The State of the Markets—Why Caution Now?

By Aline Wealth Management on April 30, 2018

• China has created, as per a recent report from the IMF, 3x more credit in 2016 versus 2008 to achieve the same level of economic growth. It suggests a lower asset and income base to cover the larger amount of debt. China has a debt level 2.7x larger than their economy (as measured by GDP) with over half of the debt on corporate balance sheets. Consumer debt is starting to accelerate as well, with faster growth in short term loans which increase instability. The accelerated growth in debt has been achieved through the shadow banking system—funded by individuals investing in “wealth management products” which in its simplest form are loans between companies—and there has been huge growth in these products. Can these WMPs be the catalyst to a larger reconciliation of these excesses? (Source: Auour Investments).
• High profit margins are one of the most mean-reverting statistics in finance (given a basic tenet of capitalism—increasing competition when profit margins are high).

• Jim Reid, a strategist at Deutsche Bank, echoed the belief that investors had few places to hide. He examined valuations of 15 stock markets and 15 bond markets since 1800 and concluded that “at an aggregate level, an equally weighted bond/equity portfolio has never been more expensive.” Mr. Reid said the high valuations come at a particularly fraught time, because of “the incredibly unique size of central bank balance sheets, debt levels, multi-century all-time lows in interest rates and even the level of potentially game-changing populist political support around the globe.”
• Sentiment indices are, while coming off their inflated highs in early 2018, are still elevated.

• Fed’s increasing interest rate policy in 2018 (and likely 4 more hikes in 2019, at least according to the current “dot-plots”) has increased the yield on cash to the highest it has been in 10 years—no longer “cash is trash” mantra for this market.

This chart shows the near perfect correlation between the increase on global central bank’s balance sheets and the S&P 500-begging the question: What will happen now that the Fed is unwinding stimulus?