Why Is The Stock Market Crashing?

Such an annoying question to ask, isn’t it? The correct answer is because people desire to hold stocks less and prefer to hold cash more than they did prior to the crash. The reasons for this are ultimately unknown but we can speculate.

The value of a stock to an investor is the present value of all future expected cash flows, discounted by the risk free rate. If you wanted to be 100% accurate you’d need to use the expected rate from now through the day of each individual cash flow, respectively, but I like to use the 20 year t-bond rate for simplicity’s sake.

Based on this there are two major reasons for stocks to crash: a drop in future expected earnings and/or a previously unexpected increase in the risk free rate.

Market action from Feb 1-8 has basically been marked by the following factors:

  • crashing stocks
  • slightly falling gold prices
  • falling/stable short term Treasury rates, rising long term Treasury rates, with a shift occurring around the 3-5 year duration (see graphic below)

Falling/stable gold prices indicate that investor expectations of future inflation haven’t fundamentally changed in recent days.

There’s no evidence that I’m aware of that indicates that corporate profit expectations are collapsing, in fact, the recent earnings season was upbeat, with positive news & expectations all over the place. But it’s also important to point that after the recent tax reform which is expected to expand deficits (a net positive on corporate profits, as I’ve explained before) one big factor towards rising corporate profits is now 100% priced in, whereas before it wasn’t.

Furthermore, there’s currently no evidence that the Fed is planning on accelerating the expected schedule of 3 rate hikes this year. In fact, at this very moment CME Fedwatch probabilities even slightly lean towards only 2 vs the widely expected 3 rate hikes!

In my opinion, this kind of action more than anything hints at a sudden change in investor expectations in the schedule of Federal Reserve interest rate increases over the coming years.

The one significant factor that I’ve been able to pinpoint is the seemingly subtle change in language in the most recent FOMC statement from January 1 2017. Minor shifts early on in the future schedule of expected rate hikes can have a huge impact on long term rates, since long term rates are basically just a bet on the average rate of short term rates inbetween.

If you do a text compare with previous FOMC statements, the following changes in verbiage stand out:

  • While most previous Fed statements said that “Market-based measures of inflation compensation remain low”, the most recent one states that “Market-based measures of inflation compensation have increased in recent months but remain low”.
  • Furthermore, most previous statements said that “Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term”, while the most recent one states that “Inflation on a 12‑month basis is expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term”.
  • And finally, another subtle difference is that statements recently always said “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate”, while the most recent one stated that “The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate”.

These changes could indicate that the Fed is beginning to prepare markets for an acceleration in the pace of raising interest rates, not immediately this year, but in the coming years.

This could explain why there hasn’t been a big shift in the rates on 3-5 year bonds, but after that the rates have increased substantially, with the 20 and 30 year Treasury rate (the one I like to use to discount future expected profits) rising by 13 basis points over just a few days. Such an adjustment in the medium to long term schedule of expected rate hikes, without corresponding changes in future profit expectations, can absolutely lead to significant adjustments in current stock market valuations, after which things should continue at the usual pace. For simplicity’a sake you could run a simplified model of present value at constant growth using different discount rates to get an idea of the possible magnitude of such adjustments.

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The Bitcoin Bubble – Why Bitcoin Has Value (An #MMT View)

I had another great conversation with Dylan from The Volitional Science Network about the bitcoin “bubble” and my theory on why bitcoin has value.

I’ve also written about why I think bitcoin ultimately has value.

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Podcast: Discussion on Investing, the Permanent Portfolio, Bitcoin, and More!

I recently had the pleasure to join my friends & fellow Being Libertarian contributors Brandon and Danny for a great conversation about investing, the permanent portfolio, Bitcoin, and so much more:

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Longer Maturity Bonds Coming? What Does It Mean For Investors?

ZeroHedge reported a few days ago that Trump’s pick for Treasury Secretary suggested in an interview with CNBC that he’d be open to issuing new bonds of longer term maturity:

“I think interest rates are going to stay relatively low for the next couple of years.” Mnuchin told CNBC. “We’ll look at potentially extending the maturity of the debt, because eventually we are going to have higher interest rates, and that’s something that this country is going to need to deal with.” Ironically, with that statement, Mnuchin quickly sent yields spiking higher, although courtesy of foreign buyers these were promptly renormalized.

