If you haven’t picked up a (digitally – free!) copy of Ray Dalio’s Big Debt Crises, I would recommend you do so since what you are seeing right now is a playbook describing exactly what is happening right now. This book contains various examples of market reactions of historical debt crises which made for some very fascinating reading.
For the quarter, the TSX is down 9% and the S&P 500 is down 10% as I am writing this. These sorts of markets will be punctuated with higher volatility – rallies, in particular, will serve to draw cash from the market from people that are fearing “missing out”.
What’s happening is the cost of capital has risen to a point, coupled with the reversal of quantitative easing, where you are starting to see assets dragged into cash. Cash is starting to return a relevant yield again (e.g. 2-year US treasuries are yielding 280bps which is about 200bps more than it was a couple years ago). Yield proxies are no longer as attractive because cash is such an alluring alternative. It is a slow squeeze of a financial vice that will continue to reverse the inflation of asset prices and encourage demand for cash – “The phases of a classic deflationary debt cycle” is listed early in this book and what is happening in the USA is precisely this.
This means that the equity end of debt-heavy operations will be especially vulnerable. The last thing to hit in this part of the market cycle will be defaults as liquidity becomes much more valuable. One canary in the coalmine is General Electric – there is a very real valuation case to be made that they will go to zero unless if management is especially astute at managing the psychology of the marketplace. When reading articles like this (Reuters), hearing about “urgent” asset sales, especially in today’s market environment, smacks of desperation.
I won’t get into the malaise that Canadian oil producers are facing – putting it mildly, the damage done with the current Western Canadian Crude pricing situation, compounded with the general drop in West Texas Crude, coupled with overall financial market liquidity drying up (as most of the producers are heavily indebted) is going to cost a lot of people a lot of money. In these situations, timing the bottom is the key to making a lot of money, but I do not see signs of a bottom presently.
This is very exciting. It’s interesting to see at what point central banks will reinflate everything with more QE… I believe companies like GE will eventually be bailed out.