Month: December 2018

Late last week, we reported that in the aftermath of a dramatic drop in loan prices, a record outflow from loan funds, and a general collapse in investor sentiment that was euphoric as recently as the start of October, the wheels had come off the loan market which was on the verge of freezing after we got the first hung bridge loan in years, after Wells Fargo and Barclays took the rare step of keeping a $415 million leveraged loan on their books after failing to sell it to investors.

The two banks now “plan” to wait until January – i.e., hope that yield chasing desperation returns – to offload the loan they made to help finance Blackstone’s buyout of Ulterra Drilling Technologies, a company that makes bits for oil and gas drilling.

The reason the banks were stuck with hundreds of millions in unwanted paper is because they had agreed to finance the bridge loan whether or not there was enough demand from investors, as the acquisition needed to close by the end of the year. The delayed transaction means the banks will have to bear the risk of the price of the loans falling further, as well as costs associated with holding loans on their books.

The pulled Ulterra deal wasn’t alone.

As we reported previously, in Europe the market appears to have already locked up, as three loans were scrapped over the last two weeks. To wit, movie theater chain Vue International withdrew a 833 million pound-equivalent ($1.07 billion) loan sale. While the deal was meant to mostly refinance existing debt, around 100 million pounds was underwritten to finance the company’s acquisition of German group CineStar.

More deals were pulled the prior week when diversified manufacturer Jason Inc. became at least the fourth issuer to scrap a U.S. leveraged loan. Additionally, Perimeter Solutions also pulled its repricing attempt, Ta Chen International scrapped a $250MM term loan set to finance the company’s purchase of a rolling mill, and Algoma Steel withdrew its $300m exit financing. Global University System in November also dropped its dollar repricing.

Today, the FT picks up on the fact that the junk bond market – whether in loans or bonds – has frozen up, and reported that US credit markets have “ground to a halt” with fund managers refusing to fund buyouts and investors shunning high-yield bond sales as rising interest rates and market volatility weigh on sentiment (ironically it is the rising rates that assure lower rates as financial conditions tighten and the Fed is forced to resume easing in the coming year, that has been a major hurdle to floating-rate loan demand as the same higher rates that pushed demand for paper to all time highs are set to reverse).

Meanwhile, things are even worse in the bond market, where not a single company has borrowed money through the $1.2tn US high-yield corporate bond market this month according to the FT. If that freeze continues until the end of the month, it would be the first month since November 2008 that not a single high-yield bond priced in the market, according to data providers Informa and Dealogic.

Separately, as we already reported, the FT notes that in the loan market at least two deals – including the Barclays/Wells bridge loan – were postponed and could be the first of several transactions pulled from the market this year, bankers and investors said, as mutual funds and managers of collateralised loan obligations — the largest buyer by far in the leveraged loan sector — wait out the uncertainty.

“This is clearly more than year-end jitters,” said Guy LeBas, a strategist at Janney Montgomery Scott. “What we’re seeing now is pretty typical for end-of-credit-cycle behaviour.”

A prolonged period of low interest rates since the financial crisis a decade ago has seen companies binge on cheap debt. However, as financial conditions have tightened, the high level of corporate leverage has raised widespread concern among regulators, analysts and investors.

In the loan market, it’s not a total disaster just yet, because even as prices have slumped over the past two months, banks that committed to finance highly leveraged buyouts – including JPMorgan Chase and Goldman Sachs –  have offered loans at substantial discounts to entice investors. As the chart below shows, the average new issue yield by month has exploded to the highest in years, with CCC-rated issuers forced to pay the most in 7 years to round up investor demand.

Still, as the following table from Bank of America shows, quite a few deals have priced, if only in the loan market:

Even so, other banks including Barclays, Deutsche Bank, UBS and Wells Fargo, have had to pull deals altogether as they just couldn’t find enough buyers no matter how generous the concessions.

In addition to the Ulterra deal, technology services provider ConvergeOne postponed a $1.3bn leveraged loan offering that backed its takeover by private equity group CVC last week. As the FT notes, Deutsche Bank and UBS had marketed the deal to investors in a package that included senior and subordinated loans, with the junior debt expected to yield as much as 12 per cent in November when prices were first floated. While the banks attracted some bids for the debt, orders failed to surpass the overall size of the deal, which was postponed to the new year, according to people with knowledge of the transaction.

Why delaying deals into 2019? One word: hope.

One person familiar with the deal said the banks would market the loans again in January, when they hope market conditions will improve, and that other leveraged loans being marketed could be postponed to 2019.

The trouble lenders have faced in the leveraged loan market has mirrored the exasperation felt by investors in other asset classes. Higher-quality investment-grade bonds have also sold off, with a number of planned deals pulled from the market in recent weeks.

