7 Years Later, Is It That Time Again?

According to almost every ‘expert analyst’ interviewed by the major news channels the world economy has made a recovery like no other from the scandalous crash of 2008. The very same ‘experts’ will tell us that there is no cause for concern and this is now reflected by Barclays now offering the first 100% mortgage since the collapse 7 years ago. But, the overriding question is – is there another recession on it’s way?

Director of Samuel and Co Trading, Samuel Leach has been monitoring the market for a number of months now and is of the view that a recession is on the way.

However, in order to delve deeper into this question, it’s important to begin with matters that can’t be disputed, manipulated or massaged to fit an agenda; statistics.

We’ll begin with Non-Farm Payroll (“NFP”). NFP is data released by the US Bureau of Labour Statistics on the first Friday of every month. Amongst other stats, the report details unemployment, job growth and payroll data. For traders, it is the single most important news event of the month and causes volatility in the market. If the figures released by the Bureau of Labour Statistics is lower than estimated the US dollar is weakened Likewise, positive figures equals a stronger dollar. In terms of the wider picture, the lower the figure, the more the US employment market contracts and this has potentially devastating consequences once amalgamated with the other contributing factors, for reasons which will follow. The NFP figure for May 2016 was 160,000, some 40,000 jobs less than expected. This, in itself, isn’t too much of a concern but once compounded with other factors it becomes alarming.

Moving on from NFP, we need to take a look at the manufacturing sector. An incredibly alarming statistic is that the US has not suffered a continuous 16 month drop in factory orders without the country being in a recession. On 4th April 2016, the US’ factory orders dropped for the 16th consecutive month year on year (Fig 1) and had a headline number of $454 billion which is the worst number since the summer of 2011 (Fig 2).

Fig 1

Fig 2

Surely, there must be something to alleviate the doom and gloom? Let’s take a look at China – an economy which has boomed in recent years. Their GDP has had a phenomenal rise and China has been lauded as the new economic superpower. Their GDP to debt ratio is staggering and nicely summed up by The Economist which states:

Problem loans have doubled in two years and, officially, are already 5.5% of banks’ total lending. The reality is grimmer. Roughly two-fifths of new debt is swallowed by interest on existing loans; in 2014, 16% of the 1,000 biggest Chinese firms owed more in interest than they earned before tax. 

It is clear that China requires more and more credit to generate less and less growth and quite obviously, this is an unsustainable for any economy. This leads us to the crux of the article; debt.

The previous demise was brought on by a variety of factors which led to the housing bubble to collapse. Having looked at the broader picture the traders at Samuel and Co have envisaged there being another collapse that is not brought on by the housing bubble. What then? The derivative market.

What is the Derivative Market?

The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets. Derivatives are traded by the world’s major banks, some of which are listed below.

The derivative market is booming. Derivative traders know that the riskier their bets, the bigger the gains and the bigger their bonuses. What does this lead to? Reckless trading which is encouraged by the major banks given that traders are given permission to leverage their positions 50-1. This reckless trading has caused the derivative market to expand at an unprecedented rate to the point where it is now bursting at its metaphorical seams. Once again, it’s time to demonstrate this by way of statistics:

Citigroup assets: $1,808,356,000,000 ($1.8 trillion)

Exposure to derivatives: $53,042,993,000 ($53 trillion)

JP Morgan assets: $2,417,121,000,000 ($2.4 trillion)

Exposure to derivatives: $51,352,846,000,000 ($51 trillion)

Goldman Sachs assets: $880,607,000,000 (￡880m)

Exposure to derivatives: $51,148,095,000,000 (51 trillion)

Bank of America assets: $2,154,243,000,000 ($2 trillion)

Exposure to derivatives: $45,243,755,000,000 ($45 trillion)

Morgan Stanley assets: $834,113,000,000 ($834m)

Exposure to derivatives: $31,0543,23,000,000 ($31 trillion)

As can be seen from the staggering numbers above, the biggest US banks are exposed to $247 trillion worth of derivatives and put simply, once the derivatives have turned against the banks the US government will be unable to bail the banks out on this occasion. This is drawn from the fact that the US government simply does not have the funds required to bail out the banks this time and it almost goes without saying that this will have disastrous consequences for the US economy and the effects of contagion.

The statistics released by the Economics and Statistics Department of the US Department of Commerce adds credence to our projection of there being a recession and this is best depicted by Fig 3:

From the above we can extrapolate that there has been a massive over extension of the temporary help services sector and once you factor in the fact that recessions come in cycles of 7 years and coincide with the presidential elections in the US there is real cause for concern. The traders at Samuel and Co Trading are predicting a collapse worse than the 2008 collapse fuelled by the derivative market and the consequences will be felt by every economy whether it is currently stable or booming.

Just remember, you heard it here first.

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Written By Sim Judge - FX Trader