Monday 26 September 2011

What Will Cause The Collapse?

Bear markets only end when price reaches a gut wrenching low. When speculators have been beaten down so much that mere mention of their favorite stock or commodity induces nausea and they do not want to touch it in their life time, ever. By that token the bear markets in the US stock markets will reach its nadir when S&P will be near 400, Dow near 3000. At these levels, 2008 will sure look like a trailer. At that level, there will be no safe haven except cash. That will be the ultimate collapse that the mega bears are hoping for.

Will that happen? If that were to happen, when will that happen? The global economy seems to be lurching from one crisis to another and still S&P has not breached 1000 yet. What we are seeing, is that a normal correction in a bull market or beginning of a bear market ? 

The Western civilization has modeled itself on the Keynesian theory where higher government spending has created an illusion of growth. In reality, there has been no wage growth in the USA in the last 20 years. The macro story is same in the USA or Greece or Japan. Only difference is, some countries can print their own money, some cannot. But printing money does not give the solution to the problem of solvency. If you do not believe, ask Robert Mugabe of Zimbabwe. With 200% debt to GDP ratio, Japan is trying for the last 20 years to bring in prosperity. And yet, the Nikkei is down from 38000 to 9000. 
The ZRIP and easy money policy that are being followed by the Fed or JCB indicates that the Central Bankers of the world are worried about deflation, not inflation. With the Balance Sheet contraction upon us, all the central banks are trying to inject as much liquidity in the financial system as possible. Their only hope of survival is to re-float the financial markets. 

What QE1 and QE2 did was just that. It helped re-inflate the collapsed bubble. There were no growth then, there is no growth now. So why then the markets are not collapsing, given that there is no QE3, there are sovereign default threats and GDP is barely moving. What is holding up the support level? 

The answer can possibly be found in the last G20 meeting. With the world economies so inter connected, it is a kind of MAD world. (Mutual Assured Destruction). Therefore, China wants to keep the markets going in the USA and in Europe so that it can keep its millions of rural poor employed and keep a lid on social unrest. US of A provide dollar swap lines to virtually dead European banks because not keeping them alive will de-stabilize the world economy big time. SNB pegs its currency to sick Euro so as to keep the Swiss Franc low. Every country is doing what it can to keep the music going.
Under such a situation, the world economy will lurch from one crisis to another, only to be propped up by more money. Volatility will be high. Even safe havens like gold swing between 2% to 7% in one market session. But TPTB (The Powers That Be) will not let the bottom fall off. The world markets are pushing on a string.

Only thing that can destroy this equilibrium is going to be something which is beyond the control of the CB and TPTB. A true black swan event. I do not think that the coming black swan event will be financial. Even if Greece defaults, it will not cause the system collapse. It has now been almost two years and the default has been priced in. The only black swan event I can imagine is going to be Geo-Political. For e.g. Israel Iran conflict. 

When the markets know that the governments are watching their back, they keep gambling. And they are doing exactly the same thing. Today, the US markets went up by 2% on no good news. Nothing fundamentally changed from last week. It is as if, yes they can. Right now, it is money moving from the pocket of one hedge fund and bank to another. Ordinary investors are not a part of it. The gamblers will continue to do so till such an external shock crashes the system. What will force that is anybody’s guess. Till that time, keep the good times rolling.

I will be travelling for the next two weeks and the posts will be somewhat irregular. But if I come across something interesting, I will do my best to bring it to your attention.