The short answer is yes.
In the last 10 years not a single fundamental economic flaw has been fixed in the US, Europe, Japan, or China.
The Fed was behind the curve for years contributing to the bubble. Massive rounds of QE in the US, EU, and Japan created extreme equity and junk bond bubbles.
Trump’s tariffs are ill-founded as is Congressional spending wasted on war.
Potential Catalysts
- Junk Bond Bubble Bursting
- Equity Bubble Bursting
- Italy
- Tariffs
- Brexit
- Pensions
- Housing
- China
Many will blame the Fed. The Fed is surely to blame, but it is prior bubble-blowing policy, not rate hikes now that are the problem.
1. Junk Bonds
Many have labeled this an “everything bubble” which is not quite accurate. Yes, the Fed re-blew the housing bubble as well as an equity bubble. But the real standout is the bubble in junk bonds.
Companies are borrowing money to buy back shares at absurd valuations.
In the US, close to 15% of the companies in the S&P 500 only survive because they can roll over their debt. For discussion, please see Rise of the Zombie Corporations: Percentage Keeps Increasing, BIS Explains Why.
I expect a junk bond crash and that will take equities lower with it.
2. Equity Bubbles
Stock valuations are stretched almost beyond belief. The CAPE – Shiller PE was only surpassed by the DotCom bubble. The CAPE PE on October 3 when I last wrote about it was 33.49.
Meanwhile, Companies are Furiously Guide Earnings Estimates Lower.
There will be few places to hide. GMO Forecasts US Equity Losses for 7 Years.
We may not see a “crash” per se, but if not, then expect a slow bleed over many years, Japanese style.
In many ways, especially pension-related, a slow bleed will be worse than a crash. In a crash, there is often a sharp rebound, and one can use leverage. In a slowing declining setup, long leverage gets crushed.
3. Italy
Italy is Openly Defiant of Eurozone Stability Pact, Deliberately and Knowingly.
The ECB’s policy of “One Size Fits Germany” does not work now and never did.
The IMF says Italy has a currency that is 9% too high. Germany has a currency that is 11% too low. Since both are on the Euro, no matter what the ECB does, it is going to exacerbate one side of the problem or the other.
Meanwhile, Target2 imbalances mount.
Italy owes creditors nearly 500 billion euros, mostly to Germany. It is impossible for Italy to repay that debt.
In an unprecedented move, EU Rebukes Italy’s Budget: Italy Politely Says Screw You.
An Italy Eurozone exit looms. It will be accompanied by a currency crash.
4. Tariffs
Trump believes “trade wars are good and easy to win”. Smoot-Hawley strongly suggests otherwise.
In a letter to Trump, the Committee to Unleash Prosperity seeks zero tariffs. There were several notable letter signers.
Steve Forbes, Arthur Laffer, Fred Smith, and Stephen Moore on the Committee to Unleash Prosperity ask Trump to seize the high ground and give U.S. firms an advantage.
I discussed the letter in Forbes, Laffer ask Trump for Zero tariffs, Zero Subsidies, and Zero Barriers.
Tariffs are a tax on consumers and importers of usable goods such as steel. If China is subsidizing steel it is to the benefit of US manufacturers who use steel as well as consumers who pay lower prices for goods.
It is absolutely correct to reduce tariffs, regardless of what other nations do, on that basis alone.
Trump’s tariffs are staring to bite. Many US manufacturers are already complaining. Unfortunately, Trump is just getting started.
5. Brexit
Short-term, a hard Brexit will be bad all around. But long-term it will be bad only for the EU.
The German export machine depends on the UK far more than the other way around. Under a WTO, hard Brexit scenario, German exports are likely to crash. That will happen at a time when German de-industrialization is already underway dues to a shift to electric and self-driving vehicles.
Surplus countries get killed in these scenarios.
For discussion, please see Inevitable De-Industrialization of Europe.
European demographics are also exceptionally poor. Even a “soft Brexit” will be bad for Europe.
6. Pensions
US public pensions are woefully underfunded despite the historic ris in the stock market.
When the crash or prolonged slowdown happens, boomers expecting pension payments either will not get them, or there will be massive tax hikes.
Both options are economic poison.
7. Housing
It should now be pretty clear that housing has peaked this cycle: Existing Home Sales Drop 6th Consecutive Month
Yet, the Fed still has four more rate hikes penciled in.
I doubt those hikes happen. Regardless, a key economic driver is already on the skids.
8. China
China’s State Owned Enterprises (SOEs) are in huge financial trouble as is China’s export machine coinciding with Trump tariffs.
In 2007 conventional wisdom was that China would decouple from the global economy. It didn’t, as I stated well before the bust.
Today, conventional wisdom is the US will decouple from the global economy.
It won’t. Trump’s tariffs will exacerbate problems in China and the US.
