Juggling Dynamite

The reckless obsession with maximizing capital risk and indebtedness under the guise of “investing” is sure to end in financial carnage.  Historical precedents are unambiguous.  When this carbuncle blows, we will be trying to patch financial holes for years to come.  Cautionary evidence is everywhere.  The recent Calpers decision is just one more egregious example, see:  Leverage on leverage is big risk for investors and their lenders:

There’s already too much money chasing too few assets and yet even the most sober investors seem ready to add to the problem.

Calpers, the $495 billion California public-employee pension fund, is planning to put more money into chasing returns by taking on debt worth up to 5% of its fund value — or roughly $25 billion — to plow into financial assets. It is doing this because it can’t see another way of hitting its long-term return target of 6.8% to meet its promised payouts.

This seems remarkable to me: A very big pension plan, which invests in lots of different funds,including many that use leverage to boost returns, is now going to start using its own leverage on top to try to boost its returns. It highlights how investors of all kinds are having to take more risk to make any money.

One caveat…investors are not “having to take more risk”; they are choosing to do so.  A wiser plan is not to take the bait and wait for investment-grade opportunities to come from future liquidation sales.  They will come, but very few are positioned to take advantage.

Treasury yields rose initially on news that Fed Chair Powell has the nod for a second term.  Apparently, Powell–who’s endlessly sought to boost animal spirits and his portfolio at every market yip–is now a hawk that will raise rates through a global downturn and tanking risk markets in 2022.  LOL indeed.

With the five most expensive S&P companies now accounting for 23.5% of its market cap (shown below since 1980, courtesy of Ridgehaven Capital), a world of FOMO surfers are more risk-concentrated and vulnerable to capital implosion than at any time in the past 41 years; even well beyond the 2000 tech top.

Breadth is brutal beneath the euphoric surface, with many former retail darlings tumbling into well-deserved repricing cycles. The list below highlights 32 standouts, camouflaged by a NASDAQ 100 Index still within 3% of its all-time high.  As in 2000, the magnitude of these drops is par for the math-less buying, which has dominated since 2020.

The U.S. dollar has been rising against the basket of global currencies again since June.  As shown below from my partner Cory Venable, since 2007, the greenback’s advance against the commodity-centric-CAD is another warning sign for risk markets.  And, lest we forget, rising greenbacks ramp carrying costs for foreign borrowers who remain heavy in dollar-denominated debt.

Bond yields have backed up since August, but as shown in Cory’s chart below of U.S. 10-year yields since 1987, the bounce purchased by trillions in monetary and fiscal stimulants looks suspiciously quick.  Like the 2007 and 2000 recessions, yields are likely to move lower for at least a couple more years, while the economy and financial markets finish the downcycle that began in 2019.  Interrupted but not yet completed.

A McKinsey report published this week examines how productively we are using global ‘wealth,’ and the conclusion is, not very.

While global net worth (asset prices- liabilities) has tripled since 2000, the increase mainly reflects financialized gains in assets, especially real estate, rather than investment in productive activities that expand economic momentum and well-being.

As financial assets and liabilities have grown faster than GDP, two-thirds of global net worth is now based on elevated realty prices and only about 20 percent on productive fixed assets such as machinery, infrastructure and inventories; this is not historically typical or sustainable:

“…in the countries in our sample, net worth in 2020 was nearly 50 percent higher relative to income than the long-run average between 1970 and 1999. Asset price increases above inflation propelled by low-interest rates drove this divergence while saving and investment accounted for only 28 percent of net worth growth. In 2000–20, annual post-inflation valuation gains quadrupled compared with earlier decades…”

The trouble is, higher asset prices are not more economically or socially productive–quite the opposite.  A reversion of prices toward historical norms would wipe out about 33% of global net worth.

The report encourages a shift in policies and focus towards productive and sustainable investments that contribute to the global gross domestic product (GDP) to mitigate the downside.  The video below gives a few of the low lights.

The market value of the global balance sheet tripled in the first two decades of this century. These findings raise important questions for policy makers and business leaders. Foremost among them: is the global economy undergoing a paradigm shift as the world finds new sources of wealth? What might some of those new stores of value be? Or are we at risk of reversion to the historic mean that could result in a decline in net worth? And what will it take to rebalance the global economy? Here is a direct video link.