Category: zerohedge

“Swimming In An Ocean Of Debt”: Gundlach Sounds The Alarm Over $122 Trillion In Unfunded Liabilities

After laying out the reasoning behind his considerably more pessimistic view on the US economy during his widely watched “Just Markets” podcast, DoubleLine Capital Founder Jeffrey Gundlach – whose flagship Total Return Fund outperformed the benchmark again in 2018 – delved into some of the same themes from his year-ahead podcast this week during a round table discussion hosted by Barron’s, during which the legendary bond trader warned that record levels of corporate debt – particularly in the lower-rungs of the investment-grade universe, which has swollen as companies binged on debt to buy back stock during the ZIRP years, could create problems for the equity  market.

But an even bigger long-term threat to markets is emanating from the supposedly “safe” market for US Treasury debt.

Gundlach

As we’ve warned and Gundlach has also highlighted, the risks posed by companies that could soon become “fallen angels” is rising as the US economy is “swimming in an ocean of debt.” But though the risks posed by corporate debt are serious, during the round table Gundlach was more focused on the risks posed by the ever-expanding US debt – which he argued is even bigger than most Americans realize.

 

Leverage

While the US government reported a budget deficit of $800 billion during the fiscal year ended on Sept. 30, the national debt increased by some $1.3 trillion dollars. The difference, as Gundlach explained, represents the cost of national disaster relief and other expenditures that are considered one-offs.

“Fiscal year for the federal government ends Sept. 30 and the official reported deficit was $800 billion dollars. The national debt increased by $1.3 trillion dollars. The differences can be things like national disaster relief and other things that are considered one off. Also there’s the lending from the social security system so that’s real debt too.”

The upshot, is the “debt has been going up a lot more than people think.” And what’s worse, is that, according to Gundlach’s calculations, the total unfunded liabilities for welfare programs like social security amount to some $122 trillion – roughly six times annual GDP. The answer put forward by most politicians is that this is a long term problem, and that the day of reckoning can perpetually be delayed by more borrowing. But there’s one problem with that. Every year, the share of the US federal budget consumed by debt service is rising.

“If you put enough short terms together, you get a long term. The CDO, they project that by 2025, the interest expense could be 5% of GDP. The near-term is turning into the long term in the next few years unfortunately.”

Meanwhile, Gundlach reiterated his view that equities have entered a bear market, saying he expects stocks to continue to weaken before a rebound begins during the second half of the year.

“So now we are in a bear market, which isn’t defined by me as stocks being down 20 percent. A bear market is determined by the way stocks are acting,” he said.

Gundlach also warned that, for all Trump’s gloating about a strong economy, most of this growth has been artificial and fueled by unsustainable debt.

“I’m not looking for a terrible economy, but an artificially strong one, due to stimulus spending,” Gundlach told the panel. “We have floated incremental debt when we should be doing the opposite if the economy is so strong.”

In other words, Gundlach expects fiscal policies to overtake monetary policy as the primary locus of concern for investors.

Watch a clip from Gundlach’s interview below:

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Hedge Fund CIO: People Are Losing Faith In The System

Submitted by Eric Peters, CIO of One River Asset Management

The ratio of US household financial assets to GDP has never been higher. Today, that ratio stands at 4.4x. In 1979 at the dawn of history’s greatest secular bull market, it was 2.3x (roughly half of where it is today). A decade later, in 1989, it was 2.7x. In the 1999 dot com bubble the ratio jumped to 3.6x. At the 2009 bear market lows, it was 3.4x. And in these past 10yrs, as the ratio jumped to 4.4x, households increased their financial assets by an amount equal to 1x US GDP. Which is $21trln. If you didn’t own/buy any assets, tough luck, you missed out.

As the value of household financial assets relative to GDP surged to historic highs over the past decade, the quantity of US equities shrank. Yet the supply of so many other things expanded during the decade. US gov’t debt grew 115% to $21.5trln, household debt jumped 49% to $4trln, and corporate debt increased by 78% to $6.3trln. But while corporations borrowed $2.8trln, the net supply of US equities contracted by $3.8trln, as CEOs borrowed money and diverted profits to repurchase their shares in quantities that dwarfed new issuance.

