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China Is Now Left With Just Three Options, And They Are All Equally Bad

Last Friday’s forceful intervention by the PBOC, in which the central bank hiked the reserve requirement for FX forwards trading from 0% to 20%, was a warning shot at the gathering yuan shorts who managed to briefly send the Chinese currency below 6.90 against the dollar last week, after losing 4% of its value in the past month, and bringing the cumulative decline against the dollar to 10% since April, a far steeper drop than seen during the 2015 devaluation.

The yuan slide had come amid growing speculation that Chinese authorities are more willing to let their currency weaken along with market forces and an escalating trade war, at least for as long as they felt any capital account leakages are contained and manageable.

And yet, despite China’s long overdue intervention – after all, once capital flight begins as new holes in the capital account are uncovered, it would be too late to prevent a repeat of the 2015 scenario – the debate about Chinese currency depreciation and what happens next with Chinese policy gathered pace, with ING last week proposing that this latest attempt to “nuke the shorts” is doomed to failure, just like previous unilateral FX interventions.

Over the weekend, JPMorgan echoed ING’s skepticism, writing that despite Friday’s PBoC announcement and despite the cumulative depreciation over the past two months, “the pressure on the Chinese renminbi to decline further against the dollar is unlikely to go away if trade tensions with the US escalate further from here.”

Meanwhile, in a move that puzzled many China watchers, at the same time that the PBoC announced an increase in the reserve requirement ratio for fx forwards trading, China announced that it would implement tariffs on $60bn of imports in response to a threat by the US earlier this week to raise the tariff rate from 10% to 25% on $200bn of Chinese exports to the US, prompting some to speculate that the FX intervention was merely implemented to prevent a collapse in the yuan beyond 7.00 vs the dollar as the market freaked out about the latest Chinese retaliation.

Of course the escalating tit-for-tat dynamic – which we have discussed extensively in the past – is familiar: as JPM explains, an argument can be made that this threat by the ‘hard case’ US to raise the tariff rate is creating a vicious circle:

… the more the Chinese currency depreciates vs. the dollar, the more it may be seen by the US administration as an attempt to offset their tariffs and the more the US tariff rate will be raised.

Last Friday, Larry Kudlow confirmed as much saying that Trump won’t back down as “China’s $60BN response is weak“, while on Sunday, CIA Director John Bolton warned that much more is still coming:

  • *BOLTON: WILL TAKE TRADE WAR `FAR ENOUGH TO GET CHINA TO CHANGE’

But it’s not just trade war that is weighing on the Yuan: according to JPMorgan, the PBOC’s recent scramble to ease monetary policy at the expense of fx policy “has seen a collapse in domestic interest rates with certain money market rates down almost 200bp YTD.” This contrasts with the Fed’s continued tightening, which keeps pushing US interest rates up. As a result, the gap – or the negative carry – between Chinese and US short-term interest rates is approaching zero, making it even less expensive for market participants to hold short renminbi/long dollar positions.

The chart below shows the difference between the 3-month SHIBOR rate in China vs. the corresponding interbank rate in the US: this gap collapsed to 60bp currently vs. 320bp at the beginning of the year, effectively wiping out the cost of shorting the Chinese currency vs. the dollar.

All else equal, the collapse in the short-term yield differential means that as trade war continues to ramp up and as China continues to ease conditions in response, the attack against the Chinese currency will only intensify forcing the PBOC to scramble plugging a growing number of leaky holes in the proverbial dyke, until finally the whole thing collapses.

It won’t happen overnight, however, because one thing China has going in its advantage, at least for now, is risk-on momentum in its capital markets offsetting FX capital flight, i.e., China continues to have strong portfolio flows into both Chinese bonds and equities by foreign investors, which have acted as a cushion. From JPM:

Foreign investors have been strong buyers of Chinese onshore bonds this year, and these inflows appear to have continued at a strong pace up until July. This is shown in Figure 4, which shows the change in holdings of Chinese onshore bonds both unadjusted and adjusted for market value changes.

What is also striking is that foreign investors also poured money into Chinese onshore equities this year, either to take advantage of more attractive valuations or in response to MSCI inclusion of A-shares. This is shown in Figure 5, which shows that adjusted for market value changes, foreign investors poured money into onshore equities each month this year with the exception of February. The total flow in the first half of the year was a strong $43bn. These portfolio inflows provide leeway to Chinese policymakers and create more room for currency depreciation as they can act as an  offset to other sources of capital leakage.

How much longer this inbound capital “momentum chasing” will continue is unclear, especially with Chinese A-shares tumbling into a bear market over the past few months, and approaching year lows. Meanwhile, with or without capital inflows, ad whether the PBOC forced short squeeze works, JPM warns that the yuan is nearing a key psychological level.

With the CNH rate very close to the level of 7.0 and the CFETS trade-weighted index very close to the level of 92, its previous historical low seen in May 2017, we believe that the Chinese renminbi and Chinese policy stand at a critical juncture.

So how, according to JPMorgan, would Chinese policymakers respond to further depreciation pressures?

Their base case is simple: the fiscal response, in particular infrastructure investment, and loan growth will pick up substantially in the coming months but that assumes that trade tensions do not worsen significantly from here. Which – as discussed above – they will, simply because neither Trump nor Xi will concede uncle the market forces them to cry uncle (and with the S&P just shy of all time highs, it certainly won’t be the Donald doing so first).

On the other hand, JPM writes that if the prospective fiscal and credit stimulus disappoints and/or the trade war with the US escalates, market pressure on the Chinese renminbi will intensify. At that point the three choices Chinese policymakers would face would all be far more difficult:

  1. intervene in currency markets to offset market pressures risking a new wave of reserve depletion;
  2. raise interest rates to defend the currency causing monetary tightening and risking economic weakness; or
  3. let the currency depreciate beyond the above critical levels along with market pressures risking capital outflows and a more abrupt move

It goes without saying that all three choices have severely adverse consequences for the market and the global economy, and yet Donald Trump would be delighted with any of the three. After all, recall what One River CIO Eric Peters said last week when he explained what the easiest way to bring China’s system crashing down was:

“The best way to bring Beijing to its knees is by running a tight monetary policy in the US. China has the world’s most overleveraged, fragile financial system.” 

In 2008, China’s total debt-to-GDP was 140%. It is now roughly 300%, while GDP is slowing. “The economy is held together by capital controls. If those fail, the whole system fails.”

The capital flight in 2015/16 cost the government $1trln in reserves, and that was with ultra-dove Yellen in charge. Imagine what would have happened with Volcker at the helm. The Chinese are dying to get their money out.”

Peters then laid out what may be the best long-term foreign policy recommendation for Trump, or any other administration: crash China…

“Engineering a decade of rolling Chinese financial crises would be the most effective foreign policy the US could run.” Forget about the South China Sea, don’t bother with more aircraft carriers, just let Beijing try to cope with their financial system.

“And we’re 80% of the way there – we instigated a trade war, implemented a massive fiscal stimulus, which created the room to raise interest rates. The combined policy mix makes capital want to leave at the same time it makes the dollar more attractive and effectively shuts down new investment inflows to China.”

… because if the US doesn’t do it first, China will have no problems doing it to the US when the time comes some time in the next 2 decades.

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Safe-Havens Are For Suckers: Specs Have Never Been More Short Bonds & Gold

With stocks at record high (price and valuations), and US macro data rolling over hard, it seems – based on speculators’ positioning – that only a sucker would worry about downside risks right now…

Markets shrugged off a weaker than expected employment report (and constantly weaker than expected macro data) this week..

With VIX Futures and options speculative positioning is now at its most net short since Dec 2017…

As it seems investors have throw in the towel on worry.

Speculators have added to their aggregate Treasury short positions for 4 of the last 5 weeks, with this week showing the biggest addition to shorts since Nov 2017…

 

And hedge funds have never been so short gold… having added to shorts for seven weeks running…

 

But no matter how much speculators pile into USD longs, the greenback refuses to rise any further…

What could go wrong?

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Polish “Vagina Beer” Contains “Essense” Of Two Smoking Hot Models

A Polish brewery has produced a unique concoction; beer with vaginal lactic acid from two smoking hot models, Paulina and Monika, whose “essences” are caputured by a gynoecologist and treated by a laboratory in the city of Poznan in order to isolate the specific bacteria required for production, according to CEO Wojciech Mann. 

“When you drink this beer, you realize that originally there was a beautiful woman who was maybe taking a shower, dancing or laughing at the very moment. You feel a close connection with this woman,” the owner of the brewery Wojciech Mann told Sputnik.

The brew, made by “The Order of Yoni” (Yoni being the Sanskrit word for vagina) boasts 8% alcohol by volume and comes in two versions; Bottled Lust and Bottled Passion. Lust contains a “subtle nutmeg aroma and is produced using Paulina’s vaginal bacteria,” while Passion is a “classic light beer made from the essence of Monika’s vagina.” 

Once the beer “containing the quintessence of femininity,” was introduced to the wider public on the brewery’s social media accounts, with a very hot advertising campaign involving Paulina and Monique, users from across the world were drawn to the Facebook page. –Sputnik

If you’re wondering about STD’s, fear not – “While a female netizen wondered whether the models had been tested for sexually transmitted diseases before contributing to the production of the beer, “The Order of Yoni” quickly replied that they had undergone gynecological examinations, and then the material was double-checked in the Poznan lab to make sure that the lactic acid bacteria were isolated from the smear.” 

 

A post shared by The Order of Yoni (@orderofyoni) on

 

From the website: 

Imagine woman of your dreams, your object of desire. Her charm, her sensuality, her passion… Try how she tastes, feel her smell, hear her voice… Now imagine her giving you a passionate massage and gently whispering anything you’d like to hear. Now free your fantasies and imagine all of that can be closed in a bottle of beer. A golden drink brewed with her lure and grace and flavored with wild instincts. Imagine a beer which every sip offers a rendez-vous with this hot woman of your dreams… she hugs you and kisses you gently, looking straight into your eyes… How much would you give for such a beer?

We, the Order of Yoni, have prepared technology making creation of such unique beer possible. The beer containing quintessence of femininity. The technology enabling materializing her loveliness, gracefulness and character, giving you the possibility of conversion of a tasty beer into a date with real goddess.

The secret of the beer lies in her vagina. Using hi-tech of microbiology, we isolate, examine and prepare lactic acid bacteria from vagina of a unique woman. The bacteria, lactobacillus, transfer woman’s features, allure, grace, glamour, and her instincts into beers and other products, turning them into dance with lovely goddess.

The company hasn’t said what it plans to do if the beer is picked up by a major distributor. Suffice to say Monika and Paulina’s vaginas would be in for quite the workout. 

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The Blowback Begins: Ohio Farmer Vents On Trade War

Via Global Macro Monitor,

Hope you all take the time to read this piece by an Ohio soybean farmer caught up in Trump’s trade wars.

Tariffs hurt the many and help the few.  The “tyranny of the minority,” if you will, and that is before taking into account the casualties of tit-for-tat retaliation.

Let me tell you a riddle.

“I slept with a billionaire because he said he loved me. I expected to make love, but in the morning I realized I was getting screwed. When I went to tell the world, I was offered cash to keep my mouth shut.”

Who am I? No, I’m not a model or someone named Stormy. I’m the American farmer.

In the mid-1980s we were awash with over production in the corn and soybean sectors. Agriculture got busy, boarded planes, trains and automobiles and started building markets around the world, one handshake and one relationship at a time. We used our own funds through our check off dollars and trade associations to build markets in Mexico, Canada, Latin America and the Pacific Rim. And we didn’t stop there. In partnership with the U.S. taxpayers, we built an ethanol industry to ensure another renewable energy source for U.S. consumers. 

–  Christopher Gibbs, Sidney Daily News

Hat Tip:  @Noahpinion

Politics

Big special election in Ohio’s 12th Congressional District on Tuesday.   President Trump was stumping today for the Republican candidate.   The seat has been held by Republicans since 1920, except for an eight-year stretch in the 1930s and a two-year term in 1980.    It’s tight, folks

A Monmouth University poll released this week shows a tight race, with Balderson receiving 44% support to O’Connor’s 43%, with 11% of respondents saying they are undecided.  – CNN

Stunning given the Republican beat the Democrat in the 2016 general for this seat,  66.6 percent to 39.8 percent,  a whopping spread of 36.8 percent.

If the Dems take this one, the Republicans and the president are in deep-deep trouble. Even if it comes anywhere near to as close as the polls suggest, it still spells doom for White House.

We are becoming more confident of our Lavender Wave prediction for the November midterms.

Massive Lavender Wave Coming In November

We believe there will be a massive “lavender wave,” in the November midterms.  Lavender is the color combination of pink and blue.

In a recent poll, the president’s approval rating among men is 54 percent positive and 45 percent negative. Among women, it’s 32 percent positive and 65 percent negative.   There are many more women registered voters than men.

In elections, women are also more likely to vote in higher numbers and have done so for decades.  Women have cast between four and seven million more votes than men in recent elections.

Moreover, the revulsion toward the president among women has not only made them more likely to vote but has turned them into activists.  Women are running for office this year in record numbers.

Recall it was the African-American women who put Doug Jones over the top in Alabama’s special U.S. Senate election against Roy Moore last year.  Exit polls showed that 98 percent of black women supported Jones.

Do the math, folks.  Listen to the water cooler talk, read the cartoons.

The Dems will control the House, and probably Senate come next January.   PredictIt gives the Dems a 68 percent probability of taking back the House but only a 30 percent chance of taking the Senate.   We will take that bet, however, a 3,600 percent compounded annual return if Chuck becomes the next Majority Leader.

A Lavender Wave is not even remotely priced by the markets.

We suspect panic will begin to seep in when everyone returns from the beach in September.  Not a political statement just our observations and inferences based on the data.

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Twitter Suspends Black Conservative For Changing NYT Bigot’s Tweets From “White” To “Jewish” And “Black”

In response to the New York Times’ decision to stand by their most recent hire – open bigot Sarah Jeong, who really hates white people, men (especially white men), and cops – black conservative Candace Owens conducted out a thought exercise we mentioned last week in which we replaced the word “white” with “black” to illustrate Jeong’s animus. 

Here are just a smpling of Jeong’s controversial tweets:

The Times has chosen to stand by Jeong – claiming that she was simply imitating other racists. 

In response to the “no big deal” attitude from the left, Owens simply replaced “white” with Jewish and Black, then mashed Jeong’s statements into one tweet, for which the Twitter police banned her for 12 hours: 

Actually, Twitter only removed (or forced Owens to remove) her tweet about Jewish people, while the one in which she swapped the race from white to black remains as of this writing…  

Meanwhile, conservative pundit Ann Coulter responsded to Jeong’s bigotry with a bit of a history lesson:

Candace responded to her Twitter ban on Sunday: 

Was Candace also suspended for her response to Hillary Clinton’s recent defense of Lebron James, who President Trump recently dissed over Twitter after James criticized Trump for fueling racial divides in the U.S.? 

To which Hillary, or her social media team, replied:  

And Candace Owens replied “This is rich. Your husband locked up more black men than any President in the history of the United States. You view Margaret Sanger (who wanted to exterminate the black race) as your idol and Robert Byrd (former Klansmen) as your mentor and dear friend.” : 

Perhaps someday Twitter will let us in on what consitutes racism and harassment – since the goal posts seem to be all over the place depending on who said what. 

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All FAANG’d Up

Via RealInvestmentAdvice.com,

Bulls Make A Charge For The Highs

Last week, we discussed how the market managed to clear the “Maginot Line” which brings January highs into focus. The chart below is the updated analysis from last week.

Given this is a “weekly” chart, it takes much more time for signals to register. The advance over the last few weeks has taken the market back into overbought territory and was a point made last week:

“The market can most assuredly get even more overbought from current levels, but does suggest that upside is becoming more limited from current levels. However, with the weekly ‘buy signal’ triggered this past week, we must give the bulls some room to run.”

Currently, the “bulls” remain clearly in charge of the market…for now. While it seems as if much of the “tariff talk” has been priced into stocks, what likely hasn’t as of yet is rising evidence of weakening economic data (ISM, employment, etc.), weakening consumer demand, and the impact of higher rates.

While on an intermediate-term basis these macro issues will matter, it is primarily just sentiment that matters in the short-term. From that perspective, the market retested the previous breakout above the March highs last week (the Maginot line) which keeps Pathway #1 intact. It also suggests that next week will likely see a test of the January highs.

With moving averages rising, this shifts Pathway #2a and #2b further out into the August and September time frames. The potential for a correction back to support before a second attempt at all-time highs would align with normal seasonal weakness heading into the Fall. 

Currently, there is a very low risk of a deeper correction (Pathway #3). However, it is a possibility that should not be ignored at this juncture. With the administration gearing up for further tariffs against China, and China retaliating in kind, at a time when the Fed is already more aggressively tightening monetary policy, it would be remiss to ignore the risk of “something going wrong.” 

It would also be remiss to not remind you that despite the “bullish short-term view,” the long-term outlook remains decidedly bearish. With valuations elevated, price extended, and deviations near historic records, the potential for a more severe correction in prices is an absolute certainty.

The issue is that these cycles can remain both fundamentally and technically overvalued for longer than logic would dictate particularly when there are artificial influences at play. However, the message is clear for those that choose to listen. This is why it is crucially important to have a discipline and strategy in place which will manage the exposure to risk when things change in the market.