Treasury Rate Spike

The mini selloff in Treasury securities on that day could have been prompted in part by anticipation: When longer bond options become available a certain portion of long bond investors while invariably sell off a portion of their current holdings to reach for the higher yield.

For example, investment strategies such as the permanent portfolio (which I follow) require you to allocate 25% to the safest & longest government bonds denominated in your local currency.

On the net such a move would simply be a gift to such long bond investors, since longer maturities offer more upwards punch precisely when needed, that is when deflationary pressures prevail and interest rates plummet. Furthermore longer maturities pay higher interest rates, essentially a risk free subsidy to those with money to invest in this manner.

If you’ve read my post about Modern Money Theory you’ll understand that most other reasons cited by Mnuchin don’t make much economic sense, since the government doesn’t really “need” to borrow money or issue long term debt at all:

Why sell longer term government bonds like the Treasury does, effectively setting a risk free rate and thus a floor for longer term loans? Again a good question! In fact, MMT ultimately suggests that beyond very short term Treasury Bills at most there’s really no reason for the government to be floating long term bonds.

Within the confines of today’s fiat money system, MMT actually offers the most libertarian alternatives regarding interest rate management and government bonds: let the overnight rate go wherever market conditions amongst private banks let it go, and don’t issue any long term government debt at all!

And in Why The National Debt Doesn’t Matter I explained:

When the Treasury pays interest on the public debt, it does so by asking the Fed (the banks’ bank) to mark up the recipient’s bank’s bank reserves via electronic keystrokes. It doesn’t need to raise taxes anywhere in order to perform this operation.

On that same token, when the Treasury retires a maturing government bond, it asks the Fed to remove said bond from the bondholder’s bank’s securities account and in turn marks up said bank’s bank reserve account accordingly. Once again, no tax money is needed to perform this operation. No future generations, to cite a popular cliche, are being asked to cough up the money to perform this operation.

And on Mnuchin’s claim that we’re “going to have higher interest rates, and that’s something that this country is going to need to deal with”, I’ve pointed out the following in that same article:

How many bonds are outstanding, at what maturity, and how much interest we wish to pay on them, are both 100% present-day political decisions that the federal government can make independently of the private sector. Theoretically, all outstanding bonds could be replaced by bank reserves that pay zero interest. All that would happen, in that case, is that one type of government obligation (government bonds, the promise to pay future bank reserves) is replaced with another government obligation (bank reserves, the promise to accept them to settle tax liabilities).

In other words: In a sovereign floating fiat money system rates on government bonds are always under the government’s control, letting them float is a choice, not an imperative.

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PIMCO Admits: Betting Against Treasurys Was a Mistake

I have been consistently bullish on US Treasurys.

PIMCO now says that betting against US debt was a mistake:

Showing a more bearish view on the U.S. economy, Gross said PIMCO had initially dumped all of its U.S. debt holdings in March as he expected economic growth to be higher, resulting in inflation down the road.

That decision greatly undermined the performance of PIMCO’s Total Return Fund. As Treasuries prices rallied, the fund lost 0.97 percent in the past four weeks, while the benchmark Barclay’s U.S. Aggregated Bond Index rose 0.23 percent in the same period, according to Lipper data.

So far this year, the fund has returned 3.29 percent, less than the 4.55 percent recorded by the Barclay’s benchmark index.

“When you’re underperforming the index, you go home at night and cry in your beer,” the Financial Times, in its online edition, quoted Gross as saying. “It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.”

Gross, who oversees $1.2 trillion at PIMCO, said it was “pretty obvious” he wishes he had more Treasuries in his portfolio right now.

Like I’ve said many times before, I think Treasury yields will stay low for much longer than people expect. Global flight to safety, over indebtedness, credit deflation or rather outright deflation, recessions, depressions … all these are bullish for cash and near-cash assets (of the world’s reserve currency), such as Treasury Bonds/Notes/Bills, and of course the mother of all cash … gold.

PIMCOs announcement above may be a nice contrarian indicator to get out of Treasurys for a little while … but then why would you want to daytrade such an investment … relax :)

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