After weeks of highly acrimonious negotiations, Greece is being asked to effectively give up its sovereignty to Germany in order to borrow billions more after having already borrowed about $200 billion in its first two bailouts. This money will never be repaid and most of us know that. The needed write-down of the Greek debt held by official institutions (that even the IMF recognizes must occur) may be an important catalyst in coming months. Europe and the euro look shakier than ever. Germany is just not big enough or strong enough to forever backstop the currency because the debt issues across that continent are too big. When tiny Greece can evolve into a gargantuan $300 billion problem, another loss of faith in Spain, Portugal, or Italy would prove overwhelming.
You can’t blame a guy for trying. Chinese leadership attempted to mimic the powers that be everywhere else by encouraging a huge stock rally even as the economy there slowed. It worked for months until a recent sharp reversal caused about $3-4 trillion in losses in the span of a few weeks. Trading in about 40% of stocks has been halted and short selling is banned to counter the selling. Needless to say, those stock losses are hitting the economy there which was already the slowest the Chinese have experienced in many years.
In the U.S., we will be lucky if first half GDP growth made it much over 1%. We struggle to find any sector that looks poised to lead the economy demonstrably higher and it seems just about every day a new soft spot emerges. Memory chip sales as well as construction equipment and heavy truck demand are just a few of the latest. The major airlines look to have misjudged passenger demand in yet another cycle. Smart phone and other electronic device markets have surprised to the downside. Even sub-prime induced auto sales have slowed. Of course, the major driver of growth in this cycle, petroleum exploration and production, crashed last year and that is now a major drag impacting many companies outside of energy. More broadly speaking, depressed prices for iron ore, coal, aluminum, and copper are signaling that all that booming industrial activity across the globe since 2009 sparked by China’s $20 trillion debt binge has resulted in a plain old-fashioned bust.
Markets are slowly coming to the realization that the cycle has likely peaked. Credit spreads have widened and what was extremely bubbly corporate bond issuance has slowed for now as risk aversion takes over. Many of those trillions of dollars in newly minted bonds provided cash for companies to buy back their stocks. If that issuance remains softer, we do wonder what will replace the only major source of stock buying we can find. Because of the tremendous growth in corporate bonds outstanding over the last few years and rising distress rates, we expect a continuation of widening spreads and losses in that fixed-income sector to eventually lead the downturn like mortgages did in 2008.
Outside of bonds, transport equities and some other cyclicals are among the first in the U.S. to reflect the enormous downside pain already endured by coal and shale stocks. Bear in mind that all of this took place without the typical tightening of Fed policy. It all seems to be rolling over in an exhaustive admission that each additional dollar of debt creation is seemingly unable to push the rock up the hill. These maladies that we face are a powerful secular counter that cannot be overcome by central planners who refuse to even consider the underlying causes of the issues.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.