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The Two Pins That Will Pop The Stock Market Bubble

Yes. We are in a stock market bubble. The only question is, what will be the issue that eventually pops it? We alluded to this answer in Friday’s #MacroView discussing why more "Stimulus Won’t Create Economic Growth."
As discussed in our previous article,

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This article was originally published by Real Investment Advice

Yes. We are in a stock market bubble. The only question is, what will be the issue that eventually pops it? We alluded to this answer in Friday’s #MacroView discussing why more “Stimulus Won’t Create Economic Growth.”

As discussed in our previous article, if market bubbles are about “psychology,” as represented by investors’ herding behavior, then price and valuations reflect that psychology.

In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise. Let me show you an elementary example of what I mean. The chart below is the long-term valuation of the S&P 500 going back to 1871.

Notice that except for only 1929, 2000, and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently.  

Secondly, all market crashes, which resulted from the preceding bubble,  have been the result of things unrelated to valuation levels. Those catalysts have ranged from liquidity issues to government actions, monetary policy mistakes, recessions, or inflationary spikes. Those events were the catalyst, or trigger, that started the “reversion in sentiment” by investors.

There are currently two “pins” that could pop the current market bubble.

The Inflation Pin

To fully explain why the Fed is now trapped, we must start with the inflation premise.

The Federal Reserve has consistently argued that monetary policy is a function of their two mandates: full employment and price stability.

While the Fed has stated they are willing to let “inflation” run hot, their biggest fear is a repeat of the runaway inflation of the 70s. However, the basis of the entire bull market thesis is low rates.

As Oliver Blanchard of the Federal Reserve recently stated concerning Biden’s $1.9 trillion stimulus package:

“How this number translates into an increase in demand this year depends on multipliers. If the average multiplier is 1 (which I think of as a conservative assumption), this implies that demand would increase by 4-times the output gap.

If this increase in demand could be accommodated, it would lead to a level of output at 14% above potential, which would take the unemployment rate very close to zero. 

Such would not be overheating (i.e. inflation), it would be starting a fire.”

Using the money supply as a proxy, we can compare the money supply changes to inflation.

The chart below advances M2 by 9-months as compared to CPI and the Fed Funds rate. If the historical correlation holds, the Federal Reserve will start talking about tapering monetary policy, and hiking interest rates, within the next year.

Of course, the last time the Fed started discussing similar policy changes was in 2017, which lead to the great “Taper Tantrum” of 2018.

The Interest Rate Pin

As noted, the problem with inflation is that if economists do get their wish for higher prices, such also corresponds historically with higher interest rates.

However, as you will note, each time that interest rate has moved up correspondingly with inflation, such never remained the case for long. While much of the media is currently suggesting that interest rates are about to surge higher due to economic growth and inflationary pressure, I disagree.

Economic growth is “governed” by the level of debt and deficits. However, it isn’t just the heavily leveraged government – it is every single facet of the economy.

Debt has exploded.

In 1980, the Federal Reserve became active in monetary policy, believing they could control economic growth and inflationary pressures. Decades of their monetary experiment have succeeded only in reducing economic growth and inflation and increasing economic inequality.

In a heavily indebted economy, increases in rates are problematic for markets whose valuation premise relies on low rates.

Each time rates have “spiked” in the past; it has generally preceded a mild to a severe market correction.

As is often stated, “a crisis happens slowly, then all at once.” 

So, how did the Federal Reserve get themselves into this trap?

“Slowly, and then all at once.”

The Trap

In an economy laden with $85 Trillion in total debt, higher interest rates have an immediate impact on consumption, which is 70% of economic growth. The chart below shows this to be the case, which is the interest service on total credit market debt. (The chart assumes all debt is equivalent to the 10-year Treasury, which is not the case.)

Importantly, note that each time rates have risen substantially from previous lows, there has been a crisis, recession, or a bear market. Currently, with rates at historic lows, consumers are rushing out to buy houses and cars. However, if rates rise to between 1.5 and 2%, economic growth will quickly stall. Such was a point we made in our COT Report:

“Can rates rise in the near-term due to “checks to households” that get spent to pull-forward consumption? Absolutely.

However, the limit of that increase in rates is between 1.56% and 2.19%. At these points, rates will collide with the outstanding debt.”

