EVERYONE LEARNS THE HARD WAY

This will do it...

"There is no political solution to our troubled evolution”

The central lesson of Nassim Taleb's Black Swan introductory, Fooled By Randomness, is that those who learn humility early on in markets go on to continued success. Those who have early success in markets, go on to ever larger bets leading to inevitable failure. It’s human nature to conflate all success as skill and all failure as personal inadequacy. Add in over a decade of central bank market bailouts and Taleb's theory is now getting tested on a biblical scale. 

So it is that this central bank experiment in moral hazard has trapped an entire society in an end of cycle super bubble. One in which liabilities remain at all time highs while assets are collapsing. For those of us who learned their lesson in prior asset bubbles this has been an exercise in humility, patience, and frugality. Which is now being rewarded in spades. The only solace in a time like this comes from knowing that bills will get paid independent of market vicissitudes.

No one can control history. Neither Democrats nor Republicans. All they can control is who gets hurt the most and the least. That is what passes for political ideology - the distribution of inevitable impacts of failed policy. Those in the heads down working class are easy prey for today’s con men. However among the educated, there is no excuse. We may not have control at the societal level, but we all have control at the individual level. Economic failure has been obvious since Springsteen first started writing about it 40 years ago. However this society has extreme survivor bias. This time around the list of survivors will be taken down to low single digits. A new low water mark that will be obvious to even the most truth challenged observer.

As I've pointed out several times, this housing bubble makes every other housing bubble i.e. 2008, 1980 seem minor by comparison. What saved many U.S. homeowners during the last housing bubble was the fact that only a relatively small subset of owners were using adjustable rate mortgages. In many countries there is no such thing as a 30 year fixed rate mortgage. ALL mortgages reset interest rates every few years. That type of system puts interest rate risk on the borrower. Whereas the U.S. system with long amortization periods puts interest rate risk on the lender. 

"Millions of people who borrowed cheaply to purchase homes during the pandemic boom face higher payments as loans reset"

"How exposed borrowers are to rising rates varies notably by country. In the US, for instance, most buyers rely on fixed-rate home loans for as long as 30 years. Adjustable-rate mortgages represented, on average, about 7% of conventional loans in the past five years. By contrast, other nations commonly have loans fixed for as little as a year"

The middle class is getting crushed at both ends now - higher inflation AND higher interest rates.

"The global economy may face a recession next year caused by an aggressive wave of policy tightening that could yet prove inadequate to temper inflation, the World Bank said in a new report"

Policy makers around the world are rolling back monetary and fiscal support at a degree of synchronization not seen in half a century

Investors expect central banks to raise global monetary policy rates to almost 4 per cent next year, double the average in 2021, just to keep core inflation at the 5 per cent level. Rates could go as high as 6 per cent if central banks look to wrangle inflation within their target bands"

There you have it, the World Bank is saying the best case scenario for investors is 4% interest rates AND 5% inflation. 

https://data.oecd.org/price/housing-prices.htm

September 12th, 2022:

"We maintain a pro-risk stance"

September 18th, 2022

"FedEx CEO Raj Subramaniam did not spare investors from the doom and gloom. Asked on CNBC if a “worldwide recession” was ahead, he answered, “I think so; these numbers don’t portend very well. We are seeing volume decline in every segment around the world. So we just assume at this point that economic conditions are not going to be good.”

His company’s poor results are “a reflection of everybody else’s businesses,” he added on a particularly ominous note"

Who to believe?

EXIT LEHMAN WEEK

It seems to have escaped majority attention that this was the week that Lehman Brothers imploded in 2008. Below is a summary of the key charts heading into FOMC next week...

First off, the Global Dow which includes the U.S.:

Emerging Markets got monkey hammered to new 2022 lows this week. The locus of risk heading into FOMC.

In the U.S., Dow Transports got monkey hammered this week both due to the narrowly missed railroad strike, and due to the Fedex warning.

