I doubt that noted English poet John Donne was a speculator, but his words are certainly relevant to this week's markets. "Therefore never send to know for whom the bell tolls. It tolls for thee."
The bells are ringing for an economic slowdown at a level at which I have not heard since the pre-Lehman days in the summer of 2008. Of course, those peals produced the Great Financial Crisis, and, in hindsight, the signs were patently obvious that the world was heading for a deep recession. As I noted in my RM column yesterday, I see many of those same signs today.
Exhibit A is the the U.S Treasury yield curve. While the spread between the 3-month (1.99%) and 10-year (1.68%) UST yields is still solidly negative, there is a point at which the absolute levels of yield are important, as well. The yield on the 5-year UST was a jaw-droppingly low 1.52% this morning. That is not a sign of healthy economic outlook. To the contrary low UST yields are signs that bond market players expect a sharp contraction in the pace of U.S. economic growth and the deflationary forces that would accompany such a slowdown.
Exhibit B is the global exchange rate complex. The People's Bank of China set its official exchange rate at 7.0136 yuan per dollar this morning. The weakening of the Chinese currency is a huge brick in my current wall of worry. Is 7.01 really that much worse than 6.99? Of course 7 CNY/USD is a psychologically important level not an instant barrier to commerce, but markets run on sentiment.
In my RM column yesterday I mentioned a conference call with noted economist Andrew Hunt hosted by my firm Excelsior Capital Partners on Wednesday. The situation Andrew is describing is one in which China needs to print money - devaluing the yuan even further - to maintain liquidity in its overleveraged financial system. Andrew pegs the real rate of Chinese economic growth at 2%-3%, not the reported level of 6.5%-6.6% which is so steady as to have zero credence with economists. At a 2% growth rate Chinese companies would not be able to meet their liabilities and Chinese banks - without government intervention - would surely fail. That's what the yuan's move through 7 should be telling the markets, and it is a very scary story.
The U.S. markets have enormous blinders on when it comes to the rest of the world. That's why I value Andrew's work, and that's why I think the stock market is heading for a major correction. The Chinese consumer has been counted on to become the incremental buyer of scores of separate goods and commodities. Without that demand pull, supply overhangs develop - as Andrew points out much of U.S. GDP growth in the first half of 2019 was driven by inventory growth - and then inventory corrections occur. These can lead to recessions.
That's what the bond market is seeing, and the low UST yields make that worldview obvious to all but the most diehard U.S. stock investors and their computers. The world NEEDS a healthy Chinese economy. Otherwise there is just too much "stuff" being produced around the world for the Western economies to consume. That would include oil, cars, agricultural commodities and a host of consumer goods, as well. That many of those products are made in China only makes this feedback loop more painful.
The scenario is as follows: China's fragile economy sputters to a halt, sending its overleveraged financial system into distress which stresses Western financial systems and causes those economies to slow, which means that Chinese workers have less demand for the iPhones, TVs and other goods they produce thereby sending China further into real recession.
It is not some far fetched worst-case scenario. It is exactly what is happening now, in August 2019. So, go back and read your John Donne. The recession bells are tolling, and they are tolling for all of us. Reduce your equity exposure now.