Artificial Markets and Where We Go From Here

In my view, we are entering a time of significant financial transition.  Most financial markets are now artificial.  As I’ve discussed, the CARES Act changed the financial rules to allow for even more money creation.  Prior to the CARES Act becoming law, the Federal Reserve, the central bank of the United States, could only purchase US Government bonds and US Government backed mortgage securities.

The CARES Act changed the rules allowing the Federal Reserve to loan money to the US Treasury to use to purchase corporate debt securities through the use of a SPV or special purpose vehicle.

Within a week of that rule change, the Fed also announced it would begin the direct purchase of junk bonds despite the fact that the central bank has no legal authority to do so. 

Monetary policy change is as extreme as the policies themselves.

Despite the Fed’s venture into purchasing junk bonds, it seems that there will still be a record number of defaults on lower quality corporate debt issues.  This from “Market Watch” (Source: (emphasis added):

Even with the Federal Reserve aiming a $750 billion fire hose at U.S. corporate debt markets to offset carnage from the pandemic, defaults at speculative-grade companies already are starting to climb as business buckle under their debts.

Frontier Communications Corp,  LSC Communications Inc.  and hospital operator Quorum Health Corp. in April defaulted on a combined $14.3 billion of speculative-grade (or junk-rated) bonds, a sharp uptick from the $4 billion seen earlier in the year, according to B. of A. Global analysts.

They called the Fed’s announcement last week to start buying riskier assets “bold, surprising, and reflecting its commitment to respond forcefully to signs of dysfunction in the key corners of U.S. debt funding markets,” in a client note Friday, but also cautioned that defaults among junk-rated U.S. companies will likely reach 21% over the next two years.

The Fed will be directly buying junk bonds.  Yet, despite their aggressive purchases, Bank of America analysts forecast that 21% of junk bonds will default.  That gives you an indication of how dismal the financial health of many smaller and already distressed companies really is.

“Forbes” reported that JC Penny elected to skip a $12 million interest payment that was due on April 15.  (Source:  “Business Insider” reported that the company was considering bankruptcy (Source:

It is an accepted fact at this point that even if the constraints put in place to attempt to contain COVID 19 are soon lifted, the second quarter of this year, economically speaking, will be the ugliest in US history.  “Market Watch” reported (Source: that Morgan Stanley recently lowered second quarter economic expectations on what was an already dismal forecast (emphasis added):

Morgan Stanley has lowered its U.S. economic forecasts, as social distancing measures and closures of nonessential businesses have spread to an increasing number of states. The bank lowered its first-quarter GDP forecast to -3.4% from -2.4% and its second-quarter GDP forecast to -38% from -30%. 

            Later in the article, it was reported that Morgan Stanley expected 2020 GDP to drop more than at any time since 1946.

            Meanwhile, over the past 4 weeks, stocks have rallied off their lows.

            The stock rally in my view is reminiscent of past stock rallies – the Fed announces more radical monetary policies due to deteriorating economic conditions and stocks rally.  Financial markets, as noted above, really are artificial at this point with markets reacting to more easy money the same way as an addict reacts to another hit.

            Short-term the effect is positive, but long term it will be harmful.  And, the longer the artificial market stimulus is applied, the worse the ultimate crash will be.

            Back in 2011, when my book “Economic Consequences” was written and then again in 2015 when my “New Retirement Rules” book was published, I predicted a Dow to Gold ratio of 2, or more likely 1.

            I still stand by that forecast.  Now; however, it seems like there is a more obvious path forward to that eventual outcome.

            Jim Rogers, billionaire investor, co-founder of the Quantum Fund with George Soros and past guest on my radio program has the same perspective.  This from a recent interview with “Business Insider” when Rogers was asked if the current crash was going to be the big one. (Source: (emphasis added):

In 2008 we had a very serious problem because of too much debt. Since then, the debt has skyrocketed everywhere, so it seems to me self-evident. The next one has to be worse than 2008. People seem to be surprised.

Anyway, so yes, this is probably it. I’m sure that the rally is going to be nice. It already is a nice rally. You know, governments all over the world are spending huge amounts of money, printing huge amounts of money. There is an election in November, so the rally will probably be nice, but it’s not over, Sara, it’s not over.”

            When Rogers was asked how low stocks could go, this was his response (emphasis added):

I can tell you in history, bear markets go down 50, 60, 70% this is just history. This is not an opinion and many stocks go down 80, 90%. Some disappear. That’s just the way bear markets work.

            It’s important to remember that markets rarely go straight up or straight down over the long term.  That’s true of every market including stocks.

My opinion remains that we are likely going to see some initial deflation and then, assuming no change on monetary policy, probably significant inflation.

            Egon vonGreyerz, founder of Matterhorn Capital Management, states that inflation or hyperinflation has to be the ultimate consequence to the greatest financial bubble in history.  He forecasts that massive inflation, like coronavirus, will quickly move from one country to the next with very few being spared (Source:  This will be as a direct result of money printing by central banks which creates artificial markets.  This excerpt from a piece recently written by Mr. vonGreyerz explains (emphasis added):

Ever since the last interest cycle peaked in 1981, there has been a 39-year downtrend in US and global rates from almost 20% to 0%. Since in a free market interest rates are a function of the demand for credit, this long downtrend points to a severe recession in the US and the rest of the world. The simple rules of supply and demand tell us that when the price of money is zero, nobody wants it. But instead debt has grown exponentially without putting any upside pressure on rates. The reason is simple. Central and commercial banks have created limitless amounts of credit out of thin air. In a fractional banking system banks can lend the same money 10 to 50 times. And central banks can just print infinite amounts.

Global debt in 1981 was $14 trillion. One would have assumed that with interest rates crashing there would not have been a major demand for debt. High demand would have led to high interest rates. But if we look at global debt in 2020 it is a staggering $265 trillion. So, debt has gone up 19X in the last 39 years and cost of debt has gone from 20% to 0% – Hmmm!

            You don’t have to be an economist to understand that today’s markets are completely artificial.  As Mr. vonGreyerz points out, when interest rates fall, it indicates no demand to borrow money.  Yet, despite this, debt has ballooned to levels that are totally unsustainable. 

            That simple fact proves my argument that all financial markets are now artificial.

            That’s also why I have long advocated the two-bucket approach to managing money.  One bucket consisting of assets that are safe and stable to provide income needs and another bucket containing assets that will function as an inflation hedge.

Leave a Comment