March 24 low thru today = bullgasm

2020年10月16日

In March 2020, the stock market melted down due to a run on securities, which started in the repo markets, dollar-funding markets, and entered every market. This was a liquidity crisis that unfolded faster than the world had ever seen before. Then, governments stabilized the markets with monetary and fiscal policy. Today, liquidity looks OK. Banks look OK. The economy bounced upward in Q2 and Q3 (although I think this was more technical due to pent up demand and stimulus).

With liquidity OK, some are calling the coast clear. Liquidity is OK because governments have been able to engage in QE, essentially printing money and borrowing to stimulate their economies. But bad things can still happen to undermine confidence in currency, which would likely cause another run on the markets.

Here are 3 bad things to think about:

Bad Thing #1. China could invade Taiwan, calling the US alliance system into question. (Bearish USD)

People want USD. Why? Because it's what people use. Why? Because it's backed by the faith of the US government. Why does that matter? Because the US government maintained what Peter Zeihan calls "the global order" or the alliance system. As a result of WWII and the Cold War, the US bribed and prodded other countries to get along as best they could. The resulted in an era of continuity that allowed trade to flourish. Everyone did business with the US and bought dollars for this. When countries did business with each other, they also used dollars.

SCENARIO 1. US does nothing about China invading Taiwan.
Japan, S. Korea, Vietnam, Australia, India, and our other partners in the region would realize they're on their own. This would signal the American abandonment of the global order. That would mean less security on the seas, less international trade and less demand for dollars. With less demand for dollars, the US Treasury wouldn't be able to print as many dollars without moving the dollar down. The consequences of QE would devalue the dollar quickly. QE would have to be reduced, and then individuals and companies would be forced to bail themselves out by going through bankruptcy or modifying loans or pumping the bakes on spending.

Scenario 2. US goes to war with China over invading Taiwan.
In this scenario, the US government defends the alliance system. But then has to focus on fighting a war. The economy becomes a war-driven economy, with factories producing things needed for the war. Stimulus checks - bye bye. All resources go toward crushing China. Meanwhile, the economy stagnates because anything that isn't war-driven becomes non-essential. The record levels of corporate debt (yes, the same companies on SPX), would be called into question by bond investors (great job, bank passing the risk onto the bond market due to post-2009 financial rules). That would mean a run on US debts, which would of course, mean lights out for stocks – since stocks are give last priority in a bankruptcy.

Bad Thing #2. US companies become insolvent
What is all of this chatter on the internet that Biden's tax plan wouldn't make much of an impact on the economy overall? In aggregate, maybe not. But when it comes to the specific companies on SPX with high debt service payments and low EBITDA, higher Taxes would suffocate earnings growth to the point of insolvency and push stock prices down.

Bad Thing #3. No more debt financing
There's all this talk about "low interest rates are causing investors to pour into stocks because it's the only area that will get a return." If that's the case, then why would anyone want to loan companies money? Why not just buy their stock – an action that, most of the time, results in no inflows of cash to the companies? In other words, fine – no more credit. We'll just trade your stock. And then companies will be left to figure out how to service their massive amounts of debt while figuring out how to grow revenue. They'll likely make more job cuts, which will spiral into less consumer spending and we know where that leads. The same idea applies to an inflationary scenario. If there's inflation, why should I settle for today's low bond yields? Inflation ticking up would either drive up real interest rates or dry up supply of capital for bonds. For SPX companies, many of which require massive inflows of debt financing to grow, this wouldn't help them grow earnings to say the least.

There are many more bad things that are likely to happen like no stimulus before the election and then political drama dragging it out until February 2021, No Deal Brexit, CLOs (oh they're doing just fine – really?), and many more wars raging across the world that could accidentally drag superpowers into them. WWI started by an accident. In 1914, British Foreign Sec., Sir. Edward Grey, said "The Scene has never looked so calm." By the summer of 1914, Chamberlain was announcing over the radio that Britain has gone to war. It took 1 month for Europe to go from peace to all-out war.