Seven years into this “experiment”, I like a lot of other common sense inclined individuals found myself scratching my head at the FOMC’s decision to hike interest rates. After all, they’ve had seven years to cherry pick their moment and somehow we are led to believe that December 16th, 2015 was the best they could come up with? I don’t buy it. Given all the data: slowing economy, rising inventories, declining corporate profits, strengthening dollar, falling inflation, rising junk bond yields, I am hard pressed to find an actual economic reason to hike interest rates at this point in time. But let’s not get into the “why?”, because as important as that is, the “what the hell comes next?” is even more important.
I must admit I enjoyed watching Fed Chair Yellen try to explain their decision. I thought she performed admirably, at times I almost believed that she believed what she was saying was true and someone who knows nothing about economics or common sense might even be inclined to fall for her incantations.
But unlike Jon Snow, I know some things. Due to the Fed’s cheap money policy credit growth exploded over the last few years. Rather than fueling investments and Capex, most of this credit growth went straight into stock buybacks and dividends. One of the few sectors where this cheap debt actually went into Capex was the OIL AND GAS sector, and we all know how well that’s doing, because the fall in oil prices is supposedly “transitory” according to Yellen.
EVERYTHING IS TRANSITORY! NOTHING LASTS FOREVER! SO TO CALL SOMETHING TRANSITORY IS FED SPEAK FOR I HAVE NO CLUE BUT I’M HOPING IT’S OVER SOON!
I’d be laughing if this wasn’t so serious, if the Fed’s miscalculations merely took place on a chalk board rather than a world with 7 billion people living on it.
Instead we find ourselves, on the verge of another catastrophic stock market explosion. Junk bond yields have spiked considerably in the last few months, which will make it harder for companies to service and acquire more debt. Once debt growth slows credit bubbles burst. So what was first attributed to the fall in oil prices causing debt bloated oil and gas companies to cry for help, has now spread to other sectors including the investment grade bonds. To make matters worse, inventories are on the rise in the US and profits are declining for the first time since the crisis. Like I said in the opening, the Fed could not have picked a worse time to hike except for perhaps tomorrow.
Let’s not forget that while the US may be the center of the world’s economy at the moment, it’s not the only one that matters. Emerging market nations OWE roughly $5 trillion in USD denominated debt. This means these companies, which do not have direct access to dollars, are going to have an even harder time paying back their debts as the Fed is now actively strengthening the dollar. The rush on the dollar will be enormous unless the Fed back tracks but it is probably already too late.
I don’t know the timescale for the collapse in the global economy but rest assured with the Fed hiking rates it has been accelerated substantially. We have now entered the end game and it’s time to get defensive.
If you read my articles for the past few years, I’m going to sound like a broken record here. But with the Fed hiking interest rates, the deflationary phase that my calls have been based around will only become stronger.
So if you listened to me over a year ago back in August 2014, you wouldn’t even be in the US equity market. The Dow is up only 5% since I made that call. It’s safe to say that I’m still not touching the long side of the US equity market with a barge pole, nor any equity market around the world for that matter. I still like long term US bonds, as inflation slows and the dollar rallies these should look like extremely attractive investments to other investors as well.
Another point of emphasis, is long/short currency positions. I’ve already mentioned the strengthening dollar but you still have to hold it against something. I prefer emerging market currencies that also are heavy commodity exporters. Saudi Arabia certainly falls under this category. As the Riyal is pegged to the dollar there is no risk of the trade going against you. It’s one way! Just sit back and wait for the fireworks, literally! Saudi Arabia is fighting a proxy war in Iraq/Syria as well as Yemen. It’s bleeding money as it struggles to defend its fellow Sunnis as well as its currency peg.
I’ve also talked a lot about China in the past, and we’ve seen the Yuan which is also pegged to the dollar weaken, but there’s still a long long way to fall. A 20% decline in the currency would certainly be a start. Then there are developed economies that are heavy exporters with divergent monetary policy that also look attractive for long dollar short their currency plays. Australia and Canada look particularly attractive. Both nations have housing bubbles high debt levels, large commodity exporters, high dependencies on Chinese consumption and are loosening monetary policy.