The relentless rise in the stock markets from the lows of 2009, to the highs seen in 2015, have made many market participants complacent. Every dip, has been bought and the traders have been rewarded. However, on close analysis, the economy and the equity markets are setting themselves up for a harsh winter ahead, which is expected to persist until 2020. The equity markets will have to go through "The Great Reset" and even the Fed will not be able to rescue us.
A collapse does not happen all at once. The weak links give out first, followed by the stronger ones. Similarly, this time, it is China's economic slowdown, the oil crisis and a probable Euro crisis, all of which will end with the crisis of the largest economy of the world.
The China Slowdown
China is a great example of how one discovers that under adverse economic conditions, any amount of propping up by the central banks, does not yield results.
The Chinese stock market continues its unabated fall, even after their government introduced various market supporting measures, throughout the year. The following are a few measures, which did not yield any results, and the markets continued to tumble:
- The People's Bank of China cut interest rates six times last year; it also lowered the bank's reserve requirement ratios (RRR) several times in 2015.
- It let go of its control on the setting of deposit rates by the banks, encouraging competition among the state-controlled banking system.
- It also allowed pension funds to invest 30% of their assets in equities for the first time ever.
- It introduced a four-month freeze on IPOs.
- A number of other measures were also announced which are outlined here.
Despite all of these measures, the stock market continued to collapse.
Along with the equity markets, the Chinese economy is also in tatters. Various interventions by the government and the Central Banks have not been successful in propelling the nation on a path toward the growth of previous years, and, as a result, the economy continues to falter.
The above chart reflects the extent of the slowdown in China. It is experiencing one of the worst growth rates of the last decade, barring a small aberration during the "Great Recession."
The continuous growth of China was the engine of growth for the world economy, as China is the largest contributor to world growth. However, since 2012, Chinese growth numbers are on a downward path and continue to spiral further.
Early in the year, Premier Li accepted the lower growth rates of 7% as the "new normal" for China. Despite lowering its guidance, China continues to struggle, as its growth in the last two quarters of 2015 was at 6.9% and 6.8%, respectively.
Some believe that the growth numbers are fabricated and the real growth numbers in China are, in fact, lower.
The Oil Crisis
The current "oil crisis" has pushed crude prices to a 12-year low. Although lower gas prices at the pump are good for consumers, lower crude oil prices are threatening to push the world economy into deflation.
According to a Standard & Poor's Ratings Service, Junk Bonds have crashed; the organization then warned that 50% of energy bonds are at a risk of default. If you believe that metals are better off, be warned, as the Standard & Poor's Ratings Service states that 72% of the bonds in the metals, mining and steel industry are "distressed." The chart below shows a 69% decline in the Bloomberg Commodity Index within the past 5 years.
The Euro Is Under Threat of a Grexit and Brexit
Milton Freidman, the great economist, predicted the "Eurozone Crisis" long before it happened. He wrote:
"The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity."
In the past five years, the Eurozone has entered the brink of a breakup on numerous occasions. The closest incidents were after the Greek crisis, on two separate occasions. The Euro members have merely managed to "kick the can" into the future of what is inevitable.
Grexit has been averted for now; however, the new threat is Brexit. The majority in Britain is favoring an exit from the Eurozone, which will be a big blow to the union. Though Britain continues to have its own monetary system, it was a part of all other activities of the European Union. One nation leaving the union could cause other nations to leave, as well, which would lead to a breakup of the Euro. The breakup of the Euro would be catastrophic for the entire world.
The Fed Is No Longer Able to Fix It Anymore
For the past six years, the FED has pumped an enormous amount of liquidity into the economy. It has kept ultra-low-interest rates for almost six years. In the past decade, the Fed's balance sheet has expanded significantly.
With such large amounts of free money available, ideally one would expect a strong growth and sustained inflation. However, in reality, the growth rate has been dismal and so has the inflation. The economy is in an economic deflationary period.
Despite all the interest rate cuts and quantitative easings, the real economy never really gained any traction and is still struggling to maintain any steady growth rate while teething between periods of flat growth and a few negative quarters of growth. The U.S. fourth-quarter 2015 GDP numbers have proven to be dismal at 0.7% growth. With an already inflated balance sheet, the Fed will not be able to contain the next financial crisis, which will lead to "The Great Reset," at which time, all of the excesses of the system will be flushed out. It will be a painful transition; however, spring will certainly arrive following such a harsh economic winter.
Unless one is adequately prepared, the chances of surviving financially are remote. A few asset classes can help you weather the cold; gold and U.S. Bonds are the place to hide. However, currently, both are likely to correct themselves and the U.S. equity markets will surge, sucking in many more equity investors, before the next big decline takes place.
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