Following the Brexit vote, jokes abounded of possible Departugal, Czechout, Italeave, Oustria, Byegium, and several other countries name-based puns.
Funny stuff, but the latest portmanteau is far from a laughing matter: read on for analysts’ fears of Crexit, the result of ballooning corporate debt and the risks it poses.
The current situation and how it could be managed
Corporate debt is the housing market crisis of its day.
The figure is projected to balloon over the next few years, due to various factors.
One of the most important of these is that Central Banks throughout the world are toying with zero or negative interest rates.
This provides cheap money to make the rounds, and the debt is piling up.
A report earlier this week has warned that this debt pileup has the potential to spark a new crisis from all that borrowed money circulating in the economy.
The figures are astronomical and growing all the time.
By the year 2020, several things will have occurred.
Britain’s socialist opposition leader will have proven his credentials or flunked like everyone predicted.
The Kyoto Protocols aimed at 2020 will have been achieved or failed.
Portugal will have lost or retained the European Championship.
And business debt will probably climb from the $51 trillion it is currently at to $75 trillion.
This is according to our friends at S&P Global Ratings, who tend to be right about this stuff.
They track the eponymously named 500 companies’ index which is a good barometer of the economy.
Of course, $51 trillion is already a huge amount.
But the thing about debt is it’s perfectly manageable as long as:
The quality of credit stays high
– Interest rates remain low as they currently are (which is why the Fed raising was such a huge event)
– Inflation remains low
– Economic growth remains high so that investors don’t worry about not getting paid
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Assuming things don’t go so swimmingly
But should things not go exactly according to this plan, there is another scenario, from where we get our horribly unimaginative and lazy portmanteau, crexit.
Should interest rates rise, which they could, and economic conditions worsen, which they might, there could be a huge problem for corporate America when trying to manage its debt.
Interest rate rises will make it harder to borrow money.
Worsening economic conditions are a huge fear now that Britain is almost certain to leave the European Single market, in some way, shape or form.
A bad global economy, let alone a sad one, would scare investors into thinking they won’t get paid, and country’s credit ratings will be slashed, making it harder for them to borrow.
Mostly, bondholders would suffer because rolling bonds over would become increasingly difficult under increased inflation and an interest rate rise.
The economy worsening would hurt businesses’ ability to pay off the debt.
A combination of these two leads to all sorts of problems for all parties.
If it did occur, we could see a crexit.
This would be lenders withdrawing from credit markets due to fears of the economy and covering their costs.
If it occurred, it would lead to a drastic tightening of market conditions.
This has the potential to cause another financial meltdown, and the world simply cannot deal with that, economically, politically or socially.
Worst Case Scenario
In the report, S&P Global said that the nightmare scenario would be a series of high-risk, high-cost negative surprises that prove to be the spark for a new crisis of confidence.
Confidence in the world economy is already at an all-time low because of how long and profound the last recession was.
Confidence is low, and it can’t afford to get any lower.
If events opposite to those listed in the bullet points, or any major economic events that no one can foresee happen, it will be destabilizing.
– Investors will feel pushed to exit their risky positions where they fear that they are going to lose big money.
– If swarm effect holds genuine and they all go in the same direction, this will see a collapse in credit growth.
– And the last time that happened? 2008
What is inevitable and what is potential
Many, S&P included, believe that a ‘correction,’ industry speaks for a significant collapse and readjustment, to be almost inevitable.
They see it as inevitable at some point in the next decade, and the real million-dollar question is to what extent they will be right.
Not whether it will happen, but how much.
They worry that investors have been too hungry for yield and have ended up going on a frenzy of buying speculative, low-grade corporate debt.
China has been as guilty as the United States in this regard, the former having used the borrowing tool to spur growth in the face of a slowing economy.
Its growth is still astronomical compared to Western economies, but it is decreasing each year.
Remember in the housing crisis (see graph below) when it was found out that mortgage bonds were weak structurally and pyramids made up of speculative and non-existent deals made the whole thing come crashing down?
This is a little similar, except now its corporate debt rather than mortgages.
The blame for much of this lies at the feet of the world’s central banks.
