EC Deflationary Transmission Through Stocks

The odds we are entering a nasty bear market in stocks have grown dramatically—price action as we saw yesterday is an example of the difference between bull and bear markets. Bulls remain supported on bad news. Bears on occasion fall on no news and have little support during bad news. 

That said, the view commodities markets are oversold makes sense—no advanced degree required to see that. But the bad news for commodities is the deflation numbers keep lurching from bad to worse—becoming self-reinforcing to a large degree now. 

So maybe despite the standard measure of overbought and oversold, there is another whole new leg down in commodities awaiting us. I have prepared long-term charts on oil in the past which target down into the teens for oil prices; and I lived and worked in Texas the last time prices went that low. But it sounds too extreme. Hard to get one’s head around those levels… but considering oil came from a speculative extreme at $147 per barrel to $30, i.e. an amazing $117—from $30 to $12 is less extreme, isn’t it? 

In a self-reinforcing deflationary trend consumers don’t borrow and they don’t spend—the” lead a horse to water” idea applies; you can lead households to water (in the form of all types of government incentive for borrowing and lots of enticements from the private side for spending) but none of this can make consumers take on more debt or spend more once a self-reinforcing deflationary environment takes hold (Japan the poster child for this). And the other side of the coin deflation leads to hoarding of cash, i.e. increasing cash balances are part and parcel to the whopping decline in monetary velocity, as I showed on page 16 of the 2016 Outlook Part I. 

Are we there yet—deflationary spiral land?Given the official improvement in the US economy and increased hiring reported, we haven’t seen much in the way of real earnings or consumer spending, we are already seeing pockets of self-reinforcing deflation (not to mention the growing rate of American who don’t participate in the labor force). But the next big kicker may be the stock market.