Month: October 2018

Authored by Economic Prism’s MN Gordon, annotated by Acting-Man’s Pater Tenebrarum,

Life After ZIRP

Roughly three years ago, after traversing between Los Angeles and San Francisco via the expansive San Joaquin Valley, we penned the article, Salting the Economy to Death.  At the time, the monetary order was approach peak ZIRP.

Our boy ZIRP has passed away. Mr. 2.2% effective has taken his place in the meantime. [PT]

We found the absurdity of zero bound interest rates to have parallels to the absurdity of hundreds upon hundreds of miles of blooming crop fields within the setting of an arid desert wasteland.

Given today’s changing financial conditions, namely the prospect of a sustained period of rising interest rates, we have taken the opportunity to refine our analysis.  What follows is an attempt to bring clarity to disorder.

The natural starting point for the topic at hand is from a place of delusion. That is, the popular delusion that central planners can stimulate robust economic growth by setting interest rates artificially low. The general theory is that cheap credit compels individuals and businesses to borrow loads of cash – and consume.

Over a sample size of five to ten years, say the growth half of the business cycle, central bankers can falsely take credit for engineering a productive economy.  Profits increase.  Jobs are created.  Wages rise.  A cycle of expansion takes root.  These are the theoretical benefits to an economy that central bankers claim they impart with just a little extra liquidity.  In practice, however, this policy antidote is a disaster.

Without question, cheap credit can have a stimulative influence on an economy with moderate debt levels. But once an economy has reached total debt saturation, where new debt fails to produce new growth, the cheap credit trick no longer works to stimulate the economy.  In fact, the additional credit, and its flip-side debt, distorts prices and strangles future growth.

Monetary policy over the last three decades and over the last decade in particular, has placed the economy in the unfavorable position where more and more digital monetary credits are needed each month just to stand still.

After nearly a decade of ZIRP, from December 2008 to December 2015, the structure of the economy was distorted to the point where a zero bound federal funds rate actually became restrictive. The Fed’s incremental increases to the federal funds rate since then, are now draining liquidity from the financial system at an accelerating rate.  A dangerous situation is unfolding.

“Get up – keep in line, It’s gettin’ tighter all the time
You say you’re feelin’ fine, It’s gettin’ tighter all the time”

Deep Purple – Gettin’ Tighter (extended Long Beach live version for connoisseurs) [PT]

Moreover, applications of additional government debt, through fiscal stimulus, also serve to promote the economy’s ultimate demise.  President Trump’s tax cuts may have temporarily increased GDP growth.  But they have also spiked the deficit, resulting in a permanent increase to the national debt.  The fleeting burst of growth has been borrowed from the future at the expense of tomorrow’s tax payers.

The fundamental fact is that the current financial and economic paradigm, characterized by heavy handed fiscal and monetary intervention, is an epic problem.  Debt based stimulus is both sustaining and killing the economy at the same time.  No doubt, this is a ridiculous situation.  Here we will look to California’s San Joaquin Valley for parallels…

The World’s Richest Agricultural Valley

Dropping down the backside of the grapevine from the Tejon Pass, along Interstate 5 between Los Angeles and San Francisco, one is greeted by an endless sea of agricultural fields.  These farms of the mega San Joaquin Valley are not the 160-acre family homestead farms rooted in the 19th century settlement of the Midwest. Nor are they in the yeoman farmer tradition envisioned by Thomas Jefferson.  They are large-scale, highly productive, corporate farms.

Indeed, if you’ve never seen them, these massive agricultural operations are quite a sight.  Yet what is even more incredible is that they exist at all.  Given the dry conditions of the area, it is a miracle that anything – aside from cactus and scrub – grows here.

As University of California Berkeley Professor Emeritus, James Parsons wrote:

“The southern part of the valley was a barren desert waste with scattered saltbush when first viewed by Don Pedro Fages in 1772 coming from the south over Tejon Pass.”

“Less than five inches of rain annually falls in southwestern Kern County, maybe ten inches at Fresno.  Pan evaporation in a summer month on the west side pushes 20 inches.”

Still, the barren desert wasteland and parched conditions observed by Fages nearly 250 years ago, including a negative water cycle, didn’t stand in the way of what was to come.  With an outsized imagination, several mega water diversion projects, federal and state subsidized water, and cheap migrant field workers, mankind was able to create what has been called “the world’s richest agricultural valley, a technological miracle of productivity.”

