Month: January 2016

It’s midnight in Japan – so it makes perfect sense that this headline – SOME BOJ OFFICIALS ARE SAID TO VIEW MORE STIMULUS AS CLOSE CALL – would drop and spark a spike in USDJPY which in turn drives Crude oil and stocks surging higher…

 

 

Once again, as we detailed over the weekend, fundamentals are simply irrelevant:

with the current magnitude of EM outflows seemingly entirely offsetting ongoing ECB and BoJ QE, it seems fair to wonder whether the sorts of increases likely from the BoJ next week and the ECB in March will have as great an effect as investors seem to be hoping.  

It appears we may need more headlines.

via Zero Hedge http://ift.tt/1VkPApi Tyler Durden

When last we checked in on Spain, the country was struggling to make sense of largely inconclusive elections held in late December.

Mariano Rajoy’s PP managed to secure the most seats in parliament, but when the electoral smoke cleared it was apparent that Spanish voters were no longer content with the political status quo.

The combined vote share of PP and PSOE sank to its lowest level since the eighties as Podemos and Citizens capitalized on widespread disaffection with Rajoy’s handling of the economy (among other things) to capture 69 and 40 seats respectively. Here’s a look at the official results:

Fast forward one month and the country is struggling to form a government.

On Friday, Rajoy delayed a confidence vote saying he didn’t have “the support that is needed” to move ahead after Socialist leader Pedro Sanchez indicated PSOE would seek to form a “progressive” government with Pablo Iglesias’ Podemos, which many equate with Syriza in Greece. “We made a serious offer for a government and Rajoy has taken a step back,” Iglesias said last week. “Change is possible [and] I hope the socialists will rise to the challenge,” he added.

As Reuters notes, “the Spanish constitution sets no deadline for a prime ministerial investiture vote to take place, but once a candidate seeks the confidence of parliament a two-month deadline for the formation of a government comes into effect.” If a government isn’t in place within two months, new national elections are held.

“An early election in the short or medium term seems the most likely outcome,” Deutsche Bank said, the day after last month’s vote.

Whether or not PSOE will ultimately be willing to align with Podemos remains to be seen, but if the coalition does indeed come to fruition, it would be bad news for Berlin and the eurocrats in Brussels. A leftist government would move quickly to roll back austerity (or “fauxsterity” as we call it, given that the country’s debt-to-GDP has actually risen since the debt crisis) and adopt fiscal policies that bear little resemblance to what Wolfgang Schaueble would consider prudent.

In other words: what happened in Portugal is about to happen in Spain. Brussels’ preferred PM is about to be ousted by a coalition of leftist parties, and that, in turn, suggests that the idea of fiscal retrenchment will be thrown out, along with anything that even looks like austerity. That could trigger a showdown between Madrid and Brussels over Spain’s intention to adhere to EU deficit targets. The threat of Catalonia moving ahead with an independence bid only complicates things, as secession would add some 25 percentage points to Spain’s debt-to-GDP ratio (as a reminder, Podemos would vote to allow a secession referendum to move forward).

Below, find some commentary from various sellside desks on where things are headed in Spain and what it means for markets.

*  *  *

From Barclays

Following a round of meetings with the King of Spain, the leader of the Podemos party, Pablo Iglesias (radical left), has made a formal offer to the PSOE party (centre-left) to form a left-coalition government. Iglesias delivered the message to the King, who in turn informed the leader of PSOE. Both parties together have a total of 159 votes (90+69 respectively). It is likely, we believe, that the conservative nationalist Basque party, PNV, which has six MPs, and the radical left IU with two MPs would also join the coalition, taking the total to 167 MPs. This would still leave the coalition needing nine MPs to achieve an absolute majority in the 350-seat parliament. Therefore, it would need some MPs from other parties to abstain in the parliamentary vote.

We don’t rule out other parties, such as PP and Ciudadanos, submitting proposals in the coming days, so a PSOE-Podemos led government is not a certainty. We are still of the view that a coalition government is more likely than holding new general elections in Q2 16. 

A PSOE-Podemos coalition: a mild negative for markets

We think that a PSOE-Podemos outcome would be a mild negative for markets for two main reasons. First, it would be a minority government, unlikely to find much support from the other groups. Second, in the past Podemos has put forward a series of reforms that would entail rolling back various reforms enacted by the previous government. While PSOE will limit the potential tail risks on the policy side, depending on the final outcome of the policy agenda agreed between PSOE and Podemos and the negotiations with nationalist parties, there could be some risks of non-growth-friendly policy changes.

Overall, as the left-coalition would lack an absolute majority, we think that the scope for any material policy change that does not have wide parliamentary support is very limited. Therefore, we strongly believe that the downside policy risks are limited. As Spain has experienced four years of important reforms, mainly the restructuring of the banking system, a new fiscal compact to control regional deficits and some notable labour market reforms, we would caution against an overly gloomy outlook for Spain. Nonetheless, the political uncertainty and the presence of some radical left members in a government would justify comparatively wider sovereign spreads, for example, versus Italy.

Next steps:

1)  The King will continue to hold discussions with the parties to hear which ones will offer some likelihood of a parliamentary approval vote. There is no specific deadline for these talks, even if it is in the interest of all involved parties to minimise the period of uncertainty. We think PP will get the first chance to form a government. After the King’s approval, PP will need to submit its government proposal to a parliamentary vote. From the time of this vote, the parliament has up to two months to nominate a government. Failure to do so would automatically lead to elections in Q2 16.

2)  If PP does not secure an absolute majority of MPs in the parliamentary vote (ie, at least 176 votes), which appears most likely, in our opinion, then two days later there would be a second vote in which a simple majority would suffice for PP to form a government.

3)  If PP fails to win sufficient support, the King would need to decide which party gets the mandate to try to form government. The would most likely be PSOE, the second most-voted party. PSOE will need to follow a similar procedure to the one described above for PP.

4)  If this process, which can last up to two months after the first vote, does not result in a government being nominated, it would mean new general elections eight weeks later in April/May 2016.

From Citi

The socialist PSOE remains the kingmaker for any possible government in Spain, following the inconclusive December 20 elections. By declining the King’s appointment, we reckon Mr. Rajoy may have tried to gain some time for finding potential support from the socialists. Rajoy’s move shifts the focus to the socialist leader Sánchez, who now has to prove his ability to assemble an alternative and credible government coalition. We believe that failure to secure such a left-wing alliance is likely to eventually push PSOE to allow a PP-led minority administration. According to Spain’s Constitution, a new round of elections would take place if no candidate is elected in Congress after two months of the first parliamentary vote to elect a PM.

We reckon at the margin, Iglesias’ comments make a left-wing alliance more likely, although by no means certain. To secure such a left-wing alliance, Mr. Sánchez would not only need support from both Podemos and United Left (jointly adding to 161 seats, i.e. 15 seats short of an absolute majority), but also a commitment from other regional parties (including the Basque and Catalan pro-independence parties) to at least abstain in the parliamentary vote to form a government. Furthermore, Mr. Sánchez would also need to tame tensions from regional factions within his own party who oppose joining forces with the far-left Podemos. In our view, A left-wing PSOE/Podemos/IU government would probably represent a significant shift in Spain’s fiscal policy towards more loosening, with Podemos calling for an end to fiscal austerity and no particular commitment to the Stability and Growth Pact targets.

According to a poll by Metroscopia for daily El Pais, 49% of respondents would prefer a broad government coalition between PP, PSOE, and C’s, while 36% would prefer a left-wing alliance between PSOE, Podemos, IU, and other regional parties. A separate poll conducted by GAD3showed that the centre-right PP would obtained 30.1% of support if new elections take place today, up from 28.7% in the December 20 elections, and accounting for 131 MPs (vs. 123 MPs currently). Support for the socialist PSOE would fall to 21.3% (projected at 89 MPs) from 22.0% in December 20 (90 MPs), for Podemos 20.0% (65 MPs) from 20.7% (69 MPs), and for Citizens 13.4% (38 MPs) from 13.9% (40 MPs). Separately, the EU Commission is due to publish a report on Spain in February warning over the rising risks on confidence levels from the ongoing political instability, daily El Pais reports citing unidentified sources.

From JP Morgan

At first blush, these developments seem to increase significantly the likelihood of a left government. If it transpires, this would be important for Spain. A left government would aim to reverse some of the fiscal consolidation and structural reforms implemented in recent years. This will likely lead to a conflict with the European Commission. The macro consequences are hard to gauge, but uncertainty and conflict are likely to weigh on economic performance.

At this stage, it is likely that the King will ask PSOE leader Sanchez to try to form a new government. And the most touted option is exactly a left coalition with Podemos. Podemos may be willing to drop the demand for a Catalan referendum, which is a red line for PSOE. But a PSOE-Podemos coalition would still need the support of the Basque and Catalan nationalist parties. While this would not be easy to achieve, it is possible and would likely have dire consequences in terms of governability (for details see below). However, we note that the opening from Iglesias should be primarily read as a tactical move to put pressure on PSOE, implicitly making it responsible for any failure to clinch a deal leading to a left government. The reaction from PSOE – which has rebuked Iglesias’ words as an unacceptable ultimatum – confirms this interpretation.

If the constraints surrounding a left government prove unsurmountable, PSOE leader Sanchez may try to form a moderate coalition with Ciudadanos (which in turn would hinge on PP abstention). Failing both options, a last resort alternative would be a centrist platform – i.e. a PP government in cooperation with Ciudadanos and with abstention from PSOE.

In our view, though, the chances of a new election have now risen as well. This is because the political climate has become even more conflictual, with both PP and PSOE struggling to entertain constructive talks and more engaged in the self-preservation of the incumbent leaderships. A new election would not necessarily change the current parliamentary configuration, but it could be the catalyst needed to foster a more conciliatory approach. The Constitution allows two months for government building following the first parliamentary vote on forming a new government; otherwise an election is called. In light of this exceptionally high level of uncertainty, we now expect a deterioration in the high frequency economic indicators.

Below, we briefly recap the constraints faced by a left government, in order to provide the reader with a set of key issues to monitor.

First of all, the birth of a left government involves two separate dimensions in Spain: the ability to forge a deal between the center-left PSOE and the extreme left Podemos on the one hand and the need to strike a compromise respectful of national unity with the nationalist parties on the other hand.

There are several conditions that would need to be fulfilled to see a left government in Spain. A deal between PSOE and Podemos is a necessary condition. We believe this is possible, but it would be very costly for PSOE, who would risk being marginalised by its radical coalition partner. As mentioned, Iglesias’ openings contain a strong tactical element, as an attempt to put pressure on PSOE, but they add nothing about the specifics of a viable government agreement. While Sanchez is very keen on forging a deal, several senior leaders in PSOE are very sceptical of an agreement with Podemos but have so far been cautious in voicing their opposition. It is possible that this will limit their room to manoeuvre, and we will discover more at the end of the month when a crucial PSOE summit is planned.

In conclusion, we believe much will depend on the cost-benefit analysis that the PSOE leaders will do and whether they will give the green light to an agreement that risks undermining the long-term survival of the party. Furthermore, at the time of forging a left coalition with help from the pro-independence camp, we think the PSOE leaders will have to face the pressure stemming from a predictable major backlash from the business and international community, together with higher market pressure and a likely deterioration in the high frequency economic indicators.

Overall, we acknowledge that the risks are shifting in favour of a left government compared to our earlier analysis. In the end, it is possible that PSOE will decide that the prospects of the party are fairly grim whatever choice is taken and will favour getting to power as the least costly alternative. In that case, we remark that the coexistence between PSOE and the extreme left Podemos will be challenging in itself. This obviously regards the Catalan issue but it applies more generally to the economic policy domain (including the 0.8% of GDP budget adjustment requested by the Commission).

*  *  *

We wonder if the ratings agencies will immediately pull a Poland and move to downgrade Spain in the event an “undesirable” government takes power and ruffles Berlin’s feathers. 

via Zero Hedge http://ift.tt/1VkPA8Y Tyler Durden

Amid the so-called "ceasefire" in Ukraine, yet ongoing shelling in many regions, the Donbass news agency reports that more than 20 Ukrainian solders have died and over 200 soldiers are hospitalized after an apparent leak of a deadly virus called "California Flu" from a US lab near the city of Kharkov.

