Scorched Earth 

Doug Nolan


November 18 – Reuters (Rodrigo Campos): 

“Global debt is expected to soar to a record $277 trillion by the end of the year as governments and companies continue to spend in response to the COVID-19 pandemic, the Institute of International Finance said in a report… The IIF… said debt ballooned already by $15 trillion this year to $272 trillion through September. Governments - mostly from developed markets - accounted for nearly half of the increase. Developed markets’ overall debt jumped to 432% of GDP in the third quarter, from a ratio of about 380% at the end of 2019. Emerging market debt-to-GDP hit nearly 250% in the third quarter, with China reaching 335%, and for the year the ratio is expected to reach about 365% of global GDP.”

Covid’s precision-like timing was supernatural – nothing short of sinister. A once in a century international pandemic surfacing in the waning days of an unrivaled global financial Bubble. 

A historic experiment in central bank monetary management already floundering (i.e. Fed employing aggressive “insurance” QE stimulus with stocks at record highs and unemployment at 50-year lows). 

A Republican administration running Trillion-dollar deficits in the midst of an economic boom. Yet, somehow, reckless U.S. fiscal and monetary stimulus appeared miserly when compared to the runaway excess percolating from China’s epic Credit Bubble. Monetary, fiscal, markets, at home and abroad: Covid bestowed end-of-cycle excess a hardy additional lease on life.

From the FT: 

“Global debt rose at an unprecedented pace in the first nine months of the year as governments and companies embarked on a ‘debt tsunami’ in the face of the coronavirus crisis… From 2016 to the end of September, global debt rose by $52tn; that compares with an increase of $6tn between 2012 and 2016.” 

According to the IIF, U.S. debt is on course to expand about 13% this year to $80 TN. 

As a percentage of GDP, U.S. debt jumped from 327% to 378%. U.S. government borrowings inflated a dismal 26 percentage points to 127% of GDP. Globally, developed (“Mature”) economy debt surged 49 percentage points to 432% of GDP. 

From the IIF: “… There is significant uncertainty about how the global economy can deleverage in the future without significant adverse implications for economic activity.”

Emerging market debt is expected to jump 26 percentage points this year to 250% of GDP, as indebtedness rises to $76 TN (Chinese borrowers accounting for $45 TN). 

China rapidly expanded already massive indebtedness, adding a staggering 30 percentage points to 335% of GDP (up from about 160% in ’08). China’s corporate sector added 15 percentage points to 165% of GDP. And more indications this week of mounting Credit stress (see China Bubble Watch below). 

Malaysia and Turkey added almost 25 percentage points of debt-to-GDP this year, with Colombia, Russia, Korea and Chile jumping around 20 percentage points. Thailand, South African and India each gained almost 15 percentage points, with Hungary, Mexico and Brazil near 10. 

From Bloomberg: 

“About $7 trillion of emerging-market bonds and syndicated loans are slated to come due through the end of 2021… Emerging markets, especially those in Latin America, have faced more pressure on credit ratings this year as debt loads rose…”

IIF projections have global debt increasing $70 TN, or a third, over what will soon be five years of synchronized “Terminal Phase Excess.” The past year, in particular, has seen rapid acceleration of non-productive debt growth. On a global basis, governments accounted for over half of new debt. 

In the IIF’s one-year sectoral breakdown, Global Government Indebtedness surged from 69.1% to 77.6% of GDP – led by a $3.7 TN increase in U.S. governmental borrowings. This was the largest of the sector gains (compared to 73.7% to 79.6% growth in Non-Financial Corporates). Canada, Japan, the UK, Spain and Italy were also notable for their massive expansions of government indebtedness.

Examining the current extraordinary market backdrop, the “pain trade” has been higher. Despite extreme bullish sentiment, many have remained less than fully invested. FOMO (fear of missing out) has been excruciating. The poor bears have been decimated. Short positions remain easy – big fat bear in a barrel - “squeeze” targets, with little concern these days for those pesky bears shorting overextended stocks. Devoid of selling pressure, the sky’s the limit.

But, mainly, there is today a pool of speculative finance without precedent. Positive vaccine news stoked a manic rotation, catching most in a highly Crowded marketplace tech heavy and underexposed to financials, small caps, myriad lagging sectors, EM and the broader market more generally. 