That said, for now the junk bond freeze and loan indigestion has remained confined to lower-rated issuers. However, that may change too, and should the “Ice-9” spread to the high-grade sector, where the bulk of issuance is to fund buybacks and M&A, that’s when the real pain begins.

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By Eurasianet.org via OilPrice.com,

Rampant cryptocurrency mining is threatening the shaky electrical network in the tiny, mostly unrecognized republic of Abkhazia, forcing officials to call for putting regulatory shackles on the money-making scheme in order to stave off power supply interruptions this winter.

Abkhazia has recently emerged as a cryptocurrency enthusiast, much like the country from which it broke away, Georgia. Cryptocurrency-producing operations have been set up in abandoned Soviet factories left behind in the territory’s rocky period of quasi-independence.

“We have the so-called mining farms, set up on the premises of abandoned or partly abandoned factories,” said Aslan Basaria, head of the state-run energy company Chernomorenergo, as he was filling in the region’s de-facto leader Raul Khajimba on the energy situation, Ekho Kavkaza reported.

The computers that churn out cryptocurrency are guzzling up electricity.

“This puts additional load on our grid, the transmission lines and substations that are loaded to capacity even without it,” Basaria said.

“If temperatures fall, there is a risk that electricity will not reach regular customers.”

Cryptocurrency may be giving energy officials headaches, but some in Abkhazia see it as a solution to their many economic woes. 

Civil war, a mass exodus of the pre-war population, and the consequent international isolation have turned Abkhazia into a shell of what used to be the Soviet Union’s prime fun-under-the-sun destination. Russia – accompanied by a handful of countries geopolitically indebted to Moscow – recognizes Abkhazia as a nation independent from Georgia and guards that independence with thousands of troops. To the rest of the world, Abkhazia remains a de jure part of Georgia run by an unrecognized separatist regime.   

But what Abkhazia and Georgia proper both share is a fervor for cryptocurrency, as well as a large hydropower complex, which straddles the de facto boundary and provides the main fuel for cryptocurrency – electricity. The complex can’t meet either side’s need for power in the winter, when water levels in giant Jvari Reservoir are low and electricity consumption is high.  

Not least thanks to low electricity costs, Georgia has become a surprise cryptocurrency powerhouse in recent years, ranking as the world’s second for cryptocurrency mining in terms of power consumed, behind only China. In Abkhazia, electricity is even cheaper. Households pay 40 kopeks (about 0.6 cents) per kilowatt-hour. On top of that, Abkhazian officials say that stealing electricity remains a major problem and that between 30 to 40 percent of customers don’t pay for power at all.

The long-troubled energy supply system is now groaning under the weight of cryptocurrency prospecting. But, on the other hand, cryptocurrency is offering the secluded region a chance to plug into an international money-making network.

Being free of state regulations, cryptocurrency is reportedly helping twilight zones like Abkhazia and the Donetsk People’s Republic, a breakaway part of Ukraine, skirt international restrictions and attract investment and trade. There is even an effort underway to digitally mint Abkhazia’s own cryptocurrency, “Abkhazia Republic Coin.”

One start-up presented the coin idea at a blockchain conference in Moscow last year. Yevgeniy Galiakhmetov, head of blockchain company BCSG, said at the conference that cryptocurrency is destined to entirely transform Abkhazia, delivering the region into the future of economic prosperity and bustling international trade, reported the news service Meduza.

“Given the limitations associated with the status of the republic, … we always seek nonconventional solutions to reach an acceptable level of [economic] development,” Abkhazia’s de-facto Economy Minister Adgur Ardzinba told Meduza.  

The Abkhazian authorities, chief among them Ardzinba, appear to support the cryptocurrency plans and even sought Russian President Vladimir Putin’s imprimatur to proceed, Meduza reported.

How Abkhazia is going to reconcile its big cryptocurrency plans with the problem of electricity shortage remains unclear. As far as the energy company is concerned, regulations are needed to keep the digital money farming in check and to keep the lights on in Abkhazia.  

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US Prosecutors disclosed in a late Friday court filing that they are concerned for the safety of Maria Butina, the 30-year-old Russian who has agreed to cooperate with the Justice Department after admitting she failed to register as a foreign agent. 

The 30-year-old gun-rights activist and former graduate student at American University networked so inventively and tirelessly in Washington that she aroused the suspicion of U.S. counterintelligence and was arrested in July. She found herself in the media spotlight as an unlikely femme fatale until prosecutors walked back one of the original accusations — that she’d been willing to trade sex for getting ahead in her influence operation. 

After spending five months in jail, Butina admitted having served as an agent of the Russian government without duly notifying the U.S. attorney general. –Bloomberg

The Friday filing was supposed to be sealed, however, it appeared briefly on the public court docket (1:18-cr-00218) for the case before it was quickly removed. In it, prosecutors discuss transporting Butina from jail to appear for interviews at US attorneys’ offices in Washington and Alexandria, VA, as well as before a federal grand jury in the capital – information prosecutors specifically did not want public.

“Once disclosed, such information could be used by individuals or entities who might seek to harm or intimidate the defendant to prevent her from continuing to cooperate with law enforcement,” the filing states. 

Butina pleaded guilty on Thursday to a single count of conspiracy to defraud the US – admitting to being an unregistered Russian agent who attempted to infiltrate the GOP and National Rifle Association (NRA). 

As we noted last week, Butina agreed to work with authorities who accused her of gathering intelligence on American officials as well as conservative political organizations. She has been in jail without bail since her arrest. 

The American Butina worked with has been identified as Paul Erickson, a longtime GOP operative based in South Dakota with strong ties to the National Rifle Association and the Russian gun rights community. Erickson, who was in a romantic relationship with Butina, allegedly attempted to establish a backchannel between the NRA and Russian Government – while also reaching out to Trump campaign members Rick Dearborn and then-Senator Jeff Sessions in a 2016 email with the subject “Kremlin connection.” The email sought a meeting between then-candidate Donald Trump and Russian President Vladimir Putin at an annual NRA convention. 

The Trump campaign declined the invitation, however Butina allegedly worked with Erickson to try and arrange a meeting between Trump and her boss, former Russian central banker Alexander Torshin – who is believed to be her handler. 

Following Butina’s arrest, the Russian embassy complained that Butina was being subjected to unwarranted strip searches and denial of proper medical care in an effort to “break her will.” Her defense attorney, Robert Driscoll, claims she has suffered health problems in jail and has been denied proper treatment. 

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When looking at the year ahead, an otherwise gloomy Jeff Gundlach last week found a rare spot of optimism within emerging markets, which have outperformed global indices and, according to Gundlach, that’s where investors should put their money “over the next seven and certainly the next 20 years.”

In his Dec. 11 webcast, Gundlach noted that the cyclically adjusted price-earnings (CAPE) ratio for emerging-market stocks is less than half that of the S&P 500. But, in the last two decades, there were times when it was much higher. Based on that metric alone, Gundlach said emerging-market equities could outperform U.S. stocks by 100%. 

Gundlach is not alone: in a recent interview, GMO Chairman Jeremy Grantham reiterated his positive outlook for emerging markets saying “There is very little chance that you’ll come back in 10 or 20 years and emerging will not have beaten the pants off the U.S.,” Grantham said.  And Rob Arnott of Research Affiliates and Mark Mobius, who recently retired from Templeton Investments, have also predicted outperformance for emerging markets.

Others however disagree, among them those who correctly predicted the 2018 crash in emerging markets. One such skeptic is SocGen’s Jason Daw, who warns that some of the world’s biggest investors are setting themselves up for a major disappointment.

The Singapore-based strategist was one of the few to anticipate the slump in emerging markets beginning in January; fast forward one year when Daw once again sees no imminent turnaround for the asset class. According to Daw, the modest rally in currencies since September, led by Turkey’s lira, Brazil’s real and South Africa’s rand, is temporary and that slower global growth and additional tightening by the Federal Reserve will continue to weaken developing-nation currencies.

“It will be a multi-year process for investment behavior to adapt to less generous dollar liquidity conditions after a decade of easy money,” he said. “The hurdle for capital to flow back into emerging markets is high and a significant macro catalyst is required to turn the narrative around.”

Of course, one such catalyst is for the Fed to announce it is cutting rates, or perhaps even launching QE, but before that happens the US economy will have to get far worse before Jerome Powell capitulates on the Fed’s 3 rate hikes for 2019 dot plot.

Until then, Daw is among a cadre of contrarians including Man GLG money manager Lisa Chua, Bank of America strategist David Woo and Harvard economist Carmen Reinhart who take the other side of the Gundlach/Grantham/Mobius trade, and warn of additional risks for emerging markets, even after eight consecutive weeks of inflows into the asset class according to Bloomberg. Specifically, they say to ignore the fund flows and focus on economic fundamentals, namely the gloomier growth outlook amid an escalating trade war, the prospect of further dollar strength as well as pockets of fragility in China, Brazil and India.

That would compound the pain from an already tumultuous 2018 in which emerging-market equities slid into a bear market and every major currency in the developing world declined against the dollar.

Of course, there is the possibility that the skeptics are wrong as some combination of Chinese stimulus, an end to the U.S.-China trade war, a pause in Fed tightening due to inflation and higher oil prices could help spur a rebound within the EM asset class according to Daw. However, so far few of these appear imminent.

Yet while bears agree that emerging markets will see continued selling in 2019, they’re split on what will be the primary source of pain.

Take the main who correctly called the EM action this year: according to ScGen’s Daw, the time to get back in emerging-market assets would be when the Fed starts to cut rates, and that could be 18 months away.