 

As Donbass News International reports,

More than 20 Ukrainian soldiers have died and over 200 soldiers are hospitalized in a short period of time because of new and deadly virus, which is immune to all medicines. Donetsk People's Republic intelligence has reported that Californian Flu is leaked from the same place where research of this virus has been carried out.

 

The laboratory is located near the city of Kharkov and its base for US military experts.

 

Information from threatening epidemic is announced by Vice-Commander of Donetsk Army, Eduard Basurin.

 

Leak of deadly virus in Ukrainian side was published first time on 12.1.2016:

 

via Zero Hedge http://ift.tt/1K6ErIg Tyler Durden

While not as dire as his Davos forecast, in which he warned that “if assets remain correlated and things continue to move in the “wrong” direction, “there’ll be a depression”, earlier today Ray Dalio released a new Op-Ed in the FT in which the manager of the world’s largest hedge fund (excluding Apple’s Breitburn of course), once again implores the Fed and other central banks to stop tightening and boost global easing.

The reason for this is what while Dalio admits the U.S. business cycle, now in its seventh year, reflects a need to tighten monetary conditions and hike rates, the bigger threat is the long-term debt supercycle, as according to Dalio we are “near the end of the expansion phase of a long-term debt cycle, which typically lasts about 50 to 75 years.”

The irony of Dalio’s Op-Ed  admits that QE has reached its limits…

What I am contending is that there are limits to spending growth financed by a combination of debt and money. When these limits are reached, it marks the end of the upward phase of the long-term debt cycle. In 1935, this scenario was dubbed “pushing on a string”. This scenario reflects the reduced ability of the world’s reserve currency central banks to be effective at easing when both interest can’t be lowered and risk premia are too low to have quantitative easing be effective.

 

* * *

[Now] the expected returns of bonds (and most asset classes) are relatively low in relation to the expected returns of cash.

 

As a result, it is difficult to push the prices of these assets up and it is easy to have them fall. And when they fall, there is a negative impact on economic growth.

 

When this configuration exists — and it is also the case that debt and debt service costs are high in relation to income, so that debt levels cannot be increased without reducing spending — stimulating demand is more difficult, and restraining demand is easier, than is normally the case.

… he urges the Fed and its peers to do more:

It is because of the long-term debt cycle dynamics that we are seeing global weakness and deflationary pressures that warrant global easing rather than tightening.

 

At such times the risks are asymmetric on the downside and it behoves central banks to err on the side of waiting until they see the whites of the eyes of inflation before tightening.

 

Since the dollar is the world’s most important currency, the Fed is the most important central bank for the world as well as the central bank for Americans, and as the risks are asymmetric on the downside, it is best for the world and for the US for the Fed not to tighten.

It is “best for the US”, or best for the world’s biggest hedge fund?

All of this, of course, has previously duly explained in the latest Matt King letter, in which he observes that we have now entered a liquidationist regime where thanks to EM selling of reserve assets, the global markets are collectively seeing asset prices decline while liquidity exits. However, unlike Dalio, King has the intellectual honesty to admit that the centrally-planned farce is effectively over, and that any can-kicking will only make the final rout that much more destructive.

For Dalio, whose career is to manage assets while piggybacking on a 75 year supercycle of central bank generosity, continued asset declines are a career killer and he knows it.

So what explains Dalio’s disingenuous appeal to the US central bank?

This: “Hedge fund billionaire Ray Dalio’s key All Weather Fund, which aims to perform well in both good and bad markets, suffered annual losses for the second time in three years in 2015. The All Weather Fund returned -7% in 2015.”

via Zero Hedge http://ift.tt/1PxlEln Tyler Durden

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

If the "solution" doesn't enable the accumulation of capital in all its forms by individuals and households, it isn't a real solution–it's just another top-down scheme that institutionalizes subsistence serfdom.

Phrases like reviving the American Dream emit the lingering stench of empty political rhetoric mouthed by bought-and-paid-for candidates. But if we wave aside this foul smell, we're left with a very profound topic: reviving broad-based opportunity.

Longtime collaborator Gordon T. Long and I discuss what it will take to revive opportunity in a new 27-minute video Reviving the American Dream.

