February 5, 7:00 pm EST

We talked last week about the correction underway in stocks. As I said, since 1946, the S&P 500 has had a 10% decline about once a year. And we haven’t had one in a while. Since the November 2016 election, the worst decline in stocks from peak to trough had been only 3.4%.

So we were due. And we’ve gotten it.

Today we’ve seen it accelerate. With the steep slide in stocks today, for a brief moment, the Dow futures were down 11% from the peak of just 7 days ago.

Now, let’s add a little perspective on this …

First, as I’ve said, when you are a hedge fund or trader and you’re leveraged 10, 20, 50, 100 times, then avoiding corrections or trend changes is critical to your survival. Getting it wrong, can mean your portfolio blows up and maybe goes to zero. That’s the mentality the media is speaking to, and frankly much of Wall Street is speaking to, when addressing any market decline.

The bottom line is that 99.9% of investors aren’t leveraged and should have no concern about U.S. stock market declines, other than saying to themselves: “What a gift! Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?”  As the great Warren Buffett has said, “be greedy when others are fearful.”

So, for the average investor, dips are an opportunity to buy stocks at a discount. Don’t let the noise distract you.

Remember, we’ve talked about the transition that is underway, with a global economy that now has the potential to officially exit the economic slog of the past decade, driven by pro-growth policies in the U.S. And those economic tailwinds have introduced the likelihood that the world will finally be able to exit central bank life support (i.e. QE). That’s all very positive.

But it has also been the trigger of the correction in stocks–this transition. QE has promoted higher stock prices. Now we get a correction, and a new catalyst (earnings and the growth picture) to justify the next leg of the global economic recovery (and stock bull market).

With that in mind, the fundamentals for stocks are very strong. As stocks tick down, the better valuation on stocks will only be amplified, when we get hot first quarter earnings hitting in a few months (thanks to the big corporate tax cut). For the S&P 500 P/E: We have the “P” going down, and the “E” going up.

How long could this correction last?

Remember when we were discussing the probability of a correction back in November, we looked at this chart …

In September 2014, with no significant one event or catalyst prompting it, the S&P 500 went on a slide. Stocks closed on a record high on Friday, September 19 (2014). On Monday, stocks gapped lower and over the next 18 days fell 10%. But over the following 12 days it all came back–a sharp V-shaped recovery. It was a textbook technical correction–right at 10%, right into the prevailing trend. You can see it in the chart above: the v-shaped move in stocks, and the bounce right off of the big trendline.

What’s happened in the markets the last few days reminds me of that correction. The moves can be fast, and the recovery can be fast, in this (post-crisis) environment. Big institutions have been trading stocks through computer programs for a long time, but the speed at which these algorithms can access markets and information have changed dramatically over the past decade–so has the massive amount of assets deployed through high frequency trading programs. They can remove liquidity very quickly. Combine that with the reduced liquidity in markets that has resulted from the global financial crisis (i.e. the shrinkage of the marketing making community and of hedge fund speculators, and the banning of bank prop trading) and you get markets that can go down very fast. And you get markets that can go up very fast too.

The proliferation of ETFs exacerbates this dynamic. ETFs give average investors access to immediate execution, which turns investors into reactive traders. Selling begets selling. And buying begets buying.

With the above dynamic, we’ve seen a fair share of quick declines and quick recoveries in the post-financial crisis era.

How do things look now?

In the chart above, this big trend line represents the move off of the oil crash lows of 2016. This 2560 area would give us a 10.8% correction in the S&P 500. I wouldn’t be surprised if we got there over a few days, and a recovery began. And I expect to stocks to end the year up double digits (still).

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September 15, 2016, 6:00pm EST

Since Friday of last week, there have been a lot of reports on the spike in the VIX.  Today I want to talk about the VIX and the performance of major benchmark markets over the past week.

In a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.  It can certainly send policy intentions off of the rails (as we’ve seen happen time and time again with the Fed).

Should they be worried?

With the above said, some might think the biggest threat to a Fed move in September (or December) isn’t economic data, but this chart.

Sources: Reuters, Forbes Billionaire’s Portfolio

First, what is the VIX?  The VIX is an index that tracks the implied volatility of the S&P 500 index.  What is implied volatility?  It’s not actual volatility as might be measured by the dispersion of data from is mean.

Implied vol has more to do with the level of certainty that market makers have or don’t have about the future.  When big money managers come calling for an option to hedge against potential downside in stocks, a market maker on the floor in Chicago at the CME prices the option with some objective inputs.  And the variable input is implied volatility.  When uncertainty is rising, the implied volatility value includes some premium over actual volatility.  In short, if you’re a market maker and you think there is rising risk for a (as an example) a sharp decline in stocks, you will charge the buyer of that protection more, just as an insurance company would charge a client more for a homeowners policy in an area more included to see hurricanes.

So with that in mind, the implied vol market for the S&P 500 had been very subdued for the past 45 days or so, quickly falling back to complacency levels following the Brexit fears of late June.  But since Friday, when market interest rates on government bonds spiked sharply (in the U.S., German, Japan), the VIX spiked from 12 to 20 (a more than 60% move).

That indicates a couple of things: 1) Stock investors were spooked by the move in rates and immediately looked for some downside protection, and 2) market makers aren’t quite as complacent as they appeared when the VIX was muddling along at low levels.  They are quick to raise the insurance premium, highly spooked by the risk of a sharp decline in stocks.

But it looks like this recent spike might have more to do with market maker community that is psychologically damaged by the abrupt market moves of the past eight years.  Gold is down since Friday – giving the opposite message of what the VIX is giving us about perceived uncertainty (people smell fear, they buy gold).  And the S&P 500 has only lost 1.3% from its peak last Friday.

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The Fed has manufactured a recovery by promoting stability. And they’ve relied on two key asset prices to do it: stocks and housing. Today we want to look at a few charts that show how important the stock and housing market recoveries have been.

While QE and the Fed’s ultra easy policy stance couldn’t directly create demand in a world of deleveraging, it did (and has) indirectly created demand by promoting stability, which restored confidence. Without the confidence that the world will be stable, people don’t spend, borrow, lend or hire, and the economy goes into a deflationary vortex.

But by promising that they stand ready to act against any futures shocks to the economy (and financial markets), investors feel comfortable investing again (stocks go higher). When stocks go higher and the environment proves stable, employers feel more confident to hire. This all fuels demand and recovery. And, of course, the Fed has pinned down mortgage rates at record lows, which promotes a housing recovery, and gives underwater homeowners (at one point, more than a quarter of all homeowners with mortgages) a since that paper losses will at some point be overcome, and that gives them the confidence to spend money again, rather sit on it.

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Along the path of the economic recovery, the Fed (and other key central banks) has been very sensitive to declines in stocks. Why? Because declining stocks has the ability to undo what they’ve done. And if confidence breaks again, it will be far harder to restore it.

The first chart here is the S&P 500. Stocks bottomed in March of 2009, when the Fed announced a $1 trillion QE program.

Source: Billionaire’s Portfolio

Stocks surpassed the pre-crisis highs in 2013 after six years in the hole. But even after the dramatic rise you can see in the chart the damage from the crisis is far from restored. If we applied the long term annual rate of growth of the S&P 500 (8%) to the pre-crisis highs, the S&P 500 should be closer to 3,150 (over 60% higher).

How does housing look? Of course, bursting of the housing bubble was the pin that pricked the global credit bubble. Housing prices in the U.S. have been in recovery mode since 2012. Still, housing has a ways to go. This is a very important component for the Fed, for sustainable recovery.

Source: Billionaire’s Portfolio

Housing prices have bounced more than 30% off of the lows (for 20 major cities in the index) – but remains about 13% off of the pre-crisis highs.

How has the recovery in stocks and housing reflected in the broader economy?

As stocks surpassed pre-crisis highs in 2013, so did U.S. per capita GDP.

Source: Billionaire’s Portfolio

While bloated government debt continues to be a big structural problem for the U.S and the rest of the world, growth goes a long way toward fixing that problem.

And growth, low interest rates, higher stocks and higher housing prices goes a long way toward restoring household net worth. As you can see in the chart below, we have well recovered and surpassed pre-crisis levels in household net worth…

Source: Billionaire’s Portfolio

What is the key long-term driver of economic growth overtime? Credit creation. In the next chart, you can see the sharp recovery in consumer credit since the depths of the economic crisis (in orange). This excludes mortgages. And you can see how closely GDP (economic output) tracks credit growth (the purple line).

Source: Reuters, Forbes Billionaire’s Portfolio

What about deleveraging? It took 10 years to build the global credit bubble that erupted in 2007. Based on historical credit bubbles, it typically takes about as long to de-lever. So 10-years of deleveraging would put us at year 2017. With that, it’s fair to think we could be very near the end of that period, where paying down debt has weighed on economic growth.

You can see in the chart below, the average annual growth rate of consumer credit over the past 55 years is 7.9%. And over the past five years, despite the deleveraging, consumer credit growth has been solid, just under the long term average. And importantly, FICO scores in the U.S. have reached an all-time high.

Source: Billionaire’s Portfolio

With the recent correction in stocks, there has been increased scrutiny on the economy. Some are predicting another recession ahead. Others are waving the red flag anywhere they find soft economic data. Consumption makes up more than 2/3 of the U.S. economy. And you can see from the charts above, the consumer is in a solid position. But stocks and housing remain key drivers of the recovery. The Fed is well aware of that. With that, don’t expect the Fed, in the current economic environment, to do anything to alter the health of the housing and stock markets.

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