The stock market is high. What gets a market feelin’ good and oblivious to everything around it is a powerful drug, one that has the ability to cloud judgement like nothing else. The opium of markets is OPM, or Other People’s Money.
Where the stock market should be feeling blue and dealing with the realities of a world unraveling with trade wars and debt, it’s taken another course. It’s decided to just get high the best way it can. In that state of euphoria none of that other stuff matters, and everything is good. We have plenty of OPM to go around.
Right now, the stock market has a serious OPM crisis that very few people are talking about.
As you may know, Barataria predicted a serious stock market crash earlier this year. Some of that was realized when the trade war started to heat up, but it was nothing like we expected. It then rallied considerable. The S&P 500, once down almost 2% for the year, is now up almost 3.7%.
This is remarkable because interest rates are rising for the first time in over a decade. Inflation is a serious concern, as we noted before, and the bond yield curve is close to signaling another recession. But no one seems to care.
What is happening?
This is the time to pull out the old saying passed down to me by Herman Miller, an accountant who first taught me about this stuff when I was young. He was old enough to remember the crash of 1929, so his perspective was unique by today’s standards. “Never forget that the stock market is only a market for stocks,” he said. And it’s true.
All markets are a matter of supply and demand. If there is more money, there is more demand and prices rise. Nevermind the underlying fundamentals. Those should be driving the flow of money, but they don’t always. There are often reasons why there is simply too much money in the market at any given moment.
As Robin Williams once said, “Cocaine is God’s way of telling you that you have too much money.” Drugs are like that for both people and markets.
There are two kinds of OPM in the market right now. The first, and most obvious, is margin debt. That is money borrowed specifically to borrow stocks, and heavily charted and regulated since it caused so many problems when the bubble of the 1920s burst. Right now, it’s up to $650 billion, or 3.27% of GDP. It hasn’t been that high since 1929.
You can see that it goes along nicely with the rising market, in general, which is to be expected. But at some point, market risk should reasonable make the margin debt level off or even fall. It doesn’t, not ever. As we saw in 2008-9, investors keep borrowing money in a rising market right up until the point that they can’t. The addiction of OPM is too strong. It takes a margin call, or a situation where the stock has fallen so far that the debt is called in, before anything happens.
Margin buying increases volatility, but on the upside and the downside. It means that when things crash, they will really crash. The total margin debt is about 2.2% of the total stock market, and if it crashes back to where it stood at the recent minimum in 2009 stocks will lose 1.2% from just margin calls.
That’s not the only kind of OPM, however. China has a lot of experience with opium, having been forced to get hooked on it by the British, who were tired of seeing all their silver disappear into the nation to buy tea and porcelain in the mid 1800s. The British introduced the addictive stuff because they knew that cash flows were the key to everything.
China is experiencing its own debt crisis. The government has tried to tighten up on private borrowing, which was completely unregulated and out of control. Authoritarian nations don’t like that sort of thing. We don’t have a good real-time estimation for money flows out of China, but they are obviously increasing. The value of their currency, the Yuan Renminbi (People’s Currency, RMB) is dropping rapidly just as it did the last time that currency fled China rapidly while large defaults increase.
Why is money leaving? For one thing, a trade war means that no one wants to hold RMB. For another, much of it was US money in the first place, US Dollars borrowed cheaply during the last Depression but sent to China for greater returns on the shadow banking market. In China, small lenders operating as something like loan sharks could easily get 20% for their money.
That’s not the case any longer. A rapidly falling RMB means that US Dollars are more expensive and money flees the nation rapidly. Think of it as margin buying for a whole nation, not a stock market.
When this money repatriates, it has to be parked somewhere. That means US Treasuries and perhaps the stock market. It’s lazy money with nowhere to go, and the appeal of hooking up with OPM in the stock market looks great on a hazy summer day.
The last time Chinese money came into the US like this, the total amount was about $1.5 trillion and possibly $500 billion wound up in stocks or equities. That’s similar to the margin amount.
None of this is good for anyone in the long term, of course. The fundamentals are still turning and the risk is there. A small hiccup can be amplified as everyone jonesin’ for another hit can’t find one and the margin calls come in.
OPM feels great as long as it keeps coming, but when it stops it’s a serious crisis. When will we run out of Other People’s Money? It’s hard to say, but it’s unreasonable to see this continue through the end of the year. Any strong shock will be amplified. It will be nasty when the market is in withdrawal after the OPM that’s keeping it high right now just plain dries up.