The status quo "solution" to the decline of opportunities for meaningful work is predictably top-down: guaranteed income for all, a.k.a. "welfare for all." This is of course a re-hash of the Keynesian Cargo Cult's 1930 fix for the Great Depression, except on a far grander scale.

There are three completely unsupported assumptions in every proposed "welfare for all" scheme:

1. The trillions of dollars/ euros/ yen etc. required to fund "welfare for all" can be raised from taxing profits and wages. Yet wages and profits are both set to decline sharply in the near-term as the global recession tightens its grip and longer term from the unstoppable forces of automation.

 

2. Paying people to do nothing will free people to become artists, entrepreneurs, etc. This is a noble ideal, but if we look at communities that have become dependent on top-down central-state welfare, we find despair, social depression and the collapse of real community.

"Welfare for all" debilitates the community by stripping away the sources of meaningful work and positive social roles. I explain this further in my book A Radically Beneficial World: Automation, Technology and Creating Jobs for All.

 

3. Though few if any supporters of "welfare for all" schemes state this directly, the underlying assumption is that "welfare for all" is a temporary measure to get the unemployed/under-employed through a rough patch, and that the economy will magically heal itself and create millions of new jobs if given time.

Automation has changed the economy in ways the status quo cannot dare admit. As a result, pundits profess their faith in the false premise that technology will always create more jobs than it destroys. As I explain in my book, this is no longer true, as the prime directive of automation is the elimination of costly human labor–not just in the developed economies, but in the developing economies.

The full-spectrum failure of "welfare for all" is the inevitable result of its essential nature as yet another central-state/bank top-down "solution." Real solutions no longer come from central states/banks that have long been captured to serve the interests of Elites. Real solutions are bottom-up: the community economy is the only sustainable foundation for broad-based opportunity and the wide spectrum of solutions that support employment, capital accumulation and vibrant local economies.

If the "solution" doesn't enable the accumulation of capital in all its forms by individuals and households, it isn't a real solution–it's just another top-down scheme that institutionalizes subsistence serfdom. Stripped of unrealistic ideological faith, "welfare for all" is revealed as nothing more than institutionalized subsistence serfdom.

Reviving the American Dream boils down to reviving bottom-up opportunities within the community economy.

Gordon and I discuss the bottom-up community economy in Reviving the American Dream (27:48 video).

via Zero Hedge http://ift.tt/1PvQQI1 Tyler Durden

If Russian and Western airstrikes are “degrading and defeating” Islamic State, someone forgot to tell al-Hayat Media Center, the brain trust for a sprawling network of discrete propaganda production units that are spread across nearly a dozen countries.

While the group’s operational capabilities may be dwindling, its propaganda arm is apparently no worse for wear having released dozens of clips this month, including a brand new video out Sunday featuring the Paris attackers.

Over the course of 17 minutes, the group celebrates the November attacks with a montage of clips taken from the Western media’s coverage of the massacre. The video also shows each attacker including alleged ringleader Abdelhamid Abaaoud whose voice is can be heard throughout. “It allegedly features one of the Bataclan theater attackers and a suicide bomber Omar Ismail Mostefai, named in the video as Abu Rayyan Al-Faransi,” RT notes.

Of course there’s the obligatory execution footage including beheadings and firing squads and near the end, French President Francois Hollande’s face is superimposed over the severed head of a prisoner.

The group also threatens British PM David Cameron who appears with a red bullseye on his face.

“We are in the process of examining this latest propaganda video which is another move from an appalling terrorist group that’s clearly in decline and in retreat,” Cameron’s spokeswoman told Reuters on Monday.

“The following are the final messages of the nine lions of the khilafah who were mobilized from their dens to bring an entire country — France — to her knees,” the video reads, after which each attacker records their “final message” to the world prior to the suicide mission.

Hours after the video was released, Europol said ISIS is planning “large scale attacks” in Europe. 

#BREAKING IS planning ‘large scale’ attacks focused on Europe: Europol

— AFP news agency (@AFP) January 25, 2016

“A report coinciding with the opening of a new counterterror centre in the Hague shows how the so-called Islamic State had developed a new combat style capability to carry out a campaign of large-scale terrorist attacks on a global stage — with a particular focus in Europe,” the chief of the EU police agency told reporters today.