Irrigation of fields in the San Joaquin Valley [PT]

Photo credit: Joe Mathews

Yet endlessly dumping chemical fertilizers, pesticides and herbicides, and imported water on sandy soil underlain by indurated hardpan is not without consequences.  What has stimulated the productive miracle of the San Joaquin Valley over the last century is the same blend of factors that has propped up America’s financial markets and blown out government debt loads over this same period.  Cheap credit and excess liquidity.

In his magnum opus, Cadillac Desert, which documents the insanity of water resource development in the west up through most of the 20th century, the late Marc Reisner offers the following characterization:

“Like so many great and extravagant achievements, from the fountains of Rome to the federal deficit, the immense national dam-construction program that allowed civilization to flourish in the deserts of the West contains the seeds of disintegration; it is the old saw about an empire’s rising higher and higher and having farther and farther to fall. 

Without the federal government there would have been no Central Valley Project, and without that project California would never have amassed the wealth and creditworthiness to build its own State Water Project, which loosed a huge expansion of farming and urban development on the false promise of water that may never arrive.”

Pistachio orchard in a dry part of the valley. [PT]

Photo via researchgate.net

Choking On the Salt of Debt

In the San Joaquin Valley, vast irrigation networks convey water thousands of miles to make the desert bloom.  But as surface water is conveyed along the open California aqueduct, it both evaporates and collects mineral deposits. The combination of these factors concentrates the water’s salt content.  Then, as it is applied to irrigation, the residual salts collect in the soil.

After decades of this, along with the over-application of fertilizer through mechanized fertigation systems, the salt in the soil has built up so that it strangles the roots of the plants.  To combat this, over-watering is required, because the irrigation water – while salty – is fresher than the salt encrusted soil. By applying excess irrigation water, the soils around the plants are temporarily freshened up so that crops can grow.

Yet, at the same time, this over-watering accelerates the mass quantity of salt being applied to the soil.  There is no outlet for the salt to flush to; the valley is the basin’s terminus.  Thus, in this grand paradox, the relative freshness of the excess water that is keeping the farmland alive is, at the same time, the source of the salt that is killing it.  Reisner further explains:

“Nowhere is the salinity problem more serious than in the San Joaquin Valley of California, the most productive farming region in the entire world.  There you have a shallow impermeable clay layer, the residual bottom of an ancient sea, underlying a million or so acres of fabulously profitable land.  During the irrigation season, temperatures in the valley fluctuate between 90 and 110 degrees; the good water evaporates as if the sky were a sponge, the junk water goes down, and the problem gets worse and worse. Very little of the water seeps through the Corcoran Clay, so it rises back up to the root zones — in places, the clay is only a few feet down — water logs the land, and kills the crops.”

So, too, goes the U.S. economy.  After nearly a decade of rapidly expanding its balance sheet, and pumping cheap credit and excess liquidity into financial markets, the Fed has produced a similar paradox.  They must keep expanding the money base to keep the economy afloat… but in doing so they are ultimately killing it.

US monetary base vs. the S&P 500 Index. After the end of QE3, the monetary base began to stagnate – the 2016 dip and subsequent rebound was largely related to a reduction and rebound in bank reserves as Treasury deposits with the Fed first increased and then decreased again. True broad money supply growth actually accelerated at the time. This is no longer the case. QT is now beginning to affect money supply growth, as the pace of commercial bank lending continues to be anemic. The slowdown in money supply growth should begin to affect risk asset prices and economic activity with a lag. [PT]

Of course, the Fed knows it cannot expand its balance sheet without periodic, and abrupt, reductions.  These are needed to whipsaw overextended debtors and attain some semblance of connection between the economy and financial markets. What’s even more absurd about our present circumstances is that the Fed is reducing its balance sheet and increasing the federal funds rate so that it can later increase its balance sheet and cut the federal funds rate to combat the forthcoming recession that will be exacerbated by its own actions.

To compound the matter, Trump’s tax cuts and trade war, during the waning days of a near decade long economic expansion, are pushing interest rates upward. Higher borrowing costs will choke the economy, which depends on cheap credit to function.

The root of the problem: total US credit market debt has climbed to almost $70 trillion as of Q1 2018. [PT]

This, in short, is why it doesn’t matter if the Fed raises the federal funds rate or cuts the federal funds rate, or if Uncle Sam borrows more or borrows less.  At this point, there is no way out.  The present financial order, like the salty crop fields in the San Joaquin Valley, is doomed to choke on the salt of debt.

