US stocks dropped last week after news broke that someone shot down a Malaysian passenger airplane over eastern Ukraine. Then came the report that Israel had ordered a ground assault on Gaza.
The Dow lost 161 points. Gold shot up $17 an ounce.
This came only days after the Princess of Peace, Janet Yellen, assured investors that most stocks were fairly priced.
We don’t doubt that she was right. Prices are set by willing buyers and sellers, operating on the basis of what they know at the time.
What they knew the day before was that Yellen had their backs. The next day, they weren’t so sure.
Today’s another matter…
Swinging Both Ways
Fair — in the context of market prices — has nothing to do with it.
Mr. Market goeth whither he wouldst…given the facts on the ground and the theories in the air.
The important questions: Does Mr. Market intend to take prices down now? Can Yellen manipulate them higher faster than he can push them down?
Helpful as always, we have no answer to either question.
Instead, we have something more important to tell you. It’s an instinct, an intuition and an observation: Prices always go both ways.
No, we are not revealing any deep market secret. Nor any special insight into the world’s crises. We are just observing that trouble comes when it is needed.
Markets can’t go in only one direction forever. Sooner or later, they need a reason to turn around.
Here’s another important insight: The longer the trouble is held off, the more trouble there is waiting to express itself.
US stock prices and corporate earnings are near all-time highs. Those two facts seem to click. But they warn us too: Lows follow highs.
A Crowded Theatre
Debt is at all time highs, too. And the cost of capital — expressed as interest rates — is at an all-time low.
Something is clearly wrong. Debt is always and everywhere a worry and a threat. It must be repaid. The more of it there is outstanding, the more cause for worry.
Who won’t be able to pay? And if he doesn’t pay, will his creditors still be solvent? What if the currency goes down? What if inflation goes up? Debt raises questions…and makes the financial system fragile.
As the quantity of debt increases, in other words, the quality should go the opposite direction. It doesn’t make sense for the amount of debt to increase as the price of it increases, too. It is contrary to the most basic law of supply and demand.
And yet, the price of debt went up…even as the supply of debt worldwide reaches epochal levels.
At the margin, worried investors turned away from equities for the security of the fixed-income market. But what security could there be in the most crowded theatre of all time? There was just a hint of smoke in the air. What will happen when a fire really breaks out?
The Federal Reserve measures the ‘stress’ in the system. Its readings show that there is less stress in the system now than at any time since 2007!
We don’t know when we will begin laughing at the Fed’s stress test again. But we do know that it will happen. It always does.
The stock market goes down. The bond market goes down. All Hell breaks loose.
And guess what?
The longer Hell hath been restrained the more furious are the little devils when the gates open and pandemonium begins.
for The Daily Reckoning Australia