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Finding a Sea of Calm in the Rising Market Mania

The markets have begun to swoon and one of the canaries was two Thai tycoons.

This pair of Thai tycoons, neither of them well-known internationally, has made a total of $27 billion in acquisitions in the past year, more than all Thai companies spent abroad in the preceding three years.

That's the kind of statistic common in today's global deal mania, fueled by the glut of funny money. It raises a dreaded question: what happens when the music stops, and when global leverage stops being so available?

We're about to see….

The Thai billionaires – 74-year-old Dhanin Chearavanont and Charoen Sirivadhanabhakdi, 69 – were both well-established in the Thai business community, but nevertheless their combined $27 billion of acquisitions represented a risky gamble.

One bought a wholesaler on 50 times earnings, while the other bought the flagship Singapore brewer Fraser and Neave for $11 billion, quadrupling his holding company's debt-to-earnings ratio.

The Trouble is Thailand has been here before – and well within living memory. It was an orgy of leveraged and overpriced acquisitions that led to the Thai banking and monetary crisis of 1997 that sparked an Asia-wide crisis and led to the Thai stock market losing nine tenths of its value.

In today's markets, the aggressive Thai acquirers seem likely to be the first victims of any credit squeeze that might occur.

It Begins

After Fed Chairman Ben Bernanke's recent news conference, it certainly looks like the squeeze is beginning.

And last Friday, an auction of short-term domestic Chinese T-bills was only two-thirds subscribed. It turns out that the interbank rate in China is currently around 8%, way above the 3.9% the government was paying for its T-bills and way above Chinese inflation, which at least on official figures is running just over 2%. Tight money in China will inevitably affect the rest of us at some point.

Bernanke and his British and Japanese counterparts (but not necessarily European Central Bank head Mario Draghi) will fight bitterly against a credit crunch, but they will have little or no effect.

Contrary to a recent revisionist theory, Bernanke was already printing money like a madman in 2007-08 when the housing bubble burst, and he proved completely unable to avert a crunch. Walter Bagehot in 1873 said that the solution to a credit crunch was to lend unlimited amounts of money, but at very high interest rates.

In 2008, that solution was never tried – instead Bernanke dropped interest rates to zero – and it won't be this time, either.

Credit crunches hit because lenders have lost confidence in the value of the collateral against which they have lent. In those circumstances, misguided "mal-investment" has occurred, as Austrian-school economists call it, and that investment needs to be liquidated.

The market has become imbalanced, with more demand for funds than supply. To ensure that ordinary profitable commerce goes on, interest rates need to rise. That reduces the demand for funds (as borrowers put off projects that are no longer viable, and cease speculative investments) and increases the supply (as banks and other lenders decide that higher interest rates make it more attractive to save than to spend.)

If this happens, a recession occurs, to be sure, but there is no financial crisis and no prolonged period of underemployment such as we have seen since 2008.

What to Expect

The good news is that interest rates are already beginning to rise; the 20-year Treasury bond yield has risen from about 1.5% to around 2.4% yesterday. That won't be a smooth rise, any more than the stock market fell smoothly in 2000 and 2007, after it had peaked.

However, at some point long-term interest rates will revert to their normal level, 2.5% to 3% above the rate of inflation – or about 5% today. That will cause a credit crunch, which Bernanke and his international colleagues will attempt to fight, but they won't succeed, because by fighting it they will merely worsen the funds imbalance and reduce the availability of funding for trade and sound projects.

It's difficult to guess the timing of this downturn, because so much depends on unpredictable market psychology. At one extreme, if China's money tightness causes ripples in the world economy and U.S. Treasury bond rates rise sharply, panic could come quite quickly.

However, with central banks continuing to ease and markets generally continuing positive, my "best guess" is that interest rates will have to rise quite a lot further before a credit crisis ensues, and that certainly no break is likely while 10-year treasury yields remain below 3%, which was their level during much of 2009-2011. 2014, not 2013, looks to be the year of the great crash.

What Are the Buys?

As investors, we should look for impregnable balance sheets and businesses which are not too dependent on the whims of the super-rich. Emerson Electric (NYSE:EMR) is a good internationally diversified example of such a business – indeed Emerson is so recession proof that it has increased its dividend every year since 1957.

We should also look for countries like Singapore, Chile and Colombia which are well-run and underleveraged, and avoid countries like Brazil, India, Russia and Thailand which have in the past shown a tendency to get in trouble. Country funds like the iShares MSCI Singapore Fund (NYSE:EWS) are a good haven.

EMR and EWS will suffer too in a recession and economic downturn, but they will not succumb to the credit crunch and will still be healthy when the market bounces back.

Join the conversation. Click here to jump to comments…

  1. Lucy Joyce | June 21, 2013

    Please stop the scrolling of the Morning Buzz. It's very distracting.

  2. Troy | June 21, 2013

    Another great post Martin. Personally, I'm just buying stocks across the board via index ETFs. I think this bull market still has a few more months to go.

  3. H. Craig Bradley | June 21, 2013


    I think for individuals to attempt to "time markets" is both unproductive and stupid. Nobody can repeatedly do it successfully. Still, day traders and short termers are always trying to "get rich quick". In practice, its the reverse that usually occurs, especially when combined with greed and hubris. Public sentiment goes into negative decline, then stock markets follow most often and finally, a recession.

    So, its crash, crash, bang, bang. Here is the same old cycle: first bonds bottom-out, then stocks, and lastly commodities, including gold. When global markets crash they all go down together and there is no place to hide except cash. Don't bet on a big turn around in gold quite yet. Patience is always a virtue. Stay in cash for now, my friends.

  4. Spartacusstoo | June 23, 2013

    Commentary of late dwells on the interpretation of Bernankes suggestions. That is, there has not been a clear declaritive and thus we are talking the market again for the nth time and of course everyone reads into it what is intended. However, that doesn't bring forth a clear definition of future action. So, it is: talk the market down and down it went.

    Left out of this discussion completely is that which is overwhelmingly obvious. The debt and unfunded liabilities of the US government, the big bloated cow of unimaginable excesses. But then, who cares? The fact that the bloated cow, stinking as it does, has been stinking for a long time and people are just used to the odor. The facts are that the government cannot meet it's commitments based on taxes and so it has to borrow more and more. The debt ceiling is just a nuiscance and some, at least, in congress want to abolish the debt ceiling, sure, why not.

    The fact of the matter is that Bernanke cannot stop printing. The government has to have more and more money and the only way to get is by printing and the current Bernanke effluent is aimed at buying time, also known as kicking the can down the road. No, folks interest rates have to be FORCED to stay low otherwise the interest increase on the debt goes up right along with the need for more debt. It's baked into the cake.

    Result: in your face inflation and soon, as the need for new money is going to be monstrous.

  5. enthusceptic | June 24, 2013

    Yes, growth markets and sectors are the way to go! "Billionaire or bust" becomes bust for almost everyone who tries.

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