Brace yourselves folks, for despite my undeniably longer-term and openly jaded concerns for our Fed-supported U.S. markets, I’m going to be sharing some very bullish data below that just might surprise you.
Why so bullish?
Well, it boils down to relative strength. That is, because things are about to turn so bearish in Europe, this actually means bullish tailwinds for the U.S.
As I’ve written elsewhere, when things go bad overseas first, this causes massive flows of capital to the U.S. credit and equity markets as the real and perceived best horse in the global glue factory.
Tracking Credits and Flows
As an American writing to you now from overseas, I have the benefit of (as well as interest in) carefully monitoring the credit markets on both sides of the Atlantic.
I also have exposure to experts, clients and bankers who speak German and French, and what they’re telling me, as well as what the objective facts confirm, is that there’s big trouble ahead for the EU.
But rather than just pontificate on such things, let’s do what we promised from the beginning and provide you with facts rather than opinion. In other words, let’s just stick to the objective data points and consider them together.
The Two Kinds of Credit Risk You Must Know
When it comes to a credit crisis, there is more than just one flavor. That is, there is your ordinary (yet dreadful) corporate bond crisis (or bubble) in which otherwise totally junky companies survive exclusively on low-rate debt rollovers, which is the case in the U.S. today.
Over 60% of the U.S. corporate bond market is now composed of high-yield credits, junk bonds and levered loans, the very D- students of the credit world, all kept alive by the Fed’s suppression of interest rates.
Such corporate bond risk is very real, and poses a direct threat to pension funds, insurance companies and, of course, individual investors seeking yield but getting risk instead. Not good. Not good at all.
But beyond such corporate credit risks, comes the second and far more dangerous flavor of credit risk, namely broken banks.
The great financial crisis of 2008, for example, was made infamous because not only were companies going broke, but the banks themselves were on their knees.
Fortunately, or unfortunately, depending on your respect for free market capitalism rather than centralized, Wall Street socialism, the Fed (and you the tax-payer) bailed out the U.S. banks to the tune of trillions and thus it goes without saying that U.S. banks are at no risk today of going broke.
The Two Data Points You Must Know
The same, however, cannot be said at all about European banks or banks elsewhere around the world.
But the BIS, or Bank of International Settlements, recently put out some reports that almost no one reads or follows but which nevertheless suggest some real trouble ahead outside the U.S.
Ironically, these troubles actually have some massively bullish implications for what happens inside the U.S., as we’ll unpack below.
Luckily, I’ve read those boring reports for you and I have some insights to share now.
In particular, the BIS provided two very predictive and objective tools for measuring the probabilities and timing of a major credit crisis.
The first tool involves not just the debt to GDP ratios of a given country, but far more importantly (and predictively), it measures the rate of growth of that ratio relative to its trend.
That is, once the debt to GDP ratio grows at a rate of 9% above trend, there is more than a 50% chance of banking crisis within the following 3 years.
And remember, when banks go into a crisis, this impacts more than just insurance companies and stock markets, it impacts the entire economy. Think Recession.
The second tool mentioned by the BIS measures the rate of growth above trend in the debt service ratio of private sector loans.
Countries Making the “Uh-Oh” List
And based upon this first objective risk measuring tool, the BIS recently determined that 43% of the global economies are now at risk of a genuine banking crisis, and remember: A banking crisis is the worst kind of debt crisis.
American readers will be happy to know that the U.S. did not make that list.
But totally broke countries like Japan (with a debt to GDP ratio of 375%) certainly did, as did
the Netherlands, Singapore and Saudi Arabia-the four most at risk “red names” names on the list.
Just below this “red list” are flashing yellow-risk countries which include Hong Kong, Canada, China, Turkey, France, Belgium and Finland.
Europe’s Place on the Bad List…
What is particularly disconcerting about this data and list is that four of the names on these warning lists are E.U. countries, and one of them, on the red list, is my dear France, which alongside my equally dear Germany, is the co-parent of the entire E.U. “experiment” that is modern Europe.
Needless to say, this does not bode well for E.U. banking, nor does it bode well for the now official risk of a major, bank-lead credit crisis in the E.U..
After all, France and Germany are the key drivers behind the single currency, shared-interest-rate E.U. project.
And today, both countries have their backs against an economic rope. France has a debt to GDP ratio of 329% and Germany’s is at 181%, yet both have the same interest rate.
This just shows how crazy the E.U. experiment is and further explains why the United Kingdom divorced the E.U. with its infamous Brexit move.
In short, the E.U. is facing big, and objectively-measured problems ahead, both financially and politically.
Furthermore, as the co-parent of the E.U. experiment, Germany , as I recently reported, is openly questioning E.U. policy and exhibiting increasing signs of family drama in the already dysfunctional home otherwise known as the European Union.
Given the now objectively confirmed measuring tools indicating increased banking risk and hence the higher probability of a systemic and massive credit crisis in Europe, what can we expect in the next three years there?
And more importantly, how does that impact U.S. investors in the coming years? Let’s take a deeper dive.
What to Expect in the E.U.
First, and as to Europeans, they are now looking down the barrel of a genuine economic and political crisis heading their way. This can lead to further social unrest as well. Never a good thing.