What’s the Catalyst?
All of the above. Alternatively, none of the above.
It does not matter what the catalyst is actually. And there might not be any catalyst other than simple exhaustion: The pool of greater fools in stocks, bonds, and housing simply ran out.
Regardless, I expect all eight of the above discussion points to be in play when the crisis does hit.
Who Will Take the Blame?
A Recession is Coming. Who Will Take the blame?
Of course, nobody will volunteer to take any portion of the blame.
Yet, fingers will be pointing.
- Trump will blame the Fed for hiking too fast.
- The Fed will blame Trump for starting a trade war.
Scarcely anyone will blame fractional reserve lending, lack of a gold standard, Congressional stupidity, or central bank cheap money and their bubble blowing tactics.
It is a given that mainstream media will not remotely come close to pointing a finger in the proper direction.
Mentioned Articles In Order of Appearance
- Rise of the Zombie Corporations: Percentage Keeps Increasing, BIS Explains Why.
- Companies are Furiously Guide Earnings Estimates Lower
- GMO Forecasts US Equity Losses for 7 Years.
- Italy Openly Defiant of Eurozone Stability Pact, Deliberately and Knowingly
- One Size Fits Germany
- EU Rebukes Italy’s Budget: Italy Politely Says Screw You
- Forbes, Laffer ask Trump for Zero tariffs, Zero Subsidies, and Zero Barriers
- Inevitable De-Industrialization of Europe
- Existing Home Sales Drop 6th Consecutive Month
- A Recession is Coming. Who Will Take the blame?
Buy gold. A financial crisis, not just a recession, is on the horizon.
Mike “Mish” Shedlock
Dear Mish.
As we enter 2020, I’m sure I’m not the only reader who would appreciate an update.
Regards. Charlie
Mish, you seein’ double? Some double posts of paragraphs in your article. The Fed is to blame.
I vote for “Congressional stupidity”. The root of all stupid laws.
“It is a given that mainstream media will not remotely come close to pointing a finger in the proper direction.”
Yup! They will be busy yelling for the Powell put. The wall street cry babies have already started wailing even though NOTHING MUCH HAS HAPPENED… (
These guys just love to gorge on the money that simply flows from the Fed’s teats. Birds of the same feather flock together. Scoundrels!
this link went missing in the above post… (
When was it that you called the top, Mish? 2014?
Nobody’s perfect, least of all you.
Crashes are systemic and the ONLY outcome every time.
It can’t possibly be good for Germany and China to be subsidizing their exports. Tariffs aren’t the problem; easy money is.
Of course the Fed is to blame coming and going. AND Alan G blew up the dot coms as much as AOL did with a pe of 400.
When it begins to really hurt expect some sort of debt jubilee else the debt will be a weight around global economy’s neck for very many years. Recovery will take ages otherwise.
With a jubilee other changes will occur.
I just wonder who/how to be on the right side of it. Possibly through gold but I don’t trust tptb not to somehow find a way to limit gold repricing upwards.
I have been hearing more and more that a debt jubilee will occur in order to wipeout the unpayable debt of govts. No one has ever postulated the details of this. I don’t see how this is possible without wiping out creditors who hold govt debt. This would be include individuals, other govts., pensions and municipalites among a lot of otheres. The damage would be catastrophic leaving many promises like pensions, social securty etc unpayable. I don’t see how this could solve anything.
Wrong again. The 8 reasons you sight are all the result of govt largess, and the UNWILLINGNESS of govt to go on a diet, which is “forcing” them to get increasingly totalitarian in going after other peoples money. This is the driver behind the anti-establishment movements around the world … and it will get worse.
The source of the economic reset will be a rising dollar and rising rates, which will impact the rest of the world first. Sadly to say, their career politicians are more corrupt and favor Marxist policies more than ours.
To say “Congressional stupidity” is partially to blame is like saying Jeffrey Dahmer had an eating disorder. It’s not stupidity if you intentionally deceive, and commit fraud and corruption to line your own pockets. If you want to place blame, look no further than the career politician. Short term-limits is the necessary first step for real reforms.
Do central banks exist in your world? Got news for you- governments and corporations alike dance to their beat. Sure, there are a lot of bad actors out there in the public/private sectors, but bankers call the shots and everyone else can only react. The last constraints on banks were severed about 20 years ago and they are accountable only to themselves.
Politicians have never mattered less than they do now, a trend that will continue at least until the whole Ponzi falls. The entire country could rally together under the red or blue emblem, the ship would still founder.
Banksters, politicians, and anyone else that thinks they can manage or manipulate the economy will once again be shown they are no match for the invisible hand and mother nature. If banksters call the shots, why do they fail so often (i.e. Hitlary lost).