Weekly Buy Signal Is In, But Don’t Jump

In the 401k Plan Manager at the bottom of this newsletter each week, I publish the model that drives our portfolio allocations over time.

There are two important concepts to understand about this model.

  • Risk knows no age: Risk doesn’t care how old you are. It is often said that if you are 20, you should take on a lot of portfolio risk. However, if that risk is taken at the top of a market cycle, the damage to the long-term financial goals can be disastrous. We believe that our allocation to risk has nothing to do with our age, and everything to do with the potential for the loss of capital. Therefore, our allocation model is broken into two parts.
    • Allocation model is based upon current valuation levels.
      • If valuations were 10-12x earnings the target allocation levels would be primarily weighted towards equity (i.e. 80% Stocks / 20% Bonds)
      • As valuations rise behind historical extremes, target equity levels are reduced. (i.e. 60/40, 50/50, etc.)
    • The EQUITY portion of the allocation is also adjusted based on current market risk. Earlier this year, the equity risk portion of the allocation model was reduced from 100% to 75% due to a triggering of a confirmed “sell” signal. There are 4-primary indicators to the model:
      • 1st signal – short-term warning signal. Only an alert to pay attention to portfolio risk. 
      • 2nd signal – reduce equity by 25%.
      • 3rd signal – (Moving average cross-over) reduce equity by another 25%.
      • 4th signal – (Trend change) – reduce equity by another 25% and short the market.

We will be posting a live version of our indicators at RIAPro.net (currently in beta) as shown below.

The 4-signals above also run in reverse. So, when a signal reverses itself, equity risk is increased in the model as is the case this week.

With that signal in place, we must now increase our portfolio allocation model to 100% of target.

However, it is important to note these signals are based on “weekly” data and are intermediate-term in nature. Therefore, by the time these longer-term indicators are triggered, the very short-term conditions of the market are generally either very overbought, or oversold.

So, Do I Buy Or Not?

At this juncture, most individuals tend to let their emotions get the better of them and they make critical errors with their portfolios. Emotional buying and selling almost always leads you into doing exactly the opposite of what you should do.

Currently, the market has registered a “buy signal,” which means we need to be following our checklist to ensure we are making sound investment decisions:

  • What is the allocation model going to look like between asset classes?
  • How will those choices affect the volatility of my portfolio relative to the market?
  • What is the inherent risk of being wrong with my choices?
  • What is my exit point to sell as the market goes up?
  • Where is my exit point to sell if the market goes down?
  • What specific investments will I use to fill each piece of my allocation model?
  • How does each of those investments affect the portfolio as a whole as well as each other?
  • Where is my greatest and least amount of exposure in my portfolio?
  • Have I properly hedged my risk in my portfolio in case of a catastrophic event?

If you can’t answer the majority of these questions – you should not be putting your money in the market.

These are the questions that we ask ourselves every day with our portfolio allocation structures and you should be doing the same. This is basic portfolio management. Investing without understanding the risk and implications is like driving with your eyes closed. You may be fine for a while but you are going to get seriously hurt somewhere along the way.

There is NO RULE which states you have to jump into the market with both feet today. This is not a competition or game that you are trying to beat. Who cares if your neighbor made 1% more than you last year. Comparison is the one thing that will lead you to take far more risk in your portfolio than you realize. While you will love the portfolio as it rises with the market; you will rue the day when the market declines.

Being a “contrarian” investor, and going against the grain of the mainstream media, feels like an abomination of nature. However, being a successful investor requires a strict diet of discipline and patience combined with proper planning and execution. Emotions have no place within your investment program and need to be checked at the door.

Unfortunately, being emotionless about your money is a very difficult thing for most investors to accomplish. As humans, we tend to extrapolate the success or failure within our portfolios as success and failure of ourselves as individuals. This is patently wrong. As investors, we will lose more often than we would like – the difference is limiting the losses and maximizing the winnings. This explains why there are so few really successful investors in the world.

With this in mind, it doesn’t mean that you can’t do well as an investor. It just means that you must pay attention to the “risks” inherent in the market and act accordingly.

• Yes, the market is on a “buy” signal. 
• Yes, we need to add exposure as shown in the 401k plan manager below. 
• No, it doesn’t mean that you need to act immediately

However, it does mean that we need to pay close attention to developments over the next couple of weeks to be sure the “intersection” is clear and that we can proceed to the next traffic light safely. Hopefully, we can catch it “green” – if not, we will obey the signal, stop, and wait for our turn once again.

While the model is being increased back to 100% of target, we will selectively add equity exposure during short-term corrective actions in the market.

As I noted last week:

“With our portfolios nearly fully allocated, there are not a lot of actions we need to take currently as the markets continue to trend higher for now. We will continue to monitor our exposure and hedge risk accordingly, but with the weekly “buy signal” registered, we are keeping our hedges limited and are widening our stops just a bit.

As noted above, a short-term correction is needed before adding further equity exposure to portfolios. That correction likely started on Friday, and I will not be surprised to see it continue into next week. A retest of 2800 is likely at this point, which would keep Pathway #1 intact. However, a violation of that level will likely trigger a short-term sell signal, which could push the market back towards previous support at 2740. 

There is a lot of support forming at 2740, which should be supportive of the market over the next couple of months. A violation of that level suggests something has likely broken and more protective actions should be taken.”

Until that happens, we will give the markets the benefit of the doubt…for now. 

All FAANG’ed Up

Doug Kass had an interesting point on Apple’s surge to $1 Trillion in market cap.

A consensus has formed among economists that the trend toward corporate concentration – in terms of the size of companies and their grasp on profits – is real and may be long-lasting.

