Epocalypse: Is the Perfect Economic Storm on the Horizon?
Retail is way down. New jobs are way down. Corporate debt has never been higher. Interest is rising ahead of the Fed. The pile of junk bonds is starting to waver. Investors are moving to gold and cash. Are these the emerging indicators of a perfect economic storm?
US Investors – Risk-Off
US investors are fleeing risky investments. Sales of US junk bonds have stalled. Initial public offerings of stocks (IPOs) are down because the risk-off environment is not conducive to launching new publicly traded stocks. Issuing new stock in such a climate almost assures a new corporation will get off to a bad start.
“Everyone has become conservative at the same time,” said Ashwin Bulchandani, chief risk officer at investment firm MatlinPatterson. “Investors are wondering if the uncertainty and growth concerns are temporary or is something more sinister going on in the background. You’ve got a particularly messy cocktail of things coming together at one point.” (Newsmax)
The junk-bond market, which flourished under the Federal Reserve’s lax monetary policies, is now experiencing its slowest October since 2005. In fact, most bond issues are on the skids just like IPOs:
“Most of the people we are talking to, unless they are forced to come, are waiting on the sidelines for a better day,” John Gregory, the head of leveraged syndicate at Wells Fargo & Co. (Newsmax)
Many corporations rushed to issue a glut of bonds in the last couple of years because interest was lower than at any time in modern history. Such low interest tempted many corporations to take out long-term debt while it was cheap; but if the rates rise while their revenues start to fall due to declining exports and a sapped economy, they could be in trouble.
The climate change that is happening in bond issues places corporations at risk if they issued bonds to raise money while interest rates were very low and now have to do a new bond issue to pay off old bonds. It means businesses are facing higher interest on massive amounts of debt at the same time that their revenue is falling.
The ability of companies to repay their loans has fallen back to its lowest level since 2009. The amount of debt taken on is so great that, even at these low interest rates, the total interest being paid out by companies it at its highest ever … and those rates are rising
“Increasingly alarming,” said Goldman Sachs. (Wolfstreet)
Yields on junk bonds have risen from about 8% to 14%! And that is without any raise in the Federal Reserve’s lending rate to banks, which remains at the zero limit. This is just the result of investors seeing growing peril and demanding more interest if they’re going to stay in the game as financiers.
US corporate earnings are in decline
US corporations are declining seriously. Moody’s has now jumped on the recession-warning bandwagon as corporate earnings start falling. One of the bellwethers is Wal-Mart, which recently announced it anticipates a 12% decline in earnings next year. That is after this year’s decline in earnings. As the result, the company is closing some of its supercenters.
The announcement caused Wal-Mart stock to take its deepest plunge in twenty-seven years. Wal-Mart’s crash comes from a combination of slowing growth in sales (though they are still growing — barely) and its attempt to raise wages from $7.25 per hour to a still-paltry $10/hr. Seems the Fortune 500 company that created the wealthiest family in America can only deliver such wealth on the backs of severely underpaid help. Merely notch the help up to an impoverished, high-school-level wage of $10/hr, and the company starts to go broke. (As a consumer, you got that cheaper underwear off the backs of underpaid employees.)
Wal-Mart’s business model has been smashed to bits. The decline of a super-giant — the largest employer in the US — that cannot even afford to pay its employees ten bucks an hours seems pretty significant.
Another American giant, McDonalds is also in peril and is closing 700 of its under-performing restaurants. (At the same time it is expanding in some parts of the world.)
“We are in the throes of a deep depression, and nothing is changing,†a franchise owner wrote in response to a financial survey by Nomura Group. “Probably 30% of operators are insolvent.†One owner went as far as to speculate that McDonald’s is literally “facing its final days.†(Intellihub)
When an icon of corporate America the size of McDonald’s is shrinking, you know something is seriously wrong. Like Wal-Mart, this could be more from the changes happening to a business model that is no longer working. Still, it is resulting in upcoming layoffs from a corporate giant, just as Wal-Mart’s closings are, and that cannot help the job market.
Dell computer is struggling against a $768 million dollar loss so far this year.
And this seems to be an emerging trend across US industry. Business data last week …
…ranged from uninspiring (retail sales) to awful (Empire State and Philly Fed surveys) to deflating (CPI and PPI) to blamed on exports (Industrial production) to recessionary (Inventory/sales ratio), to a bit surprising (JOLTS report which showed a drop in job openings). (Contra Corner)
Stocks continued their counter-intuitive post-Great-Recessional trend of going up upon hearing bad news because all this bad news is interpreted to mean the Fed will continue with its free-money extravaganza, and that’s where all the action is right now on the game floor. So, the stock bubble continued to reinflate after its August-September exhaustion. Some people want to look at that as a sign of hope. I see it as proof of serious sickness. It’s a proof of total addiction to the Fed’s free money in a market that is not functioning as a market at all. So, the only thing that is rising, is sickness.
Corporate debt seems to have peaked at the same time that corporate earnings have started broadly declining, and interest rates are rising on their own, regardless of Fed inaction. That sounds like the chemistry for a perfect storm that isn’t likely to wait for a Fed rate hike to cause calamity.
