Markets are calmer…at least overseas ones are.
The All Ords will most likely follow the US’ lead and have a better day today.
It’s been a tough year for Aussie share investors. The year started with such promise. After an early dip in January, the All Ords went vertical for three months. We came oh so tantalisingly close to the psychologically important 6000 point mark. Since then it’s all been downhill.
The All Ords is back under 5000 points — a level first reached in early 2006. For nearly a decade, our index has failed to make any lasting gains. In the long term shares go up. But will they go up in your investing lifetime?
Depends on how old you are.
My guess is that our Aussie market will not make any appreciable gains over the next decade. Yes it’ll go up, but then it’ll go down and then it’ll just sit there doing nothing. Lasting gains — ones that don’t evaporate — are going to be much harder to come by.
Lasting gains are the ones that occur in strong economic times. The prolonged period of credit expansion, from 1980 onwards, lifted our market higher. In 1982 the All Ords was around the 500 point mark. The world is a different place today. It’s deleveraging. Unwinding the excesses of three decades of credit expansion.
In the bad old days of credit expansion, anyone with or without a pay-slip was given some form of credit — personal loan, subprime home loan, credit card, student loan, car loan, margin loan.
In an economic system based primarily on credit expansion for growth, the ability to spend is directly related to the ability to borrow.
Lenders have gone back to basics. Simple questions like ‘can the borrower repay the money?’ and ‘if they can’t, can we sell the asset to recover our money?’ are being asked.
Lenders are acting with a little more caution.
How do we know the world is deleveraging?
There are three tell-tale signs.
First: budget deficits increase. This happens due to a combination of falling tax revenues (from lower economic activity) and ramping up of spending initiatives to re-ignite economic activity.
Second: zero-bound interest rates. The theory behind this is to ease the existing debt burden and to make it affordable to take on new debt.
Third: expansion of central bank balance sheets. Central banks printing vast quantities of new money with the express purpose of buying assets is not normal economic activity.
Looking at the credit expansion and contraction data of major economies between 2007 and 2014 provides us with an insight into what’s happening on a global basis.
|Country||Increase/Decrease in Government debt||Increase/Decrease in Corporate debt||Increase/Decrease in Household debt|
With the exception of Australia and China, private sector credit contraction is evident in the major economies. Households in the US, UK and Germany felt the full brunt of the economic lesson in 2008/09. They have consciously reduced debt levels, or been forced to.
Australia’s household credit expansion is a direct result of China’s private sector credit binge. China’s willingness to go deeper and deeper into debt shielded us from the worst of the economic fallout in 2008/09.
We eased up a little after the events of 2008/09, but old habits die hard. The property booms in Sydney and Melbourne have also encouraged Australian households to gear up.
Then we have Japan. Government deficit spending is a permanent fixture. The world’s greatest economic basket case continues to defy the odds. Government debt levels are beyond repayable.
Where it all ends is anyone’s guess…but it can’t end well.
What’s clearly evident is governments have attempted to fill the void left by the household sector’s reluctance to take on new debt.
Australia is all but locked into a path of growing deficits and ballooning public debt.
As China continues to slow, I expect our household debt levels will fall into line with the rest of the world. Without significant tax increases and meaningful expenditure cuts, balancing the budget is nothing more than a pipe dream. Both measures (raising taxes and curtailing entitlements) are political hot potatoes — nothing meaningful is going to happen overnight. Therefore the public debt meter will continue to tick higher.
Which means the RBA will also follow the well-worn interest rate path of the northern hemisphere and reduce interest rates to near zero. Reducing the servicing cost on higher levels of public debt will be one way of providing some temporary expenditure relief for the government of the day.
Lower interest rates may help those with debt but does precious little for those with savings…like boomer retirees. Investors looking to earn a dollar or two on their savings are forced to go in search of ‘opportunities’ paying a higher rate of return.
US investors are getting a glimpse of what level of risk that extra reward comes with.
The Third Avenue Focused Credit Fund (you just have to love the names they give these funds) was, according to the marketing spin, ‘invested in deep value high-yield bonds’.
What utter rubbish. The only thing Third Avenue were focused on were the fees they extracted from their over-promise.
But people bought the spin. At the start of this year there was over US$2 billion invested in the Focused Credit Fund.
When the manager announced on Monday the fund was being closed to redemptions (due to a forced liquidation of rubbish assets) there was US$780 million still left in the fund.
Another two hedge funds dealing in junk bond investments, Stone Lion Capital and Lucidus Capital, are also reported to have shut down their funds.
Fund closures invariably end up with investors being paid back (progressively) a few cents in the dollar.
In chasing extra return on their capital, investors place themselves in a position where they lose some or all their capital. This is the flip side of making credit cheaper; investors feel compelled to take on risk they shouldn’t — or even risks they are unaware of.
Retirees with less capital are eligible for more age pension under the assets test. Creating additional pressure on the federal budget.
We’ve trapped ourselves into being totally dependent on the creation of more and more credit to stand still. The financing of that credit comes with a level of risk that lenders and investors eventually won’t accept. Then what?
That, my friends, is the $64 question.
QE and zero bound interest rates haven’t provided a permanent solution to private sector deleveraging. Therefore, the policymakers will have to go for something stronger.
Do we have People’s QE — a money printing program to finance government spending?
I think when the looming credit crisis hits, this is a very real possibility. How will it play out? I do not know.
When QE was first introduced the popular thinking was ‘hyperinflation’, and so gold took off. But it hasn’t worked out that way. We are in unchartered waters.
Japan has tried all sorts of voodoo economic remedies…to no avail. It may well be that we go into a prolonged deflationary funk which they can’t print their way out of.
The thing is to stay nimble — plenty of cash reserves — and be alert to the changing conditions.
My gut feeling is we’re on the verge of a deflationary depression from which it will be hard to extract ourselves. A lot of people are going to lose a lot of money.
Err on the side of caution — losing a percent or two in return is nothing compared to losing the majority of your capital.
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