Stocks Perfectly was already Poised to Plummet Past Point of No Return at the beginning of May.....it will happen by year end or in 2019 first quarter...

We are now well into the year when I said stocks would plunge in January and would prove to be a gaping "crack" in the economy by summer, and look at how seriously the market has fallen apart since it started to drop in the last week of January:

It was just three months ago that stock-market investors were being swept up by a euphoria pinned to the idea of economic expansion taking hold harmoniously across the globe—a dynamic that hadn't occurred since the 1980s, and one that was expected to extend into 2018.

However, less than midway through the year and some market participants are already spotting cracks in the notion of so-called synchronized global growth, with some fearing that a whiff of stagflation is starting to permeate. Stagflation is typically described as persistently high inflation and high unemployment, combined with weak economic demand….

"The problem is that there have been macro forces that have been clouding the outlook, so it's preventing the investor from taking the good earnings news and running with it," Young told MarketWatch….

Economic growth in the U.S. has tapered a tad, with the first-quarter gross domestic product, the official scorecard for the economy, coming in at the slowest pace in a year owing to a big pullback in consumer spending. (MarketWatch)

 

Dow down relentlessly in spite of good news

 Even though corporate earnings reports posted lots of good news last week and this, the market fell again and again along the relentless downward trend line I noted in last week's article. Eighty percent of companies beat analysts predictions for earnings, making the past quarter the highest earnings rate in history, and yet the stock market continued doing this:

 

Dow continues down precisely along new 2018 trend line.

 

It's not hard to see that each bounce up has become weaker than the bounce before. What happens when the collapsing ceiling and the floor meet? If the market breaks through that floor, typically the floor collapses. From there, it now has a long way to fall without any obvious support. In my view, its a fall that eventually leads back to the bottom of the Great Recession and maybe even further.

As you can see below, the Dow has now broken below its 50-day moving average, its 100-day moving average and its 150-day moving average:

 

 There is not much floor left. What used to be support beneath the market has become the ceiling. The market has inverted, and is now sitting right on its 200-day moving average (often regarded as the ultimate floor):

 

2018 Dow settling on its last line of support, the 200-day moving average.

 

The 200-day SMA … is commonly used in stock trading to determine the general market trend. As long as a stock's price remains above the 200 SMA on the daily time frame, the stock is generally considered to be in an overall uptrend…. It is possible there is also something of a self-fulfilling prophecy aspect to the 200 SMA; markets react strongly in relation to it partially just because so many traders and analysts attach so much importance to it. (Investopedia)

 When stocks fall below their 200-day trend, the market is generally considered to have made a change in trend. While I have not based any of my predictions on charts, this chart reinforces what I've said would happen this year because many investors do put emphasis on charts, and breaking through the 200-day average on the way down with no clear support below is a frightening sign to many investors … to which they may respond as frightened people often do … in a panic. So, we are now perfectly poised to see where this market is going from this point forward.

Standard and Poors 500 doing poorly, too

The S&P 500 just recorded a dubious milestone: the broad-market benchmark has put in its longest run in correction territory since May 1, 2008. The S&P … has been in correction territory, defined as a decline of at least 10% from a recent peak, for 57 trading sessions, including Tuesday, when the benchmark index fell 0.7%. The S&P 500 slipped into correction territory on Feb. 8, along with the Dow Jones Industrial Average DJIA, -0.27% , and remains there because it hasn't set a new high above its record set Jan. 26. (MarketWatch)

It has become common now to read that the closest economic comparison to our own time is found in the Great Recession, and this retreat to Great Recession milestones in the US stock market is happening just as the market enters what has typically been the weak half of the year for stocks (May – Oct.). That doesn't give a lot of hope that things are going to return to any upward trend, especially when stocks keep dropping in the face of generally positive-sounding corporate reports.

Trump Tax Plan feeds stock buybacks and still fails to float market

This is by far the worst sign for the market.

So far the Trump Tax Plan has failed to deliver the positive economic results intended, even though its tax benefits are being captured. The market continues falling because almost none of the tax savings are going to wages, as was promised, or capital improvements. (Other than those one-time token $1,000 bonuses. Those were all window dressing intended to help sell America on the benefits of the tax cuts that were just passed, but more on that at another time.)

Those tax cuts have poured almost entirely into a massive expansion of already voluminous stock buybacks. Those make shareholders richer, but no one else. At least, they have made the rich richer … until now when they're making no one richer. As noted in my last article, the stunning revelation here should be that the hyuuge increase in stock buybacks this year — the biggest ever — hasn't been able to shore up falling stock prices.

