Trouble Ahead: Stocks Gain, but the "Super Crash" Is Accelerating

October 13th, 2015
in contributors

Money Morning Article of the Week

by Michael E. Lewitt

The lunatics are running the asylum.

After an incessant flow of bad economic news from both the U.S. and abroad, investors decided that "bad news is good news" and they should bid up stock prices.

Follow up:

Saying "bad is good" is like saying "down is up" or "Hillary is telling the truth." It is so obviously contrary to the facts that you can't take it seriously.

And yet investors, in their infinite wisdom, decided that the economic news is so bad that the Federal Reserve (which itself doesn't know up from down) is not going to raise interest rates.

It's not clear how long this insanity will last, but I wouldn't be chasing stock prices here.

And here's why...

There's Nothing Solid Underneath Last Week's Gains

It won't make much of a difference if the Fed does raise rates by year-end. At most they will move by 25 basis points, which is like a flea on an elephant's back.

The primary effect of such a move would be to further strengthen the dollar, which in turn would keep the pressure on commodity prices.

Markets are likely correct that the Fed isn't going to raise rates by year end. My bet is that they won't raise them as long as President Obama is in office.

But that doesn't mean those same markets are reaching the right conclusion in bidding up stock prices. A weak global economy that is on the verge of recession is bad for stocks.

There's no doubt much of last week's strong gains in stocks was due to short covering.

The Dow Jones Industrial Average added a strong 3.7% to 17084.49 while the S&P 500 rose by 3.3% to 2014.89 and the Nasdaq Composite Index added 2.2% to 4830.47.

These were the strongest gains for the Dow and S&P 500 for the year. The Chicago Board Options Exchange Volatility Index (VIX) dropped to 17.08, its lowest level since August 18.

On the surface, markets were looking good last week - but do not be fooled.

Most of the Indexes Are Dead

Only the capitalization-weighted indexes are showing a pulse after a brutal pummeling over the last two months. But much of the rest of the market is solidly in bear market territory with losses of 20% or more in anything remotely related to energy, commodities or basic industry.

The junk bond market has also sold off sharply, following commodities and stocks into a tailspin.

There are a lot of fund managers and pundits who have been 100% wrong about the market this year and are desperately praying for a huge fourth quarter rally to bail out their reputations (and pad their bonuses).

Unfortunately, there is very little good news on which to base such a rally.

You see, third quarter GDP clocked in at under 1% on the Atlanta Fed's GDPNow model. First quarter GDP will likely be weak again next year.

So the big question is whether fourth quarter GDP is going to be anything to write home about - because if it isn't, the US economy could see three consecutive quarters of growth averaging very close to 1%. That may not meet the official definition of a recession, but it's damned close.

Third quarter earnings are just starting to be reported and are expected to be lousy. Bad news better be good news because that's likely to be all there is in the weeks and months ahead.

Watch These Stocks Closely for Short Profits

Investors should keep their eyes on a few key stocks in the weeks ahead.

Glencore PLC (LSE: GLEN), one of the world's biggest commodities traders - which I've written about at Sure Money Investor - has doubled since its recent lows as short-sellers have covered their positions and a few true believers have bought the company's thin assurances that it isn't a house of cards.

Glencore's debt and credit default swaps are still trading as though the company is far from out of the woods, which is a much more accurate picture of its true financial status. Glencore remains at high risk of losing its investment-grade rating, which would trigger a host of problems for the company as well as for financial markets.

Stay tuned here and at Sure Money Investor for more on this company, its stock and the fallout its failure will create.

Meanwhile, there's another systemically important firm that's flirting with disaster.

An Unfathomably Huge (and Dangerous) Loose Cannon

Deutsche Bank AG (USA) (NYSE:DB) announced a multi-billion dollar write-off last week. I have been watching DB for a while as its stock price has been cut in half over the past couple of years.

Deutsche Bank has $75 trillion - with a "T" - worth of derivatives on its books and has been in trouble with the New York Fed over lax reporting as well as a serial law breaker that has paid billions of dollars of fines to the government in legal settlements.

It has poor management, lax financial controls and, as its write-off suggest, a lot of bad assets on its books. Of course, Deutsche Bank is a "too big to fail" global institution, which really means it is "too big to save." As one of the biggest banks in the world, trouble for Deutsche Bank spells trouble for the global financial system.

They're not the only ones in trouble.

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