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Why global markets are collapsing, and who is to blame

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china sink holeREUTERS/Stringer

  • Markets are falling all over the world, but this should not come as a surprise.
  • From US President Donald Trump’s trade war to Chinese debt, global markets are full of hair-triggers waiting to be pulled.
  • You are to blame also. All that mindless ETF-buying in your retirement account has created an unsustainable momentum boom in stocks.
  • The US Federal Reserve may be making a historic mistake about the bond yield-curve signal.
  • And you’re probably going to be surprised to learn about the $2.5 trillion in risky leveraged loans that corporations are sitting on.

Global markets are falling so fast it’s difficult to keep up with the numbers.

  • The Dow Jones industrial average in the US fell 3.2% on Wednesday.
  • In China, the Shanghai Composite was down 5.2% overnight.
  • Virtually all European indexes lost more than 1.5% Thursday.
  • Britain’s blue-chip FTSE 100 lost 1.6% in midday trading Thursday.

This is not random.

A major correction in the asset markets has been building for a while. There have been 10 years of economic growth since the great financial crisis of 2008 and a bull market in stocks of pretty much the same length. That’s a long time in terms of economic cycles, and we were overdue for a “reversion to the mean,” as statisticians say.

But it is not merely the case of the pendulum naturally swinging back. Eleven factors have distorted global markets over the past few years, priming the global economy for a sharp pullback.

Here is who you should blame if this correction turns into a full-blown rout or — worst-case scenario — a recession:

1. Trump, for starting a global trade war

America voted for a race to the bottom in President Donald Trump’s trade strategy, and now we’ve got it.

Putting up barriers to competing foreign goods, and taxing the services of other countries, may feel great in the short run. Who doesn’t want to protect the workers at home from their cheaper competitors abroad? But in the long run it means domestic production becomes more expensive, imports become more expensive, inflation goes up, less trade gets done in global aggregate, and investors reduce their expectations — and their actual investments — for the future. The global pie gets smaller, and markets are finally reacting to that.

2. The Chinese government and its love of theft

The trade war didn’t come from nowhere. Trump is angry for a reason. For years, China has allowed its companies to steal Western technology and to rip off Western intellectual property. For years, the West did nothing about it. Finally, the Trump administration has gone to war against China for its flouting of international trade norms. Now we are living with the result.

3. The Chinese government and its love of debt

china debt gdpPantheon Macroeconomics

Chinese debt of all types is nearly 320% of its gross domestic product, according to Pantheon Macroeconomics. At the same time, its GDP growth has slowed. For years, the Chinese government allowed its state agencies and supported industries to take on cheap loans to fuel growth. That produced an economic miracle that has propelled the Chinese economy into the most important on the planet.

But debt is debt. It doesn’t go away. Someone either has to pay it (and become poorer) or suffer a default (and become poorer). Debt merely pushes problems into the future. As Chinese debt rose, the growth it got from that debt has declined. So now the country is stuck with a slowing economy but a much larger debt pile than it had 10 years ago. Investors don’t like what they see, and Asian stocks are hurting as a result.

china gdpPantheon Macroeconomics

4. Venture capital: Excessive private valuations have created an opaque, illiquid market

SoftBank, the vast Japanese venture-capital investor, wants to invest $50 billion a year mostly in tech startups. It intends to raise $100 billion every few years on a rolling basis to do this. Ten years ago, it was considered a big deal if a startup in San Francisco or London received a $10 million investment. Now, companies struggle to generate headlines unless they are receiving cash injections in the hundreds of millions.

$100 billion here, $100 billion there, and pretty soon we’re talking about real money.

To sustain and justify these investments, company valuations have gone through the roof. There are more “unicorns” — private tech companies worth at least $1 billion — than can be counted.

The problem is that this is all occurring in the private market. It is difficult for outsiders to get information about these companies. Are they successful? Are they profitable? Are they growing? Do their business models make sense when scrutinized in the light of day (case study: Tesla)?

VC-funded companies sustain their valuations because VCs tell us they are valuable. The market for privately held equity is illiquid and opaque. This works just fine in a market that is rising. But in a downturn it will be very difficult to sell some of these stakes. So a lot of money from the large institutions — banks, retirement funds — is tied up in illiquid VC investments. Good luck, everyone!

5. Private equity: Leveraged loans are recreating the junk-bond crisis of the early 1990s

BIS leveraged loansThe Bank of International Settlements

The global total of “leveraged loans” has reached about $2.5 trillion. The Bank of International Settlements is worried about them. The Bank of England is worried about them. Credit Suisse recently wrote a letter to its clients defending its investments in them. Yet few normal people — those outside the world of finance geeks — know what they are.

