DEBT GRAVEYARD
or CURRENT US ECON CRISIS
If you are thinking this is a “Goldilocks economy,” “there
is no recession in sight,” “Central Banks have this under control,” and that “I
am just being bearish,” you would be right... But that is also what everyone thought in
2007.
Market
Review & Update
Last
week, we discussed the setup for a near-term mean reversion
because of the massive extension above the long-term mean. To wit:
“There is also just the simple issue that markets are very extended
above their long-term trends, as shown in the chart below. A geopolitical
event, a shift in expectations, or an acceleration in economic weakness in the
U.S. could spark a mean-reverting event which would be quite the norm of what
we have seen in recent years.”
See Chart:
Trend Line Support
My friends at Polar
Futures Group laid out the same concerns on Friday:
“The mean reversion trade: For the past few weeks I’ve been musing
that the “irresistible force” that has moved all markets has been the
aggressive repricing of future interest rate expectations since last
November. We’ve had a
HUGE rally in the bond market, MASSIVE flows into bond funds, record levels
(>$13.7T) of negative yielding bonds, inverted yield curves, even Greek
bonds trading through Treasuries…as markets anticipate a recession and much
more Central Bank largess…which might just take us into MMT and/or never-never
land where the Central Banks just buy all the bonds and that’s that. I’ve thought that this
irresistible force may have gone too far too fast and was due for a “set-back”
which would precipitate mean reversion trades across markets.
The core concepts of the mean reversion trades I’m considering are as
simple as, 1) the public buys the most at the top (thank you, Bob Farrell,) and 2)
when they’re yelling you should be selling, and 3) positioning risk leaves some
markets especially vulnerable.”
They are exactly right.
While the market is rallying in anticipation of more Central
Bank easing, especially following the recent announcement by the ECB of lower
rates and more QE, the markets are momentarily detached from weaker earnings
growth, weaker economic growth, and a variety of other market-related
risks.
However, in the very
short-term, the market is grossly extended and in need of some correction
action to return the market to a more normal state. As shown below, while the market is on a near-term “buy signal” (lower
panel) the overbought condition, and near 9% extension above the 200-dma,
suggests a pullback is in order.
See Chart:
As we have noted over the last few
weeks, the very tight trading range combined with negative divergences also
does not historically suggests continued bullish runs higher without some type
of corrective action first.
See Chart:
The $70 Trillion
Dollar Graveyard
On
Thursday, Congress passed the spending bill we
discussed last week:
65 Republicans joined the Democratic majority
in the 284-149 vote, with 132 Republicans voting against the bill, despite
President Trump’s endorsement and pressure from key outside groups, including
the Chamber of Commerce, to avoid a potentially catastrophic default on the Government’s
debt.”
I highlighted the last sentence in red because it is an
outright “LIE” used to convince Americans that out of control spending must be
done.
The reality is that “interest payments on the
debt” are part of the MANDATORY spending in our budget along with
social security, medicare, etc. Currently, about $0.75 of every dollar of tax revenue goes to mandatory
spending. For the last few months
the Government has been at its statutory debt limit, and “surprise” we
didn’t default on our debt. Why? Because there is enough revenue currently
coming in to cover the mandatory spending.
As I noted specifically last
week,
“In 2018, the
Federal Government spent $4.48 Trillion, which was equivalent to 22% of the
nation’s entire nominal GDP. Of that total spending,
ONLY $3.5 Trillion was financed by Federal revenues, and $986 billion was financed through debt.
In other words, if 75% of all expenditures is social welfare
and interest on the debt, those payments required $3.36 Trillion of the
$3.5 Trillion (or 96%) of revenue coming in.”
Do some math here.
The U.S. spent $986
billion more than it received in revenue in 2018, which is the overall
‘deficit.’ If you just add the $320 billion to
that number you are now running a
$1.3 Trillion deficit.
See Chart:
Projected FED Debt & Deficit
The U.S.
will not default on its debt.
But that’s
not the real story.
The crux of that article was focused on the roughly $6
Trillion of unfunded liabilities of U.S. pension funds which Congress is now
drafting a piece of legislation for entitled the “Rehabilitation For Multi-employer
Pensions Act.”
As noted in that article, while Congress is preparing a
bailout for U.S. pension funds, there is a $70 Trillion pension problem globally which
is not being addressed.
“According to an analysis by the World Economic Forum (WEF), there was
a combined retirement savings gap in excess of $70 trillion in 2015, spread
between eight major economies…
See Chart:
“America’s debt load is about to hit a record. The combination of cheap
money and soaring debt helped fuel the decade-long economic expansion and bull
market, but America’s gluttony of loans could work against it if its fragile
economic balance shifts.
In the first quarter of 2019, the United
States’ total public- and private-sector debt amounted to nearly $70
trillion, according to research by the Institute of
International Finance. Federal government debt and
liabilities of private corporations excluding
banks both hit new highs.”
Oh…you are
talking about THAT $70 Trillion.
The chart below is Total U.S. Credit Market Debt (including
Student Loans) which is currently running just a smidgen over $74
Trillion.The last time there was even a hint of
deleveraging was during the “Financial
Crisis.”
