Brexit vote signals new era
Mark Thursday June 23rd as a key date in the Kondratieff Winter cycle phase that began in March of 2000. This underscores yet another wave of protectionism that is a hallmark feature of late stage economic winters. We have advanced this theme more and more in recent months by pointing out that the currency wars seen over the past few years have closely resembled the trade wars of the 1930’s. Now the theme of every man, or country, for himself just intensified even more as the UK voters chose to reject the onerous terms being imposed upon them by an EU that had strayed from its original purpose.
Such draconian actions are the result of countless policy missteps by central banks and governments all over the world who have been more concerned with keeping paper asset prices elevated than achieving any meaningful reform. There are headlines each day pointing to new proposed trade barriers in Europe, Asia and in the US underscored by the bombastic rhetoric in recent weeks by Donald Trump. Even the Wall St.Journal took note of the parallels with a recent article titled How the 1930’s are Echoing in Today’s Politics. It underscores a core theme of the K-Wave theory that history repeats itself within each of the long wave cycle phases as the same cycle phase components are repeated over and over again.
The end result for all these protectionist measures is deflationary. Advocates of this brewing protectionist wave don’t realize that the impact of their collective actions hurt their own cause because the deflationary impact on the macro level severely outweighs any benefit gained on the micro level. History has proven that to be true time and again but protectionist advocates refuse to let the facts get in the way of a good rabble rousing claim.
Negative Rates all the buzz
For most of 2016 the debate and growing outrage over negative interest rates set by Japan and Europe and others have been all the rage. Former PIMCO chief Bill Gross recently proclaimed that capitalism can’t survive negative rates and he is right. Today there is over $10.4 trillion in global sovereign debt now in negative territory and this has caused serious dislocations in the allocation of capital that is sure to have a horrible ending. Last week Swiss 50-year bonds went negative, which just goes to show we are living in a capital markets fantasy land. Aside from denying savers and right to earn any interest the negative rates are causing mayhem for the world’s largest commercial banks, especially in Europe. Shares of Deutsche Bank are now trading lower than the nadir of the 2008 crisis and together with Credit Suisse and so many others it suggests a banking crisis in Europe is looming.
I look at Deutsche Bank as perhaps the single best “tell” on a global banking crisis because it’s balance sheet is loaded with billions in non-performing loans and it has exposure to trillions in derivatives meaning that any small spike higher in interest rates or other unexpected event could cause it to be insolvent quicker than anyone could believe. So many of the world’s large commercial banks, especially in China, have ever growing non-performing loans that aren’t properly accounted for. So in essence the entire global banking system is underpinned by fictitious figures, i.e. their books are cooked.
Yet global investors in paper assets such as stocks and bonds have been whistling past the graveyard, blissfully ignorant of these non-performing loans sure to default together with hundreds of trillions in aggregate global sovereign, corporate, municipal and individual debt that has more than doubled since the 2008 crisis. Yet the TINA theme- There Is No Alternative- keeps blowing the asset bubble bigger than ever. Just look at the insane PE multiples of the small cap index (mid 70’s) and the utilities (mid 30’s) as they are several standard deviations removed from their norms. Any reversion to their historical measures is sure to result in a market crash pure and simple.
Central banks finally see their limitations in this late stage winter Something notable occurred in this second quarter of 2016- our Federal Reserve and their global peers changed course in dramatic fashion. They did not signal plans to engage in hawkish policy measures but instead declined to make open ended promises of unlimited monetary QE and further push negative rates down to even more surreal levels. This development is monumental given these twin towers of monetary largess have become a hallmark in their policy actions since the 2007-8 financial crisis. For the first time since the crisis they all blinked.
And why not? We have advanced time after time for seven years here that their approach of trying to stimulate the economy with such outrageous, radical and monetary measures is utterly futile. The jury has been out for many years now on this catastrophic failure that has produced seven years of sub 2% growth and hundreds of trillions in new debt obligations that aren’t going away.
So let’s review the recent sudden policy shifts and try to glean their impact.
The first domino toppled in the May policy statement from Japan’s central bank chief Karouda who stunned everyone by announcing no additional QE or rate changes in his recent statement. Japan has been plunging into an economic abyss for over 20 years and had recently entered their fourth recession since the 1990’s. Every financial analyst still breathing had forecasted a further push deeper into negative rates and a new round of QE given the accelerated decline in their GDP since the downturn for most global markets that began last fall.
But finally they admitted the futility of their largess and stood pat, a courageous but tough move to make. Given Japan’s stature as the godfather of modern day QE this was a real shocker. But given that since they initiated their negative rate policy last year their stock market has declined almost 20% and their currency has appreciated to much higher levels it was the right move. Their policies were meant to cheapen their currency to promote growth and also to boost their market and the exact opposite occurred. That one-two punch was enough to finally shake some sense into them and they responded accordingly.
This unexpected outcome occurred because they are so deep and late in their own Kondratieff Winter as Japan is the most indebted country on Earth and thus they would naturally be the first country to see their policies backfire. This outcome is going to be seen over and over in the coming years in so many countries and all for the same reason- central bankers and most people still remain clueless about the existence of long wave economic cycles, i.e. the Kondratieff Wave Theory.
The second major reversal occurred in mid-June soon after the worst employment report in several years as Janet Yellen declared at the Federal Reserve meeting that the outlook for growth in the US and abroad would be so challenged that she telegraphed perhaps only one or a few rate hikes were on the table for the next several years and the Fed would not push for negative interest rates like her desperate European peers.While this outlook was seen as ultra dovish at the outset, some investors chose to focus on how pathetic and gloomy her forecast was and how much it reflected a real shift in policy. And while Mario Draghi did continue his claim to do “whatever it takes, and it will be enough” a new reality had set in- the sheer inventory of corporate bonds available was so low it was clear they would not be able to buy as much bonds as they had originally promised. No matter what the bulls may proclaim there are limitations to what global central banks can accomplish. We are without a doubt now in the late innings of their grand experiment that has failed so miserably.
In each case central banks failed to deliver what was expected because a new reality was setting in that promises of unlimited QE to eternity was indeed not plausible after all. Yet markets have for so long believed in central banks would act to backstop the markets in case a crisis was looming it is going to be very interesting to see their reaction when this new normal finally does set in to them. This new normal is a natural feature of any late stage economic winter where the real limitations of unlimited monetary fantasies are put in check by the sheer weight of the hundreds of trillions of debt that has amassed globally over this economic long wave cycle that has endured longer than any other due entirely by the collective efforts of global central banks so committed to overcome this naturally recurring boom-bust cycle with ever more debt issuance.
So where do markets go from here? They plunged worldwide after the initial shock last Friday but rebounded the following week I suppose because most of the damage will be done down the road. But we are still left with pathetically slow global growth, debt levels in the stratosphere, and slowing productivity that has resulted in five consecutive quarters of reduced corporate earnings and revenues yet the US market is within 1% of its all-time high. But most other stock markets are down on average between 12-15% from their recent highs which indicates we are in a topping pattern in the overall long wave pattern. US corps have for years been more determined to use stock buybacks and dividend increases to keep their stocks propped up but how long can that continue, even with low rates?
I believe we are closer than ever to peak highs in the US market as the confluence of all of these factors looms larger than ever before. All the central bankers, governments and investors have fought this long wave economic winter for a long time now but the forces we have advanced here are stronger than ever.