On the surface the Wall Street gyrations seem confused. But last night’s two per cent fall in American markets was delivering a chilling message to the world, which is easy to understand. There are deep global problems that are not being recognised by the market in the big US stocks. Actually the smaller American stocks and the oil market have recognised these problems.
So let’s list the four big dangers that created the jitters that caused last night’s fall. These dangers may be contained and overcome by good news but we need to be aware of them.
-- While the American economy is performing well, Japan and Europe look like they are facing recessions and China is slowing more than the official figures indicate. The oil price is being depressed by additional US production but remains the best public illustration of these underlying trends.
-- We have military threats in too many parts of the world for market comfort, including Ukraine and on China's borders. But, most serious of all, the war on extreme Islam looks like being an expensive and prolonged affair that unsettles domestic economies via the threat of terror attacks. Add that to the uncertainties of Ebola.
-- Quantitative easing (money printing) in the US flooded the world with liquidity. Now it is about to end so money is returning to the US and so making it tougher in Europe and developing countries. In turn this sends up the value of the greenback and lowers US bond yields. Europe is talking about its own quantitative easing but that is a far more complex task. The rise in the greenback will put pressure on US exports.
-- Then, finally, we have the biggest problem of them all -- what the US investment bankers did with all that liquidity. In essence they took a similar set of high risks that brought on the global financial crisis. Stephen Bartholomeusz wrote a brilliant commentary on what has happened to much of the money based on the latest securities markets risk outlook issued by the International Organisation of Securities Commissions (IOSCO).
The IOSCO group reveals that this year high-yield American bond issues will reach an historic high of $US617 billion; subordinated bond issues will be close to pre-crisis levels at about $US297bn; so called covenant-lite issues will be about $US177bn and issues of ‘’payment-in-kind’’ debt (‘’repaying’’ debt by issuing more debt) and contingent capital have also increased to levels well ahead of those experienced pre-crisis.
High leveraged lending has also returned to pre-crisis highs, with about $US1.8 trillion originated this year. Margin debt in the US hit a record $US1.4 trillion in the first quarter of 2014. Leveraged financing via junk bond markets is also at pre-crisis levels of about $US119bn this year. (The hunt for yield takes a risky turn, October 2).
When you add that crazy US debt situation to the other world forces you can see why the market has such big gyrations. The bulls try to get the market up but those who have borrowed deeply to punt the US market get out and as the market falls they multiply selling.
Given all these forces we had better become accustomed to big gyrations.
And in Australia our new natural gas projects will be insulated from the oil price fall in the short term but over time the impact of the lower oil price will kick in. And so along with the iron ore fall it means that our taxation revenues from minerals are going to be savaged.
Westpac Chairman Lindsay Maxsted speaking at the Transurban annual meeting made a ‘throw away remark’ -- the Australian financial system’s ability to fund the economy is a bigger issue than bank capitalisation. If these high-risk games the US bankers have played start to turn sour we will see a very different outlook. Liquidity instead of being flush will be in short supply.