“I get the feeling consensus is on the more optimistic side,” he said. “We have believed that EM FX could weaken since the end of last year.”

He sees some value in Argentina, which led emerging-market currency declines this year. The Societe Generale strategist also recommends shorting the Brazilian real against Mexico’s peso as the initial market euphoria following Jair Bolsonaro’s election wanes.

Meanwhile, as we reported previously, the biggest concern for BofA’s head of global rates, David Woo, is that Xi Jinping’s government has no incentive to make concessions on trade, especially with Donald Trump hobbled by congressional gridlock. Domestically, Chinese authorities must juggle the need for stimulus with the desire to rein in runaway home prices. Woo recommends shorting the Indian rupee and Mexican peso as the slowdown in China weighs on assets across the developing world.

“You want to buy EM?” he said. “I wouldn’t touch EM with a 10-foot pole until there’s a resolution between the U.S. and China.”

At the same time, Ecstrat founder and China bear, John-Paul Smith, said he’s confident that a slowdown will hurt emerging-market equities. He recommends being underweight or zero-weight Chinese shares, Russian stocks and South Korea’s won, given their sensitivity to trade and commodities.

“I expect all three to have significant downside in dollar terms between now and the end of 2019,” Smith said.

Last but not least, there is the biggest reason of them all to be short EMs: the dollar is strong – in fact it is just shy of 2018 highs – and will likely remain strong for the foreseeable future even as bears continue to rise, expecting the dollar to tumble as the Fed suggests its rate hiking cycle is over. According to Schwab’s Kathy Jones, “it’s best to remain underweight emerging-market bonds as spreads potentially widen to 450 basis points over U.S. Treasuries.” She also expects the dollar to remain strong in the near term, while additional Fed tightening, slowing Chinese growth and lower commodity prices also prevent a big rally.

“There is a case for a rebound in EM sometime in 2019 once the peak in tightening financial conditions has been reached,” Jones said. “We just aren’t seeing it in the near term.”

We now eagerly look forward to the EM bulls’ response. And considering that Gundlach is among them, we won’t have long to wait.

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In the holiday spirit, One River Asset Management’s Lindsay Politi will devote the next three weeks to an arc focusing on the past, present, and finally her thoughts about the future. Here goes Part I: Ghosts of Investments Past

Demographics are Destiny? The December 1938 keynote address to the American Economic Association was titled “Economic Progress and Declining Population Growth.” Slowing population growth combined with increasing technological innovation would mean perpetually low capital investment. Secular stagnation, disinflation, and underemployment were inescapable. Within months World War II began. By the end of 1941, inflation was 10%. There was capital investment of historic proportions. There was a population boom. Even seemingly inescapable trends can change more abruptly than we dare imagine.

How We Got Here: Say’s Law states that supply creates its own demand, so a secular stagnation, a general deficit in demand, cannot exist. Yet they seem to occur periodically. Irving Fisher said we’re perceiving the problem incorrectly, that “the common notion of over-production is mistaking too little money for too much goods.” Friedman tells us “inflation is always and everywhere a monetary phenomenon.” Samuelson taught Bernanke that negative interest rates would make any investment profitable, thus creating enough demand that rates wouldn’t be able to stay negative very long. So, the solution seemed obvious: more money.

The Other View: John Hobson theorized that under-consumption is a natural stage of capitalism. People consume out of income, but only fractionally because they also save. The savings turns into capital investment, which boosts supply. As this trend plays out, capital and supply grow and, on a relative basis, income and demand shrink. Credit can only exacerbate the problem because credit most naturally goes to investment, not consumption, adding to the imbalance. The ultimate resolution is for incomes to increase faster than asset prices (or asset prices to decline more precipitously than incomes).

Hobson’s Critique: What might Hobson think of the monetarist response to secular stagnation? I imagine he’d point out that trying to increase credit for investment is counterproductive because investment further increases supply, exacerbating the supply demand imbalance. Then perhaps he’d point out that inflating asset prices through QE only exacerbates the capital/income divide that is the central cause of secular stagnation. Maybe then he’d point out that, especially for a demographically older population, reducing interest income for the one group most likely to convert savings to consumption only further exacerbates the income deficit. QE likely exacerbated, not alleviated, the problem.

* * *

Anecdote: “Why was consensus so wrong in the 1960s?” asked the US pension CIO. The 1960s parallel seems to be roughly playing out today: very low unemployment leading to higher wages had disrupted the stable, low interest rate regime. In 1965-66, a shift higher in yields sparked a scary correction in stocks and housing. Recession fears drove the Fed to pause and then reverse their hikes, incorrectly.

