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Month-End Market Update: September 2018

Last month we acknowledged that the normally “lighter” monthly read was an exception due to the emailing of our fully transparent performance reporting. That was not “lighter” and this month marks the 10 year anniversary of the 2008 financial crisis. Now that doesn’t sound like a “lighter” topic either, does it? Don’t worry, we have a happy ending.

On September 15, 2008, Lehman Brothers collapsed and filed for bankruptcy. Few professionals saw it coming and fewer fully understood the ramifications and the collateral damage that would occur from that single Lehman event. What really caused the recession that rivalled only the Great Depression in its magnitude?

Subprime mortgage loans, derivatives, too much leverage, credit default swaps, a bursting housing bubble or the accounting regulation FAS 157 on November 15, 2017. The requirement of banks to use mark-to-market accounting to account for mortgage backed securities, which made these securities worthless overnight. Balance sheets were shattered and the credit markets froze overnight. According to a Wall Street Journal article, former Fed Chair Ben Burnanke, released a new research paper stating that it was this credit-market panic and the runs on credit markets, not the housing bust, that better explains the crisis.

So who is to blame? Regulators, politicians looking for votes, greedy Wall Street Bankers, greedy Mortgage originators, greedy individuals flipping houses like stock day trading portfolio’s. They all had their hands in the cookie jar. And here we are, 10 years later, after trillions of dollars of bail outs, on a 10 year-long economic expansion and a bull market that continues as I write this article.

However, there were a few professionals who called the housing bubble. Gary Shilling, the president of consultancy A. Gary Shilling & Co. was quoted as saying in January of 2004 “Subprime loans are probably the greatest financial problem facing the nation in the years ahead.” In June of 2006 he said “The speculative housing bubble’s break will cause widespread pain…and be much worse economically than the 2000-2002 bear market.”

Here is what Shilling has to say about today’s environment, “The ultimate thing that brings down financial markets is excess leverage….So, you look where’s the big leverage, and right now I think it’s in emerging markets”. Shilling is particularly worried about the 8 trillion in dollar-denominated emerging market corporate and sovereign debt, especially as the U.S. dollar rises along with interest rates”. “The problem is as the dollar increases, it gets tougher and tougher for them to service (that debt) because it takes more and more of their local currency to do so.” According to Bloomberg, of that 8 trillion, $249 billion must be repaid or refinanced through next year.

It appears that American households have learned their lesson. According to the Federal Reserve Bank of St. Luis, American debt service payments as a percent of disposable income was too high at almost 14% pre-2008. Today, that number is just a little over 10%. While households and banks have cut back on leverage, corporations and the U.S. Government have gone the other direction according to Axios. Why is this a happy ending? Because we realize where the debt is in this world and we are watching it on a weekly basis through multiple research resources. When we do experience the next recession, I have confidence that the U.S. economy will bounce back as will the stock market. We Americans will live through it and we will be stronger, smarter, more efficient and better off in the long run. We will not hold through that market pullback, we will adjust accordingly. Markets change and so will we.

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