We are definitely not alone in our view about a potential debt crisis in China.  Billionaire investor George Soros said “China’s debt-fueled economy eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fueled by credit growth.  Most of the money that banks are supplying is needed to keep bad debts and loss-making enterprises alive.”  The Financial Times also weighed in with their own calculation that China’s debt is now 237% of GDP, far above emerging-market counterparts.   Such a level of debt is much higher as a proportion of national income than in other developing economies.  While the absolute size of China’s debt load is a concern, more worrying is the speed at which it has accumulated – China’s debt was only 148% of GDP at the end of 2007.  New borrowing increased in the first three months of 2016 at the fastest rate on record and more than 50% ahead of last year’s pace.  Debt levels are now getting to where even the IMF recently warned that China poses a growing risk to advanced economies.

The CEO of Blackrock, one of the world’s largest money managers, issued a warning in his annual letter to shareholders.  He believes that negative interest rates risk hitting consumer spending and undermining the economic growth they are intended to encourage.  His argument is that not enough attention was being given to the effect of negative rates on saving habits highlighting the dangers of reaching a tipping point where people would start to hoard cash.  He goes on to say that low rates are preventing savers from getting the returns they needed to prepare for retirement, so they were increasingly being forced to divert money from current spending into savings.  This flies in the face of the strategies being employed by most central banks around the world, which have been using low, and even negative, interest rates to try to stimulate global growth.   When we look at the global growth numbers, we have to conclude that these policies have been an abject failure and have actually caused more harm as savers are punished and forced to take higher levels of risk to achieve historical rates of return.  In Japan, the lack of spending has been blamed on deflation, and is the reason cited for continuously lower rates.  Those lower rates were imposed on an aging demographic saving for retirement, which led to even lower spending (and increased savings).  Central banks then appeared to reason that, after years of continuously declining interest rates not working, the solution had to be negative interest rates!  Unfortunately, “common sense” is not an input on any of the central bank models.

Slower economic growth leads to slower corporate revenue growth which, combined with falling profit margins, leads to negative earnings growth.  The first quarter of 2016 extends the losses in annual profits to four consecutive quarters, with the 9% rate for the current quarter being the worst one since the 2008 recession.   More importantly, it has not been confined to just the Energy sector.  With over 75% of S&P500 companies having reported their earnings as we write these comments, we do not see any substantial revisions to that earnings forecast.  More importantly, guidance for the second quarter suggests that earnings are not making any sort of recovery.  The best news for earnings is that the year-over-year comparisons will start to get easier as we head into the 3rd and 4th quarters, particularly for the energy companies.

Earnings keep falling

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