Last week began with a historic presidential debate and ended under a cloud of worry regarding the potential failure of a truly too-big-to-save financial institution, Deutsche Bank (NYSE: DB). I have been warning for nearly a year that DB is the canary in the coal mine and poses genuine systemic risk. This week fears about the future of the bank came to fruition after the US government asked for a $14 billion fine to atone for DB’s sins during the mortgage crisis a decade ago, an amount that would severely hurt the bank even if it were cut in half. By the week, there were unconfirmed reports that a settlement of $5.4 billion was reached, a number that would wipe out the bank’s legal reserves but let it live another day.
DB’s imminent and well-deserved failure makes me happy.
The debate just made me scared.
The prospect of future financial crises should give serious pause to anybody who watched Monday night’s debate. Solving the world’s economic problems – too much debt and too little growth – is going to require the types of leadership qualities that were in short supply on the stage at Hofstra University.
The truth is, neither Mrs. Clinton nor Mr. Trump understands what we’re really facing here…
Trump and Clinton Ignore The Real Issues Facing The Markets Right Now
Leadership will require an acknowledgement that leverage is a bad thing, that governments can’t keep borrowing themselves into insolvency, and that regulation has to be a lot smarter. The world also faces geopolitical fractures that can only be healed by courage, character and strength. Watching the trivial discussion and name-calling on Monday night was not reassuring.
Right now, stocks remain close to record highs. Last week the markets barely moved with the S&P 500 gained 0.17% to close at 2,168.27, only 22 points below its all-time high of 2,190 set on August 15. The S&P 500 gained 3.3% in the third quarter, recovering from a short-lived plunge after Brexit to recertify its blind faith in central banks and willful suspension of disbelief in reality.
But no one (especially our candidates) is talking about this:
- Valuations remain stretched with the Shiller Cyclically-Adjusted P/E trading at around 26, its highest level other than 1929 and 2000.
- S&P 500 Non-GAAP earnings are expected to drop for the sixth consecutive quarter. GAAP earnings are much lower than non-GAAP earnings.
- Corporate leverage is higher than it was on the cusp of the financial crisis due in part to many investment grade companies borrowing to raise dividends and buy back overvalued stock.
In addition, oil prices rose last week by 8% on stories that OPEC is going to cut production. A harder look at the news, however, revealed that the cuts are rounding errors that will do little to change the supply and demand dynamics of the oil market. Higher energy prices are going to require sustained higher economic growth, something that is going to be difficult to achieve. Exxon-Mobil (XOM) and Chevron (CVX) were up 5% and 4% respectively last week, but I wouldn’t get too excited about the sector until we see more evidence of a global economic recovery.
A couple of “real world” points to observe here include:
- The troubles in the global shipping sector, which is wrestling with huge losses and the bankruptcy of South Korean shipping giant Hanjin Shipping, are a sign that the global economy remains weak.
- China is at best growing at half the rate of a few years ago (if you believe the numbers, which you shouldn’t) and energy markets are still oversupplied.
The truth is, the markets are vulnerable to any bad news that can’t be outweighed by the misplaced belief that central banks are all-powerful. As we learned again last week, the Fed has no idea what it’s doing and is navigating uncharted waters. The odds of a positive outcome from this maelstrom are low.
And we desperately need leaders who will talk about that.