What's Going On With Stocks? Millions of 401(k) Holders Want To Know

With the 600+ point drop in the DOW yesterday many investors are understandably getting nervous. They are asking: What the heck is going on?  Is my 401(k) money safe or is it gonna vanish?

What we do know is that, mathematically, the latest stock drop has wiped out all the gains  for the year. 

The sell off, according to The Financial Times,  "was deepening all day and accelerated sharply into the close, with the S&P 500 and DOW Industrial average ending in negative territory for the year.".

Adding:

"And sending the NASDAQ Composite Index to its biggest loss in seven years, putting it on course for its worth month since the 2008 financial crisis."

Could what's happening now be the harbinger of the 50 percent  crash predicted back in January by The Utility Forecaster, e.g.
Well, we can't be sure, but we do know that historically, October has tended to be a terrible month in terms of stock investors' fortunes - from the great 1929 crash to the 1987 crash, and the infamous 2008 crash that hurled us into the Great Recession which took hundreds of billions of stimulus dollars to get out of - on account of massive credit freezes (owing to the spread of credit default swaps in mortgage bonds, other bonds).

In the immortal words of Adam Sender, chief investment officer of Sender Company & Partners:

"It's super ugly and who knows when it will be over."

Meanwhile, Max Gokhman, head of asset allocation for Pacific Life Fund Advisors, also quoted in the FT piece, is pretty certain the picnic is over. As he put it:


"There is definitely the fear that we are at peak earnings."

Meaning the only way for the market now is down. But what gives? What has seemingly and suddenly pricked the bubble? Well a confluence of factors, not least of which are growing trade tensions - especially with China, and increasing interest rates.   THis is being reinforced by the growing belief that the best days of the Bull cycle are in the past.

Beyond that, according to Michael Arone ('DOW Sinks As Threats To Markets Multiply' WSJ, October 19, p. B1), chief investment strategist for State Street Global Advisors:

"Strong earnings and economic data haven't been able to overpower geopolitical concerns."

He's referring here to the fallout with the oil rich Saudis from the Khashoggi incident, as well as the trade war with China, which also has the potential for military confrontation - i.e. with the U.S. recently testing Chinese mettle by sending two warships through the Straits of Taiwan.

Oh, and the midterm elections are also now looming large. Thus, the business community dreads a likely takeover of the House (which governs budgetary issues) by the Dems, because it may well mean an end to the current gravy train. More regs, fewer tax cut freebies.

Arone again (ibid.):

"Until we receive some clarity on on trade, monetary policy and the midterm elections, we're likely going to see this volatility continue."


Another problem concerns the behavior of the term premium on the 10-year Treasury bond. This is the additional yield investors demand for the risk of lending over long periods.   The problem is that if the terms premium keeps going up (i.e. becomes less negative), the acronym stocks (e.g. Facebook, Amazon, Alphabet, Netflix, Microsoft etc.)  will keep suffering as a result.   Well, this occurred yesterday as the FT observed (ibid.):

"Analysts said the selloff put pressure on richly- valued  tech stocks more broadly.  Investors dumped shares of technology companies, which have led the  market rally  in recent years."

In more detail,  just a simple return of the term premium to where it stood three years ago (before the Fed interest rate increases began) could easily jack up 10-year yields to 3.75%.  But a return to what used to  to count as "normal" could take it to 4% . Now, correct (discount) future profits back to today, i.e. at higher interest rates, and they are worth less.  This then hits rapidly growing companies more than the rest of the market because more of their profits are future- oriented. 

A third fact, call it a worry if you want, is that the stock market was already looking unhealthy from last month. Since the start of September smaller companies have been having a terrible time and bank stocks have fallen sharply. We know one big reason for the latter is that in the past year alone, according to the WSJ and FT, nearly $30 b has been pulled out of parked "no interest" accounts of large businesses, institutions. They  - the big depositors- were tired of getting nada while banks kept lending money out at higher interest, even after Fed rate hikes. This pullout of bank deposits and transfer to higher yield institutions, from banks like Wells and Citibank, have left fewer bucks for lending to the small fry.

The bottom line is that both effects suggest a lack of confidence in the economic outlook. Let us also note that more and more worries - especially concerning the nation's long term political stability- are now creeping in as this tumultuous an divisive election cycle reached its climax and particularly after the bomb threats exposed the past few days. 

The myth that the stock market rests in splendid isolation far above the tribal turmoil of national politics may have finally reached its end.  Well, it's about damned time.


Update:  As per the article (p. B12)  in yesterday's WSJ 'Business and Investing' section ('Moves in Lockstep Suggest Risk Ahead') no one who is sober should expect any uptick in stocks suggests the threat of a crash is over. As the piece observes:

"Riskier assets such as stocks and commodities are moving in unison as the market selloff deepens, a worrying sign for some analysist who believe it indicates more turbulence ahead.

Lockstep moves are a worrying sign because they signal excessive optimism or fear in markets. That means investors are largely buying or selling holdings all at once rather than weighing fundamental information like earnings or supply and demand.

Rising correlations often presage more drastic moves in either direction."

As I wrote in my Feb. 6 post  a lockstep  movement in asset prices can lead to a "multiplier" sell-off effect that would overshadow a normal correction, So if 10 percent is a normal correction and the DOW was initially at 25,000 or so, that would mean a loss (total) of 2500 points.    If investors sell - then flee to bonds and sell them too - that means a "multiplier"sell off and that's what triggered the nearly 1200 point drop of the DOW on Feb. 5th.  The takeaway? A much larger multiplier effect is yet to come, and The Utility Forecaster projects a 50 percent drop.

