ONE EXTRAORDINARY YEAR / CREDIT BUBBLE BULLETIN

One Extraordinary Year

Doug Nolan


Confirmed coronavirus cases almost doubled over the past week to 67,000. Part of the spike was the result of including a group diagnosed through CT imaging scans rather than with typical coronavirus testing. The ballooning number of patients with viral symptoms has overwhelmed the capacity for normal testing.

Troubling news came Friday of 1,700 Chinese healthcare workers having been infected (with 25,000 deployed to Hubei Province). Also, quarantines were further tightened in Wuhan as well as Beijing. Returning Beijing residents are to remain isolated in their homes for 14 days. As the NYT put it, “It was the latest sign that China’s leaders were still struggling to set the right balance between restarting the economy and continuing to fight the coronavirus outbreak.”

Staring at a rapidly unfolding economic and financial crisis, Beijing has made the decision to move forward with efforts to get their faltering economy up and running. This comes with significant risk.

Global markets, by now fully enamored with aggressive monetary and fiscal stimulus, are predisposed to fixate on potential reward (keen to disregard risk). That future students of this era will be more than a little confounded has been a long-standing theme of my contemporaneous weekly chronical. Booming market optimism in the face of what has been unfolding in China will ensure years and decades of head-scratching.

China is definitely not alone in gambling with aggressive late-cycle stimulus, as it desperately tries to postpone the unavoidable dreadful downside after historic Bubble Inflations. Coming at this key juncture of end-of-cycle fragilities, it’s a challenge to envisage more delicate timing for such an outbreak – in China and globally. Clearly, when global markets hear “stimulus” they immediately salivate over the thought of bubbling liquidity and ever higher securities prices. Critical nuances of global Inflation Dynamics go unappreciated.

February 9 – Bloomberg: “China’s consumer prices rose the fastest in more than eight years last month, with the outbreak of the coronavirus and subsequent shutdowns of transport links across the country making further gains in the coming months likely. Consumer prices rose 5.4%, with food prices jumping the most since 2008 in January. Even before the coronavirus, prices were likely to have risen sharply due to the normal spike in demand around the Lunar New Year and the effects of the African Swine Fever outbreak which has killed millions of pigs and damaged pork supplies. Pork prices gained the most on record.”

China has an escalating consumer price inflation problem, one manifestation of intensifying Monetary Disorder. It’s a fundamental Credit Bubble Analytical Postulate that inflationary fuel will gravitate to areas already demonstrating the strongest inflationary biases. As we’ve been witnessing globally, dump stimulus into a backdrop of powerful securities market inflationary psychology and the upshot will be more intense speculation, acute asset price inflation and increasingly destabilizing market Bubbles.

China, facing its own particular Inflationary Dynamics, has now embarked on a course that never ends well: aggressive fiscal and monetary stimulus in an environment of rising consumer inflation and general monetary and economic instability.

China’s CPI Food Index posted a 20.6% y-o-y increase in January, the highest since March 2008. For many of its citizens, food purchases make up a significant percentage of monthly expenditures (some estimates as high as 30%). While the doubling of pork prices is inflating price aggregates, even vegetable prices were up a notable 17% y-o-y. And this was before the escalation of the coronavirus outbreak.

Beijing has acknowledged the risk to social stability from the coronavirus. Policymakers as well face a challenge in trying to stimulate a faltering maladjusted economy without exacerbating the hardship inflicted upon much of its population from surging consumer prices. Stimulus measures are working well for global market participants. For Chinese citizens, the jury is out.

Meanwhile, China’s Credit mechanism is in disarray. Over the past two years in particular, stimulus measures stoked China’s consumer borrowing and spending boom. This upsurge was integral in sustaining China’s Bubble economy in the face of mounting manufacturing overcapacity and associated corporate Credit issues. It comes with a steep cost. In particular, China’s apartment Bubble went to even more precarious extremes.

February 10 – Bloomberg: “Home sales in China have been dealt a huge blow by the spreading coronavirus with figures showing transactions plunged in the first week of February. New apartment sales dropped 90% from the same period of 2019, according to preliminary data on 36 cities compiled by China Merchants Securities Co. Sales of existing homes plummeted 91% in eight cities where data is available. ‘The sector is bracing for a worse impact than the 2003 SARS pandemic,’ said Bai Yanjun, an analyst at property-consulting firm China Index Holdings Ltd. ‘In 2003, the home market was on a cyclical rise. Now, it’s already reeling from an adjustment.’”

The above “apartment sales dropped 90%” Bloomberg article was confirmation of the dramatic upheaval the coronavirus is having both on China’s economy and Credit system. And while Beijing stimulus will surely have significant economic impact, it will not easily replace the flow of household mortgage finance that evolved into a powerful force for Chinese and global economies.

China’s aged apartment Bubble was increasingly vulnerable prior to the coronavirus. At this point, it would appear there is a clear catalyst for the piercing of one of history’s greatest Bubbles. I’ll assume easier lending terms and additional borrowing will bolster the gargantuan - and highly indebted - Chinese homebuilders.

Yet sustaining China’s highly inflated apartment prices will prove a much greater challenge.

Estimates have as many as 60 million unoccupied apartment units throughout China. Homes for “living in and not speculation”? When risk aversion begins to take hold generally in Chinese housing (a break in inflationary psychology), there is potential for far-reaching economic and financial disruption.

China will inevitably face its first housing and mortgage finance bust, a painful bursting Bubble episode made much worse by Beijing repeatedly resorting to stimulus measures. It’s difficult to overstate ramifications for China’s economy, financial system and social stability.

February 9 – Bloomberg: “Just as it looked like Beijing was starting to get a handle on its regional banking crisis, a much more severe threat is engulfing the world’s largest banking system as a deadly new virus hits the country’s economy. The impact of the spreading coronavirus risks bringing to life the worst-case economic scenarios contained in China’s annual banking stress tests. Last year’s exercise envisaged annual economic growth slowing to as low as 4.15% -- a scenario which showed that the bad loan ratio at the nation’s 30 biggest banks would rise five-fold. Analysts now say that the outbreak could send first-quarter growth to as little as 3.8%. Banks are already suffering record loan defaults as the economy last year expanded at the slowest pace in three decades. The slump tore through the nation’s $41 trillion banking system, forcing the first bank seizure in two decades and bailouts of two other key lenders.”

China’s protracted Bubble aroused delusions of grandeur - within the communist party as well as throughout its population. It’s incredible to ponder what’s at stake. Beijing is in no way willing to cede its global ambitions.

An assertive American administration only strengthens their resolve. Communist leadership will reject any challenge to its control and dominance.

Meanwhile, a bursting Bubble will throw everything into disarray.

Beijing has declared a “people’s war” against the forces of Bubble deflation. And this explains why markets so confidently operate under the assumption a bust won’t be tolerated.

Extraordinary fragilities only ensure epic stimulus; Chinese and global Punchbowls Runneth Over. “Washington will never allow a U.S. housing bust.” “The West will never allow Russia to collapse.” There are monumental presumptions that underpin historic boom and bust cycles. “The Beijing meritocracy has everything under control.”

February 12 – Associated Press (Joe McDonald): “China’s auto sales plunged in January, deepening a painful downturn in the industry’s biggest global market and adding to economic pressures as the country fights a virus outbreak. Sales of SUVs, sedans and minivans fell 20.2% from a year earlier to 1.6 million, an industry group, the China Association of Automobile Manufacturers, reported… ‘Enterprises are under huge pressure,’ it said…”

Over the past decade, China’s domestic auto industry grew into a behemoth. It is another critical sector both from economic and financial standpoints. And while I don’t view it in the same context as the vulnerable apartment Bubble, it is another market that could suffer lingering effects.

I am well aware of the market view that the coronavirus crisis will soon pass. We can expect Beijing stimulus measures to help shore up GDP figures and stock prices. At least in the near-term, it will support confidence. Hopefully the outbreak has peaked, with stimulus measures and an accommodative banking system helping China’s economy to muddle through. Global equities markets have been content to “look across the valley.”

Disregarded are China’s acute financial and economic fragilities, the of risk stimulus measures exacerbating monetary disorder and mounting risks to social stability. How quickly does the Chinese population bounce back – again eagerly taking on debt, buying apartment and cars and dreaming of a bright and prosperous future?

That equities can run higher in the face of mounting risks is not as confounding as it might first appear. Credit drives the global Bubble – and Credit in the near-term is further benefiting from the outbreak. Overheated securities (speculative) Credit is really benefited.

Global monetary stimulus is further assured - rate cuts and more QE. One can now add aggressive PBOC liquidity injections to the Fed and global central bank QE throwing gas on a speculative fire raging throughout global fixed-income markets.

February 13 – Bloomberg (Gregor Stuart Hunter): “Investors who poured money into bond funds last year are showing little sign of stopping in 2020… Inflow to fixed-income assets nearly doubled last year to $1 trillion, according to… Morningstar Inc. With fears about the coronavirus outbreak dimming growth prospects for the global economy and prompting a search for haven assets, bond funds are on track to exceed this haul in 2020. ‘We’re in uncharted territory,’ Nikolaos Panigirtzoglou, a JPMorgan... strategist, said… ‘Based on January flows, it’s going to be another very strong year for bond fund flows.’”

Equities at record prices garner all the attention. Yet the manic behavior in global bond markets is more extraordinary and consequential. U.S. fixed income ETFs attracted another $7.3bn this week (ETF.com), as “money” keeps rolling in.

The $64 TN question is how much speculative leverage continues to accumulate throughout global bond and derivatives markets. Here again, the timing of the coronavirus outbreak is of great consequence – inciting speculative excess and attendant leverage when global fixed-income was already engulfed by powerful Inflationary Biases.

Added leveraging works to inject additional liquidity into already over-liquefied global markets. And the last thing overheated global risk markets – with such powerful Inflationary Biases - needed at this point was additional liquidity.

I view the equities Bubble as an offshoot of the greater Bubble that continues to inflate in global debt, securities Credit and derivatives markets. On the one hand, it is extraordinary to see equities markets essentially dismiss such consequential developments in China. It does, however, present important support for the Bubble Thesis.

Equities rallied to record highs just months before the LTCM/Russia collapse in 1998.

Stocks rallied to record highs in 2007 even as the mortgage finance Bubble faltered.

It’s only fitting that global stocks rally to record highs as the faltering China Bubble places the global Bubble in serious jeopardy. If the coronavirus stabilizes over the coming weeks and months, attention can then turn to November U.S. elections. It’s poised to be One Extraordinary Year.

A Friday CNBC headline: “White House Considering Tax Incentive for More Americans to Buy Stocks, Sources Say.” A strong equities market boosts optimism of a Trump reelection - bullishness that spurs further stock gains.

Yet there is potential for self-reinforcing dynamics to the downside. A break in stock prices would incite election nervousness and heightened market risk aversion.

Can this game sustain for another nine months?