What Happened to Stocks Last Week?

Stock bloodbath.  That about sums it up after the worst week for stocks since the financial crisis.

I have been writing about the volatility of stocks of late on this site and have been publishing my long-term forecast for the Dow to Gold ratio for many years.  For new readers, the Dow to Gold ratio is calculated by taking the value of the Dow Jones Industrials and dividing by the price of gold per ounce.  That ratio now stands at about 16.

My long term forecast for this ratio is 2, more likely 1.  Granted, it may take a while to get there, but given all the artificial stimulus that has been used to prop up the stock market, I expect the ultimate bust to be 1929 like.

For those readers who believe that we have free markets, let this short piece serve as a quick primer and a wake-up call to taking steps to protect your assets.  A word to the wise, no matter what your relationship is with your broker or advisor, no one cares as much about your money as you do.

Back in 1988, after the ‘flash crash’ in the stock market, President Reagan put in place a group known as the Working Group on Financial Markets.  In 1997, “The Washington Post” coined the term “Plunge Protection Team” to describe the group.  The group was created by the president’s executive order (Executive Order 12631) and was charged with “enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation’s financial markets and maintaining investor confidence.”

The original purpose of the group was to report on the market events of October 19, 1987 or “Black Monday”.  It was during that time that the Dow Jones Industrial Average fell 22.6%, rattling the confidence of investors and creating panic in the markets. 

Yes, the Plunge Protection Team does exist.  This from “Seeking Alpha” in December of 2018 (Source:  https://seekingalpha.com/article/4230043-plunge-protection-team-to-strike-again):

In plain English, monetary sovereign currency creation powers are being used to make the markets maintain stability. Treasury funds are made available, but the WGFM is not accountable to Congress and can act from behind closed doors.

This illustrates how central banks can create money electronically without causing consumer price inflation, rather than taxing populations to pay for government budget deficits.

The PPT is meeting at this very moment.

The main reason we have a stock market plunge at the moment is the general withdrawal of world Central Bank liquidity support. 

The same thing happened in 2015-2016 and the world stock market response was the same. 

A withdrawal of central bank liquidity that began in 2014-15 resulted in a stock market and GDP slump twelve months later. 

            So, let’s look at this.  What does ‘monetary sovereign currency creation powers are being used to make the markets maintain stability’ really mean?

            Money is/was being created to stabilize the markets.  Need a stock rally?

            In comes the Plunge Protection Team to save the day.  On the committee is the Chair of the Federal Reserve, the nation’s central bank.  A stock rally can be fueled by throwing newly created currency in the markets.

            Skeptical?  I don’t blame you, but here is a quote from an interview with Richard Fisher, former member of the Federal Open Market Committee (Source: www.cnbc.com/2016/01/06/dont-blame-china-for-the-market-sell-off-commentary.html) (emphasis added):

“I spent 10 years (through last March) as a participant in the deliberations of the Federal Open Market Committee, setting monetary policy for the U.S. The purpose of zero interest rates engineered by the FOMC, together with the massive asset purchases of Treasuries and agency securities known as quantitative easing, was to create a wealth effect for the real economy by jump-starting the bond and equity markets.

The impact we had expected for the economy and for the markets was achieved. By February of 2009, the Fed had purchased over $1 trillion in securities. With interest rates throughout the yield curve moving in the direction of eventually resting at the lowest levels in 239 years of history, the stock market reacted: It bottomed in the first week of March of 2009 and then rose dramatically through 2014. The addition of a third round of QE, which had the Fed buying $85 billion per month of securities to ultimately expand its balance sheet to over $4.5 trillion, juiced the markets.”

Translation?

The Fed printed $1 trillion and dumped it into the financial markets.  As Mr. Fisher so plainly stated, the Fed “juiced the markets”.

Quietly and unbeknownst to the average IRA or 401(k) investor, the Fed manipulates markets.  Stock markets and bond markets are being artificially influenced to attempt to achieve a desired outcome.

So, if that’s the case, what happened this week?

Is the coronavirus to blame.  Mostly not in my view. 

The market fundamentals have been screaming correction for a long time as I’ve often written here.  Significant market corrections typically begin when stocks are overvalued and margin debt levels are high.  Then a “black swan’ event occurs, and the market correction begins.  That’s how I view the current situation (I am not attempting to trivialize or minimize the coronavirus situation, only look at it from the perspective of the massive market correction that occurred this week).

One of the most common methods used to value stocks is the price-to-earnings ratio.  This ratio is calculated by taking the price of stocks and dividing by earnings.  The higher the number, the more overvalued stocks are.

Notice from the chart on this page that the current 10-year P/E ratio average was slightly higher than in 1929.  Only once have stocks been more overvalued and that was prior to the tech stock bubble collapsing.

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To muddy the water up a bit when it comes to calculating P/E ratios, as I have reported here, many publicly traded companies have been buying back shares of their stock.  This once illegal practice increases earnings per share but not by increasing company earnings.  Higher earnings per share is accomplished by having fewer shares outstanding.

Margin debt is also high.  Margin debt is debt an investor acquires to buy securities, often stocks.

This chart illustrates the level of margin debt that exists according to FINRA.  Notice how margin debt pulled back prior to the stock market corrections of 2000 and 2007.  Then observe how margin debt has recently pulled back perhaps forecasting the correction that began this past week.

So, what’s next?

I expect the Plunge Protection Team and the Federal Reserve to pull out all the stops.  Look for interest rate cuts for sure.

But the reality is still the reality.  Stocks have long been artificially manipulated.  Basic laws of economics tell us that cannot go on forever.

Can the Fed and the PPT squeeze some more juice out of this market?

Perhaps, but given the market activity of last week, it’s looking less likely.

So, what should you do?

Make sure you’re protected, at least on some of your investments.  Especially those that you might need for retirement.  Given market action last week, I think there is a strong possibility that this correction will continue long term although I do expect markets could rally some first.  I would view any rally at this point as a bear trap.

For that reason, you may also want to think long and hard about taking the traditional broker and advisor advice about staying in the stock market for the long haul, ‘keeping your eyes on the horizon’.  At some point here in the relatively near future, I am of the mind it will fail many investors miserably and cost them their dream of a comfortable, stress-free retirement.

“Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months.”

-Irving Fisher, Ph.D. in economics, October 17, 1929

“Stocks look pretty cheap to me”        

-Larry Kudlow, National Economic Council Director, February 28, 2020