"We’re Raising the Crash Flag"
By Bill Bonner
YOUGHAL, IRELAND – "Shhh…! Take off your shoes. Walk on tiptoe. Be quiet. In front of us lies inflation. It hasn’t moved for years – rising only about 1.5%-2% – despite all the prodding from the feds. The Fed tried to shock it awake with $3.6 trillion in stimulus money. And Congress hit it with more than $10 trillion in deficit spending stimulus over the last 10 years. But… nothing. Not a whimper. Not a twitch.
Greasing the Wheels: And the authorities are deeply concerned. Here’s Peter Coy, at Bloomberg, explaining why: "While five-digit, Venezuelan-grade inflation is destructive, a little bit greases the wheels of commerce. It makes it easier for companies to give stealth pay cuts to underperformers, because keeping their pay flat is tantamount to a reduction in real wages. Some inflation is also useful to central banks because it helps them fight recessions. To spur borrowing, they like to cut their policy rates to well below the rate of inflation. But they have no room to do so if the rate is barely above zero. A surprise decline in inflation also punishes borrowers by making their debts more burdensome."
Yes, the feds, the professors, the politicians (including Donald Trump), and the business elite all think the same thing – that a little inflation is a good thing. They worry now that there may not be enough of it. That fear was ably expressed in Bloomberg’s Businessweek (BW) with what might become another landmark cover story, the kind you remember for many years, and laugh at each time it’s mentioned. “Is Inflation Dead?” is the headline. It immediately reminded us of the famous Businessweek cover from 1979 – “The Death of Equities.” That cover turned out to be excellent timing – for contrarians.
Equities had been in a bear market for the previous 14 years. And inflation had been going up. The geniuses at BW could only imagine that the two trends would last forever. And thus, within months, began one of the biggest turnarounds in market history. Stocks, as measured by the Dow, went up more than 1,000% over the next 20 years. Inflation went down.
Firing on All Cylinders: Here at the Diary, we keep track in gold… and time. In gold terms, you could have bought the entire 30 Dow stocks for 3 ounces of gold when that BW cover story was printed. Today, you’ll need 20 ounces. In other words, stocks are nearly seven times more valuable.
We missed much of that increase. Our model tells us to sell stocks when the Dow/gold ratio goes over 15 – which it did in 1996. Since then, it has never come down low enough to trigger our buy signal, which is a Dow/gold ratio of 5. So for the last 23 years, we have sat – comfortably – on our little pile of gold coins. [New readers can catch up on our Dow/gold indicator by going here.]
But yesterday, stocks hit a new high on the S&P 500 and the Nasdaq. Commentators this morning are out in force, explaining how the economy is “firing on all cylinders”… and how “inflation shows no sign of picking up”… and that “all that money that has been on the sidelines since last fall is now coming back into the market.” Pundits now believe inflation is dead and the bull market in stocks will live forever. Our guess is that they are wrong about both.
Doom Index: According to Dow Theory, new highs tell you that the “primary trend” is up. But, it must be a new high on the Dow, not the S&P, and it must be confirmed by a new high on the Transportation Average Index. Transports – railcars, trucks, ships – tell us that the real economy is not only producing goods, but delivering them.
Neither the Dow nor the Transports are at new highs. The Dow is only off by a few points, but the Transports are not even close. And while the blah-blah on CNBC celebrates the new highs, our own research team is sending an entirely different message.
Head of Research, Joe Withrow: "This is it. The Doom Index just hit 8 – triggering the tattered crash flag. As we covered in our crash alert earlier this month, our indicators suggest that the great bull market of 2009-2018/2019 is coming to an end.
To be clear, this doesn’t mean we will see a market crash tomorrow… or next week… or even next month. That’s because nobody can perfectly time tops and bottoms… Not even our vaunted Doom Index. As the old Austrian economist Friedrich Hayek demonstrated way back in 1945, information is dispersed throughout society.
What is known by any single entity is only a small fraction of the sum of knowledge held by all members of society… That’s why no single person or institution can have all the answers. That said, we built the Doom Index to monitor the financial and economic indicators that give us an early warning of trouble ahead. We designed it to tell us when conditions are ripe for a crash, supported by back-tests of the previous two market crashes in 2001 and 2008. And now, the Doom Index says conditions are ripe."