Retail is crashing
It is not just Wal-Mart, the drop in retail is industry-wide:
September retail sales were grudgingly reported by the Census Bureau this morning and they were absolutely dreadful. This followed an atrocious August report. The MSM couldn’t blame it on snow, cold, flooding, drought, or even swarms of locusts. So they just buried the story in their small print headlines. The propaganda media machine had nothing. They continue to spew the drivel about a 5.1% unemployment rate as a reflection of a booming jobs market. If we really have a booming jobs market, we would have a booming retail sector. The stagnant retail market reveals the jobs data to be fraudulent. (Contra Corner)
And, yes US jobs are already in decline
A job market that has, at least statistically, been slowly trickling up (but, in real fact, has been doing rather bad all along) is now falling off statistically. The number of new job openings have taken two major hits in August and September.
Currently 103 million working-age Americans are unemployed.
Gold on the rise
Another bellwether of trouble. Gold has outperformed stocks now for half a year. Investors rarely favor gold over stocks unless they are convinced bad times are coming. Flight to gold is the kind of move investors make when they are battening down the hatches for a storm.
And it’s global. Investors are moving their money into cash and gold. Says Credit Suisse,
Following meetings with clients in the U.S., Europe and Asia over the past few weeks, we make the following observations: Confusion: Never have we seen so many clients who just do not know what is happening and have cashed up…. The wall of bearishness was extreme in the U.S. – roughly 80 percent of meetings. (Newsmax)
Two words summarize client marketing in the past month: ‘lost’ and ‘bearish.’ This is the first time that we have come across so many people who say they are completely ‘lost’ in the current environment. (Newsmax)
Sounds like a hurricane is coming.
Monday, December 21st 2015 at 7:07 am |
Hi David, Im new hear, like to read facts, and you bring the facts. I am not in stocks or bonds or metals, my holdings are all income producing real estate. Whats your view on rental property prices in 2016?
Thks, Harry
Monday, December 21st 2015 at 7:36 am |
Hi, Harry. Welcome aboard. I think that rental property is better than stocks or bonds if you don’t have mortgages to feed. If you do, it depends on the size of your mortgage. Property prices have largely recovered by back to their pre-economic-crisis highs in many areas of the country; but those prices are as unsustainable now as they were back then because incomes have not risen, so those prices require all the same foolish credit risks that we took in the run-up to the Great Recession.
We have gone right back to those policies because realtors and bankers and government all want to keep the old dinosaur economy alive; but they are unsustainable and will disrupt the economy all over again. This time, however, they are not going to lead the way. The commodities collapse is already leading the way, turning into a high-yield bond collapse now, which is just turning into a stock market collapse. All of the devastation will lead to banking collapses, and the resulting return toward low employment will EVENTUALLY lead to a housing market collapse equal to the one we just saw.
Of course, rents decline slower than housing prices when such a fall happens. So, you have a little shield. Property has intrinsic value because it is necessary for one of the three fundamentals of human life — food, shelter and clothing. Therefore, unlike stocks, it never stays down for good. With stocks and bonds, companies can go out of business and bonds can default, and you can lose everything with no hope that it will ever come back.
So, property is a little safer; but it’s still going down and will probably stay below the peak values we have now seen twice because those values cannot hold unless incomes skyrocket upward, which is not likely.
Keep an eye on what is happening now, as you probably have a little time to move in if you need to. If you see that I’m right and that the commodities crash continues to worsen and the bond troubles develop into a bond meltdown, then have your plan already in pace to make a change while peak values still hold … for this reason: If I’m right on this, properties will be worth maybe half of what they are now; so if you can sell them for a gain now, sit on the cash for a couple of years, you could buy the same properties (or equivalent ones) back at half of what you have into them at present. Sell high, buy low; but with real estate where the cost of selling is high, and where mortgage rates may go up, that’s a harder call than in stocks. Just be ready to move before the housing market does if you see the signs lining up. Have your plan already in place.
Most of all if you find yourself deciding to sell after the down flow as already started to move a little, don’t do what I always warn people against. Don’t price to the current market because if you are already in a falling market, you will only wind up following the market down. I have seen people do that time and again. You need to bite the bullet in that kind of circumstance and price under the market in order to be the first to sell at the time you hit the market in order to get ahead of the deluge. The philosophy at that point becomes, not one of maximizing profit, but of cutting your losses quickly.
But it’s all going to take time to go down because there is a lot of mass to move, and you probably have a little more time to watch what trends are developing. Be elastic. Be read to move. Those that are adaptable and who can see realities they don’t like to see are the best suited for survival during any extinction period. Be one of the survivors by having your plan ready to launch in a hurry if you need to move (knowing that sales of rentals take 3-6 months in the best of markets, so you can’t wait to the last minute).
–David
Monday, December 21st 2015 at 8:18 am |
Dave first thank you for your detailed response. My sentiments are the same and in line with yours. I am in the process of selling 30 units with no mortgages. Then shop the florida market for a 1031 exchange. Which as you know puts a 45 day clock on me identifying property and 180 day window to perfect title. Which makes me pause, will there be another crash in Florida prices and is it just better to sit on the sidelines and watch the deals amass. I guess you see my quandary. Harry
Monday, December 21st 2015 at 8:39 am |
I do because that clock is too narrow to work well for your desire to sell high and buy low. The price decline will take a couple of years, at least, to fully play out, as most people will be reluctant to sell and people can hold out for a long time if they don’t have to sell. That, however, likely gives you a little time to move on your starting date, except that it will may be easier to sell as the rush begins for low-interest rate mortgages before the Fed does any more rising. You are, at least, thinking along the right lines. At least, since you have no mortgage, it is just a matter of selling high and buying low, since you will not be forced into a bind when rents start to decline. Even declining rents are still income if you have no mortgage to feed, and rents drop slower than housing prices.
–David