What shouldn’t get lost here is that ISIS conducts near daily attacks across the globe, but those tragedies are generally relegated to the back pages because they occur outside of the “civilized” world. If and when the group does strike Europe again, you can bet that will be the last straw for voters exasperated with the flood of asylum seekers flooding across the bloc’s porous borders. In other words, Schengen is one suicide bomb away from being officially dismantled, which means that the next time someone dies in a suicide attack in Europe, Europe itself will die with them.

via Zero Hedge http://ift.tt/1njncJj Tyler Durden

Following a rerun of September 2015, when Draghi sent market expectations about ECB action sky-high only to massively disappoint in December (we will have to wait until March to see if it is deja vu all over again) last week, this week is just as big for central bank jawboning with the FOMC (Wednesday) and the BoJ meeting on Friday, with hopes that they will at least hint of more easing if not actually do much.

As DB’s Jim Reid summarized, “it feels unlikely they will be negative events for the market even if there is no actual hard signs of a Fed relent or fresh stimulus this month from Kuroda. As a minimum we should hear hints of more dovish soundbites relative to their last meetings.”

Here are the key events in the coming week, courtesy of Deutsche Bank:

• There’s no shortage of important data releases, central bank meetings and corporate earnings results this week. We kick off this morning in Europe with the German IFO survey and UK CBI orders data while in the US this afternoon the Dallas Fed manufacturing activity print is due.
• There’s no data of note in Europe on Tuesday but its set to be a busy day in the US with the FHFA house price index and S&P/Case-Shiller home price index data due, the flash January services and composite PMI’s, consumer confidence and finally the Richmond Fed manufacturing activity index.
• Early on Wednesday we get the only data of the week out of China with December industrial profits data and the January consumer sentiment reading. In Europe on Wednesday we will see consumer confidence readings from Italy, Germany and France. In the US new home sales data for December is due before the conclusion of the FOMC meeting later in the evening.
• Turning to Thursday in Europe we’ll get the final January consumer confidence data for the Euro area. In Germany we’ll see the preliminary January CPI report along with the advance Q4 GDP report for the UK. In the US it’s all about the preliminary durable and capital goods orders data for December, while pending home sales and initial jobless claims data is also expected.
• We close out the week in Asia on Thursday with a bumper set of data from Japan including CPI, employment indicators, industrial production and housing starts. If that wasn’t enough we’ll also get the BoJ meeting. The European session will be focused on the Euro area CPI report, while we’ll also get inflation and GDP data from France. Any hopes for a quiet end to the week in the US will be in vain with the advance Q4 GDP report due (expectations for +0.8%) along with the advance goods trade balance, core PCE, employment cost index, Chicago PMI and University of Michigan consumer sentiment print.

For those who prefer table format summaries, here it is from BofA…

… and Citi:

Source: DB, BofA, Citi

via Zero Hedge http://ift.tt/1TjUDYT Tyler Durden

Submitted by Wolf Richter via WolfStreet.com,

“Some very critical things are hidden.”

After the white-knuckle sell-off of global equities that was finally punctuated by a rally late last week, everyone wants to know: Was this the bottom for stocks? And now Moody’s weighs in with an unwelcome warning.

If you want to know where equities are going, look at junk bonds, it says. Specifically, look at the spread in yield between junk bonds and Treasuries. That spread has been widening sharply. And look at the Expected Default Frequency (EDF), a measure of the probability that a company will default over the next 12 months. It has been soaring.

They do that when big problems are festering: The Financial Crisis was already in full swing before the yield spread and the EDF reached today’s levels!

And so, John Lonski, chief economist at Moody’s Capital Markets Research, has a dose of reality for stock-market bottom fishers:

For now, it’s hard to imagine why the equity market will steady if the US high-yield bond spread remains wider than 800 basis points [8 percentage points]. Taken together, the highest average EDF metric of US/Canadian non-investment-grade companies of the current recovery and its steepest three-month upturn since March 2009 favor an onerous high-yield bond spread of roughly 850 basis points.

