The global stock market sell-off continued on Monday with a vengeance as Asian markets plunged, followed by one of the worst one-day sell-offs in U.S. market history. The Dow ended down nearly 600 points or just over 3.5%, but at the opening of trading, it was down nearly 1,100 points! While investors and market participants can never know all of the reasons for the sell-off, there is an underlying theme to the global market rout that will continue to play an outsized role in the coming months: central banks.
Monday’s turmoil was certainly severe, and although it doesn’t make the cut for some of the worst days in stock market history, that didn’t stop some from taking to Twitter with #BlackMonday trending (for comparison, on the Black Monday of 1987, the Dow lost nearly 23% in one day.) Monday’s drop put many indices in or near ‘a correction’ which is usually regarded as being 10% off their highs.
The first question on everyone’s lips is “Why?” or “What started it?” but that is like asking “Which straw was it that broke the camel’s back?” However, it is true that the U.S. was taking cues from China’s markets with the Shanghai composite index down 8.5% the previous night, the biggest drop since the beginning of the last crisis in 2007. China’s stock market bubble continues to deflate because the government has either decided not to, or is unable to, prop up the markets, this being something we have covered here in the past. Feeding the China decline was their government’s surprise announcement to devalue the yuan a couple of weeks ago, prompting fears their economy’s growth is slowing.
More important than trying to discern the snowflake that caused the avalanche is to assess why and how markets came into such a fragile state that they could be caught off guard. After all, the decline was incredibly sharp and fast, and yet it wasn’t due to a comparable world event shock such as 9-11. I personally believe investors had previously been lulled to sleep by low interest rates, easy money, and a warm feeling that the Fed and other central bankers around the world have things under control.
On Wednesday afternoon, the Federal Reserve released minutes from their July 28-29 Federal Open Market Committee meeting. Investors were looking forward to the minutes to discern if the Fed might start hiking rates this September, as previously expected. The minutes were somewhat muddled as they showed members continue to debate whether it is appropriate to start raising rates. But in the end, the minutes appeared to show a bias toward keeping rates low, largely due to inflation not being near the Fed’s target figure.
Conventional theory says the Fed, in trying to fulfill its dual mandate of stable prices and full employment, must try to interpret economic data to see which way the economy is tilting; is there slack in employment and therefore low rates are needed, or is inflation becoming a risk and therefore higher rates are needed? While this teeter-totter of prevailing conditions sounds good in theory, what we often find is the Fed is faced with contradictory data on economic conditions.
The recent release of July’s minutes is an example of this confusion. The Fed noted the labor markets have been improving with unemployment at 5.3%, the lowest rate so far since the recession. But historically, this isn’t that low; unemployment reached lows of 4.4% and 3.8% before the last two recessions in 2008 and the early 2000’s, respectively. Furthermore, the Fed itself admitted the labor force participation rate and the employment-to-population ratios both declined. Translation: the unemployment rate continues to decline, as less people look for work.
GDP remains tepid. Recall that growth estimates for GDP were well above 3% not too long ago, which is why many expected a rate hike as the Fed wouldn’t have as much trouble hiking rates going into a stronger economy. Meanwhile, the Fed continues to brush off the weak first half of the year as being ‘transitory.’
Inflation continues to sit below the Fed’s 2% target. The meeting minutes also labeled this as transitory, as the low inflation was attributed to lower energy prices and the decline in import prices due to past dollar appreciation.
News stories of high-frequency trading, market rigging and interest rate manipulations make the average individual investor feel like they have no chance of making any money in the markets. It seems like the guys on the inside track, such as the hedge funds, private equity funds and other “accredited investors,” only have access to all of the great deals. But there is a huge advantage you, as an individual investor, have over Wall Street and the entire investment management industry – independence.
What I mean by this is you as an investor of your own money only have to answer to yourself. Almost every hedge fund or investment manager in the industry is managing money for someone else and therefore have to answer to to their clients every month or quarter and report on their performance. This is of course a good thing in itself, but it can be a hindrance to the manager and something you can use to your advantage.
For example, hedge fund manager David Einhorn has recently been under fire for his bet on gold. His publicly traded reinsurer, Greenlight Capital Re, is down 18% year-to-date partly due to the fund’s gold position as well as other positions that have not been working out.
Top highlights from the interview.Five of the ways that inflation is misunderstood in today’s world:
1. “Demand pull” inflation (Keynesian concept) a.k.a. an “overheated economy”
2. “Cost push” inflation (Keynesian concept) e.g., increase in the price of oil can spark inflation.
3. Velocity can exacerbate or mitigate inflation (when it reality it does not exist and is a poor proxy for monetary demand).
4. Demographics directly impacts the price level (e.g., an aging population is “deflationary” per people like Harry Dent), the impact is really indirect and only results from the nature of fractional reserve banking
5. The Federal Reserve can not successfully control inflation, it can only contribute to the price increases with its ability to print money at its leisure.
Last week, the U.S. Mint sold out of its 2015 American Eagle silver bullion coins, citing a ‘significant’ increase in demand, according to Reuters. This also coincided with the drop in silver spot prices from $15.67 per ounce to a low of $14.62 per ounce last Tuesday. Silver hasn’t seen spot prices this low since 2009!
Given the decline in silver prices, it is not surprising to see the surge in demand for physical bullion. Contrary to the actions of futures traders who normally don’t take delivery of the physical metal, bullion investors tend to buy more when the price declines, viewing it as a buying opportunity. Managed futures traders and other money managers may instead be trading based on momentum or other strategies that are not related to an actual desire to own the physical metal.
The U.S. Mint has temporarily run out of silver bullion coins in the past, as they did last November through the end of the year. In this case however, the Mint said they expect sales to resume within a couple of weeks.
Looking at the American Eagle silver coin sales data on the U.S. Mint’s website, we can see demand has indeed been strong in the past two months. In June, the Mint sold 4.84 million 1 ounce silver coins; 80% more compared to June last year. In addition, July sales of 2.7 million ounces have already outpaced last July’s 1.975 million ounces, despite us being only half-way through the month. However, year-to-date silver sales are still slightly behind last year.
Last month we wrote about the Chinese stock market bubble that was being inflated, largely by delusional retail investors and easy access to margin and debt. But it wasn’t as if something was in the water – Chinese Mom-and-Pop investors were being egged on by their government to invest in the market as the central planners tried to juice economic statistics, bail-out heavily indebted state-owned firms and turn attention away from the sagging real estate market.
Unsurprisingly, the government-fueled rally is coming to an end as both the Shanghai and Shenzhen Indices have crashed over 30% in less than one month! Approximately $3.9 trillion has been wiped out, more than the total annual output of Germany and 16 times Greece’s GDP, to put it in perspective.
Over 1,400 Chinese companies have suspended trading, which is almost 50% of the market. Some of this is due to stocks hitting maximum daily decline limits imposed by the exchange, but much is due to the companies themselves halting trading. This is because these companies were using their own corporate stock to collateralize or secure loans from banks.
A correction of 30% would actually be somewhat normal and healthy in any market that has