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The S&P 500/Dow have started to sell-off relentlessly since the beginning of the year.  This morning’s excuse was IBM and, once again, China.  I guess Obama’s “America is exceptional” speech infected the brains of more people than I thought.  The sell-off in the stock market surely can’t be attributable in any small way to the fact that the U.S. stock market never been more overvalued in its history.    Not only is it trading at record valuation levels, the “value” of the stock market is resting on a mountain of debt and derivatives in the U.S. financial system of unprecedented size and diminished credit quality.

Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief.  – William White, form chief economist of the BIS – LINK

Unpayable debt and counter-party defaulted derivatives are the hidden financial bombs that are beginning to detonate both globally and in the United States.   Faux analysts like to point to the fact that consumer debt is lower now than in 2009.  However, the reason the amount of stated debt declined was a result lender write-offs – not consumers repaying any debt.   Now automobile and student loans are at all-time highs – over $1 trillion outstanding now in each.  Unlike mortgage debt, this debt is largely unsecured (cars are collateral that depreciate quickly in value).

Well-known/regarded hedge fund titan Ray Dalio of Bridgewater Associates was in the news today warning that “if assets remain correlated, there’ll be a depression”  LINK

Who am I to question Ray, but he’s got it wrong.  The mistake embedded in his assertion is that economic activity is currently connected to the massive global financial bubble. Sorry Ray, but if you use unmanipulated data, the world is already in an economic depression. The price of oil, the baltic dry index, the Cass shipping and freight index (LINK a volume-based index down almost 20% since 2013), etc – measurements of actual economic activity – are reflecting a level of economic activity globally and in the United States that is suggestive of a deep recession on Main Street.

I’ll say we are in trouble up here [Canada]. Aside from the obvious, oil and the Canadian dollar crashing in unison, we have a seriously over-priced housing market and a totally unsustainable condo boom in our two largest cities. Alberta is an unfolding disaster and, for all intents and purposes, the largest province by far Ontario, is bankrupt. Superimpose on that a neophyte federal government and a totally clueless central bank head and we are headed for very big trouble. At least gold is $1575 in Cdn. Dollars and will explode higher shortly.  – John Embry in an email exchange with IRD

The error in Dalio’s assertion is that financial assets drive economic activity.  The “wealth effect.” Unfortunately, while record hedge fund management fees might determine whether or not Mr. Dalio decides to bid on the latest Picasso up for auction or buy a new Ferrari this year, the majority of wealth accessible to most humans has nothing to do with the current price of AMZN or the dividend paid on KMI.  The “wealth effect” concept is yet another Keynesian rhetorical diaper wrapped around the mechanism by which the elitist suck wealth from the middle class.

Real Main Street economic activity has been receding since 2008.  The illusion of economic “growth” has been created by issuing more debt used by the hoi polloi to buy cars, unaffordable homes and online college degrees.  At this point in time, the relative trading level and correlation of financial assets has nothing to do with economic activity, other than maybe the ad rates that can be charged by the adult Nickelodeon channels:   CNBC, Fox Biz and Bloomberg.   This chart perhaps best illustrates this point – click to enlarge:

This graph on the left plots Kinder Morgan stocks vs. the S&P 500 for the last two years.  KMI here represents real economic activity because its business is based on the price and demand for oil.   Even if you want to argue that KMI has take or pay contracts, if its customers can’t pay, KMI does not “take” revenues.  It’s no coincidence that KMI’s stock has crashed along with the price of oil (and gas).   The misnomer of “Dr. Copper” is that it should be “Dr. Oil.”  After all, for every pound of copper used it takes energy to mine that copper.  For every product produced with copper, it takes energy to produce that product.  For every copper-embedded product purchased, it takes energy to deliver to that product.  Get it?

It’s the human condition to believe irrationally that bad things can’t happen.  Denial and hope are the two strongest forms of the human emotional defense mechanism.  But bad things are starting to happen.  The price of oil is telling us that the world, including the U.S., is already entering an economic depression.

Referring back to that graph of KMI vs. S&P 500, KMI represents the “poster child” for the U.S. economic system.  KMI is loaded down with debt that will eventually become unpayable, some of it possibly by this fall.   It’s also emblematic of the proverbial stock idea that was supposed to be “can’t miss.”  It paid a huge dividend and it’s business model was “safe.” But KMI’s operating income has plunged 45% from Q3 2014 to Q3 2015.  How on earth is that reflective of a stable business model?

KMI is somewhat of a Ponzi scheme.  It relies on generating growth to fuel bullish stock reports and investor interest.  It relies on an unfettered ability to issue debt in order to pay its dividend.  I’m working on a big research report and you might be surprised at my conclusions.  Kinder Morgan stock has already decimated a large number of investor portfolios.  And yet, the indefatigable  bullishness on the stock coming from  the “it’s too cheap to sell” or “opportunity of a lifetime” CNBC zombies continues to blossom.

The orange line in the graph above is the S&P 500.  You can see just how disconnected the real economy, as represented by KMI stock, is from Ray Dalio’s “financial assets.”   And you can also see that the real economy is headed for a depression.  In other words, it’s too late to worry about whether or not correlation among financial assets will cause an economic problem.   “Financial assets” are a creature of Wall Street.   The real economy is a creature unto itself and adheres to natural laws uncorrelated with Wall Street’s money-making gimmicks.  Sorry Ray, but eventually your “financial assets” will be inextricably correlated with the real economy.

People want to believe that bad things don’t happen.  But the laws of nature don’t care about what people want to believe.  These laws are not necessarily correlated with human faith and bad things are about to happen out “there.”

If you want to hedge yourself against what is coming, subscribe to my Short Seller’s Journal.  Homebuilder stocks are getting hammered this week and I will be featuring two ideas connected to homebuilders that have not been sold down hard yet.