September 13, 2018

If Stocks Catch a Whiff of This, We're In For Serious Trouble

Something has changed in the market.

And it's not good.

The momentum-driven rally that pushed stocks to new all-time highs completely floundered a few weeks ago.

What should have been a monster breakout on massive buying power ended up being a feeble push to new highs before stocks promptly rolled over.

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More and more, that is looking like a false breakout.

This opens the door to a SHARP correction downwards. The first major line of support is just below 2,800 at 2,780.

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That is the GOOD outcome. The BAD one is if US stocks finally get contaminated with what the rest of the world is currently facing= a full-scale meltdown. If the US goes the same route as China, the Emerging Markets, industrial metals, and other growth-related asset classes, the S&P 500 could easily collapse to sub-2,500.

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Continuing with our theme of the last two days, the big issue today is not stocks, but bonds.

The bond market is the de facto backstop for the current financial system. The yields on bonds, particularly, sovereign bonds, represent the risk-free rate of return: the rate against which all risk assets (stocks, commodities, etc.) are priced.

For this reason, when the Fed and other Central banks worked to corner the sovereign bond markets in the aftermath of the 2008 Crisis, they were effectively creating a bubble in THE senior-most asset class on the planet.

When sovereign bonds go into a bubble, EVERYTHING follows.

Which is why the fact that sovereign bond yields are now rising around the globe, is a serious issue.

Because if these bond yields continue to rise… countries will find it more difficult to service their debt.

That, in of itself, is a big problem. But when you add in the fact that most countries are already running fiscal deficits when bond yields were at historic lows… the potential for a crisis arises.

A fiscal deficit occurs a country spends more money than it collects via taxes. In order to finance a deficit, a country turns to the bond markets.

And a country is already running a deficit when bond yields are at historic lows… one can imagine just how massive the deficit will be once yields are rising.

Which brings us to today.

Globally bond yields are rising for most developed nations.

Here’s Germany’s 10-Year Government Bond yield:

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Here’s the US’s 10-year Treasury yield:

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Even Japan’s 10-Year Government Bond, which is actively managed by the Bank of Japan, has begun to breakout.

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Yesterday’s piece generated a lot of interest, so we’re going to develop this theme some more.

The key item of note is that while US stocks are holding up, the Fed’s hawkishness has already blown up much of the global financial system. In particular, Emerging Market Stocks have already entered full-blown bear markets.

That’s the GOOD news.

The bad news is that the global debt bubble is in the process of bursting.

Quietly, and with few noticing it, sovereign bond yields have broken out of their long-term downtrends.

This is a massive deal... because it is BOND markets, NOT stocks that determine true systemic risk.

When a stock market breaks down, investors lose money.

When the bond market breaks down... entire countries go broke.

We are already seeing this happen on the periphery of the bond market with countries like Argentina and Turkey... but eventually this mess will spread to developed nations.

Best Regards.

Deo Talaverano.

Chief Market Strategist DHF.

George Town. Cayman Islands.