CEOs are paid in shares, so they naturally buy them back. But that’s not the only way to boost their value. Expanding earnings does it too – increasing revenues, cutting costs, lifting profit margins. Profit margins grew from 10% at the 2007 peak to today’s 12.5% record highs (and 6% in 1979). Reducing the tax you pay also helps. In the past decade over 20 companies redomiciled to reduce their tax burden. Countless other opaque structures helped lessen tax payments too. Then they got a huge tax cut. It’s been an extraordinary decade.

Another powerful way to lift equities is to reduce the discount rate that investors use to value them. Every major global central bank did just that. Over the decade, central banks cut rates to zero and below. Their balance sheets grew by over $14trln through printing money, further depressing yields and in some cases buying stocks directly. Wealth and income inequality naturally rose, achieving levels last seen in the late-1920s. In the 4 decades since 1979, Labor’s share of US national income fell inexorably from 64% to today’s 57%. Capital receives the rest.

Americans all want to get rich. We understand risk/reward. We also get right/wrong, fairness, justice. In the past decade, virtually everyone who took reckless risk got bailed out. Practically no one at the center of the greatest financial fiasco since the Great Depression went to jail. This undermined faith in the fundamental relationship between reward/risk, wrong/right, fairness, justice. Capitalism. To top it off, American labor read in the newspapers that US public pensions – despite 10yrs of equity gains that made others rich – were underfunded by $6trln.

Anecdote:

Let’s go back a decade, I told the CIO. We were discussing where to put money for the coming years. Most often investors look backward for trends and extrapolate their trajectories into the future, or they search for beaten down assets, hoping for mean reversion. But what should you do after a year where nearly everything declined? Treasury bills outperformed virtually all assets last year.

Such broad outperformance happened only in the early-1980s under Volcker, during the Great Depression, and at the outset of WWI. So before thinking about what to buy, it’s important to explore why such a rare event happened and what it might mean.

Imagine we were talking in 2009 and could foresee the decade to come:

  • The household financial asset-to-GDP ratio would hit a record 4.4x.
  • Corporations would borrow $2.7trln.
  • Buybacks would shrink the supply of US equities by $3.8trln.
  • Profit margins would hit historic highs.
  • Labor’s share of national income would decline to record lows.
  • Central banks would bail out overleveraged speculators and amplify economic inequality.
  • Tax policy would favor redomiciling.
  • Politicians would hold no one to account for wrongdoing.
  • Despite the historic rise in wealth, worker’s pensions would remain underfunded by $6trln.

And as people lose faith in the system, there would be a dramatic political shift that catches the beneficiaries of these trends by utter surprise. It would be a protest vote. It would be a vote to redistribute the economic pie. To slash corporate profit margins. This trend would go global. And if we had known all this in 2009, would we have expected the trends and investment strategies that would dominate up through 2019 to then extend beyond? Or would we have expected them to face profound challenges?

And so today, shouldn’t we look to those strategies that have performed worst to begin to perform best?

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A Massive Winter Storm Buries Parts Of The US, Kills Seven 

After what was a quiet but abnormally warm start to 2019, a severe winter storm has left seven people dead as it charged across the Midwestern US, striking the Mid-Atlantic coast on Sunday.

By late Saturday night, the storm had shifted over the Virginia, Washington, D.C., and Baltimore region, where 4 to 7 inches of snow is on the ground.

Weather models suggest the snow could get heavier around 2:30 p.m. for a few hours, especially in the Washington metropolitan area.

The Weather Prediction Center (WPC) warned that freezing rain would also be a big concern for the region into the overnight. 

Virginia Gov. Ralph Northam declared a state of emergency on Saturday in anticipation of the storm.

“I am declaring a state of emergency in order to prepare and coordinate the Commonwealth’s response to anticipated winter storm impacts, including snow and ice accumulations, transportation issues, and power outages,” said Northam.

The state of emergency allows officials to “mobilize resources and to deploy people and equipment to assist in response and recovery efforts,” according to the press release.

