China joined the World Trade Organization in December 2001 and global trade entered an era of unprecedented reciprocity. Chinese workers made goods cheap and the west bought trillions by increasing debt at every level from households to corporations to governments.
Each time debt levels approached rational limits, ‘genius’ investment bankers conspired with politicians and product-sellers to conjure fresh tricks to move debts ‘off-book’ and package them into derivatives that made liabilities look like assets. The effect was truly unprecedented and the add debt and stir potion enabled more global consumption than any other period in human history. Until of course, the bubble inevitably burst in 2008 and slumped the world economy into the deep, long pay back period that persists today. Global growth has been coming in at less than half the rate it was in the debt building period to 2008.
As US debt accelerated, the value of the US dollar plunged by 36% in just 7 years between 2001 and 2008 and commodities priced in US dollars soared. Few indicators reflected the consuming on debt/falling dollar story more than copper.
In this long-view chart of copper since 1980, we can see the sideways range from 1980 all the way to 2005, and then the blow off top from 2005 to 2007 as the property bubble peaked and burst in America and the US dollar bottomed.When consumption fever broke at last, realty prices and demand plunged into the great recession of 2008. In response central banks rushed in with ‘liquidity’ backed by taxpayers to rescue the investment bankers and speculators that had enabled the bubble and bust.
At the same time, price fixing and illegal manipulation by ‘market makers’ became a widespread practice across a range of asset markets. As a result, over the past 4 years, even as global demand weakened and copper inventories piled up, copper prices– historically monitored as a global growth barometer–managed to magically levitate north of $3.00 a pound. Last week this changed with copper closing below $3.00 a pound for the second time in 2014, and being the first year it has done so since it rebounded out of the 2008 recession-lows (see above).
For those who think that a breach below $3.00 a pound is surely fleeting, we point out that the pre-credit bubble range of 1.00 t0 1.50 a pound is long-term support, and still some 50% lower than current prices. Food for thought.
With the equity mongrel horde still calling for higher interest rates and insisting that bonds are for dummies– even though the total return on treasuries has outperformed the total return on stocks by 5.7 x since 1982 (well how’s a devoted risk-seller to make outrageous commissions if people insist on owning the lowest risk deposits for heaven sake?)– here’s a thought: what if US government bond prices were only just started into their next leg of ascent?
I have written many times about higher yielding North American treasuries being relatively attractive when compared with other developed country bonds and in an era of strong deflationary forces caused by a global debt overhang and aging demographics. See: North American Treasury yields: how low can they go? for more context.
As shown in the chart below, each time the German 10-year yield has taken another leg lower during the economic ‘recovery’ over the past 6 years, the US 10-year has not only followed, but actually made a lower low (ie., US treasuries have increased in price by more). With the German 10-year yield today at .84%, the US 10-year yield is now looking downright fat at 2.19%. Could this time be different? Or could US 10-year yields actually move below 1% in risk-averse months ahead (as per dashed blue line) and racking up further capital gains in the process? The answer seems to be yes. Of course, don’t look for the investment sales monkeys to see that one coming…
Danielle was a guest today on Talk Digital Network with Jim Goddard, talking about recent developments in the world economy and markets. You can listen to an audio clip of the segment here.
Traditionally the Canadian dollar has tracked global demand for the nation’s rocks and trees.
As shown in the chart below, the connection between Canadian exports and the strength of its currency historically reflected in a correlation between Canadian resource-based venture companies (CDNX Index) and the loonie. In 2011 as central banks went full nut-job with herculean promises of monetary power, the resource sector remained unconvinced and followed global manufacturing output lower, while the C$ weakened to a lesser extent.
Over the past couple of months, the loonie has rejoined the resource sector’s trajectory but with a glaring gap now evident between the two. This morning wildly volatile, the Canadian dollar index has now broken below cyclical support that had held out of the 2009 recovery. Further downside to at least the last recession bottom in the .80 range seems probable, with further declines possible into the .70′s after that.
The head of the Bank of International Settlement’s market committee, Guy Debelle, warned in a speech in Sydney this week that “global markets are dangerously stretched and may unwind with shock force as liquidity dries up.” In addition, Debelle added that investors have become far too complacent, “wrongly believing that central banks can protect them, while making shaky bets that are bound to blow up at the first sign of stress.”
Worse than the 2008 crisis, Debelle pointed out that the world has never been more leveraged than it is today with debt ratios far higher today than the peak of the last crisis. While advanced economy debt levels peaked at 250% of GDP in 2007, since then they have risen to more than 275% as shown in this chart.
At the same time, interest rates are already at zero across most of the industrial world: “that is a point we haven’t started from before” when heading into a global downturn, Debelle pointed out. This means monetary tools that have historically been used to help truncate downturns are not available this time. See: BIS warns on ‘violent’ reversal for global markets
Make no mistake: the next bear market is no black swan. It has been well earned, and participants have been amply warned.
