Most Popular Choices
Share on Facebook 32 Printer Friendly Page More Sharing
OpEdNews Op Eds    H2'ed 8/25/15

Wall Street Panic

By       (Page 1 of 2 pages)   4 comments
Message Mike Whitney
Become a Fan
  (44 fans)

Reprinted from Smirking Chimp

US Dollar, China, Economic crisis
Copyrighted Image? DMCA

"Not only is the equity market at the second most overvalued point in U.S. history, it is also more leveraged against probable long-term corporate cash flows than at any previous point in history." ~~ John P. Hussman, Ph.D. "Debt-Financed Buybacks Have Quietly Placed Investors On Margin," Hussman Funds

"This year feels like the last days of Pompeii: everyone is wondering when the volcano will erupt."~~ Senior banker commenting to the Financial Times

Last Friday's stock market bloodbath was the worst one-day crash since 2008. The Dow Jones dropped 531 points, while the S&P 500 fell 64, and the tech-heavy Nasdaq slid 171. The Dow lost more than 1,000 points on the week, dipping back into the red for the year. At the same time, commodities continued to get hammered with oil prices briefly dropping below the critical $40 per barrel mark.

More tellingly, the market's so called "fear gauge" (VIX) skyrocketed to a 2015 high, indicating more volatility to come. The VIX has remained at unusually low levels for a number of years as investors have grown more complacent figuring the Fed will intervene whenever stocks fall too far. But last week's massacre cast doubts on the Central Bank's intentions. Will the Fed ride to the rescue again or not? To the vast majority of institutional investors, who now base their buying decisions on Fed policy rather than market fundamentals, that is the crucial question.

Ostensibly, last week's selloff was triggered by China's unexpected decision to devalue its currency, the juan. The announcement confirmed that the world's second biggest economy is rapidly cooling off, increasing the likelihood of a global slowdown. Over the last decade, China has accounted "for a third of the expansion in the global economy," almost double the contribution of the US and more than triple the impacts of Europe and Japan." Fears of a slowdown were greatly intensified on Friday when a survey showed that manufacturing in China shrank at the fastest pace since the recession in 2009. That's all it took to put the global markets into a nosedive. According to the World Socialist Web Site:

"The deceleration of growth in China, reflected in figures on production, exports and imports, business investment and producer prices, is fueling a near-collapse in so-called "emerging market" economies that depend on the Chinese market for exports of raw materials. The past week saw a further plunge in stock prices and currency rates in Russia, Turkey, Brazil, South Africa and other countries. These economies are being hit by a massive outflow of capital, placing in doubt their ability to meet debt obligations." ("Panic sell-off on world financial markets," World Socialist Web Site)

While a correction was not entirely unexpected following a 6-year long bull market, the sudden drop in equities does have analysts rethinking the effectiveness of the Fed's monetary policies which have had little impact on personal consumption, retail spending, wages, productivity, household income, or economic growth -- all of which remain weaker than they have been following any recession in the post war era. For all intents and purposes, the plan to inflate asset prices by dropping rates to zero and injecting trillions in liquidity into the financial system has been an abject failure. GDP continues to hover at an abysmal 1.5% while signs of a strong, self-sustaining recovery are nowhere to be seen. At the same time, government and corporate debt continue to balloon at a near-record pace, draining capital away from productive investments that could lay the groundwork for higher employment and stronger growth.

What's so odd about last week's market action is that the bad news on China put shares into a tailspin instead of sending them into the stratosphere which has been the pattern for the last four years. In fact, the reason volatility has stayed so low and investors have grown so complacent is because every announcement of bad economic data has been followed by cheery promises from the Fed to keep the easy-money sluicegates open until the storm passes. That hasn't been the case this time, in fact, Fed chair Janet Yellen hasn't even scrapped the idea of jacking up rates some time in September, which is almost unthinkable given last week's market ructions.

Why? What's changed? Surely, Yellen isn't going to sit back and let six years of stock market gains be wiped out in a few sessions, is she? Or is there something we're missing here that is beyond the Fed's powers to change? Is that it?

My own feeling is that China is not the real issue. Yes, it is the catalyst for the selloff, but the real problem is in the credit markets where the spreads on high yield bonds continue to widen relative to US Treasuries.

What does that mean?

It means the price of capital is going up, and when the price of capital goes up, it costs more for businesses to borrow. And when it costs more for businesses to borrow, they reduce their borrowing, which decreases the demand for credit. And when the demand for credit decreases in a credit-based system, then there's a corresponding slowdown in business investment which impacts stock prices and growth. And that is particularly significant now, since the bulk of corporate investment is being diverted into stock buybacks. Check out this excerpt from a post at Wall Street on Parade:

"According to data from Bloomberg, corporations have issued a stunning $9.3 trillion in bonds since the beginning of 2009. The major beneficiary of this debt binge has been the stock market rather than investment in modernizing the plant, equipment or new hires to make the company more competitive for the future. Bond proceeds frequently ended up buying back shares or boosting dividends, thus elevating the stock market on the back of heavier debt levels on corporate balance sheets.

"Now, with commodity prices resuming their plunge and currency wars spreading, concerns of financial contagion are back in the markets and spreads on corporate bonds versus safer, more liquid instruments like U.S. Treasury notes, are widening in a fashion similar to the warning signs heading into the 2008 crash. The $2.2 trillion junk-bond market (high-yield) as well as the investment grade market have seen spreads widen as outflows from Exchange Traded Funds (ETFs) and bond funds pick up steam." ("Keep Your Eye on Junk Bonds: They're Starting to Behave Like '08," Wall Street on Parade)

As you can see, the nation's corporations don't borrow at zero rates from the Fed. They borrow at market rates in the bond market, and those rates are gradually inching up. And while that hasn't slowed the stock buy-back craze so far, the clock is quickly running out. We are fast approaching the point where debt servicing, shrinking revenues, too much leverage, and higher rates will no longer make stock repurchases a sensible option, at which point stocks are going to fall off a cliff. Here's more from Andrew Ross Sorkin at the New York Times:

Next Page  1  |  2

(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).

Must Read 2   Well Said 1   Supported 1  
Rate It | View Ratings

Mike Whitney Social Media Pages: Facebook page url on login Profile not filled in       Twitter page url on login Profile not filled in       Linkedin page url on login Profile not filled in       Instagram page url on login Profile not filled in

Mike is a freelance writer living in Washington state.

Go To Commenting
The views expressed herein are the sole responsibility of the author and do not necessarily reflect those of this website or its editors.
Writers Guidelines

 
Contact AuthorContact Author Contact EditorContact Editor Author PageView Authors' Articles
Support OpEdNews

OpEdNews depends upon can't survive without your help.

If you value this article and the work of OpEdNews, please either Donate or Purchase a premium membership.

STAY IN THE KNOW
If you've enjoyed this, sign up for our daily or weekly newsletter to get lots of great progressive content.
Daily Weekly     OpEd News Newsletter
Name
Email
   (Opens new browser window)
 

Most Popular Articles by this Author:     (View All Most Popular Articles by this Author)

Class Warfare Scoreboard -- Guess Who's Winning?

Henry Kissinger calls for a New Post-Covid World Order

Newt's Victory: Was it a "Surge" of popularity or faulty voting machines?

Is Fukushima's Doomsday Machine About to Blow?

The Broken Chessboard: Brzezinski Gives Up on Empire

Troublemaking Washington: Pushing Ukraine to the Brink

To View Comments or Join the Conversation:

Tell A Friend