InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
DECEMBER 6 , 2017
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As we wind down our 2017 publication of IntelDigest … before taking a break over the Holidays … we continue to discuss the Equities Markets and The Economy. We have returned several times to this topic over the last four months, and we find that the data continues to support the “Melt Up” thesis for the U.S. and global economies.
Writing one month ago, in our November 8 issue, we set out a number of factors and indicators which support the extension of this market run well into 2018. These include:
* continuation of low Interest rates (even if the Federal Reserve bumps up the rate by 1/4 percent next week)
* continuation of improving economic conditions around the world
* strong earnings in the largest U.S. corporations
* Holiday Season, typically the strongest time of year for many companies in the Dow 30 and S&P 500 … this year, featuring blockbuster holiday sales
* positive technical indicators signifying continued strength … the Advance/Decline Line and market breadth moving up, major stock indices (Dow, S&P 500, Russell 2000) rebounding from any decline to achieve new highs
Add to that the potential for massive gains in Corporate America if any version of the proposed Tax Reform legislation comes to pass.
All of the above support the “Melt Up” of equities, both domestically and internationally, for another few months.
So, let’s start looking further down the road, so we can begin planning for the downside to come. Here are some warning signs:
Bubbles
There are indications of financial bubbles (irrational exuberance?) forming in different sectors:
* Stocks have had a long, strong run to previously-unheard-of levels, buoyed by never-before-seen machinations by central banks
* Prices of Cryptocurrencies have been soaring
* Corporate bonds are paying record-low yields
* Investors bidding up non-financial assets, such as Art, to prices in the Hundreds of Millions of Dollars
* Consumer debt has returned to an all-time high (less than 10 years after a Financial Crisis which reverberated across the globe)
Sovereign Debt
The cornerstone for all of the above is Sovereign Debt. Governments around the world have taken on loads of debt and flooded marketplaces with liquidity, which has flowed primarily into asset values rather than productivity. This will inevitably lead to the bursting of several of these bubbles … perhaps as soon as mid-2018, or perhaps not until 2019.
In other words, when the market “Melt Up” comes to its end, the resulting recession will not be mild … expect some serious unpleasantness when the Bust arrives.
The current market is analogous to the market boom leading up to 1998. Stocks were flying then, and Internet stocks were flying fastest and highest. Debt was growing at unprecedented rates.
At the beginning of a massive credit boom, everything seems great. When credit growth far exceeds savings, it allows an economy to consume far more than it is producing. This “pulls forward” consumption, magnifies economic growth, and increases spending and wages.
But, by 1998, so much consumption had been pulled forward that it exceeded global aggregate demand. Bust! Commodities and emerging markets were hit hard. Russia defaulted. Eventually, bubbles burst in Technology and Telecoms, and a bear market ensued. Many Tech stocks fell 80% from their peak.
There is a high probability that we suffer a similar bust next year.
Government debt (both here and abroad) is at unprecedented levels. On a per-capita basis, U.S. federal debt has more than tripled since 2000. (Some things which have NOT tripled in that time: American wages and the American economy).
In just the last eight years, U.S. government debt has more than doubled on a rolling 10-year basis. By the end of this year, total federal debt per person in America will reach $62,000. That’s nearly $250,000 for a family of four.
This is bad enough to cause street protests, as well as “rending of garments and gnashing of teeth” (to get all Biblical). But no … there hasn’t been much protest at all. Because these massive increases in government debt have not (yet) caused the nation’s borrowing costs to rise.
By reducing Interest Rates to practically nothing, the Federal Reserve has anaesthetized the public to the growing debt. The Federal government is paying about the same amount in interest on the debt as it did back in the early 1990s, when our national debt was only 22% of the size of today’s burden.
The thing that matters to policymakers is how much the debt costs to maintain, not how much it costs to repay.
But, the Reckoning is coming. The debt explosion is finally reaching its peak. More and more consumer loans are starting to go bad. Default rates are rising on subprime auto loans. Now, credit card default rates are moving higher, too. Student loans will be next.
The Federal Reserve intends to slowly bring short-term Interest Rates back up to “normal” levels (around 4%), from the current level of 1.25%.
What will happen to the Federal government borrowing costs as Interest Rates rise? The Congressional Budget Office estimates that Interest Payments will nearly double, going from 6% to 11% of the federal budget.
Next week, we will discuss the warning signs to look for in advance of difficult times to come next year.