“The Most Critical Time Since the Financial Crisis”

“We’re faced with the most critical time since the financial crisis.”

This we have on the grim authority of money man Sven Henrich.

Last evening prepared us for this morning’s hells…

In overnight trading, S&P futures plunged 5% in four hours. The selling frenzy tripped the “circuit breakers.”

These fail-safes were installed after 1987’s “Black Monday” to prevent encores.

Thus S&P futures trading screeched to a halt, suspended… lest the fever deepen.

But the opening whistle blew this morning. And the delirium resumed precisely where it had ended…

A Trading Halt

The S&P went instantly careening. It shortly sank 7%.

Once again the violence tripped the circuits (the threshold for regular-session trading is higher than after-hours trading).

The referee called a halt at 9:34 — the first ever under existing rules — and administered a 15-minute standing count.

For 15 minutes the market fought to recapture its legs… and its wits.

At 9:49 the ban came off. Though woozied, the market “stabilized.”

But the battened and bludgeoned market could scarcely maintain the vertical.

The Worst Day Since “Black Monday”

Both S&P and Dow Jones went along, 5% down through noon. The remainder of the afternoon worked little improvement.

The Dow Jones tumbled 8% at one point this afternoon — the most since another Monday, long distant — “Black Monday” in 1987.

It closed the day down 7.79% to 23,851, a 2,014-point waylaying.

The S&P gave back 226 points on the day, for a 7.60% loss.

The Nasdaq similarly absorbed a 625-point trouncing, losing 7.29% on the day.

Thus the three major averages presently camp upon the doorstep of a bear market. One more slip… and they go in.

A bear market is a 20% plunging from recent peaks.

European stocks officially crossed over today — down over 22%. Not three weeks ago they traded at record heights.

Meantime, 10-year Treasury yields plunged to a starvation-level 0.318% this morning.

Words fail us.

“The Path of Least Resistance is Still Down”

Is the worst over?

“The path of least resistance is still down,” shouts Liz Ann Sonders, chief investment strategist at Charles Schwab.

Once again we must point our accusing finger at “passive investing.” The computers caught a fever, unloading positions at electronic speeds.

But there are few buyers on the other end to take them in.

That is why — we theorize — “corrections” have attained great ferocity in recent years.

That is also why markets have gone from record heights to bear market’s doorstep within three weeks.

But what happened this morning? Why did the bottom drop away?

Oil Collapses

Oil is the explanation most widely on offer. Investors Business Daily:

Oil prices began to collapse on Saturday as negotiations between Saudi Arabia, the de facto leader of the Organization of the Petroleum Exporting Countries, and Russia over production quotas failed. The breakdown in talks led the Saudis to sharply slash prices in the onset of another price war. The Saudis also said they would abandon OPEC’s current production curb, a move that opens the same door to other OPEC members, threatening to flood the already-oversupplied oil market with possibly more than 3 million barrels per day in additional production.

Oil prices had already sold off for three straight weeks, losing more than 37% as global markets grappled with the potential impact upon demand of the coronavirus outbreak begun late last year in China.

Crude oil hemorrhaged 25% today — its heaviest rout since 1991. It has come all the way down to $30.93. And oil stocks took a savaging today.

Two “Black Swans” Converge

Thus two “Black Swans” pooled their mischiefs… and came swooping in this morning.

These nightmare birds are the coronavirus and oil. Combined they account for this sudden terror.

So argues Seabreeze Partners Management president Doug Kass:

Over the weekend one old Black Swan (coronavirus) and a new Black Swan (substantially lower energy prices) joined forces in the pond as the collapse in yields and energy prices is serving to crater global equity markets this morning. In scope and rapidity, the accumulated declines in bond yields and stock prices are unprecedented…

There will be enormous fallout where large bets have gone wrong — ranging from bond, equity, commodity and VIX positioning.

Adds one Chris Rupkey, chief financial economist at MUFG Union Bank:

[Stock market investors] want out. Big-time. The sky is falling. Get out, get out while you can. Wall Street’s woes have to eventually hit Main Street’s economy hard.

A Minefield of Debt

The energy sector is soaked through with debt. A fair portion is “high yield.” That is because it is, as the professionals say… risky.

Many of the big banks hang on the other end of it. Bank stocks absorbed some of the heaviest slatings today — not coincidentally, we hazard.

What if losses pile up in the energy sector? Defaults could go barreling through the credit markets.

And woe to ye of earth and sea once they do…

Nordea’s global chief foreign exchange strategist Martin Enlund:

If “unforeseen losses” show up in the high-yield sector (very energy-heavy), it might damage the credit cycle… and if the credit cycle cracks, forget about buybacks, mergers and acquisitions and the S&P’s current valuation.

Buybacks are the chief gimmick behind the market’s gorgeous multiyear spree.

Who will buy if the corporations do not? Who will pick up the standard… and carry forward?

The questions nearly answer themselves.

Next we come to a central actor in the drama unfolding before us — the central bank.

Heading Back to Zero

What can you expect from the Federal Reserve in the days and weeks ahead?

Its recent “emergency” 50-basis point rate cut came thudding down… like a zeppelin of lead.

But of this you can be certain: More is ahead.

Goldman Sachs chief economist Jan Hatzius is convinced the Federal Reserve will hatchet another 50 basis points at this month’s FOMC meeting.

It will proceed to another cut in April, says he:

We now expect a 50bp cut, in part because the bond market is already priced for a large move and the FOMC will likely be reluctant to risk further tightening in financial conditions by refusing to deliver. We are also penciling in a final 50bp cut at the April 28-29 meeting.

At which point rates would hover between 0–0.25% — all the way back to post-crisis lows.

Remember “Normalization?”

And so Mr. Powell’s previous designs to “normalize” rates now appear a cruel, cruel jest.

We never believed he would succeed. The market is so entirely dependent on abnormal interest rates… it would collapse without the backstop.

He attempted to pull it out gradually after he came on duty. But he put it back after December 2018, when the market wobbled badly.

Now it is riveted into place and reinforced with cement.

But recession menaces — greater than at any point in years.

And like a blunderbuss artillery man who squanders his ammunition ahead of the main action… the Federal Reserve is blasting its remaining “dry powder” ahead of time.

As we razzed last week:

The Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

Monetary policy is a spent cartridge, an empty shell casing.

Central banks will be forced ultimately to surrender command to the fiscal authorities.

Prepare for Fiscal Policy

“Helicopter money,” Modern Monetary Theory, some variant of the two, these we will see.

Depend on it.

We opened today’s reckoning with a lament from analyst Sven Henrich:

“We’re faced with the most critical time since the financial crisis.”

And so we conclude with Mr. Henrich:

The constant subsidy of markets and the economy has led us to the largest credit and asset bubble in our lifetimes and the architects of the monstrosity have left themselves weak and depleted. They are now begging for fiscal stimulus from governments that are traditionally slow to react. The big bazookas will come, the question is whether it will be too late.

That is our question as well.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning