#1. The Market Gave and The Market Shall Taketh
How the 'Everything Bubble' is bursting, what caused it & where we are heading.
Background
Back in November 2021 I had written a short article for myself, as a reminder to avoid the noise and focus on the macro. Following two years of extreme market gains I had anticipated that the bubble might finally be bursting.
During the COVID saga, I had been astounded by the markets. We are led to believe that markets are efficient yet here we were with entire industries, states and nations closed for business whilst the main US Indices were making new all time highs every week. The S&P 500 made 70 [SEVENTY] all time highs in 2021, more than once a week. That was 2021.
2020, the year when Covid entered the conversation was even more wild. Once the virus was confirmed to be ravaging Europe in Northern Italy, the markets dropped 35% in two months. The markets were efficient. Lockdowns were being ordered in Central Europe and the US would surely follow. The markets reacted as is expected. However, under Trump and Jay Powell’s leadership the markets not only recovered, they gained 16% by end of year.
Clearly the markets were not working efficiently anymore.
This Time is Different
So why was this happening? The common answer seems to be that people were bored at home trading. Statistics would suggest this was to an extent, true. In 2020, the iGaming industry grew 17%, again, during a period of economic uncertainty. Trading platforms also saw an increase in volumes of around 4%. Not overly significant but still a decent increase. Furthermore, the amount of people I know that all of a sudden had a trading platform on their phone increased substantially. The idea that people were bored at home gambling therefore has some truth to it although it wasn’t the main contributor to the market mania.
“This time is different”. This is a popular saying in trading circles. It’s a sarcastic comment usually stated when markets become inefficient. The notion of course is that new participants entering the game are often led by emotions, not skill or experience. These new participants see markets gaining at a substantial rate and as such believe that the market goes one direction, Up Only. This mentality leads them to believe that they are immune to draw downs, the market will just go back. We know of course that this isn’t true. Throughout history markets go through cycles of booms & busts and always revert to the mean.
But this time it would be different, right?
The Blow Up
So we know that markets were highly inefficient in 2020 and 2021. Coming into 2022 we must be optimistic. Economies are re-opening again, Covid is consigned to the history books and we’re entering the new generation of the ‘Roaring 20's’.
Not quite!
You see the markets are efficient until they are not. And they are not for one simple reason, Manipulation. The markets reacted as they should have in Feb 2020. A global lockdown and drop in economic activity would naturally lead to a financial market meltdown. That’s an efficient market. The manipulation happened from the Central Banks. The Fed along with other Central Banks had no option but to prop up the economy through asset purchases and quantitative easing [QE]. This ‘free’ money created to supplement business, wages and stimulus checks, saved the economy during the pandemic. Undoubtedly, society would have been on the verge of a Mad Max setting had the Central Banks not stepped in. However every action has an equal and opposite reaction.
The creation of new money is not something new. Inflation is useful, when controlled, to stimulate growth. The problem is that when inflation spirals out of control, it creates chaos in pricing and the local economy. Rapid inflation, like we’ve seen in 2022, happened because the new money was pushed into the market without the appropriate demand being available. Because Supply Chains were so disrupted during these years, goods and services required premiums to secure. This new money therefore was able to purchase less goods for every dollar issued. Obviously, the consumer would pay the difference anyway.
So now, it’s 2022, the economy is open and mean reversion is on track. Except that everything costs substantially more. It’s not hard to understand that higher costs equals higher prices, which in turn equals less consumer spending which is bad for the economy. This compounded with the fact that stocks and assets were highly overvalued meant that investors were keen to start unwinding their positions.
The Exit Pump
As the market ran hot on free money I had deep concerns. I wasn’t old enough to remember the Dotcom Bubble but I researched it enough to see the similarities.
Asset prices were largely inflated through cheap money.
Media frenzy gained worldwide attention.
Increase in retail participation.
The third point was my biggest concern. I am of the belief that the abundance of user friendly brokerage apps were created and licensed for the sole reason of bringing retail to the slaughter. The Robinhoods and Plus500s of the world arrived just in time for average Joe to deposit his cash into an Up Only market. Mr Joe would double or triple his money in a couple of months and then decide he is a market genius. Naturally, a double or triple isn’t enough money when the market just goes up. So why not try CFDs? And this is where the big boys wanted them.
The big boys in Wall Street and The City of London are no fools. They are master chess players and they baited the pawns into gambling their savings. Everyone knows that in the casino, the house always wins. Wall Street is no different. And so the institutions, in tandem with the central banks made the largest wealth transfer in modern history. Tricking the plebs into depositing more and more cash into the Up Only market to pull the rug from under their feet just as the economy was opening up post Covid. The perfect exit pump was initiated and what’s even better for our Kings and Queens of the chessboard is that they didn’t even have to bury each other.
What Now?
As we head into 2023 the economy is largely in disarray. The US refuses to admit its in a recession. Europe is in a recession and are compounded by a currency that lost 20% against the USD [this effects Chinese imports too] an energy crisis and of course a war on their doorstep. I will write a separate piece about the war however I had predicted back in 2021 that a war would arise as it always does during periods of financial instability.
The financial markets are unwinding and note that they are doing it slowly. This is 100% by design to continue trapping participants. 2022 has been a relatively slow bleed. 2023 will be a year of capitulation. The markets will reflect the economy and one of two scenarios will arise:
The economy enters a short period of contraction before a return to economic growth - Much like crash in 2008.
The economy enters an extended period of contraction resulting in decades of stagflation - Like the 1970s.
I would like to believe that the first scenario will happen however my gut says scenario 2. After a 13 year bull run and a blow off top, I see no reason to believe why this is a short term fix.