Financial markets no longer reflect reality. Neither small businesses or the bottom 90% can afford the “greatest economy ever”. Here’s what happens next…
by Charles Hugh Smith via Of Two Minds
Neither small business nor the bottom 90% of households can afford this “best economy ever.”
After 10 years of unprecedented goosing, some of the real economy is finally overheating: costs are heating up, unemployment is at historic lows, small business optimism is high, and so on–all classic indicators that the top of this cycle is in.
Financial assets have been goosed to record highs in the everything bubble.Buy the dip has worked in stocks, bonds and real estate–what’s not to like?
Beneath the surface, the frantic goosing has planted seeds of financial crisis which have sprouted and are about to blossom with devastating effect. There are two related systems-level concepts which illuminate the coming crisis: the S-Curve and non-linear effects.
The S-Curve (illustrated below) is visible in both natural and human systems.The boost phase of rapid growth/adoption is followed by a linear phase of maturity in which growth/adoption slows as the dynamic has reached into the far corners of the audience / market: everybody already caught the cold, bought Apple stock, etc.
The linear stage of maturity is followed by a decline phase that’s non-linear. Linear means 1 unit of input yields 1 unit of output. Non-linear means 1 unit of input yields 100 unit of output. In the first case, moving 1 unit of snow clears a modest path. In the second case, moving 1 unit of snow unleashes an avalanche.
The previous two bubbles that topped/popped in 2000-01 and 2008-09 both exhibited non-linear dynamics that scared the bejabbers out of the central bank/state authorities accustomed to linear systems.
In a panic, former Fed chair Alan Greenspan pushed interest rates to historic lows to inflate another bubble, thus insuring the next bubble would manifest even greater non-linear devastation.
Ten years after the 2008-09 Global Financial Meltdown, analysts are still trying to understand what happened. For example, the new book Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze is an attempt to autopsy the meltdown and investigate the mindset and assumptions that led to the panicky bailouts and frantic goosing of a third credit/asset bubble–the bubble which is about to pop with even greater non-linear effects.
This is the nature of non-linear dynamics: everything is tightly tied to everything else. Tightly bound/connected systems are hyper-coherent, i.e. every component is tightly bound /correlated to other components.
This is how the relatively modest-sized subprime mortgage market ($500 billion) almost toppled the entire $200 trillion global financial market.
The vast imbalances created by 10 years of unceasing goosing will unleash a non-linear avalanche of reversions to the mean and rapid unwinding of extremes. Consider the impact on hedges, a necessary function of the financial system. With yields so low, the cost of hedging negatively impacts returns, so hedging has been abandoned, trimmed or distilled down to magical-thinking (shorting volatility as the “can’t lose” hedge for all circumstances).
With shorting volatility being the one-size-fits-all hedge, the signaling value of volatility has been distorted. The same can be said of other measures: the information value of traditional financial signals have been lost due to manipulation and/or goosing.
The interconnectedness of global markets means a small blaze in a distant market can quickly become a conflagration. Put these two together and you get a perfect setup for crisis and crash: nobody really knows anything because the signals have been distorted, but everyone thinks they know everything— sell volatility and buy the dip. It works great until it doesn’t.
Meanwhile, beneath the “best economy ever” the rot is accelerating. This article on the empty storefronts proliferating throughout New York City’s neighborhoods, This Space Available, mentions one dynamic in passing that is an example of the distortions that will be unwound in the next financial crisis.
Desperate for yield in the near-zero yield world engineered by central banks, investors have piled into commercial real estate and overpaid for buildings as the bubbles in rents and valuations expanded in tandem.
These owners are now trapped: their lenders demand long-term leases that lock in nosebleed rents, but back in the real world, no business can survive paying nosebleed rents, and agreeing to long-term leases in this environment is akin to committing financial suicide.
If you actually want to make a profit, it’s impossible to do so paying current commercial rent rates. And if you want to retain the absolutely critical flexibility you’ll need to adjust as conditions change, you can’t sign a long-term lease. Everyone signing a long-term lease today will be declaring bankruptcy in 2019 when the recession trims sales but leaves expenses unchanged.
In other words, neither small business nor the bottom 90% of households can afford this “best economy ever.” The financial markets have completely disconnected from reality, and the process of reconnection will unravel all the imbalances and extremes and deflate every interconnected bubble.
The current fantasy is that bubbles will never pop and recessions are a thing of the past; financial engineering can maintain bubbles and “growth” forever.Everything is distorted to the point that those wandering the hall of mirrors believe they know everything they need to know to continue reaping fat returns on capital.
Conventional thinking that performs well in linear eras is disastrously ill-prepared to navigate non-linear eras like the one we’ll be entering in 2019–right on schedule.
SocGen: "Storm Clouds Are Gathering" As Next Recession Looms
Last week it was Morgan Stanley, today(13/09/2018) it is SocGen's turn.
Societe Generale's latest Global Economic Outlook report titled "Storm Clouds Gathering" is gloomier than the last three editions. The French bank's posits that while global growth is stable right now, downside risks are becoming increasingly more pronounced. These risks are deeply rooted in cyclical and financial factors, but more importantly in policymaking, predicting that the next US recession looms in 2019/20.
Four of the bank's most essential downside risks (Protectionism/ trade wars, Sharp market repricing, European policy uncertainty, and China hard landing) are developing into significant threats. They are laid out in the bank's now iconic "Swan Chart."
Over the next 12 months, further intensification of the US-China trade war is set to damage global growth, alongside a sharp repricing in financial markets. SocGen said that while the trade war's impact on global GDP growth remains hard to quantify, it affirmed that global trade and GDP growth will slow as it would increase import prices in economies that levy tariffs or impose quotas.
