Debt will soar, growth will slump
- 12 Dicembre 2018
- by Blogger
Stocks are now falling. Worldwide, about $5 trillion has already been knocked off stock values. The S&P 500 is about 10% below its top in September. And the FAANG stocks are down about 25% from their highs. Still, they’ve got a long way to go. Warren Buffett’s favorite yardstick for valuing stocks measures the relationship of total market capitalization (the value of all stocks added together) to GDP. The ratio should be well below 100%. Stocks cannot be worth much more than the GDP of the country that supports them. But this ratio is now as high as it’s ever been – it’s about even with the top of the great bubble market of 1999. Stocks today are equal to about 150% of GDP. The Dow would have to fall by nearly 50% to get back to normal.
But not to worry. Investors think they have both the Fed and the White House backing them up. You’ll recall the famous “Greenspan Put.” The idea, developed after the 1987 crash, was that the Alan Greenspan-led Fed would come to the aid of stock market investors and prevent any permanent losses. Greenspan’s successor, Ben Bernanke, used this magic again after stocks collapsed in 2008-2009. Again, the remedy worked – in the sense that it reinflated the bubble.So investors are probably thinking that another big downturn will be followed by another big rescue... But this time, it may not be so easy to restart the party.
First, the Fed now has only 225 basis points to work with. It can cut them. But then, it will be in negative territory. But since the inflation rate is about 2.50%… it is already in negative territory, in real terms. But like the Fed, he starts from a weaker position than Bush did. The feds are already running a $1.2 trillion deficit. Their knees will quake at the thought of a $2 trillion deficit. That won’t stop them, of course… but the additional deficits will drive up consumer prices, and probably result in some form of stagflation in the economy. Debt will soar. Growth will slump. The Japanese had plenty of puts, too, and used them all after their bubble popped in 1989. But the Nikkei index never recovered. It’s still down 30% – 30 years later! When the next crash comes, it could be decades before we see the Dow at 26,000 again. The same goes for the S&P500.
The World’s Biggest Hedge Fund Is Getting Whacked, And Why “Moneyness” Matters
A few years ago the Swiss National Bank (SNB) – which traditionally held “monetary assets” like government bonds, cash and gold to back up the Swiss franc — decided to branch out into common stocks.
This was a departure, but for a while a brilliant one. The SNB loaded up on Big Tech like Apple, Amazon and Microsoft, and rode them to massive profits, which enriched both the Swiss people and the SNB’s stockholders (in another departure, it’s a publicly traded company as well as a central bank).
But live by the sword, die by the sword. Turning your central bank into the world’s biggest hedge fund means outsized profits in good times, but potentially serious losses if those aggressive bets go wrong.
The following table shows the SNB’s seven biggest stock positions. Note that 1) they’re all US based multinationals – not a single Swiss stock – and 2) they’re all way up over the past few years but way down over the past two months. Total loss from these positions since September 30: nearly $2 billion.
SNB’s stock price, after quadrupling during the FANG stock bubble, has given back some of that gain.
Now, why should anyone other than the Swiss and the SNB’s stockholders care whether this central bank/hedge fund wins or loses? Because of the concept of “moneyness” and what it implies for the future.
The quick version of the story is that investors generally hold a variety of assets, some of which are money and some of which are not. Money is seen as risk-free or nearly so, and makes up the part of a portfolio that is expected to hold its value. Once that risk-free core is secured, other assets that fluctuate in value are added to generate excess returns.
But – here’s where it gets interesting — at different points in the credit cycle, different things are perceived to have “moneyness.” In stressful times the range of assets perceived as risk-free shrinks down to cash, gold and major-government sovereign debt. In more optimistic times – like the later stages of a credit bubble – other things come to be perceived as having moneyness because they’ve been going up for so long that it’s hard to conceive of them behaving any other way.
This sense that Amazon and its peers can never fall, and if they do that’s just an opportunity to buy the dip, had become widespread lately, to the point that most classes of investors had bought in. Pension funds, desperate to meet their unrealistic return targets, added equity and emerging market exposure. Hedge funds whose old models stopped working in the Everything Bubble were reduced to trend following, which meant loading up on FANG stocks because they were going up. Even retirees who couldn’t live on sub-1% bank CD rates moved into growth stocks, junk bonds and emerging market debt. All had the sense that these previously-risky asset classes had, by virtue of their awesome price charts, achieved moneyness and could therefore be trusted.
But now we’ve entered the downward sloping stage of the credit cycle, and the pool of assets with moneyness is shrinking. Here’s how Credit Bulletin’s Doug Noland explains the impact:
Throughout this Bubble period, I have referred to the “Moneyness of Risk Assets.” A “run” on perceived money-like Credit instruments sparked the collapse of the mortgage finance Bubble. Runs unfold when holders of perceived safe and liquid instruments suddenly recognize risk is much greater than previously appreciated. Past crises have typically originated in the money markets. But never have central bank and government policies so fostered the perception of safety and liquidity (“moneyness”) for risk assets – equities and corporate Credit, in particular. I would argue the proliferation and massive growth of index fund products poses a major risk to financial stability. And when it comes to policy-induced distortions, already extraordinary risks to financial stability are only compounded by the proliferation and growth of derivative trading strategies, both retail and institutional.
In other words, pretty much everything the financial world is doing these days relies on a false sense of security fostered by “innovations” (ZIRP, QE, ETFs) that hide the true risks of financial assets. And people are starting to figure this out.
The ultimate end game is the realization by investors that most major asset classes – including today’s fiat currencies — lack moneyness. The resulting stampede out of the dollar, euro and yen and into real assets (such as Gold) will be one for the history books.
This article does not constitute investment advice and is not a solicitation for investment. Auromoney does not render general or specific investment advice and the information on this article should not be considered a recommendation to buy or sell gold or precious metals. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility.