The Trade War Is Not The Problem With The Global Economy

I chuckle when the hedge fund algos grab onto “positive” trade war headlines and trigger a sharp spike in stock futures.  Settlement of the trade war between the Trump Government and China will do nothing to prevent a global economic recession – a recession which will likely deteriorate into a painful depression.  The Central Bank “QE” maneuver was successful in camouflaging and deferring the symptoms of economic collapse.  Ironically, treatment of the symptoms made everyone feel better for a while but the money printing ultimately served only to exacerbate the underlying financial, fiscal, economic and social problems that blossomed after the internet/tech bubble popped.

Trade war “hope” headlines coughed up by Larry Kudlow last Friday morning were designed to offset the disappointing job report and sent the Dow up 156 points in the first 12 minutes of trading. But alas, the gravity of deteriorating systemic fundamentals took over and the Dow ended up down 558 points:

All three major indices closed below their key moving averages (21, 50, 200 dma). I wanted to show the chart of the Nasdaq because, as you can see, the 50 dma (yellow line) crossed below the 200 dma (red line) last week. This started to occur for the SPX on Thursday. The Dow’s 50 dma remains above its 200 dma, but that will likely change over the next few weeks.

The point here is that investors, at least large sophisticated investors, continue to use rallies to unload positions. The stock market has a long a way to fall before the huge disparity between valuations and fundamentals re-converges. This reality will not be altered even if Trump and China manage to reach some type of trade agreement. Nothing but a painful “reset” can correct the massive overload of fiat currency and debt that has flooded the global financial system over the last ten years.

I also believe that a massive credit market liquidity problem is slowly engulfing the system. This is a contributing factor in the yield curve inversion, which moved from the 3yr/5yr interval to the 2yr/5yr interval last week, thereby reflecting the market’s growing awareness of the percolating systemic problems. In 2008 the liquidity problem began with widespread sub-prime bond defaults and was compounded by derivatives connected to the sub-prime credit structures. This time, it appears as if the credit market problem is starting in the investment grade bond and leveraged bank/senior loan markets.

It was reported last week that $4 billion was removed from leveraged loan funds over the last three weeks. Although the loans are leveraged, these are typically senior secured “bank debt equivalent” loans. Money is leaving this segment of the loan market because of a growing perception that the leveraged senior loan market is becoming risky. Loan and bond investors are more risk-averse than stock investors. They thus tend to be more vigilant on the ability of debt borrowers to make loan payments.

Currently there’s a record high amount of triple-B rated corporate debt outstanding. This amount outstanding is higher than any other rating category. At some point, as the economy continues to weaken, a large percentage of this triple-B rated will be downgraded. Assuming cash continues to flee the loan market, and as a lot of low investment grade paper is moved into junk-rated territory, it will exert huge pressure on bond yields. It will also make it much harder for marginal credits to raise capital to stay alive.

General Electric losing access to the commercial paper market is an example of the market cutting off a source of liquidity to companies that need it. It’s also a great example of a company with a large amount of outstanding debt that is headed toward the junk bond pile (GE is one notch away from a junk rating – at one time it was a triple-A rated company). Ford is headed in the same direction – the stock of both companies trades below $10. If this is happening to a companies like GE and Ford, it will soon happen to smaller companies en masse.

The commentary above is an excerpt from the latest issue of the Short  Seller’s Journal.  Also included is an updated analysis on Tesla and why I am increasing my short exposure in the stock plus follow-up on my Vail Resorts (MTN) short presented a week earlier. You can learn more about this newsletter here:  Short Seller’s Journal information.


One thought on “The Trade War Is Not The Problem With The Global Economy

  1. Former Fed Chairman Blasts McKinsey and Hedge-Fund Billionaires

    By Mary Childs
    Dec. 12, 2018

    The book explains why ending the fixed conversion to gold was politically imperative. But what if we hadn’t? Would that have ended the U.S. hegemony?

    I was a great defender of Bretton Woods. I thought it could be reformed, and I discovered it couldn’t be, partly for immediate political reasons. But you can’t maintain a fixed exchange rate system and commonality without a very strong hegemon. Brits were that before World War I when they had the gold standard; they lost it in the ‘20s and ‘30s and things were a mess. We had it after World War II for 20 years or so. But even back in the ‘70s, it began. We could not negotiate an agreement, which I was hopeful about, but in hindsight I think was an impossible venture because we were no longer strong enough to, in relative terms.

    What the French were really worried about in the ‘70s, when that phrase “exorbitant privilege” originated, we had a current-account deficit and we were buying up French industry. And they didn’t want us buying up French industry. But we sat here for 20 years running deficits, because it was so easy for us to finance these big deficits. I once coined a phrase which nobody picked up: Exorbitant privilege is also an invitation or temptation to lack discipline. Some day that might come back and bite us. It hasn’t yet.

    There’s an argument now: What if it doesn’t matter and we can just pile debt on?

    Someday confidence is lost. The longer the imbalance lasts, the more difficult it is to correct. This is part of what we’re paying for now. We were willing to run these current account deficits, and it was favorable for businesses — they could invest abroad, import more freely. But eventually it breaks down. During that process you lost a lot of small American manufacturing. Now we’re getting the blowback from that. A lot of people feel left out, and they were! We took great pride in open markets, free competition, no tariffs. That pleases the scholars, it pleases big business, but it doesn’t please the people in the part of the country that lost out.

    Is that an argument for protectionist…?

    Sounds awful, doesn’t it? That’s a bad word.

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