This is NOT the chart I promised you yesterday. That’s coming.
I wanted to lead out today’s Rum Rebellion with the Dr Jean-Paul Rodrigue’s ‘Four Phases of a Bubble’ chart. The psychological mapping of a market’s ‘rise and fall’ was developed in response to the GFC.
The extent and duration of each rise and fall varies, but the psychology never does. Mankind has made tremendous progress over the centuries. However, one thing that’s not changed is human nature.
Our highly predictable herd responses are why psychological mapping is an invaluable tool in identifying where we are in the cycle.
And at present we are over in the far left ‘blow-off phase’.
Denial. Bull Trap. Return to ‘normal’.
Fair warning of what’s to come
These are all playing out as per the psychological responses to previous bubbles going back as far as Tulip Mania.
The reason for showing you this upfront is to again give fair warning of what’s to come…fear, capitulation and despair.
Source: Dr Jean-Paul Rodrigue
I know people don’t see this in their future. And why would they? Things are going to ‘return to normal’.
But are they?
In the US there’s a growing chorus of people wanting life to go back to normal…
Source: NBC News
People should be very careful what they wish for.
While infection rates in the US might have peaked, that doesn’t mean the worst is over. That just means the containment measures — to date — have been effective.
Any relaxation of the measures could have deadly consequences.
In mid-March 2020, John Hussman developed an algebraic model to project 60-day fatality rates in the US (yellow line).
This chart is the OPTIMISTIC scenario, a peak in new cases on 13 April 2020.
As at 5 April 2020, the actual fatality rate was tracking the projected rate.
Source: John P Hussman PhD
The updated OPTIMISTIC scenario is based on case numbers peaking and containment measures ‘driving daily case growth below 1% by 30 April 2020’.
Up until last week, the actual to projected was an almost perfect overlay.
Then something has gone wrong as tweeted by John Hussman:
‘Apr 16 (667,801 [total cases], 32,917 [deaths]): This isn’t good. U.S. fatalities just jumped off book. We shouldn’t see 31,000 yet.
‘Apr 18 (735,076 [total cases],, 38,903 [deaths]): So much for the optimistic scenario. We’re way off book. I had hoped this was just a one-time adjustment. Understand this: PEAK daily new cases in a containment scenario is also PEAK infectivity if containment is abandoned at that moment.’
Source: John P Hussman PhD
And this is the OPTIMISTIC scenario before containment measures are relaxed.
According to John Hussman (emphasis added):
‘It’s not clear whether that peak will be durable, but even in the optimistic case that the “peak” is behind us, it’s important to understand that the epidemic curve has a long, fat tail. Cases and fatalities do not simply collapse to zero. Even in the optimistic case, we’re only about half-way through this thing from the standpoint of likely U.S. fatalities.’
Easing restrictions too soon risks another COVID-19 outbreak in the US.
And with that comes reinstatement of restrictions, more uncertainty and an almost certain increase in fatalities.
Talk of a return to normal is fanciful. As John Hussman says, ‘the epidemic curve has a long, fat tail.’
The economy is suffering
The US government is in a damned if we do, damned if we don’t situation.
The economy is clearly suffering. Record unemployment. Massive debt bailouts. Severe GDP contraction.
The extent of the underlying damage has not yet been fully priced into markets. Why?
The belief in return to normal.
In attempting to fast track the return to normal promise, it’s likely we’ll see a bad situation made even worse.
Which could be the catalyst for the next stage in the cycle…fear.
The pressure to return to normal has intensified due to sheer amount of debt in the system.
Households and businesses need income to service debt obligations. Some have been thrown lifelines. Some have been given debt moratoriums.
But not all. And that’s where the real sleeper is in all of this.
Before I show you the chart I promised, this is from an article I wrote in Markets & Money on 19 February 2019 (emphasis added):
‘…what’s going to happen when the next credit crisis hits?
‘The economy contracts. Business activity slows. Less profit. Lower Dividends.
‘And that’s just on the income side.
‘On the capital side, the multiple paid on those lower earnings will also shrink…driving share prices even lower.
‘My thoughts on the depth and severity of the next crisis are well known…it will make 2008/09 look like a Sunday School picnic.’
And now we come to the chart that shows why that prediction of 2008/09 looking like a Sunday School picnic is not so far-fetched.
But first, a reminder of the cause and cure of that ‘GFC picnic’.
In 2008/09, US$300 billion of subprime debt gave us — as Barack Obama described at that time — the ‘worst economic crisis since the Great Depression.’
To avoid a second Great Depression, the US Federal Reserve went into stimulus overdrive.
Interest rates went straight to (almost) zero and ‘quantitative easing’ became a household term.
The Fed’s balance sheet went vertical and drifted higher with each new QE. In total, the subprime US$300 billion problem required US$3,500 billion solution.
Source: Federal Reserve Economic Data
And faced with a new crisis, the Fed’s balance sheet has once again gone vertical.
In the blink of an eye, US$4 trillion has gone to US$6 trillion…and this is just the beginning.
Remember, the GFC forced the Fed to throw US$3500 billion ($3.5 trillion) at a US$300 billion problem.
Here’s the chart that shows you why 2008/09 is going to look like a Sunday school picnic.
That hardly noticeable dip in ‘At Risk’ loans in 2008/09 was your subprime problem.
Compare that with the current At Risk loan total…US$10,000 billion (US$10 trillion).
This is 33 times greater than in 2009!
This is going to be much worse the 2008/09
To be fair, you didn’t need to be particularly gifted to realise the next debt crisis would be far worse than the previous one.
When you try to solve a debt crisis with a further US$110 trillion of new debt, logic tells you the magnitude of the inevitable problem is going to be greater.
Obviously that logic was lost on central bankers…or more likely, ignored.
Either way, their recklessness/stupidity/arrogance/smugness has created a debt crisis that’s going to make 2008/09 look like a Sunday School picnic.
How they’ll print their way out of this one is beyond my thinking.
Using 2008/09 as a guide, does the Fed need to conjure up US$50 trillion or US$80 trillion or US$100 trillion to repair the economic damage caused by US$10 trillion of At Risk loans?
The longer the US economy remains ‘contained’, the more at risk those At Risk loans become.
This chart shows the precarious cash position of US small businesses…a sector whose debts are represented in the At Risk loan total.
This is the headline from The New York Times on 16 March 2020:
That was 38 days ago…well beyond the median of 27 days cash buffer.
How many of those small business owners also have mortgages, car loans, credit cards? And the (former) employees of those small businesses more than likely also have debt/s.
There are no good outcomes from this.
The pandemic’s long, fat tail will keep wagging well beyond the period that businesses and households can remain solvent.
How much of that US$10 trillion in At Risks loans are going to default 10, 15, 20% or more?
Defaults and debt restructuring are what’s coming.
Returning to normal is a pipe dream.
When that reality dawns on people, we’ll see a discernible shift in society’s thinking.
Fear. Capitulation. Despair.
Be prepared, this is going to be much worse the 2008/09.