A Mixed Thanksgiving Bag
Black Friday shopping over las weekend sent conflicting signals to the markets. While online sales were reported to be over $9 billion, anecdotal reports from retailers – the numbers aren’t in yet – seem to indicate that brick-and-mortar sales were slow.
Regardless of how much was or wasn’t spent, what seems likely is that most of those big screen TVs, Fitbits and PS5s were paid for with plastic.
According to the NY Fed, credit card balances are at a record high, with over $900 billion of consumer and business debt accruing on higher-interest, revolving charge accounts.
Of course, this is only a fraction of the total US debt. Gordon Long of MATASII.com provides this chart:
Chart courtesy of matasii.com
The key on the left is inaccurate… it should read Billions. Nonetheless, 93,827 billion *is* almost $94 trillion in total system leverage, including margined trading accounts.
We’ve written before about the looming impact of rate hikes on debt service across the board. From overpriced real estate to zombie corporations to stretched households, when interest payments start to rise, so will defaults. Here’s what Long says about the debt in his article titled US DEBT IS BOTH UNPRODUCTIVE AND INEXTINGUISHABLE!:
The U.S. has too much leveraged debt. As such, it has become increasingly dependent on low-interest rates to spur debt-driven consumption and to pay interest and principal on existing debt.
Lower than appropriate interest rates lead to unproductive debt, as can be seen with debt outstanding rising at a much faster pace than GDP. Simply the growing divergence between debt and the ability to pay for it, GDP is unsustainable.
In other words, the more it costs to service debt, the less spending there will be for productive economic activity. Combined with the effect of rising default rates, the impact of elevated interest rates – which are still not being fully felt – can only be recessionary.
It’s also worth remembering that all this debt is collateralized into derivative instruments. Just as we saw in 2008, and as is now the case with failed crypto brokerage FTX, once the string-pulling begins, the whole thing can unravel quickly.
Or, to use another metaphor, the U.S. credit bubble remains a house of cards…one which is inevitably going to come crashing down, covering the economy in worthless paper.
Stocks at the Tipping Point?
In our previous issue two weeks ago and in the Concierge letter that same week, we pointed out that the current bear market rally was running into the long-term downtrend off the January all-time high, looking at both the S&P and the NASDAQ.
Charts courtesy of themarketear.com
With the market trading down early this work on news of protests in China, the resistance of the down trend line has not been tested. However, the flag is closing, and the likelihood of a break – one way or the other – is increasing.
Our primary thesis has been that the market is heading down, probably another 15-20% at least. Economic fundamentals are simply too weak for a real recovery, and despite the rampant “financialization” of the stock market – detaching market outcomes from economic reality – there just isn’t any impetus for a major reversal.
Here’s how we put it in Monday’s Concierge letter:
With last week’s developments, the pressure on sideline money is even greater. Since seasonal patterns seem to reinforce the idea that an end-of-the-year rally is likely in any case, the reasons we pointed to then are even more valid today…there are several reasons to expect the market to continue trending upward in the short run.
This becomes a self-fulfilling prophecy…the “Santa Claus effect” predicts a December rally, money managers fear missing out on a late opportunity to improve annual returns, so they rush into the market, expecting the usual lift. As a result, stocks go up. Voila!
We are not, however, going to be the Grinch at this Whoville party, despite our conviction that the worst of this bear market is still ahead.
For several months, our core thesis has been that the market will trade sideways until some serious, “unexpected” development knocks Wall Street and Washington for another loop. The usual suspects (inflation, geopolitical uncertainty, debt crisis, recession) remain at large.
The news out of China is intriguing, but it’s probably too much to expect a governmental crisis that would seriously upset the U.S. markets. This possibility of a “Santa Claus rally” remains, but on the other hand…
The VIX volatility index reflects the nonchalant attitude among traders — nobody seems too concerned about the unresolved problems bubbling away in the background.
What we can say for sure is that when a major disruption occurs, no one will see it coming. With the VIX back down to around 22, the divergence from the S&P is starting to look like one of our preferred asymmetrical trade setups.
Chart courtesy of themarketear.com
We covered the China situation in Monday’s Concierge, too. (Subscribe now!)
While it’s too soon to tell how deep the opposition runs, it is unprecedented in breadth, with demonstrations reported in several cities.
Triggered by a fire in a high-rise apartment, reportedly made more deadly by anti-COVID measures, the outbreak of anti-government action in the far-western province of Xinjiang is sparking a vocal opposition to zero-COVID policies now spreading rapidly throughout the nation.
Perhaps most surprising is that calls for Communist Party leader Xi Jinping to step down are being heard, along with demands for a lifting of censorship.
Mr. Market likes stability, and when major threats to the status quo arise, volatility often results. Until now, developments in China have mostly been shrugged off by the markets, on the assumption that “little problems” like Speaker Pelosi’s trip to Taiwan or bumping heads in the South China Sea are just business as usual.
It’s very possible that these recent developments will also be a non-issue for traders this week. However, the situation bears monitoring. Any major internal upset in China could easily spill over into broader economic and geopolitical channels.
In summary, there are a lot of unresolved variables in play…but the chances of a relatively calm December are still better than 50-50.