With the S&P nearing all time highs, all seems well again. It appears, as is often the case, that fears were overblown. The cataclysmic and unprecedented British decision to leave the European Union was not the doomsday for stocks that investors and "experts" initially thought it would be. Although briefly dropping to low 2000s, the S&P has rallied impressively, wiping out all post-brexit losses and then some. However, is all truly well? Or is something not quite right…
Yes, indeed, stocks have done well post-brexit - at least in America. Unfortunately, around the world the same cannot be said. There appears to be some significant problems with the European banking sector. Since brexit, the Europe Stoxx Bank Index is at the European banking crisis lows.
Indubitably brexit has not actually changed the fundamentals consequentially enough to warrant the sort of decline that these bank stocks have had. Perhaps though, Brexit was not the problem but the catalyst. For years the European banking sector and the ECB has scrupulously supported each other with all sorts of financial magic (ranging from the obvious monetary printing press to the lesser known hidden capital injections). Meanwhile, balance sheets have gotten worse and worse with ever more leverage and ever more bad loans -- as can be seen in the two charts below.
(Chart: Zerohedge, "The Texas Ratio, which measures the amount of non-performing assets and loans (including loans delinquent for more than 90 days) divided by the bank's tangible equity plus its loan loss reserve.")
(As is clearly evident, European banks are on average far more levered up than their peers)
Sooner or later, the house of cards has to come tumbling down, and brexit may have been the force (but not the reason!). Regardless of this, all is clearly not well here and it should concern US investors (if you need evidence of this, just look up the Austro-Hungarian bank Creditanstalt).
More close to home, the situation also looks very strange. Yes, stocks have rallied to highs, but bond yields have completely diverged with stocks.
The divergence doesn't appear to bode well for a continuation in the equity rally. But perhaps more scarily, the yields on these bonds have reached all time lows! Can any other generation of Americans imagine a time in which the prospects of growth are so low in this great country as to warrant a pathetic 1.38% yield on a 10 year US treasury? Or a 2.32% yield on a 30 year US bond?! Something is off.
To close, I wanted to talk about the absurd amount of negative yielding debt. Pre-2014 not a bond was negative yielding (in-fact, the idea of negative yielding debt was laughed at - and rightly so!). Pre-brexit, the amount of negative yielding debt was $11 Trillion. It is now a staggering $13 Trillion. $13 Trillion!
Perhaps this is the new normal, but as an Austrian, I believe a turn in this ridiculousness will emerge sooner or later - and more likely sooner rather than later. Evidence of the stupidity of current government bond yields can easily be seen in Spanish government 10-year bonds. Who in their right mind would purchase a Spanish 10-year bond yielding 1.14% when they can purchase an equivalent US treasury yielding 1.38%? A nearly completely bankrupt government with almost no chance of paying back its massive liabilities yields less than a (supposedly) risk-free US bond? Right…
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.