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Is this the beginning of a global financial meltdown?

Three weeks ago I wrote a post titled ‘The Perfect Storm’, about why I am extremely bullish about Bitcoin. Since then the Bitcoin price has been very volatile and it’s down about 10 percent since I wrote the piece, but I still stand 100% behind my message that Bitcoin is ready to break out. This post is related, although it’s less about Bitcoin and more about the more traditional financial markets: I think we are at the beginning of a global financial meltdown.

Since I wrote my last blog post the Coronavirus turned from a local epidemic into a global pandemic. It is now spreading all over the world and many countries seem to be failing to contain it. It will have a huge economic impact and I believe this has not yet been priced in, simply because markets underestimate the global effects. One of the biggest economies in the world has come to a virtual stand still and this has been the case for over a month already. People in China are slowing going back to work, but it can take months before the country is back to it its pre-January levels. That means products and parts are not shipping, and factories all over the world can’t deliver their products on time.

Now the same is happening in other countries as well: South Korea and Japan are leading the pack by closing schools and factories, Iran’s leadership seems to be infected (10% has the virus already), and now Europe will be the next victim. In N-America Seattle could be the next Wuhan, simply because the government neglected to contain the virus in time and they are still not doing much. Don’t be surprised if in a few weeks the whole US economy comes to a stand still as well.

The day before I wrote my last blog post the Dow reached an all time high of 29,551 points. Since then there has been huge volatility and the index is now down about 12%. This may seem like a lot, but it’s not: the index first reached this level in January 2018, so basically 2 years worth of returns have been wiped out. What’s happening now because of the Coronavirus is just the tip of the iceberg.

From the outside it may look like things are fine, but when you look under the hood you will realize we are in for some major trouble. First of all, the FED tried to stop the fall in stock prices by doing a 50 bp rate cut. That is a major event that only happened a few times during the past 20 years (among others after 9/11 and during the 2008 financial crisis). There are some differences though: because interest rates are so low now, a 50 bp rate cut basically means cutting interest rate levels by 30%. That is huge. But worse, this time the 50 bp cut had no effect at all! The markets kept on falling after the rate cut. Huge overnight repo operations (basically printing $100 billion or more per day) also did not help anymore. I believe the FED is helpless unless it will start printing even more money (which could lead to hyperinflation) and that means the markets will be on their own. Likely interest rates will go to zero and we’ll probably even see negative interest rates, but it won’t help. It’s too little too late.

With powerless Central Banks equity markets will start falling heavily. In 1987 the market dropped 23% on Black Monday. If that would happen now it means the Dow would close below 20,000 points. I think it will happen, but it may take a few weeks to get there. Most people simply don’t seem to grasp the effects of the virus and what the secondary effects will be. If this becomes a depression you could see the Dow in 15,000 territory and possibly even lower. Maybe that’s good, because the markets were in a huge bubble caused by quantitative easing, but keep in mind it might wipe out most of the pensions of baby boomers. You don’t want to imagine the effect of that…

Most of the bubble in stock markets was caused by companies buying back their own shares. Because money was incredibly cheap they issued tons of debt (bonds) and used that to buy back their shares, causing their share price to go up. Because of stock options managers were strongly  incentivized to do this (their stock options go up in value when the share price goes up), instead of investing the money in the business.

The money mainly came from pension funds that lent it to corporates. So what will happen now? When the economy gets into a downward spiral these companies will be less profitable or even start to lose money. That means they won’t be able to borrow anymore or it will be more expensive for them to borrow. So they will be forced to stop buying their own stock, meaning that share prices will start falling. They may even have to sell their own stock again in order to pay back their debt, which means stock prices will go down even more. At that point baby boomers will likely start selling as well: their retirement is for a large part in equity so if markets go down 20-30% they might start to panic.

We are pretty close to that in my opinion. Unless the money printing press goes into overdrive there just won’t be buyers anymore and that’s when things really get scary. Pension funds are much more diversified than many individual investors, but their equity investments will also be hit hard and they may not be able to fulfill their financial obligations. It gets even worse, because a lot of baby boomers are now at their retirement age, so pension funds will be net sellers to pay for their pensions. Without corporates buying share prices might drop even more. Some pension funds may actually blow up because of this.

It’s not a coincidence that over the past weeks a lot of corporate CEOs resigned, January 2020 actually set a record for the most CEO departing their jobs in the US. They saw this coming and did not want to end their careers with their companies in big trouble. It’s almost a perfect storm and unless the Coronavirus would be contained there is no real way out anymore.

The best way to play this is in my opinion to get out of equity if you are still in there and switch to cash, bonds, gold and bitcoin. Although gold and bitcoin both did not show a lot of strength when the markets started crashing, I believe both are great stores of value during a recession or even a depression. Cash is good so you can get back into the equity markets at much lower valuations. Of course shorting the market is a great idea as well, but because of volatility it’s a lot more expensive than a few weeks ago. Because markets may go down for a longer period of time you would need expiration dates that are at least 6-8 weeks from now (and possible much longer).

We will be in for a wild ride with many people losing their jobs, their investments, and even their pensions. It could change society completely, and not for the better. Just like most people in North America the markets still don’t see how bad the situation is, so at least there might still be time to position yourself well. Be prepared for the worst. Good luck.

Disclaimer: this is my personal opinion and not meant as investment advice.

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  1. I understand your reasoning, but why are you so sure about hyperinflation when we probably should have seen some of that already?

    “ I believe the FED is helpless unless it will start printing even more money (which could lead to hyperinflation) and that means the markets will be on their own.”

  2. @Yme, because of printing of money the real inflation is already about 6% per year, not the official 1-2%. Because most people don’t see the effects there is no risk of hyperinflation at this level. If central banks should decide to up their game to bail out equity investors (while calling it saving the economy) that could change though. It’s all about perception in my opinion.

  3. What source do you use for that ‘real inflation rate’ of 6%?

  4. Who would have thought a virus could have such a huge impact on the global economy!! But I think a lot of it is fear generated.. the actual power of the virus is totally overblown. I think there are a lot more people who probably carry the virus but have not been tested, yet don’t show any sign of ill health. A financial meltdown is certain, it makes one wonder though if there will be major world conflicts.