A Market Without a Bottom?

Normalcy syndrome is a mental state wherein the sufferer convinces himself or herself that nothing is dramatically different because, through the course of their entire life, events have followed a certain course.

After the crash of 2008 and the recession which followed, governments around the world rushed to restore confidence in financial systems by flooding the market with a tsunami of cheap cash and manipulating the global bond markets in order to maintain artificially low interest rates.

The idea behind this was simple: providing financial institutions with practically limitless amounts of nearly-free cash would induce banks to loan out money to the real economy—the construction companies, retailers and other small to medium sized entities. But banks are run by very smart individuals; individuals who make their living from determining where the quickest and safest ROI is to be found.

Instead of lending out this free cash over longer terms to businesses that were operating in a continually risky market place, the banks chose to plunge their newly acquired capital into a burgeoning stock and bond markets. The logic was simple, with the world’s central banks driving sovereign bond prices higher and higher (in order to maintain 0% rates) there was practically a government guarantee on bond returns. While these returns are not enormous, this guarantee and the volume of the investments would provide enormous returns over the space of five or six years.

In addition to this approach, the commitment by governments to provide unlimited future liquidity, either directly through programs such as the Toxic Asset Relief Program (TARP) or indirectly through zero interest rate policy (ZIRP), practically dared the banks to begin augmenting their guaranteed returns form the bond market by seeking higher, faster returns in the equities’ market. With such an influx of capital into their stock, especially in the tech space, companies such as Google (which saw its share price surge from $131.09 in Nov ’08 to over $640 this month), flush with cash flowing into their share price, began using it to consolidate their market share by gobbling up competitors and start-ups who were entering their space. It is now generally accepted that this has resulted in ballooning valuations for companies who not only don’t generate a profit, BUT ALSO appear to be struggling to figure out how to monetize their services.

Five years ago the mainstream financial pundits were ridiculing any talk of a new tech bubble. Today such talk is commonplace and the real conversation is about when this bubble will pop and what the effect may be.

When the enormous global issuance of cheap credit began in the shadow of the ‘08 crash many were predicting hyper inflationary forces. Indeed, this seemed highly likely as such a large increase in the monetary base had always resulted in price increases in commodities and services. However it became evident that there was something different about this approach, and the main difference was this: the massive sea of cash being given out by the central banks to the financial institutions was NOT flowing down into Main Street. Instead this flood of trash cash was flowing into long term bonds (effectively parking the velocity of said money) and also into giant tech companies balance sheets, said companies were then sitting on that cash (overseas in most cases) because the constant rise in their share price guaranteed an ever increasing flow of cash.

The net effect of this strategy has turned out to be not one of inflationary pressure (as desired by the debt driven economies of the modern world), but rather DEFLATIONARY pressure as cash and credit are hoarded by the multi-nationals while SMEs and individuals continue to suffer a major credit crunch. It will soon be generally accepted that most western governments implementing policies of financial austerity has only added additional deflationary pressure on the global economy rather than easing it. By squeezing wages and welfare payments of those in the real/productive economy in order to bolster those supporting the bond and equities’ markets, government has actually been making economic recovery a near impossible prospect. Ironically, the governments of the west may have got more bang for their buck had they increased the amount of money they provided in welfare rather than giving it to mega corporations who were simply hoarding it or stashing it into non-productive assets.

Those of us that saw this scenario play out knew that it would only require one major event to burst the state of normalcy syndrome and bring the whole world to a realization of how bad things are. The crash in the Chinese equities’ market may indeed be that event.

For several years, the Chinese central authority has been attempting to cool the obvious property bubble that has been forming. By limiting overseas property investments, increasing interest rates and requiring a 40% down payment on purchases, the effect was swift and successful: too successful, the bubble was popped, prices fell and the speculative fervor in property was cooled. For a people who enjoy a savings rate of 50-70% and whose traditional savings vehicle of choice has been property, this presented a major problem. What happened next shouldn’t have been a surprise to anyone. Seeking continued returns, and buoyed by the success of ventures such as Ali Baba, the savings began to flood into the equities’ market and a bull market outpacing the previous Bull Run in 2005 saw valuations soar. A huge amount of liquidity coupled with very loose rules regarding the use of leverage saw the Chinese indices surge to a point where turnover (amount of money changing hands on the exchange) was larger in China than in the US (a market more than twice its size!).

Again the central authority stepped in and new regulations regarding margin requirements, controls of foreign capital trading on the Chinese exchanges as well as restricting what stocks could trade popped the bubble hard and fast with Shanghai plunging 30% in three weeks. It is quite possible that the Chinese will now take note of their financial situation and we may see further sell-offs in real estate and investment accounts. If this happens, it could have a major impact on the global stage by adding more sell side and deflationary pressure onto the global markets. However, what good does it do to have a world full of sales when nobody has the desire or the money to buy? Today’s sell off in Chinese equities and its roll over in negative sentiment in U.S. markets may be an indicator of things to come.

About the Author

Karl Gray

Author & Editor

Karl has been investing in financial markets all over the world for the last 10 years. Forecasting both the commodities bull markets of the naughties and the rise of crypto currencies, Karl has a proven track record in identifying global trends.

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