The Bottom Is Still Ahead For This Bear Market

 |  Includes: SPY
by: Acting Man

By Bill Bonner

The dog days of summer continue. Not much action on Wall Street. Everything is on hold. The future will have to wait. But (taking a wild guess) when history starts up again we will see that:

  1. The bond market topped out in May. (Since then, bondholders have lost a lot of money. People who depend on low bond yields – debtors, the U.S. government, pension funds – should be getting muy nervioso.)
  2. The stock market is topping out now.
  3. Although not fully healed, the gold market bottomed in July.

Maybe that will turn out to be true. Maybe it won’t. But dear readers are advised to believe it – until proven otherwise. There is a big risk that stocks and bonds will drop – heavily. The stock market began a major decline in January 2000. But it has never completed its rendezvous with destiny. At real stock market bottoms you can buy leading stocks for 5-8 times earnings. And you can buy the Dow group for just one or two ounces of gold. That dark bottom has been postponed twice – each time by massive intervention on the part of the feds, first following the recession of 2001… second following the Great Recession of 2007-2009. But you can’t put off destiny forever. The final bottom still lies ahead.

Get Ready for Rising Yields

Trends in the bond market are even slower to develop - and more important. The last top in Treasury prices (and a bottom for yields) occurred in 1946. Yields rose for the next 34 years. Now the Treasury market appears to be topping out again and is headed for a new high in yields, which may not arrive until 2047. It may be a long way off, or right around the corner. Either way, it will be hell getting there. The Detroit pension disaster is just the first of many. Wait until long-term interest rates hit 5% … or 10%. How many companies, cities and pension funds will still be solvent? We’ll see! But wait. You don’t think the Fed will sit on its hands and let the markets take over, do you? When stocks and bonds fall, you can expect Ben Bernanke – or whoever has taken his place (still no call from Mr. Obama!) – to panic, just as Bernanke did in November 2008.

Taper off? Forget it.

The End of Bullion-Backed Money

Let’s review the basics. In 1971, the U.S. switched from bullion-backed money to a fiat monetary system. A bullion-backed currency keeps debt under control. A fiat system is more flexible, more accommodating. Since 1971, credit has gone through the roof. The US economy expanded all right. But the expansion was driven not by increases in real productivity and higher ways. Instead, it was driven by increases in credit. You can’t expect a debt-driven expansion to last forever. The private sector reached its limit in 2007. It couldn’t take any more debt. A correction began, wringing excess debt out of the system by means of defaults, bankruptcies and write-downs. Then the feds panicked – offering more credit on even better terms through ZIRP, Operation Twist and three rounds of debt monetization (aka QE). Most of this new credit has gone to - you guessed it - the feds and their favorite zombies: Wall Street, the TSA, the NSA, education, health, food-stamp recipients and the disabled. But this kind of resource allocation doesn’t create productive jobs or increases in real income. That’s why, five years into a “recovery,” we still have 3 million fewer jobs than we did when the crisis began (despite population growth of an additional 8 million). And it’s why the average person – according to our simple math – has less buying power today than he did during the Eisenhower administration.

How to Join the Super Rich

No, dear reader, the real economy is not helped by trillions of new funny-money credits. But the people who get the loot love it. Who are these people?

From Forbes:

The best chance of becoming Super Rich is to be one of the highest-paid hedge fund masters of the universe. In 2010 the top 25 hedge fund managers combined earned roughly 4 times as much ALL 500 of the CEOs at the top of the 500 giant corporations that make up the S&P 500 index. The average pay of these 25 hedge fund managers was $134 million in 2002, peaked at over $1 billion in 2007 and was sliced to a measly $537 million in 2012. Private Equity is your next best shot at becoming a Forbes billionaire. Private equity fees have averaged $34 billion a year in the period, 2005 to 2011. And in 2012 the three founders of Carlyle each received a distribution of $300 million while the founder of Blackstone got over $200 million, and Henry Kravis and George Roberts of KKR each received more than $130 million. Like these financial investors of huge pots of money, becoming far more Super Rich than the other 300 million Americans requires an education and training that “raises the productivity of skilled workers relative to unskilled workers,” let’s say in computers and information technology,” and on a giant global scale, say economists Steven Kaplan of Chicago’s Booth School of Business and Joshua Rauh of Stanford Graduate School of Business.

Hedge funds have nothing to do with productivity in the traditional sense. Productivity has to do with output, not the ability to invite investors into your casino in exchange for a big share of their winnings (and none of their losses). As long as the Fed is flooding the markets with cheap credit, and financial asset prices are rising, these investors are happy to pay exorbitant fees to hedge fund managers. They won’t be so happy if our three predictions for the fall turn out to be correct. Few hedge funds are really hedged. Instead, they have been “fragilized” by their own go-go incentives. Take a big gamble? Why not? Your typical hedge fund manager figures that if his fund makes a big profit, the investors will think he is a genius and he will get a big chunk of their money. If the fund loses a lot, well, the poor schmucks should have known better!