The real risk going forward for a big correction in the U.S. markets

In my post two days ago, I mentioned that the U.S. markets will not have a big correction while emerging markets will continue to have serious problems due to China. I do want to point out a realistic risk of a big correction in the U.S., due to the actions of developed market central banks, especially the Fed.

The Fed and ECB are de facto tightening stimulus. The Fed has a strong tendency to taper, even if it is premature, and thinks the US market is already a mini-bubble. So they have changed the stance since September 2012 when they show the spirit of whatever it takes to reflate and stimulate the economy and are committing the same stupid mistake since early 2011 (which I pointed out in an earlier post from my thoughts about my visit to the Fed in early 2011). Remember I turned all out bullish and have stayed that way until now. Also, even though they are right that tapering is not really tightening or raising interest rates and they have been signaling so since early last year, investors continue to believe otherwise. If we take a global view, investors are right, because the condition is being tightened in emerging markets due to the Fed’s actions. Japanese Central Bank is now being quite silly to believe that they should wait till things falter before they act to reflate instead of preempting the dangers and reach their feasible 2% target ASAP (the target is reachable if they are determined enough). It is courageous to commit seppuku after failure, but why not use the same courage to achieve positive results and avoid being a tragic hero?

At the same time, China almost has no choice but to reduce the suicidal steroid that it has been taking if it wants not to have a few lost decades that will be the most painful in history. This is what’s different between now and all the prior episodes of risk on and risk off, and China lies at the heart of the downtrend of emerging markets. So stay away from EM in the next couple of years and waiting for all the casualties to fall.

These forces may converge later this year and crash the global markets, and taking U.S. markets as a casualty. For the U.S. markets, the biggest danger is not from EM but from Western central bankers who start to commit the same mistake of premature tightening even though inflation is nowhere to be found. These central bankers, especially the Fed, can trigger another round of disinflation or even deflation (in Europe) scare or actual reality of disinflation and deflation.  That will be a trigger for a large correction in the U.S. markets. For one thing, without inflation, corporate sales and profits could falter.  So this will set up a shorting opportunity, especially for the riskiest assets. It will also likely set up another risk on rally after they do the 180 degree Fed turn again to stop the premature tightening. So there will be more money to be made at these junctures.