From the last Crisis Progress Report, dated October 1: “Assume a rally like the one in 2008 is in the offing. If the 2008 rally’s timing is any guide, this one will start between now and New Year’s, but there are no assurances; it may begin next year.” SLL did not know then that the rally was already underway, the market having made its recent closing low on September 28. Now that the market has rallied, in the perverse way that markets work, Friday’s employment report, the best in some time, may well kick off the next down leg. October has had its share of market crashes, so with fear high at the beginning of the month, the market rallied and October was its best month in years. November and December are often strong, marked by end-of-the-year “Santa Claus” rallies. Again, in their perverse way, markets this year may leave a lump of high-sulfur-content, CO2-releasing, soon-to-be-outlawed coal in investors’ stockings.
This latest employment report will be revised multiple times; it is subject to a variety of abstruse statistical criticisms; it is seasonally and birth-death-model adjusted; it shows that almost all the jobs in October were taken by older workers, and finally, employment is, as any economist will tell you, a lagging indicator. Whatever the ambiguities in the employment report, there is no gainsaying that debt contraction is rolling through, and roiling, the global economy in textbook fashion. Global debt, central bank and government-force fed, approaches $225 trillion and has grown faster than global GDP for decades. It is the most massive in history, measured in either absolute terms or in relative terms against global GDP.
Debt is close to or at a high point that may not be exceeded for decades, but the underlying forces of contraction are in full flower. They first appeared in the most leveraged sector relative to its ability to repay: natural resources. China blew a debt-fueled bubble, and its economic “miracle” stoked investment in natural resources around the world. That investment binge was aided mightily by artificially low, central-bank suppressed interest rates. Once China’s bubble started to deflate, as all such bubbles must, investment that looked “opportunistic” on the way up has became malinvestment, with gluts in oil, iron ore, coal, aluminum, nickel, fertilizer, and a host of other raw materials.
Earlier this year, it was possible, if one was completely ignorant of debt dynamics, or “debtonomics” as SLL has christened them (see Debtonomics Archive), to argue that the raw materials situation would be contained. The same assurances were given in 2007 about the pending collapse of the housing and mortgage finance markets, and the present assurances will prove as spot off as those were. Natural resources are a far larger part of the global economy than the what proved to be earth-shaking US housing and mortgage finance market was in 2007. There are too many debt contraction ripples rippling out; the only way the contained argument can be made now is through willful ignorance. (SLL has been glutting its blog postings with stories on those ripples. Rather than clutter up this article with a multitude of links, readers who have missed those stories and are interested should scan through the blog over the last month.)
The glut of raw materials has led to a glut in raw materials transport. Tankers, bulk shipping vessels, and container ships are in oversupply and shipping rates have collapsed, in some cases to all time lows. China’s exports and imports are shrinking, as is overall global trade. The ripples are reaching US shores, where railroads are reporting shrinking volumes of not just natural resources, but chemicals, containers, and industrial products. The trucking industry is following suit; the US load-to-truck ratio just hit a 33-month low. Neither US railroads nor trucks are directly tied into China, but they are nevertheless being affected by reduced demand from China that is anything but “contained.”
Notice that the contraction has moved beyond raw materials. Cheap money and China’s supposedly perpetually expanding demand prompted fervid increases in Chinese and global industrial capacity, now overcapacity. Exhibit A is the steel industry, burdened with massive oversupply. Its raw material, iron ore, has gone from $154 per dry metric ton in February of 2013 to its current price below $50 per dry metric ton. It’s the same story with cement, finished aluminum and copper products, industrial machinery, tractors, and engines, to name a few. The segment of the global economy that makes things, especially the segment that makes things for other industrial users, is looking at gluts as devastating as those faced by producers of raw materials. Last month, Daniel Florness, the CEO of Fastenal, a US company that makes nuts, bolts, and other fasteners said, “The industrial environment is in a recession—I don’t care what anybody says, because nobody knows that market better than we do. You know, we touch 250,000 active customers a month.” (“‘Our Data Is Not Good’ – US Companies Warn That A Recession Is Coming,” by Tyler Durden, SLL, 10/26/15).
The fashionable refrain is that none of this will put the US in a recession because the US economy is based on services, not mining, manufacturing, and exports. The stock market has recovered most of its August and September losses, the housing market is holding up, and service sector statistics still show growth. This optimism is misplaced. The things-you-can-touch economy buys legal and financial services, communications, technology, insurance, consulting, office space, real estate, and advertising. The idea that significant cutbacks by America’s mining, manufacturing, transport, and distribution companies will have minimal impact on its service companies ignores the extensive commercial relationships between the two groups.
Layoffs have begun in mining, oil, and gas and will spread. The newly unemployed cut back on store trips, restaurants, entertainment, and other discretionary spending in the service economy. They may, heaven forbid, even cut back on their smart phone usage. Then we’ll know that things are really, really bad. About the only sector that may appear immune, at least for a while, is the government, but the relative health of this nonproductive—or more accurately, counterproductive—sector, will come, as it always does, at the expense of the rest of the economy.
One of the US’s world-beating service industries—the production, packaging, and distribution of debt—is already showing the strain. Fracking and mining companies are seeing their credit lines curtailed or eliminated, and bond financing unavailable or prohibitively priced. What started in the oil and gas corner of the bond market—widening credit spreads—has spread out to a general increase. The ultra-cheap interest rates that allowed companies to finance shareholder friendly dividends and buybacks are ratcheting up. Banks are cutting their commitments to both the investment grade and high-yield corporate bond markets. Constriction in credit markets often precedes significant stock market declines, but hey, things are different this time. Flinty creditors spend all their time looking at boring old balance sheets, revenues, expenses, and cash flows. Equity markets have hope and faith and central bank pixie dust!
They can ignore the writing on the wall, but not the wall. That would be the one into which the global economy is smashing. Pixie dust has probably taken US equity markets about as far as they’re going to go. A crash that begins before Christmas will surprise only those who still believe in Santa Claus.
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