Yes, China again.
Don't blame me, blame Ambrose Pritchard, who decided today would be a good day to talk about China's continuing bad debt crisis, with non-performing loans now approaching 20% of all loans and that number would be much WORSE if it were not for the fact that overall loan growth jumped 25% this year, from $8Tn to over $10Tn. That made the $2.1Tn in bad loans shrink back from 25% of $8Tn to “just” 20% of $10Tn – see, problem solved!
“The longer debt grows, the greater the risk of asset quality and liquidity shocks to the banking system,” said Fitch. “Capital shortfalls are currently 11% to 20% of GDP, but this threatens to hit 33% in a worst case scenario by the end of 2018. Defaults in China could lead to mutual credit guarantees in the background pulling other firms into distress. A large increase in real defaults risks triggering a chain of bankruptcies that magnifies the potential for financial instability,” it said.
To put that in perspective, the losses we endured in the 2008/9 crisis added up to 8% of the US and Europe's GDP and we're still recovering from that! Overall public debt is now 55% of China's GDP and China's A+ debt rating may also be in danger. An attempt to reform the system last year led to an over 40% collapse in the Chinese market last summer and it's been hands off ever since and the banks and corporations have gone hog wild at the debt trough.
Overall credit in China is now 243% of their GDP, up 100% since 2008 so their 7% annual GDP growth over 7 years (49%) has been paid for by a 120% increase in debt. Once could extrapolate then, that had China not gone MASSIVELY into debt, their economy would be contracting faster than Japan's and do you know who went MASSIVELY into debt to stave off a recession 20 years ago? JAPAN!!!
If China were to dedicate 10% of their GDP to paying down their debt and their debt was completely interest-free, it would take them 25 years to pay it off. That would be proportional to the US taking $2Tn per year to pay down our debt for 25 years so, clearly, that's not going to happen, is it. So, if repayment is never going to happen and if the Fed is right and interest “normalizes” at 3% down the road, then what happens to China and Japan when they have to pay 3% interest on 250% of their GDP (7.5% of their GDP or $1.5Tn/yr if it were the US)? Does this bother anyone? Bueller?
If a debt is unpayable then the other option (after much can-kicking, of course) is default. Never in banking history has “none of the above” been the option. With Japan and China pushing 250% of their GDP over the debt line and the US and Europe each around 100% Global default is inevitable – the wild card is simply the form of the destructor.
Way back in 2008, I wrote “Inflation Nation” and predicted the only acceptable end-game for all this debt (half at the time) that we're wracking up would be a decade of hyperinflation where (hopefully) the GDP will rise faster than the debt and we will get back to controllable numbers – that's how we got ourselves out of debt in the 70s (Nixon took us off the Gold Standard and the Dollar collapsed – making our debts cheaper to pay back) and it's very likely that all the countries are heading that way today – hence the massive amount of money-printing that's been going on.
That's why we're long-term bullish on the markets – it's not that we think the economy is likely to heat up but that we believe equities will stay ahead of currencies and rise rapidly in value as inflation kicks in, inflating relative profits along the way – if not proportional.
Speaking of equities, Microsoft (MSFT) is trading $40Bn worth of funny money in for 10% of their stock and Lockheed Martin (LMT) is using $4Bn in worthless paper to buy back 5% of their stock. MSFT is still a bit toppy but LMT is a great long-term play at $73Bn ($246/share) while dropping $3.6Bn to the bottom line (p/e 20) and paying a $6.60 (2.7%) dividend.
What I like most about LMT is their research on fusion and, if they pull it off (very likely), they could become a Trillion Dollar Company (but not before AAPL is one) and, very possibly, save the World but for now they can save an underperforming portfolio by buying them for $198.15. But Phil, you may say, I thought LMT was $246, how can you buy it for $198.15.
Now I know you are a retail sucker and don't know how to buy a stock properly. What we do is promise to buy LMT for $210 by selling the 2018 $210 puts for $11.85 and that will net us in at $11.85 if LMT does go lower but, if it stays above $210 (15% down from here) the short puts expire worthless and we just keep the $11.85.
We love plays like this during a treacherous market as they have built-in downside protection AND they put money in our pockets on day one – it's one of the reasons we have so much CASH!!! on the sidelines in our 4 Member Portfolios (see yesterdays' Member Chat for current positions).
Have a great weekend,
Provided courtesy of Phil’s Stock World.