How quickly can markets change? Wednesday’s and Thursday’s stock market selloff was (temporarily) disrupted by some late day buying on Friday – although in my opinion it simply looked like some shorts covering their positions heading into the weekend. The trend seems to have shifted from a risk-on and buy attitude, to a slam the breaks and sell one. There’s no doubt, stocks have performed incredibly well since their 2009 lows. But the longer an economic expansion lasts, the more will governments, central banks, investors and economists be concerned about when the next recession finally shows up. But what will trigger the next global recession? Here are seven possible causes that could potentially trigger the next major crisis.
Without a doubt, China’s unprecedented economic expansion was financed by debt. That is why Peking’s leaders have taken measures – rather unsuccessfully – to try to reign in the explosive growth of private debt, which at these levels simply isn’t viable. The possibility that China can successfully steer it’s massive debt on sustainable paths while transitioning its economy from exports to domestic consumption successfully is rather low. According to the World Bank, of 43 countries whose national debt as a percentage of GDP increased at such a fast pace as China’s, only 5 did not endure a dramatic decline in growth or avoid a financial crisis. Sure, there’s some sunshine between the clouds such as their trade surplus with the rest of the world. That said, the trade wars with the United States make it harder for China to continue their efforts to reduce their debt levels. If China experiences a downturn in growth, even a small one, their problems would cause an economic tsunami in the Asia-Pacific region.
Rising interest rates in the United States, coinciding with a strong performance for the greenback (thus far) in 2018 has caused a lot of problems for emerging market economies. That’s because emerging markets are having a harder time financing their debt obligations in US Dollars, while their ability to borrow more is also inhibited. Argentina, for example, borrowed $57 Billion Dollars in an effort to stabilize their currency – the Peso is down nearly 50% year-to-date. The Turkish Lira has also collapsed because investors doubt President Erdogan has any plans to tame inflation, which in September reached 24.5%. These as well as other indebted emerging market nations have borrowed more than their ability to repay, thus making the countries which import large quantities of oil extremely vulnerable.
The price of crude oil has risen 17% from it’s August lows to it’s October 10th high – the price is currently sitting comfortably at $80 dollars. This is a trend that’s been going on throughout the year, and many analysts and economists are calling for the price of oil to reach $100 dollars for the first time in four years before the end of the year. This rise in oil prices is hurting national economies that depend on importing large quantities of oil. That is why growth in economies like India, Chile, Germany, Japan, France, Taiwan, and South Korea has started to stall. While an increase in oil prices benefits producer nations, if prices continue to rise over the next six to eighteen months, this will put even more pressure on the global economy and especially emerging markets, who are already struggling with rising interest rates and the strength of the US Dollar.
Since mid-2009, no one other than corporations themselves has been bigger buyers of US equities. Non-financial corporates have bought a whopping 18% of market cap, in turn creating the biggest debt-funded buyback in history. Well, today these non-financial corporates find themselves between a rock and a hard place – in financial terms between rising inflation and rising interest rates. As things stand right now, this is the highest level of non-financial corporate debt in the last 30 years. Given that the last recession was triggered by unserviceable financial and household debt, the possibility of the next recession being triggered by corporate debt is very high. Because almighty Central Banks simply cannot fight inflation and lower interest rates at the same time. Earnings season started this past Friday which means that corporates cannot buy back any of their stocks at least for another month. Thus the selling could get even uglier.
Anyone following EU politics knows that the week ahead is crucial. Yet how prepared are investors for the possibility of a “Hard Brexit” – that is Theresa May and the EU not coming to an economic agreement over trade between the UK and the EU economic area? I for one can’t see how she can survive politically should she kowtow to the European Union’s demands on immigration among other commitments, which is exactly why plan’s such as the Chequers agreement got binned. In any event, the developments between this week and March 2019, is highly likely to be a period of turmoil as the UK plan’s to leave the EU without any plans. This is going to hammer financials, particularly European financials as British banks will have their right to offer services to banks in the EU rescinded. As we know from history, the global financial system is closely interconnected – so if there is a problem in Germany, Britain or France, you can definitely expect problems elsewhere.
The United Kingdom isn’t the only one leaving the EU – there is also a high likelihood of Italy following the British Isle out of the Eurozone. Italy’s national debt currently stands at more than 2 Trillion Euros. This is an amount larger than any national debt in the Eurozone, with Italy’s Debt to GDP ration coming in at 130%. Further to this, leaders in the EU are concerned that Prime Minister Conte plans to increase the national debt even more; this can possibly push the entire Eurozone into a debt crisis not seen since 2009. At least that is what the price of Italian bonds seem to be suggesting with the spread on the 10-year bond yield topping 300. When that goes up, something is terribly wrong with that nation.
Democrats Win The Midterms
Political tensions in the US have been high since Donald Trump’s election in November 2016. Have we seen “peak resist” from the Democrats during the Kavanagh senate hearings and subsequent confirmation? I don’t think so. Despite President Trump’s latest “victory” with the confirmation of Judge Kavanagh, most generic polls have the Democrats leading Republicans by a wide margin. Sure, these pollsters have been wrong before – I for one believe that both the House and Senate races will be extremely tight. But have investor’s decided what would be a good election outcome for the economy and equities? Consider this; there is not a single Democrat in either the House or the Senate that voted in favour of the tax reform bill last year. Therefore what would a blue wave signal for the economy for 2020, or even earlier? The way I see things, there aren’t that many business-minded Democrats in the Midterm race and should a sufficient number of them win enough key seats, that makes tax-reversion more all the more likely.
We’re in October, in the late stages of an economic expansion, and there are too many flies in search of a windscreen. The market double topped and from a technical standpoint, this should put us at the early stages of a selling cycle. The Fed could try to comfort the markets, but with inflation on the rise, is left with little ability to de-escalate any selling panic in equities. But even if the Fed and other Central Banks abandoned their faint attempts at a tightening cycle, started easing again, this will send a signal to investors that something is wrong and might as well lead to further selling. More often than not, bear markets in equities is followed by a recession. How low can the market’s go? You can carry on reading more over here.