“The number of papers that are being written on this from week to week is remarkable,” said David Autor, a Massachusetts Institute of Technology economics professor who has studied the phenomenon…”Apple and Google combined now provide the software for 99 percent of all smartphones. Facebook and Google take 59 cents of every dollar spent on online advertising in the United States. Amazon exerts utter dominance over online shopping and is getting bigger, fast, in areas like streaming of music and videos.” –New York Times, Apple’s $1 Trillion Milestone Reflects Rise of Powerful Megacompanies

With much justification, a small group of stocks, referred to as FAANG, has dominated the U.S. stock market and U.S. economy.

Nearly half of this year’s gains in the S&P 500 Index have come from the five component stocks of FAANG (Facebook (FB) , Amazon (AMZN) , Apple (AAPL) , Netflix (NFLX) and Alphabet — aka Google (GOOGL) ).

Lance here: 

A couple of week’s ago I addressed this market capitalization issue, to wit:

“The current environment has the look and feel of a late-stage market cycle. This is particularly the case when you have 20-stocks making up more of the overall S&P 500 index than the bottom 400 combined.”

“Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”– Bob Farrell’s Rule #7: 

Back to Doug:

Indeed, FAANG stocks have fueled much of the near-decade-long bull market since March 2009.

The rise of FAANG has contributed and influenced our domestic economy, in a not-so-good way. Facebook, Amazon, Apple, Netflix and Google’s unfettered growth has manifested in declining levels of unionization and contributed to the disruption of numerous industries, thus influencing the general trend of weak wage growth and impacting the rise in income inequality.

As the technology of FAANG has rapidly eclipsed the influence of regulatory supervision and an antiquated antitrust legislation, their sales growth and market dominance have gone nearly untouched by the hand of government.

The business media has rejoiced in Apple reaching a $1-trillion market cap and, not surprisingly, has embarked on a trivial, simplistic and superficial discourse, questioning how much further Apple can rise, which will be the next $1-trillion company, and so forth.

Rather, one should consider the consequences of the concentrative issues relating to FAANG and consider what happened to the U.S. and global economies when our banking industry grew exponentially by leveraging itself into oblivion, proving that it was not too big to fail in 2008-2009.

“A year ago, the big tech companies were basically untouchable; today, they seem not to be.”
–Luigi Zingales, University of Chicago

To me, the existential risk to FAANG is that their growth is dulled by the above realities and the U.S. government takes a more aggressive position toward FAANG’s domination. After all, in an age of populism seen both on the political left and the right, assaults by legislators and government regulatory bodies seem likely to intensify.
As well, should the current phase of protectionism continue and the possibility of trade wars intensify even further, it could result in the disruptors being disrupted.

After all, nearly 19% of Apple’s sales are derived from China.

By contrast, the existential risk to our economy is that their growth is allowed to continue at a helter-skelter pace, with some of the downside factors mentioned in this morning’s missive multiplying should the growth snowball be permitted to roll further down the economic hill.

*******

Doug’s point is interesting as it dovetails into an article that David Robertson, CFA wrote for RIA this past week wherein he noted:

“Such competition moves the tradeoffs of centralization vs. decentralization to the geopolitical stage: ‘The AI competition may be better viewed as part of a broader struggle between a decentralised democratic model and a digital authoritarian system.’

So are technology companies breaking bad? That would probably be an overstatement, but it is very fair to say that many of the elements crucial to harness the full potential technological innovation are underrepresented in today’s environment. Knowledge of technologies is insufficient, governance is slow and weak, and public engagement is low. This creates a weak position from which to wrest power from companies with strong economic incentives. This is important for investors. Unless things change, there is a good chance that not only will the great potential of technological innovation fail to be realized, but also that such innovations will continue to be exploited right up until things break.”

The risk of concentration into the few stocks poses an enormous risk to investors when, not if, something inevitably goes wrong.

As we saw just recently with plunges in $FB and $NFLX, given the massive levels of leverage currently built into the system a concentrated sell-off in the FAANG stocks could lead to a rather disastrous unwinding for investors.

While such an event is widely dismissed as impossible, it is important to remember it was deemed to be that way previously. This tweet from David Rosenberg sums it up succinctly.

As I noted last week, the underlying economic environment, and the associated structural deformations pose a substantial risk to investors longer-term.

“While fighting trade wars, pushing tax cuts and increasing government spending may provide short-term boosts to the economy by pulling forward future consumption – they do not address the issues which are detracting from longer-term growth.’

  • Debt
  • Spending Hikes
  • Demographics
  • Surging health care costs
  • Structural employment shifts
  • Technological innovations
  • Globalization
  • Financialization

While Doug’s, David’s and Rosie’s points are valid, these are issues that will take time to develop. As such, the ongoing performance of FAANG stocks will continue to lure unwitting investors into the trap which will eventually lead to their demise.

But such is the nature of markets historically.

Just be careful you don’t get F.U.B.A.R.ed. (FAANG’ed Up Beyond All Recognition)

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Armed Bystander Takes Down Gunman At Florida Children’s Event

An armed bystander licensed to carry a firearm shot a gunman who opened fire at a back-to-school event at a Titusville park, reports local ABC affiliate WFTV9.

The shooting occurred at Isaac Campbell Park on South Street shortly after 5:20 p.m. when the shooter, whom police have not identified, returned to the park after a fistfight and began firing. 

A bystander licensed to a carry a firearm then shot the shooter, who was flown to a nearby hospital with life-threatening injuries, police said. –WFTV9

(full video here, shooting at 7:50)

The bystander who shot the gunman has been fully cooperative with the investigation, according to local police. “We are extremely grateful that nobody else was injured in this incident,” said Deputy Chief Todd Hutchinson. “This suspect opened fire at a crowded public park, this could have been so much worse.”

A flyer posted on Facebook and Instagram said a back to school event called “Peace in the City” was going on at the park when the shooting happened. –WFTV9

While we expect 2nd Amendment advocates will point to this incident as a “good guy with a gun” taking down a “bad guy with a gun,” gun control activists are likely to pretend it never happened – or that local police would have intervened.

After all, when seconds count, the police are just minutes away! 