“What did they miss?” pressed the CIO. The 1960s Fed misdiagnosed the problem — a weak stock market and weak housing market looked like a monetary overtightening that was likely to precipitate a recession. They weren’t paying enough attention to bond market dynamics. The real affliction in the 1960s was a bond market bubble. The easiest place to see this was in negative term premium and incredibly low bond volatility.

The early stages of a bond bubble unwind look a lot like monetary overtightening. But 1966 asset price declines weren’t reflecting a problem with economic fundamentals, rather, it was the removal of distortedly low discount rates that caused the asset price declines.

That misdiagnosis led the Fed to reverse their hiking cycle and cut interest rates. And because there was no real underlying economic weakness, housing rebounded and the stock market made new highs. Inflation rebounded quickly too, and employment never weakened.

So it’s not what the 1960s Fed missed, I told the CIO, it’s that they were fitting the available information into the wrong framework. I see something similar today. Everyone is using a business cycle framework: does 2018 market volatility indicate an imminent recession or not? It’s hard to answer because it’s not even the right question.

Market corrections are ultimately about excesses: wrong decisions writ large. And what we’re seeing today is the initial unwind of the excesses built up during the secular stagnation bubble.

— Next week when I discuss the present, I’ll point out the signposts that guide us toward this conclusion.

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It’s been a painful start to the new week for traders, who were hoping to get a head start in early futures trading only to find that the E-mini orders submitted into the Globex are either not showing up, or being outright rejected.

pic.twitter.com/VrLjaborFA

— PIG BBQ (@DavidPfdle) December 16, 2018

While most traders are seeing their orders canceled, some have managed to see execution.

The culprit behind the (selective) failure in early futures trading appears to be connectivity issues at the Globex, which trades the S&P Emini future (h/t @Guido_Espinosa_) .

And while it is unclear why, the start of trading saw a big sell order that sent the Emini sharply lower at the start, only to levitate consistently for the subsequent hour since the 6pm ET open.

We will update if/as the CME provides more information on tonight’s connectivity outage.

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Authored by Celine Ryan via Campus Reform,

In an effort to demonstrate its “commitment to inclusivity,” Washington State University has begun stocking men’s restrooms with free menstrual products.

The initiative is one of many focusing on “improving the transgender community experience on campus,” and is currently being tested in three restrooms on the Pullman, Wash. campus.  The university is in the process of “assessing similar needs” at other WSU campuses to determine which men’s rooms will receive new accommodations. 

Additional changes include allowing students to choose a name other than their legal name for their student identification card and a new policy requiring all new buildings to have gender-neutral single-user restrooms. Some individuals found the practice of requiring a legal name on student identification cards “alienating” for transgender students who use chosen names.

“Affirming folks’ identities on their CougarCard is a really big piece for us,” Director of WSU Gender Identity/Expression and Sexual Orientation Resource Center Matthew Jeffries, who also co-chairs the Gender Inclusive and Trans* Support Working Group, a function of WSU’s Campus Culture & Climate Initiative, said. Jeffries’ working group has been tasked with addressing “inequities” on WSU campuses through collaboration with departments and other university entities.

“Throughout the system, students are coming forward and advocating for change,” Nolan Yaws-Gonzalez, assistant director of WSU Vancouver Student Center, said.

“We’re going to make changes that impact the whole system.”

However, not all students see these changes as productive. WSU College Republicans President Amir Rezamand told Campus Reform  Friday that he found the idea of stocking men’s restrooms with tampons and sanitary napkins “pretty ridiculous,” so much so that he feels it is “indicative that we live in a clown world.”

Campus Reform reached out to WSU for comment, but did not receive a response in time for publication. 

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Days after revealing that businessman Michael Spavor – who became the second Canadian citizen detained in China since Beijing warned it would retaliate against Canada for the arrest of Huawei CFO Meng Wanzhou in Vancouver earlier this month – had been arrested for “threatening national security”, the Communist Party made clear that this is only the beginning, and that Canada should expect “further escalation” as Beijing has no intentions of backing down – and every intention of sending a message to US allies that they should stay out of the still-simmering dispute between the world’s two largest economies.

Via an editorial in the Global Times, an English-language Chinese media company considered to be a mouthpiece for the Communist Party, China accused Canada and other US allies of forming “a collective encirclement and suppression of Chinese high-tech enterprise Huawei” – likely a reference to the US’s campaign to convince its allies to avoid Huawei equipment, citing its vulnerability to Chinese spies, as well as Canada’s cooperation in Meng’s detention – the editorial “suggested” that China should leverage its economic heft to deter US allies from taking actions contrary to China’s interest.

By calling on its allies, the US has gradually formed a collective encirclement and suppression of Chinese high-tech enterprise Huawei. It is a wicked precedent.

Almost all US allies maintain active economic and trade ties with China, of which China is the biggest trading partner of many of them. China needs to urge these countries to keep neutral in the conflict between Washington and Beijing.