The chart of the week is the Nasdaq which is heading for its first weekly double test of the 200 week moving average since 2009:

Nowhere near capitulation. Complacency reigns supreme:

Lehman week is over. 

CPI cemented policy error for next week with 100% probability.

EXPLODING HUBRIS

Lethal doses of bull shit are reaching the point of hot air explosion...

The eagerly anticipated pivot to depression will seal the fate of this buffoonish Idiocracy. Their best case scenario is now the worst thing that could happen to markets and the economy. 

Last week Mohamed El-Erian warned investors to get out of these "distorted" markets and hide in cash and short-term t-bills. I highly concur. What makes El-Erian credible is that over the past year he warned the Fed was moving far too slow on inflation and that they ran the risk of slamming on the brakes down the road. And he was right, because that is exactly what they are doing now. They are compounding their earlier mistake of easing for too long by making a larger mistake of tightening too quickly. At the beginning of this year, Goldman Sachs predicted four rate hikes for all of 2022. Now many people are calling for four (1/4 pt) rate hikes NEXT WEEK.

Not the least of which is Harvard dunce Larry Summers:

"Just a couple of days ago we were debating whether 50 or 75 would be sufficient,” he said. “100 bp would be perceived as a panic move.” 

Recall that the Fed panicked in June after the CPI report. They had been telegraphing a .5% move but after the shock CPI they did a .75% increase which sparked the beginning of the summer rally. No doubt many bulls are assuming the same thing could happen now.  

However, this time the set-up is substantially different. 

Peter Boockvar explains:

Sept. 13th, 2022:

"The next rate hike is going to be only the second time in 40 years that the Fed funds rate is going to exceed the prior peak in a rate hiking cycle"

“This 75 bps rate hike might even be a mistake. We know there’s a lag.”

One day later, Jeff Gundlach goes much further saying that these serial mega rate hikes are turning deflationary:

Sept. 14th, 2022:

"The action of the credit market is consistent with economic weakness and stock market trouble"

Gundlach now sees deflation — a fall in the overall level of prices — as the key threat to the economy and markets"

"Buy long-term Treasurys, because in spite of the fact that the narrative today is exactly the opposite the deflation risk is much higher today that it's been for the past two years"

Gundlach goes on to say he's not talking about next month, he's talking about next year.

I'm talking about NEXT WEEK because this is becoming a binary equation similar to 2015 and 2018. However, on 10x scale.

The world's richest man, Elon Musk is also now FIRMLY in the deflation camp as well. He has made it clear that business is slowing. 

"Impending deflation is neither subtle nor secret"

Of course this whole problem stems from the fact that the Fed uses lagging indicators to set interest rate policy. So just as last year the lagging indicators ignored soaring commodities and strong consumer, now this year the lagging indicators e.g. CPI, are ignoring crashing commodities and buckling consumer. 

Regardless, I only showed the above opinions to prove that the deflation theory is now going mainstream.

It doesn't matter what these pundits think the Fed should or will do next week because the damage is ALREADY done. Whether the Fed pivots sooner or later, they have ensured a depression at the zero bound. When they made the mistake of delaying rate hikes far too long, their only real option was to hike rates as quickly as possible before the economy and markets crashed. However, now they are trapped halfway in between the zero bound and normalization, in no bailout land. 

As we see in the chart below. 

Clearly, the Fed's other big mistake was totally ignoring the yield curve and the signals the bond market is sending. The inverted yield curve is saying that yes there is high inflation today, but the Fed has already tightened enough to bring it down in the future. Meanwhile, there were no recoveries in the past 50 years with less than a 5% Fed rate, EXCEPT the pandemic which included the largest fiscal expansion in U.S. history fully monetized by the largest QE in history. Neither of which is going to happen this time around. 

On an Emerging Markets basis this current set-up makes BOTH the 2015 and 2018 pivot scenarios look like a picnic. Which means that the binary "pivot" trigger of global market crash is closer than ever.

