Turmoil in the markets
After the big drop in June 2022, the Dow managed to rally from about 30,000 to about 34,000. As I said in our last market letter #741 in June, “Expect Rallies.” Our DOWNSIDE PROJECTIONS of a DOW 28,000 to 27,000 (High 37,000 – Now 30,700), NASDAQ-10,000 to 9,000 ( High 37,000 – Now 11,400) S&P-2,900 to 2,700 (High 4, 800 – Now 3,855) are being revised downward as follows: DOW 26,000 to 24,000, NASDAQ 9,000 to 8,000, S&P 2,800 to 2,700
Bond Market back at risk
In Mondays (9/12/2022) New York Times Business Section, 75% of the page was taken up by an article about going back to the office. At the bottom of the page, taking up 10% of the page, almost unnoticed, was an article titled . “Fed’s Fading Support Puts Bond Market Back at Risk.” With a sub title “Declining liquidity in Treasuries could end up causing turmoil.” What’s this all about and how come everyone isn’t talking about this? Shouldn’t investors be worried about the world’s largest and most important government bond market, as the Federal Reserve quickens the pace at which it removes one of its primary pandemic supports, quantitative easing, or Q.E.
When the global economy crashed in 2008 and in early 2020 when the corona virus pandemic hit, markets went into free fall, the U.S. Treasury market, the $25 trillion bedrock of the global financial system broke down. Sellers struggled to find buyers, and prices whipsawed higher and lower. The Fed stepped in, devoting trillions of dollars to steadying the market. In response to market turmoil in the early stages of the corona virus pandemic in 2020, the Fed unleashed the full force of its firepower, buying mortgage bonds and government debt in huge quantities, in a move known as quantitative easing, or Q.E. By becoming the buyer of last resort, the Fed helped restore confidence in markets, and trading in Treasuries began to recover.
The Fed’s balance sheet ballooned from a little over $2 trillion in early 2008 and $4 trillion in 2020, to a peak of nearly $9 trillion now. Stability also brought investment back to the stock market, enriching investors and helping stoke inflation. However, now, the Fed is reversing course through quantitative tightening, or Q.T., pulling back its support for financial markets while it raises interest rates to quell inflation. Investor’s should worry that the quickening pace of the Fed’s pullback could become too much for markets to bear, undermining the safety and reliability of the Treasury market.
Ralph Axel, an interest rate strategist at Bank of America, wrote in a research report last week. He sees emerging strains in the Treasury market as “the single greatest systemic financial risk today,” with the potential to do more damage than the housing turmoil that preceded the 2008 financial crisis. Oh my! The sheer scale of U.S. government debt also plays an important role. The Treasury market has doubled over the past decade, to around $25 trillion (some say it’s $30 trillion), as the government’s financing needs have grown. All that debt needs to be bought by someone, and not just the Fed. In a May report the Fed noted a worsening of liquidity and said that “the risk of a sudden significant deterioration appears higher than normal.” We have been warned!
If demand for Treasuries can’t keep pace with the supply, it could pull prices down. Prices move in the opposite direction to bond yields, a measure of borrowing costs. Higher Treasury yields would put more pressure on borrowers already grappling with the Fed’s campaign to lower inflation by raising interest rates. I am worried that we are piling Q.T. on top of these rate hikes and it will push us into recession or worse.
Trouble in China!
There is trouble in China. The Chinese Hang Seng Index has hit a new 10 year low. Also the China’s Consumer Confidence Index is at a record low. Something is wrong! Is this supposedly successful fast growing super-giant in trouble? I have said so for some time. And if so, what are the economic global implications? In the September 17, 2022 edition of the Economist Magazine this was the headline on the finance and economics section “China’s Ponzi-like property market is eroding faith in the government. Its meltdown could scarcely come at a worse time for Xi Jinping.”
