Markets always have the dubious nature of surprising everyone, a bull market will make even the biggest bulls gasping for breadth while a bear market would in the end make even the most vociferous bears taking cover. While I am not at all convinced by the recent upswing in the market but then I could be one of the many who are thinking the same and the market could prove all of us wrong, nevertheless it would be foolish to go short in such a market, at best short condors/butterfly static trades might work for the time being.
The reason I wrote the last article was to set a setting for this article and the following ones, to emphasise on the importance of asset over cashflow. Hold this thought while you read on. The world was on the verge of a collapse (literally), the governments across the board came up with stimulus and relief packages, with relief packages of over 10% of current world GDP flowing in a span of 1 year it's a lot of money coming into the system in such a short span of time.
Ceteris Paribus if I put this kind of money flow in this basic Keynesian equation:
Y= C +I +(G-T) + (X-M) the economy size increases proportionately. The issue here is that this is just a very instantaneous type of equation i.e. captures just the moment. The point is that because of such Herculean government spending the global economy that was falling apart at rapid pace not only stopped falling but infact has even started to grow for the time being.
What the government's across the world did was important and should have been done but it would not be enough because there is a structural misplacement in the global economy (would discuss this in the next blog) and that the worst is yet to come and this is just the part 1 and unfortunately the global slowdown might be longer than earlier anticipated. Here is the thought process behind this argument.
By end of this year the debt of the great American nation would equal it's GDP, in other words the nation has to grow at around 3.5-4% annually to even pay it's interests!!! or else get into a debt trap or sell assets. Even at the best of the times US grew at around 4%, so simply put it US assets are going under the hammer, A 12 trillion dollar economy is currently driven by around 60 trillion dollar of assets, an impressive return of around 20%. But when this quantity of assets start going down the growth itself would start coming down and lower growth would mean more asset dilution leading to further lower growth leading it into a vicious circle. Europe is even in worst shape with debt ratios of many countries almost matching that of the US but even less growth. Lesser assets would further mean more exposure to event risk(last blog) and lesser financial stability. So while I believe that this temporary hump is because of this huge government spending all it has done is to shift the leverage from private balance sheets to that of government and the bolts of this ship would start falling apart once again but maybe not before it converts the last of the bears to bulls.
The next article I shall walk through the major countries of the world and talk about their debt situation and if and how they can come out of it, then after painting this doomsday scenario I shall talk (probably in the 3rd article) on how ultimately this issue would be resolved, by talking about the structural problem the world is facing today, till then hopefully enjoy the bull run......