This is the definition of optimism:

In summary, the amount of hubris taking place right now is ludicrous. Investors have been conditioned by central banks to ignore all risk. And in turn investor complacency is now feeding back into central bank rate policy error. It's a hubristic death spiral.

An entire generation of NEW investors has known nothing but continuous monetary bailouts. They believe that recessions and bear markets are a relic of the past. So it's highly ironic that at the end of the cycle the Fed is removing all chance of a timely bailout.

I call it a "paradigm shaft"

 

Jim Cramer claims it's too late to sell. He believes the worst is already over. Many bearish pundits such as Jeff Gundlach are calling for a further 20% decline. However, even that is likely highly optimistic. Today's investors believe that a one month bear market corrected the longest bull market in U.S. history. If you measure the ratio of each bear market in months to the duration of the preceding bull market, this is the ratio you would see for the 2020 one month bear market relative to the 2009-2020 bull market:

It's clear now in hindsight with all of the late cycle indicators flashing red, that the pandemic was not a true bear market. It was merely the pullback prior to the final melt-up of the post-Lehman rally. A massive sugar rally fueled by unprecedented stimulus. 

Stimulus of such a magnitude that the Fed literally has no way out, other than to collapse markets and the economy.

And they lived happily ever after. 

GLOBAL LIQUIDITY COLLAPSE

Now that every investor is positioned for higher inflation, it's time for the totally unexpected deflationary financial "accident"...

Zerohedge/GS: "The CPI Doesn't Matter At All"

Sure.

It's clear that whoever writes this crap for Goldman Sachs was recently playing Dungeons & Dragons in their dorm room.  Then Zerohedge charges a premium to read it, which means the reader is paying twice: once for the bullshit, and twice for the failed trade.

The desperation on Wall Street is becoming palpable, as the pandemic pump and dump is turning into a major bust:

Not to say that ZH/GS are alone by any means in late cycle chicanery. It's now becoming clear that today's pundits were only "good" at predicting markets when central banks were guaranteeing a one way trip higher. Now that true price discovery has returned, they can't find their ass with both hands.

On the economy it gets far worse of course because the Fed is now being pushed into making a biblical magnitude policy error. They are using the 1970s demand-side playbook to deal with supply side inflation. 

Today we learned that real wages were FLAT in 2021:

So much for the wage-push inflation theory. Year over year wages flat. And the U.S. Federal deficit has fallen the most in history year over year. And the Fed is tightening the most on both ends in history: They've never simultaneously tightened on the short end and long end by this amount.

As I showed on Twitter recently, the Fed has tightened mortgage rates back to the level of 2008. However, rates rose from a much lower level and at a far greater pace. Whereas in 2007 era, rates rose from 5% to 6.5%. This time they rose from record low 2.5% to 6%. And they did it with home prices at record highs. 

What we are witnessing is extreme RATE SHOCK added on to extreme inflation shock:

Which is why the monthly supply of homes is increasing far faster than the last tightening cycle. Back then, the Fed raised rates by 4% the same amount they plan to raise rates this cycle. However, at the point the Fed stopped raising rates in 2007, the monthly supply of homes was lower than it is today.

And then it kept rising even as rates came DOWN. 

What this all points to is FINANCIAL inflation caused by a combination of asset bubbles and rampant corporate profiteering. Which is why the traditional inflation models are not working.

Therefore policy makers are making a huge mistake deja vu of September 2008 when they were solely focused on inflation. 

This CNBC article sums it up:

“This period of accelerating rate hikes that we’ve seen so far has impacted the real economy because it has squeezed the borrowing costs … for real people, real consumers,” 

“Whereas for Wall Street, money still remains cheap and leverage still remains high in the system, and the Fed’s book still remains just a touch under $9 trillion, which is double what it was going into the pandemic period, and since the financial crisis of 2008.”

