And here we go again…
Sellers are not letting up.
More declines for the ASX. More declines for the S&P 500. And a whole lot more declines for stocks in China.
Fund managers welcomed the recent declines. According to the monthly Bank of America Merrill Lynch survey, fundies were net buyers in October.
Cash balances fell from 5.1% in September to 4.7% in October.
Far fewer fundies were long on the most crowded trade: FAANG (Facebook, Apple, Amazon, Netflix and Google), plus BAT (Baidu, Alibaba and Tencent). Yet, there was still little room to move in that space.
The number of fundies that were overweight on tech fell 18%. One of Apple’s suppliers, Lumentum Holdings, added to fears of a tech slow down.
The company slashed sales and profit forecasts. Orders from major customers haven’t kept pace with previous years, Lumentum said.
The stock is down almost 50% from its high this year.
And you won’t believe what the Morrison government is planning to do…
The Fed oversteps their role
How did we get into this mess?
How are tech companies trading on high double-digit multiples? A few trade at triple-digit multiples.
Investor get enthusiastic, yes. But who’s supplying these enthusiastic investors with boat loads of cash? If you work your way back to the source, you can either point the finger at banks or central banks.
It’s the central bankers that control the money supply. And its banks doing as much as they can to earn as much as they can.
The latter is actually a good thing. We want profitable businesses in an economy. We also want competition, which spurs businesses to invent, innovate and offer more value to customers.
The former, you could argue, is detrimental to businesses and households.
I understand the reason for a central bank.
Before the US Federal Reserve for example, the US had about 15,000 banks. Each had their own currency backed by their own reserves.
This meant there were a whole bunch of different notes floating around the US economy. All these notes had different and changing values.
US fund manager John Huber explains that while total reserves were substantial in the US, each bank would act in their own interest.
So, when things got hairy and banks got the slightest whiff of panic, they locked the doors and refused to lend any more money.
As a result, cash quickly evaporated form the system. With little liquidity and huge demand for cash, the bad times lasted longer and grew deeper.
There was also no secondary market for loans. Like the stock market for shares, there is a secondary market for debt. Nowadays, banks can bundle loans into a security and sell it to investors wanting a stable stream of income.
This allows banks to get these loans off their balance sheet and collect an upfront payment from investors to continue lending.
So in 1907, the US had the idea to form an institution that could solve these problems. They would be the lender of last resort, pumping liquidity into a system when it was bone dry.
But if the Fed solves these problems, why do we still have financial crises? And why have we been seeing more of them as time goes on?
I think it’s because the Fed oversteps their role.
In recent years, they’ve been far too aggressive when pumping money into the system. They allow banks to create far too much money.
The rate of new goods and services being created hasn’t kept up. Yet still more cash was created.
So where does all this money go? A lot of it goes into existing goods and services. And instead of a growing economy, which is made up of goods and services, you get growing prices.
It’s one reason why tech stocks have climbed so high.
Newly created money is looking for growth. And investors are parking it in tech stocks. It’s how you get a Netflix trading at 100-times earnings…investors just have nowhere else to go.
It isn’t until the Fed takes money out of the system (which is what they’re trying to do now) and banks stop creating money that prices start to fall. And if we’re talking about tech stocks, they tend to fall in short sharp bursts.
And what’s Morrison’s remedy?
For government to keep pumping more cash into the system.
Taxpayers pick up the bill…again
From the Australian Financial Review (AFR):
‘The Morrison government will inject $2 billion into the small business loan market in an unprecedented effort to boost lending to cash-starved firms which have complained of a worsening credit squeeze.
‘The creation of a taxpayer-backed securitisation fund to invest in small and medium enterprise (SME) credit will also potentially expand an asset class for institutional investors such as superannuation funds to invest in.’
Again, I understand the idea.
Encouraging lending to small businesses could create more new goods and services. It could increase employment, creating even demand for more new goods and services.
The AFR continues:
‘Treasurer Josh Frydenberg and Small Business Minister Michaelia Cash will announce the small business funding policy on Wednesday, promoting the soon-to-be-established Australian Business Securitisation Fund as a way to overcome banks typically only lending to the self-employed when they pledge their personal home as collateral.
‘The government fund will buy packages of secured and unsecured SME loans issued by smaller banks and non-bank lenders such as fintechs, boosting funding to these non-big bank lenders to lend to small businesses and potentially lowering SME borrowing costs.’
Basically, this means the government will fit the bill for those small businesses that don’t pass the banks’ initial test.
Remember, banks want to make money. If they’re not writing loans for particular businesses there’s probably a good reason why.
Maybe it’s a risky business to begin with. Maybe there’s a good chance the business won’t be able to meet interest repayments or maybe even the original principal is at risk.
Yet I’m sure banks will now take more risk as it will be the Morrison government buying the securitised loans off their balance sheet.
And of course, this will be done with taxpayers’ money.
So, if these small business’ securitised loans don’t work out, it’s not the government who’ll pay.
It’s you and me, the taxpayers.
Editor, Money Morning
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