Best of the Week
Most Popular
1. 2019 From A Fourth Turning Perspective - James_Quinn
2.Beware the Young Stocks Bear Market! - Zeal_LLC
3.Safe Havens are Surging. What this Means for Stocks 2019 - Troy_Bombardia
4.Most Popular Financial Markets Analysis of 2018 - Trump and BrExit Chaos Dominate - Nadeem_Walayat
5.January 2019 Financial Markets Analysis and Forecasts - Nadeem_Walayat
6.Silver Price Trend Analysis 2019 - Nadeem_Walayat
7.Why 90% of Traders Lose - Nadeem_Walayat
8.What to do With Your Money in a Stocks Bear Market - Stephen_McBride
9.Stock Market What to Expect in the First 3~5 Months of 2019 - Chris_Vermeulen
10.China, Global Economy has Tipped over: The Surging Dollar and the Rallying Yen - FXCOT
Last 7 days
QE Forever: The Fed's Dramatic About-face - 21st Feb 19
Gold Technical Perspective – Why So Bullish? - 21st Feb 19
Sheffield "Mi Amigo" Memorial Fly Past at 8.45am on 22nd Feb 2019 - 20th Feb 19
Here’s The Real Reason You Stress About Money - 20th Feb 19
Five Online Marketing Predictions that will Matter in 2019 - 20th Feb 19
Has Gold Price Reached Upside Resistance Near $1340-1360? - 20th Feb 19
So Many Things are Not Confirming Stock Market Rally - 20th Feb 19
Forex Trading Management: The Importance of Being Prepared - 19th Feb 19
Gold Stocks are Following This Historical Template - 19th Feb 19
Here’s Why The Left’s New Economic Policies Are Just Stupid - 19th Feb 19
Should We Declare Emergency for Gold? - 19th Feb 19
Why Stock Traders Must Stay Optimistically Cautious Going Forward - 19th Feb 19
The Corporate Debt Bubble Is Strikingly Similar to the Subprime Mortgage Bubble - 18th Feb 19
Stacking The Next QE On Top Of A $4 Trillion Fed Floor - 18th Feb 19
Get ready for the Stock Market Breakout Pattern Setup II - 18th Feb 19
It's Blue Skies For The Stock Market As Far As The Eye Can See - 18th Feb 19
Stock Market Correction is Due - 18th Feb 19
Iran's Death Spiral -- 40 Years And Counting - 17 Feb 19
Venezuela's Opposition Is Playing With Fire - 17 Feb 19
Fed Chairman Deceives; Precious Metals Mine Supply Threatened - 17 Feb 19
After 8 Terrific Weeks for Stocks, What’s Next? - 16th Feb 19
My Favorite Real Estate Strategies: Rent to Live, Buy to Rent - 16th Feb 19
Schumer & Sanders Want One Thing: Your Money - 16th Feb 19
What Could Happen When the Stock Markets Correct Next - 16th Feb 19
Bitcoin Your Best Opportunity Outside of Stocks - 16th Feb 19
Olympus TG-5 Tough Camera Under SEA Water Test - 16th Feb 19
"Mi Amigo" Sheffield Bomber Crash Memorial Site Fly-past on 22nd February 2019 VR360 - 16th Feb 19
Plunging Inventories have Zinc Bulls Ready to Run - 15th Feb 19
Gold Stocks Mega Mergers Are Bad for Shareholders - 15th Feb 19
Retail Sales Crash! It’s 2008 All Over Again for Stock Market and Economy! - 15th Feb 19
Is Gold Market 2019 Like 2016? - 15th Feb 19
Virgin Media's Increasingly Unreliable Broadband Service - 15th Feb 19
2019 Starting to Shine But is it a Long Con for Stock Investors? - 15th Feb 19
Gold is on the Verge of a Bull-run and Here's Why - 15th Feb 19

Market Oracle FREE Newsletter

The Real Secret for Successful Trading

These Are the 3 Biggest Market Risks in 2019

Stock-Markets / Financial Markets 2019 Jan 24, 2019 - 06:57 AM GMT

By: John_Mauldin

Stock-Markets

A Federal Reserve policy mistake is our top risk this year.

Correction: The mistake is already happening. So that’s less a forecast and more a recognition of reality.