St. Louis, which was pounded the hardest by the storm so far, recorded almost 11 inches, forcing closures of Interstates 44, 64 and 70 around the city.

Parts of central Missouri, around Harrisburg, recorded almost 20 inches of snow.

Columbia, Missouri, saw more than one foot of snow, more than doubling a 109-year-old record for snowfall.

A Winter Storm Warning remains in effect for much of the Baltimore–Washington metropolitan area through 6 p.m. Sunday.

Vallee Weather Consulting meteorologist Ed Valle suggests that a “classic El Nino pattern” is developing, which combined with cold air, could mean additional storms for the East Coast into Feburary.

Valle made the point that natgas could be the greatest beneficiary of a significant cold pattern change coming to the East Coast in the second half of January into Feburary.

“The warm pattern much of the United States has been enduring to end December and start January is gradually changing now, and will continue to progress colder toward the end of January. We are seeing the beginnings of this change as a winter storm pushes through the Midwest, Ohio Valley, and Mid-Atlantic this weekend. This system has delivered locally up to 20 inches of snow in the St. Louis, MO metro area, and has already delivered up to 8 inches of snow in the DC metro area. As we push through the rest of January, a more classic “El Nino” pattern looks to develop, including a strong southern jet stream, which, combined with some cold, can likely bring additional winter storms to the Ohio Valley and East Coast into early February.

Another area impacted by this shift colder will be natural gas – after a strong start to the demand season, a bearish pattern with plenty of warmth has stifled early season cold, pushing natgas lower over the last 4-6 weeks. However, with this cold coming to end the month, we expect heating demand to continue to rise as populated areas of the southern Plains, Midwest, and East shift colder and stormier.”

Heating degree day (HDD), a measurement designed to quantify the demand for energy needed to heat a building, is already signaling that natgas demand is likely to increase in the lower 48 over the coming week. 

After a near -41% collapse in natgas from November’s 4.92 high, the current shift in cold and snowy weather is expected to blanket the East Coast in the coming weeks, could be a relieving sign for energy bulls. 

Valle warns that another snowmaker for the East Coast is dead ahead. 

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Trump Threatens To “Devastate Turkey Economically” If Kurds Attacked, Sends Lira Sliding

In the fiercest words directed at Turkey in a long time, and certainly since Trump and Erdogan managed to patch up the rocky diplomatic relationship between the two nations over the fate of (since released) Pastor Brunson, President Trump on Sunday evening put President Recep Tayyip Erdoğan on notice, threatening to “devastate Turkey economically if they hit Kurds” — which has sent the Turkish lira sliding. 

Trump further confirmed in no uncertain terms that his announced “long overdue” troop pullout from Syria has begun, but that it’s been initiated while “hitting the little remaining ISIS territorial caliphate hard” and “from many directions”.

The warning to Turkey came as Ankara has mustered military forces, including tank regiments, along the Syrian border and deep in Afrin after last year’s ‘Operation Olive Branch’ plunged pro-Turkish forces accross the border inside Syrian Kurdish enclaves.

Last week Turkey’s leaders, including the defense minister, described preparations underway for another major Turkish assault on US-backed Kurdish positions east of the Euphrates, following the exit of American advisers based on Trump’s previously announced pullout. But it appears Trump is now putting Ankara on notice, and is prepared to thwart any Turkish invasion plans by establishing a “20 mile safe zone”. 

Presumably this “safe zone” will be towards protecting American forces while a precise exit logistics take shape, and will occur simultaneously to the US pounding remnant ISIS positions; however the details remain uncertain. 

Trump followed his tweet threatening to “devastate Turkey economically” if the Kurds are hit with another promise to “stop the endless wars!” — in what appears another sign he’s currently in a fight with the deep state and hawks within his own administration over Syria policy. 

Among those recently accused of “going rogue” after weeks of mixed and contradictory messages coming from administration and Pentagon officials over the Syria draw down is National Security Advisor John Bolton. 

