The Great Liquidity Crisis of 2014

Central banks of the world, as led by the U.S., have mostly conquered the short sellers and silenced the skeptics with the greatest global debasement of currencies ever known to man over the last five years. And despite the fact that monetary printing presses have been running 24/7 and at full tilt, inflation somehow remains subdued, interest rates are still near historic lows, and Gold is only now finding a bid after one of the worst years for precious metals prices on record.

For all intents and purposes, the U.S. stock market is at record highs following a 5-year bull run that saw the S&P 500 Index advance 178% from 667 in March 2009 to 1851 in January 2014. The Russell 2000 Index soared 245% over the same period. Except for the so-called “Emerging Markets”, stock prices worldwide have experienced exceptional gains over the last five years. The fact that economies in Turkey, Spain, Italy, Portugal, and Greece (among others) are in disarray seems to mean almost nothing to buyers of stocks. The focus of Big Money investors is on Central Banks. Is China poised on the precipice of a major debt crisis? Probably yes, but no worries, the PBOC was there in January last month to provide record monetary stimulus, and it will be there again when needed.

Now is the perfect time for Central Banks to demonstrate their “mastery of the universe”, but they just don’t understand what it takes to finish the game on top. Now is the time to drive a stake so deep into the bears that short-sellers never raise their heads again. George Soros just doubled down in the S&P 500 Index with $1.3 billion in put options. SO BURY HIM AND EVERYONE ELSE LIKE HIM! But no, Central Banks just don’t understand the game, and they never will. Now is the time when Central Banks should not only be buying sovereign debt, they should also be vigorously supporting the very life-blood of the system --- Stock Index Futures. Central Banks should immediately expand their reach and buy stock index futures (unannounced, and with no transparency, but with lots of leaked bullish rumors). Does anyone really believe they’ve never done it before? Now is the time to really step on the gas! Take the Dow Jones Industrial Average to 30,000 over the next two years. Heck, that’s not even a double from here!

It’s all about “Escape Velocity”, but we’re not there yet, and Central Banks just don’t seem to understand this concept. What does Escape Velocity mean in this context? It means that economic growth must be self-sustaining, but we’re not there yet. And unfortunately, we’re not even close.

And just like a sick man who takes antibiotics to get well, the global economy needs its monetary medicine now more than ever to finally get well. If the sick man feels better and stops taking antibiotics early, then his disease sometimes comes back stronger than ever. The same principle applies now to the global economy. Now is not the time to stop the medicine!

However, the Federal Reserve, under new leadership, appears to be taking away life-giving medicine with its “tapering” strategy. While the markets are currently acting well in the face of this negative change in monetary policy, I firmly believe this is all about to change. With the Fed’s tapering strategy, the window of opportunity for curing the sick economies of the world is closing. And incredibly, in the minutes of the Federal Reserve’s January 2014 meeting, as released last week, there is now even discussion among the hawks on the Board about possibly raising interest rates later this year. While most Fed watchers dismiss such thoughts, the mere fact that it was mentioned in the latest minutes must be considered another very real threat to liquidity and ANY bullish case for stocks.

Bottom Line: The stage is set for a sharp downturn in U.S. stocks that will surprise most investors with the scale and swiftness of its decline. When the dust settles 60 to 90 days from now, most observers will be justified in blaming this correction on a liquidity scare that originated with the Fed’s tapering policy and was then exacerbated by the minutes from the Fed’s January Meeting (as released on February 19^th) where actual rate hikes were discussed. How much will stocks decline over the next 60 to 90 days? A 20% correction must be considered a very real possibility here! In the interest of full disclosure, I hold a large position in the Pro-Shares Ultra-Short S&P 500 ETF (symbol SDS) in one of my managed accounts.