THIS TIME IT REALLY IS DIFFERENT
As readers will know, BOOM watches many financial markets around the world and BOOM also watches what is happening between markets. In other words, how markets are inter-acting with each other. In a complex system, the inter-action between variables is far more important to observe than any single variable.
Lately, BOOM has been taking note of a very significant aspect of the US financial markets. This is the marginal preference for stocks over bonds (or vice versa). And it is worth noting that over the last 8 weeks, there appears to be a growing preference for investors to move towards stocks over bonds.
Some analysts point to recent equity fund outflows and predict “the stockmarket is going to crash”. But one variable can be very mis-leading. BOOM does not subscribe to the view that markets need large volumes to move prices significantly. Why? Because in a deep enough, well regulated market, prices can be moved steadily by relatively marginal levels of volume being traded. In other words, the only price that matters is the last one and if it is effected by a trade involving just $ 500, then it is still the last price traded and is therefore as significant as the trade before it which involved $ 1 Million of volume.
If this trend continues, we could (perhaps) see bond prices in the USA move slowly sideways to down while the equities markets move slowly but steadily higher in price.
BOOM read an article last week that asked the question — Are stocks now behaving more like bonds? It is an intriguing question especially if the companies represented by the equity markets are heavily laden with debt. That might well be the case as investors simultaneously accept that the stand-off between CPI Dis-inflation and CPI inflation is now almost a steady state situation in the US.
The other consideration is the volume of share buybacks which clearly reduce equity in companies and thus increase the debt to equity ratio. BOOM monitors share buybacks in the US very closely and can report that they are currently surging ever upwards in frequency and volume.
A quick analysis of US listed companies (excluding banks, financial services and real estate sectors) that have a Debt to Equity Ratio above 200% reveals a list of 405 companies. That is a staggering fact and many of the names on the list are household names, large companies that are easily recognizable by even non-US residents. BOOM could not look closely at them all, of course, but a quick look at the top 20 stocks in that list alphabetically arranged revealed strong share price performance in most companies over the last 5 years plus regular dividends in many cases. There were some exceptions, General Electric, for example.
One of those twenty companies had $ 23 Billion of Debt compared to just $ 5.5 Billion of Equity. Another had $ 17.8 Billion of Debt with just $ 2.4 Billion of Equity. Another had a Debt to Equity ratio above 4,500 %. And yet another had a Debt to Equity ratio above 8,000 %. Yes — you read that right. At this point, BOOM began to doubt the accuracy of the data base that he was using to select the companies and to analyse their balance sheets. However, that data base has certainly been reliable in the past.
So BOOM examined the Balance Sheet and Cash Flow of the latter company that had a Debt to Equity ratio above 8,000 percent. It has a a Free Cash Flow of over $ 2 Billion, pays a regular dividend of about 3% from strong earnings and its share price rises steadily. The cash position hovers around $ 500 million. The Long Term Debt position is currently around $ 8 Billion with a net Shareholders Equity of around $ 100 Million. This company is an impressive sales and cash generating machine run on a capital base made up principally of debt (much of which is held as issued bonds). So, it is much more like a highly leveraged private company than a traditional public one. It could be argued that it is a possible harbinger for the future. A company that can operate on debt rather than on equity. Works well as long as the free cash flow is very consistent and the cost of debt never rises.
So when you are buying shares in these companies, are you really buying equity or are you buying debt? BOOM suggests that readers do their own deep research before buying some of these companies.
But, certainly, it looks like we have entered a new financial paradigm — just as BOOM has suggested many times before. In other words, this time it really is different.
THE US DOLLAR REVISITED
In last week’s editorial, BOOM said in regard to the foreign holders of US Government debt over the last 12 months, “The amount of Treasury securities held by foreign nations has increased from US$ 6.22 Trillion to US$ 6.77 Trillion. There does not seem to be any significant loss of international confidence in the US Dollar recently, quite the contrary.”
Let’s look again at the data and discover which were the nations that actually increased their holdings of US Dollar denominated US Government debt in that period.
Interestingly, they include Japan, United Kingdom, Luxembourg, Cayman Islands, Switzerland, Hong Kong, Belgium, Taiwan, Saudi Arabia, India, Singapore, France, Canada, Korea, Norway, Thailand, Bermuda, Germany, Mexico, Netherlands, Sweden, Italy, Israel, Kuwait, Spain, Philippines, Iraq, Colombia, Chile.
That is certainly an interesting list. Worth reading and thinking about each nation in turn.
So which nations reduced their US Dollar denominated holdings of US Government debt? They were China, Brazil, Ireland, United Arab Emirates, Poland, Australia (marginally). The only one of those that made a significant reduction was China with a reduced holding by US$ 49 Billion over the course of the last 12 months. That is a 4.25 % reduction in their total holding which is a very, very small number when you consider that it represents just 0.8 % reduction in the Grand Total of all foreign holdings.
But some analysts have written that this 0.8 % reduction in holdings by China represents a “crisis of confidence in the US Dollar”. And they continue to say “the US Dollar will collapse”. I’ll leave you to think about statements of that kind and reach your own judgement.
BOOM is not biased towards the US Dollar as the major reserve currency but it is important to acknowledge the reality of its dominance in world trade and in foreign currency reserves held in the global central banks. That role is not easily or quickly destroyed or substituted by any alternative.
CHINA IMPORT INDICATORS
BOOM has promised to keep readers updated on the key indicators that he uses to monitor imports going into China. One is as strong as ever. It is the key indicator. The other (secondary) indicator has declined since mid-October but has recovered a little lately and is now going sideways. BOOM will continue to watch and report on the situation as it unfolds.
In economics, things work until they don’t. Until next week ………… Make your own conclusions, do your own research. BOOM does not offer investment advice.
EMAIL: gerry [@] boomfinanceandeconomics.com
Return to the BOOM Main Website – BOOM Finance and Economics at http://boomfinanceandeconomics.com/
HOW MOST MONEY IS CREATED
BANKS CREATE FRESH NEW MONEY OUT OF THIN AIR (but they always need a Borrower to do so)
THERE IS NO SUCH THING AS A DEPOSIT
BANKS PURCHASE SECURITIES, THEY DON’T MAKE LOANS
How is Most New Money Created ?
LOANS CREATE DEPOSITS — that is how almost all new money is created in the economy (by commercial banks making loans).
From the Bank of England Quarterly Bulletin Q1 2014 —
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.“
Quarterly Bulletins Index
Most economists are unaware of this and even ignore the banking & finance sectors in their econometric models.
On 25th April 2017, the central bank of Germany, the Bundesbank, released a statement on this matter —
“In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers. Sight deposits are an example of book money: sight deposits are created when a bank settles transactions with a customer, ie it grants a credit, say, or purchases an asset and credits the corresponding amount to the customer’s bank account in return. This means that banks can create book money just by making an accounting entry: according to the Bundesbank’s economists, “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – i.e. that banks can only grant credit using funds placed with them previously as deposits by other customers”. By the same token, excess central bank reserves are not a necessary precondition for a bank to grant credit (and thus create money).”
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