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Strategies & Market Trends
A possible global depression and collapsing monetary system.
An SI Board Since January 2020
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Emcee:  RZCanada Type:  Moderated
I have recently come up with some analysis regarding the macroeconomic trends, US securities, and the global monetary system.
I would like to share with everyone and listen to your thoughts.
In general, with the close-to-zero or even negative-interest rate environment, along with the vicious depreciation of currencies and geopolitical disputes among countries, the world in my opinion would enter into a depression that is going to be as bad as the Great Depression during the 30s.

The Forthcoming Global Depression and The Collapsing Monetary System

1. Major global economies have all the ingredients for brewing a recession and even another Great Depression.

1) It is a common sense that “borrowing for repaying” is unstainable and will eventually become a vicious cycle that drags every party within the cycle deep into the spiral. Major global economies currently demonstrate this pattern, issuing new debt, lowering interest rates, and monetizing debts. The majority of the economies are competing with each other for keeping the bubbles afloat and for not being the first one to burst the bubbles.

2) Under the long period of a low-interest-rate environment, it is highly likely that the economies will enter recessions: interest rates are the reflection of overall market returns. With the major global economies enter into the era of zero- or negative-interest-rate environment, generally speaking, the overall market no longer creates value for investors. In fact, the market is draining the wealth accumulated in the past and exerting its future. Currently rolling over $10 trillion negative-yielding bonds worldwide not only indicates the distortion of the global economy but also implies a potential economic slowdown and a reset of the game.



(Source: https://www.bloomberg.com/graphics/negative-yield-bonds/)

3) The prolonged skyrocketing housing price in major global economies such as the US, the Eurozone, and the Greater China will fuel the progression toward the economic slumps in the foreseeable future: most of the regions mentioned above have entered into a state where the housing price could neither go up nor down because it ties closely with citizens’ and companies’ wealth. The longer that the housing bubbles float and the bigger they inflate, the wider the wealth gaps are, hence leading to an eventual domino effect when they burst as it happened in 1929 and 2008. A big portion of the rising home price is due to the leverage from low cost and ease of borrowing (further explanations on debt are under Section 2). Leverage is a double-edged sword: when the market goes up, asset price goes up even more; when the market goes down, asset price goes down even more. Although everybody might be benefited from leverage when the economy is doing great, it gets much uglier when the economy goes the opposite direction because just as bubbles inflate each other, panic also feeds itself.



(Source: fred.stlouisfed.org



(Source: fred.stlouisfed.org



(Source: tradingeconomics.com



(Source: fred.stlouisfed.org

2. US dollar and US government debts have traditionally been considered by investors worldwide as the safest assets. However, during the past decades, they gradually have become riskier and even toxic.

1) The United States has completely headed to a one-way-trip – “Borrowing for Repaying”. Simply think of the US as a company, the GDP is the revenue and the issued debts are liabilities. The country has a fiscal deficit almost every single year with increasing debt issued endlessly.



(Source: fred.stlouisfed.org

The US GDP was $20.5 trillion in 2018 and is expected to be $21.5 trillion for 2019. The total public debt alone accounts for over 105% of the US GDP as of Q3 2019, amounting to $23 trillion, while it was around 70% before the 2008 Financial Crisis, not mentioning the country’s corporate and household debt.



(Source: fred.stlouisfed.org



(Source: fred.stlouisfed.org



(Source: fred.stlouisfed.org

Even though the total household debt to the US GDP has been declining since 2008, from nearly 100% to 75%, the nominal amount, which is now $13.95 trillion, has exceeded its historical record in Q3 2008 by 1 trillion. As discussed in Section 1, US households are highly levered, particularly in the mortgage. As of Q3 2019, the US household mortgage level is $9.4 trillion, which surpassed the last peak of $9.3 trillion right before the financial crisis in 2008. Although this time the delinquency rate is better, the low-interest rate really imposes troubles on households and businesses. Imagine that the interest rate rises from 8% to 9%, interest payments for new debt only increase by 12.5%. However, if the interest rises from 1% to 2%, the interest payment for new debt jumps by 100%.