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Schiff: “The Next Crisis Is Not Going To Look At All Like 2008”

Peter Schiff is an economist who served as an advisor to Ron Paul in 2008 and even made a run for Senate on his own at one point. He’s well-known in the “Austrian” as well as the libertarian economic community, but is perhaps best known for his belief that our next coming crisis is going to be “an order of magnitude larger than the crisis in 2008”, only this one, the Federal Reserve is not going to be able to print their way out of, Schiff predicts in his most recent interview.

“What the Fed is worried about is a repeat of the 2008 financial crisis. What they don’t realize is the next crisis is not going to look like the 2008 crisis,” Schiff said.

He makes the why the dollar going up in 2008 helped the Fed bail everyone out, and why it’s going to be impossible for the Fed to do the same thing when the dollar collapses during the next recession. Schiff also explains that a loss of confidence in the dollar as the world’s reserve currency could see interest rates move much higher, resulting in the U.S. defaulting on its debt. 

Despite getting the 2008 housing crisis right, Schiff’s appearances in the mainstream financial media have declined precipitously due to his bearish outlook. As an alternative, he has created a substantial voice for himself on his YouTube channel, which boasts hundreds of thousands of subscribers. 

On Saturday, August 4, Peter Schiff appeared on the Quoth the Raven podcast to talk about a multitude of topics, including:

  • Why the mainstream media doesn’t have him on anymore, despite predicting the 2008 financial crisis production dead-on
  • Why the government should have let more banks fail in 2008
  • Why he believes that a socialist will be elected in 2020 and why a libertarian may actually have a chance in 2024
  • Why he believes the price of gold will be appreciating drastically in the years to come
  • Why people are going to want to own commodities and emerging markets and get out of dollar denominated assets in the United States
  • Why the Fed “stress tests” are rigged
  • Why macroeconomic data shouldn’t be relied upon
  • How inflation will hit when newly printed money finally exits the capital markets

On the podcast, Schiff also notes how wrong the media and economists were in 2008, an accusation he himself has been the target of in recent years:

“It’s a total double standard because it shows you their way of thinking. If you look at all of these experts that were completely wrong now that we’re 10 years from the financial crisis…by 2007, the bubble had burst…even after it was so completely obvious. I was predicting it. They didn’t figure it out until everything imploded…”

“I was going on television in mid 2008 saying ‘we’re in recession’ and they were saying ‘you’re crazy, there’s no recession in sight…'”

You can listen to the full podcast here:

In the podcast, Schiff also talks how Keynesian and Austrian economic theory differ, how inflation has an effect on the middle class, the politics of Trump’s economic policy, and the recent volatility in tech stocks and tons more.

Peter’s YouTube channel can be found here, meanwhile for those looking for some of the best alternative podcasts around, check out QTR’s work at the following link.

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CA Bullet-Microstamping Law Upheld By 9th Circuit, Even Though Technology Doesn’t Exist

A California “microstamping” law that requires new semi-automatic handguns automatically imprint bullet casings with identifying information has been upheld by the 9th circuit court of appeals in a 2:1 split decision – despite the fact that the technology doesn’t exist, reports ABC News.

The microstamping law – the first of its kind in the nation signed in 2007 by then-governor Arnold Schwarzenegger, took effect in 2013. It requires that brand new handguns sold in California imprint the gun’s make, model and serial number in “two or more places” on each bullet casing from a spent round. 

The result of the new law was Smith & Wesson, Ruger and other manufacturers opting to pull out of California.

Gun rights advocates have slammed the law, as the technology doesn’t exist to stamp bullet casings in two places as the law is written, and even if it did, criminals could replace or file down the firing pin and any other mechanism to “microstamp.” 

The law became effective as soon as the California Department of Justice certified that the technology used to create the imprint was available. When this certification occurred in 2013, the State clarified that the certification confirmed only “the lack of any patent restrictions on the imprinting technology, not the availability of the technology itself.”  In layman’s terms, the state was saying that nothing was stopping someone from developing the technology, so it was “available,” even though it wasn’t. –NRA-ILA

As a result, compliance with the law’s “dual placement microstamping” requirement was both practically and legally “impossible,” according to court documents from a lawsuit brought by the National Shooting Sports Foundation (NSSF) and the Sporting Arms and Ammunition Manufacturers Institute (SAAMI). In support of their claim, writes the NRA Institute for Legislative Action, the plaintiffs cited an existing provision of California law, Civil Code section 3531, which states “[t]he law never requires impossibilities.” 

California gun rights advocates say the law effectively bans the sale of new semi-automatic handguns in the state. 

And what did the 9th circuit say to that? 

Too bad – as residents can still buy used handguns that don’t carry the yet-to-be invented microstamping technology, as well as any guns on a pre-approved roster – thus, the inability to buy a new semiautomatic handgun that’s not on the roster doesn’t infringe on the 2nd Amendment right to self-defense. 

Writing for the majority, Judge M. Margaret McKeown said the inability to buy particular guns did not infringe the 2nd Amendment right to self-defense in the home.

“Indeed, all of the plaintiffs admit that they are able to buy an operable handgun suitable for self-defense — just not the exact gun they want,” she said.

McKeown, joined by Judge J. Clifford Wallace, also rejected the argument that the stamping technology was impossible to implement. –ABC News

Calguns foundation executive director Brandon Combs said that the 9th circuit used a less rigorous judicial standard in order to arrive at its “policy preferences.” 

“Really what the 9th Circuit is saying and has said in other cases basically is as long as a person that is law abiding has access to one handgun inside of their home, then that’s it,” he said. “That’s the extent of their right. We think that’s quite wrong.“

Dissenting from the majority was Judge Jay Bybee, who cited conflicting evidence over whether the microstamping technology was even technologically feasible – and that if the state adopted an impossible requirement that no gun manufacturer can satisfy, it would not help the state solve handgun crimes and would illegally restrict gun purchases. 

