CREDIT BUBBLE
BULLETIN Closer to the brink in
2007 Doug Noland wraps up the
year
The year was remarkable for the
unusual divergences between bursting bubbles and
others continuing to inflate. This was the case
both in the US and globally. As an example, the US
KBW Bank index sank 24.8%, while the NASDAQ100
surged 19.9%. The AMEX oil index surged 32.8%,
while the S&P500 Homebuilding index collapsed
60%. Globally, major Chinese stock indices about
doubled in price, while Japan’s Nikkei 225 fell
11%.
In Europe, Britain’s FTSE mustered a 4.1% gain,
while Germany’s DAX posted a 22.3% rise.
“Decoupled” Asian bubbles inflated
dangerously. The Chinese Shanghai Composite surged
96.7%, inflating two-year gains to 355%. China’s
CSI 300 index, which includes stocks on the
Shenzhen Stock Exchange, gained 162% this year.
The Shenzhen Composite was up 420% in two years.
Hong Kong’s Hang Seng index rose 37.1% this year,
with 2-year gains of 81.2%.
Taiwan’s TAIEX
index gained 5.7%, increasing two-year gains to
28.7%. South Korea’s KOSPI index gained 32.3% (up
39% in two years). Singapore’s Straits Times index
advanced 15.4%, increasing two-year gains to 47.4%
(up 156% in 5yrs). Thailand’s SET index rose 26.2%
(two-year gain of 22%). Malaysia’s Kuala Lumpur
Composite index rose 32%, with two-year gains of
61.6%. Indonesia’s Jakarta index surged 52.1%,
with two-year gains of 136% and five-year gains of
546%. The major Philippine index posted a 21.4%
gain (two-year gain 75.2%). The Vietnam Stock
Index gained 23.3%, increasing two-year gains to
202%.
India’s Sensex index jumped 46.6%,
increasing two-year gains to 118% and five-year
gains to 495%. The Karachi Stock Exchange 100 rose
47.1% (two-year gain of 56%).
Fourth
quarter losses (3.5%) reduced 2007 gains in
Australia’s S&P/ASX index to 11.8% (two-year
gain 33%). The New Zealand Exchange 50 dipped
0.5%, reducing two-year gains to 20.7%.
Latin America certainly participated in
the global bubble phenomenon. Brazil’s Bovespa
index surged 43.7% (two-year gain of 93%). The
Mexican Bolsa rose 12.3% (two-year 68%) and
Chile’s Select index 13.3% (two-year 56.8%).
Argentina’s Merval gained 2.9% (two-year 40%), and
Peru’s Lima General index jumped 36.0% (two-year
263%).
While December numbers have yet to
be reported, better than 25% year-over-year growth
pushed International Reserve (central bank) Assets
to $6.06 trillion. Through September, China’s
reserves were up 45% year-on-year to $949 billion.
Russian reserves were up 56% this year to $466
billion, with India’s reserves increasing 56% to
$264 billion. Brazil’s reserve assets almost
doubled to $162 billion. OPEC reserves were up 36%
year-on-year to $421 billion. “Sovereign wealth
fund” was added to financial market vernacular.
The dollar drifted further away from reserve
currency status.
Despite the significant
fourth quarter US slowdown, 2007 will post only a
modest decline from last year's record total
global debt issuance. The global IPO market
enjoyed a record year, approaching $275 billion,
up from the previous record $242 billion set last
year. Although second-half deal flow slowed
sharply, global M&A activity was still 20%
ahead of 2006 (according to Dealogic), led by Asia
and the emerging markets.
Gold gained
31.8%, its largest annual gain since the
tumultuous year 1979 (when its price doubled) and
its seventh straight year of positive returns.
Crude oil surged 59%. Heating oil gained 62%,
gasoline 54% and natural gas 17%. Despite
declining 10% from its recent high, wheat prices
inflated 77% this year. Soybeans prices rose a
record 79% this year to the highest level since
1973. After gaining 80% last year, corn climbed
another 16% in 2007. Cotton prices rose 20%. The
CRB index inflated 16.5% this year, and the more
energy-weighted Goldman Sachs Commodities index
surged 40.6%. It was the year when the markets
came to recognize that significantly higher energy
and commodities prices were having only minimal
impact on demand.
