When Will 'Muricans Grasp The Next Stock Crash Is Around The Corner?

Examining the prime financial news of the last three weeks it's clear we're headed for another crash. The only question is 'when?' When it comes to irrational exuberance, it’s never if there will be a bust but when. Examples:

Automated Trades Seen Worsening Swings (Sept. 5)

"The growing influence on markets of algorithmic traders and trend-following funds - which use automatic directives - potentially makes markets more vulnerable to sharp swings if everyone starts to sell at once."

Is Indonesia the Next Emerging-Market Domino to Fall? - WSJ   (Sept. 11)

"Investors who gorged themselves on Turkish delight and Argentine beef have had a rude awakening in 2018—the two countries are at the heart of a broadening crisis that has sent emerging-market currencies tumbling.

In Asia, one name keeps coming up: Indonesia, which also has a growing trade deficit—and lots of foreign debt."

The Bear Mauls Another Market -- WSJ - Morningstar (Sept. 12)

"Hong Kong's stocks fell into a bear market Tuesday, another casualty of an international selloff driven by trade tensions, a stronger dollar and worries about the resilience of developing economies.It is the latest sign that stocks around the world are feeling the pressure of the trade fight, exposing the global market's fragility to the sparring between the U.S. and major trading partners in Europe and Asia."

And perhaps most worrisome:

Retiring Soon? Plan for Market Downturns - WSJ

Wherein we read:

"For each year in which a bull market persists, workers become likelier to retire. But those who leave the workforce now—the ninth year of the longest U.S. bull market—are potentially setting themselves up for a tough stretch that could test their portfolio’s long-term resilience.

Why? When the stock market becomes historically expensive, as some metrics suggest it is today, research shows it’s often a harbinger of below-average future returns."

All of these (and more) are screaming alarm - but who's paying attention? Anyone? Perhaps not because too ,many are drowning in irrational exuberance. Trump, always exuberant when talking about himself and his putative accomplishments, loves to boast about how well the American economy is chugging along. The stock market reached its all-time high at the end of August. In its second quarter this year, U.S. economic growth was 4.1 percent. Unemployment remains below 4 percent, and inflation remains moderate. Even wages are going up.

Irrationality enters the picture because there’s little if any connection between Dotard's spurious  policies and the outcomes he lauds (since these trends began before he took office). Also, the prosperity that has resulted from this economic expansion has largely been enjoyed by the wealthier sectors of society. Finally, Trump’s economic fever dream is fueled by an enormous and growing amount of debt.

This is an issue I've warned about in many previous posts. For example, citing a Financial Times report  dated 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. 

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."

In the above context, although Trump promised to balance the books if he became president, he’s done the opposite. The deficit for this year will rise to $890 billion (it was about $660 billion when Obama left office). The shortfall in government expenditures will rise above $1 trillion next year. Deficit spending makes sense during a recession. But what Trump is doing now is essentially allowing the rich to siphon the cream off the top, providing the middle class with some skim milk, and leaving the sour dregs for everyone else. 

And to the point of Vitor Gaspar,  government revenues are actually falling, which is what small-government advocates are secretly cheering: less money, less government.  But they are perversely courting disaster.   Further, it’s not just the government that’s in hock. Total household debt reached a new high in August: $13.3 trillion. That includes a record amount of student debt ($1.5 trillion), an ever-growing amount of mortgage debt ($9 trillion, which is perilously close to the $10.5 trillion it reached during the mortgage crisis in 2008), and an overall credit card debt that just surpassed $1 trillion for the first time.

Then there’s corporate debt which is now set to be on rocket power given the corporate tax cuts.  Companies have taken advantage of low interest rates to borrow like crazy. This summer, corporate debt hit a new high of $6.3 trillion. Worse, the cash-to-debt ratio, which was 14 percent in 2008, has dropped to 12 percent: that’s $1 in cash for every $8 of debt.

