The Truth about China and the First Trades of 2016

Markets have opened the New Year with a resounding thud! Pundits are attributing this to trouble coming out of China, whose currency is again being devalued by the authorities. That’s not quite true.

sandp-chartReaders will remember that U.S. stocks fell sharply last August when China unexpectedly began devaluing the yuan. 2016 has started off with another round of devaluations that sent Chinese stocks sharply lower – in fact, the Shanghai Index opened the year down 7%. This sent U.S. stocks down sharply on the first trading day of the year. After a brief reprieve on the second trading day, both markets headed lower again on Wednesday and Thursday as China leads the way down.

The truth is, China is just a symptom of a larger problem, one I’ve been talking about non-stop, and we’re starting to feel the full-blown disease.

The mainstream financial media is in denial about China’s economy. Talk about how China is going to grow at 6 or 7% is ridiculous. The country’s economy is probably shrinking.

Sooner or later markets get religion and sins get punished. That time is now. That means investors should get religion before they end up meeting the Devil in person.

Keep reading.

Before the financial crisis, the world experienced a housing bubble that formed in the United States and spread to the rest of the world and caused a global financial panic in 2008-09.

After the financial crisis, the world experienced a commodities bubble based in China that spread to the rest of the world that began to come apart in mid-2014.

This has been smoothed over in the media, but it was a key turning point and the start of a stealth bear market.

After seeing its debt quadruple from $7 trillion before the financial crisis to more than $30 trillion today, China is left with overcapacity in its commodity industries, a landscape littered with massive ghost cities, an underdeveloped consumer economy, and no way to repay all of the debt that it incurred to battle the 2008-09 financial crisis. It continues to produce and ship mountains of iron ore, aluminum, copper, zinc, and anything else that isn’t nailed down to the rest of the world, pushing down global commodity prices to levels that are bankrupting the global commodity complex. China has announced some cuts in commodity production but any slowdown in production will further reduce its already shrinking growth.

The consequences of this are manifold:

  1. We see the consequences of the end of the commodities bubble not only in the collapse of oil prices (which keep making new 11-year lows below $34 today (WTI) – and will fall into the $20s), but also in the collapse of all commodity prices.

Companies like Glencore plc (GLEN.L), Anglo American plc (AA.L), and other commodity traders and miners are eviscerating themselves in order to survive. Their stock prices have been decimated.

  1. We see the consequences in the collapse of the stocks and bonds of all commodity companies as well as those connected to the commodities complex such as pipeline giant Kinder Morgan Inc. (NYSE:KMI).
  2. We see the consequences in the collapse of the high yield bond market, where the losses in energy and commodity bonds are spreading to all low-rated bonds and poor liquidity conditions are causing losses across the board.

But the damage is just beginning because the global financial system and the U.S. financial system are more leveraged than ever before. This is a very important point, so I want to take a quick moment to discuss it.

Today, U.S. non-financial corporations (meaning corporations other than banks) have 40% more net debt (i.e. debt net of cash) than they did in 2007.

We hear a lot of talk about how U.S. corporations have high cash balances. That’s true but that statistic is very misleading. First, a lot of this cash is sitting offshore and would have to be taxed if brought back to the U.S. Further, the brilliant analyst Stephanie Pomboy of MacroMavens points out that the top 25 S&P companies hold half of the $1.6 trillion of this cash while the bottom 250 companies have just $89 billion among them. This cash shortage among the “have-nots” will be a big problem when they have to refinance their debt at higher rates due to the fact that their bond prices have crashed and their cost of capital is much higher than it was than during the post-crisis bond bubble. And the situation is much worse among smaller high yield borrowers who aren’t large enough to be included in the S&P 500. So most U.S. companies are not cash rich at all.

The low interest rates created by the Fed’s seven years of zero interest rate policy and QE disguised a lot of sins. They allowed China to play host to the biggest debt bubble in history. That bubble is now popping. And they allowed U.S. corporations to borrow more money than at any time before in history.

Sooner or later markets get religion and sins get punished. That time is now. Take cover in 2016.

15 Responses to “The Truth about China and the First Trades of 2016”

  1. Arminius Aurelius

    I find it very interesting that the average Joe who decides to put money in a Bank off shore [ money that he or she paid tax on is considered illegal whereas corporations can leave money earned off shore and not pay taxes on it as long as it is not brought home…….this is legal. how do you spell Congressional C O R R U P T I O N

  2. I have sold out of most US stocks. I have gold an silver. No bonds anymore- the junk bond market will crash and its effect will pull down the others. Am in some options, mostly puts. But have moved 90% of my capital from the USA now. Gold , silver, gold stocks and options.

  3. A very good article. I believe we will go into a bear market. More than likely it will extend into 2017.
    My forecast is below 1600 on the S&P index by the end of 2016. How low in 2017? A lot lower than
    what most people think. Maybe the 666 low of 2008? Who knows? I will have a better idea towards the end of this year before I can forecast 2017. Suffice to say “Short across the Board”.

  4. Since we are in a commodity “bubble” and this bubble will burst – it would lead one to assume that gold and particularly silver (which are commodities – traded on the commodity exchages) will also burst and go down and not up! In deflation, is Au and Ag really a “good investment” or just a hedge against catastrophe?

  5. Joseph E Fasciani

    Your article is accurate as regards what has transacted, but you are very far off the mark on China’s future. China is still –despite its many new multi-millionaires– a state-controlled economy. And while you may mock and lash out at its newly built cities in Nowhere, these can quickly be filled by order of the State and its worker bees in a new colony, wherein to commence production that will swamp the world.

    As Napoleon remarked, when China was the industrial power of the world, “China is a sleeping giant. Let her be, for when she awakens the world will tremble.”

    By the bye, yours is the very worst ever website to leave a comment, as our vision of the field is terribly restricted, but perhaps that was your intent?

    I think I’ll drop my sub very soon. Good luck, and good night.

Leave a Comment

View this page online: