If you’ve ever wondered why you can’t get a straight answer from the Federal Reserve, you’re not alone. And you’re not imagining it.
 
Beginning with Paul Volcker in the early 1980s and continuing with Alan Greenspan in the 1990s and early 2000s, Fed officials developed a new language called “Fedspeak.”
 
Fed governors and chairmen frequently have to testify before Congress, give speeches or do media interviews. They know they have to say something that seems to have substance and is technically correct.
 
On the other hand, they often don’t want to disclose what they actually intend or what they see behind the scenes. Either that or they really don’t know what they’re doing and can’t let people know that.
 
The way to reconcile these public appearances with as little transparency as possible is to use Fedspeak.
 
Fedspeak consists of an artful blend of platitudes and jargon that intends to sound intelligent but actually says nothing.
 
Fedspeak is both confused and confusing. And that’s the point.
 
Paul Volcker used to practice Fedspeak behind a cloud of smoke from his huge cigar, back when you could smoke indoors. Alan Greenspan later captured the essence of Fedspeak when he testified to Congress, “If I seem unduly clear to you, you must have misunderstood what I said.”
 
Another bit of candor was when Greenspan said, “We really can’t forecast all that well, and yet we pretend that we can, but we really can’t.” (It’s a mystery to me why many people actually place credence in their forecasts).
 
Fedspeak may have been invented by Volcker and Greenspan, but it’s alive and well today. The latest example comes from Fed Vice Chairman Randy Quarles while testifying before Congress on the possibility of inflation due to Fed policies of zero rates and huge asset purchases.
 
Quarles first says, “I don’t want to overstate my concern” about inflation, and adds that he does not expect a breakout. He then pivots and says, “If my expectations about…inflation…are borne out…and especially if they come in strong…it will become important…to begin discussing our plans to adjust the pace of asset purchases.”
 
In other words, we may be getting close to a new “taper” and a possible taper tantrum. So, which is it? Inflation or no inflation? Quarles says both and, therefore, really says nothing of substance.
 
A perfect example of Fedspeak.
 
What is clear is that the Fed has become a serial bubble machine that has dangerously distorted the entire financial system through constant intervention, which greatly increased during the pandemic.
 
Right now, it has created not one, not two, but three simultaneous bubbles. What are they? And how much longer can they last before imploding? Read on.

The Fed’s Inflated Three Simultaneous Bubbles

I don’t hold many mainstream economists in high regard. They mostly cling to obsolete or defective models (such as random walk, efficient markets hypothesis, Phillips Curve, wealth effect, and many more). They are also impervious to contrary data, alternative models, and common sense.
 
But, one of the few mainstream economists whose work I follow closely is Robert Shiller, winner of the Nobel Prize in Economics in 2013.
 
Shiller is a true pragmatist. He develops models that reflect reality rather than creating abstract models and forcing data to fit some preconceived and erroneous curve. He has also developed metrics such as the Case-Shiller home price index and the CAPE Ratio to track price movements and potential bubbles in key asset classes.
 
And right now, Shiller is issuing one of his most dramatic warnings ever...
 
Shiller is warning that stocks, housing and cryptos may all be in extreme bubbles at the same time.
 
Shiller uses data series that go back over 100 years in some cases, so he has a deep perspective on business cycles and prior bubbles on which to base his forecast. Savvy investors are well-advised to follow Shiller and be alert to his warnings.
 
There’s no doubt that U.S. stock markets are in bubble territory.
 
One of the best metrics in terms of predictive analytic power is the Shiller Cyclically Adjusted Price Earnings Ratio, known as the CAPE Ratio.
 
The CAPE Ratio uses a price-to-earnings ratio (PE ratio) similar to many other PE ratios in use. The main difference is that the CAPE Ratio uses earnings per share (EPS) averaged over ten years and adjusted for inflation.
 
These adjustments smooth out earnings through an entire business cycle (with a ten-year average) and present real earnings (with the inflation adjustment).
 
The all-time high CAPE Ratio was 44.19 in December 1999 at the peak of the dot-com bubble. The ratio was 30.0 immediately prior to the historic stock market crash of October 1929.
 
Today the ratio is about 37.0, the second-highest in history; higher than it was before the crash that started the Great Depression.
 
This does not mean the market crashes tomorrow. The CAPE Ratio could go higher. However, it does mean the market is in bubble territory, and no one should be surprised if it does crash.
 
Another widely used metric, more popular than the CAPE Ratio, is the S&P 500 PE Ratio. This ratio is currently around 44.0.
 
That’s higher than the rallies in the Roaring Twenties, the dot-com bubble, and the rally that preceded the 2007 subprime mortgage crisis.
 
