62% of Americans are losing sleep over a financial concern. About 40% specifically cite worrying about their retirement savings.
I’m not going to do much to help you today, but at least you can sleep in on Sundays. If you waited to read this, it isn’t on me.
If you’re pretty familiar with what we’ve covered in recent years through the Outsider Club — or, quite frankly, pay attention to any financial news or analysis at all — there are a handful of clear conclusions to make about the grand QE experiment.
Among them:
- Interest rates are unmoored, and with $13 trillion in negative bonds, are often out of control;
- As a result, central bank efforts to prop up markets have distorted them by removing rewards for risk, and created the appearance of no risk for paltry rewards;
- Corporations have soaked up as much “free” money as possible, with far too little capital investment to spur growth.
The list could go on, but this is all we need for now, considering it tells a basic, post-recession history.
It Ain’t Natural
Interest rate cuts, classically thought to spur growth magically on their own, have not done so at all. Subsequent cuts and market forces have made them an indicator of central bank sentiment alone.
The assumption was that companies would take the easy, nearly free money and reinvest it with little risk. Instead, it has mostly fueled share buybacks that improve headline metrics.
Very little capital expenditure is going on relative to the buybacks. When coupled with rotating cheap debt and not paying it off until interest rates rise, it will only lead to restricted cash flows and profits down the road.
Looking further down the road, more and more of this corporate debt is going to flow into central bank balance sheets, which no one has figured out how to unwind to date. European central banks are buying corporate bonds, Japan is next, and more will inevitably follow suit.
The result has been a kind of slow burn melt-up in the face value of bonds and stock markets. One that looks kind of familiar, but is driven by unprecedented actions. Yields have been gutted, markets are at all-time highs, while revenues have shrunk for several quarters in a row.
It’s just weird. I think we can all agree on that whether we’re bullish or bearish, or carefully rotating MREs in a refurbished Cold War bunker. It just ain’t natural.
The Buying Spree
All this is throwing risk and reward checks and balances out the window. Money is chasing yields without any real regard for the possibilities.
Emerging markets are a mess, with a slew of bad policies being highlighted by slowing growth. China and India in particular stand out in this category. I still remember when Russian stocks were hot, but the memory is dim and distant.
Meanwhile, Brazil takes the prize for 2016’s most disastrous economic turn, if you assume, as I do, that Venezuela is already a failed state.
But who cares? The herd will chase the yield and ignore the risks. Emerging market debt investment is seeing a massive surge:
On a global scale, we’re now around $30 trillion in outstanding corporate debt. As Bloomberg noted earlier this year:
“Credit-rating downgrades account for the biggest chunk of ratings actions since 2009; corporate leverage is at a 12-year high; and perhaps most worrisome, growing numbers of companies — one third globally — are failing to generate high enough returns on investments to cover their cost of funding. Pooled together into a single snapshot, the data points show how the seven-year-old global growth model based on cheap credit from central banks is running out of steam.
“’We’ve never been in a cycle quite like this,’ said Bonnie Baha, a money manager at DoubleLine Capital in Los Angeles, which oversees more than $80 billion. ‘It’s setting up for an unhappy turn.’”
The question is, who is going to deal with this “unhappy turn?” Might as well line up those Ambien pills on the nightstand now, if you have them.
This One’s On You
Since we all know the answer now, let’s go straight to the chart:
The BofA Merrill Lynch report this chart comes from bluntly states “that expansion was bought by just two investors — mutual funds/ETF and foreigners.”
Those are your mutual funds and bond ETFs, bought by your 401(k) and IRA managers.
Here is where it could, and quite probably will, all go wrong. Any big shock to this fragile system can easily set off a chain reaction.
Let’s say a recession hits us again. As normal, we don’t see it coming and markets react quickly. ETFs will price it in immediately, but mutual funds only settle at the end of the day.
Even then, institutional investors move faster than you and have preferential treatment from exchanges. They get to sell first for a smaller loss.
The assets unloaded at the end of the day push ETFs lower at the next day’s start. A feedback loop is starting to form with gluts of available shares and assets hitting the market in volatility bursts.
Corporations, facing a slower economy yet again, also face higher yields that sharply diverge from central bank fund rates. This has already slowly started, actually. Any semblance of centralized control is thrown out the window.
Higher interest payments on rotated debt constrict already reduced cash flows to the point of corporate asset fire sales. Markdowns ravage balance sheets, shares sell off even more, defaults hit bonds.
Suddenly, both sides of your traditional allocation are trashed. The face value of bonds drops quickly with higher yields, and stock gains are all but erased.
So there you go, America. I’d thank you for picking up the tab for yet another burst bubble, but you didn’t have a choice.
Something tells me the only people coming out ahead on this rotten, engineered outcome won’t either, especially when they come hat in hand to dip into taxpayer funds to start the cycle again.