In possibly an attempt to clean up the mess made by his latest trip to Israel and Turkey, the latter country in which he was snubbed by President Erdogan, Bolton said during an interview with the Hugh Hewitt radio show on Friday that Trump elicited a guarantee from Erdogan to not attack those particular Kurdish militias that have assisted the US in the anti-ISIS campaign. This was reportedly during the Dec. 14th call that appears the catalyst for Trump’s full US troop draw down in Syria.

Predictably, the mainstream media has expressed “outrage” that Trump could speak so aggressively with “a NATO ally”…

Bolton explained that Erdogan agreed; however, it could come down to definitions and labels as the Kurdish core of the US-armed and trained Syrian Democratic Forces (SDF) — the YPG — is officially designated by Turkey a terrorist extension of the outlawed PKK. 

But given Trump’s power to send the Turkish lira tumbling with a mere Tweet – already after it hit new lows last week – the Turks (or at least TRY trader) no doubt believe that Trump is capable of following up on threats. 

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Markets Have “Returned To The Scene Of The Crime” – What Happens Next?

Authored by Sven Henrich via NorthmanTrader.com,

Markets have returned to the scene of the crime and participants act like nothing’s happened. After an 11 day rally propelling $ES futures nearly 11% off of the December lows happy days are here again.

The lows are in, any retest will be bought, the Fed’s turned dovish, slashed earnings projections are the basis for future gains, get a China deal and there’s nothing but blue skies ahead. I put myself at the mercy of readers and correct me if I’m wrong, but this is generally the current consensus of analysts and pundits that did not see the Q4 2018 drubbing coming in the first place. And, to be fair, that is an acknowledged possibility I outlined myself in my 2019 Market Outlook.

And frankly I can’t blame them for taking this view, indeed, if you take a linear view of markets, then we’re just simply repeating the same script we’ve become accustomed to over the last 10 years. Markets tank and the systemic rescue patrol gets active at just the right time and the bull market trend gets saved again:

Treasury Secretary Mnuchin’s emergency calls just before the lows followed up by over a dozen dovish speeches and appearances by FOMC members on the heels of the now famous Powell cave on January 4th had an immediate and violent reaction in credit and stock markets.

No chart probably better highlights this point than that of high yield credit:

Whether words, and that’s all there has been so far, are enough remains to be seen. After all QT remains on schedule although the Fed’s rate hike schedule is over for now. Again. And right at this moment in time:

The observable fact remains: When markets drop hard the Fed reacts. Either in policy action or in words. And the Fed has reacted by pausing the rate hike schedule away from the advertised rate hike schedule for 2019. In short: They have altered policy by managing expectations. Again. Because that’s what you do when unemployment is below 4%, the economy is strong and there’s no risk of recession. Oh yes, that’s what Jerome Powell said this week again. Things are awesome, but let’s stop rate hikes and be flexible on the balance sheet. Please.

However, if you take a log view of markets, maybe things are not so awesome:

This is a view that suggests that this market is technically broken and that markets have topped and look to pursue a historical path with a recession and a larger bear market to emerge.

And this view is not only supported by the break of log trend lines, but also by the concurrent rejection of the 10 year yield at its multi decade trend line:

Let’s review the technical state of the recent rally.

Firstly let me state clearly:

I don’t blame central bankers for the rally. The rally was technical and the technicals told us a big rally was coming. What central bankers did was juice the slope and speed of the rally.

In Dirty Rally I had outlined the case for a 10% rally to emerge around a near Christmas time bottom based on the 2000/2001 analog, but back then it took until the end of January from December 21. Now we had a 10% move from December 24th to January 10th.

In my previous Weekly Market Brief I outlined imbalances that demanded technical reconnects and I stated:

“As of now we have massive imbalances to the downside and these disconnects will cause an effort at a reconnect… Despite technical extensions bulls kept screaming for every higher targets in September. Bears are now screaming for ever lower targets in December. Ignore the screaming. Focus on the technicals. Everybody chill. Imbalances don’t last.”

And here we are returning to the crime scene, the December breakdown zone, and are seeing reconnects with some key moving averages such as the 50MA.