As Breitbart‘s resident Second Amendment columnist AWR Hawkins detailed in 2015, Maryland canceled a similar “ballistic fingerprinting” program after 15 years and $5 million dumped into the program resulted in no crimes solved. 

The law did not call for “microstamping” like California’s – rather it relied on unique metallurgical “fingerprints” left behind by a gun’s firing pin. Each new gun sold in the state would need to be fired one time, and the resulting bullet casing sent to the state’s police headquarters. Unfortunately, while the forensic technology to match a bullet casing with a gun exists – the computerized system designed to sort and matched images of casings never worked – so the state canceled the program. 

Of course, just wait until DNA identification is implemented:

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Stock Market Manias Of The Past Vs ‘The Echo Bubble’

Authored by Pater Tenebrarum via Acting-Man.com,

The Big Picture

The diverging performance of major US stock market indexes which has been in place since the late January peak in DJIA and SPX has become even more extreme in recent months. In terms of duration and extent it is one of the most pronounced such divergences in history. It also happens to be accompanied by weakening market internals, some of the most extreme sentiment and positioning readings ever seen and an ever more hostile monetary backdrop.

 

Who’s who in the zoo in 2018

The above combination is consistent with a market close to a major peak – although one must always keep in mind that divergences can become even more pronounced – as was for instance demonstrated on occasion of the technology sector blow-off in late 1999 – 2000.

Along similar lines, extremes in valuations can persist for a very long time as well and reach previously unimaginable levels. The Nikkei of the late 1980s is a pertinent example for this. Incidentally, the current stock buyback craze is highly reminiscent of the 1980s Japanese financial engineering method known as keiretsu or zaibatsu, as it invites the very same rationalizations.

We recall vividly that it was argued in the 1980s that despite their obscene overvaluation, Japanese stocks could “never decline” because Japanese companies would prop up each other’s stocks. Today we often read or hear that overvalued US stocks cannot possibly decline because companies will keep propping up their own stocks with buybacks.

Of course this propping up of stock prices occurs amid a rather concerning deterioration in median corporate balance sheet strength, as corporate debt has exploded into the blue yonder (just as it did in Japan in the late 1980s). The fact that an unprecedented number of companies is a single notch downgrade away from a junk rating should give sleepless nights to fixed income and stock market investors alike –  as should the oncoming “wall of maturities”.


A giant wall of junk bond maturities is looming in the not to distant future. Unless investors remain in a mood to refinance all comers, this threatens to provide us with a spot of “interesting times”. Something tells us that “QT” could turn into a bit of a party pooper as the “Great Wall” approaches.

It should also be mentioned that past stock market peaks as a rule coincided with record highs in buybacks. This indicates that record highs in buybacks are mainly a contrarian indicator rather than a datum providing comfort at extreme points.

Of course, what actually represents an “extreme point” can only ever be known with certainty in hindsight, as extremes tend to shift over time – particularly in a fiat money system in which the supply of money and credit can be expanded willy-nilly. What can be stated with certainty is only whether the markets are entering what we would call dangerous territory.

Stock buybacks are zooming to unprecedented heights

From an anecdotal evidence perspective the continued existence of curmudgeons like us who are aware of the above and are pointing out that this is a dangerously overstretched market may actually be a good reason to believe it will become even more overstretched. When the bubble pops one of these days, we may superficially look like the proverbial stopped clock that finally showed the right time – note though that our views on the big picture and our short term tactics are two different cups of tea.

After all, we even trade cryptocurrencies, which are well beyond fundamental analysis – this is to say, we don’t believe it is possible to assign a “proper” valuation to them. We don’t know if a Bitcoin is worth nothing (that seems unlikely though) or a million dollars. What we do know is that it is a market that is extremely suitable for short term trading based on technical analysis.

In terms of long term investment strategies we prefer methods that eschew market timing altogether. We mainly rely on a specially adapted version of the permanent portfolio (which is extensively discussed in Austrian School for Investors, a book we modestly contributed to and warmly recommend, mainly for the contributions of the other authors).

Moreover, the “big picture” can only be judged once the cycle has fully run its course.

Diverging Indexes and Major Stock Market Tops

In view of the growing intra-market divergences mentioned above, we decided to create a few comparison charts which show three major market indexes on occasion of major stock market peaks of the past three decades, plus one additional indicator, namely the spread between 2- and 10-year US treasury yields as a proxy for the yield curve.

The indexes are the Dow Jones Industrial Average (DJIA – not really an index, but a price-weighted average), the NDX (a proxy for big cap technology stocks) and the NYSE Composite (NYA – a proxy for the broad market). We have chosen three major turning points, namely the 1987, 2000 and 2007 peaks, which we compare to today’s situation.

The charts follow in chronological order, starting with 1987.

The 1987 top: the DJIA and the NYA topped at the same time and also and made a secondary lower high concurrently, but the NDX diverged from them by making a higher high on occasion of the secondary peak – this is par for the course at major market peaks. Interestingly the crash of 1987 did not presage an imminent recession. A recession occurred much later (in 1990), but by that time the market had already regained the losses it had suffered in the crash. Note that the yield curve did not invert prior to the crash – in fact, the low of the 2-10 spread was at a relatively high 75 basis points – the spread did explode to 140 basis points as the crash unfolded, but it provided no actionable advance warning. So much for the theory that “nothing bad can happen before the yield curve inverts”.

The flame-out of the tech mania in early 2000. Once again there was a divergence between the peaks in DJIA and NDX, but it was extremely large on this occasion. After its initial 36% crash in April of 2000 the NDX proceeded to lose a rather disconcerting 83% of its value over the next two years. At the peak, the NYA diverged from both DJIA and NDX, but in this case by being the last index to top out. The reason for this was in our opinion that value stocks had already declined for more than two years by the time the mania peaked, and there was a big rotation from growth to value when the Nasdaq crash began, as value stocks were genuinely cheap at the time. The yield curve had inverted rather dramatically, but it gave no advance warning – rather, the lowest point of the 2-10 spread – a negative -52 basis points – coincided perfectly with the low of the initial crash wave in the NDX.