Yes, I should have said CAPE PE – Thanks
The real solution is to strip the fed of all of its mandates and delegate their only function to being the lender of last resort to prevent a liquidity crisis. They have no business setting interest rates or anything else based on their “theoretical models” they learned about in their ivory towers. Recessions, crashes ,and depression self clear a lot quicker without those idiots at the fed trying to help their Manhatten friends get richer. The free market will clear any the detritus resulting from the crash quite well on its own and a lot quicker. This happened in 1923 as an example. James Grant wrote a book about it.
“The real solution is to strip the fed of all of its mandates and delegate their only function to being the lender of last resort to prevent a liquidity crisis.”
And then, one minute at most later, to strip them of that function as well.
There is no difference between a “liquidity” and a solvency “crisis.” All that is just newspeak. If you can’t pay your bills, you are insolvent. Having some progressive halfwit opine that “I deem A, unlike B, will somehow become solvent again sometime in the future, so “we” (never me with my own money at risk) should bail him out….” After all, that’s what A’s lobbyist told me, and stuff…
Also, a “financial crises” is not a crises at all. It’s a complete nonevent in and of itself. A farm going bankrupt doesn’t cause wheat to stop growing. Nor tractors from working. Nor farmers from knowing how to harvest. Ditto bankrupt oil drillers and anyone else.
The only real effects, are frictional. Drag induced by slow, expensive and inefficient bankruptcy processes. Instead of worrying about imaginary, or at a minimum irrelevant, hobgoblins; focus on reducing the time, cost and uncertainties introduced by BK processes. Then sit back and let nonevents like “financial crises” be nonevents like “financial crises.” Farms will continue to produce food, drillers oil etc. Just under different ownership.
Actually I am not sure if you know what I am referring to. When your bank runs out of money during a run or crisis, because it only keeps about 10% on hand would you prefer they just tell you to stick it? And then the rest of the banks also will start to get bank runs. I guess thats to bad for the rest also. What the fed is supposed to do is take the banks collateral in return for cash to provide money for the depositors who are panicking. To strip them of that function is stupid to say the least.
Why you say “forward P/E” when referring to CAPE? That’s a backward P/E.
The PE ratio is a function of three things. Those three things are the interest rate, the market risk premium (stocks are riskier than bonds, and should provide a higher expected return), and the expected growth rate. If inflation rises, the interest rate will follow, driving down the PE ratio. If the growth rate declines, that will also drive down the PE ratio.
What Realist doesn’t seem to realize is that, in the scenario he describes in his post below, with the growth rate declining from 4% to 1%, the result will not be that stocks appreciate at 1% rather than 4%. Rather, in times of increasing growth rate, stocks appreciate much faster than growth (as we have just experienced) because the PE expands while earnings expand. Conversely, in times when the growth rate is falling, even though earnings continue to rise, the PE contracts, and stocks fall even as earnings rise. If the overall economic growth rate falls to 1% from 4%, as Realist predicts, that will cause the PE rate to drop by 1/3. A 33% decline in the PE ratio over 10 years implies a stock market that falls 3% a year for a decade. If interest rates return to historical norms, the decline will be even greater.
The point Mish may miss is that the CAPE PE ratio is not independent of other factors. The current PE of 34 is not an inexplicable bubble. The high PE right now is to be expected because the interest rate is low, and the growth rate is high. While it is true that the CAPE PE typically falls back to historical norms over time, it doesn’t get there via random behavior. Interest rates will not remain low forever, and GDP growth will not remain at 4% forever. As interest rates rise, and as the economic growth rate falls, the PE ratio will behave in a normal fashion and fall as well.
So long as interest remains low, and growth remains high, the current stock prices can continue to rise. Mish seems to believe rates will remain low, and that is quite possible, and if they remain low, it will continue to support high stock prices. On the other hand, continued growth at 4% seems unlikely, and if it drops to the 2.5% range, that will take about 15% off the market.
The trailing P/e ratio is 22. Moreover, I’ve seen analysis that if you remove the FAANG stocks the P/E ratio of the remaining 495 stocks is about 20% lower. So, a P/E ratio around 18 really isn’t that high.
So what you’re saying is “except for over-valued stocks, stocks are fairly valued.”
Pretty much, that’s called value investing.
And after the crash there will be calls to restrict stock buybacks because the corporations didn’t do what they were supposed to do with the low interest money the fed put out on the street. “We’re going to keep doing this until you get it right!”
No doubt. The companies didn’t do the “right” stock buybacks. Just like Lenin, Stalin, Mao, Chavez…. and all other who have ever tried, didn’t do the “right” socialism…
But printing money and socialism is really good….
And we’ll have a split legislative branch that will be paralyzed to do anything. The house will vote to impeach Trump, the senate won’t. And that’s the only thing that will happen in 2019-2020.