Example $RUT:

To reiterate, despite the speed of this move, NOTHING here so far is surprising. We moved into technical reconnects and there is room to connect higher still into MAs, gap fills, etc. And while we have some short term overbought readings, there’s nothing overbought on the 2 hour, daily, or weekly time frames. Indeed, many of these have plenty of room to run to the point where this move can go on for some time. Add a China deal and $SPX could be back tat the 2750-2800 zone in a flash.

What we just witnessed so far was a technical move higher alleviating some of the historic oversold conditions we saw in December:

The influence of the Fed however has helped bring about another historic abnormality and I highlighted this in “Intrigue” the massive squeeze on the $NYMO. The oscillator closed the week at its 2nd highest weekly closing print ever:

In 2016 we saw a similar read as central banks went into intervention overdrive and embarked on a $5.5 trillion+ intervention schedule in the 2 years that followed. There is no such expectation this time.

In 2008 we saw the highest $NYMO print ever right near the top of the counter rally before markets reverted to significant new lows.

And perhaps that’s the key question here: Is this current technical rally a counter rally that will produce new lows or have we seen a significant low in markets?

I remain open minded either way at this juncture as we still need confirming evidence. Over the next few weeks we will get some significant new information to evaluate. Earnings will come in full force next week. So far the earnings seasons has brought about plenty of warnings and downgrades which have been ignored by markets in context of this current rally.

Fact is markets have begun to enter a significant zone of resistance:

$WLSH:

$NYSE:

$DJIA:

Key indices are approaching key MAs, trend lines, gap fills and previous support all of which are technical resistance.

It is what happens from there that will be key to determine whether the historical script plays out of whether the bull market can resume its regularly ordained path higher.

In fact, bears now have to prove their case and the only path forward for them is new lows. Not a retrace, not a retest with even temporary new lows, but sustained new lows.

And with the Fed now being easy on the rate hike front and a potential China deal still looming that is a challenging path.

After all one can envision all kinds of bullish scenarios.

For example, a technical retrace could potentially set up for a cup and handle pattern:

Or a retest with new lows could set up for a positive divergence and produce a formidable “W” bottom:

The message of all of these speculative examples offer the prospect of wide price ranges and plenty of opportunities for active participants.

I can even imagine us remaining within the larger 2018 price range and producing an inside year rendering all larger bullish and bearish debates unresolved.

Much will depend on the evolution of the larger macro picture. Germany and France just saw large reversals in their industrial production numbers raising well founded concerns that Europe is heading into a recession:

Retailers have just produced rather unimpressive earnings suggesting perhaps that the inventory builds of Q4 vastly overstated underlying GDP growth which in return could set up for a rather disappointing Q1 GDP print.

There is no China deal still, Brexit remains under a big cloud of uncertainty, the government remains shut down, deficit spending and government debt financing remains on a historic accelerated path and political drama and uncertainty appear to continue unabated. If the Fed had any confidence in the economic outlook they project they would not have paused their rate hike path and not felt it necessary to placate markets with dovish talk. Unless of course they saw the drop in equity prices  to be a direct threat to their economic outlook, which of course is the ugly truth they would never admit to.

While the rally has improved recent sentiment that in itself is not evidence of future market gains. Indeed in recent months it’s been the polar opposite:

Remember: Violent rallies are the hallmark of emerging bear markets and so far all we’ve seen is technical reconnects returning to scene of the crime. As much as bears may have to prove so do bulls and it’s still very early into the year.

Fact is major technical damage has been inflicted on markets in 2018. We remain in a structure of lower highs and lower lows on the macro front and one could even imagine a larger structure that leaves room for lower prices to come in the months ahead:

And if a bear market is to unfold and the Fed’s jawboning fails then participants may come to realize that the lows are not in, rather we’re just at the first inning of the historical script:

For now markets have still room higher as many charts are not anywhere near overbought on the daily or weekly time frames, but this rally has not yet been tested. Earnings reports, economic reports and coming liquidity withdrawals will likely put this rally to the test during the rest of January and the test could come at any moment for any reason as none of the structural causes of the Q4 drop have disappeared or solved.

