WASHINGTON – If you believe that US stocks are priced fairly, then the current sharp dip experienced by Wall Street is an opportunity to buy good assets at a discount. But if you believe instead that we are experiencing the bursting of a bubble induced by an unprecedented period of Fed-induced zero interests and by a parallel gigantic increase of the Fed’s balance sheet, then you have ground to be scared.
High stock prices, modest economic growth
Here is the picture. After the end of the bad 2008-2009 recession, the US stock market kept going up and up, while the US economy was growing –but only modestly, at about 2% a year. At the same time, Washington did not make even an attempt to cut persistent and absurdly high Federal Budget deficits. Yes, Uncle Sam is virtually broke. But the whole world keeps buying US Bonds, because they are supposed to be a truly safe investment.
Europe is sick
Looking at the global picture, notwithstanding many attempts engineered by the European Central Bank, the Eurozone is really in bad shape. And the broader European Union is not doing much better. Most states carry too much debt. Their economies are at a standstill, or in recession, while unemployment is above 10%.
Does this concern America? Yes, it does, because Europe is still our main trading partner. Most US multinational corporations make more money abroad than at home. If Europe keeps doing so poorly, expect General Electric, United Technologies and Caterpillar to suffer.
China not doing so well
And what about China? With China one never knows exactly, because of unreliable official statistics. But we know that the era of 10% growth, year after year, is over –for good. Now the real question is whether the cooked up figures –officially growth is above 7%– are in truth closer to 5% or 4%.
Add to this the incredible industrial overcapacity created by unwise “stimulative” economic policies in China. Steel production capacity reached absurd levels, even as the construction boom had ended. While Chinese state banks for the time being will keep supporting virtually bankrupt corporations, they cannot do this for ever.
China’s economic future will be at best a mixed bag. Expect lots of non recoverable bad loans and plant closings. Do not expect China to be the locomotive that will pull ahead global growth.
Japan is in decline
Japan, still the number three world economy, has its own problems. Prime Minister Shinzo Abe is engaged in a heroic, if futile, effort to reignite sustained economic growth.
But Japan has stupendous macro-economic problems. Its public debt is now 240% of GDP. The phasing in of a new sales tax aimed at increasing revenues has frozen purchases, and this has depressed economic activities. Add to the mix a steady population decline and you can figure out that Japan’s long-term economic growth prospects are not that good.
Energy stocks hit by low oil prices
Last but not least, the US and global energy sector is now significantly down because Saudi Arabia decided that this would be a good time to flood the market with plenty of oil at discounted prices. This may be a temporary phenomenon. But nobody really knows when this downward pressure on oil prices –and therefore on the profitability of oil companies– will end.
Of course, this is great news for consumers in the US and elsewhere. But it is horrible news for Exxon and other energy companies that have seen the value of their reserves reduced on account of sharply lower crude prices. Their stock prices are down, significantly.
For all of the above, this new low prices trend is horrible news for all the investors who believed that energy stocks were “safe”. If you are holding Exxon, Chevron, BP, Shell, Halliburton or Schlumberger stocks, you are not happy.
Is this a stock market bubble?
All in all, if you agree that Wall Street’s recent high valuations were largely the result of a bubble created by years of Fed-induced low interest rates, you have reasons for serious concerns. Those high stock prices cannot be sustained, especially in the light of weak global demand caused by Europe’s endless stagnation and China’s loss of altitude.
No help from the Fed
To make things a lot worse, as noted by David Stockman and other analysts, unlike 2007-2008 the Federal Reserve today has no more ammunition to fight a new financial crisis. Interest rates are at zero, while the Fed has already increased its asset purchases to unprecedented levels.
In this environment of seriously limited monetary policy options, no “soft landing” scenario, in case of a crisis. No bail out. Not even thinkable.
In the past, there was the semi-guarantee that the US Government had to intervene to save the “too big to fail” financial institutions. This is what happened in 2008. The Federal Government stepped in, in a massive way, and prevented a global collapse.
Now, it is different. The over leveraged Wall Street guys should know that this time they are on their own. Hence the likelihood that, if and when some will start rushing towards the exit, we may see a real stampede.
In other words, if the US stock market took a real dive, hard to see where the floor might be.