Stocks have been taking a pounding so far in 2016. It may or may not be a coincidence that they have been in virtual free fall since the Fed’s decision to “hike rates”.
I fear that people are going to blame the Fed for the wrong reasons. The Fed is certainly at fault, along with the massive spending by the government, but it is not because of the Fed’s little rate hike in December.
The reason the economy is on the verge of recession is because of the massive monetary inflation from 2008 to 2014. The Fed ended QE3 in October 2014. Despite the low interest rates, the Fed has been in tight monetary mode for over a year now.
The Austrian Business Cycle Theory teaches us that when the money supply stops expanding, or even decelerates, the unsustainable bubbles that occurred due to the easy money will be exposed. The malinvestment is exposed as malinvestment.
A recession will occur, which is basically a correction of the misallocated resources. The only viable way for a recession to be avoided is for the money supply to grow again, and even this may not be enough. And if the recession is avoided, it is only temporary, as the resources continue to be misallocated.
The sinking stock market is a strong indication of a recession. There is even talk of it in the media (outside of the internet).
Like so many things in economics, cause and effect are often confused. It is important not to make this mistake in terms of falling stocks and recession. There is a correlation of falling stocks and recession, but falling stocks do not cause a recession. The falling stocks are a symptom. Correlation does not mean causation.
Treasury rates are telling us a similar story. The 10-year yield is now around 1.64%. The 30-year yield is about 2.5%. The yield curve is not close to inversion, but it has flattened a bit. An inverted yield curve, or even a flattening yield curve, is a classic sign of a recession.
Perhaps the most interesting thing to me is that gold has done really well. It has burst above $1,200 per ounce. It is surprising it has done so well in the face of a possible recession. Gold does not typically do well in a recession that is coupled with relatively low price inflation.
Gold stocks, which have been beaten down badly over the last several years, have shown a lot of signs of life. I don’t know whether this is the start of a new bull market for gold stocks, but it is encouraging. When a new bull market in mining stocks does emerge, there will be huge potential profits in this sector.
I think everyone should be preparing for a recession. I hope the Fed keeps a tight monetary policy and allows it to happen. Maybe one day we can actually have a real and genuine recovery. The last time anything close to that happened was in the early 1980s when Paul Volcker allowed interest rates to skyrocket with a tight monetary policy.
I am still a strong advocate of the permanent portfolio, or something similar. It has not performed very well over the last several years, but this is an environment of low interest rates and low price inflation. Still, the permanent portfolio has been great to have over the last two months. It also shows why bonds are still an important piece to the puzzle.
If you are a conservative investor, stick with the permanent portfolio. Even if you are more aggressive, I still think you should have over half of your investable assets in such a setup. For the speculative money, I am looking at mining stocks. I also want to consider silver, but silver has yet to show the same signs of promise that gold has.
Most importantly, it is a time to make sure that you have a reliable source of income. It is also important to have a good Plan B.
Unless the Fed steps in and starts another round of money creation, we should assume that a recession is likely. The plunge in stocks is not causing the recession. It is telling us to watch out for one.