For over a year now, I've said that buybacks would reach their extreme this year and would prove by summer to finally be ineffective against the enormous downdraft coming from other macro-economic factors — namely the Fed — that begin pressing down on stocks. No corporation exemplified this in action more than Apple (long a leading stock) did this week when its now mammoth buybacks and positive earnings reports failed to lift the market (or, for that matter, even Apple) from its declining path.

Apple spent a record $22.8 billion in stock buybacks during the first quarter of 2018. (That's not just an Apple record but a historic record for any corporation!) To give that some perspective, that's a buyback greater than the aggregate value of more than half of the companies in the S&P 500! Apple also gave out over $3 billion in dividends — not something Apple ever does. It did this by repatriating in its foreign profits, which it had banked in bonds.

Those massive moves should have driven Apple stock through the roof of the market during the first quarter and would have during all the past years of "recovery," but here is what Apple stock looked like through the first quarter to the present (starting from the second half of last year for contrast):

Apple stock on slight downtrend for 2018.

Not too exciting for a former social climber who is really trying to put out for everyone. Not much bang for the buck there! No wonder Apple has decided and just announced that it needs to do another $100 billion in stock buybacks! That's simply what it knows it will take to get its stock riding upward again! Apple — just to get its stock higher again — now has to mainline almost half of its $250 billion cash hoard. Not a cheap crack whore here. This is the madame of the marketplace failing to put out for all her stock delivery boys!

The Great One's tax plan continues to fail to deliver in every way except, as I've said it would, because all the gains are being pocketed by the wealthy few at the top in the form of stock buybacks and dividends, and those have run out of effectiveness, as I also said they would. That is a particularly dark turn in a market that had long trended upward due to buybacks.

Bondage is the new game in town

And let's not even talk about what all that repatriation of Apple money banked in bonds will do as Apple now sells all those bonds in a market already flooded by treasury bonds because the Fed is unwinding its bond holdings, which pushes the US government to refinance those bonds without the Fed as its automatic buyer at the same time that it is issuing new bonds for rapidly expanding deficits! Then multiply that by other corporations doing the same thing with their foreign holdings in bonds, which they will be repatriating. (You can read more detail on that huge problem at ZeroHedge.)

The US government just set a quarterly record by borrowing a net $488 billion while the Treasury this week signaled further increases in its rate of borrowing, but Trump's Treasury secretary says he is not concerned:

"By definition, supply and demand will equate," Mnuchin said on Bloomberg when asked if he was concerned.

 Of course they will. They always do ("by definition"). But at what price?

At what price?

The Bank of Japan’s Balance Sheet is Now Over 95% of Japan’s GDP

Let's cut through the BS about Central Bank Balance Sheet reduction.

Once a Central Bank begins to employ ZIRP and QE for years at a time, there is no going back. If you don't believe me, take a look at Japan.

Japan is ground zero for Central Bank monetary insanity. The Fed first employed ZIRP and QE in 2008. Japan went to ZIRP in 1999. It launched its first QE program in 2000.

And it never looked back.

There were brief periods in which the Bank of Japan would NOT employ QE. But as soon as Japan's economic data turned south… you guessed it… MORE QE… and not for a month or two… this has been going on for 18 years.

The end result is that today the Bank of Japan's balance sheet is roughly the size of the country's GDP.

Central Banks Have “Thrown in the Towel” on Monetary Responsibility

To understand the recent shift in policy by the European Central Bank (ECB) and Bank of Japan (BoJ), we need to first revisit what lead us to this point.

With that in mind, let's take a step back to mid-2016.

At this time, the US Fed was the ONLY Central Bank that was tightening policy. Meanwhile, the ECB, BoJ, Bank of England (BoE) and Swiss National Bank (SNB) were engaged in what can only be described as EMERGENCY levels of easing.

The worst offender was the BoJ, which launched a policy of targeting 0% on the 10-Year Japanese Government Bond (effectively announcing "we will print as much money as it takes to keep these bonds at this level").

All told, Central Banks were printing over $160 BILLION in new currency per month at this time. This was MORE than they were printing at the depths of the 2008 crisis. And they were doing this at a time when their respective economies (Europe, Japan, the UK and Switzerland) were all growing.

Put another way, Central Banks, with the exception of the Fed, were pumping record amounts of liquidity into their respective financial systems at a time in which their respective economies were no longer flat lining.

And that is when inflation was unleashed.

The most notable illustration of this concerns the bond markets. Sovereign bond yields are meant to trade based on economic activity and inflation. So if inflation rises, bond yields should rise and bond prices should fall.

This is precisely what happened in mid-2016 with yields on the 10-Year German Bund, 10-Year US Treasuries, 10-Year Japanese Government Bonds, and 10-Year UK Gilds, all rapidly rising (see the red rectangle below). Since this time, these same bonds have either broken their long-term downward trendlines (Germany and US) or are now challenging them (Japan and UK).

