Monday, January 8, 2018

China Shoes to Drop

The hot new theme for the past few months has been global reflation.  With WTI crude over $60 and the metals steadily rising, global investors are piling into materials, energy, and other "value" areas since tech is too expensive.  These value names are loaded to the gills in debt, and their return on equity over the past 10 years is horrible.  They have consistently lagged the S&P 500 during this 9 year bull market.  And they are in one of the sectors which don't have quasi-monopolies like the tech names. 

I mention the materials because they were being touted on CNBC Fast Money on Friday as being a good place to put your money because tech is overextended and expensive.  It is coming to this.  Reaching for the laggards which have worse fundamentals hoping these dogs with fleas will catch up.  And usually they just keep lagging, because in the late stages of a bull market, the growth names usually outperform value because they are the only ones able to hold up as economic growth starts to flatten out. And contrary to what you hear from the CNBC cheerleaders, economic growth has been stagnant, stuck around 2% growth for years. 

The sad part is that this mediocre growth has been achieved by pushing global yields to historic lows along with QE, encouraging more debt.  And the masses have obliged by piling on more debt.  Oddly enough, in the country with one of the highest interest rates in the G20, China.  That is where the financial imbalances are building.  Chinese private debt (corporate + household debt) to GDP is exploding higher, now well over 200%.  Japan, US, and Europe are all around 150%.

Nonfinancial corporate debt growth since 2006.  Its all China. 

The above charts are as of middle of 2016.  The numbers have only gotten bigger since. 

China is the gorilla in the room when it comes to iron ore and copper demand.  It has provided the marginal growth for the global economy via debt expansion for the past 9 years.  I know they say that its a command economy and they can paper everything over by cutting rates, printing yuan, and backstopping everything, but you think the owners of the debt will just stand still holding assets in yuan when the yuan gets devalued?  It is ticking time bomb and what happened in 2016 is totally forgotten.  That was just part 1 of the China crisis.  Part 2 isn't far off. 

SPX has been on fire this 1st week of January.  I was completely off on my expectations for the new year.  I am still short, but I will look to exit as gracefully as possible on any 20 point pullback.  I underestimated the equity inflows for the new year and the crowd excitement for this market.  We are clearly in a bubble blowoff phase, which is something new.  Before, there would be a grind higher, but with pauses along the way.  Now its a mad rush into risk assets.  The fundamentals haven't changed, so there will be give back of these moves in a few months.  But it definitely will not go down quietly, and the top will take longer than expected.

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