Prins argued that by targeting wage inflation when wage rises are failing to keep pace with broader inflation was a mistake"

Yes, it's a huge mistake which is going to lead to deflation. This past week Elon Musk asserted that the Fed policy would be deflationary. Peter Schiff said it would be hyperinflationary. But he also admitted that it will first lead to a massive crash.

Clearly Schiff has never heard of Japan or China, both of which countries are further down the path of deflation than the U.S. Japan is easing at the zero bound and yet they have lower inflation than every other developed nation. Why? Excess capacity and consumer UNWILLINGNESS to borrow. Chinese consumers are just about done on the borrow to buy strategy. And the U.S. is NEXT. 

One could call this central bank induced liquidity collapse a "Black Swan" event, because it's clearly non-linear. However, ALL of the attendant risks are coalescing in broad daylight. So it will be hard to claim that no one saw it coming when Michael Burry has been pounding the table the hardest. Can you imagine these dolts ignoring the exact same guy who became famous calling the last exploding bubble? I can. 

Which gets us to the casino.

The market is no longer oversold. In fact it's as overbought as it was back in June which was the last time the CPI surprised everyone to the upside. As we recall that event took place the week before the FOMC and then the Fed decided over the weekend to upgrade their rate hike from .5% to .75%. A decision that was leaked via the Wall Street Journal. Markets crashed into the meeting. So it is that we find a similar dynamic taking place, with the risk of an accident having increased dramatically. Let's say to September 2008 levels. Fed futures now see a 35% chance of a full 1% rate hike at next week's meeting. 

In summary, the Volcker gambit is going to explode at the zero bound. Which will be highly deflationary when there is no adequate policy response to global meltdown. Bulls will be reliant upon the politics of the day, which are the most divisive in U.S. history. There is no incentive to bailout anyone this time around. 

It took 20 years for inflation to become fully entrenched by the 1970s. Throughout that time the U.S. middle class was ascendant with respect to quality of jobs and benefits. This era is NOTHING like that one. What investors are positioned for right now is the worst "inflation" since 1979. What they are about to receive is the worst deflation since 1929.

Hugh Hendry predicted investors would become addicted to monetary bailouts to the point at which they would create their own fictional market narratives, which he called "Imagined Realities". 

ENTER LEHMAN WEEK

Prior to Bernie Madoff's Ponzi scheme imploding in the Fall of 2008, a financial analyst named Harry Markopolos warned it was a Ponzi scheme. But, none of the investors would listen. Because they were fat and happy. Until it exploded...

Likewise, those of us who questioned the borrow-your-way-out-of-debt strategy were proven wrong by global central banks after 2008. Now however, global central banks are proving us right. It turns out that in a global Ponzi bubble, you only have to be right once. 

Before it explodes and makes everyone look like an idiot. 

When this year started, it looked like China would be the locus of risk for 2022. Their signature COVID ZERO policy was achieving its goal of collapsing growth down to ZERO percent. Meanwhile, China Evergrande - the world's most leveraged property developer was heading for bankruptcy. Subsequently, the entire Chinese real estate market has imploded, and Hong Kong stocks are trading at the lowest level since 2015. 

That risk was soon eclipsed by the Russian war in Ukraine which sent commodity prices sky-rocketing. Europe threatened to cutoff all energy imports from Russia, but they had no way of following through without causing self-imposed depression. All of that sanction posturing led Russia to pre-emptively cut off natural gas to Europe, THIS week. In the meantime, the ECB  has embarked on the most brutal tightening campaign in Euro history, culminating in a super sized .75% rate hike also THIS week. 

Not to be outdone by competitive idiocy, the U.S. entered 2022 as the tallest midget in the circus, but then the CPI skyrocketed and the Fed was forced to abruptly taper QE and begin rate hiking. In June they began Quantitative Tightening and the most aggressive rate hiking regimen since Volcker 1980. Subsequently, stocks entered bear market, GDP crashed, the housing market rolled over, and consumer sentiment hit an all time low.

