Market dynamics have changed.
While markets can technically be classified as being in the ‘bull’ phase, the overarching trend is bearish.
The overhang from a decade-long corporate debt binge can be ignored but that doesn’t make it go away.
Massive stimulus programmes and temporary debt relief measures are masking the underlying reality…job losses, business closures, growing civil unrest.
V-shaped recovery? Implausible.
And when you do the numbers on what it takes to not just get back to where we were BUT also resume trend growth, the implausible becomes laughable.
Over the past decade, a US dollar of GDP growth has been derived from US$3.80 of debt.
|Year||Global Debt USD||Global GDP USD||Debt/GDP Ratio|
|2008||$142 trillion||$58 trillion||2.4 : 1|
|2019||$253 trillion||$87 trillion||2.9 : 1|
|Increase||$111 trillion||$29 trillion||3.8 : 1|
But that was then…in the good times when confidence was high, unemployment and default rates were low.
Generating a net US$3.80 in borrowings (to create a dollar of GDP growth) in an environment of defaults, high unemployment, lending caution and general uncertainty is going to be extremely difficult.
The fact that hardly any mainstream commentary recognises the crucial role ever-increasing debt has played in GDP growth continually astounds me.
If NET debt levels (new borrowings, less defaults) do not resume the pre-COVID-19 trajectory then economic growth is at best, in the very slow lane and at worst, contracting.
Neither options produce a V-shaped recovery.
Fierce competition for the shrinking consumer dollar is going to apply pressure to profit margins.
Highly indebted businesses are literally living on borrowed time.
Those that remain in business will look to trim overheads…labour and rental expenses are the obvious cost-cutting choices.
Creating a vicious spiral in defaults (mortgages, consumer finance, commercial property loans, corporate debt), unemployment, lending caution and uncertainty.
At present the share market is not pricing in this scenario.
There remains an unbridled belief in the Fed’s ability to (once again) conjure up a debt-fuelled economic recovery.
Can the Fed make the debt soufflé rise again?
Central bankers are committed to blow another debt bubble
If they can’t, it definitely won’t be for the want of trying.
We crossed the Rubicon on sound economic management in September 2008…when Lehman Brothers collapsed. Quantitative easing (QE) entered our collective vocabulary.
There is no going back. The unorthodox is now accepted as orthodox. No amount of intervention/meddling can be too much.
Be assured, the central banks are absolute and resolute in their commitment to blow another debt bubble. The only other option is to let the system correct itself.
And, for political and economic academia reasons that’s not going to happen.
Get ready for central banks to mount a concerted and sustain effort to move debt levels (much, much) higher.
Whether society responds in the same Pavlovian way as it did on previous occasions is an unknown.
In anticipation of a more reserved consumer attitude towards credit, the Fed has a bag of treats ready to tempt/bribe/cajole people into resuming old habits.
I’ve had a sneak peek inside the Fed’s bag of goodies and this is what I saw…
Forward guidance on interest rates as far as the eye can see. In pre-COVID times, the Fed could tempt or temper markets with ‘cash rate’ forward guidance. An announcement to the effect of ‘we expect rates to remain low’ was a green light to go to the Wall Street casino. Alternatively, ‘we are going to gradually raise rates’ put the skids under the market.
Having seen how effective ‘forward guidance’ can be in setting the market mood, expect to hear the Fed announce ‘the cash rate will be held at zero for five years or longer’.
While that will be greeted with initial enthusiasm, it’s hardly the ‘big bang’ that markets have become accustomed to…they always want more.
Negative rates are coming. Not possible. Won’t happen. It’s not our intention. Yeah, heard all those protestation before. And guess what? What was once inconceivable, became, not only conceivable, but very achievable.
Constitutional roadblocks will be picked up and shifted…just like the once sacrosanct ‘debt ceiling’ now keeps getting raised. Negative rates will be the ‘BIG news’ that puts a rocket under the market. The failure of the market to question how bad is the economy for rates to be taken into the negative? will be a mere oversight when the animal spirits take charge.
QE becomes a Formal Programme. Previously the creation of dollars was done on an ‘as needed basis’. QE1, 2 and 3.
In this current crisis, additional money is needed on a daily basis.
‘…the Treasury Department said the gap between what the U.S. government spends and what it collects in taxes widened to [US] $1.88 trillion for the first eight months of this fiscal year …’
The Washington Post, 11 June 2020
The US government needs an extra US$2 trillion to cover its budget shortfall.
The annual deficit is not going to get any less in the coming years with either a Trump OR Biden administration. Both will spend (much) more — especially if it’s decided to pay a universal wage — than what’s collected from a stagnating tax base.
The US Treasury’s ability to raise the funding needed (on a continual basis) from the private sector is limited. The Fed will print and buy Treasuries and continue its corporate debt buying for good measure. They’ll do everything possible to stop the corporate debt bubble from deflating.
Which leads into…
Yield Curve Control (YCC). They’ll do it. They have no choice. Creating this much Federal debt means long rates — five-, 10- and 30-year bonds — need to be suppressed.
The Fed says it’s ‘considering’ and ‘investigating’ the merits of yield curve control. That’s like me saying I am ‘considering’ and ‘investigating’ whether I should take my next breath. It’s going to happen.
The Fed commitment to blowing another debt bubble is absolute and unwavering.
YCC is an integral part of that plan.
The policy has already been preordained by the same wackos that sanctioned the previous bubble blowing efforts (emphasis is mine):
‘Prior to the COVID-19 crisis, current Fed Governors Richard Clarida and Lael Brainard, as well as former Fed chairs Ben Bernanke and Janet Yellen, said the Fed ought to consider adopting YCC when short term rates fall to zero.’
Brookings, June 2020
Well, short-term rates are (almost) at zero.
And it’s not like YCC hasn’t been used by other central banks…
‘The Bank of Japan (BOJ) committed in 2016 to peg yields on 10-year Japanese Government Bonds (JGBs) around zero percent, in a fight to boost persistently low inflation. To hit that yield target, the BOJ has a standing offer to purchase any outstanding bond at a price consistent with the target yield.’
Brookings, June 2020
If the intent of Japan’s YCC programme was to ‘fight to boost persistently low inflation’, then the BOJ has lost the fight.
Japan’s core inflation (at best) rose to 1%, but has now fallen to MINUS 0.2%.
Source: Trading Economics
But this minor detail won’t stop the Fed.
They have to tinker, meddle and be seen to be doing something…even if it does more harm than good.
Buying shares. The Fed will follow the BOJ’s lead on this as well.
As reported by ETF Stream in February 2020 (emphasis added):
‘Unconventional monetary policies in Japan have gone way beyond just interest rates and government bonds and since 2013 have extended into the area of central bank buying of equities.
‘In the seven years since the BoJ embarked upon is own QE programme or ultra-easy monetary regime, the holdings have now reached phenomenal level. According to the BoJ funds flow report for Q3 2019, the bank now owns some 8% of the entire Japanese equity market, mostly through the current ETF-buying programme.’
The purchase of share ETFs has helped pushed the Nikkei 225 Index higher…but it was coming off a very low base.
During the recent market downturn, not even the might of the BOJ could stop the index plunging almost 30%.
While the BOJ might own 8% of the market, all it takes is a few weak hands amongst the other 92% for the market to fold.
Source: Trading Economics
Again, that logic will be dismissed in the Fed’s pursuit to leave no stone unturned in its bubble blowing endeavours.
A few of the reasons why the Fed will go down this path are…
- The US share market has become a proxy for economic strength.
‘U.S. stocks are closing out a terrific year and President Trump loves it. He’s bragged about the stock market hitting record highs six times this week alone on Twitter. On Friday, he boasted “Trump stock market rally is far outpacing past U.S. presidents,” and he vowed that the “BEST IS YET TO COME!” Trump is making the economy and stock market a key focus on his re-election campaign.’
The Washington Post, 28 December 2019
- Share prices need to stay elevated to maintain the pretence of pension fund solvency.
- Lower share prices translate into higher borrowing costs for corporates. The Fed is already bailing out enough of these zombies and would be keen to avoid adding to the list.
These treats were the ones on the top in the Fed’s bag of tricks. Are there more treats we don’t know about? Probably. Desperate times call for desperate measures.
Central bankers may possess academic smarts, but they must be some of THE dumbest people walking this Earth.
The challenge we face as investors
Let’s say these extraordinary and unconventional efforts actually work. Consumers and corporates do their patriotic duty and borrow in even greater amounts. The economic outlook is once again rosy. GDP growth is on trend.
Then what happens when this even BIGGER debt bubble bursts in five or 10 years’ time?
Why they persist with an economic model that is so seriously flawed and will continually require the application of even more desperate measures to remain functioning, speaks volumes about the mental capacity of these so-called prudent stewards of the economy.
Whether we like it or not, these nutters are going to dig deep into their bag of unconventional tricks.
Their dumb decisions mean we have to make intelligent choices on how to position our portfolios.
That’s the challenge we’re all facing in the coming years.