See the thing is, as marvelous as this rally appears, its structure leaves room for a decidedly bearish interpretation:

A rising wedge with weakening internals beneath new highs. So buckle in, nothing’s been proven either way yet and it’s early in 2019. Lots can and will happen.

*  *  *

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Macron Pens 2,300 Word Letter To Yellow Vests Seeking To Turn “Anger Into Solutions”

After weeks of failing to calm down the Yellow Vest anti-government movement raging into its 9th week across France, French President Emmanuel Macron has resorted to the pen – releasing a 2,300 word open letter to the country which seeks to turn “anger into solutions.” 

Macron says in the letter that he is open to ideas and suggestions but was clear that his government would not reverse previous reforms or key measures from his 2017 election campaign. 

“No questions are banned,” reads the letter. “We won’t agree on everything, that’s normal, that’s democracy. But at least we’ll show that we are a people who are not afraid to speak, to exchange views and debate. And perhaps we’ll discover that we might even agree, despite our different persuasions, more often than we think.”

The letter, set for publication in French newspapers on Monday, is a new tactic for the Macron administration – marking the first time citizens have been invited to share their views on four central themes; taxation; how France is governed; ecological transition; and citizenship and democracy, reports The Guardian. 

Macron’s missive asks a number of questions, including: what taxes should be reduced?; what spending cuts might be a priority?; is there too much administration?; how can the people be given a greater say in running the country?

Macron said the proposals collected during the debate would build a new “contract for the nation”, influence political policymaking and establish France’s stance on national, European and international issues.

“This is how I intend, with you, to transform anger into solutions,” he wrote.

Accepting that everyone wanted taxes that were “fairer and more efficient”, he warned against unrealistic expectations, adding there could be no drop in taxation without cuts in public spending. –The Guardian

The Macron administration has been under intense pressure since a November backlash over a climate change-linked fuel tax morphed into nine weeks of anti-government protests which have spread to nearly a dozen other countries. To try and calm the Yellow Vests down, Macron has dropped the fuel tax, raised minimum wage, and attempted to employ other economic measures amid a “state of social and economic emergency.” 

Thus far, none of it has worked, as the gilets jaunes (yellow vests) continue to picket across the country – calling for lower taxes on food and essential goods, among other things. 

In his 2,300 word letter, Macron writes that he will accept “no form of violence,” including “pressure and insults” against “elected representatives, media journalists, state institutions or public servants.” 

“If everyone is being aggressive to everyone else, society falls apart,” writes Macron. 

Too late Emmanuel… 

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What Trump’s Syrian Withdrawal Really Reveals

Authored by Stephen Cohen via The Nation,

A wise decision is greeted by denunciations, obstructionism, imperial thinking, and more Russia-bashing…

President Trump was wrong in asserting that the United States destroyed the Islamic State’s territorial statehood in a large part of Syria – Russia and its allies accomplished that – but he is right in proposing to withdraw some 2,000 American forces from that tragically war-ravaged country. The small American contingent serves no positive combat or strategic purpose unless it is to thwart the Russian-led peace negotiations now underway or to serve as a beachhead for a US war against Iran. Still worse, its presence represents a constant risk that American military personnel could be killed by Russian forces also operating in that relatively small area, thereby turning the new Cold War into a very hot conflict, even if inadvertently. Whether or not Trump understood this danger, his decision, if actually implemented – it is being fiercely resisted in Washington – will make US-Russian relations, and thus the world, somewhat safer.

Nonetheless, Trump’s decision on Syria, coupled with his order to reduce US forces in Afghanistan by half, has been “condemned,” as The New York Times approvingly reported, “across the ideological spectrum,” by “the left and right.” Analyzing these condemnations, particularly in the opinion-shaping New York Times and Washington Post and on interminable (and substantially uninformed) MSNBC and CNN segments, again reveals the alarming thinking that is deeply embedded in the US bipartisan policy-media establishment.

First, no foreign-policy initiative undertaken by President Trump, however wise it may be in regard to US national interests, will be accepted by that establishment. Any prominent political figure who does so will promptly and falsely be branded, in the malign spirit of Russiagate, as “pro-Putin,” or, as was Senator Rand Paul, arguably the only foreign-policy statesman in the senate today, “an isolationist.” This is unprecedented in modern American history. Not even Richard Nixon was subject to such establishment constraints on his ability to conduct national-security policy during the Watergate scandals.