Basically, it’s high-risk, low-quality debt. As central banks have held interest rates near zero for years, private equity has been on the hunt for investments with much higher interest rates. But higher rates come with higher risks.

A typical example of a leveraged loan looks like this: A PE firm finds a company that is already carrying debt but is still in trouble. Perhaps it is an old company that has been badly run. It is in need of restructuring, and it may succeed if you can inject a bit of cash. So the PE firm partners with a bank, which arranges a loan, underwrites the loan, and maybe packages it with a bond. The PE firm then bundles that with its own money and takes over the firm. At this point it restructures the company, which is a polite way of saying it lays off a lot of workers, ousts the incumbent management, and sells off the useless bits. After a while, the PE firm finds itself in charge of a smaller but more functional company that has a future ahead of it. So it sells the company, or floats it with an initial public offering. In the sale, the PE company gets rich and the bank gets back its loan.

The problem with leveraged loans is that they have a low credit rating, and the rating resets — downward — if interest rates go up. And interest rates are going up. A lot of investors automatically sell their debt holdings when they get downrated — so this is a pile of $2.5 trillion in high-risk debt resting on a series of negative rating triggers.

If this sounds a lot like the junk-bond crisis of the late 1980s and early 1990s, that’s because it is.

6. You and your addiction to ETFs: Mindless buying has created a boom in stocks based on momentum, not fundamentals

bernsteinBernstein Research

You probably have a retirement fund, like a 401(k) in the US or a private pension fund in the UK. And inside that savings account, you are probably pouring a percentage of your salary every month into an exchange-traded fund, which is an investment that simply tracks a major market index like the S&P 500.

They are good investments. Most “active” fund managers fail to beat the market each year, so an ETF guarantees that your return is the same as the market’s. For years, the market has been good. The more good it is, the more people pile into ETFs. It’s a boom based on momentum, and no one who owns an ETF actually examines the stocks inside it for their fundamental flaws or values.

Booms come to an end, of course, and momentum can reverse. We may be seeing that now.

7. The US Federal Reserve, which was warned against misreading the bond yield curve

The bond yield curve is an infamous predictor of recessions. If it inverts — meaning that if the yield on the two-year Treasury note rises above the yield on the 10-year note — recessions often follow, as such an inversion suggests that investors are very worried about the near-term economy. But US Federal Reserve Chairman Jerome Powell said recently that the flattening curve was less important than the neutral rate of interest. Many serious people believe that is a mistake or at least a version of “this time it’s different.” The yield curve has trended toward an inversion, and a lot of people think the Fed is misreading that signal.

yield curveFederal Reserve Bank of St. Louis

8. Italy, for failing to reform its politics or its banks

Italy is the third-largest economy in Europe and the ninth-largest globally, and yet it’s a basket case. Its bank system is riddled with sketchy debts. And the Italian economy is not growing fast enough to solve its problems.

Its government is on a fiscal collision course with the European Union. The EU wants to force it to set a budget that its elected government does not want. It cannot extract itself from the euro currency system without defaulting. And its people have refused to vote for reforms to their electoral system that may end the country’s infamously sclerotic governance.

Italy is shuffling toward a crisis, and it has neither the will nor the ability to change course. On its own, that’s not a huge problem. But in times like these, it’s just another layer of uncertainty telling investors to flee.

ItalyPantheon Macroeconomics

9. Britain: Brexit has left the world’s 5th-largest economy without a plan

The UK is the fifth-largest economy on the planet and yet it does not have a functional economic or trade plan for after March 2019, when its break from the EU is due.

That’s madness.

10. Chickens coming home to roost in Turkey, Argentina, Venezuela, and Pakistan

You can blame the individual, idiosyncratic governments of all these emerging-market countries for their economic crises, but that would be like blaming the trees for being in the woods. The underlying fact is that all these EM countries took on big US-dollar-denominated debts for inward investment purposes, and as the US Fed has strengthened the dollar those debts are now onerously expensive.

Currency crises don’t come from nowhere. In the short term, it’s bad for each individual country. But in the long term it’s bad for the US and the West too. EM countries grow faster than the developed economies, and if that growth disappears, then that will slow down the larger economies too.

11. The price of oil is heading toward $100 a barrel

Every extra dollar spent burning oil is a dollar not being put to better use elsewhere. Oil price rises contribute to inflation, too. Brent crude is over $81 a barrel, and that will cut economic growth, according to Louis Mullen and Gabriel Sterne, analysts at Oxford Economics.

They told clients Thursday morning: “We estimate that their rise since mid-2017 will reduce global GDP growth by 0.2ppts this year, compared to a scenario in which oil prices remain at $50pb after mid-2017. It could get worse. Should Brent continue to $100pb, our simulations show further cuts to global GDP growth by an average of 0.3ppts relative to our baseline in 2019 and 2020.”

