Is A Correction In Our Future?
As you well know by now, I have been looking for, and times begging for, a correction in this bull market. My reasons were always simple: 1. PE multiples have gotten way ahead of themselves and those levels can not be maintained indefinately. Corporations can buy back stock all they want, but at some point earnings growth will stall along with revenue growth and then what? Stocks pull back. 2. Corrections are a healthy cleansing of portfolios and it is always the natural course of events for investors. Painful at first but in the longer term it’s a good thing. 3. The Fed, which pretty much has been propping up the economy and the market for the last 9 years will at some point have to deal with other issues on their plate, mainly inflation. The move to combat inflation generally revolves around interest rates and the credit markets and if you think things can get ugly when stocks stage massive selloffs wait until you see what happens when the credit markets in this country come under stress. Business grinds to a halt.
Since I have gone through multiple corrections over the years and seen my share of crashes, flash and otherwise, I can tell you simply that almost every true correction starts with a moment. Look back over the years and you will see that there has always been a trigger. Something to get people off their butts and take profits or limit losses (depends when the investor makes the decision).
Fed announcements sometimes are responsible but those announcements taken by themselves generally have limited stock market impact.
It is usually something that can reverberate throughout different sectors and impact many elements. While rising or falling interest rates can have that effect, there usually are winners as well as losers so the impact is lessoned.
What I am talking about is something large and substantial and unfortunately, seeing the property Chinese property conglomerate Evergrand on the brink of failing could be just the thing to set a correction in motion. That could be the trigger.
Seeing some turbulence in the Chinese Real Estate economy should surprise no one. They built and built and then for good measure, built some more. Along with all that building, they borrowed and borrowed and borrowed some more If growth continued at 7% annually, the rising middle class in China probably could have absorbed a lot of this excess inventory but China is no longer that newly developed wonder it was in 1990. It has become a collosal economy that is second to the US in size and gaining fast. Of course there is this huge rising middle class but that is also going to be a problem. A rising middle class causes higher wages and those higher wages are going to be a huge bump in Chinese growth. They no longer can compete on cost to gain market share around the World so a significant portion of their economic might is slowing and that does not bode well for real estate.
It is possible that the Chinese government may just take over Evergrand and the execs disappear, they restructure and the Chinese miracle is still intact. However if this company is allowed to fail, there are bricks that you will see and many more bricks you won’t. That is where the trigger might be. That potential failure of a company that has over 300 billion dollars in debt would be similar( on a much larger scale) to what happened with the failure of Long Term Capital in the mid ‘90’s. LTC was basically bailed out fairly quickly by The Fed and a dozen or so money center banks. It avoided a global collapse but we did see a correction (albeit a short one) for several months afterwords.
I do think we are ripe for a correction. I have been saying it for months but nothing popped up that would trigger a solid , sustained selloff. Until now.
While I do think the Chinese government will go in, clean house and restructure the way the Chinese do and this to the outside World might be just an interesting footnote, I also think the damage might be deeper, more systemic and that is where investors might want to be proactive as opposed to being reactive. Systemic risk is what happened in 2008. The system was close to failure and it took multiple components of the banking system to act together and dig out from that mess. In the end, there were almost as many winners as there were losers and we look back and hopefully it’s a historical plot point that we won’t let happen again.
The big fear is that the Chinese don’t look at past historical financial situations the way we do. They do have a tendency to sweep things under some rug somewhere and keep marching forward but a failure of this magnitude will be hard to sweep under any rug. The global financial community is holding their collective breaths and markets will react accordingly as the PRC tries to find a way to mitigate what could be a disaster of epic porportions.
The sweeping under the rug principle may not truly fly with this one however. The investors in Evergrand are not just local money people, they are the creme’ de le Creme’ of investors and thats the component we should worry about. Before you say “so what!”, think bigger picture here. If a financial portfolio suffers a significant, unanticipated loss, there is a good chance that investors will start to flee. That flight causes ripple effects across all of the financial markets and at times it is very hard to put the toothpaste back in the tube. Thats what we need to worry about.
We will see how it plays out over the next couple of days and see what the Fed’s is thinking regarding this and of course, the expected tapering down of bond buying.
A lot of moving parts for the middle of September so as a very astute investor once said, “keep your powder dry and your finger near the trigger”.