It is possible for China to achieve this goal to a considerable extent because China does not threaten the strategic security of the US and its allies and it is more conducive for them to pursue national interests by maintaining good ties with China than to follow the hard line of the US.

And if these countries continue to work against China to appease the US, China should not hesitate to retaliate.

However, this does not mean that Beijing will capitulate to them at every step. For those countries that seek to ingratiate themselves to the US without regard to China’s interests, China should firmly fight back, causing a heaving price for them.

Though China should carefully pick and choose when to accommodate these intrusions and when to react, the editorial resolutely stated that Canada had “crossed a line” by detaining Meng.

Canada crossed the line by helping the US detain an executive of Huawei and China needs to clearly express that it doesn’t accept it. If Canada were to ultimately extradite Meng Wanzhou to the US, it would certainly be at the cost of a backslide in China-Canada ties.

In addition, it would be a test for China’s national will and wisdom to decide when to accommodate certain countries for decisions made while being caught between China and the US, and when to resolutely counter their damage to China’s interests.

The editorial goes on to suggest that perhaps if China had taken a harder line against Australia when it became the first country to accept the US’s advice and ban Huawei’s equipment, other countries (like, maybe, Canada) would have thought twice about interfering.

Australia was the first to follow Washington in blocking Huawei devices. As Wu Xinbo, a scholar of Fudan University, pointed out in an interview with the Global Times, “If China firmly fought back on Australia’s decisions, other countries might think twice before considering calling off Huawei’s products.”

China certainly will not overact, because such a move will isolate China and construct the outcome the US prefers. Beijing needs to meticulously select counter-targets to really make them learn a lesson.

When weighing retaliation against the US, China must focus on participants in the “Five Eyes” intelligence alliance – particularly Canada, Australia and New Zealand. As we’ve previously reported, infiltrating the “Five Eyes” cabal has long been a focus for Chinese intelligence services.

And as it seeks to do this, China must be prepared for conflicts to escalate.

In this complicated game, China should focus on the Five Eyes intelligence alliance, especially Australia, New Zealand and Canada, who actively follow the US against China. The first two nations are far from the European continent and have a subtle distance with most Western countries. China is the largest trading partner of both Australia and New Zealand and the second largest of Canada, thus the country has enough means to counter them.

In the struggle with Canada, China needs to prepare for the possibility of conflict escalation. Beijing must take the contest seriously and maximize the support of international public opinion, leaving Western media no smear to slander its counterattacks as “degradation of China’s opening-up.”

China’s new round of opening-up is in its ascendancy and in the wake of complicating external games for the country. No matter how difficult the situation is, sincere opening-up is not contradictory to a reasonable defense of China’s interests.

Canadian officials have yet to learn much about the circumstances in which its two citizens have been detained, and China has given no indication that it will release them, despite Meng being granted bail last week.

And judging by the tone of this editorial, China doesn’t plan to relent.

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Authored by John Rubino via DollarCollapse.com,

The past few years have seen more than the usual amount of political upheaval. But, interestingly, most regime changes have resulted in pretty much the same thing: Higher government spending and bigger deficits.

Apparently the only “reforms” today’s voters will accept – which is to say the only actions that don’t get a leader kicked out of office – involve spending rather than saving money.

Three recent examples:

The US
Republicans – the party of smaller government – gained control of the White House and Congress in 2016, and proceeded to take a meat ax to bloated entitlements, lowering the government’s share of the economy to levels not seen since the Reagan years.

Just kidding. They tried to eliminate the newest entitlement, Obamacare, but failed to produce even a coherent proposal. So instead they cut taxes, expanded the military and left everything else on autopilot. Now, nine years into a recovery with official unemployment below 4% — and with the small-government party in charge:

U.S. budget deficit approaches $1 trillion

(MarketWatch) – The Treasury Department says that adjusted for timing-related transactions, the deficit would have been $270 billion over the last two months compared to $250 billion during the same period the prior year, with tax revenue up by 1% but spending up by 4%.

The budget picture is deteriorating as the U.S. taxes individuals and companies less and spends more, mostly on defense and benefit payments to an aging population. Though a growing economy is softening the blow, it’s possible that the annual deficit will top $1 trillion this year.

Italy 
Voters recently installed a coalition of left and right-wing populists who immediately tried to make good on a number of campaign promises while ignoring the EU’s deficit guidelines. Threats flew and bond yields spiked, making it clear that the new government would have to be more circumspect. So Rome promised to keep its spending within EU limits. However…

Italy’s Budget Pledge Is Just Cosmetic

(Bloomberg) – Italy’s populist government has pledged to the European Commission that it will lower its deficit target to 2 percent of national income next year. For a cabinet that vowed to defy the “bureaucrats” in Brussels, this is a stunning climb-down. But unless Rome is ready to row back on some of the key pledges included in its 2019 budget, it will amount to little more than cosmetic change.