Global trade volume already weakening
Global trade index and China export growth has peaked
Naturally, an all-out trade war between China and the US would hurt China in most plausible scenarios, said the French bank. In 2017, the total Chinese exports to the US amounted to just over $500bn, close to 4 percent of China GDP. A 50% reduction in those flows would make a material dent in China’s growth. And with China’s weight in the global economy at about 15%, this would result in a downside shock to global growth. To get ahead of these shocks, Chinese authorities have already scaled back their shadow banking system in preparation for turbulence.
SocGen then directed their concerns onto "vulnerable" emerging market economies, particularly Argentina, Turkey, Brazil and South Africa, whose currencies have depreciated by 18-20 percent against the USD since the start of 2018. The attention centers on governance and high external foreign-currency debt in the context of a rising USD and US interest rates.
Tightening of US monetary policy and the end of cheap money is also making SocGen more risk-conscious, adding that a dollar shortage has been primarily the culprit of emerging market chaos.
More importantly, SocGen believes that the US rate hike cycle has more to go (hike until something breaks), and the pressuring of emerging market currencies and asset markets could spill over into 2019. Further, the economies that have ignored the emerging market pressure could come under some pressure in the near term, but mentions unless a lot goes wrong, an emerging market financial crisis seems to be contained.
Meanwhile, the repricing risks in developed economies’ equity markets remain a significant threat. SocGen said US stock market indices have continued to set new records, though most other developed economies’ stock markets are down year-to-date, especially in Europe.
This Indicator Is Signaling 75% Chance Of Bear Market (Which Experts Say Could Last 5 Years)
Even if the next economic downturn turns out to be mild, it may prove difficult to reverse. Here’s why…by Brian Maher of Daily Reckoning
Meantime, a different type of menace drifts into view…One prominent market indicator is presently blaring its loudest warning in 50 years.What does it forecast?
Answer anon. First we take a reading of markets today… while the weather holds.Stocks were up and away today.
The Dow Jones ended the day 114 points in green territory.The S&P closed 11 points higher… the Nasdaq, a hearty 48.But to the topic under discussion…The Goldman Sachs Bull/Bear Market Risk Indicator is a market barometer tracking the following metrics:Stock valuations, growth momentum, unemployment, inflation and the yield curve (the spread between short-term and long-term interest rates).
No single metric throws off sufficient light to read by.But string them all together, says Goldman’s Peter Oppenheimer… and you’re on to something:All of these variables are related. Tight labor markets are typically associated with higher inflation expectations. These, in turn, tend to tighten policy and weaken expectations of future growth. High valuations, at the same time, leave equities vulnerable to de-rating if growth expectations deteriorate or the discount rate rises, or, worse still, both of these occur together.
This indicator has mirrored closely the S&P’s forward performance since 1955.The higher the reading, the greater the risk.And now… Goldman’s number crunchers claim their indicator is “flashing red.”It gives 75% odds of an impending bear market.Not since 1969 has it recorded such heightened levels — and such heightened risk.In fact, lower readings preceded the 2000 and 2008 bear markets:
But returning to the all-important question:What next?Goldman concedes two possibilities…
Possibility one: A “cathartic” bear market (English translation: a devastating collapse that cleans everyone out)…
Possibility two: A “long period of relatively low returns across financial assets.
”That is, not a crash, but a dismal slump — not a squalling rain, but an endless drizzle.Which is more likely?We anticipate a “melt-up”… followed by a meltdown perhaps next year or the year following.
A crash, that is.But the Goldman men incline toward the drizzly forecast.
Stock market valuations hover at or near record highs, they grant.
But inflation is just now finding its legs.And they believe “structural factors” such as globalization’s disinflationary bias may keep it caged.A lower inflation means the Federal Reserve will not be forced to raise interest rates nearly so hastily.That, in turn, means the market is less vulnerable to a rate shock.Hence, Goldman’s gradualistic outlook.
You may prefer a slow motion bear market to the “cathartic” sort that comes by way of a single knockout blow.But catharsis has its points…Once done, the business of recovery can proceed immediately — as a village can build anew after the hurricane knocks it flat.The “long period of relatively low returns” is rather a long gray twilight, a death by inches, an extended and demoralizing siege.Goldman projects this protracted bear market could last five years… until 2023.
Why so long?
Two reasons:
- The U.S. has already expanded fiscal policy and its debt levels and budget deficit are rising, which could make it difficult to find room for significant easing.
- There may be room for U.S. interest rates to be cut in the next downturn but less so than in other downturns.
Thus Goldman concludes:“Even if the next economic downturn turns out to be mild, it may prove difficult to reverse.”These Goldman fellows sound lots like Jim Rickards.Jim’s been high on his rooftop for years, hollering the same warnings to anyone with ears to listen.Debt at all levels has swollen to dimensions truly obscene, Jim insists.Meantime, he says the Federal Reserve should have begun to tighten in 2009, 2010 and 2011:
If they had raised rates, many would have grumbled, the stock market would have hit a speed bump, but it wouldn’t have been the end of the world.We’d just had a crash. But by the end of 2009, the panic was basically over. There was no liquidity crisis. There was plenty of money in the system. There was no shortage of money and interest rates were zero. They could have tried an initial 25-point rise but didn’t.
Instead, “Helicopter” Ben Bernanke found the courage to act… by opening the monetary floodgates.That is, he found the courage to cave before the entire financial and political establishment.That is, he found the courage to boot the soda can down the road… and inflate a gargantuan bubble so doing.
Perhaps if our courageous banker had instead found true courage — the courage to raise. Fonte: qui
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