A week ago, the Fed lowered interest rates (for the first time in over a decade) and the White House reignited the tariff war with a single tweet.
What happened? The markets had a tiny hissy fit. Monday’s one-day plunge in global equities was the largest since February 2018.
By last Friday’s close, the S&P had tanked by 2.8%, and by Tuesday’s close, by 5.7%. That’s a pretty sharp and quick ride south.
Tuesday saw a slight claw back as China appeared to stabilize its currency-fueled market scare. Markets, as usual, will likely rise in the near-term, as bad days are typically followed by good ones – until the debt party ends.
Readers are getting nervous and asking if we are heading toward another “’08 moment.”
How Conditions Are Worse Than the Last Crisis
So, are we finally having our moment?
The short answer for the near-term is this: not yet.
Near-term price action will depend on whether the trade war cools or gets hotter. Most fund managers are expecting increased tensions, and hence another shoe to drop. Meanwhile, the bubble-heads at CNBC are saying not to worry, don’t go to cash.
That’s what they always say – they’re salesmen, not traders. Perhaps they overlooked declining growth, GDP, and earnings forecasts. Anyway, they read prompts, not charts…
Already, U.S. farmers (and hence U.S. debt costs) are hurting, as China stuck it to us by cutting all U.S. agricultural purchases.
So, let’s compare August of 2019 to August of 2007 and see just how much history may repeat itself – or, at the very least, rhyme.
In 2007, the U.S. was chugging along, blissfully ignorant of a ticking debt timebomb of D- subprime mortgages, all nicely packaged by our too-big-to-fail (TBTF) banks as A+ “asset-backed securities.”
The S&P was ripping and the Fed fund’s rate was at 5.25% – 260 basis points above inflation.
Then, suddenly, the Fed got a bit nervous as the first tremors of a mortgage debt crisis began to shake. In response, they cut rates by 50 basis points over the next 60 days, and the markets happily ripped northward once again, putting everyone at ease. (We’ll likely see the same pattern.)
But within another 30 days, the markets fell, and kept falling. For the next 16 months, the U.S. went into the greatest nosedive since the Great Depression as the Fed desperately cut rates by another 500 basis points until our Titanic markets hit the ocean floor lows in March of 2009 – a 57% fall.
Today, things look hauntingly familiar.
As in 2007, markets keep rebounding with dip-buying joy (and media drivel), blissfully ignorant of a corporate (rather than mortgage-backed) debt bomb of D- borrowers living off loan extensions rather than earnings growth.
The S&P has touched record highs, but today’s Fed funds effective rate, at 2.13% (rather than 5+%), is much weaker than ’07 and is just 53 (rather than 260) basis points above reported inflation.
And as in August of 2007, the Fed is once again getting nervous as the first tremors of a corporate debt crisis in need of “assistance” has prompted the recent 25 basis point rate cut.
The trillion-dollar question today is this… are we following the same slow path toward a debt-driven sell-off, or is this time really different?
This Time Isn’t Different… It’s Worse
When the ’08 crisis hit, the Fed’s balance sheet was just north of $800 billion and it had five percentage points to play with (i.e. cut) to hasten a “recovery.”
Today, the Fed’s balance sheet has ballooned to $3.6 trillion, and it has just two (rather than five) percentage points to play with – hardly enough to act as a “recovery tool” when the next recession hits.
In 2007, total U.S. government debt was at $8.6 trillion, today it’s at $22 trillion.
In 2007, U.S. consumer debt was at $2.7 trillion, which was 80% of wage income. Today, that debt number has skyrocketed to just under $16 trillion and represents a staggering 180% of wage income.
In 2007, the inflation-adjusted yield (return) on the world’s benchmark sovereign bond – the U.S. 10-year Treasury – was 2.38%. Today, that same benchmark bond, when adjusted for even dishonestly low inflation, yields a pathetic negative 70 basis points.
In 2007, none of the great nations of the world were issuing negative yielding bonds. Today 26% of the entire $55 billion tradable sovereign bond market is in the negative, and now $14.5 trillion of all global bonds have subzero returns.
This, folks, is absolutely appalling. It is a sign of distortion.
In short, as of August of 2019, and compared to August of 2007, the U.S.:
- Is more in debt;
- Its benchmark Treasury is more broken;
- Its central bank is more bloated;
- It has less interest rate and balance-sheet ammo to halt another recession, and;
- The world in which it operates (i.e. trades) is in the midst of the largest debt bubble ($250 trillion) in history, one supported by central banks who have artificially pushed sovereign bonds into negative-yielding territory for the first time in the 5,000-year history of financial record.
Ouch. This is not an ideal setting for another “uh oh” moment.
But in the wake of the 2008 crisis, it was believed that never again would the U.S. find itself in such a pickle.
The Bernanke Fed promised its emergency measures of money printing and low debt would end within a year or so.
But that was simply a fib – one of so many.
We are still in pure emergency mode, as last week’s rate cuts confirmed, only now we have just a few bullets left and are just 2.25% of rate cuts away from zero and the end of our monetary rope.
If the Fed went to negative rates, that would push us (and the global markets) over a cliff of total panic and market bleeding.
The Next Trigger?
In 2008, a “Lehman moment” sparked the domino fall. Today, some fear the tariff war will do the same.
Are they right?
We’ve said many times that no one wins a trade war. Furthermore, history confirms that past protectionist measures (the 1890 McKinley tariffs, or the 1931 Smoot-Hawley tariffs) ended badly for the U.S.
But even those disastrous examples were less dangerous than the current trade war, because they were aimed at all nations – not a single nation like China, which, as much as we love to hate its duplicitous trade, market, and ethical sins, is still 40% of global GDP and thus a key player in the $17 trillion game theory playing field of a highly intertwined global and technological supply chain.
So, will this trade war spark the next recession and market drawdown?
Will it get hotter, or will the White House and China reach a nice little accord just in time for election season here in the U.S. – thus buying our country a bit more headline salvation until a U.S. recession rather than trade war pushes our market toward new lows?
Well, China’s leader doesn’t have to worry about re-election. This week, he weaponized his currency to stick it to the U.S., reminding investors that China can play dirty in this losing game.
Was yesterday’s sudden FX stabilization by China a white glove or just a card trick?
Many feel this war could easily get hotter and hence your money closer to getting burned.
And as for the Fed saving you, don’t bet on it. As we pointed out in Monday’s report, the last two times the Fed used rates to “save” us, a recession followed within three months.
The White House says money is flowing into U.S. markets and that China will rot (or blink) first. Perhaps. Our pathetic, yet at least nominally positive bond yields may be a near-term and relative safe haven for foreign funds, thus buying the U.S. markets more near-term support.
Time and market signals will tell.
Regardless of a trade war trigger, U.S. markets will inevitably fall/rot from within – led by a Main Street recession.
Walgreens, by the way, just announced another 200 store closings, adding to a record-year of pain in our real economy – the one the bubbleheads and Fed have forgotten.
Folks, be careful out there – and stick with us as we carefully track developments in a China-U.S. showdown whose ramifications are as volatile as our markets have recently been and will certainly continue to be.
15 responses to “Is This Our “Lehman Moment”?”
August 07 2019