West Texas Crude is today flirting with $80 a barrel, down 10% year to date, 24% since the QE-rebound into 2011 and 45% since the bubble mania of 2008. Oil cos are taking a much deserved drubbing in the process (chart to left).
Global oil supply continues to overwhelm demand as technology advancements have bumped US production to levels not seen since the 1980′s. Here’s a stat: since 2004, U.S. oil production increased 56% while U.S. demand for gas and other fuels fell 8%. See: Global oil glut sends prices plunging.
The host of new tech-savvy competitors, brings increased competition to pricing that was previously ‘controlled’ by the OPEC cartel (mainly the Saudis).
Break-even pricing for many US shale producers is said to be in the $80 to $85 a barrel range, so at present prices, projects are quickly becoming uneconomic. In the bigger picture it also presents fiscal problems for many exporters whose budgets have been based on higher prices to sustain their expenditures.
In previous recessions, as prices fell, the Saudis announced production cuts to help support pricing. This time there is talk of their plan to maintain production in the hopes that falling prices will serve to wipe out some of the more recent global competitors and restore OPEC power in the longer run. As the chart below shows, a decline below $80 for WTIC, would be a breach of the secular up trend that has held since 1999. If the secular trend is broken, a decline to long-term support in the $40 a barrel range would be within the realm of technical probabilities.
On the fundamental side, we think that falling demand as the global economy again recesses, along with excess inventory and the proliferation of alternatives and more efficient energy usage, are all reasons for the secular bull that began for oil in 1999 to now end.
On the upside, the next economic ‘recovery’ is likely to be less about monetary tricks out of central banks and more about consumers finally rebuilding their personal balance sheets through increased savings and lower spending. Lower energy prices will help households cut expenses as they continue to pay down debt.
The resource-based Canadian Venture Index is today down another 2%. Around 807, the index has taken out its previous 2013 low with no support now left between present levels and the 639 and 678 recession lows reached in 2001 and 2008.
This decline is what we thought was probable as the resource sector completed a secular peak in 2008/11 and has been mean-reverting ever since back to the lows from which the great consumer credit/China/commodity boom began in 2000. I explained the factors driving all of this in this presentation I gave in January 2013, which is available here.
Financial analysis and risk management, in real time, are more art than a precise science. It takes a multitude of disciplines and humility to do the job well, and predicting exact turning points is highly unlikely. But if one can get general themes right and avoid losses, we have a good chance of protecting and growing capital over full market cycles no matter how treacherous the conditions may be. In doing so, we can end up miles ahead of the herd-following masses.
As I review this presentation today, the break down in general stock markets took about a full year longer than we thought likely. And the wait has been tedious. But the delay only means the downside is now likely to be all that much deeper.
Here is a September 2012 version of my partner Cory’s secular chart of the Canadian Venture exchange that I refer to in the presentation. He noted the previous secular lows as the next cyclical test marked in red on the far right bottom. The question is will the resource sector hold here, or does full mean reversion require a move below prior support. Ironically QE mania and the capital misallocations it encouraged over the past 2 years, now make that scenario more likely. Same goes for the lagging broad market stock indices.
Today the Canadian dollar continues to tumble, now down 16% from its QE-driven rebound peak in July 2011. At the same time, the Canadian stock market has officially delivered its first 10% ‘correction’ in 3 years. Foreigners who flooded into Canadian assets in search of relative fiscal strength following the 2008 recession, are not enjoying the mean reversion as their capital continues to fall. A migration toward the exits from Canada and other commodity-centric nations like Australia and New Zealand seems likely to continue this cycle. In fact we see many reasons to suggest that deflationary trends may be just getting started.
North American bonds seem to agree. As shown in this updated chart of the US 10-year Treasury yield, those believing that lax monetary policy would jump-start global growth and inflation seem to be losing the argument with those who have said paralyzing debt levels, aging demographics and commodity over-investment the past few years would lead to weak demand and asset deflation.
My family have started playing a car game as we drive around. When we drive past new property listings we each take a price guess while one of the passengers looks up the listing to name the winner. Even with an informed understanding of location and features we often under-estimate current asking prices by 20% or more. Even an hour north of Toronto, the most basic houses with a single car garage and 2 bathrooms are routinely listed in the $500 to 800K range. Those in older neighborhoods, that have been renovated, are commonly north of 1m. We have seen this movie in other countries the past 8 years and the outcome has always been eventual mean reversion of -25%+…Toronto’s condo market seems to be at the leading edge of ‘greater fools’:
“While Toronto’s housing boom rolls on, some of the housing itself is falling apart.
Canada’s biggest city has more than 100,000 units under construction as developers and investors seek to cash in on condo prices that are up 25.7 percent in the city over the past five years. The trouble is, many buildings are so poorly constructed that some residents fear that the money-spinners of today could become the slums of the future.”
