Talking Numbers

Fleckenstein: Why Japan (And Easy Money) Could Blow Up America’s Stock Rally

Talking Numbers

In a rare interview, given exclusively to Talking Numbers, Bill Fleckenstein discusses how higher interest rates in Japan could have a disastrous effect on the world markets.

He was an early and correct voice on the subprime crash back in 2007 and the tech bubble of 2000. Now, noted market contrarian Bill Fleckenstein of Fleckenstein Capital says there are three major risks in the market.

On Japan:
“What is going on in Japan is potentially very, very dangerous not just for Japan but for world markets. And, I’m not speaking about the Nikkei. What has taken place in the Japanese JGB [Japanese government bond] is extraordinary. In the last three days, the yield has gone from 60 basis points to 86. Can you imagine what would happen in America if yields on 10-year Treasuries went from 6% to 8.6%?

“There are huge derivative books in Japan where there’s been tremendous amount of derivatives written assuming that rates would stay low forever. I think this could be on the verge of blowing up. This may be the start of it, this may get quiet, or it may get ugly right now. That will impact the American bond market and it will affect equities everywhere. So, it’s potentially dangerous.”

On the risks with Japanese and American monetary policy:
“Money printing such as the Japanese are doing and the Fed is doing is a lot of fun in the short run. That created two bubbles in the last decade but when it stops working, it’s a disaster.”

“QE [Quantitative Easing] in itself does not solve problems. The Fed money printing is what created the bubbles. Of course, the Fed doesn’t understand that so their antidote to the bubbles is more of the same. Thus, that’s what’s propelled stock prices higher. But now because stock prices have gone higher, people assume that means the problems underlying for a while have been solved. That isn’t true.

“To the extent that the money printing from the Fed pushes stock prices up [and] causes people to take on more risk, if the problems reassert themselves or they show up in the form of a money-printing bond market blowup in Japan, then that creates an even bigger problem here. Stock prices going up doesn’t make stocks less risky, it makes them more risky, especially if the predominate fundamental driving point is money printing.”

On the stock market rally:
"I closed my short fund in 2009 because I saw what these central banks around the world were going to do. The problem is most people are not capable of navigating the back side of this. So, while professionals might be able to participate in this and [noted hedge fund manager] Stan Druckenmiller might get out and maybe get short, the average person is going to get deluded make bad decisions because of this and wind up getting hurt again. Just like most people did in the stock bubble.

“I heard it a million times. ‘Well, just enjoy the ride. It’s not going to be a problem for a while. Where else are you going to go with your money?’ And then most people got wiped out. And the same thing with the housing bubble. This is an artificial construct. That doesn’t mean it has to die tomorrow nor does it mean it can’t go a lot higher. But the average person or people involved in the market needs to understand that it’s a game.

“It’s a form of a Ponzi scheme. It’s not a Ponzi scheme really but it’s a form of that because it’s all being promoted by easy money and it’s not being promoted by sound fundamentals. I don’t mean to say everything is wrong in America but, from a financial standpoint, there are a lot of problems and risks that are not being taken into consideration which is always what happens when markets levitate on the back of money printing.”

On what’s wrong in the markets right now:
“The market is at quite a high valuation. I see a lot of speculation. It’s all a false premise in that people believe that if the market’s up [then] the economy is going to necessarily get better. That was the view the last spring and the spring before and it didn’t quite happen. I mean, two years ago, people were so excited about how the market was doing and they thought the economy would get better, that QE would end. Well, not only it didn’t end, but we started another one.

“So, the immediate risks are if the bond market turbulence in Japan starts to accelerate soon and what that might mean to treasuries here if it does. That’s the risk most people aren’t focused on. And then the other risk is the fact that stock prices being high make them riskier, especially when people are being a bit careless.”

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