A Global Economic Crisis is Coming and I Want to Go on Record Calling It
If you are one of my family members, close friends, or coworkers, you would know that I am a finance fanatic and that once I start, I won’t shut up talking about the economy. Additionally, you would know that for about the last ~3 months, I’ve been incredibly concerned with the frothy corporate debt market as well as equities. You would have had to endure me blabbing about the fact that we are on the brink of crisis, because we are. I’ve promised to put my thoughts down into writing so that those I hold dear don’t have to endure another lecture. However, I have been slaving away at an internship in a faceless corporation so I have been tight on time. Recent developments in financial markets have me worried that if I don’t publish anything soon then I will never be able to receive credit for my foresight of the crisis that will be facing us imminently. I promise I will publish a lengthy magnum opus detailing all of my thoughts on every issue in markets currently as well as how the next crisis (or perhaps by then the current one) will unfold, but for now you will have to be satisfied with this brief explanation.
So, why is the financial world as we know it going to shit? Is it coronavirus? Is it Donald Trump? Is it Bernie? Nah. It starts with the Federal Reserve and central banks across the globe. Ever since the 2008 financial crisis, central banks have been pumping money into the economy. Whether it be in the form of QE or pushing interest rates so low that you might think they’re playing limbo, there is a metric f***ton of cash sloshing around the market. They’ve tried to stop artificially propping up the economy by tapering off QE and raising rates but like the children that financiers are, they cry and throw a temper tantrum leading central bankers to allow markets to resume suckling on the teat of easy money. Even worse the Fed is essentially engaging in QE4 with its repo market interventions and doesn’t want to admit it. So what though, right? We haven’t had runaway inflation and all assets seem to want to do is go up and up and up like a balloon… or a bubble!
The inflation argument is bullshit. That’s simply because the Fed’s measure of inflation (CPI) is derived from a basket of goods that is pretty much designed to show as little inflation as possible. Costs that are increasing wildly such as rents (this one is for you millennials) and healthcare are not counted. So when Jerome Powell (complete idiot by the way) is concerned that inflation measures are below the Fed’s target of 2% he is full of shit. Estimates done by third parties that include all the things omitted by the CPI place inflation at around 10%. So we’re already in trouble there but that’s not even the big concern.
What I’m really worried about is corporate credit markets and by extension their effect on equity markets. All this cheap money has gotten corporations hooked. Cheap money is like the financial version of cocaine and corporations can’t seem to kick the habit which is why the Fed had trouble tightening policy during this expansion. The yields on corporate debt have just fallen and fallen and investors are not getting compensated for the risk they are taking because they are so hungry for yield. Yields on junk bonds are at ludicrously low levels because investors that would normally be in less risky assets like treasury bonds and investment grade debt are moving into these riskier assets for higher returns. This is in turn allows corporations to raise practically unlimited debt for incredibly cheap prices. This has lead to companies that survive solely on being able to pay off their debt payments by raising more debt, also known as zombie companies. Even worse is that not only are these companies using this debt to pay off more debt but they are using virtually none of it for capital expenditures like new equipment, factories, or more employees but instead are using it to buyback their own stock. This in turn inflates equity prices and boosts C-suite bonuses. This is what is largely behind the record stock market growth that we have seen in the past several years and not any real economic growth as many think.
To make matters worse, the quality of the debt issued is deteriorating rapidly. Over 50% of investment grade debt is sitting at a BBB rating. That is one rung above junk status. And considering how there is approximately 3 downgrades in credit ratings for every upgrade, you can appreciate how quickly shit can hit the fan and how quickly rising defaults can spread to the wider economy since so many are exposed to corporate bonds. Moreover, covenant-lite bonds are at an all-time high with over 70% of corporate bonds having little to no covenants safeguarding an investor in the event of a default. In short, the market is playing with fire and only one push will send the house of cards tumbling down.
So what is going to be the push? I wouldn’t be surprised if it’s the coronavirus but make no mistake, the global economy has been on the decline since the middle of last year. If coronavirus will have any effect, it will be the hammer that strikes the final nail in the coffin. Japan is expected to head into a technical recession after this quarter and our neighbors to the south in Mexico seem to be on the same track. The panicked market this week has led to the worst week in markets since the financial crisis. Thank god markets have finally realized that this virus is worse than anticipated and even now reports are underestimating its growth rate and lethality. Forget getting sick from the virus though, the real killer is how the volatile markets have caused all bond issuance to come to a halt. That’s right, there was virtually no new issuance of debt this week. If this keeps up we should start seeing defaults soon and that will be the end of us. The Fed and global central banks will throw everything they can at this but it will be to no avail and only more inflation will come of it. I hope you’re holding some gold to protect yourself from that inflation.
The world economy has been running on Twinkies and Big Macs instead of broccoli and fish and it shows. For far too long have we been reliant on endless amounts of cheap money and the time is nearing for us to pay up. I know it, Wall Street knows it, and now you do too. Protect yourself and your money because we are in for something far worse than 2008. But most importantly, remember that I was here and that I told you so.