Numerous other measures could be used, but they all show similar results. Stocks are at or near all-time highs compared to earnings. That’s indicative of a stock bubble by any definition.
 
The Bitcoin bubble is an even greater bubble than the stock market. The 630% ramp from $8,900 per coin on May 25, 2020, to $64,830 per coin on April 15, 2021, is one of the most spectacular asset bubbles in history.
 
If one goes back slightly further to the $210 per coin price on January 20, 2015, the percentage gain is 31,000%. That gain puts the Bitcoin bubble ahead of tulipomania, Beanie Babies, the South Sea Bubble and all of the other investment manias in history.
 
Bitcoin has struggled lately and trades at around $36,000 today. It’s too soon to say the Bitcoin mania is over, but the fact remains; we’ve been witnessing bubble dynamics in real time.
 
What about housing?
 
In real terms (again, adjusted for inflation), Schiller says that housing prices have never been as high as they are today. He uses data going back over 100 years, so that’s pretty remarkable.
 
One thing bubbles have in common is that they are driven by their own narrative. What are the narratives that propel today’s bubbles?
 
One narrative goes by the name TINA, which stands for There is No Alternative. U.S. bond yields are near all-time lows, so bonds are not attractive compared to stocks even at sky-high stock prices. European stocks have been hammered by back-to-back recessions since the pandemic began.
 
Gold has mostly moved sideways lately in the absence of inflation. (Inflation expectations have been high, but inflation has not).
 
Commercial real estate is in distress because of the work-from-home trend and the exodus of talent from major cities due to COVID, crime and riots.
 
In short, bonds, gold, foreign stocks and commercial real estate are all unattractive, so investors buy U.S. stocks, Bitcoin and residential real estate because there are no attractive alternatives.
 
Another narrative has the name FOMO. This stands for Fear of Missing Out. This narrative says stocks, cryptos and residential real estate may be high, but they’re going higher, and if you stand on the sidelines, you’ll miss out on further gains.
 
The third major narrative for the stock market, in particular, is the idea that “You can’t beat the market.” This idea emerged from academia in the 1960s under the names random walk and the efficient markets hypothesis.
 
The random walk hypothesis says that stock prices are inherently unpredictable and whether markets will be higher or lower in the near future is essentially equivalent to a coin toss. The efficient markets hypothesis says that markets continuously incorporate new information and move smoothly to new levels (higher or lower) based on that information.
 
Both the random walk thesis and the efficient markets hypothesis are nonsense and are not supported by empirical evidence. The evidence shows that the time series of stock prices are not random. They move in path-dependent trends with momentum and can be predicted in the intermediate-term with high accuracy.
 
Markets are not efficient at all. They tend toward bubbles, extreme dips and continually overshoot or undershoot in reaction to the news. Market prices do not move smoothly from one level to another. They gap up or down in huge spikes or dips that leave investors unable to get out of a position before the new level is set.
 
And you can beat the market with legal inside information that you develop yourself through proprietary models, expert analysis, or superior information gathering techniques, ranging from polling to satellite imagery.
 
But narratives have their own dynamic and do not rely on truth. Some narratives are true, some are not, but it doesn’t matter. They can exert power on markets either way.
 
If you think that stocks, cryptos and housing are unrelated markets, you may be in for a nasty surprise. These markets seem unlinked when times are good, but severe problems in one market tend to spill over into other markets quickly.
 
Investors suffering huge losses in cryptos will sell stocks to raise cash. Investors suffering huge losses in stocks may put off buying a new house or even sell their existing home to deleverage. Crashes in one market quickly lead to crashes in other markets because of leverage, liquidity preferences and simple panic.
 
In a market meltdown, you don’t sell what you want; you sell what you can, which often means dumping assets in one market to make up for losses in another. That’s how uncorrelated markets become conditionally correlated in a meltdown.
 
Again, Shiller is not saying markets will crash tomorrow. Bubbles can go much higher and last much longer than most expect. It’s a bad idea to short bubbles because they may continue far beyond the point at which common sense says they should collapse.
 
Schiller’s only saying they’re exhibiting the kind of melt-up behavior that often precedes a crash, as happened with dot-com stocks in 1999 and the housing market in 2006.
 
There may be further gains ahead, but we’re closer to the end than the beginning. Based on Shiller’s advice, it may be time to lighten up on exposure to all three asset classes, even if you don’t get out completely.
 
Be sure to have plenty of cash in reserve. I also recommend you have 10% of your investable assets in gold.
 
Markets may not crash tomorrow. But no one should be surprised if they do. Don’t be caught in the stampede once it happens because you’re probably going to get crushed.

Regards,
 
Jim Rickards
 
Jim Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital.

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