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Credit Markets Are In Big Trouble

In 2016, the market had the worst start to a new year ever. In the first 2 weeks of trading the SP 500 had lost nearly 10% of its value. This is just the start to the volatile 2016 markets. The Federal Reserve has kept rates near zero for too long, in hopes that it would boost consumer spending and help recover from the 2008 recession. Due to a decade of low interest rates the debt outstanding is at dangerous levels now.

After almost a decade of zero interest rates our economy has had almost no growth. Figure 1 shows that as of yearend 2015, we are at the same level we were at back in 2006. In summary, this is due to weak growth in the labor force and productivity. Many predict that the economy is now going to grow 2% vs a vigorous 3%. To put this in context, that's saying in 10 years the US will have a $21 Trillion economy vs $23 Trillion. A $2 trillion difference is a lot; the size of Italy economy is roughly $2 Trillion. With slower growth, that will mean fewer jobs, lower incomes and less investment opportunities.

(fig 1)

If we take a look at the high yield spreads in the market, we are at levels that were present back in August of 2008. From highs back in late 2007, the Sp 500 had lost roughly 24% of its value and continued to fall 70% from the August 2008 spread level as depicted in figure 2. The spread indicates fear in the market, as investors reduce exposure to risk and move to safer, higher quality bonds. I predict this spread to widen as the whole commodities market has extreme volatility in 2016 with volatile commodity prices, debt will continue to rise and repayment will become harder for commodity based companies.

(fig 2)

The level of US Distressed debt in the market right now is also at the same level as that of September 2008. With the low interest rates for almost a decade long it has allowed for companies to load up on credit but at these levels this amount of debt is unsustainable. In a one month period, distressed debt shot up 22% in January. We are nearing the end of a credit bubble and without a doubt the Central bank had a helping hand in creating once again, an inflated market.

(Fig 3)

Citi has a market clock chart (fig 4) which depicts the cycle of the US economy and it is blaring a warning sign right now. In Citi's Research, we are in "phase 4" which represents the stage where, stocks react to the lack of credit in the market. When we see a lack of credit in the market, a recession tends follows.

(Fig 4)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.