Only several lifetimes – or more – of fallow conditions will restore economic growth and fertility to the country.  The demise of the San Joaquin Valley as an agricultural region, however, will be indefinite.

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Echoing commentary published here during the weekend, overnight Goldman’s chief commodity Jeffrey Currie repeated his recommendation to overweight allocation to oil to “hedge against increased geopolitical risks, driven by elevated US-Middle
East tensions” which as of this weekend, have “broadened to include Saudi Arabia.”

Specifically, Goldman now believes that “the balance of risks given the potential magnitude of supply shortfalls from Iran in the short-term or Saudi potentially outweighs for now a backdrop of weaker fundamentals and increased macro uncertainty.

Although our 12m forecast for the S&P GSCI now stands at 3%, we still see significant portfolio value in staying long and including commodities in a diversified portfolio, particularly given the geopolitical environment.”

Earlier on Monday oil spiked after Saudi Arabia vowed a strong retaliation amid the latest back and forth between the US and Riyadh.

Still, one should not overplay the potential of a Saudi-induced price spike, and Currie warned that focusing on near-term geopolitical tensions and trading volatility risks missing the core reason for being long commodities late cycle: “they are a hedge against rising interest rates and are one of the few assets which outperform in the late-cycle.”

Furthermore, in terms of its bullish price outlook, and separate from the Saudi escalation, Goldman noted that elevated uncertainty around this politically-engineered market tightening is due to the potential timing or size mismatch of the Iran declines and new capacity coming online as well as the uncertain stance of the US administration on waivers.

This has driven consumer hedging and investor buying, with producers not inclined to hedge given trending prices and the  diminishing activity of HY independents. The risks are therefore that long-dated prices continue to drift higher, keeping spot prices above our year-end $80/bbl forecast until producer hedging resumes.

Looking further ahead, Goldman sexpect prices to sequentially decline to $70/bbl next summer as a wave of new Permian production comes online, and expects Brent-WTI spreads to remain wide until such new capacity comes online as Brent prices need to outperform to cover the costs of sending crude to the USGC by rail. Finally, as Permian constraints ease, Currie expects the WTI-Brent spread to normalize to $5.5/bbl in 2H19.”

Going back to Goldman’s Saudi warning, what was odd is that the bank recommended staying long even though its year-end target for Brent of $80 is slightly below current prices. There may be a good for that: as we noted earlier, Goldman’s flash update followed an escalation in rhetoric in which Trump threatened Saudi Arabia with severe punishment if it is found that the Saudis were involved in Khashoggi disappearance and/or death, sending Saudi stocks plunging the most since 2016.

In response, Riyadh made a not so veiled threat to use the kingdom’s oil wealth as a political weapon – something which Bloomberg said was “unheard of since the 1973 Arab embargo that triggered the first oil crisis.”

On Sunday, Saudi Arabia said on Sunday it would retaliate against any punitive measures linked to the disappearance of Washington Post columnist Jamal Khashoggi with even “stronger ones.” In an implicit reference to the kingdom’s petroleum wealth, the statement noted the Saudi economy “has an influential and vital role in the global economy.”

Additionally, the fact that the Arabiya article was published only minutes after Saudi Arabia’s press release was issued led many to conclude it was either a message conveyed outside diplomatic channels or a trial balloon that quickly went flat.

Roger Diwan, a longstanding OPEC watcher at consultant IHS Markit Ltd., said the Saudi comments broke “an essential oil market taboo.”

While few think that Saudi Arabia is prepared to follow through, even the suggestion of using oil as a weapon undermines Riyadh’s long-standing effort to project itself as a force for economic stability. Jeffrey Currie, the head of commodities research at Goldman Sachs Inc., said Middle East tensions impacting the oil market have now “broadened to include Saudi Arabia.”

The tensions were exacerbated by an article written by Turki Al Dakhil, who heads the state-owned Arabiya news network and is close to the Royal Court, in which he openly talked about using oil as a weapon.

“If President Trump was angered by $80 oil, nobody should rule out the price jumping to $100 and $200 a barrel or maybe double that figure.”

As we noted overnight, the Saudi embassy in Washington later said Al Dakhil didn’t represent the official position of the kingdom and Saudi officials, speaking privately, said there wasn’t a change in the long-held policy that oil and politics don’t mix.

