There Is A Big Reckoning Coming

by Dave Kranzler, Investment Research Dynamics

You want to make sure that you have a chair to sit in when the music stops.  Of course, the critical flaw in thinking that a chair will be there is that the Fed has sawed off all the legs of the chairs.  –  Investment Research Dynamics

I stopped into Super Target to pick up some tennis balls.  I saw several young moms with 2 or 3 kids bouncing around.  The moms I’m sure were thinking “life is good.”  These people have no clue what’s going to hit this country.  If they understood, I doubt many of them would have bothered having kids. There’s going to be mass economic and social devastation.

A couple days ago I wrote that the economy appears to be in trouble.  The majority of economic indicators are falling back to 2008, pre-Lehman levels.  This morning May factory orders continued the theme, falling .4% from April and declining 6.4% vs. May 2014.  This was the sixth month in a row factory orders declined year over year.  The index has been negative in 8 of the last 9 months.

Gallup reported that it’s U.S. Economic Confidence Index dropped to -7 in May, down from -3 in April.  This is the third straight month in negative territory.  The economic outlook component was -10.   What’s shocking about this poll result is that, historically, there has been a very high correlation between consumer confidence measures and the direction of the stock market.   The S&P 500 hit a new all-time high last week.   If consumer confidence is diverging negatively from the upward bias in the stock market, then the economy must be in far worse shape than is reflected by the Q1 GDP contraction.

Speaking of an indicator that measures economic health, pre-tax corporate profits fell 5.9% in the first quarter of 2105.  It was the biggest drop in corporate profits since…2008. It was the first time since the middle of the 2007-2009 recession that corporate profits dropped two quarters in a row.

But, in fact, corporate profits now vs. 2008 are worse than the headline report.  Why? Because the accounting rules were changed in 2009/2010 in a way which enabled all the big financial firms to book much higher non-cash income than was allowed in the 2007-2009 comparison period.  In fact, these non-cash items added in to net income have represented the majority of reported net income for most of the big banks since 2009.  In other words, once again, reality is far worse beneath the veneer of superficial headline reports.

This graph below shows the year over year percent change in the value of manufacturers’ new orders for all manufacturing industries.   As you can see, when this metric goes negative, the stock market crashes.

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Compounding the risk of a stock market crash is the fact that NYSE margin debt hit a new all-time record high at the end of April.  Not only is it at an all-time high, it’s 50% higher than it was at the 2007 stock bubble peak (source:  Zerohedge, click to enlarge):

margin debt April 2015

I’m part of an email group with several well-known, highly regarded money managers and market analysts. One of the members sent around a list of market attributes which indicated the onset of increased volatility.  I responded by taking the thought process one stop further:

  • Fact 1:  Central Banks have been working to remove as much volatility as possible out of the primary paper asset markets – i.e. stocks and bonds;
  • Fact 2:  the underlying economic, political and financial problems are far worse now than in 2008;
  • Fact 3:  stock and bond markets are historically at their most disconnected in value vs. the underlying fundamentals of the variables listed in Fact 2.

Thus:  The increase volatility we’re seeing, such as bunds today and the USDX today and yesterday and the SPX recently reflects the market’s perception that the risk of owning paper assets is increasing AND reflects the Central Banks’ decreasing ability to keep volatility muted.

I have noticed that since December there’s been increased volatility in gold, silver.  John Embry and I both independently observed this and we both concluded that it reflected something going bad behind the Central Bank “curtain.”

The volatility in the metals reflects the war between smart money moving in to the metals – likely primarily physical – and the Fed/ECB/BOE’s collective attempt to keep a lid on the price of gold/silver.  I predict that we will start to see an acceleration in the movement of cash out of paper assets and into physical gold and silver.

The system – specifically the U.S. economic system – is now speeding up in its collapse.

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