Cheap Credit Will Sink Us Again

The past few years have been a great data driven example of finance not being a science.  Globally, central banks have done everything from bailing out institutions, displaying a complete lack of discretion when it comes to disbursing cash (GOP leader’s wife received 2009 bailout funds), and we have also seen attempts globally to devalue currency.

Talking heads have parroted three points lately:

  1. The FED commentary regarding the economic expansion we’ve seen
  2. The bad data thanks to weather (laughter is still being heard about that excuse)
  3. Inflation 

Japan and the United States are both ready to drop fresh inflation data on to our laps this week with the United States issuing data on Tuesday July 22 and Japan hitting the wires on Thursday July 24.  Japan is expecting 3.7 percent YOY inflation compared with the prior reading of 3.5 percent. The US is looking for 2 percent compared with a prior reading of 2.1 percent.

Zero Hedge highlighted some commentary from Goldman Sachs on Abenomics in a piece titled “Goldman Slams Abenomics; Questions ‘Validity of BoJ’s Target’” on Friday (emphasis mine):

  • “A significant relationship between price and sales is not visible before this year’s tax hike, but a strong negative correlation is evident after the tax hike.” 
  •  “Consumers have been forced to reduce spending in response to more aggressive corporate pricing.” 
  •  “Aggressive corporate pricing has exacerbated a large decline in real wages.”

This impact of the Abenomics inflation target on wages and prices in Japan is complicated further when we consider that Japanese corporate entities will not increase wages (easy to raise but hard to lower) because of the demand-pull Abenomics has created, thus limiting the income of an industry where the supply of workers is low and the demand for the services is high.

Benzinga noted on June 27, 2014The demand created by Abenomics, along with the demand rush prior to a hike in consumption tax, is viewed as fleeting by corporations”.

This is one reason why global inflation is such a large focus point.  Market participants will be looking for data (inflation estimate is 2 bps higher than last reported) to continue the story about Japan and their inability to generate organic demand.  A form of demand that would drive wage increases and also help to spur money velocity and the nation’s standard of living.   Central Banks are very good at pulling future demand into the present but when it comes to organic wealth creation through the allocation of resources to those that require it most, Japanese and American central banks fail in spectacular fashion.

Our prices in the market place are skewed thanks to cheap capital and less-judicious deployment of that capital from the borrower.  Goldman Sachs has said that excess credit will not squelch the rally.  However, Benzinga noted that credit has driven the biggest nominal amount of M&A activity we’ve ever seen, thanks to the FED.  Data is so shoddy UBS had to issue a report on how “worried” they are. 

Judicious analysis of the data before deploying capital is the mark of a great trader/investor.  High quality and honest analysis may cause participants to lose out on the last bit gains in a bull rally but it will help to protect the potential of losses that will occur before acknowledging a bear market.

We are at the beginning of what could be a major shift in prices and global economic policy.  All we’re going to need is a catalyst that will reintroduce the fear removed by FED policy to correct over-valuations which should cause selling.  That selling will be contained to few percentage points thanks to the dynamics of margin credit and interest received from brokers.  Large corrections can be contained by a base of participants who have bought assets on credit. 

Once the brokerages feel the interest they are receiving is no longer compensating them for the risk of a borrowers default, the brokerages will begin to sell off assets in those accounts no possessing the necessary cash to cover the credit of borrowed funds.  When this realization manifests, capitulation will be generated, and that will cause added downward pressure on prices which most likely will lead to an over-correction. 

Participants ahead of the curve will have an opportunity to capitalize on the chaos and fear that will catch the broad majority of market players off guard.  Don’t be the one caught off guard, be the one ready to take advantage of fear.

Stay up-to-date with breaking news and ideas to trade it with BenzingaPro and #PreMarket Prep.




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