In an attempt to further defuse the tense situation, on Monday, Khalid Al-Falih, the Saudi energy minister pledging his country will continue to be a responsible actor and keep oil markets stable, during a speech in India.

“I want to assure markets and petroleum consumers around the world that we want to continue support the growth of the global economy, the prosperity of consumers around the world,” Al Falih said.

On Sunday, Saudi Arabia said it’s begun an internal investigation into the disappearance Khashoggi at its Istanbul consulate and could hold people accountable if the evidence warrants it. This was followed by a Trump tweet in which he said that he has spoken to the Saudi King who denied any knowledge of whatever may have happened “to our Saudi Arabian citizen” and that he was working closely with Turkey to find answer. Trump also said that he is “immediately” sending Secretary of State Mike Pompeo to meet with the Saudi King.

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US equity markets are tumbling from their pre-open algo buying-spree and while no obvious catalyst stands out, somewhat hawkish comments from former Fed head Yellen may have sparked some selling…

Yellen is speaking at a Mortgage Bankers Association conference in Washington:

• *YELLEN SAYS 3% GROWTH IS TERRIFIC BUT DOESN’T THINK IT CAN LAST

• *YELLEN: INVERTED YIELD CURVE A GOOD RECESSION SIGNAL IN PAST

• *YELLEN: THIS TIME MIGHT BE DIFFERENT ON YIELD CURVE SIGNAL

• *YELLEN: FED NEEDS TO MOVE RATES TO NEUTRAL, STABILIZE LABOR MKT

• *YELLEN: NOT DESIRABLE FOR A PRESIDENT TO COMMENT ON FED POLICY

• *YELLEN: POLITICIZING FED POLICY RISKS UNDERMINING INSTITUTION

So “keep hiking rates”…  “ignore the yield curve coz it’s different this time”, and “ignore President Trump…”

And the reaction – coincident – was notable…

 

 

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Authored by Charles Hugh Smith via OfTwoMinds blog,

By the standards of previous generations, the middle class has been stripmined of income, assets and purchasing power.

What does it take to be middle class nowadays? Defining the middle class is a parlor game, with most of the punditry referring to income brackets as the defining factor.

People tend to self-report that they belong to the middle class based on income, but income is not the key metric: 12 other factors are more telling measures of middle class membership than income.

In Why the Middle Class Is Doomed (April 17, 2012) I listed five minimum threshold characteristics of membership in the middle class:

1. Meaningful healthcare insurance (i.e. not phantom insurance with $5,000 deductibles, etc.) and life insurance.

2. Significant equity (25%-50%) in a home or equivalent real estate

3. Income/expenses that enable the household to save at least 6% of its income

4. Significant retirement funds: 401Ks, IRAs, etc.

5. The ability to service all debt and expenses over the medium-term if one of the primary household wage-earners lose their job

I then added a taken-for-granted sixth:

6. Reliable vehicles for each wage-earner

Author Chris Sullins suggested adding these additional thresholds:

7. If a household requires government assistance to maintain the family lifestyle, their Middle Class status is in doubt.

8. A percentage of non-paper, non-family home hard assets such as family heirlooms, precious metals, tools, etc. that can be transferred to the next generation, i.e. generational wealth.

9. Ability to invest in offspring (education, extracurricular clubs/training, etc.).

10. Leisure time devoted to the maintenance of physical/spiritual/mental fitness.

Correspondent Mark G. recently suggested two more:

11. Continual accumulation of human and social capital (new skills, networks of collaborators, markets for one’s services, etc.)

And the money shot:

12. Family ownership of income-producing assets such as rental properties, bonds, etc.

The key point of these thresholds is that propping up a precarious illusion of consumption and status signifiers does not qualify as middle class. To qualify as middle class (that is, what was considered middle class a generation or two ago), the household must actually own/control wealth that won’t vanish if the investment bubble du jour pops, and won’t be wiped out by a medical emergency.

In Chris’s phrase, “They should be focusing resources on the next generation and passing on Generational Wealth” as opposed to “keeping up appearances” via aspirational consumption financed with debt.

What does it take in the real world to qualify as middle class?

Here are my calculations based on our own expenses and those of our friends in urban America. We can quibble about details endlessly, so these are mid-range estimates. These reflect urban costs; rural towns/cities will naturally have significantly lower cost structures. Please make adjustments as suits your area or experience, but please recall that tens of millions of people live in high-cost left and right-coast cities, and millions more have high heating/cooling/commuting costs.

The wages of those employed by Corporate America or the government do not reflect the total cost of benefits such as healthcare insurance. Self-employed people like myself pay the full costs of benefits, so we have to realize there is no ideal average of household expenses. Some households pay very little of their actual healthcare expenses, other pay for part of these costs and still others pay most or all of their healthcare insurance and co-pays.

1. Healthcare. Let’s budget $15,000 annually for healthcare insurance. Yes, if you’re 23 years old and single, you will pay less, so this is an average. If you’re older (I’m 64), $15,000 a year only buys you and your spouse stripped down coverage: no eyewear, medication or dental coverage–and that’s if your existing plan is grandfathered in. (If you want non-phantom ObamaCare coverage, the cost zooms up to $2,000/month or $24,000 annually.)

Add in co-pays and out-of-pocket expenses, and the realistic annual total is between $15,000 and $20,000 annually: Your family’s health care costs: $19,393 (this was before ACA).

Let’s say $15,000 annually is about as low as you can reasonably expect to maintain middle class healthcare.

2. Home equity. Building home equity requires paying meaningful principal. Let’s say a household has a 15-year mortgage so the principal payments are actually meaningfully adding to equity, unlike a 30-year mortgage. Let’s say $5-$10,000 of $25,000 in annual mortgage payments is interest (deductible) and $15-$20,000 goes to principal reduction.

3. Savings. Anything less than $5,000 in annual savings is not very meaningful if college costs, co-pays for medical emergencies, etc. are being anticipated, and $10,000 is a more realistic number given the need to stockpile cash in the event of job loss or reduced hours/pay. So let’s go with a minimum of $5,000 in cash savings annually.

4. Retirement. Let’s assume $6,000 per wage earner per year, or $12,000 per household. That won’t buy much of a retirement unless you start at age 25, and even then the return at current rates is so abysmal the nestegg won’t grow faster than inflation unless you take horrendous risks (and win).

5. Vehicles. The AAA pegs the cost of each compact car at $7,000 annually, so $14K per year assumes two compacts each driven 15,000 miles. The cost declines for two paid-for, well-maintained clunkers and increases for sedans and trucks. Let’s assume a scrimp-and-save household who manages to operate and insure two vehicles for $10,000 annually.

6. Social Security and Medicare Taxes. Self-employed people pay full freight Social Security and Medicare taxes: 15.3% of all net income, starting with dollar one and going up to $127,200 for SSA. But let’s take a household of two employed wage-earners and put in $8,000.

Property taxes: These are low in many parts of the country, but let’s assume a level between New Jersey/New York/California level of property tax and very low property tax rates: $10,000 annually.

Income tax: There are too many complexities, so let’s assume $2,000 in state and local taxes and $5,000 in federal taxes for a total of $7,000.

7. Living expenses: Some people spend hundreds of dollars on food each week, others considerably less. Let’s assume a two-adult household will need at least $12,000 annually for food, utilities, phone service, Internet, home maintenance, clothing, furnishings, books, films, etc., while those who like to dine out often, take week-ends away for skiing or equivalent will need more like $20,000.

8. Donations, church tithes, community organizations, adult education, hobbies, etc.: Let’s say $2,000 annually at a minimum.

Note that this does not include the cost of maintaining boats, RVs, pools, etc., or the cost of an annual vacation.

Here’s the annual summary:

Healthcare: $15,000
Mortgage: $25,000
Savings: $5,000
Retirement: $12,000
Vehicles: $10,000
Property taxes: $10,000
Income and Social Security/Medicare taxes: $15,000
Living expenses: $12,000
Other: $2,000

Minimum Total: $106,000

Vacations, travel, unexpected expenses, etc: $5,000.

Realistic Total: $111,000

That’s almost double the median household income of $59,000. Note that this $111,000 household income has no budget for lavish vacations, luxury vehicles, large pickup trucks, boats, second homes, college expenses, etc. There is no budget for private schooling. Most of the family income goes to the mortgage, taxes and healthcare. Savings are modest, along with living expenses and retirement contributions. This is a barebones budget.

$111,000 household income is right about the cut-off point for the top 20% of household income. How close are you to the top 1%?

Toss in a jumbo mortgage, college tuition paid in cash, an aging parent to care for or any of a dozen other major expenses and the minimum quickly rises to $155,000, which puts the household in the top 10% of household income.

