DYI
World Wide
Economic Market Smash
August 7, 2017
John P. Hussman, Ph.D.
The unwinding of the accompanying excesses in the credit cycle may also be profound. Nonfinancial debt as a fraction of corporate revenues is now easily at the highest level in history. As of June, a record 72.5% of the U.S. leveraged loan market (loans to already highly indebted borrowers) was comprised of “covenant lite” loans, offering little protection to creditors in the event of bankruptcy. In 2016, a record $875 billion of these loans were issued. The situation in Europe is even worse, where 72.8% of loan volume is now covenant lite.
Euro Junk Bonds and “Reverse Yankees” Go Nuts
The ECB’s efforts to buy corporate bonds as part of its stupendous asset buying binge has not only pushed a number of government bond yields below zero, where investors are guaranteed a loss if they hold the bond to maturity, but it has also done a number – perhaps even a bigger one – on the euro junk-bond market.
It has totally gone nuts. Or rather the humans and algorithms that make the buying decisions have gone nuts. The average junk bond yield has dropped to an all-time record low of 2.42%.
Let that sink in for a moment. This average is based on a basket of below investment-grade corporate bonds denominated in euros. Often enough, the issuers are junk-rated American companies with European subsidiaries – in which case these bonds are called “reverse Yankees.”
These bonds include the riskiest bonds out there. Plenty of them will default, and losses will be painful, and investors – these humans and algos – know this too. This is not a secret. That’s why these bonds are rated below investment grade. But these buyers don’t mind. They’re institutional investors managing other people’s money, and they don’t need to mind.
In my view (supported by a century of market cycles across history), investors are vastly underestimating the prospects for market losses over the completion of this cycle, are overestimating the availability of “safe” stocks or sectors that might avoid the damage, and are overestimating both the likelihood and the need for some recognizable “catalyst” to emerge before severe market losses unfold.
We presently estimate median losses of about -63% in S&P 500 component stocks over the completion of the current market cycle. There is not a single decile of stocks for which we expect market losses of less than about -54% over the completion of the current market cycle, and we estimate that the richest deciles could lose about -67% to -69% of their market capitalization. As in 2000 and 2007, investors are mistaking a wildly reckless world for a permanently changed one, and their reeducation in the concept that valuations matter is likely to be predictably brutal.DYI:
The probability of world wide recession growing at first by the month then weeks and beginning to make its shift to
days. Not just excesses here in the
States with a stock and junk bonds “gone wild” this includes our across the
Atlantic neighbors. Other countries by
themselves would have zero to marginal effect upon the U.S. but in their totality
is equivalent of piling on after the running back has been tackled. Canada, Australia and New Zealand with their
debt/real estate bubbles tacked alongside Brazil’s hyperinflation, Argentina’s perennial
debt defaults and Venezuela’s Marxist 3rd world hell hole all adding
on to the world’s economic woes. DYI’s
contention China’s debt bubble will be pierced as Europe, U.S., South America,
and Oceania all go into the economic tank as central banks are now impotent due
to sub atomic low and negative interest rates.
Oil
This possible economic smash will drop the
price of oil. IF oil trades
as a teenager – prices under $20 – a bargain of a lifetime will present
itself. I have no idea which way oil
will trade what I am saying be prepared; if this occurs the Adams Natural
Resource Fund symbol PEO is a solid closed end fund. Not only will oil but the whole range of
natural resources will be on the give-away-table.
DYI’s model portfolio has plenty of dry
powder just itching to be put to work but only when positive long term
valuations prevail. Returns are baked
into the cake based upon valuations and when they improve our cash horde will
be put to work. Until then be prepared
as the Great Wait Continues.
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