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Stock Market in the Cross of Fire and Fury - FINANCIAL-24

By David Haggith, The Great Recession Blog

August is a sultry month for stocks as markets thin out during the dog days of summer. Everyone leaves investing for a break from the heat. Statistically, August is the worst month for overall stock performance, while September delivers more of whatever August sends its way or brings its own dark surprises. After that, October loves a surprise and is the worst for having the most major crashes.

As markets now slide into their toughest time of the year, they also also face a major war of words that may quickly become more than words. The days of market calm appear now to have ended. $500 billion worth of supposed US market “value” just cascaded into oblivion last week. (Over a trillion worldwide. Of course, it could reappear tomorrow.)

Markets crawling under the clouds of war

One place where August is living up to its reputation is in volatility. August is usually the most volatile month of the year.

The US stock market’s volatility index (VIX) became eerily placid for many weeks this summer, but this past week the VIX rose 70%. Of course 70% from a position so small and calm is not a lot, but it’s an awakening. And there appear to be many people and institutions now awakening.

PIMCO, as one big example, began loading up on puts to hedge against a market plunge while building up a strong cash position, suspecting the highly unusual calm is the kind that comes before a big storm. PIMCO’s chief investment officer said that Pimco “has been taking profits [a nice way to say selling off its stock holdings] in high-valued corporate credits and built cash balances for when better opportunities arise.” That’s also a cautious way of saying,

“We’re getting liquidity higher,” Ivascyn told Reuters in a phone interview. “If we see actual military altercation, markets can go a lot lower. And at the same time, volatility has been so low for so long that it doesn’t take much for markets to get worked up.” The PIMCO CIO said that although the market has yet to panic, “you will certainly see panic if all of this turns into a sustained military encounter.” (Zero Hedge)

So, not everyone in high places sees the market’s languor as good. Now, under the clouds of war with North Korea, the calm is giving way.

Trade war with China on horizon

Not all wars that can damage an economy or a stock market involve weapons of mass destruction. While Trump and Kim Jong-Un are going nuclear with their rhetoric as well as their actual war footing (“Military solutions are now firmly in place … our nuclear arsenal … now far stronger and more powerful than ever before,” Trump tweeted), Trump has also declared trade war on China, saying such a war will be launched in a week.

As if there weren’t enough geopolitical and social stress points in the world to fill a lifetime of “sleepy, vacationy” Augusts, late on Friday night President Trump spoke to Chinese President Xi Jinping and told him that he’s preparing to order an investigation into Chinese trade practices next week, according to NBC. Politico confirms that Trump is ready to launch a new trade crackdown on China next week…. It is also an escalation which most analysts agree will launch a trade war between Washington and Beijing…. Should Trump follow through, the move will lay the groundwork for Trump to impose tariffs against Chinese imports, which will mark a significant escalation in his efforts to reshape the trade relationship between the world’s two largest economies. In other words, even if there is now conventional war announced with either North Korea or Venezuela, Trump’s next step is to launch a trade war against China. (Zero Hedge)

The near inevitability of both wars

Both wars may be next to inevitable and were certainly not unforeseeable (black swans) when I said the economy would crash this summer. They are those dark clouds among a whole horizon of storm clouds that I’ve been pointing out — the clouds that I’ve been saying have been growing closer to us and would be here by summer, making a summer economic storm almost inevitable, too.

The US government under Obama refused to take military actions against North Korea while it was becoming a nuclear power, so now North Korea is a nuclear power. Surprise! Not really. Who couldn’t see this coming for more than a decade? The now globally known reality forces the US to a worse conundrum — wage a war with an unstable nuclear nation run by a lunatic or let an unstable nuclear power with an insane leader achieve a great deal more nuclear capability. (Some might wonder which nation I’m speaking of.) That’s what inaction on tough problems for too long brings you — worse problems. The US kicked the can down the road when there was no real threat of nuclear retaliation; so, now there is a clear and credible threat of nuclear retaliation.

The same is true with Chinese trade. The US government under Obama turned a blind eye to Chinese trade practices that fly in the face of truly “fair trade,” again kicking the can down the road for years, rather than confronting the problem head on. So, now the US faces the risk of starting a trade war at a time when it may be starting a military war, which means at a time when it needs China to remain neutral with respect to North Korea if there is a war or to be an ally in getting North Korea to change (an unlikely prospect). Congress and Obama kicked the can down the road with respect to needed US economic reforms, Korean nuclear armament, and resolution of unfair Chinese trade practices, always preferring to “talk about it,” and each problem has only become far harder to solve.

That, of course, is what I claimed would happen when I started writing The Great Recession Blog: all of the government’s weak-kneed, temporary solutions would push the nation’s economic problems ahead, making them much harder to face in the future. That future is here.

President Trump, Secretary of State Tillerson and Defense Secretary Mattis have all made it clear that a nuclear-armed North Korea with ICBMs that can hit the United States will not be allowed. If North Korea persists, this means war with the U.S. There’s only one problem: North Korea thinks we’re bluffing. North Korea believes that the U.S. is bluffing based in part on the prior failures of the U.S. to back up “red line” declarations in Syria over its alleged use of chemical weapons. Their belief is also based on the horrendous damage that would be inflicted on South Korea. China also believes the U.S. is bluffing. (–Jim Rickards in The Daily Reckoning)

They probably do … after years of just talking about it or applying a smattering of half-hearted sanctions that were largely ignored by China.

This is how wars begin: not because anyone wants a war, but because two sides misread each other’s intentions and stumble into one. Make no mistake — Trump is not bluffing. He’s deadly serious about ending the threat from North Korea. And he has support within the national security community.

Trump probably is not bluffing when he threatens “fire and fury like the world has never seen.” If he is bluffing and tries to back away, the military industrial complex will tie a knot in his tail to keep him moving forward; but I think they have already fully won him over.

Said Nikki Haley, the US Ambassador to the UN, “The time for talk is over.”

Flatly stated.

North Korea’s response to all this last week was to telegraph to the US its intentions to shoot nuclear-capable missiles over the heads of people in Guam. If it does so, is there anyone who believes the US military (or president) will wait to see if the missiles are armed or if they change course downward once they are over guam?

As a number of writers noted last week, this is Trump’s Cuban Missile Crisis.

A war of words

Markets have not priced in war, but they are starting to now, and now they will have to price in congressional war, too, as congress returns from its summer vacation and starts fighting over the debt ceiling, which is thought to be a greater battle than Obamacare. Some prognosticators, like David Stockman, have been saying for months that congress will end up in an inevitable stalemate over the debt ceiling, leading to a full-on credit crisis.

Maybe so, but Republicans have created such stalemates before in the form of government shutdowns and brinksmanship over the debt ceiling, and they might remember it didn’t turn out well for them the last time they created a situation that caused credit agencies to question their resolve to pay the nation’s debts. The nation was not terribly pleased with the resulting credit downgrade, and the market fell off a cliff exactly when I said it would, saved only by the Federal Reserve’s announcement of much more stimulus. As I noted in what seems now like many years ago, the US credit rating would be downgraded because, even though congress knew it wouldn’t take the nation over the cliff of default, no one else knew congress wouldn’t go that far.

More than likely, congress will find a way to kick the can down the road with some stop-gap, ill-conceived measures, as they’ve done throughout the Great Recession; but, in the meantime, a heated war of words will assault the stock market amid many other currently heated wars of words … all in the sultry heat of the market’s worst time of year. It doesn’t bode well for stocks.

Rudy Penner, former director of the Congressional Budget Office said he anticipates a “very scary” fall in 2017. Fiscal issues will come to dominate, disrupting markets.

“There are so many politically hard issues and so little consensus on budget and tax policy. I assume we’ll somehow get through this, but not without getting frightened on a regular basis,” Penner said. “Probably the best we can hope for is muddling through the … budget and the debt limit and getting very limited health, tax, and infrastructure legislation. There is not going to be significant stimulus coming out of Washington in the foreseeable future…. “The markets don’t seem to have absorbed the reality of Washington yet,” he said. “I have an uneasy feeling this will all end badly–that there will be a very major market correction.” (Zero Hedge)

Something wicked this way comes

Actually, a lot of somethings.

Even if the wars simmer down, this is August and then comes September and October — all tending to be bad months for the market. This timing comes as market breadth has been narrowing down to fewer and fewer stocks carrying the main bullish action, usually a bearish sign. The action is now extremely narrow.