Economists are quick to reassure the public that all of this debt is not catastrophic. After all, the economy is humming along. America doesn’t look like Greece. But in fact debt is like a hidden hive of termites eating away at the foundation of your house. You don’t see anything wrong except a bit of sawdust and the faint sounds of consumption. And then one day, you’re sitting at your kitchen table and, boom! You’re sprawled out in your basement with the wreckage of your house around you.

Currently,  as I noted in my previous post on the Reep tax cuts,  the U.S. government owes $21 trillion, which is slightly more than the household and corporate debt combined. The owners of U.S. debt include federal agencies like Social Security (which currently runs a surplus that it uses to buy Treasury bonds), the Federal Reserve (which bought a lot of debt during the financial crisis to lower interest rates), mutual funds, and banks.

 

Foreign countries also hold about a third of the debt. China and Japan own a little more than a trillion dollars each, followed by Brazil, Ireland, the UK, and Switzerland.In ordinary times, foreign ownership of U.S debt is uncontroversial. Countries with revenue surpluses need a safe place to park their money. And the United States has never defaulted on its sovereign debt, unlike Greece or Argentina.

But these are not ordinary times. With the sharp downturn in U.S.-Russian relations, Moscow decided this spring to unload 84 percent of its holdings of Treasury bonds. That amounts to about $87 billion, a considerable sum.  In addition,  Japan got rid of $18.4 billion in Treasury bonds in the spring. In the first half of 2018, Turkey unloaded 42 percent of its holdings in U.S. debt. Both countries currently have trade disputes with Washington.

The big player, however, is China, and right now the Trump administration is escalating its trade war with China. Trump just announced tariffs on another $200 billion in Chinese imports after targeting $50 billion of goods in the first round. China retaliating with more tariffs of its own is one thing but another possibility  is  devaluing its currency. An even more potentially devastating action would be to follow Russia’s example and sell its stake in Treasury bonds.

Each of these bond selloffs is akin to a gambler cashing in his chips. If the house lacks the money to pay the guy, then all hell will break loose- and that casino - like a Trump casino - wil be a loser and not last long.  In the U.S. case, each selloff of Treasury bonds creates even more instability in the markets and all that is then needed is a trigger to incite a shitstorm and crash, such as the Utility Forecaster predicted at the beginning of the year.

An even more somber warning: Americans (1 in 3 homeowners who earn less than $30,000/yr.) are now using home equity loans to cover their day to day expenses.  ('Americans leveraging their homes to pay bills', Denver Post, Business, p. 5K, Sept. 23)

My hypothesis is the trigger will likely arrive via algorithmic trades (see topmost header), and a massive lockstep selloff - leading to a crash of 50 to 60 percent.   In other words, a lockstep in asset prices - subject to algorithmic trading-  could lead to a "multiplier" sell-off effect that would overshadow a normal correction, So if 10 percent is a normal correction and the DOW was initially at 25,000 or so, that would mean a loss (total) of 2500 points.  If this is a multiplier effect at work, we could instead be looking at a  50 percent correction, or a 12, 500 point drop    If you have $100,000 parked in your company's 401(k) you might be lucky to see $50,000 in it at the end of the trading day.

Then there is the not wholly unrelated surmise of economist Martin  Feldstein (WSJ,  Save Interest For Rainy Day', July 27th)  who wrote:

 

"The downturn is almost certainly on its way. The likeliest cause would be a collapse in the high asset prices that have been created in the exceptionally relaxed monetary policy of  the last decade. It's too late to avoid an asset bubble. Equity prices have already risen far above their historical trend.  The price -earnings ratio of the S&P 500 is now more than 50 percent higher than the all time average, sitting at a level reached only three times in the past century.

The inevitable return of these asset prices to their historical norms is likely to cause a sharp decline in household wealth and in the rate of investment in commercial real estate. If the P/E ratio returns to its historical average, the fall in share prices will amount to a $9 trillion loss across all U.S. households."

 

Feldstein basically is predicting a   $10 trillion drop in U.S. household assets, warning:. “When the next recession comes, it is going to be deeper and last longer than in the past,”

Again, is anyone paying attention? I somehow doubt it. Too many are enamored of and trapped in Dotard's  asset bubble of irrational  exuberance.