As banks, insurance companies and pension funds in these zip codes begin to implode, there will be an immediate need to take both political and economic emergency measures, which means both the politicians and the central bankers will be panicking/reacting at the same time.
As for the European Central Bank under Christine Lagarde, her options will be very simple and very obvious.
With interest rates already below zero, her only remaining “emergency tool” will be massive amounts of money-printing, aka, “quantitative easing,” or “QE,” and by that I’m talking about insane levels of printed money as outlined by the maniacs who invented modern monetary theory (MMT).
Typically, of course, a normal credit crisis is deflationary in profile, but in the atypical world (or Twilight Zone) of QE-based stimulus, this next E.U. credit crisis (and “solution”) will be inflationary, as QE will go into the real economy, not just the broken banks.
As gobs of printed euros come off the ECB’s printing press, the Euro will weaken, bond yields will rise (as bond prices fall) and the shocked politicians will likely have no choice but to impose caps on the government yields so that inflation is held in check, though it is more than likely that the inflation-adjusted (i.e. real) returns on European bonds will be negative.
This means European savers will get punished.
Under E.U. law, only the first 100,000 Euros of investor deposits are guaranteed by the government, which means lots of wealthier European savers will be taking their money out of their banks and sending it… guess where: to the U.S..
But more on that below.
For now, suffice it to say that all the dangers I’ve outlined ad nauseum about the numbing effect of QE morphine handed out by central banks in general will eventually lead to a slow death by the same drug.
But morphine feels good at first, as any wound victim can attest.
When QE pours into the broken E.U., the initial effect will likely be bullish for banks and stocks (and of, eventually, gold), but harsh for savers and currency holders.
As to how and when this all plays out, this is objectively clear to expect, yet nearly impossible to time, as much of these inevitable reaction measures will be driven by politicians, and they are the hardest market indicator to predict.
Nevertheless, and based on pure realism in a world now addicted to QE morphine, one thing we can be sure of this: Expect tons more of it.
More importantly, don’t forget that too much morphine is ultimately fatal. The E.U. will be no exception.
The Fed’s longer-term prognosis (and that of the U.S. markets) is equally no exception to this slow death, yet based upon current data and risk tools, the evidence suggests that this slow death will occur in the E.U. first.
And ironically, this means very good news, in the near term, for U.S. markets and an even stronger U.S. dollar down the road.
What to Expect in the USA: Bullish!
Over the next few years, the problems and headwinds in the E.U. will be manna and tailwinds for the U.S. markets.
Already, we are seeing flows out of the E.U. and into U.S. stocks and bonds, and this flow will only increase as problems overseas slowly unfold/worsen, though the EU may impose various forms of capital controls to limit this outflow.
Nevertheless, we can expect a lot of those euros to be converted into dollars and directed toward longer duration U.S. Treasury Bonds (10-30 year), which means prices there will go up, and hence yields (i.e. rates) will remain down, thus buying our otherwise broken and dangerously yield-compressed bond market more critical and precious time.
As I wrote/forecasted here, foreign inflows of U.S. dollars from overseas act like “Free QE,” and helps keep our otherwise dead bond market from naturally tanking without having to ask the Fed to over-print more currency, as inflows from elsewhere do this for them-at least to a point/limit.
That said, both bonds and stocks will benefit from these inflows, for again, and as discussed earlier, the U.S, will likely enjoy a further melt-up based upon the simple fact that our markets, as broken and rigged-to-fail as they are, remain the best horse in the global glue factory.
But Don’t Get Too Bullish…
Of course, this does not mean that U.S. markets won’t continue to see volatility or risk down the road, but at a 30,000-foot level analysis, the next great recession to hit our shores will likely be further postponed by the simple fact that such a recession will hit the E.U., and elsewhere, first.
Nor do such data points from the BIS and the E.U. suggest that U.S. investors should be fully “risk-on” in these surreal tail and headwinds.
Despite potential inflows from overseas, U.S. markets are not without risk and thus our Storm Tracker cash allocations, which change as conditions change, should be followed.
Furthermore, contagion risk from overseas is equally as likely as in-flow reward, and thus rather than sit here today and time either bull or bear reactions, all that informed investors like us can do now is watch the market signals as they come in, and hence adjust our portfolios accordingly.
That’s because the race to the bottom begun by the global central banks years ago is a marathon not a sprint, and as informed investors, we need to make portfolio adjustments as both bull and bear signals show themselves.
For now, however, the data above suggests more good news than bad news for U.S. markets, which proves yet again that as bearish (or Fed-disgusted) as Tom and I might be over the long run, we know when to look for near-term bullish indicators and are eager to share them.
The above data, in short, is certainly bullish looking ahead.
Stick with us over the marathon, not the sprint, and we’ll keep you protected as well as signaled toward the right allocations, bullish or bearish, as these markets gyrate like crazy.
Again, we plan to provide those signals and allocations with far more detail within the next six weeks on an on-going basis so that your portfolio will always be positioned for both headwinds and tailwinds, and based upon facts and market signals rather than just macro opinions.
We are working very hard right now to put this service together.
In the interim, stay informed and watch those flows out of Europe, for they do impact U.S. markets, which means YOUR portfolios.
Matt & Tom
6 responses to “European Union Credit Crisis Ahead? That’s Super-Bullish for the United States”
January 24 2020