Ironically, Japan has been the outlier country in 2022. As of this week they have the strongest MAJOR economy in the entire world, in Q2 registering a by comparison blistering 3.5% REAL growth rate. In addition, Japan's inflation rate is also the LOWEST of the major economies. Which is why it makes no sense that the Japanese Yen is trading at the lowest level since 1998. Except in the context of interest rate policy divergence from the U.S. Which is what global hot money traders are betting will continue forever.

We are one global overnight RISK OFF event away from hot money explosion circa 1998 LTCM.  

All of which gets us to this coming week - the anniversary of Lehman collapse in 2008. Then as now, policy-makers are totally concerned with inflation. Also, then as now there is RAMPANT recession denial. However, this time around the falling dominoes that are being ignored are not U.S. banks, they are entire countries.

Right on time, Michael Burry of 2008 Big Short fame was out this week with another warning of bubble collapse. He ticked off SPACs, Cryptos, Meme stocks and Ark ETFs as evidence of collapsing bubbles. However, those risks are CHUMP change compared to the real risks listed above. When this gong show explodes, no one is going to be talking about Gamestop. Which is why most U.S. investors don't see this coming - because even the bears are totally focused on U.S. markets. Whereas the greatest risks are taking place overseas.

Lehman week is bracketed by the two big central bank meetings - ECB and the Fed. This week, the ECB raised rates by .75% which means that AT MINIMUM this month will see 5x the monetary firepower that imploded markets in 2015 and 2018. Not including all of the other smaller central banks. AND not including U.S. QT ramping up to $95 billion this month.

There is one bullish argument that still holds water - which is that the market is relatively oversold. Which I agree, it IS oversold for a BULL market. But by bear market standards, it's not oversold at all. And by bull market standards, positioning is bearish. But by bear market standards, today's positioning is actually very bullish. If you don't believe me, just look at the Fed's own proprietary Financial Stress index which includes 18 different stock and bond market indicators of financial tightening:

https://files.stlouisfed.org/files/htdocs/publications/net/NETJan2010Appendix.pdf

In summary, entering Lehman week we are watching all of the risks of all of the past several economic meltdowns coalescing into one massive super clusterfuck. Bought with both hands by zombies on auto-pilot. 

  

OFFICIALLY, THE WORST CASE SCENARIO

What is taking place right now is officially the worst case scenario for markets and the economy. Sold to the public as a "soft landing"...

The multi-decade collapse in interest rates to the zero bound was driven by mass outsourcing, mass immigration, and of course mass automation which was accelerated by the infinite rate of return implied by "free money". This theory that record low interest rates could abide infinite valuations as the economy collapsed, will soon be viewed as one of the greatest  mass delusions in human history. After 2008, the patented borrow-your-way-out-of-debt crisis gambit worked so long as economic growth remained stagnant. 

Then, along came the pandemic at the end of the cycle which foiled the Fed's attempts to normalize interest rates for the first time in history. The pandemic forced the Fed to record ease into pandemic-exacerbated global supply chain bottlenecks. The worst case scenario for end of cycle normalization. In addition, pandemic fiscal stimulus programs drove up demand for durable goods as services collapsed. And then QE drove up asset prices into the largest asset bubble in world history.

Now, investors are trapped in what I call the Fed punishment zone. 

Why? For ignoring end of cycle risk, which came back with a vengeance as soon as the economy re-opened. 

Now it's all unwinding, however the decelerating rate of economic change has concealed the end of the cycle. Goldman Sachs said just this week that "soft landing" is STILL on the table. When the year started, Fed futures predicted four rate hikes for 2022, now they're predicting 16 rate hikes, but the soft landing is the same:

We are to believe that the longest cycle in U.S. history was corrected by the shortest recession in U.S. history - two months - featuring not only NO de-leveraging, but a massive increase in debt. The pandemic was the first time in history that corporate debt rose during a U.S. recession. 