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4 things kids need to know about money

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(NC) Responsible spending includes knowing the difference between wants and needs. Back-to-school season, with added expenses and expectations around spending, is the perfect time to not only build your own budget for the year ahead, but also to introduce your own children to the concept of budgeting.

The experts at Capital One break down four basic things that every child should know about money, along with tips for bringing real-life examples into the conversation.

What money is. There’s no need for a full economic lesson,but knowing that money can be exchanged for goods and services, and that the government backs its value, is a great start.
How to earn money. Once your child understands what money is, use this foundational knowledge to connect the concepts of money and work. Start with the simple concept that people go to work in exchange for an income, and explain how it may take time (and work) to save for that new pair of sneakers or backpack. This can help kids develop patience and alleviate the pressure to purchase new items right away that might not be in your budget.
The many ways to pay. While there is a myriad of methods to pay for something in today’s digital age, you can start by explaining the difference between cash, debit and credit. When teaching your kids about credit, real examples help. For instance, if your child insists on a grocery store treat, offer to buy it for them as long as they pay you back from their allowance in a timely manner. If you need a refresher, tools like Capital One’s Credit Keeper can help you better understand your own credit score and the importance of that score to overall financial health.
How to build and follow a budget. This is where earning, spending, saving and sharing all come together. Build a budget that is realistic based on your income and spending needs and take advantage of banking apps to keep tabs on your spending in real-time. Have your kids think about how they might split their allowance into saving, spending and giving back to help them better understand money management.

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20 Percent Of Americans In Relationships Are Committing Financial Infidelity

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Nearly 30 million Americans are hiding a checking, savings, or credit card account from their spouse or live in partner, according to a new survey from CreditCards.com. That’s roughly 1 in 5 that currently have a live in partner or a spouse.

Around 5 million people — or 3 percent — used to commit “financial infidelity,” but no longer do.

Of all the respondents, millennials were more likely than other age groups to hide financial information from their partner. While 15 percent of older generations hid accounts from their partner, 28 percent of millennials were financially dishonest.

Regionally, Americans living in the South and the West were more likely to financially “cheat” than those living in the Northeast and Midwest.

Insecurity about earning and spending could drive some of this infidelity, according to CreditCards.com industry analyst Ted Rossman.

When it comes to millennials, witnessing divorce could have caused those aged 18-37 to try and squirrel away from Rossman calls a “freedom fund”.

“They’ve got this safety net,” Rossman said. They’re asking: “What if this relationship doesn’t work out?”

As bad as physical infidelity

More than half (55 percent) of those surveyed believed that financial infidelity was just as bad as physically cheating. That’s including some 20 percent who believed that financially cheating was worse.

But despite this, most didn’t find this to be a deal breaker.

Over 80 percent surveyed said they would be upset, but wouldn’t end the relationship. Only 2 percent of those asked would end the relationship if they discovered their spouse or partner was hiding $5,000 or more in credit card debt. That number however is highest among those lower middle class households ($30,000-$49,999 income bracket): Nearly 10 percent would break things off as a result.

Roughly 15 percent said they wouldn’t care at all. Studies do show however that money troubles is the leading cause of stress in a relationship.

That’s why, Rossman says, it’s important to share that information with your partner.

“Talking about money with your spouse isn’t always easy, but it has to be done,” he said. “You can still maintain some privacy over your finances, and even keep separate accounts if you and your spouse agree, but you need to get on the same page regarding your general direction, otherwise your financial union is doomed to fail.”

With credit card rates hovering at an average of 19.24 percent APR, hiding financial information from a partner could be financially devastating.

But, Rossman adds, it’s not just about the economic impact but also the erosion of trust.

“More than the dollars and cents is that trust factor,” he said. “I think losing that trust is so hard to regain. That could be a long lasting wedge.”

Kristin Myers is a reporter at Yahoo Finance. Follow her on Twitter.

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7 Examples Of Terrible Financial Advice We’ve Heard

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Between television, radio, the internet and well-meaning but presumptuous friends and family, we’re inundated with unsolicited advice on a daily basis. And when it comes to money, there’s a ton of terrible advice out there. Even so-called experts can lead us astray sometimes.

Have you been duped? Here are a few examples of the worst money advice advisers, bloggers and other personal finance pros have heard.

1. Carry a balance to increase your credit score.

Ben Luthi, a money and travel writer, said that a friend once told him that his mortgage loan officer advised him to carry a balance on his credit card in order to improve his credit score. In fact, the loan officer recommended keeping the balance at around 50 percent of his credit limit.

“This is the absolute worst financial advice I’ve ever heard for several reasons,” Luthi said. For one, carrying a credit card balance doesn’t have any effect on your credit at all. “What it does do is ensure that you pay a high interest rate on your balance every month, neutralizing any other benefits you might get from the card,” Luthi explained. “Also, keeping a 50 percent credit utilization is a surefire way to hurt your credit score, not help it.”

