1994 when the Fed and other central banks began their money printing spree in earnest, the combined value of the world’s stock markets was about $15trillion. By contrast, at the May/June peak this year total global market cap had exploded to $75 trillion.
Since then nearly $13 trillion has been wiped out— about two-fifths of that in the China stock market alone. But that’s just the beginning.
During the last crisis in 2008-2009, world equity markets plunged from $64 trillion at the peak to $30 trillion or by more 50%. On top of that came trillions more of losses on sub-prime mortgages, securitized debt and junk bonds. In all, about 16% ($38 trillion) of the $240 trillion of worldwide equity market cap and debt then outstanding was liquidated.
At the recent peak, worldwide finance stood at $300 trillion ($225 trillion of debt plus $75 trillion of market equity), but this time it is far more vulnerable to a drastic, sustained wipeout. That’s because the 2008 collapse was quickly, albeit artificially, arrested by an unprecedented money printing campaign led by the Fed and soon embraced by virtually every central bank on the planet.
This time there will be no Wall Street rescue because the central banks have shot their wad. They have pinned money markets to the zero bound for 80 months running, and as practical matter can’t go lower. And they have amply demonstrated in the US, the Eurozone and Japan alike that quantitative easing (QE) does not stimulate the main street economy after a condition of “peak debt” has been achieved; it only inflates financial asset prices, thereby fueling ever more dangerous financial bubbles.
So notwithstanding the widespread expectation that central banks will attempt a new round of wild-eyed monetary stimulation as the global deflation gathers force and financial markets continue to fracture, it is highly unlikely that these desperation measures will reflate the world’s $300 trillion financial bubble.
The world market cap chart above might then get a new caption. Namely, “Look out below!”