So when prime minister Giuseppe Conte told reporters on Monday that Italy would now target a 2.04 percent deficit, this was indeed a remarkable U-turn.

The markets shouldn’t celebrate too soon, though. For a start, Di Maio and Salvini have yet to utter a word about what Conte has said. In most other countries, a prime minister doesn’t have to wait for his two deputies to confirm that his words have value. But in the strange coalition arrangement that rules Rome, this is certainly the case.

Moreover, details matter. In a sense, the 2.4 percent deficit target for next year wasn’t the main problem with Italy’s budget. Worse is the wildly optimistic growth target, which means that borrowing will probably be much higher than predicted. Then you have the non-credible budget deficit targets for the following two years, which rely on VAT increases that no one believes in. Finally, there’s the decision to keep the structural deficit unchanged between 2019 and 2021, instead of aiming to reach a balanced budget over the medium run. For a country whose public debt stands at more than 130 percent of GDP, these are hardly details.

France
New president Emmanuel Macron tried to modernize the laughably hidebound French labor markets. But it blew up in his face, as tens of thousands of protestors took to the Paris streets in a conflagration that generated global headlines and raised questions about Marcon’s political future.

Macron’s response? Higher spending, of course:

Macron’s credibility shattered as France joins Italy in budget disgrace

(Telegraph) – Emmanuel Macron’s bid to buy off France’s “gilets jaunes” protesters with instant budget handouts threatens to blast through eurozone’s fiscal limits, fatally damaging his credibility as the champion of the European project and the guardian of French public accounts.

The package of short-term measures announced in a theatrical mea culpa on Monday night leaves President Macron’s putative “grand bargain” with Germany in tatters.

He had pledged root-and-branch reform of the French economy and a restoration of spending discipline after 11 years in breach of the EU’s Stability Pact. The calculation was that Berlin would in return drop its long-standing opposition to fiscal union and shared liabilities, agreeing to rebuild the euro on stronger foundations.

To the extent that this bargain was ever more than wishful thinking, it is dead now. The German Kanzleramt and finance ministry have watched near insurrection sweep the major cities of France over the last four weeks – with “Act V” already announced for next weekend – and watched a belated riposte from Élysée Palace that amounts to a climbdown.

“Macron’s response suggests that a rioting and pillaging mob can dictate politics, while those who demonstrate peacefully – or not at all – are ignored,” said Clemens Fuest, president of Germany’s IFO Institute. “His whole ability to push has been called into question. What he has announced are just tax giveaways.

“It is quite obvious that the budget deficit will be at least 3.5pc of GDP next year, and probably 4pc because the economy is heading for a light recession,” said Professor Jacques Sapir from the École des Hautes Études en Sciences Sociales in Paris.

Risk spreads on French 10-year debt jumped to 48 basis points on Tuesday as bond vigilantes began to digest the scale of fiscal slippage. This is the highest level since the ‘Frexit’ scare before the French elections in early 2017, when the Front National’s Marine Le Pen was riding high in the polls.

Kallum Pickering, from Berenberg Bank, said Mr Macron has “turned from darling to fallen angel very quickly”. The cancellation of the fuel tax rise and latest sweeteners will together cost €14bn. “France’s debt-to-GDP will likely rise beyond 100pc as a result,” he said.

Macron’s travails have broader implications. From the above Bloomberg article on Italy:

The [EU] Commission is in an awkward spot. The decision by Emmanuel Macron, France’s president, to pass a string of tax cuts and spending increases to appease the “Yellow Vest” protesters has made it politically harder to move against Italy without smacking of hypocrisy. But if Brussels were to accept a few cosmetic changes from Rome without any real substance, its already shaky reputation as the enforcer of the bloc’s fiscal rules would be in tatters.

So the poker game between Brussels and Rome goes on. It’s just that both players have far fewer chips than they originally assumed.

Keep in mind that all this is happening in an expansion. During the next recession, government spending and deficits around the world to soar to stunning levels, raising questions about the viability of not just presidents and prime ministers, but of currencies.

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Submitted by Adventures in Capitalism

Like all industries, the hedge fund industry is highly cyclical. 2018 is proving to be a catastrophe for many of my fund brethren. Let’s face it; most hedge funds have produced pretty awful returns for the past few years—a time when the S&P (the global benchmark) has shot the lights out. There’s an obvious reason for this underperformance and it comes down to the demands put upon most hedge fund managers.

While funds theoretically can do whatever they want (within reason) if they want to actually raise substantial capital, they’re supposed to beat the S&P every month of the year, with a Madoff level of volatility, while providing monthly liquidity. As you can imagine, this is simply impossible to achieve, yet many of my friends try anyway. This is because the hedge fund industry is mostly about asset aggregation—rather than performance. Ironically, quite a few of my hedge fund friends that have great performance can never raise much capital. Investors may claim they want uncorrelated, idiosyncratic portfolios with plenty of alpha, but they can never stomach the volatility or periods of underperformance that those portfolios entail—despite consistent rolling 3-year out-performance. Is it any wonder that so many funds instead try to focus on achieving the impossible?

