Sympathy for the Devil

No, this isn’t a special Halloween edition of TWR in August. I’m not sitting here with my Ouija board trying to evoke the appearance of the Devil. The number “666” has special connotation depending on who you ask. The Bible refers to it as “the mark of the beast.” Gamblers know that all of the numbers on a roulette wheel add up to 666. In China, 666 can mean “everything goes smoothly.” In 1980, 666 was the winning number in a rigged Pennsylvania lottery. Stock market historians know that 666 was the Financial Crisis low in the S&P 500. But no, I’m not talking about any of these today. The only 666 I care about are the 666 central bank rate cuts that have occurred since the Financial Crisis. And yes, the devil is in the details.

We live in a world of soundbites and headlines. If you can’t boil something down to 140 characters, most people just aren’t interested. The beauty for those of us who are willing to actively use our literacy and read beyond the headline is that we can find things that others miss. The phrase “the devil is in the details” means that something may appear straightforward but the details are likely to cause problems. Doesn’t that nicely summarize the financial experiment that has been taking place for the last 8 years?!

Coming into last week there had been 664 rate cuts, then the Bank of England and the Reserve Bank of Australia piled in with 2 more just for good measure. Central bankers have been making this whole thing up as they go. Most of the world just pays attention to how markets are trading or if the latest data point met or exceeded Wall Street expectations, for a gauge on how things are going. The problem is that these people tend to miss a lot along the way, last week was no exception.

In the US, everyone was focused on the slight improvement in the monthly US labor reports and the latest consumer data which showed that US consumers are still spending. The problem is that the monthly labor reports don’t explain why the US economy has been growing at less than 2% for 9 straight months. What the headline on the US consumer data didn’t say was that both wage growth and disposable personal income are falling while consumption is increasing. Say what?! 

If US consumers have less money to spend, how are they able to increase their consumption? They are spending their savings! Yes, the pathetic sub-2% growth rate of the US economy is currently being propped up by people spending their savings, which as we all know is a finite resource. What happens to US growth when the consumer runs out of savings or implements their own brand of austerity and stops spending money? This divergence of higher spending and lower savings has been in place since January. I’m not sure how much further it can go and I’m convinced that everything will not go smoothly.

Also last week, the Fed released its latest Senior Loan Officer Survey, which is a survey of 75 banks that allows the Fed to gather information from bank officials on the supply and demand for certain banking products. Sounds like a fun read, right? I’ll admit, it’s a little dry but there can be some real kernels of intel in there. The survey showed that for the 4th consecutive quarter, banks tightened their lending standards on loans for commercial and industrial purposes, as well as on loans for commercial real estate. 

Why is this important? Because banks have never tightened lending standards for 2 consecutive quarters without an ensuing US recession coupled with a significant corporate default cycle. “Never” as they say is a very long time. So, if 2 consecutive quarters always spells disaster, what does 4 consecutive quarters mean? Survey says, “the devil is in the details!”

We all know what it means if the US enters a recession; anything equity related is going to get trashed and the S&P may once again flirt with the number 666. But what’s more interesting to think about is what happens if there is a significant round of US corporate defaults. 

Remember what’s happening right now in the global bond market. Everyone and their mother is bum rushing into US debt, government and corporate alike, because our yields actually have a plus sign in front of them. US Treasuries have been a go-to move for a while, but the demand for US corporate debt is quickly picking up steam. 

The Eurozone currently accounts for 80% of all foreign ownership of US corporates, but Asian investors are coming on strong. Governments and central banks around the world are trying to keep up with a world chock full of negative rates that continue to plunge. One example, the Taiwanese government recently made regulatory changes to allow domestic entities to own more foreign debt. This has led many Taiwanese insurance companies, among other entities, to significantly boost their US corporate holdings. The bottom line is that there are more and more sources of funds for US corporate bonds than at any other time.  

So at a time when the US is possibly on the verge of a recession and a serious round of corporate defaults, central banks, who account for almost half of all bond buying worldwide, and now foreign entities are piling headlong into US corporate debt. Does it feel like we are playing a game of financial roulette yet?

Things are percolating in places other than the US and no one seems to care about the details. 

Saudi Arabia avoided a full-blown banking crisis last week and it got no air play. The Saudi central bank offered banks $4B in discounted and 1-year loans to ease liquidity issues. SA banks were facing a cash crunch because the government has been withdrawing deposits and selling local-currency debt to fund the budget deficit caused by the prolonged period of low oil prices. You’re probably thinking that outside of oil, who cares about Saudi Arabia? 

I would remind you about a little country named Greece, which has the same GDP as South Carolina or Kentucky, but caused quite a global issue when it defaulted on its debt back in 2012. Saudi Arabia is 4 times as large as Greece and crude is kind of a big deal in our world today, which means that what happens in SA probably won’t stay in SA.

All of this is happening right now, after almost a decade of truly unprecedented central banking policy and action. 666 may in fact be the mark of the beast but it’s also the mark of insanity. 666 rate cuts and the globe is still experiencing banking issues, liquidity issues, trade issues, and most importantly, economic growth issues. You don’t need a Ouija board or rigged lottery equipment to see what is really going on in the world. Just a willingness to look beyond the headlines and read more than just the first 140 characters.