The Fed is raising rates and reversing its quantitative easing. At the same time! They should be doing one or the other, not both.

The media and investors focus on the rates. But as you’ll learn, the global balance sheet reduction may be even more harmful.

If Jerome Powell doesn’t realize this in early 2019—or the rest of the FOMC disagrees with him—2019 could get rocky, and very quickly.


But the Fed’s experiment is not the only risk I’m worried about for 2019.

Let’s look at a few things that crossed my inbox in the last month and piece them together.

Risk #1: Balance Sheet Reduction

I’ve been tough on the Fed but I may have understated the danger. My friend Chris Whalen, chairman of Whalen Global Advisors, described the problem last week (my bolding):

The FOMC cannot withdraw the liquidity provided to the US financial system via QE without causing the system to implode. Chairman Jerome Powell needs to publicly state that the Bernanke-Yellen inflation in asset prices will entirely reverse as the FOMC tries to reduce “excess reserves” to pre-crisis levels. Regardless of whether the FOMC raises the Fed funds target rate or not, continuing to shrink bank reserves via QT implies a significant reduction in prices for stocks and real estate…

… the POTUS is right to criticize the Fed’s policy actions, but for the wrong reasons. The fixation of markets and the financial media on whether the FOMC raises the target rate for Fed funds or not is misplaced, part of a time-worn policy narrative that is completely antiquated. Since 2017, the only important trend in credit markets has been whether the Fed’s balance sheet is shrinking and at what rate. The move in credit spreads that started in August signaled that there is a growing problem with liquidity, yet the FOMC ignored the warning.

To use a metaphor, the Fed’s QE left the economy addicted to a highly potent drug. Removing this addiction without a crash is impossible. And yet its supply is disappearing.

That is a big problem.

Rate hikes are secondary here. In real terms, short-term rates are still close to zero. Even if the Fed keeps hiking, they will stay historically low.

The QE reversal is much more impactful.

Worse, it’s not just the Fed that is reducing its balance sheet. The BAJ, BAE, and ECB are in the same boat.

Risk #2: Corporate Debt

Another problem is the corporate bond market. To put it in a quaint and polite term, it’s gone berserk.

Companies are more leveraged than ever. And yet investors still lend them more.

Why?

Low rates made debt capital less expensive than equity. Borrowing has been cheaper than issuing stock for the last decade. That’s how many businesses funded themselves.

The problem is artificially low prices stimulate malinvestment. You might think today’s highly paid CEOs are immune to that. But many are not.

Most of them put their companies in debt to fund share buybacks at double or triple their current stock prices.

Lenders were equally foolish. They felt forced to take credit risk due to low Treasury rates. Many went too far.

The result: Corporate debt as a percentage of GDP is now at a record high. And as the chart below shows, debt at these levels tends to end with a recession.



Source: The Wall Street Journal

Worse, a lot of this debt is in mutual funds with legally mandated daily liquidity. If more investors want their money than the fund has cash on hand, they must instantly liquidate assets at whatever price they can get.

This can quickly snowball into a financial crisis. Something similar happened with commercial paper in 2008.

But this has the potential to be even worse. Because it could come at a time when the Fed and Treasury can’t help much.

Given this, I see serious risk of a corporate bond crisis in 2019. It will likely begin in high-yield and leveraged loans, but won’t stop there.

Risk #3: Legislative Gridlock

We’ll also face new political challenges.

With Democrats now in charge, there will be no more tax relief. But there will be a lot of other drama as they investigate and resist the Trump administration, which is their right.

How the president will navigate this is not yet clear. I am not optimistic. The mostly likely outcome is (at least) two years of legislative gridlock.

However, that may not stop Trump from using executive authority to continue his trade war—especially with China.

Beijing simply can’t give everything Trump wants without crashing its own economy. Maybe there is a compromise somewhere. I’m sceptical, though.

Tariffs may go back up and further bite into US growth at a time we can least afford it.

Throw in the government shutdown?

Multiple central bank policies, the run-up in high-yield corporate debt, tariff and trade wars, political battles, government shutdown. These are the risks I see this year.

They are all unforced errors, every one of them. The economy might be able to ignore them individually. Together? It is a witch’s brew for upsetting the applecart.

Get one of the world’s most widely read investment newsletters… free

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules