Been There, Puked That

This has happened before, albeit way back at the beginning of time in April 2000 when today’s day traders and robo-machines were still in short pants.

During the year before March 27, 2000, the NASDAQ 100 had soared by 139% to 4704, but then the pin hit the bubble. In the next 14 trading days the go-go index of the era plunged by a heart-stopping 32% to 3207.

Still, that was just the warm-up round. The air didn’t come fully out of the balloon until October 2002 when the index finally bottomed why down in the sub-cellar at about 800.

That’s right. The 83% cliff-dive from the March 2000 peak wiped out the life savings of millions of Baby Boomers who have never recovered because they had nothing left to invest.

NASDAQ 100—March 2000 Blow Off Top

Undoubtedly, history does not repeat, but when market manias get rabid enough, the charts tend to come pretty damn close.

To wit, February 19, 2020 is apparently the new March 27. On the former date, the NASDAQ 100 hit 9718, which represented a 65% gain during the previous year and change.

That same index hit 7900 at today’s low. So here we are 14 trading days from the February 19 peak, and the index is down 19% and counting.

So the issue at hand, therefore, is whether today’s punters, who are now hanging in there for dear life, still have another 50% loss ahead before they finally sleep with the fishies, or have the central banks and fiscal authorities in their wisdom learned their lessons and maneuvered the financial markets and economy into what just a few weeks ago Jay Powell called a very “good place” from whence only a vigorous rebound may issue?

February 2020—NASDAQ 100 Blow-Off Top?

We’d say the above amounts to the $75 trillion question. That is to say, has the massive increase in debt, financialization and Wall Street speculation since March 2000 made the US economy and financial system more resilient or has the whole thing become even more fragile and unstable?

We’d acknowledge that when debt is used with pin-point accuracy and steely discipline to fund only the safest and highest possible return projects, an expansion of the debtberg’s girth can actually fuel growth and greater prosperity. But when its used to live high-on- the-hog, it’s an unequivocal negative where any short-term accounting gains in GDP are overwhelmed by the rigidities and fragilities it introduces into the economy and financial system.

As it happens, back at the first NASDAQ 100 peak in March 2000 total public and private debt in the US was $27 trillion compared to today’s $75 trillion. Not only did this 178% gain in total debt far exceed the 115% growth in nominal GDP during the last 20 years, but the composition of the gain was entirely of the living-high-on-the-hog variety.

That is, it went to household consumption, government waste/ boondoggles/transfer payments and financial engineering by the business sector. Between Q1 2000 and Q3 2019:

  • Household debt rose from $6.8 trillion to $16.0 trillion or by 135%;
  • Business debt soared from $6.2 trillion to $16 trillion or 158%;
  • Government debt positively exploded from $5.5 trillion to $21.9 trillion or by 298%.

Needless to say, we know exactly what most households did with their massively increased debt: They acquired not earning assets but vacations, fuller closets and dresser draws, man-caves, jewelry, furnishings and anything else chargeable to a credit card.

Likewise, the government debt explosion funded essentially transfer payments, health care for the poor and old and defense spending. These may or may not be “public goods” as the statists like to aver, but such political brownie points today almost never produce income returns tomorrow.

But it is the business borrowing spree of nearly $10 trillion over the last two decades which is the most egregious example of unproductive debt accumulation.

The level of real net fixed business investment did not even reach its year 2000 level until 2017 and even with last year’s tax-cut fueled increase it stood at just 115% of its turn of the century level.

Stated differently, $10 trillion of incremental business borrowing over the last 18 years has produced a mere 0.81% annual gain in real productive capacity after inflation and current year capital consumption (i.e. depreciation and amortization).

By contrast, stock buybacks have cranked skyward and during recent quarters were running at 8X their turn of the century level. During the same period, aggregate S&P 500 earnings have not even increased by 2X.

Needless to say, this massive recycling of corporate cash flows and debt capacity back into the canyons of Wall Street did mightily fuel share prices, and, in fact, provided nearly 100% of the net new buying power in the stock market. But it also left corporate balance sheets far more fragile than ever before, and certainly dramatically more vulnerable than they were when the first 14-day meltdown commenced in March 2000.

It goes without saying that the higher they fly, the harder they fall. Yet to hear Wall Street tell it, there was nothing “high” or bubblicious at all about the level of share prices back on February 19th.

The absurd argument was even being made that since the central banks have driven interest rates to rock bottom levels, it was only appropriate that corporate earnings be capitalized at sky high PEs.

Then again, what drives value at the end of the day is earnings and cash flow. And when examined from an economy-wide angle, GDP is a proxy for aggregate income while the market value of total financial assets held by households captures the financialization level of the US economy.

The chart below leaves no doubt that we are in the midst of a historic bubble that has been building for several decades. Namely, back in Q2 1987 on the eve of Greenspan’s arrival at the Fed, total financial assets of US households stood at $12.8 trillion compared to GDP of $4.8 trillion.

In effect, the economy-wide capitalization rate was about 2.7X, a ratio of financial assets to GDP that had not changed much since the early 1970s (The ratio also stood at 2.7X in Q2 1971)

But once Greenspan and his heirs and assigns got into the wealth effects and monetary central planning business, it was off to the races:

  • By Q4 2000, the market value of household financial assets stood at $35.6 trillion or 3.6X GDP of $10.0 trillion;
  • But by Q3 2019 household financial assets had ballooned to a staggering $91.0 trillion or 4.3X GDP of $21.4 trillion.

In a word, there is at least $33 trillion of bottled air in the financial system today. That’s because at the pre-Greenspan capitalization rate of 2.7X, the purple line in the chart below would stand at just $58 trillion.

So we think, the 14 days since February 19 are just the beginning of the implosion to come. And that’s also why, as we will address tomorrow, the Fed is being forced once again to pump massive amounts of new liquidity into the financial markets. As Zero Hedge noted,

With the term repo expanded from $20BN to $45BN and the overnight repo ceiling also raised from $100 to $150BN, moments ago the Fed announced that it had received the most liquidity demand on record, as Dealers indicated some $93BN in term repo submissions (which thanks to the expanded facility size meant that the oversubscription dropped from a record 3.6x to 2.1x)..

… alongside a fully allotted $123.625BN in overnight repo (out of $150BN eligible)…

… for a total of $216BN in indicated liquidity. Of this, $168BN in liquidity was released between the overnight and fully-alloted $45BN term repo facility.

There is a big hint in the charts above. In their Keynesian madness, our monetary central planners are attempting to hold the repo rate to 0.83% for 14-day money.

That’s downright insane. It’s the fuse which will blow the financial system sky-high, and make the market Puke of April 2000 look like a walk in the park.