Last week I read a fascinating article about the stock market titled “Why The Next Market Crash Will Be The Sharpest On Record,” and I thought about sharing my views on the same.
First, I would like to mention that I really enjoyed this article, and you should absolutely give it a read. Briefly, the article explains how the world has seen an increase in leverage and not growth to fuel the profits of the rich and affluent.
The leverage in the stock market and other financial instruments have caused their prices to increase as more and more money is being introduced in the system using leverage.
The institution can use $100 million as collateral to get a $500 million loan and use that $500 million as collateral again to generate loans furthermore if they desire.
This has caused profits to soar when the times are good. Still, as soon as there is a hint of a problem, people withdraw their money, causing deleveraging, market crashes, and ultimately liquidity drying up.
This action causes the Fed to pump liquidity by giving this institution money and keep and the markets going. Still, the Fed can only help these institutions to an extent, and sooner or later, they will have to stop.
Evidently, in 2008, the said crisis happened. The financial system broke in half, the authorities’ combination of bailouts, liquidity injections, and “asset relief” programs restored confidence, and those bearish speculators went bankrupt.
It was this extraordinary confidence revival that created the foundations for the longest bull market in history, the idea that you could ignore reality, zombifying the economy, and get paid for it.
Because why create an improved system free of all existing bad ideas when you can simply restart the profit machine and convince everyone to play along?
The article goes on to explain how economic growth has halved while investors have put their faiths in the Fed to prop up the economy and the stock market, which produces an absurd range of financial assets and systems created specifically to support them.
Instead of savings, capital, and real wealth growing the American economy, the Fed has financial engineering: CDOs, CBOs, MBSs, and to back them up, a plethora of alphabet soup “asset relief” programs: CPFF, TALF, PDCF, SMMCF, TALF, MSCLF.
Now you get the idea.
Financial institutions have been revived not via real economic growth but via leveraging debt-financed assets that would instantly go to zero in post-financially insane world.
And as leverage has become the de facto funding source that the megabanks, hedge funds, pension funds, and insurance firms use to bankroll these products — generating huge returns for themselves — we’re about to experience the sharpest market crash on record.
As the financial system considers CLOs to be “assets,” the hedge fund can use their newly-acquired $1 billion CLO tranche as collateral to purchase even more assets.
By exchanging that collateral for cash via money markets such as repo or interbank, the hedge fund can embark on an additional asset binge, using leverage to buy up mortgage-backed securities (MBS), junk bonds, REITs, stocks, and any other supposedly high-yielding assets.
That original investment has turned into a vast portfolio of financial slop. Yet, no one questions their motives or credit history because money is ultra-cheap.
This hedge fund now has a leverage ratio of 20:1; their liabilities exceed their net worth by 20 times. What could possibly go wrong?
With the least expensive money related condition on record, the state is making ever-expanding types of good peril.
The Fed is apparently conceiving new bailout programs each week, the normal influence a flexible investment takes on has detonated to record-breaking highs. Indeed, as long as you’re leveraged, it’s considered conservative.
Nonetheless, this should not shock anyone as the Fed Put continues.
Financial institutes have every motivation to use as meager cash-flow to purchase up; however, many resources are prudent to the point that this asset binge has advanced into each market: stocks, garbage securities, contracts, bank loans, and so on.
Before, we just had a bubble burst in tech in 2001 and in real estate in 2007–2008, but the next bubble to burst will be the bubble of everything.
This leveraged house of cards was tested by COVID-19.
As speculators began to sell anything, the worldwide lockdown may contaminate, a deleveraging occasion in the financial framework has caused the sharpest market decline ever to be witnessed, obscuring the record from the 1930s Great Depression.
A synchronized cross-market crash that Guggenheim CEO, Scott Minerd, depicted as “the Great Leverage Unwind.”
However, the COVID-19 accident will be nothing in contrast with the follow-up market crash. The memorable rise in the Fed’s balance sheet outlines how much cash will be needed to paint over the pandemic-induced cracks, by using — yes, you guessed it — more leverage.
The quality of assets has reached rock bottom while the leverage needed to finance their survival has increased to all-time highs.
So when the next crash occurs, leverage on top of leverage on top of more leverage will have to be wiped out by the system to restore “stability.”
It will be thrice as fast and thrice as sharp. It will be known as the Great Deleveraging: Part 2.
At the point when the unavoidable crash happens, be that as it may, the Fed will again step in.
Nevertheless, this time, they’ll declare the outright purchase of stocks — which they would already be able to accomplish by loaning cash to essential banks which, at that point, purchase stocks for their benefit.
The Fed will do this not because it has any impact on the system but because it will revive risk appetite enough to become self-fulfilling.
They may even toss in a couple of more “asset relief” programs only for theater — the SMR (Stock Market Relief) program has a decent ring to it. The Fed lies when it says stimulus stimulates the economy.
Authorities know it just energizes the financial institutions to loan to firms that are on the verge of bankruptcy.
The amount of harm the Great Deleveraging: Part 2 perpetrates on the system relies upon what the Fed says and does.
Yet, post-pandemic reaction, it’s just almost certain — to the dismay of the sound money advocates, the Fed’s critics, the bears, the poor, and the young — that the financial behemoths will miraculously but blatantly save the biggest Ponzi scheme in modern history, and that we’ll continue to climb the wall of worry for months or years, maybe even decades, to come.
Based on the current market conditions, I think there are three possibilities that could happen, and we should be prepared for all that these possibilities torment in order to profit from it.
The debt to GDP level has been the highest it has ever been at 106.9%, and that’s not normal, but it’s not bad.
The bad thing is that the rate is growing extremely fast as this year alone, the debt has increased by 15%.
The Fed needs to be visionary and maintain the ratio as they just can’t keep on printing money and expect no consequences from it.
Right now, they are afraid that if they stop printing money and providing liquidity, the market will dry up, the stock market will crash, and there won’t be any credit to give, which will cause companies to go bankcurpt.
I agree that this is a bad situation, and I am very grateful to the Fed that they are looking out for people.
Still, they also need to stop before they go over the point of no return.
The Fed’s balance sheet has almost doubled in the past 6 months alone from $4.2 trillion to $7 trillion, which is huge.
See, this huge jump is expected because of coronavirus, but this is causing the market to be leveraged. If you believe it or not, it is becoming more leveraged.
The big financial institutions and companies that run the stock market now think that whatever they do, the Fed will be their safety blanket and bail them out by supplying them with more money.
This can be witnessed by anyone reading the news that the stock market has disengaged from the economy and is making all-time highs.
The best-case scenario is the Fed realizes this and stops unnecessary funding risks taken by these people to make money for themselves by stepping on the common people who don’t have this facility and backing of the Fed.
The Fed also needs to make-known that it won’t continue to provide money to these institutions if they mess up or bail them out before they hit the consequences.
If the Fed doesn’t stop printing money circulating it to everyone, there will be a lot of dilemmas.
Nobody can predict the future, and I don’t know what exactly will happen or the magnitude of the problem.
Still, based on what I know and understand, I think that the Fed won’t be able to act if anything else goes wrong.
Let me explain why I think that.
The Fed has committed to keeping the interest rates at 0% for around 5 years, which leaves them with only 1 option to fight off any future issue.
That option is printing more money to keep the flawed system going.
The consequence this is that adding so much money in circulation will devalue the dollar and increase inflation, which the Fed has willingly already agreed to increase.
This will cause a spiral reaction where your money decreases in value.
As you all know, that dollar is the world reserve currency, so this could potentially harm the whole world while making it difficult for countries to hold dollars as the value will be declining at an increased rate.
This could very well challenge the dominancy of the US dollar as the world reserve currency. However, I agree that the chances are quite low.
This decreasing dollar value combined with the increased supply of dollars has helped the stock market as well as every other financial instrument like gold, real estate to soar in price where it is generally seen that gold and the stock market have a negative correlation.
There could be a third scenario that I do not see here, but the Fed can. Therefore this may be the most likely scenario considering that they are way more qualified than me.
They could steer the ship to safety that they might be planning. Yet, I am sure that this will cause a problem in the future as rather than fixing the system, they are just throwing money at it to keep the broken system functioning for as long as they can.
Once the system finally cracks, all hell will break loose, and it will be the worst crash in history, possibly even worse than the 2008 recession.
Nonetheless, whatever the situation is, you should be prepared for the worst and hope for the best.
This is from my personal perspective, and I would recommend you to do your own research before arriving on any decision.
What do you think is the most likely scenario and how it will all play out?
Let me know in the comments.