Don't Like Thinking About Deficits? Then Better Be Sure You Win The PowerBall Or Mega Millions.

Let's concede that deficits are not a choice subject of conversation or discussion for too many Americans. They'd almost rather reach for their Instagram and look at the latest flicks of kitties punching each other than delve into any economic topic, especially deficits.   But with the latest planned shitstorm by the GOP - passing a new round of tax cuts they ought to be paying more attention.

In a WSJ report on Friday we learned just how reckless the GOP and Trump bunch has been in pumping up spending (via tax cuts) to record levels, even as the likes of 'Bitch' McConnell talk about "having to cut entitlements" - namely Social Security, Medicare and Medicaid. Why pray tell?  Well, because the tax cuts passed last year didn't "pay for themselves" as the Repuke hucksters had promised. Indeed, the Treasury Department reported that the federal government's budget deficit grew to $779 billion for the year ending Sept. 30th.  This was up 17 percent from the year before and came as a result of last year's sweeping tax cut.

That tax cut drastically reduced tax revenues as a share of gross domestic product .  At the same time, according to the WSJ report '(Federal Deficit Has Widened') government spending rose 3 percent to $4.1 trillion.  Meanwhile rising interest rates and the amount of total debt outstanding drove up federal interest costs 14 percent last year, by $65 billion".  (Imagine paying $65 b  just in interest on your credit card)  Trump complained that this was because of the Fed raising interest rates, but of course he was talking out of his fat ass.

The interest rates being leveraged by the Fed are most directly concerned with too rapidly rising wages and prices. However, it is true that the national debt does increase if  the federal interest rates increase.  Higher short and long term Treasury rates mean the federal government's borrowing costs also rise, so generating significant consequences for the budget and national debt.   This is why generating revenue - especially in an environment already replete with aggregate demand (because of the exceptionally low unemployment rate) - is more important than reducing revenue via tax cuts for an unnecessary stimulus.

But that is why we need circumspect leaders and political parties who are courageous enough to add revenue - via higher taxes - when needed, instead of tying to score political points.  Every manjack in the country - especially students with massive loan debt and ordinary folks tapped out on their credit cards- knows that interest on their debt can eat them alive if they're not careful. That is why credit card companies insist you pay back only a minimum amount each month - hoping to keep the interest $$$ flowing into their bank coffers.

But this is now the situation with the U.S. government which is spending way more than it takes in.  And instead of increasing our income to accommodate our spending - like you or I would -it insists on spending even more while reducing revenue!  Can anyone say madness?

But lo and behold there's a method to the madness.   Thus, earlier last week Sen. Mitch McConnell responded to the growing deficit by blaming "entitlement" programs like Medicare, Social Security and Medicaid.  Indeed, he and the putative next House GOP chair (if the Reeps win everything again) have promised the 'big three' will be the first things they will go after for cutting.

Trump himself has called for massive cuts - trillions of dollars worth - to food stamps, disability benefits, welfare and student loans.  (Not cutting interest on them, but cutting the loans altogether).

Nancy Pelosi, say what you will about her, was at least honest in her assessment of the situation, quoted in the WSJ report:

"Republicans have exposed their true agenda in budget after budget: add trillions to the deficits to justify slashing the Medicare, Medicaid, and Social Security that seniors and families rely on."

But, of course, we knew this from the time the odious "stimulus" tax bill was passed, when no stimulus was needed, see e.g.
http://brane-space.blogspot.com/2017/12/paul-munster-ryan-admits-he-wants-to.html

The shortfall in government expenditures will rise above $1 trillion next year. Deficit spending makes sense during a recession. But what Trump is doing now is essentially allowing the rich to siphon the cream off the top, providing the middle class with some skim milk, and leaving the sour dregs for everyone else.  The stimulus where none is needed also makes it much more probable the Fed will have to continue raising interest rates to cool off an overheated economy. Fed chief Jerome Powell has already indicated that if things keep going as they are several more interest rate hikes may be coming next year - not good news for those who have mortgages, or plan on buying a home. (Already as reported in the weekend  WSJ and FT, home sales are receding - as interest rates now approach 5 %.)

Then there’s corporate debt which is now set to be on rocket power given the corporate tax cuts.  Companies have taken advantage of low interest rates to borrow like crazy. This summer, corporate debt hit a new high of $6.3 trillion. Worse, the cash-to-debt ratio, which was 14 percent in 2008, has dropped to 12 percent: that’s $1 in cash for every $8 of debt.  Nor are companies doing much with that tax cut money other than share buybacks, further fueling excess valuations, higher P/E ratios in the asset bubble, overheated stock market.  It's no wonder now the volatility is spiking again.

Here's another alarm bell for those (mainly investors) who might need one. For several years the term premium (the additional yield investors demand for the risk of lending over long periods) on the 10-year Treasury has been negative.  This is a rarity that is tied - in part- to supply constraints and bond buying by the Fed and other central banks.  But this month the term premium became less negative, rising to -0.32 from -0.45 percentage point (at the end of last month)

In the months ahead the term premium could get even less negative and possibly even turn positive. Also, supply constraints on the bond market are likely to shift as the Fed continues to reduce its balance sheet, i.e. the trillions of bonds purchased via quantitative easing after the financial crisis.  The more imminent danger point then will arrive as other central banks also rein in their bond-buying programs and the U.S. government issues more debt in order to cover its growing budget deficit.

Buckle your seat belts and pay attention, because ultimately - unless you're independently wealthy - what happens with the deficits and tax cuts will affect you!