The Federal Reserve is well aware of the problem. Such is why they have been quick to reduce rates and increase bond purchases, as higher rates spread through the economy like a virus.

The Rate Virus

In an economy that requires roughly $5 of debt to create $1 of economic growth, changes to interest rates have an immediate impact on consumption and growth.

1) An increase in rates curtails growth as rising borrowing costs slow consumption.

2) As of January 21st, the Fed now has $7.38 trillion in liabilities and $39.2 billion in capital. A sharp rise in rates will dramatically impair their balance sheet.

3) Rising interest rates will immediately slow the housing market. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in rates means higher borrowing costs and lower profit margins for corporations.

5) Stock valuations have been elevated due to low rates. Higher rates exacerbate the valuation problem for equities.

6) The negative impact on the massive derivatives market could lead to another credit crisis as rate-spread derivatives go bust.

7) As rates increase, so do the variable rate interest payments on credit cards. With the consumer already impacted by stagnant wages, under-employment, and high living costs, a rise in debt payments would further curtail disposable incomes. 

8) Rising defaults on debt services will negatively impact banks that are still not adequately capitalized and still burdened by massive bad debt levels.

9) The deficit/GDP ratio will surge as borrowing costs rise sharply.

I could go on, but you get the idea.

Since interest rates affect “payments,” increases in rates negatively impact consumption, housing, and investment, which ultimately deters economic growth.

With “expectations” currently “off the charts,” literally, it will ultimately be the level of interest rates that triggers some “credit event” that starts the “great unwinding.”  

It has happened every time in history.

No Way Out

The problem for the market going forward, as noted, is that markets have priced in a speedy recovery back to pre-recession norms, no secondary outbreak of the virus, and a vaccine. If such does turn out to be the case, the Federal Reserve will have a huge problem. 

The “unlimited QE” bazooka is dependent on the Fed needing to monetize the deficit and support economic growth. However, if the goals of full employment and economic growth get quickly reached, the Fed will face a potential “inflation surge.”

Such will put the Fed into a very tight box. The surge in inflation will limit their ability to continue “unlimited QE” without further exacerbating the inflation problem. However, if they don’t “monetize” the deficit through their “QE” program, interest rates will surge, leading to an economic recession.

It’s a no-win situation for the Fed.

As Doug Kass concluded last week:

“To me, there is only one inescapable economic conclusion – inflation and interest rates are heading higher as better economic growth in the last half of 2021 is delivered by the unprecedented stimulus. Unfortunately, the stimulus is in the form of mostly transfer payments and not in expansion of productivity or capacity.  

The economic boom will be a sugar-based high and there is an almost inevitable bust cycle emerging by or in 2023 when the heady fiscal stimulus ends.      

Today’s record stock prices belie a likely hard economic landing that may lie ahead.”

Of course, this has always been the case historically. Just as the “Coyote” still wound up going over the cliff when chasing the “Roadrunner,” excessive bullish optimism is always eventually met with disappointment.

The post The Two Pins That Will Pop The Stock Market Bubble appeared first on RIA.

Economics

Looking for the Next Big Crypto to Explode in 2021? Try These 5 Coins

Bitcoin (CCC:BTC-USD) launched on January 3, 2009. The oldest and largest cryptocurrency, prices of this coin have swung wildly since its inception. But…

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Bitcoin (CCC:BTC-USD) launched on January 3, 2009. The oldest and largest cryptocurrency, prices of this coin have swung wildly since its inception. But last year, Bitcoin experienced explosive institutional and retail interest in the space alongside the broader crypto world. Now thousands of altcoin investors are betting that they can pick the next crypto to explode.

Even though Bitcoin recently underwent a correction, trading volume remains strong between $42,000 and $50,000. Of course, that is very expensive, considering the median household income is $62,843 right now. Yes, you can invest in Bitcoin through PayPal (NASDAQ:PYPL) and Square (NYSE:SQ). But the crypto is still expensive when you compare it to several altcoins out there.

Plus, there are over 7,000 cryptocurrencies you can choose from for your portfolio. When it comes to making big gain, it’s easier for a coin to gain 100x if you’re starting from a smaller size, rather than chasing after a rocket that’s already taken off.