Since the crisis, they have embarked on a policy of low-interest rates and cheap money as a spur to economic growth.
The problem with this is the notion that growth fueled by credit rather than innovation and investment is healthy is an entirely false one.
The global economy needs real growth, not one made out of printed bills.
Monetary policy by said central banks has increased the financial risk that the world faces, the opposite effect that it was meant to have.
After uncertainty about growth during the crisis, central banks wanted to give the economy a jolt to restore confidence and stability.
But it has done the opposite.
The problem is that corporate borrowing is shooting way ahead of global economic growth.
And who can blame them when credit is so cheap with interests rate set so low?
More debt? Don’t fret
Even in the face of this impending crisis with sky-high debt levels, central banks are too terrified to put the brakes on to their policy of low rates.
Interest rates are low from Tokyo to Texas, from London to Lagos, Moscow to Medellin (okay maybe not exactly in all those places but you get the picture).
The low-interest rates have caused a boom in not only corporate debt but government debt too.
$12 trillion of government bonds now carry negative yields.
That means investors aren’t getting anything back from buying government bonds.
Debt flow is predicted to grow by over $60 trillion by 2020.
– Two-thirds of this are expected to be in refinancing (so just managing current debt).
– The remaining one-third will be in a brand spanking new debt. Shiny, shimmering debt.
– This will include bonds, loans, and any other financial instruments.
– This projection has increased from that of under $60 trillion that was given by S&P some time ago.
Best case scenario
While the debt market is reaching its upper limits, S&P and others are hoping for an orderly drawdown.
A gradual scaling back of current policy of low-interest rates and cheap money for more sound future finances.
This is the best case scenario, but it will be difficult to become a reality.
Firstly, things like Brexit will unnerve world leaders.
The most important political events such as the high vote throw a spanner in the works and a change to the status quo of the last 40 years is bound to cause some paranoid visions of what its result will be.
Nervous leaders are prone to pulling back from giving cheap credit to higher-risk borrowers.
Debt is piling up in China’s somewhat opaque but robustly expanding corporate sector, and there is also growing debt in the United States’ leveraged finance sector.
The risk is in credit quality.
‘Highly leveraged’ is a term applied to around half of companies that are outside the financial sector.
This category is the lowest one available for risk, and about 5% of this category group have negative earnings or negative cash flows.
In 2016 so far, there have been 100 debt defaults.
This is the most for this period in the year since the financial crisis.
S&P and other firms are worried that investors who have tried to play a long game and bought bonds with long-term caveats are at risk.
They have done so to chase high yield, but the risk is that they will lose money and pull out of the market to play it safe.
Unfettered funding of debt has created conditions for elevated prices of financial assets.
Low-interest rates have added to this factor and increased the effect.
Investors are searching for yield, and financial assets are seeing augmented prices because of it.
Market volatility could increase over the next few years because of this.
Small secondary-market cash flow and liquidity will lead to credit spreads for even riskier securities and longer contracted assets being the most exposed.
China will be responsible for most credit flow growth.
The nation is predicted to add almost $30 trillion to global demand, while the US and Europe will add $14 and $9 trillion respectively.
US Housing Sales Boom Will Last Until 2021
Redfin CEO Glenn Kelman told CNBC on Thursday that he sees the US housing sales boom will last until 2021. Total US Home sales increased 9.4% in September, surpassing estimates. Meanwhile, median prices went up 15% year over year. This is according to data provided by the National Association of Realtors.
Shares of Redfin, a real estate brokerage firm, were higher by 1% Thursday to $45.60. The stock more than doubled during this year. It now has a market cap of $4.5 billion.
Why do people buy houses during a recession?
During this time when the economy is reeling and jobs are tight, people buy homes. Why? There are a couple of reasons.
The bigger acceptance for remote work freed many people from living in the city. The opportunity to leave cramped apartments and expensive city living. The pandemic gave enough reason for workers to pack up and head for greener pastures. Next, interest rates are going down hard. From 3.7%, 30-year mortgage rates are now 2.9%, the lowest rates ever. Despite higher prices, people know this is the best time to buy on the cheap.