How can we even talk about a “middle class” when the minimum thresholds put the household in the top 20%? And we haven’t even considered the ultimate  minimum threshold of middle class membership: family ownership of income-producing assets such as businesses, rental properties, bonds, etc.

The key takeaway of this chart is the concentration of the household wealth of the bottom 90% in the family home. The wealthy and upper-middle class own income-producing assets, while the bottom 90% own some life insurance, cash and pensions, but their largest asset by far is the family home. (They also “own” a tremendous amount of debt.)

The problem is life insurance, cash and pensions don’t generate much income, and neither does the family home. Households counting on the equity in bubble-priced housing are not factoring in the unwelcome reality that all bubbles pop, even housing bubbles that can’t possibly pop.

To have the equivalent security and generational wealth enjoyed by the middle class two generations ago, households have to check off all 12 minimum thresholds. I’m not sure there is a “middle class” any more; if we use these 12 minimum thresholds, the U.S. now has a super-wealthy class (top .01%), a very wealthy class (top .5%), an upper class (top 9.5% below the wealthy) and the rest (bottom 90%), with varying levels of security and assets but at levels far below what median-income households enjoyed in bygone eras.

By the standards of previous generations, the middle class has been strip-mined of income, assets and purchasing power.

*  *  *

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With the algos anxiously buying the f**king dip into the US open this morning, to convince the world that the Saudi threats are a storm in a teacup, you could be forgiven for thinking that last week’s bloodbathery is behind us and we’re back to the teflon bull market… until the cash open and everything tumbled…

And while nothing in the news suggests that should be so ebullient, former fund manager and FX trader Richard Breslow notes that the market has an optimistic feel to it. Despite the facts that the news from Brexit to Saudi Arabia isn’t exactly bubbly; that traditional havens like the Swiss franc and the yen are bid; that U.S. equity futures have been down all night; and amid warnings of downside risks to the global economy were the norm at the IMF meetings in Bali – Breslow notes that unlike last week, it just doesn’t feel scary this morning, adding that “I’m pretty sure this is so for all the wrong reasons.”

via Bloomberg,

Friday’s last minute ramp-up in share prices didn’t set the stage for today. Certainly Asian equities weren’t impressed. But markets are taking a somewhat troubling, yet sadly understandable, comfort in the fact that global bond yields, most notably Treasuries and bunds, have ceded all of their recent momentum higher and the dollar is acting lackluster despite having all sorts of reasons to be pushing higher. Traders are also realizing that while the S&P 500 futures might be cracking the 200-day moving average, they still have the equally important 55-week level right below. And, so far, it has withstood some heavy strain.

There is very little to suggest that the increase in official global rates or balance sheet reductions will be stalled. Certainly nothing in the numbers or speeches to make one expect that should be anyone’s base case. But it feels like the idea is being entertained in the back of peoples’ minds. Sometimes it is just too much to expect that all of the news flow can be totally ignored.

We all love a good canary in the coal mine story. Have you noticed how gold has been behaving? Not only has it broken out higher from its recent mind-numbing range, but has had the courtesy of leaping right up to very important resistance. Which makes it not only in play but interestingly so. Whether you look at last December’s low, August’s highs or significant retracement levels, where it goes from here will be a good indicator of rate and dollar expectations.

The 10-year Treasury also sits at a crossroads. The yield can sag a little further without completely discrediting the higher rates story. But I wonder. Current levels around 3.15% are more important than the charts might otherwise suggest. This is one of those rare situations when sinking toward important technical levels between 3.08%-3.04% may be a sign that it is an opportunity you might want to think twice about taking. Frankly, I’d rather sell here than at those better levels.

The same can be said about the dollar. Everything economic suggests that it is a buy. But it trades poorly. Some have explained the lackluster performance as showing that a lot of good news is already priced in. I don’t see it that way. Investors, and reserve managers, are increasingly asking if enough bad news is priced in. It’s not a good thing when an ultimate safe haven doesn’t act the part. Having said that, I’d still rather take a shot here than at cheaper levels. I’m pretty sure I can define my stops with greater accuracy because this very much feels like make-or-break territory.

A lot of assets have disappointed those basking in their recent trading patterns. I’m not quite ready to give up on them yet. But if there appears any danger that bad news is becoming good news again, than an entire rethink would be required.