Here are 5 coins that could be the next big crypto to explode:

When investing in any crypto, remember to check if there is an inherent utility to the coin. Even cryptos meme coins need developers to crank out regular updates to stay relevant.

The Next Big Crypto to Explode: Ethereum (ETH-USD)

A stack of ethereum coinsSource: shutterstock

Ethereum is a decentralized, blockchain-based software platform, and its cryptocurrency is called Ether or Ethereum. Ether is the world’s second-largest cryptocurrency and has held this position for a long time now. Recently, Ethereum has been in the news for its hard fork “London upgrade,” a major revamp for the platform. The hard fork comprises five Ethereum Improvement Proposals (EIPs). The upgrades are important, but the most notable is EIP 1559, which reduced Ether supply with every transaction.

In addition, the upgrade will lead to the Ethereum network handling more transactions per second, improving scalability, and bringing down transaction fees. Another major benefit is expected to decrease the total number of ether coins in circulation, making it a deflationary cryptocurrency. In the run-up to the upgrade, Ethereum did very well. However, considering the next upgrade will occur at the end of 2021, there is an upside here that you can exploit.

Binance Coin (BNB-USD)

A Binance Coin (BNB) sits in front of trading charts.Source: Shutterstock

Binance is one of the most successful crypto exchanges globally when ranked by trading volumes, which is why BNB, its native cryptocurrency, is soaring.

Much like Bitcoin, the thing to like about Binance Coin is the hard limit on the total number of tokens in circulation. It has a strict maximum limit of 200 million BNB tokens. As a result, the token price has risen exponentially for the year thus far.

Binance uses around one-fifth of its profits every quarter to eliminate or “burn” BNB tokens. The reason for destroying or “burning,” coins makes sense: it increases the worth of the remaining tokens.

One of the biggest reasons to be optimistic about Binance Coin is its many use cases. Initially, it was developed as a utility token for discounted trading fees in 2017. But now, you can use it to make travel payments, financial services, and entertainment, among others.

The driving force behind any token is its usability and that’s why BNB will be the next crypto to explode.

Tether (USDT-USD)

A concept token for the Tether (USDT) cryptocurrency.Source: DIAMOND VISUALS / Shutterstock.com

Stablecoins are a new breed of crypto gaining prominence. They are a less volatile alternative to Bitcoin because they are linked to an asset like the U.S. dollar, as is the case with Tether. The cryptocurrency allows you to transact in traditional currencies and avoid the complexities of digital currencies.

Tether is designed to bridge fiat currencies and cryptocurrencies, allowing users to transfer other cryptocurrencies back to U.S. dollars in a less complex, faster manner. Tether has a 1-to-1 ratio with the U.S. dollar for valuation.

Consequently, the altcoin is less speculative than popular cryptocurrencies like Bitcoin and Ethereum. For crypto investors who want to avoid the wild swings that are part and parcel of this space, Tether should be right up your alley as the next crypto to explode.

Monero (XMR)

XMR logoSource: Wit Olszewski / Shutterstock.com

Monero is very popular these days because it has the ability to anonymize users. Ring signatures and stealth addresses help in accomplishing this task. Due to the technology at its disposal, the privacy-focused Monero cab hides the identities of the sender and the receiver.

The only problem some might have with Monero’s approach is that privacy isn’t really an option. It enforces anonymity at a fundamental level. That may rub certain people the wrong way.

But there are several people out there who love this feature and want to protect their identity online since this was one of the main initial benefits of blockchain technology — to remain completely anonymous.

Algorand (ALGO-USD)

Algorand logo in light blue against a simple dark-colored, futuristic-looking backgroundSource: shutterstock.com/Shizume

Algorand investors have enjoyed blockbuster returns following an announcement that El Salvador would establish blockchain infrastructure using Algorand.

Italian computer scientist Silvio Micali is the man behind the platform. ALGO-USD has positioned itself as a competitor to Ethereum. One of the biggest things going for it is the proof-of-stake proofing algorithm, which is less energy-intensive to run. One of the main criticisms against Bitcoin is that it consumers a lot of energy. Through using a proof-of-stake mechanism, ALGO-USD sets itself apart from the rest of the altcoins out there.

