The Last Bubble?

It's time to check in with the stock market, which I last wrote about in Human Craziness Goes Hyperbolic (November 25, 2013).

Although we are in Year 18 of what I call the Bubble Era, things seem to have taken a turn for the worse lately, a development which remained only a (remote?, likely?) possibility only a few years ago.

The most conspicuous of these bubbles is in the U.S. stock market, whose valuation (as measured by various indices) now threatens to touch Heaven itself. We acknowledge of course that the U.S. stock market is not in a bubble "officially" unless former Fed fixture "Easy Al" Greenspan says it is not in a bubble. Happily, we've got the reverse confirmation we need.

The S&P 500 on November 25, 2013 in the 18th year of the Bubble Era

Closer inspection of the S&P 500 reveals that a "correction" may have begun.

I was prompted to write this post when I heard from Eric Janszen, who recently posted a warning on iTulip called The Last Bubble. I hadn't heard from Eric in a long time. He is not optimistic.

A Dec. 30, 2013 update to Eric's 2011 chart. The red line is his April, 2011 forecast for a 56% reversion to the mean (black line) in 2014. Click to enlarge

Eric is sticking to his 2011 forecast. If he's right, the "last bubble" began to burst in January, 2014.

CI: This may be more than a correction, then? I mean, really? A 56% decline?

EJ: In mid-2011 I projected what I called the Extended Asset Price Inflation Case. That's the green line [chart above]. The Real DJIA was to climb from 83 at the time to just over 100 by the end of 2013. Early in 2014 it begins to price-in a mid-gap recession later in the year. The first chart was published April 2011 as the watermark indicates. The update was generated from the same excel file. The DJIA data are from the Dow Jones & Co. and the inflation adjustments updated using the latest data from the Real DJIA web site that we've been using since 2006.

CI: So the crash you forecast in mid-2011 for early 2014 is happening? Wish you'd reminded me of this chart sooner!

EJ: That would appear to be the case. However, a crash of the full extent of 56% shown spells complete disaster for the U.S. economy. I seriously doubt that the Yellen Fed will stand by, or at least I hope they understand the danger. The correction is a delayed reaction to the beginning of the end of the Fed's bond price fixing operation, which ending I have warned for years was to produce chaos in the bond market as market participants thrashed around trying to figure out what the market price of a long bond is without the Fed's interference in the market. By the way, a member asked me about this in December in the Ask EJ section here, which is why the update has a Dec. 30, 2013 watermark on it.

Eric may be right about the timing and extent of the next "correction". Or he may be wrong about one or both.

I believe that what goes up (which shouldn't have gone up to the extent it did) must come down.

The Federal Reserve reflated the financial/insurance/real estate (FIRE) economy after the 2008/2009 crash. For example, now we are getting a new wave of  "financial innovation" (sigh) which is similar to but not the same as that which blew up the world five years ago.

Wall Street’s latest trillion-dollar idea involves slicing and dicing debt tied to single-family homes and selling the bonds to investors around the world.

That might sound a lot like the activities that at one point set off a global financial crisis. But there is a twist this time. Investment bankers and lawyers are now lining up to finance investors, from big private equity firms to plumbers and dentists moonlighting as landlords, who are buying up foreclosed houses and renting them out.

The latest company to test this emerging frontier in securitization is American Homes 4 Rent. The company talked to prospective investors at a conference in Las Vegas last week about selling securities tied to $500 million of debt, according to people briefed on the matter.

American Homes 4 Rent, which went public in August, has tapped JPMorgan Chase, Goldman Sachs and Wells Fargo as its bankers for a debt deal that is expected to be sold by the end of the first quarter, these people said.

While this securitization market is still in its infancy, a recent Wall Street estimate put potential financing opportunities for the single-family rental industry as high as $1.5 trillion.

Already some members of Congress and economists are worried about another credit bubble.

If the stock market and various other bubbles crash, it is hard to imagine the Fed will whip out the money-printer and reflate this mess once again. This latest securitization boondoggle/rip-off opportunity will fall flat on its face.

That's why we may be witnessing the crash of the "last" bubble.

Comments

[Brian]

Maybe, but the current "state of the art" economic thinking (as espoused by the likes of Summers, Krugman, and the rest of the neoclassical horsemen) is that we are now in a period of... wait for it.... "secular stagnation". During this period, the real "clearing" interest rates would be negative, which, of course, cannot happen. In fact, apparently we have been in this state for some time. Evidence for this is the need for bubbles in order to improve the employment situation and the increasingly poor response of the economy to previously successful stimulation procedures. In short, these people are now saying the economy has for some time been in this negative interest condition and now requires bubbles just to get by.

Given this mentality it's hard to see how these people would fail to find some way, almost any way, to create future bubbles (along with the associated blowback they inevitably bring). Their view of the economy requires it.

Economists are, for the lack of a better word, insane.