In the latest part of the Nasdaq’s gains, the number of stocks seeing new lows increased — an even more bearish sign that overall movement is shifting downward.

Finally, while market sentiment has recently been euphoric, in the past week it has started turning openly sour and worried — usually the last of signs before the market plunges. People start to visibly move toward the exits, and the noise of the crowds starts to grow. Formerly very bullish voices start to worry that something is about to give … because it is.

It’s not panic yet, but the stock market has built up near-record levels of margin debt, and volatility is stirring again at last. The margin departments in brokerages are historically far more likely to give margin calls when volatility is rising, forcing those who have shorted stocks to pony up more collateral, which usually means selling stocks to raise the cash. That forced selling pushes the prices of stocks down further, creating a meltdown. That creates panic! And all the right chemistry is in place for panic.

In the face of all this, the Fed is promising it will unwind its years of money printing, starting in September — something never attempted before, which will begin from a height never imagined before the Great Recession. (They may backpedal on that if war gives them cause, or if the market starts to slide badly before September combes because of the growing tensions of nuclear war.)

Then there is this little omen: During the past century, almost all years ending in seven have seen the market plunge at the end of summer or in the fall. While that is merely something that can feed superstition, the market has never been immune to human superstition.

Then there is Trump’s failing war on crime

The war on white-collar crime is a war that never was … and never was going to be. Just like the battle to lock up Hillary never was going to happen. It was total baloney every time Trump yelled it out, and he knew it. He said it simply because it effectively stirred the crowds, and Trump relishes stirring the pot, especially if it adds to his popularity with his base. Trump knew there was huge untapped anger in the populace over the Great Recession and the failure of the Obama administration at bringing anyone to justice, and anger is easy to stir. It was perfect chemistry for Trump’s M.O.

Under Trump and his cabinet full of Goldman Sachs boys and girls, enforcement of financial regulations has plummeted. Regulatory penalties leveled against Wall Street are down by 60% this year from the same period last year and are on track to be the lowest number of penalties assessed in one year since 2008.

Maybe Wall Street has just turned over a new leaf and the boys, and girls who gamble in its casinos are behaving better so that fewer penalties are needed. Or maybe things have returned to the same lax state of deregulation that helped create the last financial crisis when Greenspan assured congress that banks didn’t need tough regulations because they were naturally self-regulating out of their own self-interest. (Anyone who buys the new-leaf, self-regulating theories, please email me about some view property I have for sale on the moon.)

Backpedaling on regulations to where we were during the last economic collapse cannot possibly end up good, but it will take time to develop new critical fault lines of corruption deeply enough into the economy to cause new troubles.

Does any of that sound like “draining the swamp?” I stopped believing Trump was going to drain the swamp as soon as I saw him putting Goldman Sachs in charge of everything financial. You don’t drain the swamp by putting the alligators in charge. Now Trump is even making love talk to Janet Yellen, having once derided her for supporting Obama and supporting Hillary’s election with a fake economy created through the Fed’s cheap money.

Now that the cheap money has continued inflating the stock market while he is president (and at an even faster clip), Trump is all for it. Even though he once claimed Obama would wrongly take the credit on his way to the golf course for the economy’s fake recovery under Yellen’s low-interest policies, that hasn’t stopped Trump from taking the credit and claiming the economy is now doing great just because he was elected.

I’m afraid Trump’s war on Washington was all talk as was his war on Hillary and on Wall Street. Talk of those battles was all just campaign puffing and bluffing. Maybe in the same way Trump’s words to North Korea will turn out to be a big military campaign bluff — sounds of fury signifying nothing. Giving him a little more benefit of the doubt, perhaps he is just heightening his rhetoric to get the rest of the world to take the North Korean nuclear problem seriously to devastate them economically in order to try to avoid a military option.

Regardless, the stock market is starting to price in the concern that it has been pretending to be unaware of. War appears almost inevitable now. The clouds are directly overhead, and the rumbles of fire and fury are clearly echoing back and forth between the clouds. Will this be one of those dry summer heat storms without rain or one of those deluges that sweeps away entire markets?

One thing is certain: summer, so far, is shaping up exactly as I said it would at the start of the year. Nothing has proven those predictions entirely true, but everything is lining up as if it is all going to prove true. You might want to prepare a path to the storm-cellar door.

Courtesy of David Haggith, The Great Recession Blog