The last two days of last week saw a drop in the Dow of nearly 500 points.
Pundits said it had to do with China…or the Federal Reserve’s upcoming tapering…or bad labour reports…or a slowdown in capital spending…the drop in foreign trade – take your pick.
Does this mean the bull market is over? Is it time to sell stocks? Or should we buy the dip?
We never know what markets will do next. And now, we are in a particularly troubling place. Never before in the history of the world have markets and economies been the subjects of so much experimentation and innovation.
And now every price is manipulated, artificial. We live in a bubble, where nothing is quite what it seems. Trying to fashion a coherent economic view or an enlightened investment strategy has never been so difficult.
And remember, no paper currency has ever survived a complete credit cycle. What will happen to the un-backed dollar when interest rates go back to ‘normal’ levels? We don’t know. But when it comes, we doubt you will be happy holding a large portfolio of stocks and bonds.
What will happen next? We’ve tried to figure it out. Inflation? Deflation? Hyperinflation? Boom? Bust? Bubble? Our guess is that we will see all those things…in good time.
In the meantime, not having much to guide us, we fall back on the old formulae. ‘Buy low, sell high’, for example. So forget buying the dip. US stock prices would have to be almost cut in half before they were cheap.
And as for selling, that is what you should have done last week, last month, last year…or whenever was the last time we recommended it. Still, it’s not too late. This market could go a lot lower.
Here is all we know:
First, the price of debt and equity in the US (and most major economies) will have to come down sooner or later. To make a long story short, today’s asset prices depend on real growth rates that haven’t existed since the early ’80s.
Second, when asset prices begin to fall seriously, talk of ‘taper’ will come to an end. The Fed has broken the stock and bond markets. Now, it owns it. Its meddling caused a big run-up in prices.
The ‘wealth effect’ – caused by rising asset prices – is the only thing keeping the economy from slipping back into recession. If the Fed stops meddling, prices will go back down to where they ‘ought’ to be. The ‘poverty effect’ will be even more unhappy than the ‘wealth effect’ was pleasant. Janet Yellen won’t permit that. She will add stimulus, not remove it.
But we will have to wait to see how this little sell-off develops. Keep an eye on prices this week!
for The Daily Reckoning Australia