With the markets in an initial crash phase the market is being driven by the need of long leveraged players for cash.
As such there are no flight to safety assets except cash. With fear and volatility at heights the classic play book says Gold should rocket. Instead it has fallen heavily. Bitcoin the new ‘flight capital’ pretender has collapsed.
This is not because they are great hedging assets in the long run, it is because there are forced sellers in the market that must raise cash to meet ‘margin calls.’
The man on main street might not understand how his works, but for those will fat chunks of assets it has been a world of near infinite access to borrowings using assets as collateral for credit lines.
If you have a million dollars in stocks, you can easily buy $800,000 more of stocks. Now you have $1.8m in stocks and that extra $800,000 gives you and extra $600,000 in stock buying power, which when bought gives you nearly $500,000 more stocks you can buy. As such f you push the envelope you can get $4m of stocks on your $1m of capital. Happy days. Buy a Picasso and use that collateral to buy a house, to buy some Lambo’s. The fun never ends, until, it does.
So with $4m in stocks, with $3m borrowed, suddenly the market is down 25% and your friendly banker says, please give me collateral to cover your $3m loan.
You say ‘opps.’ You cant sell the Lambo because that just pays out the loan on it, covered buy the house and you cant ell the house fast and the Christies auction wont be held for 6 months and if you are a forced seller of those assets you are going to have your face ripped off. So you sell you Gold or your Bitcoin.
This is the trouble with Crashes, they can easily become vicious circles.
Happily the government got its training in how to respond in the ‘global financial crisis’ or as it was called then, ‘the credit crunch.’ They simply print money and get it into the system, so that no lender runs out of cash or is forced to pull funds in and instead is pressure to themselves push money out into the market to the cash hungry.
As such there is zero chance of a repeat of 2007-2009, in so much the banking system will not be a ‘single point of failure.’
However this is a new emergency because the future is going to be about a demand shock, in so much as people are going to slow down spending dramatically for a period and perhaps even a ‘supply shock’ if China and other economies don’t come back onstream fast enough.
Lots of new credit and insufficient supply could create an unexpected outcome, but we have to expect supply capacity to catch up faster than new money reaching the hands of spenders. So the biggest risk is how the developed economies will bridge the demand shock already underway.
We may well been on the brink of helicopter money as a solution which will come in the for of tax cuts, financial holidays and/or jubilees of one flavor or another, but the trouble is you cant make people spend money. When they are scared they stash it, so handout do not create the desired demand.
All this says to me is this remains the beginning of this situation and while we might bottom in the markets in the next few days/week, we wont get a fast recovery, instead we will be in for a lazy one as per 2008.
There is one critical question that will need solving and it is yet to be addressed. Who and how are the mountains of corporate debt going to be rolled. We live in a highly leveraged world and there will need to be a way big business can roll their bonds. A high yield is simply not going to be enough to create investment appetite from a cash hoarding world for many businesses. This is where the governments of the west need to be building solutions.
When you try to bridge a gap, which economically is exactly what this crisis will create, an inch is a bad as a mile. It is that economic gap that needs to be bridged and the criticality will be corporate debt in the form of bonds. This is not really that much of a liquid market and somehow a lot of liquidity will need to be injected into it. Somehow a new deeper kind if QE (Quantitative Easing) will have to be engineered that can reach into a tier or two lower than the current reach of US and European QE programs.
Until that is muted or we see the pieces come together, investors need to be very careful about the equity markets because right now the US markets is not seeing sort of crash Europe has seen hitting 2016 levels and who is brave enough to say the US won’t follow that path?
The ‘demand shock’ ahead guarantees an extremely bumpy road ahead and cash will be king for a long time to come.