On the publication date, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.

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Economics

Use Caution As the Pullback Could Continue for Ethereum

After making it back near $4,000 per token, Ethereum (CCC:ETH-USD) prices have pulled back in the past few weeks.
Source: shutterstock
Mainly, the pullback…

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After making it back near $4,000 per token, Ethereum (CCC:ETH-USD) prices have pulled back in the past few weeks.

Source: shutterstock

Mainly, the pullback was a result of the crypto flash-crash experienced on Sept. 7. But profit taking by traders who bought the popular altcoin before it surged due to the launch of its London Hard fork may have also played a role as well.

No matter the reason, one thing’s for sure. Don’t assume this latest pullback will be short-lived. Yes, with its increasing utility and institutional interest, Ethereum’s chances of hitting $4,000 again look high. So too, do its prospects of ultimately rallying to five-digit price levels.

Yet such a move may take time to happen. For now, with the concerns with crypto overall I’ve highlighted previously still on the table, and the likelihood that this rising uncertainty compels more traders to take profit, you can expect Ethereum to remain on its current downward trajectory.

Trading for around $3,100 as of this writing, a move back below $3,000 may be in the cards. For cryptocurrency investors with a long-time horizon, possible short-term volatility may not be a big issue. Buying now may still be worthwhile.

If you’re looking for a quick profit, however, you should hold off for now.

It May Be a While Before Ethereum Surges Again

Rival altcoins like Cardano (CCC:ADA-USD) could eventually give Ethereum a run for its money. But for now, ETH remains the main crypto used in DeFi, or decentralized finance, transactions. Recent and upcoming improvements could help it hold onto this dominance. I’m talking about last month’s hard-fork upgrades, plus its planned switch from running on proof-of-work (PoW) to running on proof-of-stake (PoS).

This bodes well for prices in the long term, assuming DeFi continues making its way toward getting critical mass, and starts to truly disrupt the traditional fiat-based financial system. What also bodes well for Ethereum is increasing enthusiasm for it by institutional investors.

For instance, growth stock guru and Ark Invest head Cathie Wood has become more vocal in her bullishness on Ethereum. But unlike with Bitcoin (CCC:BTC-USD), which she predicts will hit $500,000 within the next five years, Wood has not provided a definite number as to where this crypto is headed during the same timeframe.

Nevertheless, one crypto market commentator has taken her recent shilling of ETH, along with the large amount of Ethereum leaving exchanges, as a sign it’s fast heading to $10,000 as institutional investors dive into it with full force.

So, does this mean it’s high time to buy the dip, locking down a position before it makes a quick trip to five-digit prices? Not so fast! While there may be a path for it to ultimately hit such levels, it’s likely not happening soon.

Still Plenty in Play to Send It Back Below $3,000

Investors bullish on Ethereum may be on the money about its eventual move to substantially higher prices. Yet in the short term, there’s just too much going on to push it lower. First, there’s the increasing call for crypto market regulation. Admittedly, this is an existing issue, and one market participants have so far ignored.

Even so, that may not continue to be the case. At first, possible regulation by the U.S. may appear to be a sign that this asset class is ready for prime time, to be followed by a large inflow of institutional money. But what if the point of increased regulation is to prevent crypto/DeFi from growing in popularity?

Take, for example, the efforts by the Securities and Exchange Commission to prevent Coinbase (NASDAQ:COIN) from launching its Coinbase Lend service. It remains to be seen whether increased scrutiny of crypto products will affect usage growth for DeFi. If it does? This may challenge the idea that increased

Along with regulatory risk, there’s the risk that, if markets get rocky, speculative assets like cryptocurrencies will fall in price as well. With both uncertainties hanging over it, don’t be surprised if traders continue to take profit, sending Ethereum back below $3,000.

Only Buy Today If You’re in For The Long Haul

In the long run, ETH-USD may have a road to $10,000 and above. If DeFi takes off and institutional investors allocate more capital to this top altcoin, it may eventually make it to five-digit price levels. Just don’t expect to happen in a matter of months. At least until the issues weighing over it today clear up or play out.

As regulatory and market risks remain, traders looking at it as a short-term play should be cautious with Ethereum. Holding it through uncertainty could pay off on the other side.