See Chart:
Total System Leverage
Corporate
debt is a problem.
The wonderful website “HowMuch” put
the corporate debt bubble into a graphic to help us visualize
the potential for widespread defaults during the next economic and market
downturn.
See Chart:
America’s Biggest Corporate Debt
The problem with corporate debt is the amount of debt which
is at risk of default during the next economic recession. (This isn’t an “IF,” it’s a “WHEN”
statement.)
Let’s start with a note from Michael
Lebowitz:
“The graph shows the implied ratings of all BBB companies based solely
on the amount of leverage employed on their respective balance sheets. Bear in
mind, the rating agencies use several metrics and not just leverage. The graph shows that 50% of BBB companies, based solely on
leverage, are at levels typically associated with lower rated companies.”
See Chart:
“If 50% of BBB-rated bonds were to get downgraded, it would entail a
shift of $1.30 trillion bonds to junk status. To put that into perspective, the entire junk market
today is less than $1.25 trillion, and the subprime mortgage market that caused
so many problems in 2008 peaked at $1.30 trillion. Keep in mind, the subprime mortgage crisis and the ensuing
financial crisis was sparked by investor concerns about defaults and resulting
losses.”
The reason BBB-rated debt is so plentiful is due to the
Fed’s ultra-low interest rate policy over the last decade. Near zero rates, and
easy credit terms, has seduced companies into taking on debt to fund
operations, dividends, and stock buybacks. The
consequence is we are now seeing corporate debt exceeding the levels of the
global financial crisis.
See Chart:
Non Financial Corp Debt to GDP Ratio
The real risk is that over the next
5-years more than 50% of the junk-bonds and leveraged-loans (which is
sub-prime debt for corporations) is maturing and must be refinanced
See Chart:
Debt Reckoning
Let that sink in for a minute.
A weaker
economy, recession risk, falling asset prices, or rising rates could well lock
many corporations OUT of refinancing their share of this $4.88 trillion debt.
Defaults will move significantly higher, and much of this debt will be
downgraded to junk.
But it isn’t just corporate debt, that’s a problem.
Whistling
Past The $246+ Trillion Graveyard
“According to the latest IIF Global Debt Monitor released
today, debt around the globe hit $246
trillion in Q1 2019, rising by $3 trillion in the quarter, and outpacing the
rate of growth of the global economy as total debt/GDP rose to 320%.
This was the second-highest dollar number on record after the first
three months of 2018, though debt was higher in 2016 and 2017 as a share of
world GDP. Total debt was broken down as follows:
·
Households:
60% of GDP
·
Non-financial
corporates: 91% of GDP
·
Government
87% of GDP
·
Financial
Corporations: 81% of GDP
And while the developed world has some more to go before regaining the
prior all time leverage high, with borrowing led by the U.S. federal government
and by global non-financial business, total debt in emerging markets hit a new
all time high, thanks almost entirely to China.”
This is why Central Banks, from the ECB to the Federal
Reserve, are terrified of an economic recession or downturn. As I said
previously, “debt is the ‘weapon of mass destruction'”
Given that global debt is 320% of global GDP, a deleveraging
cycle will be too large for Central Banks to contain.
The deleveraging cycle WILL occur, all that
Central Banks can do is hope to extend the current cycle long enough that
“maybe” economic growth will catch up with the problem and lower the risk.
The irony is that it is the Central Banks on
actions (lowering interest rates to zero and flooding the system with
liquidity) which has inflated the debt bubble.
But that’s everyone else’s problem, right.
As noted above, the U.S. is currently running a debt-to-GDP
ratio of roughly 350% so we are certainly not immune to
the risk of a global “debt contagion.”
See Chart:
We can
look at this a bit differently. The economy currently requires $3.50 of NEW
debt just to generate $1 of new growth.
See Chart:
Total
System Leverage
The problem with the exceedingly high debt levels is that
since economic growth is a function of debt-supported spending, there is a
finite limit to how much debt can be absorbed. As “HowMuch” showed, 10-years
after the financial crisis, individuals are more levered today than they were
then. (Notice the
doubling of auto and student loan debt in particular.)
See Picture:
The Real
Crisis Is Coming
As I noted
this past week, the real crisis comes when there is a “run
on pensions.” With a large number of pensioners already
eligible for their pension, and a near $6 trillion dollar funding gap, the next decline in the markets will likely spur the “fear” that benefits will be lost entirely.
The combined run on the system, which is grossly
underfunded, at a time when asset prices are dropping,
credit is collapsing, and shadow-banking freezes, the ensuing debacle will make 2008 look like mild recession.
It is unlikely Central Banks are
prepared for, or have the monetary capacity, to substantially deal with the
fallout.
Never before in human history have we seen so much
debt. Government debt, corporate debt, shadow-banking debt, and consumer
debt are all at record levels. Not just in the U.S., but all over the world.
If you are thinking this is a “Goldilocks economy,” “there
is no recession in sight,” “Central Banks have this under
control,” and that “I
am just being bearish,” you would be right.
But that
is also what everyone thought in 2007.
….
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