Juggling Dynamite

As the US, European and UK central banks drenched the world in dollar, euro and pound QE liquidity 2010 to 2016, developed market interest rates fathomed record lows and their currencies weakened relative to many emerging market currencies. In response, emerging market borrowers reached for lower interests rates with foreign denominated loans (primarily dollars). Today, according to the Institute of International Finance, corporate debt in foreign currencies is the highest ever at $5.5 trillion.

A standout in this area, Turkey fueled a period of rapid growth by borrowing foreign-currency debt (mostly dollars) more than any other major emerging market. With the Lira losing 40% against the dollar in August so far, it is already clear that many borrowers cannot repay their dollar-denominated loans.

Turkey is not the only country now swamped with skyrocketing borrowing costs and spreading defaults, see Indian rupee tumbles to record low amid spillover from ‘full blown currency crisis’ in Turkey and Fall of the Turkish Lira raises concerns for emerging markets. This has broad domino risks through highly levered sectors like real estate, banking and financial markets, globally.

As we have been noting for some time, the payback for reckless financial choices is inevitable and will not be ‘contained’.  With debt and asset valuations at obscene levels in most countries today, the global financial system is more fragile than ever.  It has only been a question of which spark will set off the next contagion.  Emerging market debt defaults have served that role many times in the past, they may well serve sufficient this cycle as well.

The first exchange-traded-fund (ETF) was launched in 1993 as a low cost, passive way to enter and exit exposure to the top 500 US companies by market cap (the S&P 500) without the work and cost of buying and selling 500 shares separately.  At inception, the idea was brilliantly simple, and the investment sales world saw huge opportunity.

Since then, passive funds of all kinds have replicated like Gremlins in water.

Capital held in global ETFs alone ballooned more than 6200% since 1999–and 70% in the last three years, according to the Federal Reserve (table here). They totaled $4.7 trillion at the end of 2017, with 72% ($3.4 trillion of it) held in 1,832 US based ETFs (as shown below from the 2018 Investment Company Fact Book).

Although the global bond market (issued by governments and corporations) is about 3 x the size of the equity market (issued just by corporations), the majority of investment funds and managers are concentrated in equities (where capital risks are higher, management and underwriting fees generally richer and blind hope eternal).

The trend is clear in the chart below of the dollar value held in exchange traded funds from 2000 to Q1 2016, with equity funds (in blue) compared with corporate and municipal debt (in orange) and government treasuries (in black).

Within the 72% of global equity funds allocated to US markets, the widely adored, and insanely valued top five US stocks (Facebook, Apple, Amazon, Netflix and Google) now account for about 12% of the S&P 500 index value and 27% of the Nasdaq 100 index (holdings which index-tracking funds and managers are mandated to replicate).

In short, a world of financial products and marketing wrappers are deceptively varied in appearance but remarkably similar in content.

Holding equity funds and trend-following are the rage as prices rise and then drive mass panic as prices fall and owners discover they are much less diversified than appreciated.

The presumption of ever-present liquidity will prove a mirage once present holders in concentrated positions look to raise cash all at the same time, selling different buckets of the same assets, all at once.

Hugely important big picture discussion in this podcast on the history and evolution of food (and excellent sound quality!). Understanding and personal discipline are power.

Bruce Friedrich is the Executive Director and Co-Founder of the Good Food Institute or GFI, a non-profit that is working to transform animal agriculture by promoting the development of innovative alternatives to meat and seafood.

Here is a direct audio link.