FX Street: Why the Market Crash is Just Beginning

Wall Street’s playbook stipulates that every down tick in the market is just another buying opportunity. While that is most often true, peak margins, a slowing global economy and the bond bubble collapse makes this time more like 2008 than just a routine selloff.  

In the vanguard of this coming market crash is China, whose make-pretend growth rate slid to 6.5% in the third quarter. This is the slowest pace of growth that the communist government has been willing to own up to since the last global financial crisis. Leaving one to conclude that the reality in China is far worse. 

According to the Wall Street Journal, investments in Chinese factories and other fixed assets are at their lowest level in 18 years. China’s economy has been on a downward trajectory in the past few months.

All this concern about decelerating growth is hindering China’s deleveraging plans that it promised to follow through on at the beginning of this year. According to the Financial Times, Chinese debt was in the range of 170% of Gross Domestic Product prior to the Great Recession. But in 2008, China responded to the financial crisis with a huge infrastructure program---building empty cities to the tune of 12.5% of GDP, the biggest ever peacetime stimulus.

According to the Institute for International Finance, China’s gross debt has now exploded to over 300% of GDP. Bloomberg estimates the dollar amount of this debt—both public and private--at $34 trillion; others have it as high as $40 trillion. With a gigantic shadow banking system, this number is obfuscated by design. 

Most importantly, China’s debt binge was taken up in record time; soaring by over 2,000% in the past 18 years. The Chinese Yuan has fallen nearly 10% against the dollar since April ‘18. The Yuan hasn’t traded that low in more than a decade. In order to defend the value of the Yuan, China has depleted much of its dollar reserves.

But China isn’t the only wild card in the global growth deck of cards. Over in the Eurozone, Italy is brazenly threatening to move forward with a budget proposal that would obscenely breach the European Union’s budget guidelines. The bureaucrats in Brussels are threatening fines. But this doesn’t appear to be enough to inhibit the Italian government, which is intent on increasing social welfare programs, adding to pensions and giving workers a tax cut. 

These bold plans have led the rating agency Moody’s to downgrade Italy’s sovereign debt to one notch above junk.  Uncertainty in Italy is a major geopolitical factor weighing on global sentiment. Investors are rightly concerned about the Rome-Brussels stand-off, given that Italy is the Eurozone’s third-largest economy and its debt is held by every major bank in Europe—and most in the U.S. As interest rates rise in Italy, the prospect of insolvency rises alongside.

These global headwinds matter because as good as things may appear in the U.S. at the moment, China has accounted for nearly 30% of global growth. And with Emerging Markets and the European Union hanging in the balance, the synchronized global growth story is now ancient history. Point being, the U.S. economy does not exist on an island.

This begs the salient question: How much lower will the growth rate of earnings be in 2019 for the S&P 500? Earnings growth in 2018 peaked at 25%. However, with the top global economies all rolling over, peak corporate margins, trade wars, the waning of repatriation and stock buybacks, soaring worldwide debt and trillion dollar U.S. deficits, mounting rate hikes from global central banks and a Fed that is destroying $600 billion this year through its reverse QE program, it is doubtful that there will by any earnings growth at all next year. Nevertheless, Wall Street Shills are still pricing in 10% earnings growth and slapping a big multiple on top of it.

The surprise here is that earnings growth could very easily be negative next year. A sharp global slowdown coupled with a plunge in earnings growth won’t sit well with a market that is trading at 140% of underlying GDP—a rare altitude indeed. That is the real reason why the stock market is crashing…and why that crash is just getting underway. 

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