Put simply, starting in mid-2016 it became clear that Central Banks had overstepped with their monetary policies and the bond markets were beginning to revolt. I say "beginning" because it wasn't until mid-to-late 2017, that things really became problematic in the bond markets.

While the financial media likes to focus on stocks because they are more volatile and therefore offer greater potential reward, Central Banks are FAR MORE interested in the bond markets. If stocks crash, some investors go bust. If bonds crash, entire nations go bust (see Greece in 2010-2012).

For this reason, I stated back in mid-2017 that Central Banks had a choice:

• Continue to engage in reckless money printing and risk blowing up the bond markets, thereby rendering most developed nations insolvent (current debt loads are so great that higher interest rates would rapidly lead to these nations failing to make debt payments).
• Taper monetary policy, save the bond bubble, and sacrifice stocks.

From mid-2017 until this month, Central Banks opted for #2. Both the ECB and the BoJ began sending signals that they would be walking back/ tapering their monetary policies.

Here's the ECB in November 2017:

The European Central Bank is assessing a key element of its stimulus plan that looks likely to gain in prominence next year.

The ECB is reviewing its corporate-bond buying program, according to euro-area officials familiar with the matter. The study by the Market Operations Committee is largely looking at the effectiveness of the strategy, which has spent 126 billion euros ($148 billion) so far, and how it influences the supply of credit to the euro-area economy.

Source: Bloomberg

Here's the BoJ that same month:

… it looks as if Kuroda (should he be reappointed by Prime Minister Shinzo Abe) has every intent of abandoning his fixation with a zero percent 10-year government bond yield. Kuroda said this of the consequences of keeping interest rates too low:

Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the "reversal rate." This refers to the possibility that if the central bank lowers interest rates too far, the banking sector's capital constraint tightens through the decline in net interest margins, impairing financial institutions' intermediation function, so that the effect of monetary easing on the economy reverses and becomes contractionary. 

Source: Bloomberg

Put simply, from mid-2016 onward:

1. Central Banks engaging in emergency levels of QE at a time in which their respective economies were growing.
2. Inflation bottoming then beginning to rise.
3. Bond markets starting to revolt.
4. Central Banks opting to walk back their QE programs.

This concludes this first part of our analysis of current Central Bank policy.

Germany Accuses Italy of "Debt Blackmail": Hello EU, Time for Reform Expired

For 10 years, the EU and EMU promised reform. None was delivered. Time is Up. Populists have taken control of Italy.

Merkel's CDU/CSU coalition is in a state of panic regarding Italy. The German parties went on the attack accusing Italy of "debt blackmail"

Eurointelligence Snips

This was the day when people who were left speechless by the political events in Italy started to talk. In Germany it was the now cancelled request for a monetary financing of Italy's debt that triggered a collective nervous breakdown.

The CDU's economic council warned about a eurozone endgame, and said that Angela Merkel's policy of kicking the can down the road had led to a situation where the debtors are now in a position toblackmail the creditors. Its general secretary was quoted by FAZ as saying: why should German households pay for rich Italians? The head of the CSU in the Bundestag, Alexander Dobrindt, also demanded that under no circumstances Germany should pay for Italy's debt programme. His colleague in the European Parliament, Manfred Weber, says Italy was playing with fire, and was risking another eurozone crisis.

Eurozone Reform Officially Dead

French President Emanuel Macron has a vision for Europe. Germany did not agree with it.

Heck, Germany did not agree with any Eurozone reforms for over a decade. Chancellor Angela Merkel blew with the wind in a perpetual can-kicking exercise, accomplishing nothing.

Now, it's too late. The new Italian government will kill any proposal that Germany and France may agree on.

And of course one of the major Eurozone flaws is that every country must agree to change the pact.

One Day

Flashback December 12, 2016: 

​This is what was said at the time regarding Italian complacency.

The Italy won't leave rationale looks like this:

• The Five Star Movement (M5S) would have to get into power, but the new technocrat government's first mission is to rig the rules so that does not happen.
• Even if M5S wins the lower parliament, it still may not control the senate.
• Even if M5S takes complete control of parliament, it would have to change the constitution.
• Changing the constitution without a super majority would require a vote.

This was my explicit warning:

"The problem with the above thesis is there is only one party that wants to keep the Euro and coalitions will form if for no other reason than people are fed up."

The Fed Doesn’t Know How to Accomplish Whatever They’re Trying to Do

It would be one thing if the Fed knew it could achieve what it wanted to achieve by virtue of its policy actions.

