Are We Heading Straight into Global Deflation?

Commodities, Led By Oil, Make New Lows

Crude Oil is an input into producing virtually everything, including itself.  It takes oil to transport, refine, drill or pump oil.  Energy is a large portion of the cost of just about everything.

West Texas Intermediate Crude Oil closed at $46.60 yesterday, a 40% drop since October.  The drop has driven nearly ALL commodities to historically low levels.

The Slide Show below illustrates the steepness of the drop in oil and other commodities.   The largest tracking fund, Invesco’s Commodity Tracking Fund (DBC), is also at new lows.  With $2 Billion in assets, it is the largest diversified commodity tracking fund or ETF. (https://etfdb.com/etfdb-category/commodities/).

Oil, after its plunge, is back to 2005 levels.  These lower prices make some production uneconomic, such as older wells and higher cost Shale Sites.

Economically sensitive Copper is also trading near its lows.  Next to energy, Copper has uses in homebuilding, electronic wiring and manufacturing.  Falling pries suggest falling demand and provide more evidence of economic slowdown.

Falling Oil and Commodity Prices even raise the highly undesirable possibility of DE-FLATION.  

Deflation Would Explain The Bloodbath in Financials

Deflation is a period of generally falling prices.  It should not be confused with DIS-Inflation, which is a lessening in the rate at which prices rise.

Inflation and Deflation have entirely opposite effects on lenders and borrowers.  Inflation assists borrowers who pay their loans back in depreciating dollars.  Deflation, on the other hand HURTS borrowers by forcing them to pay in APPRECIATING dollars.

Deflation is not necessarily good for lenders, however.  Most loans are collateralized by assets like real estate.  In a deflationary scenario, the value of the collateral depreciates while the loan appreciates.  Heavy indebtedness is financial DEATH during a deflationary spiral.

Deflation has NEVER been historically associated with prosperity.  The Great Depression was accompanied by plunging prices and asset values.  These in turn precipitated bank failures. Following the bursting of its REAL ESTATE BUBBLE, Japan suffered long periods of deflation coupled with economic stagnation.  The 90’s in Japan, are referred to as the “Lost Decade”.

The devaluation of real estate in Japan, relative to the loans outstanding, precipitated a financial crisis.  Three significant lenders, Yamaichi Securities, Long-Term Credit Bank of Japan and Hokkaido Takushoku Bank failed despite efforts from the Bank of Japan to keep them afloat. (https://www.brookings.edu/opinions/japans-shrinking-economy/).

Are financial stocks anticipating a Japanese style deflation?

Interest Rates Make New Lows In Front of Federal Reserve Meeting

As things stand, the market has priced in a hike on Wednesday.  From there on out, the visibility is poor.  The consensus is for another raise sometime in 2019, but not until the second half of the year.

The Slide Show below shows the latest Yield trends in the 3 Month T-Bill, 5, 10 and 30 Year Treasuries:

The longest maturity 30 Year Bond has slipped below 3.1%.   It’s plunging yield is indicative of FALLING inflation expectations.  The 5 and 10 Year maturity Treasuries also fell to new recent low yields.

The Federal Reserve Is A Lagging Indicator

Today’s decision is, at this point, primarily theater.   The Federal Reserve, above all else, is reactive to the markets.   On October 2nd, Chairman Powell characterized the economy as “too good to be true”.   (https://www.washingtonpost.com/business/2018/10/02/this-is-almost-too-good-be-true-economy-fed-chair-says/?noredirect=on&utm_term=.54554d21f4f3).

Almost immediately thereafter, Crude Oil Prices went into freefall.  “Crashing Crude Oil Prices A Sign of Oncoming Recession”? (https://markonomics101.com/2018/11/18/crashing-crude-oil-prices-a-sign-of-oncoming-recession/).

Oil was joined by the critically important Financial Sector.   “Collapsing Financials Lead Stock Market Lower” (https://markonomics101.com/2018/12/08/collapsing-financials-lead-stock-markets-lower/).

Couldn’t an economy, reportedly so strong, handle a 0.25% increase on top of the historically skinny 2%-2.25%?  The Markets don’t seem to think so.

The Federal Reserve, paying attention to the markets, telegraphed a change in stance late last month.  Powell’s 3 projected rate hikes for 2019 were effectively eliminated.  Even December’s previously predicted hike wasn’t entirely certain.

Regardless of what the Federal Reserve does or says, the arbiter of last resort is the Market.  It isn’t the news.  It’s the REACTION to  NEWS that counts!

Bear Market to Accelerate

Once the Federal Reserve meeting has concluded, the “Market” will sift through each and every syllable of the “official statement” for clues.  Ironically, the Fed closes watches the markets for clues as to what IT should do.

Market internals are simply horrible!  The Dow Jones Industrials and Nasdaq 100 registered small gains.  However, the Russell 2000 AND New York Composite closed at new 2018 LOWS.  Both the NYSE and Nasdaq each registered more than 300 new 52 week lows.

Financials continued to slide across the board.  In fact, barely half of all traded issues registered gains.  This is CLASSIC BEAR MARKET action.

Whether it’s today, tomorrow or next year, odds are that the Major Indexes will trade through their support zones.  Probably SOONER rather than LATER.  The market appears in a hurry.

The Bear is shifting into high gear.

If you wish to survive the BEAR, what better way than to “Be Informed, Not Misled”?.
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