It seems that 2018 is the year when investors have finally grown tired of underperforming while overpaying for that privilege. The redemption requests are coming in hot and heavy. What happens when you have redemptions? You have to sell stuff. This, combined with general de-leveraging is creating mayhem—particularly in sectors that have already underperformed over the past few years. It also creates strange outlier moves—the death spasms of an industry getting liquidated.

Take Tesla for instance. It is up almost 40% since the low in October, has outperformed the NASDAQ 100 Index by 5000bps and its FAANG cohort by nearly 6000bps. Sure, they beat Q3 estimates, even if the “earnings” quality was horrid. However, I think the real reason for this outperformance was that Tesla had become the short hedge to every fund manager’s long book.

• Got exposure to industrials with waning end-market demand? Hedge with Tesla—it is an auto OEM with a demand cliff.
• Got exposure to companies with substantial overseas business that will be impacted by a trade war? Hedge it with Tesla—its overseas business is a substantial portion of overall revenue, but is vaporizing as newer products are introduced in its top markets.
• Got exposure to companies with questionable accounting? Hedge with Tesla—no one’s books are worse.
• Worried one of your positions is a fraud? Hedge it with Tesla—it has more red flags than a May Day parade.

You get the point. While short interest was only about $10 billion at the peak, that number doesn’t include the massive implied short through outstanding puts—which are many times the entire float. What happens when people take down their overall exposure through redemptions? They take down their longs AND their shorts. In this case, they liquidate their puts—causing the never-ending melt-up we’ve seen at Tesla. We can be sure it’s not due to financial performance, as it seems that most Q4 metrics are tracking negatively compared to Q3.

Moving to small caps; I’ve been involved in this sector for nearly two decades. I can only think of two other times where I have seen so much pain and frustration amongst my small cap friends. That would be the 2008 to 2009 period and to a lesser extent during the first few months of 2016. I am stunned at how many high quality businesses trade for mid-single digit cash flow multiples—despite strong balance sheets. I’m even more stunned at how many slightly leveraged businesses trade at low single digit cash flow multiples. It’s outright insane how many companies trade for massive discounts to NAV. Take a look at shipping for instance—you have dozens of companies where you can liquidate the fleet and double your money based on current vessel values. This is despite the fact that charter rates are up and values are increasing. Of course, this still doesn’t quite compare to anything exposed to the energy sector. These things are being given away as dozens of energy funds liquidate and sell everything they own. You could say that some of these businesses are challenged—they aren’t all challenged. Moreover, they shouldn’t all be declining by a few percent a day—with hardly an up day.

What is going on?

You are witnessing a massive culling of the hedge fund industry as hundreds of funds are liquidated and thousands more get sizable redemptions. Many of these funds own the same companies—the outcasts from the indexed world, the cheap, the unloved; the same stocks that many other hedge fund managers own. With the hedge fund industry going in reverse, there is suddenly no natural buyer for what must be sold. As a result, you are seeing waves of forced sell orders and few buyers. It is creating rather insane bargains all around.

Like all trends, this one too will end. If your fund is facing a year-end redemption, you need cash in hand by December 31 and you probably finish selling a few days before then. Therefore, at most, there’s 9 ½ days left to make sales. It may get even uglier—it may not. No one knows how to time this.

What I suspect, is that the pain will finally abate in two weeks. Or at least the forced selling pain will be done. If you look at Q4, despite only a small drop in the S&P, it has been one of the most painful that my friends or I can remember. There are lots of guys down 20% to 30% this quarter and suddenly forced to de-lever further, to get their risk ratios in order. This sort of pain and indiscriminate selling creates lots of opportunities.

I am bearish on the overall market—I am bearish on the economy. Increasing interest rates will matter more than people realize. There’s a reason that I sold so many positions this summer—I wanted less exposure. I was afraid this would happen. All of those positions that I sold are down substantially from where I sold them—even though most have reported great results. In a downdraft, even the good companies get hit.

Despite my bearishness, I have been putting capital back to work over the past two weeks. Many of the companies that I am buying are down more than half this year—some are down a whole lot more. It’s the most exciting opportunity I’ve seen since 2016—even though I have been a bit early in buying some names. I suspect that even if the overall market is down dramatically during 2019, the bargains of late 2018 will shine given their current valuations—especially as many institute buybacks to soak up the newly freed up shares hitting the market. Christmas has come early once again—at least in the stock market—I might as well take advantage of hedge fund Armageddon.

Read more over at Adventures In Capitalism

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