Businessweek was wrong in 1979. Stocks weren’t dead. They’ve been going up – with only short interruptions – for the last 39 years. Meanwhile, inflation has been going down… and seems moribund. Lifeless. And now BW says inflation is dead. Is it wrong again? Most likely.
Which is why we’re whispering. Shhh… Neither stock crashes, nor inflation is dead. They are just resting, like bears in hibernation, sleeping in a cave. When they will wake up, we don’t know. But they are sure to be hungry."
"Doom Index Update: We/re Raising The Crash Flag"
By Joe Withrow, Head of Research, Bonner & Partners
"It is time to raise the Crash Flag… As Bill reported above, the Doom Index hit “8” this quarter – signaling that conditions are ripe for a market crash. Remember, the Doom Index is a proprietary early warning system. It monitors important financial and economic indicators to let us know when the economy and U.S. stocks are in danger. For a full description, go here.
As we showed you recently, cracks are forming in the credit markets… The stock market is stretched to the upside… And economic strength appears to have peaked last year. Today, we’ll break down the indicators that pushed the Doom Index over the line.
Credit Indicators: In the credit markets, we have seen a greater ratio of corporate bond downgrades (compared to upgrades) this quarter than in any other quarter since Q2 2009… when the dust from the financial crisis began to settle.
A total of 297 bonds have been downgraded so far, compared to only 139 upgrades. And junk bonds appear to have topped out way back in 2013. They have caught a small bid since the start of this year… But they are still trading well below their post-crisis highs.
Plus, we are staring down a $1 trillion junk bond tsunami that’s about to make landfall. Remember, “junk bonds” are non-investment-grade bonds. The companies that issue these bonds are on shakier financial ground than companies that offer “investment-grade” bonds.
By dropping interest rates to zero and keeping them there for nearly a decade, the Federal Reserve enabled shaky companies to go on a trillion-dollar debt binge. There’s no way those companies could have accessed $1 trillion worth of credit in a normal interest rate environment… And now the bill is coming due.
One-trillion dollars worth of junk bonds will mature over the next five years. But there’s no way these companies can pay their $1 trillion debt wall off in full… which means they will need to secure favorable refinancing terms or declare bankruptcy. And as our corporate bond upgrade/downgrade indicator is telling us, these junk bonds are getting even junkier. That spells trouble…
Main Street Indicators: Looking at the Main Street economy… The ISM Manufacturing Index, which broadly measures manufacturing activity, dropped another 3% this quarter. It’s now plunged 16% over the last 14 months. That suggests Main Street is slowing down.
Confirming the slow-down, railcar utilization – which simply tells us that finished goods are being shipped and transported – fell 6% this quarter. It’s now dropped 12% since the third quarter of last year.
What’s more, total nonfarm payrolls dropped more this quarter than in any other quarter on record going back to 1998… which is when we started our back-tests for the Doom Index.
And the data on building permits that just came out this week showed a sharp decline. In fact, most of the quarterly housing data suggests weakness on Main Street.
Simply put, the metrics we think are important all point to a slowing economy.
Storm Is Brewing: Then if you look at the stock market, the snapback rally we’ve seen since Christmas Eve has brought stocks right back up to their previous highs. By the three traditional valuation methods we track – the Shiller PE Ratio, Total Market Cap-to-GDP (Buffett Indicator), and Tobin’s Q Ratio – stocks are more overvalued today than they were in 2007… And margin debt – money borrowed so investors can buy stocks – is now higher than where it was in 2007, as well.
To sum it up, a perfect storm appears to be brewing. So, be warned. The Doom Index has triggered our crash alert, and the Crash Flag shall fly again. But remember, this doesn’t mean the crash will come tomorrow. It could… But we can’t know for sure. In fact, in our 2007 back-tests, the Doom Index hit 8 about a month before the stock market peaked. And it took five quarters for the biggest part of the 2008 crash to hit. We were early.
So, it would not be prudent to liquidate your entire portfolio immediately. Instead, we recommend you take stock of your positions and make sure you have a clear exit strategy in place. In most cases, that means you need to know what your stop loss is for each position and be prepared to sell the next day if any position closes below your stop. That’s how you protect your bull market gains and preserve capital to invest at the bottom of the coming bear market. It will likely be a doozy. Oh, and make sure you own plenty of gold. Gold has preserved wealth for centuries.
Then, as Bill would say, all that’s left to do is love your family… pet your dog… and enjoy the absurdity of the public spectacle that is sure to come…"