Predicting Loan Default Crisis and Stock Market Crash 2024-2025

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The US economy has been toyed around with. All the distress alarms have started to ring. Let us dive deep into the US economy and find its major pitfalls. I have strong evidence to show that the US and the Global economy might be in huge danger.

It was after the market crash of 2008 when Ben Shalom Bernanke introduced a stimulus package for economic relief in the country. He was a strong proponent of  Keynesian economics, which talks about how injecting money into the market helps to stimulate an economy. If there is more money in the economy, more the people will spend, more will be the economic growth. This money is usually injected into the markets via lowering the Fed rates or by circulation of stimulus packages. Let's see what actually happened in the 2008 crisis.

2008 Subprime lending crisis

Subprime loans were loans when the LTV was higher than 100%. There was a trend seen in the total debt of the US economy, which was the continuous increase in debt YOY from 2000 to 2004.

Source - U.S. Department of the Treasury Fiscal Services

Now, these loans majorly were subprime as well as NINJA in nature. Basically, the banks had stopped to differentiate between people who need loans and people who deserve loans. Banks were happy to earn from the securitization of their subprime loans. The Federal Reserve even saw a stupendous rise in the10-year breakeven inflation rate during 2000-2004.

Subsequently, we saw a rise in the Federal rates. It came into action to reduce the inflation, however, the loans which were distributed were subprime in nature. Hence, the rate of increase YOY delinquency rate in the USA started rising in 2004 itself. The Fed rates from 0.95 % in 2004 went to a whopping 5.25% in 2006. This kind of rate hike is beyond the wildest of the dreams of an investor.

Source - Board of Governors of the Federal Reserve System

 

Look at the YOY delinquency rate chart, its perfectly showing how the rate hikes of 2004 led to significant rise in default risk. 

Source - Board of Governors of the Federal Reserve System

A smart investor should have understood this trend in 2006 itself, when YOY delinquency rate started to become positive. The credit derivatives in the market were bound to fail. Markets were bound to crash.

Blunder since 2008

Ben Shalom Bernanke introduced a trend of extremely low rates of interest as well as stimulus packages. During the 90's, public debt grew only by 4.5% CAGR. From 2008-18, total debt increased by 7.27% CAGR. From 2019-23, the total debt has grown at 7.87% CAGR. This is a staggeringly huge number.  

US Department of the Treasury

Till when would this kind of debt-oriented growth in the economy be sustainable? Inflation and delinquency would come into the picture some or the other day. All kinds of markets would inflate due to excess money in the economy.

2024-25, CRASH KNOCKING AT THE DOOR

USA has recently witnessed its worst ever fiscal tightening since 2008 crisis. The Fed rates are above the 2008 crisis levels !

Source - Board of Governors of the Federal Reserve System

The YOY delinquency level had increased during the COVID period, but it was controlled by an extreme reduction in Fed rates. 11 Trillion dollar debt has been pumped into the economy since 2019 to 23. That's a massive amount.

Source - U.S. Bureau of Economic Analysis

As we can see, the GDP spiked massively on YOY terms in 2021. The GDP post rate hikes, has failed to deliver. US is also having a tough time managing its record-high unemployment rates in normal years. The unemployment caused due to COVID-19 is not considered for the analysis as this period is regarded to be a non-normal period.

Source - U.S. Bureau of Labor Statistics

This unemployment rate is the highest since 2018. The only way that the USA has got unemployment rates down over the years is by keeping the Fed rates dirt low. Now comes the main point, theYOY delinquency rate has now slowly crawled up in the positive territory during 2023. This indicates that these dirt cheap loan borrowers are not able to withstand this rate hike.

Source - Board of Governors of the Federal Reserve System

Now the argument that one can put up is, let's bring down the Fed rates. It will again increase employment as well as lower the delinquency rate. People having this argument are forgetting that rate decrease from here would lead to further inflation and eventually lead to a massive trend of layoffs by the companies cost cutting. When inflation would peak, people will have the highest unemployment rate and this would further amplify the rate at which loans would default. Reducing the rates would just amplify the crash.

Even if we increase the rates from here, this would just call the crash to happen much sooner. The rates would rise and the delinquency would magnify. This default crisis would also be followed up by a real estates crisis as there would be an oversupply in the markets post the loan default crisis.

Investor Sentiment 

What do we generally expect in a booming market?

• We expect that Small Cap Index returns  >  Large Cap Index returns.

If we see 1-year returns of Indices with different market caps, as of today (4th July 24)  -

• S&P 400 (Midcap Index) - 11 % return
• S&P500 (Largecap Index) - 24% return
• S&P 600 (Smallcap Index) - 6.38% return

How is this possible? Isn't the market all about high risk high reward?

The market is totally opposite of what it should be. The entire Stock market is showing its scared risk-averse nature as of now.

It's not only happening in the stock markets, it has even taken a toll on the bond markets. Just look at this US Treasury Bond yield curve.

The yield curve has also totally inverted now. Usually, long-term bonds have higher maturity premiums, higher default risks and much more. Hence in normal times, long-term bonds yields more than short-term bonds.

The current inverted graph is showing a massive shift of investors towards long-term bonds, hence the long-term yields have reduced. Due to the convergence of factors such as high delinquency rate, interest rate hikes and high unemployment, investors are seeing short-term bonds as more risky options.

THE INVESTOR IS SCARED, but he will not tell. He will still continue to think that high risk means high return. 

Market Overvaluation

Lets take very simple data to understand market overvaluation. The 5 year average PE ratio of Dow Jones Industrial Average has been 19.58.

The current PE is 31.29. The market is approx 60% above its 5-year PE average. The market is highly overvalued even according to the most simplest and fundamental indicators.

Market overvaluation is not even the point. The point in totality is the changing sentiment of the investors in an overvalued market. It also, might be an early call for the economic downturn.

 

 There is a possibility of a market crash. This crash at worst can go up to 45%.

This is a disastrous intersection between delinquency, Fed rates, unemployment and overvalued stock markets has been stretched beyond its tensile strength. I predict a market crash in 2025.

Citations and references

 

1.	(U.S. Department of the Treasury. Fiscal Service). (N.D.). FRED. https://fred.stlouisfed.org/series/GFDEBTN
2.	(Federal funds effective rate). (N.D.). FRED. https://fred.stlouisfed.org/series/FEDFUNDS
3.	(Board of Governors of the Federal Reserve System (US)). (N.D.). FRED. https://fred.stlouisfed.org/series/DRALACBN
4.	(U.S. Department of the Treasury. Fiscal Service). (N.D.). FRED. https://fred.stlouisfed.org/series/GFDEBTN
5.	(Federal funds effective rate). (N.D.). FRED. https://fred.stlouisfed.org/series/FEDFUNDS
6.	(U.S. Bureau of Economic Analysis). (N.D.). FRED. https://fred.stlouisfed.org/series/GDP
7.	(U.S. Bureau of Labor Statistics). (N.D.). FRED. https://fred.stlouisfed.org/series/UNRATE
8.	(Board of Governors of the Federal Reserve System (US)). (N.D.).FRED. https://fred.stlouisfed.org/series/DRALACBN
9	(Highcharts.com). (N.D.). Worldgovernmentbonds. https://www.worldgovernmentbonds.com/country/united-states/#:~:text=The%20United%20States%2010%2DYear,economic%20confidence%20and%20investor%20sentiment.
10.	(fullratio.com). (N.D.). https://fullratio.com/stocks/nyse-dow/pe-ratio