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Hillary Clinton can’t seem to take a few weeks off ahead of the most crucial midterm elections for Democrats in recent history – as the former Secretary of State begins a media roadshow to drum up interest for her speaking tour with husband Bill. 

In a Sunday interview with CBS‘s “Sunday Morning,” Clinton said that Bill was right when he refused to step down in 1999, after he was impeached by the House of Representatives for lying about his affair with White House intern Monica Lewinsky – and then obstructing the investigation.

When asked if he should have resigned, Hillary replied “absolutely not,” since “She [Lewinsky] was an adult.” Of note, Bill Clinton was 49 and Lewinsky was 22 at the time, less than half his age. He was also the President of the United States and she was his suboordinate. 

Perhaps Clinton thinks that her friend Harvey Weinstein didn’t abuse his power over more than 80 women who have accused him of sexual assault? Clinton’s infidelity resurfaced last October when the Weinstein scandal resulted in the #MeToo movement.

Lewinsky has spent years processing the smear campaign launched against her.

As the Daily News notes, “New York Sen. Kirsten Gillibrand, one of the most outspoken politicians against both former Sen. Al Franken and Trump, has said several times that Bill Clinton should have resigned at the time.” 

“I think this moment of time we’re in is very different,” Gillibrand said during an appearance on “The View” in January. “I don’t think we had the same conversation back then, the same lens, we didn’t hold people accountable in the same way that this moment is demanding today. And I think all of us — or many of us — didn’t have that same lens, myself included.”

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Submitted by Bill Blain of Shard Capital

“Slain, after all man’s devices had failed, by the humblest things that God, in his wisdom, has put upon this earth””

After last week’s stock market ructions, my market spidey senses are tingling… https://morningporridge.com/stuff-im-watching

In the headlights this morning:

• Saudi Arabia: forget the IPO and worry about MbS threating an oil war if the West doesn’t let him murder whomever he doesn’t like. $100 by year end?
• Brexit: The next millennium bug? Very good interview on Andrew Marr show with head of Next outlined a no-deal will be less than optimal, but it won’t be a disaster. Lets get on with it.
• Germany: Merkel’s affiliate party takes a pasting in Bavaria. Who is out a job first? Merkel or May?
• Trumpland: It’s the Fed’s fault. “I know more about markets than anyone else..” Blahbity blah blah blah.. That man never ceases to amuse us.

Thought for the day: “It’s always about politics..”

Market Psychology

I’ve never met a stupid chief investment officer*, but market moves never cease to bemuse me. Market perceptions seldom reflect economic reality. The “group-think” that is the market’s collective mind doesn’t have the time to ponder the deeper implications of news and events – it spontaneously reacts to headlines. The group psychology of markets swings from profoundly fearful to over-exuberant in a heartbeat.

At the moment the mood remains profoundly negative – reflecting very scared traders. The stock market’s crash, the news flow, the IMF and others predicting a slowing global economy, Italy vs Brussels, Brexit – and its doom’n’gloom all round. A few bright spots of news, like Brazil, aren’t improving sentiment. The market believed we were doomed on Thursday and saved by Friday. This morning the coin flip says: “we’re all dead by Wednesday.” Risk-off then?

Contrarians believe the smart way to play these “End of the Worlds” scenarios is to put their buying boots on and start hoovering up the bargains. Sell when everyone else is buying. That’s a little too simplistic – but generally buying solid assets at distressed prices when the rest of the market is losing its head is the way to massive returns. The secret is…. Timing.

Never easy to get timing right. Is this a stock market correction before the beginning of the next leg even higher? I’ve talked to plenty of market participants who think it might be. However, many also believe we’re going higher because there is absolutely nothing else to do with money when bond yields are heading higher and stock dividends continue to look attractive. These guys believe at some point soon – which will be when bond rates stop rising and global recession becomes apparent – then the stock market is set for an absolute thumping – the Global Stock Market reset.

Global Market Reset?

The inherent danger of a reset makes sense to me. The reason stock markets are so high might be due to expectations of higher corporate earnings, but I reckon it’s got more to do with the unintended consequences of QE; flooding markets with liquidity and forcing yield tourists out of bonds and into the equity markets. Ultra-artificially-Low interest rates have allowed corporates to borrow trillions. Have they spent it on new factories or creating new jobs? Nope.. the cash was used for stock buy-backs which inflate executive bonuses, or to leverage up private equity by converting equity into debt.. which again benefits the few – the owners!

