Tuesday, April 24, 2018

IMF Debt Warning Ought To Send Chills Through Every Stock Investor

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Barely over a month ago, the lower headline in the Business & Investing Section of the WSJ blared: 'Investors Fear Goldilocks Market Is Ending', noting "Nine years into a roaring stock bull market, fund managers are paying their last respects to Goldilocks".  Hmmm....do they know something others don't?   Maybe they're just processing more of the financial news including another WSJ B&I piece, 'Bear Markets Can Fly In On Their Own'  warning "stock market bulls shouldn't be basing their bullishness on recent bullish activity."

And, of course, there are the repeat warnings of the markets sending mixed messages, which have played no small role in stoking the ongoing volatility.

Readers may recall that in my January 25th post, I cited the Utility Forecaster predicting possibly the largest stock market crash in U.S. history - as much as 50 percent.  This was based on a number of factors but particularly the ongoing risk of carrying huge debt, and then sudden deleveraging of that debt.  I quoted the most salient part of the UF, citing  legendary investor Jim Rogers:

 "Why should we listen to him?  The 74 year old not only helped found one of the most successful hedge funds of all time, he's made a number of market calls including the last housing crash. As Rogers observed, the debt that fueled the last downturn is nothing compared to the debt we've piled up since then. Over the last 10 years our national debt has more than doubled. His advice, 'Be worried!'

He cited a debt of $19.8 trillion but that is before the Republicans effectively added at least another $1.5 trillion with their idiotic tax cuts -  which are now scheduled to make the trade deficits much worse too (See Greg Ip's piece:

Tax Cut to Widen Trade Gap That Riles Trump - Wall Street Journal  )

Add to that the IMF issued warning on the global debt, in comparison to which the U.S. slice is paltry.  From The Financial  Times , April 17, ('IMF Sounds Alarm On Excessive Global Borrowing') :

"The world's $164 trillion debt pile is bigger than at the height of the financial crisis a decade ago, the IMF has warned, sounding the alarm on excessive global borrowing.  The fund said the private and public sectors urgently need to cut debt levels to improve the resilience of the global economy, and provide greater firefighting ability it things go wrong.

Fiscal stimulus to support demand  is no longer the priority the IMF said Wednesday in a report published at its spring meetings in Washington. "

To fix ideas, let's note here that "support demand" refers to support of  "aggregate demand", i.e. getting citizens to spend more - which was the basis for the Trump-GOP tax cuts. This was an incredibly bad play given how much they will add to the debt, and deficits going forward, and how little they will contribute in terms of a job picture already near full employment. (4.1 %). And as the WSJ's Greg Ip showed, they will now increase the trade deficit as well, approximately $35 for each $100 increment in the budget deficit.  Since the tax cuts are now conservatively estimated to add $1. 5 trillion to the deficit, you can do the math for the trade deficit using Ip's ratio. 

Why does the U.S. run a trade deficit? Well, because "it consumes more than it produces while its trading partners collectively do the opposite."  Ip notes "another way of saying this is that the U.S. invests more than it saves while other countries save more than they invest."

Hence,  the only way to counter that is for Americans to invest less, and save more. There is a difference, because now investing means leveraging - going into debt to buy shares. Even if one doesn't go into debt personally and buys shares with "found" money or disposable income, a net loss in share prices before redemption translates to a loss in that savings.  Also, your 401k or IRA may be tied to big institutional investors who do the leveraging for you.  In the Business & Investing section   WSJ piece 'In Selloff, A Trading Strategy Is Faulted' (Feb. 9th,  p. B11) we learned:

"Risk parity funds aim to reduce the danger from a collapse in any one market by limiting bets on more volatile assets like stocks and commodities, and use leverage to load up on safer assets such as government bonds."

In other words, these funds use debt, i.e. leverage,  to purchase safer bonds.   However, as the piece goes on to point out, when volatility jumps the leverage can force the funds' automated trading strategies to dump those assets, forcing a selloff.

For this and other reasons,  I no longer invest but still save, despite being retired. How much?  Every year wifey and I try to save the equivalent of three month's salary each from our last jobs (wifey as a beta tester for a radiotherapy software company, me as a technical writer for the same). Because of this rigorous saving ethic our principal hasn't gone down at all despite health issues, paying enormous Barbados taxes, (up to $11,000 BDS a year) and large outlays for home upkeep (e.g. new carpet, current repair of our fence blown down by 74 mph winds in the area five days ago, etc.)    Greg Ip in his WSJ piece noted the only ways now for the ballooning trade deficit to go down are for Americans to save more and those in other nations (like Germany) to save less, or for Americans to cut their on credit consumption, while other nations' citizens increase it. I have a newsflash for Mr. Ip, that's not likely to happen.

Anyway, the FT piece on the IMF warning goes on noting what is most worrisome:

"World borrowing is more than twice the size of the value of goods and services produced and 225% of global gross domestic product. This is 12 percentage points higher than the peak of the previous financial crisis in 2009."

And the U.S. is singled out as a debt offender, e.g.

"Vitor Gaspar, the director of fiscal affairs at the  IMF, singled out the U.S. for criticism, saying that it was the only advanced country that was not planning to reduce its debt pile - with the recent tax cuts keeping public borrowing high.

The fund urged policymakers to stop 'providing unnecessary stimulus when economic activity is already pacing up' and called on the U.S. to 'recalibrate' its fiscal policy and increase taxes to start cutting its debt

Good advice, but it's unlikely the irresponsible Trump cabal and tax cut -delirious GOP will take it. They are hooked on tax cuts like crack addicts on cocaine.  It is also appalling - as per a WSJ editorial ('The Fed's Capital Mistake',  April 20, p. A13) -  that now the Federal Reserve plans to "give in to the banking lobby's wish for more leverage".  How much?  Well, the Fed has deemed the current 6 percent leverage limit "too restrictive" for the eight globally significant banks. It is now prepared to halve that requirement to 3 percent. As the WSJ puts it (ibid.)

"This would have the effect of reducing capital requirements for the biggest insured depository institutions by 20 percent. Banks could thus take on more leverage and boost returns to shareholders as market heat up and profits improve. Sweet."

Can anyone say myopic, dumb and dangerous given the IMF's debt warning?

 The FT article ends by warning that in the worst case scenario- with all that monstrous debt out there- a rapid deleveraging in the private sector  occurs that can destabilize the markets. This would occur if all borrowers (including especially institutional) tighten their belts simultaneously.  In this case, we'd see a collapse of lockstep asset prices  leading to a "multiplier" sell-off and major crash. Perhaps in the 50-60 percent region. 
But as the article lays it on the line, regarding any positive precautionary action from the Trumpies:
"There is no sign the Trump administration has any intention of increasing taxes, as the IMF recommends."
Of course not! Such fiscally prudent behavior would be too much like the Germans who almost always enjoy budget surpluses and have the sense not to give it back in tax cuts, e.g.
Addendum 4/ 26:

Financial Times columnist Gillian Tett has referenced the darkest side of U.S. leverage  in terms of the deterioration in credit quality, writing: "The proportion of U.S. loans with a rating of single B or below (i.e. risky) rose from 25 percent in 2007 to 65 percent last year. And a stunning 75 percent  of all 2017 institutional loans were 'covenant lite'  -  which means they offer few protections for investors if a company starts heading for default. This is the highest share on record."

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