The last time the stock market crashed it wasn’t to do with stock values, or results or overheated p/e’s or glory stocks falling from the skies.
It wasn’t anything to do with stocks and shares at all.
The stock market crashed because the debt markets froze.
This debt crisis roiled all the other markets because debt is senior in market terms to equity.
To rephrase an old saying: “when debt catches cold, equity get pneumonia.”
There is likely no major corporation that could survive if it couldn’t roll its debt. Debt is the oxygen corporations breath.
That apart, to look at dangerous markets ahead, we shouldn’t be looking at companies at all we should be looking at the health of the debt markets.
I have been a bear for over a year and have reached the conclusion that we could be in for an equity bubble before we are in for a slump.
The markets are expensaive and that makes it hard for a value investor to play, but if we are in for a bubble, moaning about value is not going to get you far, in fact you can easily be left high and dry, just another poor failed prophet moaning it isn’t fair and that it is against all things good that braver folk are building their wealth on the back of a financial sacrilege.
You just have to suck it up, go long and watch your back.
The 800lb Gorilla in the coal mine has to be the bond market.
The bond market is a messy place right now and in a way that is to be expected.
Governments in the US, Europe and Japan have been buying them up out of the market to keep interest rates low and to keep cash flowing around the sclerotic veins of the first worlds economic system. Europe is the latest economic superpower to be pumping the QE transfusion through its banking veins.
This keeps bond price up and interest rates low. However at the high risk end of bonds, the boom days are over and there is a lack of demand for junk debt. Holders want to get out of junk and to get in to higher quality debt. This is pushing up quality debt values but it is hardly reassuring for the debt market as a whole.
Meanwhile a lot of institutions need to park their money in safe treasuries for all sorts of technical and practical reasons and the tight supply created by various QEs is driving prices.
It is ironic that national debts aren’t big enough to satisfy the thirst of financial institutions for national debts. The system itself has created what might be a chronic toxic dependency.
Yet just over the horizon, US interest rates are going up and so are the UK’s, so the central banks say. This is a counteracting force.
Central banks have cornered the markets and now have to reverse the situation.
That’s going to be messy.
In Europe QE is having a faster impact than the QE of the US. Europe is not a trade deficit zone, so the cash is staying in the system and seems to be about to drive the prayed for inflation. As such the Euro has stopped falling and reversed. European QE might not be as long needed or long lived as expected.
Just to confuse the picture more, if Greece goes for the Euro Grexit, the Euro will strengthen. With the dog of Europe back to its old inflation wracked funny money, the Euro will look stronger and more Deutsche Mark like. It will deliver a huge message to Italy and Spain, as Greece and it public sector implode, not to mess with the Euro. This strength could undo the QE. So Greece is a wild card to look out for.
However these factors could have been considered for months now and many people have run up red warning flags suggesting the debt markets could come off the rails.
They simply haven’t.
Interest rates will go up.
They didn’t.
The trend in debt has been dow and down in a straight line.
Rule one of speculating is: don’t mess with an emphatic trend.
10 year bond rates have been as clear as the nose on Pinocchio’s face.
Up till a couple of weeks ago.
They’ve reversed.
Interest rates have surged in the 10 year bonds of the west. The trend is very clearly broken.
This is a signal to watch very closely indeed.
All hell broke loose in the debt markets mid-2007 which was roughly 6 months before the peak of the equity market and nearly a year before the stock market went into freefall because of it.
There maybe a stock market bubble ahead, but as you step on the gas keep one eye on bonds, because if they rip, then things are going to get messy for stocks too.