Moody’s EDF began spiking last summer and has nearly doubled since then to 8%, the highest since 2009.

The average spread between high-yield bonds and Treasuries has widened to 813 basis points (8.13 percentage points). But at the lower end of the junk-bond spectrum (rated CCC and below), the yield spread is a red-hot 18.4 percentage points.

This chart shows the average high-yield spread (blue line) and the CCC-and-below spread (black line). Note how far we were already into the Financial Crisis before both spreads reached the today’s levels: March 13, 2008, and September 30, 2008, respectively:

So how does the yield spread impact equities and the broader economy?

A wider-than 800 basis-point high-yield spread reflects elevated risk aversion that will reduce capital formation and spending by non-investment-grade businesses. In addition, ultra-wide bond yield spreads favor a continuation of equity market volatility that should sap the confidence of businesses and consumers.

Which has consequences for stock prices.
 

Yield Spreads and EDF sink M&A.

The premium over market price that acquiring companies pay has been rocket fuel for share price increases in entire sectors as analysts hype the potential for all these companies to receive buyout offers with huge premiums.

Last year, US M&A activity (involving at least one US company) soared to $3.34 trillion, a record 18.6% of US GDP. The prior record was 17.8% of GDP in Q1 2000, just before the dotcom bubble began to implode. The report:

A cresting by M&A may offer valuable insight regarding the state of the business cycle. The two previous yearlong peaks for US company M&A were set in Q3-2007 at $2.213 trillion and in Q1-2000 at $1.745 trillion. Recessions struck within one year of each of those peaks.

But the markets didn’t wait for those official recessions. Stocks began their multi-year crash at the end of those quarters!

The buyout frenzy is funded in part by large amounts of debt. As corporations lever up, risks rise and downgrades hail down on them. In 2015, M&A-related “net downgrades” (difference between M&A-related downgrades and upgrades) by Moody’s rose to 36. This year, Moody’s expects them to increase further.

The M&A activity last year was fueled by low borrowing costs, high stock market valuations, and “diminished prospects for organic revenue growth,” as Moody’s put it euphemistically: S&P 500 companies waded through four quarters in a row of revenue declines!

The importance of the latter helps to explain why record highs for M&A tend to occur close to the end of a business cycle upturn. The urge to merge will be greater the more convinced corporations are of the imperative to meet long-term earnings targets via mergers, acquisitions, or divestitures.

M&A is the easy way to growth. But it comes at a high price, increased financial instability, subsequent downsizing and cost-cutting, and slow-moving waves of layoffs that then sap consumer demand and the economy.

Yield spreads and EDF sink share buybacks.

“In order to supply a more immediate lift to shareholder returns,” Lonski writes, companies lower total shares outstanding by buying back their own shares. This lowers the dilution that occurs when they issue new shares for M&A and executive compensation. These financial engineering tactics have been another type of rocket fuel underneath the market.

“A more uncertain earnings outlook,” as the report euphemistically calls the ongoing three-quarter earnings recession for S&P 500 companies, “will increase the incentive” to engage in share buybacks “as opposed to investing such funds in a company’s production capabilities.”

This leads to even more problems:

Sometimes, efforts to enhance shareholder returns trigger credit rating downgrades. Typically, strategies which benefit shareholders at the expense of creditors employ cash- or debt-funded equity buybacks and dividends.

So Moody’s downgrades stemming from “shareholder compensation” rose to 48 in 2015 but were still shy of the record 78 in 2007, at the cusp of the Financial Crisis.

At some point, market volatility, which means downward volatility because no one lambastes upward volatility, will put a damper on M&A and share buybacks, thus knocking over two of the remaining props under the market.

And more ominous still:

The two latest recessions were partly the consequence of markets not knowing the full extent of deteriorations in household and business credit quality. Not everything can be quantified, if only because some very critical things are hidden.

Ah yes, we won’t even really know how bad it is with our over-leveraged corporate heroes until the house of cards comes down to reveal what’s left inside.

But nothing goes to heck in a straight line. Read…  After $7.8 Trillion Got Wiped Out in three Weeks, “Global Stocks Surge Most since 2012”

via Zero Hedge http://ift.tt/1KzBYkx Tyler Durden