The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]
2016-02-04 11:20 by Karl Denninger
in Market Musings , 1424 references

This is arithmetic, not politics or "market structure" or anything else of the sort.

The last 30+ years have driven the S&P 500 from approximately 100 in 1980 to 1900 today.  This is commonly reported as being due to increasing sales and earnings, that is, a "larger economy" and "better efficiency."

But that is, for the most part, a lie.

Oh sure, there is a kernel of truth in it, and that truth is responsible for some of the growth.  Maybe a doubling, tripling or even quadrupling between all of if -- after all, population has gone up in the United States by a cumulative 1% annually, for example, and there has been a very material expansion in overseas trade and economic improvement.

But the rest of the nineteen-fold expansion didn't come from there.

It came from this:

If I borrowed $1 million dollars for 10 years in 1980, and was as good a credit risk as the US Government, I had to come up with about $150,000 a year to service that debt.  That is, I could keep that million dollars forever but to do so I had to generate $150,000 in free cash flow each and every year to do so -- and that $150,000 could not be spent on anything else.

But by 1990, when the debt rolled over, I only had to come up with $75,000.  The other alternative was to keep coming up with the $150,000 a year but to borrow and spend another million dollars.  Guess what most firms -- and the government -- did?  The credit growth numbers tell the story.

This pattern continued; today, as I write this, the 10 year Treasury yields 1.865%, which means that I can borrow about eight times as much money and keep it out for the same $150,000 that I could have borrowed in 1980.

That's what drove the stock market.

Now here's the important part: The market prices in forward expectations -- not today's "value."

Today the market believes this pattern will continue.  But it cannot; negative interest rates at central banks are in fact deflationary; they do not drive increased borrowing because the cash that is deposited by the borrower or held by lenders is effectively taxed by said negative rate; that is, instead of increasing the amount of "moneyness" in the economy it is confiscated instead.

Negative rates serve to attempt to coerce spending rather than investment and thus increase velocity.  However, that is immaterial to what drove the market's price appreciation and that cannot be promoted further; for short-term money the effective rate is already zero and as such only time preference remains which will never completely disappear.

Even if rates do not normalize the increased borrowing is what drove appreciation.  That increase has now come to an end, and the bursting of the housing bubble occurred because when rate decreases stopped happening at a rate that was sufficient to maintain the "rollover" behavior banks and others substituted ignoring credit quality.  This is a guaranteed way to lose money because an unqualified borrower obviously won't pay, but if you can manage to avoid going to prison, and lots of political arm-twisting accomplished that, you can steal "the last meal" from the "peasants" (that's you and I, by the way.)

Unfortunately that truly was the last meal.  The amount of time it will take for markets to recognize this will vary from place to place; China, for example, is still playing the "hide the rotting fish" game as is Europe and, to some degree, the United States, but again that's a timing matter rather than an outcome issue.

The outcome is not in doubt because arithmetic just is.

The stress this time is showing up first in natural resources (e.g. oil and shipping) companies but at its core the problem is in the financial system because essentially all of these projects are (or rather "were") financed at or near 100% "coverage" assuming the price of oil and/or shipping would not fall and thus the operating cash flow would be sufficient.

But the price didn't just fall, it collapsed.

None of these debts are covered, and we're now arguing over how long it takes before the cash flow insufficiency starts to create losses that cannot be hidden and bankrupt not only the borrowers but those holding the paper who have used it to lever up other bets by using it as collateral.

This isn't 2007 -- it is in fact much worse because it's global rather than being concentrated in subprime housing in the United States.

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Without comment......

other than the striking resemblance to another chart which failed to recover in '08-09....

Did someone's attempt to paper over the dead fish stench finally come unglued?

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The day approaches when the sign goes up.....

Incidentally, look at Sprint if you want a clue to what happens to those who take a lot of debt and do silly things.  A stock that I really liked (and strongly recommended) a few years ago, made plenty of money on, and then got out of when Softbank got involved, well..... from ~$9 to $2.64, how's it going, jackass?

Singular example?  Uh uh....

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It's rather amusing, really, to listen to people on Wall Street and in the mainslime media (here's looking at you, CNBC!) prance on and on about "low oil prices" and how this too shall pass.

Well, yes, it will -- eventually.

But probably not before we have our Penn Square moment.  Oh, you don't remember that?  Well fancy you.

Bill Patterson most-certainly did; he went to prison.

I've talked about this repeatedly since the whole "shale and fracking miracle" claptrap started a number of years ago.  There was no miracle; these deposits have been known about for a very long time, and an earlier attempt was made to extract them which became uneconomic when oil prices fell.

Of course the enviro-weenies, egged on by people like Obama and the complicit media, led you to believe that oil would never again be below $100 a barrel.  We're running out, you know, and that means we must all drive electric cars and deal with energy prices 5x what they were, simply because....

So where are those people now?  Why aren't they crying behind a set of iron bars?  This claptrap nonsense led people to make "loans" to folks digging oil out of the ground via schemes that were only viable with the price double or more what it is now, and what's worse much of that oil is high-sulfur and to refine it requires much higher operating temperatures and pressures than the low-sulfur, "sweet" crude that has flooded the market.

In other words that high-sulfur crude isn't worth "something less" than $30/bbl, it's worth zero because if I can get all the $30/bbl low-sulfur crude that my refinery can process, with storage (and thus backlog) filling to the brim there is no reason for me to buy and process the high-sulfur stuff at any price since it requires more energy input on my part and is harder on my equipment.

Now about all those loans and the payments due on them.... Hmmm....

One question I'll leave you with: Who's holding that paper and why isn't there full and public disclosure of both where the paper is and what derivatives have been written against it?

Coming to a bank (and economy) near you... just remember, "subprime is contained."


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How's that looking this morning?  Overnight the S&P Futures lost almost 35 points, or nearly 2%.  The Naz has lost 2%.

Last evening was amusing with folks like McClellan being trotted out to say "well, we're due for a rally" -- after we already had one.  How is that actionable?  That's very nice Tom, but unfortunately the 200+ point day already happened and it this morning the DOW futures are down 300, so lotsa-good that "information" did 'ya.

The various screamers are all over themselves trying to claim that China doesn't matter (when it did all the way up) and that low oil is good (well, I like cheap gasoline, but all those $60,000+ jobs in North Dakota are vanishing like a fart in the wind.)

The impetus yesterday was probably, as is frequently the case, Bullard (that is, The Fed.)  But here's the problem with such a premise: As I've pointed out "The Fed" and their 30-year secular trend lower in bond rates has run out of ability to provide additional leverage room because there's literally no further to go.

A 30 year trend that changes doesn't get recognized overnight, and didn't.  But now it's coming to the forefront of consciousness, and as that spreads through not just traders and investors minds but more important is reflected in balance sheets and quarterly results what do you expect to happen?

Examples?  Intel, last night, among others.  GoPro, what happened to their holiday sales?  Best Buy, same deal.  Hmmmm.. but Christmas was going to be good, right?


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