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Investments, Bankruptcy & Monetary Shadows.
Here is what we will be getting into today:
Investments Shifting Internationally.
Small Business Bankruptcies Rise Significantly.
U.S. Wealth Over Estimated.
Let's Dive In!
Fund Managers Are Shifting Investments Internationally
US fund managers are increasing their investments in international stock markets due to rising interest rates and fears of an economic slowdown. For over a decade, US stocks have outperformed most other developed and emerging markets since the financial crisis, but the trend began to reverse last year. European stocks have posted stronger returns than Wall Street's S&P 500 for four consecutive quarters, its longest period of outperformance since 2008.
Asset managers that rode the US growth trend have recognized the need to diversify and are working to boost their capabilities in international fixed income and global equities. The BlackRock Investment Institute has also said it expected US equities to underperform stocks in emerging markets, Europe, and China over the coming decades. Investors have pulled $34bn from US equities funds so far this year, while Europe has seen $10bn of inflows.
The US retains the biggest stock market in the world, but a combination of macroeconomic factors and differences in market structure are encouraging a shift. US dominance over the past decade was powered by outsized gains for large tech groups, which have been particularly sensitive to rising interest rates. European indices, in contrast, are more heavily weighted towards industries such as financial services and commodities, which are less affected by high rates.
In Asia, almost $16bn has flowed into Chinese equities funds, encouraged by Beijing's reopening after years of stringent coronavirus restrictions. China accounted for almost 50% of the $34bn inflows into emerging markets more broadly. Investors are realizing that China is investable again, and the increasing sophistication of investors such as charitable foundations, endowments, and family offices should also provide a longer-term boost to US investments overseas.
Small Business Bankruptcies Surge in the US.
Small businesses in the United States are witnessing a significant increase in bankruptcies, surpassing levels not seen since 2020. According to a UBS note, the situation could worsen as the consequences of recent banking crises begin to emerge. Private bankruptcy filings in 2023 have exceeded the highest point recorded during the early stages of the COVID-19 pandemic, with the four-week moving average for private bankruptcy filings in late February being 73% higher than in June 2020.
Small and mid-size enterprises are experiencing distress due to rising rates, persistent inflation, and slowing growth. The Federal Reserve's monetary tightening to combat inflationary pressures has contributed to the increase in bankruptcies. The fear of a credit crunch has further exacerbated the rise in defaults. Credit conditions are tightening for large businesses and individual borrowers as well.
Data from the American Bankruptcy Institute reveals that monthly bankruptcy filings in February 2023 exceeded 31,000, an 18 percent increase from February 2022. Chapter 11 bankruptcies, typically used by larger businesses, rose by 83 percent over the same period. The industries most affected by the wave of bankruptcies include real estate, health care, chemicals, and retail outlets.
Despite these challenges, President Joe Biden has cited higher rates of new business formation over the past three years without acknowledging the issues entrepreneurs face. The American Rescue Plan Act of 2021 provided emergency loans to millions of businesses; however, the administration plans to raise the corporate income tax to 28 percent in the coming months, which could further impact small businesses amid tightening credit conditions.
When Shadows Deceive: The Dangers of Extrapolating Nominal Wealth
At the end of 2022, U.S. households had a net worth of $139.9 trillion, with $124.9 trillion in non-cash assets such as stocks, bonds, and real estate. Non-cash assets derive their value from their utility and convertibility to cash. The total value of these assets is extrapolated based on a small percentage of daily market transactions, making the nominal wealth an extrapolation that can change dramatically.
In an extreme hypothetical scenario, if U.S. households wanted to trade their $124.9 trillion of non-cash assets for physical cash, they would only receive $8.7 trillion, resulting in a 93% write-down in nominal value. Similarly, if all commercial bank depositors demanded cash back in physical bills, they would receive just $0.19 for every $1.00 deposited due to the banking system being undercollateralized on a cash basis. During the COVID pandemic, the Federal Reserve created $4.7 trillion in new cash, while household net worth increased by $34 trillion. This massive increase in nominal net worth occurred during a period when nominal GDP increased by only 12%.
Like looming shadows, these wealth calculations can create the illusion of greater wealth than what truly exists, and it is essential to focus on the underlying factors. For instance, FTX token's market capitalization was an illusion used as collateral for borrowing and justifying commingling of client assets. The collapse of FTX occurred days after these revelations.
The U.S. stock market has a total market capitalization of around $40 trillion, but daily trading volume is significantly lower. The Fed's pandemic QE policy and current rate of QT have a significant impact on market value due to their relation to daily traded volume. Systemic risk can arise from seemingly small events, such as a single bank losing $18 billion on its bond portfolio, due to factors like rapid rate increases by the Fed, QT and RRP eliminating bank reserves, and the inherent risk of a run on the banking system since total bank deposits far exceed cash on hand.
For more in depth analysis of these topics, check out these articles:
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