Some credit experts recommend keeping your balance below 30 percent of the card limit, but even that’s not a hard-and-fast rule. Keeping your balance as low as possible and paying the bill on time each month is how you improve your score.

2. Avoid credit cards ― period.

Credit cards can be a slippery slope for some people; overspending can lead to a cycle of debt that’s tough to escape.

But avoiding credit cards on principle, something personal finance gurus like Dave Ramsey push hard, robs you of all their potential benefits.

“Credit cards are a good tool for building credit and earning rewards,” explained personal finance writer Kim Porter. “Plus, there are lots of ways to avoid debt, like using the card only for monthly bills, paying off the card every month and tracking your spending.”

If you struggle with debt, a credit card is probably not for you. At least not right now. But if you are on top of your finances and want to leverage debt in a strategic way, a credit card can help you do just that.

3. The mortgage you’re approved for is what you can afford.

“The worst financial advice I hear is to buy as much house as you can afford,” said R.J. Weiss, a certified financial planner who founded the blog The Ways to Wealth. He explained that most lenders use the 28/36 rule to determine how much you can afford to borrow: Up to 28 percent of your monthly gross income can go toward your home, as long as the payments don’t exceed 36 percent of your total monthly debt payments. For example, if you had a credit card, student loan and car loan payment that together totaled $640 a month, your mortgage payment should be no more than $360 (36 percent of $1,000 in total debt payments).

“What homeowners don’t realize is this rule was invented by banks to maximize their bottom line ― not the homeowner’s financial well-being,” Weiss said. “Banks have figured out that this is the largest amount of debt one can take on with a reasonable chance of paying it back, even if that means you have to forego saving for retirement, college or short-term goals.”

4. An expensive house is worth it because of the tax write-off.

Scott Vance, owner of taxvanta.com, said a real estate agent told him when he was younger that it made sense to buy a more expensive house because he had the advantage of writing off the mortgage interest on his taxes.

But let’s stop and think about that for a moment. A deduction simply decreases your taxable income ― it’s not a dollar-for-dollar reduction of your tax bill. So committing to a larger mortgage payment to take a bigger tax deduction still means paying more in the long run. And if that high mortgage payment compromises your ability to keep up on other bills or save money, it’s definitely not worth it.

“Now, as a financial planner focusing on taxes, I see the folly in such advice,” he said, noting that he always advises his client to consider the source of advice before following it. ”Taking tax advice from a Realtor is … like taking medical procedure advice from your hairdresser.”

5. You need a six-month emergency fund.

One thing is true: You need an emergency fund. But when it comes to how much you should save in that fund, it’s different for each person. There’s no cookie-cutter answer that applies to everyone. And yet many experts claim that six months’ worth of expenses is exactly how much you should have socked away in a savings account.

“I work with a lot of Hollywood actors, and six months won’t cut it for these folks,” said Eric D. Matthews, CEO and wealth adviser at EDM Capital. “I also work with executives in the same industry where six months is overkill. You need to strike a balance for your work, industry and craft.”

If you have too little saved, a major financial blow can leave you in debt regardless. And if you set aside too much, you lose returns by leaving the money in a liquid, low-interest savings account. “The generic six months is a nice catch-all, but nowhere near the specific need of the individual’s unique situation… and aren’t we all unique?”

6. You should accept your entire student loan package.

Aside from a house, a college education is often one of the biggest purchases people make in their lifetimes. Often loans are needed to bridge the gap between college savings and that final tuition bill. But just because you’re offered a certain amount doesn’t mean you need to take it all.

“The worst financial advice I received was that I had to accept my entire student loan package and that I had no other options,” said Gina Zakaria, founder of The Frugal Convert. “It cost me a lot in student loan debt. Now I tell everyone that you never have to accept any part of a college financial package that you don’t want to accept.” There are always other options, she said.

7. Only invest in what you know.

Even the great Warren Buffett, considered by many to be the best investor of all time, gets it wrong sometimes. One of his most famous pieces of advice is to only invest in what you know, but that might not be the right guidance for the average investor.

In theory, it makes sense. After all, you don’t want to tie up your money in overly complicated investments you don’t understand. The problem is, most of us are not business experts, and it’s nearly impossible to have deep knowledge of hundreds of securities. “Diversification is key to a good portfolio, and investing in what you know leads to a very un-diversified portfolio,” said Britton Gregory, a certified financial planner and principal of Seaborn Financial. “Instead, invest in a well-diversified portfolio that includes many companies, even ones you’ve never heard of.”

That might mean enlisting the help of a professional, so make sure it’s one who has your best interests at heart.

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