(Source: fred.stlouisfed.org



(Source: statista.com

2) Like Japan and the Eurozone, the US is picking up its pace to monetizing its debt.

3) The huge amount of US debt that China holds has become a “Trump Card” that the US plays against China, as well as to other countries that hold a significant amount of US debt.

4) The US dollar and US debt have been weaponized by the US government to sanction and pressurize other countries/regimes instead of a reserve currency that is in a neutral and fair state.

3. The confidence in reserve currencies has been falling.

1) The currency basket currently contains a basket of “rotten apples”. In the past, the US dollar is better than the Yen and the Euro because it was not as bad as its counterparts were, relatively speaking. Therefore, whenever there was a geographical or economic hiccup, capital flew to the US securities. Flight to the quality, however, now becomes flight to the “not-the-worst”.

2) In the past decade, the negative yields of the Yen and the Euro, the monetization of Japan’s and Eurozone’s debt, and the huge trade surplus between China (as well as some other countries) and the US force the capital in these regions to flow to the US, thus pushing up the asset price in the US.

3) Since the end of 2018, the US dollar and US debt pick up their pace to follow the Yen, the Euro, and the debt of Japan and the Eurozone. The basket of “rotten apples” has completely shifted from “relatively rotten” to “absolutely rotten”. The credibility of the international monetary system has deteriorated.

4. The current US stock market closely resembles the pre-Great-Depression period. With the price being pushed up by highly levered capital, the US stocks have become highly risky.

1) The decade long QE and the low-interest-rate environment in Japan and the Eurozone, along with the capital from trade surplus from China, Japan, Northern Europe, and the Middle East, force the capital flow to the US, thus further fueling the rising US stock price.

2) Similar to 1929, right before the US stocks slumped when investors levered up to push up the stock price, this time public companies took advantage of the extremely low cost of capital and leverage to repurchase companies’ stocks, further pushing up the US stock price.

3) The rising geopolitical disputes (e.g., protectionism) across the globe, particularly among the major economies, also happened during the Great Depression.

5. The flow of capital has been reversed and the leverage has come to an end, meaning the US stock will start to decline.

1) The net capital outflow has increased significantly during the past decade. More and more investors, whether privates or officials, are fleeing the US. This had never happened in the history of the US, at least in this abnormal magnitude. The data are demonstrated in the following charts across various years, with the blue bars indicating net capital inflow while the red bars indicate net capital outflow. Since 2008, there has been an obvious trend that the capital has fled abroad, partly due to the depreciation of the US dollar, low interest rates, and losing confidence in US assets.



(Source: Chart derived from data published by the US Department of the Treasury)



(Source: Chart derived from data published by the US Department of the Treasury)



(Source: Chart derived from data published by the US Department of the Treasury)

2) After the second half of 2018, the Eurozone stopped QE, the interest rate of Japan hit the bottom, and the trade surplus between China and the US started to decline, all of which indicate that the flow of capital started to reverse its direction, which caused the US stocks tumbled in October and December of that year.

3) Since the two major declines in October and December of 2018, the Fed halted the QT, stopped raising the interest rate, and restarted lowering the interest rate and QE (even though the Fed does not recognize repurchasing short-term debt as QE). Actually, the Fed reversed the inverted yield curve by purchasing shorter-term debt and selling more long term debt, an operation that did not happen too often in the past.

Furthermore, the Fed’s operations in the repo market from September to December 2019 amounted to over $5 trillion, which is on par with those during the same quarter of 2007 and 2008 combined. This is, in turn, a signal that there is a shortage of money in the market, along with oversubscription rates ranging from ~2% to 10%, which in turn is the evidence that there is a mismatch between the demand and supply of money and that the flow of capital is reversed.



