Monday, August 24, 2015

Blood & Gore: Global Markets Crashing Everywhere

As I write this morning stock markets are selling off everywhere. China's market fell close to 9% overnight, U.S. DOW futures are down 600 points while most other global markets are down over 3%.

It's interesting listening to the media trying to figure out "why" stocks are down. "What was the one trigger that pushed us down?" Was it China? The Fed? Donald Trump?"

The reality is global stock markets have been trading at prices that do not reflect the economic strength of the economy that supports those prices. The global economy has been slowing down for some time now, but in many areas of the world (specifically the United States) people have not paid attention because the stock market was moving higher.

Many people wake up in the morning and check the markets. They see green and they assume everything is right in the world. They believe the market is a rational indicator of the current and future health of the economy.

The reality is the stock market is one of the most irrational gauges of the economy available, especially at the high and low extremes. The future growth potential for the U.S. and global economy was far better than the U.S. stock market reflected in 1982, and it was far worse than the U.S. market reflected a month ago.

There was not one "trigger" that pushed the markets lower over the past week. There is never one triggering event at a high (people are still trying to determine what it was in 1987, 2000 and 2007). Markets fall when prices become overvalued and people finally move toward a more risk averse mind set. Here are some thoughts from John Hussman from over the weekend.

"The way to understand the bubbles and collapses of the past 15 years, and those throughout history, is to learn the right lesson. That lesson is not that overvaluation can be ignored indefinitely – we know different from the collapses that have regularly followed extreme valuations. The lesson is not that easy monetary policy reliably supports stock prices – persistent and aggressive easing did nothing to keep stocks from losing more than half their value in 2000-2002 and 2007-2009. Rather, the key lesson to draw from recent market cycles, and those across a century of history, is this:

Valuations are the main driver of long-term returns, but the main driver of market returns over shorter horizons is the attitude of investors toward risk, and the most reliable way to measure this is through the uniformity or divergence of market internals. When market internals are uniformly favorable, overvaluation has little effect, and monetary easing can encourage further risk-seeking speculation. Conversely, when deterioration in market internals signals a shift toward risk-aversion among investors, monetary easing has little effect, and overvaluation can suddenly matter with a vengeance."

We know markets usually fall a lot faster than they rise, especially when everyone is on one side of the boat and there is heavy leverage involved. Is this the wash out moment to cleanse the mal-investment over the past 7 years? Will the Fed step in with an announcement to launch stocks higher into the realm of absurdity? I have no idea. What I do know is that U.S. stocks this morning are still a long, long way away from being undervalued. We'll see if the market can finally bring us back to a rational entry point for buying.

My guess is you are unlikely to see experts on CNBC today "so bullish it hurts."


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