Over the next two weeks amid incipient global meltdown, the ECB and Fed combined will attempt to raise interest rates by somewhere in the range of 1.5% (.75% each). This is 6x the amount of monetary firepower that exploded global markets in 2018 (Not including the Fed's double QT gambit).

It's a dumbfuck idea, in the tradition of ever-increasingly dumbfuck ideas.

Which means I'm all for it. 

Fortunately, for today's con men, by the time the public realizes this is all a massive con job, it will be far too late. 

Because as the first chart above clearly shows the NBER has an unbroken history of declaring recessions long after most of the stock market damage is already done. And that's just fine by Wall Street, because what else can they say when official confirmation arrives, but  it's too late to sell, you may as well ride this one out. 

Which explains how investors end up BURIED in the "valley of death" wherein returns are negative for years if not decades.

Any questions?

PREPARE FOR SYSTEM TEST

Gamblers are convinced it's different this time.

They're right, it's far worse...

Let's see, newbie gamblers piling into a bear market lured by Reddit-ordered pump and dump schemes. Peak Boomer retirement. Central banks correcting their massive over-easing error by massively over-tightening. Europe's Lehman Moment. China's Lehman Moment. Japan-U.S. largest monetary divergence since 1998. Tech bubble imploding, housing bubble imploding. Record low liquidity.

What's next? System test.

This coming week is all about Europe because Russia finally cut off natural gas supply and stated that it won't be coming back online. The nuclear option. 

Back in June, many pundits warned this would catalyze Europe's Lehman Moment:

June 23rd, 2022.

As we see in the bottom pane, in August German economic confidence was already the lowest since 2008, even before this latest gas cutoff. Now consider this chart in the context of an ECB STILL planning to raise interest rates on Thursday. 

It's totally ludicrous. 

 

This past weekend, in a very rare warning El-Erian told investors to get the hell out of these "distorted" markets.

"Stock and bond markets appear "distorted," meaning it's high time for investors to tweak their portfolios, according to Mohamed El-Erian... El-Erian's embrace of cash is somewhat contrarian, as historically high inflation is eroding the value of currencies"

Contrarian indeed. 

El-Erian's warning is far too little, too late. 

As we see above, the August AAII positioning report indicates that investors are far too over-loaded on stocks going into recession. This is because they believe the inflation hysteria and are convinced "Cash is trash". Which means the impending losses will be exorbitant.

As I showed on Twitter, investors are now in a bind between a Fed intentionally forcing recession and a Fed rate that is  currently nowhere near high enough to offset recession. In both 2000 and 2008, the Fed had to cut rates by 5% to forestall depression. However with the CPI far higher today, the Fed has no choice but to keep pushing rates higher. All of which means that the 2000/2008 -50% stock decline is now the best case scenario. It also happens to be the least likely scenario.

The most likely scenario is markets meltdown and a lack of stimulus at the zero bound.

Bailout failure means system failure. First and foremost because it portends extreme volatility and market dislocation. Secondly because it means that people will lose faith in the "system". They have poured their life savings into a dead end Ponzi scheme. As John Hussman constantly points out, at these levels of over-valuation, future returns are deeply negative years into the future. However, that's not how it happens in the real world. What really happens is that losses are "front loaded", after which forward returns become positive again. Once the masses panic out of the casino at the bottom. 

 "Prepare for an epic finale," Grantham said. "If history repeats, the play will once again be a Tragedy."

Zerohedge: In Order To Hit New Lows Markets Would Have to Do Something They've Never Done Before:

"The S&P has never set a lower low in any of the 13 post-World War II bear markets after recovering 50% of its peak-to-trough decline"

Pre-War World II. The most famous crash in history. 

 

Finally, investors will ask themselves the question ALL pundits should be asking right now - Why are WE different than Japan and China, who are already stuck at the zero bound? And the answer is because we're not.