But it's not nearly that simple. What's more, the US economy, situated within the vast backdrop of the global economy, has innumerable inputs, variables, influences…it's not as if you can change one thing (like an interest rate), directly affect one other thing (like inflation), and leave all else unscathed.

Given all the interference in the markets wrought by decades of Fed policy, at this point trying to undo it all would be like unmixing cake batter. But the Fed soldiers on, figuring that just a little more or this or a lot more of that is all that's missing in its fatally flawed recipe.

There seems to have been no correlation or even a negative correlation of the Fed conjuring nearly $4 trillion with which to buy (and sell) unprecedented quantities of Treasury's (particularly the 5 to 10 year variety), and the direction of interest rates. In fact, the lowest rates seen on the 10 year were while the Fed was systematically rolling off $450 billion in 5 to 10 year debt in mid 2016!

Regarding the short end, as the Fed dumped short duration holdings amid Operation Twist, interest rates fell to zero...and as the Fed began buying, interest rates surged. This is entirely contrary to the nature of a free market...and that should be the real takeaway.

Oops, It’s Starting, Says This Chart from the FDIC

And its eerie exhortations to the banks to prepare for a downturn to avoid

"undue disruption to the financial system."

The FDIC's quarterly report on commercial banks and savings institutions was cited in the media mostly for the $56 billion in profits that FDIC-insured commercial banks and savings institutions made in the first quarter, which was up 27% from a year ago. An estimated $6.6 billion of the profits were due to the tax-law changes.

It remained mostly unmentioned that this increase in profits came after the huge charge-offs banks took in the fourth quarter mostly due to write-downs of tax assets, also a result of the new tax law. These write-downs slashed bank profits in Q4 to $25 billion, the worst quarter since the Great Recession.

Overall, Q1 was really exciting. Banks were firing on all cylinders, according to the FDIC: Net income jumped, loan balances rose, net interest margins improved, and the number of "problem banks" edged down. But worries are creeping up:

The interest-rate environment and competitive lending conditions continue to pose challenges for many institutions. Some banks have responded by "reaching for yield" through investing in higher-risk and longer-term assets.

Going forward, the industry must manage interest-rate risk, liquidity risk, and credit risk carefully to continue to grow on a long-run, sustainable path.

The industry also must be prepared to manage the inevitable economic downturn, whenever it comes, smoothly and without undue disruption to the financial system.

I added the bold. This is a goodie. We had an "undue disruption to the financial system" during the last downturn, and we don't want another one, the FDIC says.

"Undue disruption" would be when banks stop lending. That's when credit freezes up in a credit-dependent economy. Everything comes to a halt. Paychecks start bouncing. So, don't do that again.

The long-term objective for banks should be to position themselves during periods of good economic and banking conditions, as exist today, to be able to sustain lending through the economic cycle so that the industry can play a counter-cyclical role, and not a pro-cyclical role as occurred during the financial crisis.

"Pro-cyclical role" means banks made things worse during the last downturn. So don't do that again, it says.

These warnings about the end of the credit cycle don't come out of the blue. We have seen in other data that defaults in subprime auto loans and subprime credit card loans are already surging. Those are early flags that the credit cycle has entered the next phase.

The FDIC also reported that the total number of banks on its "Problem Bank List" declined by 3 to 92 banks. Which banks are on the list is a secret. It said that three institutions were added to the list. Thus, five must have made if off the list. None of the banks toppled in Q1, which is a good thing, after six bank failures in 2017 and five failures in 2016. All this is benign compared to the 148 bank failures in 2009 and 157 bank failures in 2010, or the 534 failures in 1989.

And then comes "Chart 8" in the FDIC's presentation, which depicts the nicely behaved number of banks on the FDIC's "Problem Bank List" (blue line, left scale), and the red bars… OOPS! The "Assets of Problems Banks" (right scale) more than tripled in the quarter to $60 billion:

This doesn't mean the financial system is going to collapse in Q2. But it does show that the three new banks that were added to the "Problem Bank List" were bigger banks with a lot more assets. This is the same kind of jump seen in 2008.

It confirms the other early indications that the credit cycle has definitely moved on to the next phase. The FDIC is not oblivious to it, and its risks:

[A]n extended period of low interest rates and an increasingly competitive lending environment have led some institutions to reach for yield. This has led to heightened exposure to interest-rate risk, liquidity risk, and credit risk.

In addition, with the current expansion in its latter stage, the industry needs to be prepared to manage the inevitable downturn, whenever it may occur, in order to avoid financial system disruption and sustain lending through the economic cycle.

I added the bold. The FDIC just cannot stay away from the phrase, "avoid financial system disruption."