THE 'D' WORD

This is the most common words used lately (especially by economists)

1. Deleveraging
2. Devaluation
3. Deflation
4. Destabilisation
5. Depression
6. Disinflation
7. Derivatives
8. Debt
9. Downturn

DELEVERAGING

The world current total debt to GDP is historical high.  To a tune of about 300%.  It was build up over the last 20-30 years.  More so during the last after China was admitted into WTO in 2001.  USA debt over GDP is about 3X, China 2.8X, Euro 2.4X, Japan 3X.  Private debt in USA is gradually shrinking.

When USA government started the QEs, most money went into many financial assets (stocks, commodities, derivatives (including carry trade), ETFs, Structured Warrants).  So, it went mostly into the wrong area, or rather, it became a liquidity trap.  If you are financial institutions, you can borrow at 0.2% p.a., what would you do.  The most popular way is carry trade (looking for higher yield return financial assets).  So, initially after the 2009, oil price went up together with most other commodities (at different time), stock markets around the world, ETFs, Properties, thinking that the economy is back on track.

In reality, most money went into the wrong place (that is why it is call a liquidity trap).  A good example is the shale oil, so much money and debt raise for this sector, and now, it burst, imagine how much write off to be made.

Others are like resources companies, feeding China

BHP

Rio Tinto

Vale

Glencore

(Their market capitalisation dropped 30-50%)

CONTRACTION

Deleveraging cause contraction, because over the last 10 years, lots of sectors over expanded.  So, the size will be contracted by downsizing, write off, close down, retrench, rationalise, and reduce.  The most common sectors is construction and properties, such as China.  It is very clear, there is a huge misallocation of capital.  More to come.

CONSUMER RETRENCHMENT

Once, the businesses contract, unemployment will build up.  Hence, the consumptions cannot take over the slow down in investments. So, consumer retrenchment will gradually make people to save more (for retirement).  

REALITY

So, the reality is that the economies of major countries is contracting due to CONSUMER RETRENCHMENT.  What will happen to all the liquidity that went into financial assets.  Example, a hedge funds can raise debt 20X its shareholders funds in USA, takes the money and invest into Asian stocks, and it burst, plus currency in Asian also went down, what will happen to this hedge funds?  More will takes their money back.  Look at the size of the hedge funds.

DERIVATIVES

Lets not forget, low interest rates cause properties, commodities, stock markets, & derivatives to go to a high level until it 'pops'.

CAPE PE

Shiller CAPE PE is 27X.  Historical average is 17X (not the floor).  Russel 2000 (Small cap stocks in USA) is trading at 85X. I think, toppish is an understatement.  Do we think NEW DEBT will solve the problem? Or further prop up the price?  Just look at CRUDE OIL.

CHINESE YUAN

Euro, Yen, Sterling, USA had depreciated against GOLD about 200% each since 2000.  Only Chinese Yuan is below 100%.  If I am from Mainland China, knowingly my currency is much stronger than the rest of the world, I will convert them into other currencies.b

CORRECTION

Correction is not over.  The rebound could be temporary.

Part 3 - How to handle the current situation