Quant strategies run amuck.  Throw in all the manic derivatives trading – beloved call options in particular – and one can easily explain the origins of market “melt-up” trading dynamics. And such a speculative, dislocated and devious marketplace welcomes negative news flow. 

This only entices some new short positions along with put buyers - to then be summarily torched by a carefree market gleefully climbing the proverbial “wall of worry.”

In reality, there’s plenty to worry about. As welcome as positive vaccine news is right now, the conclusion of the pandemic will not, unfortunately, usher in a return to normalcy. 

The massive amount of debt noted above will overhang the system for years, as will deep scars throughout the real economy. 

From the New York Times: 

“Maps tracking new coronavirus infections in the continental United States were bathed in a sea of red on Friday morning, with every state showing the virus spreading with worrying speed and health care workers bracing for more trying days ahead.”

U.S. daily infections surpassed 100,000 for the first time on November 4th. And just over two weeks later, we’re on the cusp of a 200,000 day (194,000 on Friday). 

Coronavirus taskforce coordinator Dr. Deborah Birx: “This is faster, it is broader and, what worries me, is it could be longer.” 

Hospitalizations nationally have surpassed 84,000, almost double the month ago level. 

Many states reported a doubling of hospitalizations over the past week. One in five hospitals now expects to face critical staff shortages within a week. Friday saw California report a record 13,005 new infections. 

U.S. equities traded to record highs on February 20th, seemingly oblivious to the unfolding pandemic. And then, within 10 trading sessions, markets were overwhelmed with panic. 

The Fed responded with rapid-fire rounds of increasingly panicked stimulus measures. These days, markets have once again been content to disregard a deteriorating pandemic environment. When the crisis erupted in March, markets confronted unknowns with regard to the pandemic as well as the scope and efficacy of the crisis response. 

Beyond the vaccines, markets’ current willingness to “look over the valley” rests firmly on confidence that fiscal and monetary policymaking will again rise to “whatever it takes.” 

A Friday evening Bloomberg headline: “Investors Look Past the Chaos and Throw $53 Billion at Stocks.” 

In “one of the biggest deluges of cash ever recorded,” U.S. equities ETFs have attracted $53 billion so far this month. What an odd backdrop for throwing caution to the wind and rushing into the market. Clearly, way too much “money” has been chasing highly speculative markets. 

November 20 – Bloomberg (Christopher Anstey and Saleha Mohsin): 

“The top two U.S. economic policymakers clashed over whether to preserve emergency lending programs designed to shore up the economy -- a rare moment of discord as the nation confronts the risk of a renewed downturn spurred by the resurgent coronavirus. 

The disagreement erupted late Thursday when outgoing Treasury Secretary Steven Mnuchin released a letter to Federal Reserve Chair Jerome Powell demanding the return of money the government provides the central bank so it can lend to certain markets in times of stress. Minutes later, the Fed issued a statement urging that ‘the full suite’ of measures be maintained into 2021. 

‘This is a significant and disturbing breach at a critical time for the economy,’ said Tony Fratto, who worked at the Treasury and the White House during the George W. Bush administration. ‘We need all the arms of government working together and instead we’re seeing a complete breakdown,’ he said, noting that Washington remains at an impasse on fiscal stimulus as well.”

As has become quite a habit, markets brushed off Mnuchin’s surprising termination of several of the Fed’s emergency programs. Remarkably, the entire contested election issue has been one big nonissue for an ebullient marketplace. 

With Biden ahead six million popular votes and holding a commanding electoral college lead, markets aren’t taking President Trump’s ranting, raving and suing seriously. 

The assumption is bluster peters out and a peaceful transfer of power emerges around January 20th. 

Does that leave two months for “Scorched Earth” shenanigans? 

Does Mnuchin’s move against the Fed foreshadow a bevy of measures meant to hamstring the new Biden administration and rattle the markets. 

From day one, President Trump suffered a peculiar obsession with all things stock market. 

Record equities prices were exalted as a reflection of his leadership prowess and adroit policymaking. So far, not even an inkling of the market crash a Biden presidency was to incite. 

If there is indeed some “Scorched Earth” scheme at work, why would the stock market not have a bullseye on its back?

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