As Always, Bond Market Will Burst This Stock Bubble, Too
(iStockphoto)
By Brett Arends
When it comes to stock-market downturns, listen to the Bible. Even if one is coming, "of that day and that hour knoweth no man," not even "the angels which are in heaven."
But one is surely coming, and the unraveling of the long-term bond market is raising the chances that one is imminent.
It is already absurdly obvious that we are in a massive stock-market bubble. Former Federal Reserve governor Bill Dudley just pointed out many of the signs, which will likely come as no surprise to regular readers of MarketWatch but which are worth repeating.
While Dudley listed a number of different issues, they boil down to three big ones. First, stock-market valuations are already crazy by any number of measures. Second, the entire artificial-intelligence financial boom is now in the kind of classic Ponzi-style loop that always happens in financial manias, and which has always been followed by a downturn or worse. And third, the rise in long-term interest rates in the U.S. and around the world are exactly the kind of thing that could burst the bubble.
The interest-rate argument is most timely. It looks increasingly like the U.S. Treasury, the global lender of last resort, is losing control of long-term rates. The alleged Treasury "buyback" program that sparked a brief rally was far less than it seemed; it involved trivial sums of money and no new money.
And the bond rally is already over: By early Thursday, the yield or interest rate on the benchmark 10-year Treasury note was already back to where it was before the announcement.
The underlying cause is that both the U.S. and other major developed countries, including Japan and in Europe, have been piling on debt like crazy for decades and lenders, at long last, are starting to ask some serious questions about how sustainable it all is. Epic levels of debt added during the COVID lockdowns, following hefty additions during the global financial crisis, have changed the financial picture.
The word "credit" comes from Latin, and means "he or she believes." People extend credit because they believe they will get their money back plus interest. Once they start to question that belief, things can spiral very quickly. This happened to the Middle Eastern emirate of Dubai in late 2009, and the so-called PIIGS - Portugal, Ireland, Italy, Greece and Spain - in the years that followed.
Every single financial bubble has burst when some people have started to ask whether they will really get all their money back. In the aftermath, the motto among high-net-worth advisers is that return "of" capital is more important than return "on" capital. Then, as markets boom in the next bubble, the lesson is forgotten.
There are astonishingly few people around on Wall Street who remember the bubble of the mid-2000s, which was followed by the cataclysmic global financial crisis of 2007-09. There are even fewer who remember the great stock-market bubble of the late 1990s, followed by the crash of 2000-03. Alarmingly, there are also astonishingly few people who seem to understand math, or how all these things are connected.
The interest rate on U.S. Treasury bonds, especially on the 10-year note, is the bedrock upon which the entire financial system is based. Back when I was still soaking wet behind the ears and being trained by business-school professors in the arcane world of "corporate finance" and "valuation," everything started with the "risk-free rate," meaning the rate of interest an investor could earn on supposedly risk-free investments - meaning U.S. Treasury bonds.
All "risky" assets, meaning all stocks and corporate bonds, are priced in relation to this so-called risk-free rate, using a variety of calculations. If the market starts to worry about U.S. debt levels and pushes up the rate of interest on Treasury bonds to compensate, this in turn pushes up the rates of return demanded by everything else.
And that's even before you factor in any rise in actual risk aversion caused by a financial crisis.
So if the Treasury is losing control of the Treasury bond market, that isn't just a matter for bondholders - it's a matter for everyone. From their peaks in 2007, the various stock markets of the PIIGS each fell between 65 percent and 85 percent, when measured in U.S. dollars, before hitting rock bottom around 2012.
So what is happening in the bond market right now is deeply ominous.
The U.S. and other major developed countries have been piling on debt like crazy for decades. Lenders –– foreign governments, financial institutions and individual investors alike –– at long last are starting to ask some serious questions about how sustainable it all is.
Meanwhile, Dudley highlighted the circular financing loop involved in AI. Right now, AI investment is driving the economy and the stock market. Corporate earnings for the S&P 500 SPX boomed in the second quarter. But according to Goldman Sachs research, more than 40 percent of the rise in earnings was actually the result of investment gains on AI stocks - such as Anthropic - made by tech giants such as Alphabet.
In other words, rising equity prices get reported as corporate earnings, which are then used as an excuse to ... raise equity prices still further.
The phrase for this is Ponzi finance. It's absurd double counting.
Matt Miskin, co-chief investment strategist at Manulife John Hancock Investments, says that the second quarter amply highlights the old adage that "earnings are a matter of opinion, while cash flow is a matter of fact." In cash-flow terms, he notes, many of the biggest tech companies are now cash flow negative as they spend gigantic sums of money on new AI data centers. They have been forced to issue bonds and even new stock to raise the sums needed.
And the assumptions needed to suggest these investments will earn a good return on capital are somewhere between challenging and preposterous, depending on whom you ask, how well they know you and how much their job depends on keeping the whole thing going.
Sadly, those who warn about stock-market manias, bubbles and Ponzi finance always look wrong until they look right. Actually, they look increasingly wrong until they look right. The late 1990s was littered with the careers of people who had called the stock-market bubble, but too early. Ditto the mid-2000s with the housing boom.
Nobody knows the day or the hour. But that doesn't mean it won't come.
Original Here
|
⭐⭐⭐⭐⭐