The 2007 market peak was a bit trickier, as there was actually no outright divergence between the three indexes. However, at the secondary peak in early October the NDX outperformed the other indexes substantially, as the “flight to fantasy” (i.e., into the most overvalued market sectors) we always see at major peaks was once again in full swing. This time the yield curve did provide an advance warning: the 2-10 spread had inverted and bottomed in late 2006 already, and was expanding noticeably by the time equities made their top. We believe this happened because the recession in the housing sector had started in 2006 already, around the time the Bank of Japan cut its balance sheet by 25% almost overnight as it reversed its previous “QE” policy. The bond markets evidently sensed that this would eventually lead to broad-based recession which would force the Fed to abandon and reverse its baby-step tightening policy.

And here is finally today’s situation (read here why we call it the “echo bubble” – explanation at the end of the article). There is once again a major divergence between DJIA/NYA and the NDX, which is outperforming the former two quite noticeably since the late January peak and has streaked to new highs. The deterioration in market internals is highly reminiscent of that seen on occasion of previous market tops, as an ever smaller number of big cap stocks  – mostly in the tech sector – is driving the advance. The so-called FANG stocks (FB, AMZN, NFLX, GOOGL) currently trade at around 9 times revenues, the highest ever. Including AAPL they now represent around 11% of the S&P 500 index – which recently reached an interim high while only 3% of its components actually made a new high. The 2-10 spread has recently made a low at a positive 24.7 basis points and has since climbed to 32 basis points. Similar to 1987 and 2000 we do not expect a major advance warning from this indicator, especially in view of the fact that a ZIRP regime has been in place for several years. Japan serves as a historical example: the last 5 recessions and bear markets in Japan all started without a preceding yield curve inversion. The last time a major market peak in Japan was preceded by an inverted yield curve was in 1989. How will the 2018 divergence between the indexes play out? We cannot be certain, but we do believe it represents a major warning sign. Keep in mind that it is not necessary for a recession to be imminent: a very overvalued and over-loved market with weak internals can crater at any time, it does not have to presage a recession. As an aside, there is a major difference between the year 2000 peak and the current situation: while growth has vastly outperformed value in both eras, this time value stocks are definitely not cheap. Rather, the “everything bubble” has pushed the valuations of almost all sectors to extremely lofty levels. There may well be rotation, but it probably won’t be as pronounced as it was after the top of the tech mania in 2000. An equal opportunity massacre seems far more likely this time around.

Measures of Giddiness

We mentioned extremes in sentiment and weak internals above and wanted to show a few pertinent examples. The charts below illustrate why there is good reason to be concerned about the divergences that have developed in recent months.

This chart mirrors margin debt – it shows “available cash”, which has recently reached a record negative USD 331 billion. Obviously, conviction is stronger than ever (note the positioning of the “excessive optimism” line).

Purchases of calls by small traders (newly opened positions) have exploded to new highs –  and the recent peak actually diverged from the SPX (though not from the NDX, which may be more relevant in this case). If there is a “wall of worry”, this group of traders does not see it.

The RYDEX leveraged bull-bear asset ratio has made a new high at 24 in late January and has put in peaks above the 20 level two more times since then.

The number of buy and sell recommendations on AMZN (we found this chart also via sentimentrader). The ratio is currently 48:1, which in a sense is an improvement, as there were zero sell recommendations previously. Look at where the ratio stood in late 2002 when AMZN could be bought for $5 (in words: half a sawbuck). They sure hated it in late 2006, when sell recommendations actually exceeded buy recommendations – it traded at $25 at the time. Well, they really love it at $1,740 (current level $1,830 – still getting the same amount of love).

Cash is trash: the ratio of US equity market capitalization to money market assets has recently left the solar system and has now reached the Oort cloud. It certainly does not look as if anyone is worried about the possibility of a stock market downturn.

We could continue along this line ad nauseam, but you probably get the drift by now. Lastly, here is an update of a chart we frequently show because it has been quite useful in the past, the SPX new high-new low percentage index. It remains extremely weak and is only a small step away from giving a new sell signal – which is quite astonishing considering the strength in the index:

New high-new low percentage index – we have left our annotations from the last update on the chart, which point out that the market failed to reach “oversold” status in the February decline. The rebound has been very weak and is a strong hint that another decline is in the offing (compare to the situation prior to the sell-offs in August 2015 and January-February 2016).

Conclusion

The conclusion from all this is obviously that risk is currently very high. Of course risk also spells opportunity, and anyone who has to have exposure to the stock market should at least consider hedging it while hedges can still be had for a song (which invariably is the case just before things go awry).

We leave you with one last chart that shows a fundamental datum – year-on-year growth of US federal tax revenues. Note that this shows the situation until the end of Q1 2018, this is to say prior to the tax cut taking effect. It flies into the face of the “strong economy” narrative and indicates to us that much of the economy’s strength was probably based on government spending.

A more comprehensive list was provided by Northman Trader from whom we have pinched the chart of buybacks shown above – as he puts it:

So if anyone tells you the economy is expanding show them this thread. It’s not. GDP growth in Q2 was inventory build, tariff front loading and debt financed consumer spend. Key drivers of the economy are not expanding. What is expanding is massive deficit spending and buybacks.

Negative growth in federal tax receipts is normally associated with the onset of recessions rather than economic booms. This datum is clearly at odds with the “strong economic expansion” narrative.

Addendum: as we have found out in the meantime, withholding tax reductions resulting from the tax cut started in mid February already, which has definitely contributed to the decline. Nevertheless, growth in tax receipts had already decreased to just 0.55% in Q4 2017 and has been in a downtrend since peaking at 21.23% in Q2 2013, so the tax cut has merely exacerbated a trend that was already well underway.

 

Modern-day hi-tech bear hunt…

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