The "New Normal" Was Never Normal

There is chaos in global markets. I may post everyday because finally something is happening. Something any reasonable person expected to happen. The only mystery is why it took so long. I never thought this central bank reflation nonsense was going to work, and it's imploding right now all over the world. Mighty China is leading the way down.

The nitwits on NPR were talking about "learning lessons" today as they urged people not to panic and stay in the market. They were so desperate to prop up the status quo that they started talking about how loss aversion causes people to panic & sell (as the VIX goes off the chart).

There's only one lesson to be learned in August, 2015:

Humans came to believe that the "new normal" was normal.

Which comes as no surprise at all. The "new normal" was never normal. And now there's even more panic because the Fed may raise interest rates by a whopping 25 basis points! (That's 1/4 of 1 percent.)

I couldn't stop laughing reading David Stockman today. 

... As Nixon might have said, they are all Keynesians now. The job of central banks everywhere and always is to goose trouble-prone economies with printing press money so that households and business will spend more, the GDP will rise more and the stock bourses will be worth more.

Under this regime, there is no reason why economies should ever falter or stock markets should tumble; the state and its central banking branch can purportedly cure any deviations.

Thus, on July 7th Goldman’s China equity strategist gave the all clear signal right after the proceeding 20-day, $3.5 trillion meltdown of the China stock market. Completely ignoring the fact that China’s newly affluent classes have opened 287 million trading accounts, mostly in recent months, and mostly amounting to highly margined table stakes at its red chip casinos,  Goldman saw nothing but blue skies ahead:

Goldman Sachs Says There’s No China Stock Bubble, Sees Rally

Kinger Lau, the bank’s China strategist in Hong Kong, predicts the large-cap CSI 300 Index will rally 27 percent from Tuesday’s close over the next 12 months as government support measures boost investor confidence and monetary easing spurs economic growth. Leveraged positions aren’t big enough to trigger a market collapse, Lau says, and valuations have room to climb.

Goldman Sachs is sticking with its optimistic forecast in the face of record foreign outflows, the biggest-ever selloff by Chinese margin traders and a chorus of bubble warnings from international peers. The call hinges on the success of unprecedented government efforts to revive confidence among individual investors who watched equity values tumble by $3.2 trillion over the past three weeks……“It’s not in a bubble yet,” Lau said in an interview. “China’s government has a lot of tools to support the market.”

Well, not exactly. The Shanghai composite is down 21% since then, and a staggering 43% from the levels attained in late March.  That amounts to a $4 trillion “wealth” implosion in less than 100 trading days.

SSEC data by YCharts

Did Goldman fire this clown yet? No it didn’t.

Why? Because Goldman’s house economic model is essentially statist, and its agents—Dudley at the Fed, Carney at the BOE, Draghi at the ECB—are strategically placed to execute that model.

So not surprisingly, Goldman’s chief equity strategist is out this morning with a buy-the-dip note, assuring its clients that the storm is over and that the S&P 500 will be back to its old highs in a jiffy:

……. Concern about China economic growth was the immediate catalyst for the correction. (But) we expect the US economy will avoid contagion and continue to expand. S&P 500 will rise by 11% to reach 2100 at year-end. Such a rebound would echo the trading pattern exhibited in 1998 when US equities rallied and largely ignored the Asian financial crisis. ………

Ultimately, the US economy was relatively unaffected by overseas financial market gyrations in 1998 and we believe a similar situation will occur in 2015. Our analysis of the geographic revenue exposure of S&P 500 constituents reveals that the US accounts for 67% of aggregate sales. Approximately 8% of revenues stemmed from the Asia-Pacific region with 1% disclosed as coming specifically from Japan and 2% from China. From an economics perspective, US exports account for roughly 13% of total US GDP, which  includes 5% to emerging markets and less than 1% to China.

That is just plain gibberish. Goldman’s statist economic model renders it utterly blind to the booby-traps planted everywhere in the world economy. For goodness sakes, this is not 1998!

No, it's not. It's not even 2008. It's 2015!

Back then China had less than $2 trillion of debt outstanding and a minor presence in the world economy. Since then its credit market debt outstanding has exploded by 14X, its steel industry has expanded by 6X, its auto sales by 25X and its exports have risen by 1300%.

China Exports of Goods and Services data by YCharts

In the interim, in fact, it has paved its landscape with a vast excess of everything——60 million empty high rise apartments that function as piggy-banks for speculators; dozens of ghost cities, empty malls and see through office buildings; scores of steel, machinery and auto plants that will soon be shutdown; mountains of copper and iron ore inventories that are hocked to foreign lenders; and trillions worth of high speed rails that are unsafe, airports that have no traffic and roads and bridges to nowhere...

You would have to write a book to list all the things that are fucked up in China.

And then there's this beautiful chart from the Royal Bank of Scotland (RBS).

Alberto Gallo, head of credit research at RBS, is more direct:

"Policymakers responded to the financial crisis with easy monetary policy and low interest rates. The critics — including us — argued against 'solving a debt crisis with more debt.' Put differently, we said that QE was necessary, but not sufficient for a recovery. We are now coming to the moment of reckoning: central bankers look naked, and markets have nothing else to believe in."

Gallo believes an overreliance on excess liquidity has actually hindered capital investment — as companies have focused on debt-funded share buybacks and dividend hikes instead — limiting the global economy's potential growth rate.

Now, contagion from China — lower commodity prices, lower demand, currency volatility — has revealed the structural vulnerabilities. More stimulus, in his words, "could be self-defeating without fiscal and reform support."

As for Fed hike timing, Gallo sees the odds of a September liftoff at just 30 percent, down from 36 percent last week, based on futures market pricing. December odds are at 60 percent.

The open question is: Should the Fed delay its rate hike and the People's Bank of China ease, will stocks actually rebound?

Or has the Pavlovian reaction function been broken by a loss of confidence?

We're about to find out. 

We sure are.

Comments

[Jack]

The problem with too much debt is not enough debt. Or something. Margin calls? You're losing too much money so you better put up more money so WE don't lose any more money. I have,(way)in the past faced margin calls. Panic city, and please don't tell my wife.
Give me a hamburger today, and I'll pay you Tuesday.
The eclectic skeptic.
J