Everyone knows that the US Federal Reserve will “never” let stock markets fall. So it makes perfect sense for investors to borrow as much as they can, in order to chase the market higher. It therefore is no surprise to see that borrowing to fund purchases on the New York Stock Exchange has reached a new record high in $2015.
The chart above from Doug Short’s great blog updates developments since December and shows:
- Borrowing to buy stocks rose 6.5% in April versus 2014, and 6.24% in $2015 (red line)
- This was just enough to take the S&P 500 to a new all-time high of 2025 (blue)
As Doug notes, new highs for margin debt have not been good news for investors in the past:
“The astonishing surge in leverage in late 1999 peaked in March 2000, the same month that the S&P 500 hit its all-time daily high…. A similar surge began in 2006, peaking in July 2007, 3 months before the market peak.”
But, of course, “this time is different” says the consensus. After all, Fed Chairman Ben Bernanke highlighted in November 2010 that rising stock prices were key to the success of his economic recovery plan.
Although, in a further warning sign, US Merger & Acquisition activity hit a new monthly record last month at $243bn. And yes, you guessed, the two previous peaks were May 2007 and January 2000. As the Financial Times’ Gillian Tett noted on Friday:
“The western financial system is drowning in excess cash and credit. History suggests such a scenario rarely ends well. After all, the crucial point about the two previous M&A peaks is that they coincided with equity and credit bubbles. Shortly afterwards, those bubbles burst — with painful consequences….
When future historians look back to May 2015, this $243bn record will be viewed as a portent of an overinflated financial world. This is an era when quantitative easing is making the owners of assets rich — not to mention boosting the wealth of M&A advisers. But it has not convinced companies to believe in a vibrant economic outlook, or not enough to invest. And that is worrying indeed”.
Thus it begins to look as though we are moving close to Stage 2 of the Great Unwinding of policymaker stimulus. Stage 1 began last August, when oil prices began to fall and the US$ to break out of a 30-year downtrend. Stage 2 will likely see a major rise in interest rates, and a major fall in stock markets.
The end-point would leave us with markets that are once again operating on the basis of the fundamentals of supply/demand, rather than liquidity injections from central banks. But it is unlikely to be a comfortable ride, due to the $57tn of debt created by the stimulus policies.
Default on much of this debt is inevitable. And who knows where the final domino will fall once investors begin to prefer ‘return of capital’ to their current obsession with ‘return on capital’?
All we do know is that the last few weeks have seen a startling rise in US 10 year interest rates, just as Great Unwinding theory would expect. Rates have risen by 0.43% since early January to 2.40%.
Of course, we can hope this is because investors have grown confident that US economic recovery is now assured. But I fear we will find out relatively soon that in fact, it is the start of the bursting of the Fed’s asset price bubble.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 46%. “While a raft of cracker outages in Europe throughout May have plagued the petrochemical sector as a whole, there has been minimal upward impct on pricing”
Brent crude oil, down 39%
Naphtha Europe, down 39%. “The market is balanced as healthy supply is offset by good demand from the global gasoline sector”
PTA China, down 29%. “Prices firmed slightly during the week ended 5 June, despite prevailing weak downstream demand.”
HDPE US export, down 17%. “Softer export demand in Texas prompted slippage in prices”
¥:$, down 23%
S&P 500 stock market index, up 7%