Debt, lest we forget, is vital to growth, but not necessarily a good thing when overdone. Despite rising interest rates, the number of market comments, blogs and articles suggesting bonds look good value here is surprising. Good luck to them… 

Volatility is not the threat

The key issue today is not to fear the current volatility but how to play it. Volatility is opportunity! If stock and markets are just volatile… what’s the big threat? Total Market dislocation? If things are set to turn really bad – maybe the right trade is to shift out of risk ad into.. US Treasuries?? If something happens.. then Treasuries will be bid-only.

If (and triple underline if) we are now poised at the end of the bond correction and stock markets look overbought… that spells opportunity. Clue: Stocks are far easier to exit than bonds.

The really frightening threat is what happens if everyone decided to take risk off the table?

Liquidity gridlock. What happens if/when the market discovers liquidity is a hollow god?

Liquidity will be the murder weapon

The last crisis – 10-years ago – taught us diminished liquidity triggers runs on banks while a complete absence kills them. What’s happened since Lehman’s demise has been a massive transfer of risk from the banking sector – which means, so the regulators tell us, that banks are now safer. Marvellous. Where did that risk go? Into the non-bank financial sector.

I suspect the Buy-Side (by which I mean funds, pension providers, insurers, credit and hedge funds, equity players, etc) are about to discover that Liquidity Risk cuts all ways when it comes to de-risking when they try to sell illiquid assets – especially in the bond market.

Risk transfer from banks to investors is yet another unintended consequence of the reaction to the last financial crisis – banks were the vector last time, so new capital regulation and investment rules means we now we face yet another classic “wake up and smell the coffee” moment as funds discover their asset valuations bear no relation to reality. Why? Because 10-year of bureaucratic handcuffing of the market’s invisible hand thru regulatory overkill means they are less liquid than ever before.

The regulators are waking up to what they’ve done – placing high quality assets like property into high-risk buckets because of their illiquidity (and as an unintended consequence making such assets even less liquid!)

Meanwhile, markets are already massively distorted by the price-bending effects of QE on asset prices. You’ve got a whole market of buy-side investors who think liquidity and government largesse is unlimited, while the sell-side are muzzled by capital rules, MiFid, and all the other tosh. All these things together – successive waves of market distortion – are likely to trigger the RESET moment and the liquidity gridlock? That’s the moment cracks in the ice become holes…

Try it. Go ask for a bid for that bank capital bond you’ve got marked on your book at 100.00. If you are lucky, you might get a distressed bid back in the low 90s. Think about the Fund that’s seen massive client redemptions force it to sell portfolios of pristine assets at “distressed seller” prices. Try to sell some European Hi-Yield.. ouch. Again.. a distressed bid is the best you can hope for. Or how about Italian govies.. When you struggle to find a bid for Europe third largest economy… that’s a problem.

Treasuries might look awfully unattractive at the moment, but if a crunch comes then the flight to quality will be the most powerful market move in years. The problem for most investors is being stuck with hi-yielding illiquid assets, and being too late to move out of them..

The global financial crisis that began in 2007 taught us perfectly solid and safe assets could only generate distressed firesales prices. Same thing is going to happen this/next time. If you are in the happy position of being long cash, there will be bargains galore if/when crisis hits. At that point liquidity fearful holders will remember the old Blain market mantra: “A bid is a bid is a bid, and you should hit it harder and faster the proverbial red-headed step-child.”

(And extra points for anyone who doesn’t need to google this morning’s quote…” A lesson in not ignoring the simple and small stuff, or assuming anything about liquidity!)

Meanwhile, what about other stuff?

Europe?

Three questions about Europe:

What happens in May? (as in next year, rather than within our PM’s head.) The whole of the current European Empire is in switch around. New European parliament elections (which approve all EU rules) could see populists elected to a majority of seats creating legislative gridlock, include trade agreements in the post Brexit world. And we are into new ECB discussions – who will run the world’s most powerful central bank? What are the implications.

Who will win the trade war?

China has historically been misunderstood. The government works by delivering a stable society and get rich social contract to the non electorate. The US works by delivering growth and wealth to voters. Painful as it is to say.. Trump is delivering. Despite growth and wealth China will lose – forcing Xi to climbdown. Which model survives?

What else I’m watching: – press link to get a list of “interesting news stories..” https://morningporridge.com/stuff-im-watching

Back to the new day job!

(*actually…. I have, but not going to name the guilty…)

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