Source: CBOE VIX (CBOE MARKET VOLATILITY)

Musing on recent market volatility! 

What is the driving factor? The question that comes to mind. Is it: 

The Middle East? Pretty much a given that chaos will be the dominant theme for the foreseeable future.

Europe? Likely to change its model substantially as we head back to defaulting sovereign and bank debt and disputes between nations about such fundamental issues as migrant distribution and open borders. 

Africa? Corruption, war, and the unlikely chance of improvement in the deflationary natural resource spiral. 

Russia? The usual reaction in dictatorships to waning poorer and horrendous economic conditions, start a war or two. 

Latin America?  Economic disaster for the populace – collapsing companies – conflicts. 

China? False statistics, economic reversal, declining currency – China Sea – all this as China becomes the dominant world power – a power with no sense of global responsibility and no worldly experience.

The U.S? The end of Quantitative Easing. In fact, Quantitative Easing has accomplished little more than inflating stock and bond markets. It has been devastating to pensioners, destructive to U.S. city and state budgets, and non productive to employment levels.  (In January of 2008 62.9% of the American population was employed.  The most recent figures as of August, 2015 only 59.4% of the population worked.  Not since 1984-1985 have we experienced this low a level in the employment-population ratio.)  From 2008 to-date to the present the bottom quintile and the 4th quintiles of U.S household incomes per household segments have been flat respectively at $11,676 and $31,087, annual household segment income.  The middle quintile $54,041 has improved by approximately .375% per annum.  The banks look to have been stabilized (if one doesn’t look too hard at the valuations of assets) while insurance companies have become share speculators and junk bond owners unable to sustain guaranteed payments through ownership of higher rated debt.  Certainly Quantitative Easing will show itself to be a medium term catastrophe, even to those enriched by its foolishness.  To this point: a 0.25% raise in rates will not be the generator of market collapse nor will it be useful to right the destruction that the program has wreaked.  In fact, though too late to save much of what has been lost, for the economies of the world to behave normally we will need to reach interest rate levels of considerably more consequence than 0.25%.

The Impending Debt Crisis. Prime and Subprime.

(Source: Bank of International Settlements; Hayer Analytics; International Monetary FundWorld Economic Outlook; national sources; McKinsey Global Institute analysis)

One can go on and on about the world risks and market volatility but, in fact, there is one looming problem, which is inching us towards the next disaster in markets, and more so, in the economy.  I detect no tools that can cope with its inevitability.  Now it may come as a surprise to many of you that we are encountering the roots of the next leg down, excessive debt, prime and subprime, with no liquidity, a reminder of 2007-2008. 

Since Q4, 2007 until Q2, 2014, and continuing, the global stock of debt outstanding has increased from $142 trillion to $199 trillion (not an exciting story of progress as to deleveraging). Debt as a percentage of world GDP has gone from 269% in 2007 to 286% in 2014. Government debt the largest culprit has increased from $33 trillion in 2014 to $58 trillion in 2014 at an annual compound rate of 9.3%. Household, corporate, and financial debt has grown at annual rates of 2.8% 5.9% and 2.9% respectively. Debt to – GDP had grown by up to 170% in Ireland with Singapore, Greece, Portugal, China, Spain, and France following Ireland’s lead (all at over 65%).  Only five countries in the McKinsey study (Argentina, Romania, Egypt, Saudi Arabia, and Israel) achieved any deleveraging during the seven year period.[1]  Once again we are experiencing a global credit bubble – sadly – replete with more subprime debt outstanding than just prior to the 2007-2008 debacle. 

Though the Volker Rule and Dodd, Frank have been implemented in the hope of protecting depositors, debt holders and shareholders against the banking missteps of the past, these rules were not intended to improve liquidity in a crisis. In the last crisis all of the world’s financial institutions ceased providing liquidity of any kind and, had it not been for government intervention, almost all would have gone bankrupt. Include such venerable institutions as Goldman Sachs, Citibank, Deutsche Bank, UBS, BNP, J.P Morgan, Morgan Stanley, ad nauseam. Today’s liquidity starts out restricted and will shut down totally when the twig bends, never mind snaps. In an effort to dispose of subprime, even A rated debt, sellers are finding limited buyer interest.  Inventories are being marked down. Refinancing becoming more and more difficult. The twig is beginning to bend. There are no solutions in place for what may soon become a deluge of debt coming to market. That is the risk to markets and the driver of current volatility. Don’t get angry at Volker or Dodd, Frank; the ability to handle the lack of liquidity now is about the same as in 2008. Currently and then about a year and a half would be required at past or current levels of liquidity to absorb what came to market in 2008. Of interest, there is more to come to market this time. How can you watch for the demise?  Financial institutions are now required to report debt transactions. Once can track what is happening and to which debt sectors. Stay carefully tuned if you are playing markets and don’t even consider that a .25% increase in rates makes a shade of difference. 

Asher Edelman

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[1] All of the above data derived from McKinsey Global Institute and U.S. Government statistics