Dead Bodies

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1. Dead Bodies

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Dead Bodies

Stan Druckenmiller is one of the most famous investors of our time

He has stellar returns performance and hasn’t had a single losing year in 30 years

He recently had a presentation at USC where he shared his thoughts on financial markets and the world economy overall

Here were a few key quotes:

“I’m sitting here staring in the face of the biggest and probably the broadest asset bubble, forget that I’ve ever seen, but that I’ve ever studied.”

“I am worried there are more “dead bodies” ahead, I just don’t know where they are. I knew them in ‘07-08. I don’t think SVB was the last one.”

“I read that 7 stocks are responsible for 85% of the S&P rise this year. It reminds me very much of Nifty Nifty era.”

What typically causes an asset bubble to pop and is the leading indicator of economic turmoil?

Credit

Credit in its simplest form refers to the ability of an individual or business to borrow money or access goods or services with the understanding that the payment will be made at a later date

Then what is a credit crunch?

A credit crunch is a financial situation where lending becomes restricted, and the availability of credit becomes limited. In a credit crunch, lenders become hesitant to lend money, which can lead to a shortage of credit in the economy.

Credit crunches often occur when banks and other financial institutions become wary of the potential risks associated with lending. This can happen when there is a sudden change in economic conditions, such as a recession, or a significant increase in the number of borrowers who default on their loans.

When credit becomes scarce, it can lead to a number of negative consequences for the economy. Businesses may find it difficult to access the funding they need to grow and invest, and individuals may struggle to obtain loans for large purchases, such as a home or a car.

Credit crunches can also have a ripple effect throughout the economy, as businesses and individuals who are unable to access credit may cut back on spending, leading to a slowdown in economic growth and potential job losses.

When interest rates are low, and lending is abundant, lenders are willing to take on more risk with their lending

People and companies are borrowing more, spending more, and productivity and the economy grows

When there is a “credit crunch” and lenders are less willing to lend money (tighten their lending standards) like require higher credit scores, aka safer bets, and its harder for companies to lend and if they do, it’s often at higher interest rates

As you can see from below, banks have begun their credit tightening

This makes it harder to loan money, buy assets (like houses), so demand drops

When demand drops, asset prices come down popping the bubble

Similar situations happen with companies

When a company has stricter credit terms, they are spending less money on growth (employees) and making productivity gains and profit, and more money on deleveraging aka paying down debt

In a deleveraging, people cut spending and incomes fall. Credit dries up, asset prices fall, banks get squeezed like SVB, the stock market crashes

With lower incomes, borrowers become less creditworthy and credit dries up

With no credit, borrowers can no longer borrow enough money to meet their debt repayment (also known as “refinancing”)

Borrowers are forced to sell assets, which floods the market at a time when spending is falling. This causes the stock markets to crash, the real estate market to collapse and banks get into trouble as the value of their collaterals (the assets) are crashing

Less spending = Less income = Less Wealth = Less credit = less borrowing (and repeat).

This hurts the performance of companies as you can see from below

Investors know the credit issues trickle into the performance of companies

The credit crunch can be the pin that pops the bubble on asset prices

The central bank/the Fed know they have to slow inflation by raising rates, and ultimately may push the US economy into a deeper recession

Pay attention to these 2 things:

1. High yield spreads

A high-yield bond spread, also known as a credit spread, is the difference in the yield on high-yield bonds and a benchmark bond measure, such as investment-grade or Treasury bonds (risk free backed by the US gov’t)

2. Jobless continuing claims data

As you can see below, it looks like a new trend is beginning to form on continuing claims….

These are 2 of the best early indicators of economic and financial markets trouble

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.