Read more here: Canada condo boom rolls on as buildings fall apart
At the same time, U.S. luxury home builder Toll Brothers CEO Douglas Yearley, says his company considered expanding into Toronto’s condo market but was scared off by the high number of investors buying real estate in the city: 60 to 70% of condo buyers in a Toronto survey said that they didn’t plan to live in their homes: “We saw a lot of people buying with no intention of living there – they just planned to flip,” Mr. Yearley said. “When you have a lot of flippers, that’s when a bubble comes.” See: ‘Flippers’ and bubble fears.
JP Morgan missed its lowered guidance this morning and set aside another billion for upcoming legal costs. More like “illegal costs” because it’s their illegal conduct that has caused these expenses. It has slowly been getting harder for the big banks to make their usual fixing, front running, double-dealing, cheating, profits over the past couple of quarters. This clip offers a good discussion of the rampant abuse at banks globally and the range of criminal investigations yet to be concluded. There is much more to come.
Bloomberg Contributing Editor Bill Cohan and Bloomberg’s Eric Schatzker discuss banking industry and Jamie Dimon’s return from sickness to helm JP Morgan. Here is a direct video link.
Reality dawning for blind believers: central banks cannot drive the world economy. Forecasters in the public and private sector have been ridiculously optimistic and financial markets have been rising on reckless leverage and wishful thinking…
Mohamed El-Erian, a Bloomberg View columnist and former chief executive officer of Pacific Investment Management Co., talks about the outlook for the U.S. and global economies, Federal Reserve policy and market volatility. Here is a direct video link.
Happy Canadian Thanksgiving…Some historical perspective to digest with Pumpkin Pie.
In the current cycle, both the Russell 2000 small-cap index, and the capitalization-weighted NYSE Composite set their recent highs on July 3, 2014, failing to confirm the later high in the S&P 500 on September 18, 2014. Through Friday, the NYSE Composite is down -7.3% from its July 3rd peak, and the Russell 2000 is down -12.8%, while the S&P 500 is down only -4.0% over the same period. What’s happening here is that selling is being partitioned in secondary stocks, and more recently high-beta stocks (those with greatest sensitivity to market fluctuations). Market action is narrowing in a classic pattern that reflects the effort of investors to reduce risk around the edges of their portfolios, in what typically proves an ill-founded belief that a falling tide will not lower all ships.
See: Hussman’s, Air-pockets, free-falls and crashes.
And the downside mean-reversion needed to resolve present over-valuations and realign with historical experience is barely begun.
The disaster scenario is that some or all of these measures do not just revert toward their long-term averages but instead revert beyond their long-term averages — the way they almost always have before.
If we go from an era with spectacularly high stock prices, spectacularly low interest rates, spectacularly high profit margins, and spectacularly stimulative Fed policy to an era characterized by the opposite (like the 1970s), the sharp crashes and relatively quick recoveries of 2000 and 2008 will seem like brief, happy corrections.
It took about 25 years for the economy and market to correct the extremes of the 1920s. It took another 25 years to fully work off the (much lesser) extremes of the 1960s.
The extremes of the late 1990s, which have extended into the 2000s and, now, the 2010s, are, by some measures, the most extreme in history (including the 1920s).
It should not come as a surprise, therefore, if it takes us as long, if not longer, to work them off.
See: My disaster scenario for some excellent charts. This big picture view of the S&P 500 since 2007 shows the likely downside tests for this cycle.
The theory of diversification is undermined in practice when it comes to the Canadian equity market. As graphed below, today the widely bench-marked TSX 60 Index mirrored by most equity funds and asset allocators, is in fact a whopping 61% concentration in the financial and energy sectors.
The following chart maps the price performance since 2007 of the broad TSX Composite, TSX 60, dividend paying Index (XDV), financial index (XFN) (all 3 clustered under green arrow at top of chart), energy index (XEG), materials (XMA) and gold companies (XGD) (as marked).
Over 2 years of QE’ mania up to July of this year, dividend-paying share prices went full nut job. Financial shares (conservative??) surged +100% in 24 months alone as Canadian households moved to DEFCON 1 in indebtedness. At the same time, the materials and metals sectors have continued to mean revert along with falling global demand since 2010. Since April, energy shares resumed following the real economy lower as all three sectors look to their 2009 lows as potential support.
The bad news for those holding Canadian equity funds and traditionally allocated portfolios today, is that as QE delirium wears off, financial and dividend-paying stocks are likely to recouple once more with the economy-driving–metals-minerals and mining–sectors.
Consider that at decline of 50% in dividend paying stocks would just take them back to their 2012 levels and translate to about -30% for the TSX Index overall. To revisit their 2009 lows would mean losses for these widely touted ‘conservative dividend paying investments’ of about -70% and a broad market decline to about 8000–some -45% from present levels.
It is long past time for complacent holders to review their risk exposure.