(Source: Chart derived from data published by the Federal Reserve Bank of New York)



(Source: Chart derived from data published by the Federal Reserve Bank of New York)



(Source: Chart derived from data published by the Federal Reserve Bank of New York)



(Source: Chart derived from data published by the Federal Reserve Bank of New York)



(Source: Chart derived from data published by the Federal Reserve Bank of New York)



(Source: Chart derived from data published by the Federal Reserve Bank of New York)

4) The Congressional hearing of Boeing in October 2019 and the stepdown of its CEO, Dennis Muilenburg, at the end of December is a signal of a death sentence of Boeing 737Max. Muilenburg is a very experienced engineer and has been with Boeing his entire career life since he graduated from college. The aforementioned two events, along with other public information regarding this matter, released a signal that the incidents of 737Max are due to design flaws that cannot be solved by software, otherwise the most talented programmers from Boeing would already have fixed the problems within no time. Given that 737Max would account for over half of Boeing’s revenue in the future and that Boeing produced nearly $60B worth of this aircraft during the time it was grounded, which would be written off if Boeing could not make it fly, this incident could drag the growth of US GDP to less than 1.5%, considering Boeing’s over 10,000 suppliers globally, of which over 600 core suppliers are within the US.

Furthermore, a 1.5% GDP growth rate just cannot justify the current 23x P/E of S&P500 and a PEG ratio of 15.33. The overall asset price in the US has already been greater than that of the pre-Great-Depression era. Since 1929, the US stocks were gradually corrected for over 6 years, amounted to 89% loss from the peak.

5) The US corporation debt has been increasing and the repurchasing activities among US companies have been decreasing since the third quarter, closing to an end. During the 12-month period of FY2019, the S&P 500 companies have spent over $770 billion on stock buybacks. Furthermore, the S&P 500 companies during the past 5 years spent over $3.1 trillion buying back company stocks, over $5 trillion during the past decade. Among the top 20 companies that repurchased company stocks, Apple is on the top of the list, repurchasing $17B worth of company stocks during Q3 2019, nearly $70B during 2019, $75B during 2018, $248B during the past 5 years, and $320B during the past decade. Compare to those of Apple, the buybacks of the runner-up, Microsoft, seem “negligible”. Microsoft during the Q3 2019 spent $4.9B on buybacks, $20B during 2019, $11B during 2018, $74B during the past 5 years, and $116B during the past decade, which is only half of Apple’s total buybacks.

Also on the lists are JP Morgan, BOA, Wells Fargo, Morgan Stanley, Intel, and etc.

Among all the sectors, Financials and Information Technology sectors account for almost 50% of all the buybacks during the past decade.



(Source: Chart derived from data published by the S&P Dow Jones Indices)



(Source: S&P Dow Jones Indices)



(Source: S&P Dow Jones Indices)

6. The top priority for investors and companies is to survive amid a collapse of the international monetary system and a depression.

1) The most recent depression began around 1929. Dow was down continuously for 6 years with an 89% loss from its pinnacle. Only after 1954, twenty-four years after the Great Depression, did Dow return to its pre-depression level.

2) The unemployment rates of most major economies were all greater than 20%, some of which even over 30%.

3) The GDP of most major economies declined over 10%, some of which even declined by 30%.

4) Compare to the last depression, current major economies bear greater debt, demonstrate wider wealth gaps, and have much less room to utilize fiscal and monetary tools.

5) The Great Depression eventually fueled the rise of populism, which ignited World War II. Currently, the escalating trade wars, currency wars, and financial wars are intensifying the distrust among countries and turning allies into enemies.

7. Where would the capital flow? Where are the safe assets?

1) Capital will always flow to countries/regions with stable fiscal and monetary policies and society.

2) The safest assets must be “strategic resources” and neutral-risk assets such as gold, silver, other precious metals, oil, agricultural products, and scarce new-energy-related mineral resources.

12/30/2019
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