Hussman Weekly Market Comment: Increasingly Immediate Impulses to Buy the Dip (or, How to Blow a Bubble)

This particular excerpt is probably more true this morning: That said, we certainly view the present gold/XAU ratio over 12.5 as indicative of a significant margin for error – looking over a horizon of several years – even in the event of a further decline in the price of physical gold. Gold shares are among the only asset classes for which we can comfortably use the phrase “margin for error.”

For more on gold sentiment, even before the recent sell-off, see Fred Hickey's March "The High-Tech Strategist" newsletter, if it is still available for download HERE.

Mark Twain wrote “Let me make the superstitions of a nation, and I care not who makes its laws.” In recent years, investors have somehow allowed themselves to be convinced that alchemy – exchanging outstanding government debt for zero-interest monetary liabilities despite what are already trillions in excess monetary liabilities – is capable having real, stimulative, and beneficial effects for the economy. Make no mistake – the faith that quantitative easing will produce anything other than temporary and ultimately calamitous financial distortion is superstition.

Keep in mind that each dollar of monetary base must remain a dollar of monetary base until it is retired. It cannot “turn into” something else. The only two forms of monetary base are currency and bank reserves, and of the trillions of dollars of monetary base created since 2008, only $300 billion has taken the form of additional currency. All of the other trillions of dollars of base money that the Fed has created take the form of bits and bytes on some computer at one bank or another in the U.S. financial system. At every moment in time, someone in the economy must be the proud owner of those zero-interest bits and bytes. If they try to exchange their bits and bytes for stocks, or bonds, or gold, or real estate, the seller of that asset becomes the new owner of the bits and bytes.

The bits and bytes can be exchanged for currency (the other form of base money), and you can then walk out the door of the bank with the dough, carry it in your pocket, or buy something from a Cypriot so they can stuff the dough under their mattress. Still, such cash conversion has been fairly limited in practice, and for the most part, the reserves simply remain in the banking system. The bits and bytes will go away at the point that the Federal Reserve sells Treasury or mortgage securities back to someone the economy, and retires that someone’s bits and bytes out of “circulation” as payment.

Meanwhile, all that quantitative easing does, will do, and is capable of doing, is to create the maximum amount of discomfort for the holder of those bits and bytes at each point in time, in the hope that the burden of zero interest will be sufficient to provoke the holder to exchange that hot potato, which goes on to scald someone else’s hands.

Undoubtedly, the hope is that the exchange will be for some productive purpose like new investment or constructive demand, but QE cannot create those productive opportunities, and there are already enough credit mechanisms to fund them even when a cash balance is not in hand. The actual effect of QE is to provoke constant yield-seeking for securities that hold out the promise of relieving the discomfort of a zero interest rate. This process has now become pathological, because it has gone to the point that investors are now finding “yield” where yield is illusory.

One type of illusory yield is the earnings yield on stocks, where profit margins are presently 70% above historical norms, and where we’ve demonstrated both by accounting identity and with nearly 70 years of hard data (accurate even to the most recent 4-year period), that the primary source of this corporate surplus is a mirror image deficit in the combined savings of government and households (see Two Myths and a Legend and Taking Distortion at Face Value). Stocks are not a claim on next year’s earnings. They are a claim on a very, very long-term stream of future cash flows that will actually be delivered into the hands of investors over time. At present, the “forward earnings yield” on stocks is a terribly elevated and misleading representative of those cash flows, and investors are likely to find themselves disappointed if they use forward earnings as a “sufficient statistic” for long-term profitability. The other type of illusory yield is on junk debt, where yields have fallen to the lowest levels in history, and where the majority – perhaps more than all – of the perceived “yield” is actually a default premium based on the likely frequency of future default.