The Breakdown - Why the Stock Market is Poised for Its Worst September Since 2011

Episode Date: September 26, 2020

On this edition of The Breakdown weekly recap, NLW looks at the fourth painful week for traditional markets in a row.  He discusses the factors contributing to the trouble, including:  A normal correction from too-high valuations The return of COVID-19 lockdowns The end of easy recovery gains  Diminishing likelihood of a stimulus bill Election volatility

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, BitStamp, and nexo.io, and produced and distributed by CoinDess. What's going on, guys? It is Saturday, September 26th, and that means it's time for the weekly recap. Our main conversation is about stocks and just how poorly they're performing. But first, let's do a quick recap of some of the topics that we looked at earlier in the week. First, let's discuss the FinCEN files. This was the big leak of thousands of documents that banks had sent to the U.S.

Financial Crimes Enforcement Network that were leaked about a year ago, but which BuzzFeed News and about 108 different news organization partners have spent the last year pouring over. Interestingly, these things kind of landed with a dud. They didn't get the big response and angry energy that you might have expected. And I think there are a couple reasons for that. First of all, I think that some people are confused about where the wrongdoing came in. In previous leaks like this, like the Panama Papers, we had secretive files that showed people specifically trying to avoid paying taxes or moving their businesses offshore to avoid regulatory regimes, etc., etc. These leaks were something different because banks were doing what they were supposed to do.

They were reporting potential suspicious activity that might involve money laundering to the authorities exactly as they were supposed to do. I had some comments on my show about this on Monday saying, well, look, what else do you want them to do? Now, the reality is that these banks then chose to continue banking these suspicious accounts, to continue processing these billions and billions and trillions of dollars in payments that they believed to be suspicious and likely money laundering. Effectively, they just passed the buck, and as we discussed on Monday, because they filed these reports, they had almost no potential of being called out

on that behavior and getting in trouble themselves. In that way, these leaks really show the corruption and rottenness at the system design level, not at the individual bank institution level. And that's a little bit harder for people to get all hyped up about. At the same time, I think a second reason that they landed with a dud is that it shows the base cynicism we have towards these institutions. Like, what did you expect? Of course these big banks were going to just continue banking suspicious activities and reaping the fees, they were just going to go by the letter of the law and not do anything more. Maybe it's just early and I haven't fully appreciated or I haven't fully seen the real response. Maybe the real response will come from regulators who use this to

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Next, another interesting note or observation just around how much activity there was in the context of central bank digital currencies this week. This came out on the show in the brief section numerous times, kind of dribbling and dropping, but if you look at it as a whole, there was quite a lot happening. You had a Fed governor reveal that numerous Fed regional banks were researching digital dollars. A People's Bank of China publication indicated that there was an intention for the digital yuan to undermine the USDA dominance that characterized the world. Christine Lagarde of the ECB talked about the importance of a digital euro in the context of a larger European integration project. And of course, we saw a Facebook Libra co-creator actually

leave to rejoin the ranks of venture capital. Tomorrow's Longreed Sunday is going to be a bit of an examination around these themes, but I do think it's notable just how many different dimensions of this battle for the future of money were on display this week. But with that, let's turn to our main discussion for the week why stocks are having their worst September since 2011. First, let's set the stage. U.S. stocks had their fourth week of losses. When I was recording this episode on Friday, the stock market was down 2.2%. This means that stocks are on track for their worst September since 2011. And what's more, It has gotten worse throughout the month.

Last week, you still had a lot of buying the dip type behavior, but this week, U.S. stocks saw their third biggest weekly outflow ever. U.S. stock funds lost $25.8 billion, and this was the most money pulled out of tech funds since June 2019. Precious metals are also having a terrible time. Gold had a 4.6% weekly drop, and silver dropped 15%. this was their worst week since March. Aligned with this is that the dollar had its best week since April.

The Bloomberg Dollar Spot Index was poised to gain more than 1.5% over the week. So what's driving this rise of the dollar and the decline of stocks and gold? When it comes to the dollar, despite near zero interest rates, we live overall in a negative interest rate world. And the dollar's 0.2% three-month interest rate is the second. highest among the group of 10 currencies behind only New Zealand. New Zealand itself is planning to go sub-zero as well, and so the dollar will likely be right at the top of that list. When it comes to gold as a safe haven as well, the real issue here is that inflation expectations are evaporating. Carson Fritch of Commerce Bank AG wrote, abating concerns about inflation

due to rising corona numbers could have something to do with this. If people have to restrict their social contacts again, the price pressure will ease, meaning that the extraordinarily high monetary dynamism will not reach consumer prices. Put differently, because we're seeing these concerns around coronavirus, it's far more likely that we have a deflationary crisis than some sort of inflationary crisis.

That means gold is out and the dollar is in. But let's go back to the larger question of why stocks are having such a hard time right now. I explored this a little bit yesterday with Sven Henrik, but let's go through quickly five different explanations or factors that are all contributing to this. The first is a concern about valuations. We discussed this yesterday again in that interview with Sven, but valuations have gotten extremely high. The total market capitalization compared to GDP is the highest it's ever been, higher than during the dot-com bubble. In that context, maybe this is just a, quote, healthy correction, right?

I would love for this to be the case. I don't necessarily think that it's the case based on what we've seen before. A second contributing factor is the return of COVID-19 lockdowns and COVID-19 cases. In the U.S., we're seeing rising case numbers again, while in Europe and Israel we're actually seeing either partial or in the case of Israel much more comprehensive lockdowns. Another round of lockdowns would bring with them reduced consumer spending, the potential that people weren't going to jobs, the potential for more layoffs, and certainly in America, massive, massive potential of social unrest. None of these are things that

stock markets are happy about having on the possibilities list, so this is clearly one of the factors contributing to this sell-off over the course of September. A third piece, even if markets aren't overly concerned about returning to a lockdown state, it does feel like there's narrative consensus around the end of easy gains, by which I mean a lot of Q3 was about just clawing back from job losses that had been temporary in the immediate lockdowns and all those sorts of things. And we've already seen those numbers show back up. Those easy gains are potentially now behind us, which means that the next set of economic gains are likely going to have to do with real economic fundamentals. And even the people who have been pushing the idea

of a V-shaped recovery wouldn't necessarily go too far in arguing the strength of the underlying fundamentals. A fourth contributing factor is, of course, the lack of a stimulus bill. A Bloomberg headline yesterday read Pelosi-Meneutcheon stimulus buzz masks deep divide to getting a deal. Basically, my read on the situation is that we've switched from the phase of politicians trying to win the upside narrative by getting a deal done, to trying to win the downside narrative by blaming the other team for not getting it done. That makes it all but sure that there won't be a deal before the election, which of course brings us to our fifth factor contributing to the very hard month for stocks, which is perceptions around election volatility. Both sides are setting up to

not accept the results of this thing. And if there's one thing that markets hate even more than a politician they don't like that they believe will be bad or difficult to deal with, it's the lack of clarity around who they have to deal with in the first place. To be honest with you guys, it feels to me like we're settling into the pattern we're likely to be in for the next month and a half or so as we go into this election. Outside of some major stimulus package, it's hard for me to see why people are going to move out of this defensive posture any time before that election happens and we see what we're actually dealing with. What do you guys think? What is the reason that stocks have had such an utterly crappy September? Hit me up on Twitter at NLW. Let me

know via the comments on YouTube. And until tomorrow, guys, be safe and take care of each other. Peace.