During the year, it
became clear that the US Federal Reserve had lost
control of inflationary forces. The year ended
with import prices up 11.4% year-on-year (y-o-y);
the Producer Price Index up 7.2% y-o-y; and the
Consumer Price Index up 4.3% y-o-y. Despite a
weakened economy and another year of dollar
devaluation (and booming exports!), the US current
account deficit remained in the neighborhood of
$800 billion. Coupled with huge speculative
outflows seeking profits from global inflation,
the world was absolutely inundated with dollar
liquidity.
It was, as well, a year of
shattered myths: that astute global central
bankers have inflation in check; that contemporary
finance effectively disburses risk to the
marketplace, in the process shielding the banking
system from credit and market risk; that “AAA”
stands for safety and liquidity; that nationwide
home prices won’t decline; that the Federal
Reserve controls marketplace liquidity; that
commercial paper is safe; that CDOs
(collateralized debt obligations) make sense; that
the financial guarantors face minimal risk.
Indeed, the entire bullish notion of contemporary
risk modeling, structuring, hedging, and financial
guarantees (“credit insurance”) is now in serious
jeopardy.
2007 saw the initial bursting of
the Great US Credit Bubble. To be sure, the
enormous bubble in Wall Street-backed finance
abruptly went from runaway boom to astounding
bust. Much of the mortgage origination market
collapsed spectacularly. Thirty percent annualized
broker/dealer balance sheet growth came to an
abrupt halt during this year’s second half.
Booming “private-label” MBS (mortgage-backed
security) issuance ground to an immediate halt.
Mortgage credit availability was reduced
radically, especially in subprime, "jumbos" and
riskier loan categories. The booming asset-backed
securities and CDO markets faltered badly. The
banking system’s off-balance sheet structured
“vehicles” collapsed in illiquidity, another
factor forcing the major lending institutions to
balloon their balance sheets. The global interbank
lending market seized up. The hedge fund industry
waited anxiously for redemption notices.
Counter-party risk became a very serious systemic
issue, as did speculative leveraging. The global
financial system ends the year on the precipice.
Meantime, US bank credit expanded almost
12% during the year, with commercial and
industrial loans ballooning almost 21%. With risk
embracement turning to risk aversion, the
marketplace called upon the money fund complex to
intermediate risk. Money fund assets expanded an
unprecedented $729 billion, or 30.6%. And as
liquidity disappeared for Wall Street-backed
mortgages, Fannie Mae and Freddie Mac’s combined
books of business inflated an unprecedented $600
billion (or so). The federal home loan banking
system ballooned its balance sheet by more than
$200 billion, in the process becoming lender of
last resort to some very troubled financial
institutions. Global central bankers engaged in
unparalleled concerted marketplace interventions
and liquidity injections, sustaining global
bubbles in the process.
From the Fed’s Q3
“flow of funds” total (non-financial and
financial) US system credit growth expanded at an
annualized $4.99 trillion, sustaining the US
bubble economy but in an unsustainable manner -
unsustainable in the quantity and structure of
credit and risk intermediation, as well as with
the nature of economic (bubble) activity.
Financial sector debt expanded at an alarming
15.6% annualized pace, with bank credit, GSE,
agency MBS, and money funds all expanding at
double-digit rates.
Of late, the Wall
Street credit crunch and severe tightening in
risky debt markets have instigated recessionary
forces. Many housing markets have gone from bad to
worse - on the way to much worse. Florida is a
mess, while California is an unfolding disaster.
Some analysts have begun to recognize that US
asset and debt markets have not faced such
precarious dynamics since the Great Depression.
Meanwhile, collapsing US and international
interest rates fuel myriad global bubbles and
inflationary pressures. In short, 2007 has been a
continuation of the unfolding worst-case scenario.
Doug Noland is a market
strategist for the Prudent Bear Funds.
(Republished with permission from PrudentBear.com.
Copyright 2005-2007 David W Tice & Associates.
All rights reserved.)
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