Don Coxe is chairman of Coxe Advisors LLC. Based in Chicago, he publishes the Coxe Strategy Journal for investors, and is an adviser to several commodity funds.
It's that time again. Leaves turn red, and, distressingly often, so do stock prices on screens.
The S&P's crash of 26 per cent in 1987 was the most memorable since 1929. It was a one-day wonder, thanks to fast hosing of liquidity from the U.S. Federal Reserve under its new leader, Alan Greenspan. There have been other painful autumn sell-offs – enough to make October the single worst month for equities.
So, you scoff, everybody knows that.
Almost everybody also knows that the most perilous reassurance peddled by the Street is "It's different this time."
Except that this time it really is different, but not in a reassuring way.
Crashes are sudden liquidity contractions driven by fear. That is why the Fed has been able to contain them. It slashes interest rates and pumps liquidity at firehose velocity.
For nearly a year, we have been warning investors that both stock and bond markets are experiencing shrinking liquidity, despite the reassurance that nothing big can happen because of those near-zero Fed funds rates. Past crashes occurred when short and long rates were at levels that seem astronomic compared with today's, with the 10-year U.S. Treasury note yielding a tiny 2.04 per cent, and Canada's a near-microscopic 1.4 per cent.
But those yields aren't just today's bargain borrowing rates that should rule out crashes: They were with us long before such surprises as the Blue Jays making it in to the playoffs, or Donald Trump and Justin Trudeau becoming prominent politicians leading the pre-election polls.
Our concern is that cheap borrowing costs have been seductive inducements for massive bond borrowing – in the United States balance sheets with bonds to buy back their stock and increase their dividends. The biggest industrial bond issuer has been the company that is among the most awash in cash – Apple. Despite boosting its dividends and buying back stock at record rates, its stock price is up just 0.5 per cent this year. (And this is the season when unpicked apples fall off trees.)
Meanwhile, at the other end of the corporate-quality scale, junk-bond issuance has been breaking all records, led by the fabulous frackers who helped give you cheap oil to go with the cheap bond yields.
Debt-to-GDP ratios seem to be climbing everywhere, which means that the next big equity sell-off may not mean a rush from stocks to bonds, but cash-outs of both stocks and bonds.
The Fed has been lightly lifting its skirts from time to time to hint it is about to begin the process of raising interest rates. It lacks the room to lower short rates – because they are at or near zero. That constraint hasn't stopped the European Central Bank from flooding its markets with newly printed euros – many government bonds there deliver negative yields – monetary masochism for investors.
Our fear is that the Achilles heel of today's bond markets is the trillions in bond and stock exchange-traded funds. There have been two flash-crashes in the past year in which frightened investors dumped their ETFs.
We also fret that nearly two-thirds of all publicly traded bonds are held by just 20 gigantic institutional investors. To whom will they be able to sell if small – and even large – investors get scared?
The balance sheets of Wall Street's big banks that gave us the 2008 crash are constrained by the thousands of pages of regulations under the Dodd-Frank legislation spawned by that crash. They may not be able to move bravely into frightened markets.
The Fed quintupled its balance sheet to avert a depression, and other global central banks have also succumbed to monetary elephantiasis. Yet, the global economy merely limps along.
That seeming oversupply of liquidity may actually be creating a new form of illiquidity, because so much of the money went into bonds and stocks – and not into capital investment that would lift economies from torpor, generating corporate profits, creating jobs and pouring tax money into government coffers.
That could mean that this October, we won't be able to tell the financial forests from the trees when financial autumn arrives.
So, what to do to make this autumn less stressful?
Improve your own liquidity as your protection against illiquid corporations, illiquid banks and illiquid markets.
Cash yields nothing – except protection against the next crash.
Sometimes the best things in life are free.