March 28, 2020 – Investors are surprised to see stocks and bonds go down at the same time. They ask:
Isn’t bonds supposed to go up when stocks go down?
Typical 401K participant is told to maintain a balanced portfolio that composes of mostly stocks and some bonds so that bonds can protect against a stock decline in tough times.
That wisdom is not necessarily true in a deflationary crash! Bonds and Stocks can fall at the same time!
Bond yields can go up when there is default risk due to deflation. Today this is visible in junk bond yields. Prices collapse, yields go up. Thus bond funds that are typically used in 401k accounts lose value.
The Everything Bubble Popped
What is a sign of a deflationary crash?
Everything falls against the US dollar in a deflationary crash. Stocks, bonds, gold, silver, oil, housing. Let’s visit recent market action below.
Note: Below charts are annotated with Elliott Wave number and letters that likely indicates a toppic bull market in stocks. You may learn about Elliott Wave Theory here.
Stocks Decline
Dow Jones crashed falling like a rock in meltdown mode.
DJIA falls like rock. Notice the historic extreme bull/bear ratio at the top of the 3rd wave.
Above chart displays sentiment as an interesting contrarian indicator. At the peak of wave 3, we had a 32 year extreme high bull/bear ratio. Everybody was convinced stocks were going up, and we had a good size decline. Then in March 2020, we had another extreme sentiment, a very low bull/bear ratio that signaled a bottom. Everybody was convinced stocks were headed down. If you want to use such sentiment indicators to your advantage, consider to signup at sentimentrader.com.
S&P 500 follows
S&P 500 falls like a rock.
Bonds Decline
Gold Declines
Zooming out on Gold price to see long term sentiment to better understand the sentiment at peak as we approach a crash:
The herd betting on upside just before the turn
Another look at Gold price and trader sentiment: The crowd gets it wrong in turning points.
Silver Declines
Noteworthy is the Gold/Silver Ratio that is going up in a historic way, i.e. Silver is declining much faster than Gold. If you are a Gold/Silver bug, at the bottom, it may be a good time to buy more Silver rather than Gold expecting that in the future Gold/Silver ratio snaps back to long term average.
USD Dollar Spikes Up!!
The violent crash that has started like a straight line down in all financial markets, and the spike in US dollar is consistent with a Deflationary Crash.
In Elliott Wave terms, first (A) wave of a major crash tends to be fast. We are seeing it. We think this is not a minor correction. This is the start of a major crash.
In November 2022, after a year long decline, we have both bonds and stocks down from their peaks. It may be a good time to buy!
TLT, the 10 year treasury bond ETF is down as seen below:
At the same time, QQQ is also down:Check your 401K and you will see there is almost nowhere to hide. This is because in a typical run off the mill recession, while the stocks fall, the FED decreases rates which makes the bond prices go up. But this time, FED is hiking the rates into the recession, thus while stocks decline, bonds crash even worse!
What happens to Stocks in a Deflationary Crash?
Flashback to the stock market crash of 1929 summarizes what could follow in the expected a-b-c decline in the stocks:
90% crash in stocks
How do we know stocks are a bubble?
There are many indicators that indicate extreme conditions. Here is one: a comparison of the current stock market bubble compared to the year 2000 which was followed by the .com bust.
If March 2000 is Pluton, we are at Neptune now. It can crash.
What we have here on the X axis is the bond yield/stock yield ratio for the S&P 400 companies. Sounds fancy, but all it means is that the further you go out to the right, the less companies are paying in dividends compared to what they are paying on their IOUs on their bonds. On the Y axis we have stock prices relative to book value. Book value is roughly equivalent to liquidation value, in other words, if you went and sold all the assets on the open market. When stocks get expensive, prices tend to rise relative to book value, and dividends tend to fall relative to the cost of borrowing. Why does that happen? At such times, people don’t really care about dividends because they think they are going to get rich on capital gains. So dividend payout falls, and stocks get more expensive.
The small square boxes indicate year-end figures. The large box is a general area that has contained values for the stock market for most of the years of the 20th century. We had a few outliers: 1928 and August 1987, which preceded crashes in the stock market. And of course stocks were really cheap in the early ’30s and again in 1941. If you are really astute, you have noticed something about this chart, which is that I’ve left off some of the data. It ends in 1990. What happened in the past two decades? Now I’m going to show you same chart but with the data from the last two decades on it. The March 2000 reading we call Pluto. Real estate wasn’t so bad; I think it only got to about Neptune. But the stock market reached Pluto in March of 2000 in terms of the bond yield/stock yield ratio and the price multiple of the underlying values of companies.
Every major peak since the early 20th century landed well outside the normal range: 1929, 1987, 2000, and 2007.
You still have a small window of time to prepare for a scenario most investors don’t even know is possible — and now even more likely.
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