On the date of publication, Thomas Niel held long positions in Bitcoin and Ethereum. He did not have (either directly or indirectly) any positions in any other securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.

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Economics

The dot plot thickens

All eyes on FOMC meeting FOMC day finally arrives with markets already being buffeted by a variety of inputs. Although I expect the FOMC to not give too…

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All eyes on FOMC meeting

FOMC day finally arrives with markets already being buffeted by a variety of inputs. Although I expect the FOMC to not give too much away on the tapering front, the best we can expect I believe is a signal that they will make a firm decision on whether to start at the November meeting, we could in for a surprise on the latest dot plot. The dot plot, which charts FOMC members’ timelines for rate hikes or cuts could see more members moving hiking expectations into 2022. We may not get a taper tantrum lite from tapering comments, but we could from a more hawkish dot plot. I’ve long given up hope that US bond yields will react materially, but we could see a further extension to the US dollar rally and equities and commodities probably won’t have a good day at the office.

It is a busy day for central banks anyway with the Bank of Japan announcing its latest policy decision this morning. Like Indonesia yesterday, I expect no change from the BOJ, with a new prime minister to be chosen next week and an election to hold in the next couple of months. They may downgrade growth expectations and hint that more stimulus is ready should the economy slow, which should be supportive of Japan equities. Paraguay sneaked in a 0.50% rate hike this morning Asia time, and Brazil this evening, after the FOMC looks set to hike rates by another 1.0%. With Russia also on a hiking path, parts of the EM world could become attractive carry propositions if Mr Powell keeps the dovish hat firmly on. Turkey should be hiking, but that is a quick path to unemployment if you are the central bank governor.

Mainland China returns to work today although Hong Kong markets are on holiday in a game of tag. China has left its one and five-year Loan Prime Rates unchanged at 3.85% and 4.65% respectively as expected. Another RRR cut, probably early in Q4, is my favoured easing path for the PBOC. With one eye on the Evergrande saga, which has captured the world’s attention, the PBOC has injected a chunky liquidity injection today of CNY 120 billion via the 7 and 14-day repos. Whether that is enough to soothe frayed nerves in China remains to be seen.

What has soothed nerves is Reuters reporting that Evergrande’s Hengda Real Estate unit will make coupon payments on onshore bonds that was due tomorrow. That saw an immediate jump in the risk-correlated Australian and New Zealand dollars, and some buying coming into early Asian equity markets. However, the Evergrande story will keep on giving with the Financial Times reporting yesterday that Evergrande issued wealth management products sold to Chinese retail investors were used to plug financial holes in various subsidiaries. Concerns also swirl around its stake in a regional Chinese bank and whether it has been borrowing from itself effectively. The coupon payment story is likely only a temporary reprieve with no signals from the Chinese government over what steps, if any, it will take to assist an orderly wind down or restructuring.

US markets are contending with their own challenges in addition to the FOMC. The House of Representatives passed a vote to extend the US debt ceiling until after next year’s mid-term elections and will vote on a full bill today. It will likely be dead on arrival in the US Senate though, with Mitch McConnell as much as saying so, forcing the process into reconciliation to pass. The tiresome gamesmanship over the debt ceiling from both sides should be another reason for the Fed to stay on the cautious side of things this evening.

Natural gas prices continue to make headlines with European gas prices having climbed by over 400%. Most of the noise is around the 10-20% of gas that producers keep for the spot market and here it seems Asia is winning the bidding war. Gazprom is reluctant to increase export volumes to Europe above contracted amounts, meaning no spot gas. Bemusingly, signals from Russia suggest that a quick approval and certification of the new NordStream2 pipeline could result in an immediate increase. All Europe and Asia, to a lesser extent, can do, is hope for a mild winter at this stage. Europe is paying the price for its naivety in tying energy security to Russia in the hope that it would be a reliable partner. That’s like me turning structurally bullish on cryptocurrencies and starting to call them an investable versus tradeable asset class.

For today, Evergrande has knocked the FOMC meeting into second place in the attention of Asian investors. I expect regional markets to be buffeted by headlines emerging from that situation and the price action after the coupon payment news suggests dip buyers hungrily await in everything if even tenuous positive news arrives.

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