A mortgaged future to protect status quo
Since our last post, the fourth KW of the modern era has spread to nearly every country and is gaining momentum. Investors have few places to hide.
In September global stock markets plunged over 15% and were teetering on the brink of key support levels on their long term charts. But once again they were rescued by massive central bank stimulus, coupled with jawboning for more if needed. The rebound was swift and powerful, led by short covering, just like mid-October 2014. However this time, the snap back rally wasnʼt as big and much shorter than that one and was noted for its lack of breadth as the so-called FANG quartet of Facebook, Amazon, Netflix, and Google accounted for most of the gains. The rest came from short covering from the worst-performing stock in the so-called “dash for trash” stocks.
In fact today much of the S&P is already in correction mode yet you wouldnʼt know it by looking at the broad indexes. But on December 30th all that changed. The price action in the final 30 minutes of the 30th and 31st was really awful which allowed the S&P to mark its first annual decline since the financial crisis. The S&P then plunged another 5% in the first week of January, provoking new fears about contagion. This may prove to be a very foreboding sign that 2016 will be troubling and volatile for stocks. So let me try to explain this backdrop in terms of our Kondratieff Wave theory.
Today the global capital markets (except bonds, for the time being) are in free-fall as a direct result of so many of the things we have advanced here for many years, including mal investment from too much cheap easy money, rampant overproduction of goods that has created the most over capacity condition ever. Furthermore, tens of trillions more in debt obligations by sovereign governments, corporations, and others suggest they will be forced to spend too much on debt service in the coming years instead of investing in their businesses. And look no further than our new budget agreement recently signed into law that increases the debt ceiling by several more trillion in the next two years. Folks, we have just hit peak debt for several generations and the fallout has already begun. Long wave economic theory helps reconcile the existing paradoxes and conundrums.
We must view the dramatic recent developments of the past few days through the lens of the long wave cycle to have any hope of understanding how perilous our current state of nature really is at present. Long wave theory is the only thing that can explain why deflationary forces refuse to abate despite tens of trillions in fiscal and monetary stimulus. We have repeated here so often over the years that deflationary forces will remain and accelerate until most of the excesses of debt have been removed through defaults and this process is still in its early stage. Accordingly, this explains why the US, Japan and nearly all developed countries just cannot get inflation even near their 2% targets and why the USD is rising and not falling as so many feared.
The truth is this: as of this week, the US and nearly all other nations on Earth have mortgaged their future several times over just to keep the status quo going as long as possible. But the cracks in the veneer are showing, and the markets are taking notice. investor sentiment for some time has been less than euphoric like early 2000 and some say we must reach that state for a true secular market top to be in. However a closer look at many charts says the top is in so look out below.
This Kondratieff Winter has played out much differently than ones in the past for one simple reason-central banks and sovereign governments all over the world have tried since 2009 to battle the deflationary forces with over $100 trillion in stimulus and zero to negative interest rates to overcome this deflation. Global growth since 2009 has been so weak and continues to decline each month, each quarter, and each year we can now say this grand stimulus was a horrific mistake because the trillions of debt still remain and no country ever reached the escape velocity in growth that was promised.
Yet the true scale of the present condition has largely gone unnoticed because global stock markets have been goosed to high levels and it seems like business as usual in our daily lives the past few years with no soup lines or mass bankruptcies or brewing revolutions on the horizon. And here in 2016, over 99% of the people have no idea what a Kondratieff Winter is but that is sure to change in the coming years.
The truth is that a Kondratieff Winter has already taken hold in many markets. Oil has plunged over 70% from its 2014 highs and natural gas has plunged over 80% since its 2007 highs. In fact the entire commodity universe has plunged to multi-decade lows and this has lead to massive reductions in capital spending and so many lost jobs. These industries are all suffering from an overwhelming over capacity that will take many years to abate. Such over capacity is a hallmark feature of any K-Winter and many are just now coming to understand this condition will endure much longer than they imagined.
There are many other important sectors also enduring the hardships of a K-Winter. Industries related to commodities such as mining and materials have been devastated for over two years and most are unable to raise enough capital to finish their projects. More than 80% of all listed mining stocks now trade under ten cents per share and are just zombies until market sentiment improves. The shipping industry is also in ruins with too many ships and not enough goods to transport. In fact the Baltic Dry Index that measures transported goods fell to an all-time low last week, underscoring the severe downturn in produced goods worldwide.
This downturn has accelerated in recent weeks as evidenced through the release of economic data measures worldwide. Hereʼs the bottom line- globally we are now in a full-blown manufacturing recession. No one can challenge that, especially after the recent release of Chinaʼs PMI numbers last week showing a contraction in produced goods. That was unimaginable this time last year. If China cannot avert a hard landing this year then the scale of this global slowdown could be much larger than we dare to believe.
I just shake my head each time I see articles or TV news telecasts reporting that the Fed or the IMF downgrade their forecasts for economic growth. Why? Because I have never seen the numbers reflect better than expected growth as they always miss by being too optimistic about economic output growth. Why might that be so, and why has no one ever heard of a Kondratieff Winter? I will now try to take a stab at both as I believe they are related.
The importance of long wave economic cycles
The answer as to why the Federal Reserve,the IMF, and most economists and financial journalists repeatedly have their forecasts downgraded is because they all fail to appreciate long wave economic theory. We are now almost sixty years into this cycle that has seen hundreds of trillions of debt issued with much of that sure to default. Today all the Fed, IMF, Wall Street and the public at large are by and large unaware of the looming storm brewing of hundreds of billions in debt sure to default in the next few years. They and sell side Wall Steet firms make projections on stocks using simplified models featuring PE multiples, projected growth rates on revenues and earnings, etc. and completely ignore the threat coming from the existing backdrop of the existing $3 trillion of debt outstanding. It seems no one wants to recognize the true threat from the spike in non-performing loans that will eventually lead to hundreds of billions in defaults.
This week Arch Coal, a Wall Street darling until just a few years ago, filed for bankruptcy and evidence continues to mount that these defaults are looming large now and will dominate the headlines for years to come. This is what occurs at the end of a very long economic long wave credit cycle. Just last week Puerto Rico announced a partial default on some of their bonds and this is just the tip of the proverbial iceberg, Now that the Federal Reserve has reversed course and have begun a tightening cycle this will put even more pressure on the holders of hundreds of billions of dollar denominated debt that must be repaid at a premium.
Thus, a new vicious cycle has now emerged with the large spike higher in the US dollar since late summer. That is when China began to devalue their currency in earnest. They now remain on that path of devaluation, marking a new era in the ongoing currency wars that are sure to disrupt the allocation of capital and accelerate the flight of capital from China.
These developments are sure to hamper global growth and reinforce the deflationary condition most thought was defeated all the massive stimulus over the past few years. We have advanced here many times that our K-Wave theory would prove otherwise and it has. I suspect that 2016 will prove to be very volatile and difficult for those who remain long this market and perhaps finally many investors will awaken to the virtues offered by Kondratieff Wave analysis.