Stocks Plunge: ‘And This Too Shall Pass,’ Or Something

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In California’s Sierra Nevada, where the snowpack is at 12% of normal, bears have been seen rummaging about for scraps of food instead of hibernating. The opposite has become true on Wall Street.

The last stock-market bears have finally gone into hibernation, browbeaten and humiliated and ridiculed by years of brilliant, irrepressible rallies. Clinging to their principles and analyses, and to the now silly notion that stocks should trade in relationship to fundamentals and economic realities, they lost clients and money, and some of them lost their jobs too, and people got tired of listening to them or reading screeds of these sceptics who simply couldn’t see how central-bank money-printing might have such an outsized impact on asset prices. But in the end, practically no one can withstand the onslaught of Wall Street’s hype machine and keep their careers and businesses intact, and they just about all converted. In the nick of time.

That the real economy would in effect no longer matter to stock prices – that central banks have succeeded in surgically separating stocks from reality – is one of the greatest accomplishments in the dubious history of mankind. The bears simply refused to acknowledge it. And they’ve gotten clobbered.

So despite lethargic economic growth in the US since the financial crisis and the continuing unemployment fiasco, stocks soared. The debt crisis in the Eurozone that led to a full-blown economic crisis? Stocks soared. Germany’s three quarters of negative or no GDP growth over the last two years, with last year’s growth a minuscule 0.4%? Stocks soared. Next default in Greece? No problem, stocks soared. Stocks soared no matter what.

And now they stopped soaring. Suddenly, people are scratching their heads.

The Dow finished last year at the all-time high of 16,588. After today’s 326-point plunge, the index is down 7.3% for the year. The S&P 500 is down 6% from its peak a couple of weeks ago. Nothing of any notable significance has happened. Stocks are off a smidgen from their peak; so what?

In no time in history has there been so much money-printing by the largest central banks in the world. But now, except for the Bank of Japan, they’re all trying to figure out how to withdraw this addictive monetary drug from the markets without destroying their masterwork, the separation of stocks from reality, which the Fed, it must be admitted, orchestrated fabulously. So the entire world has been focused on every nuance of every syllable emerging from the Fed.

Could the party be over? No way, José. This party will never be over, the thinking goes. This is just a temporary blip, a healthy pullback, a minor squiggle. The market is building a base for the next leg up….. The Wall Street Journal reports about those intrepid investors:

They view the current pullback as a natural occurrence, the kind of passing storm that can hit every year or so. Since the Dow hasn’t fallen 10% since the middle of 2011, a drop of that size is overdue, they say. Some are even talking about a 15% or 20% decline without sounding too upset, because they think it will be over in a few months and stocks will finish the year with gains. And, they point out, stocks gained more than that last year alone, when the Dow was up 26.5%.

They have their reasons. They ceaselessly cite “better than expected” corporate earnings, though they never cite how these “expectations” are plunging in the months before the announcement so that earnings could actually be better than “expectations.” And they point at forward earnings multiples, based on distant and lofty earnings expectations, but they forget to mention that these earnings expectations will be plunging once they get closer to reporting time, making a mockery of their calculus.

And if there is a downturn, no big deal – because life has been so goooood.

“Maybe I’m going to give back some of the money I made last year, but as a long-term investor I’m not too worried,” explained Rex Macey, CIO at Wilmington Trust Investment Advisors with $20 billion in assets under management.  “You need occasional weakness to shake people up,” he said.

But no prior situation can be used as a model because never before have central banks done so much to inflate financial assets around the world. Already, there are some worrywarts in that mega-herd of bulls. The mere fact that stocks can do other things then just go up is causing concern. Didn’t the Fed get that bug fixed? And they’re already speculating that the Fed would step in with more QE and put stocks back on track.

Forget it, said Dallas Fed President Richard Fisher two weeks ago. Investors were using “beer goggles,” he explained. “Things often look better when one is under the influence of free-flowing liquidity.” So stocks may have become expensive, given economic realities, he said. “Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing….”

And today, as stocks were plunging, he pointed out that the events “in the real economy” would be the key to future monetary policy. “Markets don’t move in one direction,” he said. A principle that, after five years of relentless QE, Wall Street seems to have blissfully forgotten.

The Fed must have seen the spiking margin debt. Leverage is a sign of investor confidence – and at a certain level, exuberance. The great accelerator. On the way up. And on the way down. Margin debt has a nasty, very consistent habit of peaking just when the stock market begins to crash. Read…. Stocks on Speed: Margin Debt Spikes, So Does Risk Of Crash

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