,hl=en,siteUrl='http://0ldfox.blogspot.com/',authuser=0,security_token="v_SeT2Tv8vVdKRCcG9CCW-ZdIfQ:1429878696275"/> Old Fox KM Journal

Saturday, March 29, 2014


This chart (a similar version was originally produced by Comstock Partners) shows the age-old story of easy credit. Once rates rise and growth slows, key sectors that took the full advantage of the readily available easy money find the debt they’ve accumulated impossible to pay back. A credit crisis ensues, and financial markets falter. The reliability of this sequence over the last half century allowed The Elliott Wave Financial Forecast to envision key elements of the last crisis well ahead of time. In April 2007, EWFF re-published the above chart from our May 2005 issue, noting a 70% rise in rates that was comparable to prior crisis-inducing spikes. By August 2007, EWFF cited a “succession of climactic credit events, from the bludgeoning of the subprime mortgage market to a booming demand for ‘covenant lite’ commercial loans” and stated that this blend was the “set-up to the onset of a new conservatism that would drive the greatest credit crisis in history.” The yellow highlights on the chart show our forecast for the ensuing months. Over the next two years, the subprime crisis expanded into the biggest real estate crash since The Great Depression; derivatives imploded, which led to the bankruptcy of Lehman Brothers and the forced bailout of financial giants ranging from AIG to Merrill Lynch; GM and Chrysler went under, and 11 airlines became insolvent.

With the help of a historically accommodative Fed, record fiscal stimulus and the decline of U.S. Treasury rates to their lowest level in history, some of the losses have been recouped. But our June 2012 Special Report on the bond market identified a key set-up for the next crisis. The first-ever combined issue of The Elliott Wave Theorist and EWFF called for a “Major Top in the Bond Market” that would lead to outright deflation and an even more devastating credit crisis than that of 2008/2009. U.S. Treasury bonds made a historic top within weeks. Now, a year later, the next crisis is fast approaching.

Through the first half of 2013, EWFF has observed the same climactic credit events that we cited in early 2007. In some ways, the conditions are more extreme, as the demand for junk bonds continued to push yields to a new all-time low in May and covenant lite loans account for twice the percentage of leveraged loans that they did in 2007 (see discussion in the June issue). The broader scope of the unfolding crisis is already evident in a more pronounced interest-rate spike. The 10-year U.S. Treasury yield jumped 97% from its low in July 2012, a one-year percentage increase that is already the largest since interest rates peaked back in 1981. As rates continue higher, trouble will ensue. Many of the borrowers that managed to survive or were bailed out during the last credit crisis are barely hanging on despite the rate relief and economic recovery. For example, since 2009, 46% (306,000) of the homeowners that received help from the U.S. government’s main foreclosure prevention program have “re-defaulted.” In the resuming crisis, credit stress will reappear in all of the areas that EWFF cited in 2007. Additionally, whole new areas of default will become focal points, as the orange highlighted list on this next chart shows. Let’s look at some of the upcoming attractions:
Emerging Markets
Emerging market debt is assuming the lead role played by subprime debt in 2007. Just as the market for subprime debt buckled ahead of the stock market top of in July 2007, emerging market rates, particularly in China, came unhinged in June (see discussion in Global Rap section of last month’s issue), ahead of what should be an imminent peak in the Dow Industrials. In 2007, EWFF observed that investors initially dismissed the subprime threat, citing “‘no clear signs’ of rising trouble in the debt market.” Here again, investors are unfazed. Some even insist that the initial scare creates “a lot of opportunities” (“Goldman Sachs Likes Emerging Market Bonds,” WSJ, July 11). The lack of concern is particularly pronounced when it comes to China. “If You Think China Is Facing a Credit Crunch, You’re CRAZY!” exclaims a Business Insider headline.

Still, some areas of easy money continue to flow even as prior spigots run dry. A July 18 Bloomberg article notes that while China’s cash squeeze is claiming domestic victims “across the nation,” Chinese money remains “cheap and plentiful” in distant markets such as Nigeria, Sudan, Russia and the Ivory Coast. In “some of the world’s riskiest” markets, Chinese banks are lending at “hundreds of basis points below the cheapest commercial loans available.” “It’s almost free money,” says a Nigerian aviation minister who just borrowed $500 million to build four airports at an interest rate of 2%. The cheap foreign lending is done through “policy banks” and is intended to facilitate Chinese business interests. In our book, it is just another example of how government is taking a lead role in the last vestige of the old trend. Because government is driven by consensus, it commits most fully to financial trends when they are over or nearly so.

No comments: