Bill Fleckenstein's take on the action:
Prologue: 'The Next Time Down'
I think this is an enormous inflection point, as I believe it will in time lead to the recognition of problems, and the consequences I warned about in my May 18 speech, "The Next Time Down." Rather than refer readers to its posting on the Special Features section of the site, I'd like to reprise the relevant portion here, to show why the stage has been set for this inflection point, and what the ramifications might be:
"I believe that the four years which have elapsed since the stock market peaked have essentially been one massive exercise in denial. Initially, folks were in denial about the fact that stocks had peaked and that we were in a bear market. Then, all of our economic and stock-market problems were blindly pinned on the attack of September 11, even though that attack wasn't the economy's true problem. The next excuse was pre-Iraq war fears.
"Finally, the combination of the fall of Baghdad, 13 rate cuts (which heretofore had been not good enough), two tax cuts, two rounds of tax rebates, and the recent tax refund was potent enough to give us the year-long rally that recently ended, as well as a big bounce in the economy. However, from a stimulus standpoint, the government is out of bullets. No more tax cuts are coming, no more rate cuts are coming (though I think no more than a couple 25-basis-point hikes are coming, either).
"But most importantly, the 'use-your-house-as-an-ATM-to-live-beyond-your-means' stimulus is finished, thanks to the recent de-leveraging/crackup in the bond market. The refi game and the bull market in housing it created postponed the consequences of the largest stock market bubble in history. Though the Fed and the rest of the government succeeded in postponing the fallout from the massive misallocation of capital that took place in the mania, they have also succeeded in compounding and exacerbating those consequences. Even more leverage was created in the system, as we attempted to speculate our way to prosperity.
"In short, the excesses from the bubble have not been cleared away, but they will be, along with the recent excesses from the refi bubble. I believe the economic rebound has peaked, the economy will slow down in the second half, and we will ultimately slide back into recession. I believe we are headed for a large slide in the stock market, as well as a resumption in the decline of the dollar. These developments will tend to be self-reinforcing, and especially damaging, if and when housing prices join the decline.
"If that weren't bad enough, in addition, the Fed is finally trapped. Easy Al can't cut rates when trouble starts, because he has already created a decent-sized inflation problem. As this scenario unfolds, in whatever variation, we will experience the 'next time down.' The realization that the market is going down again, and with it the economy, will force people to come to grips with the fact that the interlude of the last year was just that. This will deal a crushing blow to confidence, causing the public to finally comprehend that the Fed can't save them. Once the business of clearing away the excesses begins again in earnest, your guess is as good as mine as to how ugly it all gets."
Fed Credibility, at a Crossroads
The first four paragraphs basically lay out the groundwork for where we are. I think the critical point is what I tried to communicate in the last paragraph: the enormous ramifications of the Fed's loss of credibility. Al has been an utterly irresponsible central banker, having set us up for the serious trouble that I have droned on about for some time. Folks should take heed that some of this may begin to hit home pretty soon, though perhaps not immediately.
To those who hope this weakness will rally the bond market enough to energize the refi game, my response is that while some more refinancing may go on, I do not think it will be sufficient to rekindle the mania there. There is another problem for the refi market: Many people have gone to ARMs and interest-only (IO) mortgages, as they try to shoehorn into beyond-their-means housing. But though a bond rally might lower refi rates for longer-term mortgages, it won't get short-term rates low enough to help out the ARM crowd.
To quote a mortgage professional whom Dennis Gartman quoted in his newsletter today: "The moment that there is a hiccup, either you've become unemployed, get fired and take a lower-paying job, or simply have a bad couple of years bonus-wise, you are in trouble, because an IO mortgage is a tacit admission that at your current salary, you cannot afford to repay your debt."
Forecasting Al's Acid Rain
In any case, the Fed certainly won't be able to take rates down very far, because it already has an inflation problem, even if that is believed just to be commodity inflation and not secular, wage-oriented inflation. Though Al may not hike rates 25 basis points next Tuesday if the stock market trades ugly enough between now and then, it's really irrelevant what he does now. To repeat, we are at a very dangerous moment in time from a financial and economic standpoint. I urge readers to take a step back and think about where we are, where we've come from, and what the ramifications of the "next time down" scenario might mean to them.
Turning to the preopening action, the S&P futures were indicating a decline of about 0.75%, and that's about what we got. From there, we had a rally, followed by a selloff, followed by another rally. It's amazing that so many people have been so conditioned to buy every dip, thinking that no trouble could ever befall us, that even on days such as today, there appears to be more bravado on display than fear.
Over the Course of the Dazed
The attempt to be brave and "buy the dip" lasted until just after lunch Eastern time, when we broke out of the range we'd been flop-chopping in and basically headed south for the rest of the day. For all intents and purposes, the box-score prices you see are the lows, though there was a modest bounce in the final half-hour.
The downside leader was the Sox, as the supposedly important 400 level turned out to be just another number. Cyclicals, retailers, and financials were also roughed up. The port in the storm was none other than the housing stocks, as I guess the people who move the Jell-O around the plate had to buy something. I would be shocked, however, if housing did not come in for a serious drubbing before this decline breathes its last.
In fact, I think today is the start of the countdown to a potential dislocation, which I discussed on July 7 in my "Crash Math" column. I would say the odds of a dislocation have now gone up substantially, though we still must remember that dislocations are low-probability events. I would not be a bit surprised to see a further extension of the selling on Monday. Then it will be interesting to see what the Fed chooses to do the next day. I can't believe that folks are going to treat a 25-basis-point rate hike as good news, but I can see how next week might be very ugly. Hopefully, Rap readers are prepared for whatever comes next.
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