The Gods must be crazy: Central banks believe ther are protecting investors from their own foolishness

The terror of the coronavirus has investors looking to the Gods for help—both the ones in charge of the world (and the virus), and the neo-Gods, the central banks. Decades ago, my father taught me that central banks should be like God—you believe she exists, but you only see/hear her in times of crisis. Unfortunately, since the 1980’s, and increasingly since the 2008 financial crisis, these neo-Gods have gone crazy.

They have come down to earth and are seen everywhere—they are the loudest voice in the market, believing that they are protecting investors from their own foolishness, and financial markets from instability. In reality, the impact has been exactly the opposite.

While US equity markets have risen by more than 350% in the last 10 years, financial stability has become increasingly wobbly. There were two nervous corrections—in 2015, and 2018—when the market lost around 15%, before the central bank ministrations picked things up again.

A parallel problem has been the huge increase in non-financial corporate debt. With Treasury yields extremely low (and now heading to zero), investors—again, comforted by the fact that the central banks are there—began to stretch out to lower credits to get some meaningful yield. As a result, the amount of non-financial corporate debt today is at levels higher than in 2008, with the debt to supporting surplus ratio exceeding 8 to 1. To be sure, the super-low interest rates make it that much easier to service this debt, but if growth slows, the surpluses will fall, and the risk of defaults will surge.

And, growth is going to slow, without any doubt. It is well-known that two-thirds of US growth is driven by consumer spending; a study reported in the FT shows that “net capital gains plus taxable distributions from individual retirement accounts” are twice the year-on-year growth in US consumption expenditure. Thus, a sustained decline in equity prices, the beginnings of which we are already seeing, is certain to push US growth lower and, likely, into a recession.

The bond market is certainly signaling this. The 10-year yield has fallen below 0.5% for the first time ever, and even after the Fed cut its funds rate off-meeting, the 10-year rate is lower than Fed funds. It is widely expected that the Fed will cut rates to zero later this month in its continuing we-don’t-know-what-else-to-do policy.

Again, the corona virus appears to be suddenly accelerating its spread in the US (and Europe). Together with this, the sudden dramatic instability in the oil market will also negatively affect growth—certainly in the shale oil industry. It will also push the equity prices of the multinational oil companies lower.
It is beginning to look like a perfect storm.

The only saving grace appears to be that the virus has stopped spreading in China. Some companies I spoke with are expecting raw material and product deliveries to come back to close to normal in a couple of months. But, that is a long time when the market is spooked.

How much more can markets fall? Technicals suggest that if the support at 24,300 gives way—and Dow futures are signaling that it will open below that tonight—the next support is below 22,000, the level I had signaled in my earlier report. If the BSE breaches 36,000 today, the next support is at 32,000.
Our government is, of course, missing in action, preoccupied as it is with defending its CAA etc stand. On the other hand, the Reserve Bank of India has been on full-time alert. It had been buying dollars non-stop since September last year, with reserves rising in a straight line with a slope of about $2 bn a week. It is now selling (some of) these dollars back to prevent the rupee from breaking below its all-time low of 74.5.

Of course, the central bank also has to deal with the fallout of the Yes Bank catastrophe, which will certainly decrease the investment attractiveness of India. Indeed, with global risk aversion increasing, India is likely to fall even further out of favour. Look for continued RBI action, increased rupee volatility, and, in all likelihood, an even lower rupee.