For decades the property industry has been symbolic of China’s rise. Private entrepreneurs have made vast fortunes. Average people have witnessed their net worth soar as home values trebled. Local governments have filled their coffers by selling vast tracts of land to developers. An astonishing 70% of Chinese household wealth is now tied up in real estate. To undermine trust in this model is to shake the foundations of China’s growth miracle. With sweeping covid-19 lockdowns and a crackdown on private entrepreneurs, this is happening on many fronts. But nowhere is it clearer than in the property industry, which makes up around a fifth of GDP. New project starts fell by 45% in July compared with a year ago, the value of new home sales by 29% and property investment by 12%.
The effects are rippling through the economy, hitting furniture-makers and steelworkers’ alike. The result is a crunch. China’s developers need to sell homes long before they are built to generate liquidity. Last year they pre-sold 90% of homes. But without access to bonds and loans, as banks cut their exposure to the property sector, and with sales falling, the Ponzi-like nature of the property market has come into full view.
Evergrande, the world’s most indebted developer, defaulted in December. An effort to restructure its offshore debts, intended as a model to follow, missed an end-of-July deadline. At least 28 other property firms have missed payments to investors or gone into restructuring. Confidence in China’s economic foundations could cross a threshold, beyond which it becomes far more difficult to recover.
In the US, I have seen prices skyrocket in Summit County Coronado. This was due to its location, which is only a hour from Denver, it’s 5 ski Hills, low temperature and humidity during summer, its vacation atmosphere, recreational alternatives and a good place to work, if you don’t have to go to the office. Just 4 months ago there was no availability. Nobody was selling but new building was progressing quickly. Now, with higher interest rates, people are being forced back into the office and with overbuilding, prices have dropped some 25% and dropping. Suddenly everyone wants to sell. Such is how fragile public confidence is. I draw an analogy to the stock market here. At the top nobody wants to sell, but panic selling once started, is hard to stop.
World debt $226 trillion up from $74 trillion in 2019
The market rise was due to low interest rates, quantitative easing, cheap oil and unprecedented growth of debt. Simply put the market went up to far. Now, high inflation, interest rates and gas prices and the war in Ukraine are worrying investors. Last year, we observed the largest one-year debt surge since World War II, with global debt rising to $226 trillion as the world was hit by a global health crisis. Debt was already elevated going into the crisis, but now governments must navigate a world of record-high public and private debt levels, new virus mutations, rising inflation and falling stock and real estate markets. Borrowing by governments accounted for slightly more than half of the debt increase, as the global public debt ratio jumped to a record 99 percent of GDP. Private debt from non-financial corporations and households also reached new highs. My concern is in the world’s ocean of corporate debt, worth $226 trillion up from $74 trillion 2019. US corporate debt has climbed during the same period from $18 trillion to $30 trillion. Two-thirds of non-financial corporate bonds in America are rated “junk” or “BBB”, the category just above junk. The growth in debt has now stopped, because suddenly bankers are worried and interest rates are high and going higher
US federal debt to GDP was in 1980 34.5%, 2000 57.9% and in 2021 100%
The US Federal debt is over $30 trillion dollars and is growing. US Federal spending is $6.2 trillion and tax revenue is $4.2 trillion ($12,000 per person) for a $2 trillion deficit. $30 trillion is a debt of $243,000 per tax payer and $91,000 per tax citizen. The US federal debt to GDP was in 1980 34.5%, 2000 57.9% and is about 100% today. The unwritten rule is anything above $100% is dangerous! Total US and State debt to GDP is 142%. ANNUAL INTEREST ON DEBT; $450 BILLION AND IS RISING AS INTEREST RATES GO UP. Here is the scariest statistic: OTC Derivatives are $600 trillion (10 TIMES WORLD GDP). $600 trillion is at about the same level that caused the 2008 trouble in the banking system.
Dow 30,606, NASDAQ 11,347 S&P 500 3,844
Carl M Birkelbach
ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST
Mr Birkelbach does not offer investment advice, but merely his own personal opinion. This report has been prepared from original sources and data we believe reliable but make no representations as to the accuracy or completeness. Mr.Birkelbach , his affiliates and subsidiaries and/or their officers and employees may from time to time acquire, hold or sell a position in securities. Past performance is no guarantee of future success. Upon request, we will supply additional information. CarlBis@aol.com