While some long-time China bears have thrown in the towel, we are convinced now, more than ever, that reckless lending there is largely responsible for what little global growth the overly indebted planet has been able to muster, especially since February of 2016. Then, the powers that be decided that they were not yet ready to let the inevitable reset of the global financial system take place. Step one in that global reset: the renminbi must be devalued and loan losses must begin to be recognized in China, but that would be incredibly painful. As a result, promises to deal with bad debt issues in recent years were simply lip service.
Recently released lending data really blows us away and highlights how big the Ponzi Scheme in China has become. Because each additional increment of debt is producing diminishing returns to GDP, it has become like running on a fast treadmill there. Much of the new debt is unproductive and only serves to delay loan losses, but the lending pace is alarmingly high. Investors who fail to factor that into exposures are running a higher risk strategy than they may know. Industrial stockholders and emerging markets investors beware. Repercussions will be felt everywhere.
The leadership in China makes all the other national central planning teams look like pikers as it force feeds ridiculous levels of debt growth on its economy, knowing that even allowing minor slowing will lead to a day of reckoning it fears more than anything. Based on the latest data, it appears that China now sits atop over a $70 trillion mountain of debt if both on and off balance sheet tallies are summed. Much of it has been piled on in recent years. The figures stagger us because while it is hard to fathom how much longer even a pretense of servicing that debt can continue, it is a crushing weight on future prospects.
The first rule of lending is that it cannot be done well, if done with great speed. However, when one considers that it is being done at the behest of communist central planners with the threat of really bad consequences for those who fail to meet lending targets, it naturally follows that such an enormous quantity of bad debt has never been created.
Central bankers in developed markets are getting misguided credit for the economic tailwind provided by the absurdity in China, but the ultimate reckoning will one day be a global headache of immense proportions.
In the meantime, while it’s fun to daily monitor the size of the equity bubble, it’s important to remember that most cycles involve a difficult second half that involves a reversal of more than a small percentage of the cycle’s profits. Maybe this time is different, but we doubt it.
Europe is still held together by yarn and duct tape as the ECB has seemingly convinced all to ignore credit and currency risks. Populism continues to be an issue for the status quo-seekers based on the vote in Catalonia to become independent from the rest of Spain. Loan losses at major banks have not been resolved.
The Bank of Japan has taken over the equity ETF market there and holds JGB balances that approach its GDP. In fact, we would be more stunned by the BOJ’s heavy-handedness were it not for the fact that our stun sensors have been worn down by stun over China and Europe.
Of course, the common refrain is that stocks are so expensive because interest rates are low. First, that ignores that rates have not been great predictors of future stock returns over the long haul. Second, Treasury rates remain low mostly because we are going through the worst recovery in U.S. history with both price and wage inflation contained at low levels as well.
If long-term rates remain low in future years, then it will likely mean that growth remains slow. Both parts of the investment equation need to be adjusted, not just the element one wants to adjust. The two variables offset each other when discounting corporate earnings streams to value stocks. Why Warren Buffett fails to mention this when conducting cheerleading exercises while holding huge cash balances will be left for you to decide.
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.