‘That however is just the beginning. We suspect that this is the start of a long, slow and painful unwind of the excesses of the last five years.
‘Along with decompression comes a tick up in defaults, and we expect those to increase in 2016 and 2017.’
Bank of America Merrill Lynch Credit Analysis
(With my emphasis)
There is no new way to go broke. It is always too much debt.
This has been the case since the creation of money and credit. Borrow more than you can service and you and your creditors have a problem.
This is what happened in 2007 with subprime borrowers. When the honeymoon interest period was over, they quickly learned their incomes could not service the debt costs. Default.
For the rest of us who are looking to protect or promote our capital we have to stand back and see the forest.
The world is sitting atop an official debt pile of US$200 trillion and counting. Since the GFC, global debt has increased by around US$60 trillion.
Low interest rates facilitated this six-year long debt binge.
Corporates chasing cash (to fund share buy-backs, triggering hefty executive bonuses) and investors chasing cash, were a perfect match. Corporate borrowers offering a percent or two above the cash rate or a swap rate were swamped with dollars from investors eager to get some return on their capital.
It’s long been my contention the next and far more powerful GFC will come from a credit default on such a scale that all the Fed’s horses and men will not put the system together again.
The US$60 trillion in post GFC debt that poured into the global economy was a masking agent. It looks like genuine economic activity but it was nothing more than a stimulant with no lasting productive value.
Now that investors are tapped out — or not stupid enough to give cash to junk bond rated corporates offering pennies — the game of finding a bigger fool to give you money is coming to an end.
The credit squeeze is impacting business revenues — lower prices mean more sales are needed to generate the revenue required to meet expenses. The more prices fall, the more sales needed. The problem is: there is only so much demand. Producing more doesn’t necessarily translate into sales. But over-production does lead to a deflationary spiral.
Heavily indebted corporates — think Glencore — are scrambling to shore up their balance sheets with assets sales and capital raising.
What happens when more corporates start to feel the revenue pinch? More asset sales and more capital raising? Good luck with that.
Distressed sellers rarely if ever manage to extract a reasonable price for assets. Less indebted competitors will be snapping up bargains.
When your solvency is questionable only lotto winning idiots would participate in a capital raising.
When you can’t reduce your debt to a level your revenue can service you default or you ask for a debt restructure.
According to Bank of America the level of defaults in 2016–17 are expected to increase.
The Bank of America Merrill Lynch report describes the current situation in the US as ‘…a slow moving train wreck that seems to be accelerating.’
At present investors in corporate debt are probably going to hang in there…they need the return on their money.
But there will be a tipping point when investors switch their investment priority from return on their money to return of their money. And when they do it will be a stampede.
A lucky few might get out. But most will be trampled in the rush to the exits. Most investors, through greed or the fear of missing out, leave the I’m outa here decision until a minute too late. The tipping point can come very quickly.
Imagine a packed auditorium of a couple of thousand people and one person leaves. No one takes much notice. If that one person is followed by five others, people might start to wonder what’s going on. If those five are suddenly followed by another 10 people in a hurried manner, the crowd becomes a little concerned. It’ll only take another 20 people to scurry out and pretty soon the crowd is on its feet rushing the exits. It only takes around 2% to panic the remaining 98%.
When the panic sets in, the marketplace will be crowded with distressed corporates desperately selling assets to stay afloat. Cashed up investors are going to be able to buy assets at deeply discounted levels.
Yes that right cashed up investors — you know those ‘silly’ investors who were told by the investment industry that cash is trash; cash is dead money; cash is not really an asset. The ones who refused to be pushed into playing the central bankers chase the higher yield game.
While cashed up investors are having the time of their lives picking and choosing from the bargain box, bond holders will be in a world of hurt. They won’t get their much needed interest payments and can only sit and wonder how much, if any, of their capital will be returned to them in the years to come…after the lawyers have feasted on the corporate carcass.
This folks, is the bigger picture. Bank of America put it succinctly with this commentary (emphasis is mine):
‘The weakness in high yield credit is to us not just a commodity story; it is about highly indebted borrowers struggling to grow, an investor base that cannot digest more risk, a market that has usually struggled with liquidity and an economy that refuses to rise above mediocrity.’
I can assure you there will be nothing mediocre about the next GFC.
The implosion of a few hundred billion dollars of subprime debt delivered us the GFC in 2008…a period that at the time drew comparisons with The Great Depression.
Pray tell me what is it going to be like when trillions of dollars in corporate and sovereign debt is shredded?
There is no new way to go broke. And with US$200 trillion in debt out there I’ll bet we’re going to see some very spectacular blow-ups in the next couple of years.
The destruction of wealth that awaits us is going to make the losses of the past couple of months look like pocket change.
The Greater Depression is coming…even Wall Street is starting to sound the warning bells.
Editor, Markets and Money