The intent is there. The pandemic allowed you to work anywhere. And interest rates allow you to pay the lowest interest rates. People are taking the plunge and buying. So what’s the problem? We’re running out of houses to buy.
Demand coming from the rich
Rich professionals who can work from home are the reason for the uptick in housing demand. Kelman said that many remote workers moved from major cities to distant suburbs. Kelman said these workers began “taking a permanent vacation where they’re working from those homes.”
People are taking advantage of low-interest rates to snap up homes. Kelman noted that “part of what is fueling this boom is that the economy has just split into two and rich people are able to access capital almost for free.” The opportunity to buy homes for cheap may be too much to resist. “Of course, they’re going to use that money to buy homes,” he added.
Meanwhile, there’s another group of people who would like to buy but can’t. Kleman said: “There’s just another group of Americans who are still struggling, who can’t access the credit because we’ve raised credit standards, and you have high unemployment. I just think those two trends, at some point, have to collide.”
Kelman foresees demand to continue until 2021 at least. Many undecided buyers will buckle down next year and take the plunge. He said: “There’s no way it can last forever. This level of demand is absolutely insane. I would expect it to last into 2021, at least.” Why 2021? “There are so many people now who have decided they’re not going to be able to buy a home by year-end,” he said. Kelman expects them to buy next year, “as their kids shift school districts. I do think we’re going to see this for some time.”
Shrinking inventory of houses for sale
With homes fast disappearing from the market, higher purchase prices are coming back. Based on data from the National Association of Realtors data, only 2.7 months’ supply of houses is available last month. This represents the lowest level since 1982 when the NAR began tracking data.
Kleman expects supply to increase after the elections. Uncertainty will decrease after voters elect a new president. Listing and selling a home can take months to process. That’s why sellers have a lower risk tolerance than buyers. “Buyers, when they see a house they love, they pounce,” he said. “I think the sellers are just looking long term in the economy and still feeling some anxiety. Many of them are going to put their homes on the market in January and February.”
Demand won’t last forever
The Wall Street Journal’s Justin Lahart thinks not everybody can live outside the big cities. A remote job in a vacation spot may pose difficulties for some. Winter conditions may also make some remote workers rethink their strategy. He also believes that the housing boom now made people buy houses sooner than later. He thinks many of the workers who moved to the suburbs would’ve done so in a few years. When the pandemic subsides, a smaller group might follow the exodus out of big cities.
The number of people who can afford houses will shrink as well. Many workers’ careers derailed during the year. Many millennials got burned during the financial crisis in the early 2000s. Now, a new career-threatening crisis is in full swing. The post-coronavirus landscape may depend on how well the economy rebounds. We’ll have next year to find out.
Watch this as CNBC reports on the US housing sales boom. Redfin CEO Says “people are buying vacation homes, then taking a permanent vacation:
Are you house hunting right now, or have you already bought a house this year? Why are you doing so? Let us know why buying a home is a good idea right now. Share your thoughts in the comments section below.
Biden Plan Could Mean 60% Tax Rates, But Here’s Who Will Get Stuck With Higher Taxes
New York and California may start losing high-income residents by the droves next year if Democratic nominee Joe Biden wins the election in a few weeks.
That’s because the two left-leaning states would have a combined federal and state rate over 60% under Biden tax plan.
Even New York resident and rapper 50 Cent tweeted earlier this week that despite his apparent dislike for President Trump, he said “Vote Trump” and “62% are you out of ya (expletive) mind,” when he learned about Biden’s tax plan.
According to calculations from Jared Walczak of the Tax Foundation, California residents earning more than $400,000 per year could face a combined tax rate as high as 62.6% under the Biden plan. New Jersey residents could see taxes reach 58.2% and New York would top out at just over 62%.
But somehow, it could get even worse.
Tax Rates Can Still Go Higher Under Biden
Walczak points out that if you include the contributions to the tax hikes by employers, which are often passed along to employees, the combined rates would jump to over 65% in California, 62.9% in New Jersey and 64.7% in New York City. They could still go even higher if California and New York raise taxes on high earners. This is something some legislators have proposed to try and close multibillion-dollar budget gaps.
“These rates would be the highest in about three and a half decades,” said Walzcak, “and imposed on a broader tax base than was in place previously.”
The Middle Class Will Suffer?
But Home Depot co-founder Ken Langone believes the wealthy won’t pay higher taxes at all – the middle class will.
“The middle class will not be exempt. Tragically, it will punish them. It isn’t going to punish us,” said Langone.
Appearing on Fox Business yesterday, Langone said due to Biden’s tax hikes, “the middle class will be in peril.”
He said that despite Biden saying the wealthy should pay more in taxes, the middle class will feel the effects of Biden’s tax plan. Langone said he is in favor of a tax code that is more progressive and equitable. This includes eliminating loopholes that favor the rich and large corporations.
“I don’t know if there’s any of us that have done well that will have a problem with paying more taxes, but it’s a ruse to think that hitting us and us alone is going to get the job done,” Langone said, adding ““It won’t and the middle class will be in peril and when you take money out of the hands of the middle class, you do a dramatic impact negatively on the economy.”
He said that increasing taxes on the middle class will lead to a recession.
“The problem is, when you go after the middle class, you begin to attack the backbone of the economy and we will have a bad recession. We will have a very bad recession,” Langone said.
“These are very precarious times and not the time to be screwing around,” he added.
Market Volatility Rises As Election Polls Show Tightening Race
The relatively calm markets earlier this month are giving way to more volatility as we approach the election. This is according to a team of strategists at JPMorgan.
“While it is perhaps true that during the first two weeks of October risk markets were supported by a widening of US presidential odds, which by itself implied a lower probability of a close or contested US election result, over the past week or so these odds have started narrowing again,” said a team of strategists at JPMorgan Chase, led by Nikolaos Panigirtzoglou.
According to recent polls by RealClearPolitics, in key battleground states, Democratic nominee Joe Biden leads President Trump by 3.9 percentage points, 49.1 vs. 45.2. That lead has shrunk from a 5 percentage point advantage for Biden about a week ago.
A general election nationwide poll by RCP shows a wider 8.6 percentage-point lead for Biden. However, there are many who feel those polls are not correcting for sampling bias.
MarketWatch recently interviewed Phil Orlando, the chief equities strategist at Federated Hermes. There, he said he doesn’t believe the polls accurately reflect how close the race is. In relation to this, he pointed to the surprise win by Trump against Democrat Hillary Clinton in 2016.
“Our base case is that the polls are wrong, there’s an oversampling biased error that a lot of polls aren’t correcting for,” Orlando said.
With a tightening race for the White House, volatility has returned to the market. It will also likely increase in the final two weeks leading up to the election.
A report put out yesterday by SentimenTrader showed that the CBOE Volatility Index or VIX, jumped to levels last seen during the Great Financial Crisis, and tends to rise as stocks fall as it is typically used as a hedge against market downturns.
Market analysts use the ratio to measure how speculative traders are getting. A rise in the put/call ratio means that investors are expecting plenty of volatility between now and November 3.
The VIX, which measures investor bullish or bearishness on the S&P 500 for the next 30 days, is currently near 29, well above its historical average between 19 and 20. This week alone the VIX jumped 6.3%.
Source of Volatility
Jeffrey Mills, the chief investment officer at Bryn Mawr Trust, said some of the volatility likely comes from investors trying to position their portfolios based on who they perceive will win the election. “There could be some front-loaded selling but I do feel like that’s a near-term phenomenon,” he said. But he says no matter who wins, there’s really only one place to invest, and that’s the stock market.
“There is going to be this continued pull toward equity markets — where else are you going to go when you need to earn a certain percentage to fund retirement, fund education?”
If investors are moving money today based on who they think will win the election, Daniel Clifton, head of policy research at Strategas Securities said each candidate will likely benefit different sectors.
A Biden victory will be good for stocks in the infrastructure, renewable energy and technology sectors, said Clifton.
If President Donald Trump is reelected, Clifton said there’s “huge upside” in some sectors. These include defense, financials and even the for-profits like prisons, education and student loan lenders.
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