Second, not surprisingly, the condemnations of Trump’s decision are infused with escalating, but still unproven, Russiagate allegations of the president’s “collusion” with the Kremlin. Thus, equally predictably, theTimes finds a Moscow source to say, of the withdrawals, “Trump is God’s gift that keeps on giving” to Putin. (In fact, it is not clear that the Kremlin is eager to see the United States withdraw from either Syria or Afghanistan, as this would leave Russia alone with what it regards as common terrorist enemies.) Closer to home, there is the newly reelected Speaker of the House, Nancy Pelosi, who, when asked about Trump’s policies and Russian President Putin, told MSNBC’s Joy Reid: “I think that the president’s relationship with thugs all over the world is appalling. Vladimir Putin, really? Really? I think it’s dangerous.” By this “leadership” reasoning, Trump should be the first US president since FDR to have no “relationship” whatsoever with a Kremlin leader. And to the extent that Pelosi speaks for the Democratic Party, it can no longer be considered a party of American national security.

But, third, something larger than even anti-Trumpism plays a major role in condemnations of the president’s withdrawal decisions: imperial thinking about America’s rightful role in the world. Euphemisms abound, but, if not an entreaty to American empire, what else could the New York Times’ David Sanger mean when he writes of a “world order that the United States has led for the 79 years since World War II,” and complains that Trump is reducing “the global footprint needed to keep that order together”? Or when President Obama’s national-security adviser Susan Rice bemoans Trump’s failures in “preserving American global leadership,” which a Timeslead editorial insists is an “imperative”? Or when General James Mattis in his letter of resignation echoes President Bill Clinton’s secretary of state Madeline Albright—and Obama himself—in asserting that “the US remains the indispensable nation in the free world”? We cannot be surprised. Such “global” imperial thinking has informed US foreign-policy decision-making for decades—it’s taught in our schools of international relations—and particularly the many disastrous, anti-“order” wars it has produced.

Fourth, and characteristic of empires and imperial thinking, there is the valorization of generals. Perhaps the most widespread and revealing criticism of Trump’s withdrawal decisions is that he did not heed the advice of his generals, the undistinguished, uninspired Jim “Mad Dog” Mattis in particular. The pseudo-martyrdom and heroizing of Mattis, especially by the Democratic Party and its media, remind us that the party had earlier, in its Russiagate allegations, valorized US intelligence agencies, and, having taken control of the House, evidently intends to continue to do so. Anti-Trumpism is creating political cults of US intelligence and military institutions. What does this tell us about today’s Democratic Party? More profoundly, what does this tell us about an American Republic purportedly based on civilian rule?

Finally, and potentially tragically, Trump’s announcement of the Syrian withdrawal was the moment for a discussion of the long imperative US alliance with Russia against international terrorism, a Russia whose intelligence capabilities are unmatched in this regard. (Recall, for example, Moscow’s disregarded warnings about one of the brothers who set off bombs during the Boston Marathon.) Such an alliance has been on offer by Putin since 9/11. President George W. Bush completely disregarded it. Obama flirted with the offer but backed (or was pushed) away. Trump opened the door for such a discussion, as indeed he has since his presidential candidacy, but now again, at this most opportune moment, there has not been a hint of it in our political-media establishment. Instead, a national security imperative has been treated as “treacherous.”

In this context, there is Trump’s remarkable, but little-noted or forgotten, tweet of December 3 calling on the presidents of Russia and China to join him in “talking about a meaningful halt to what has become a major and uncontrollable Arms Race.”

If Trump acts on this essential overture, as we must hope he will, will it too be traduced as “treacherous” – also for the first time in American history? If so, it will again confirm my often-expressed thesis that powerful forces in America would prefer trying to impeach the president to avoiding a military catastrophe. And that those forces, not President Trump or Putin, are now the gravest threat to American national security.

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“Cars Have Just Been Crushed”: The US Auto Market Is Officially In Recession Again

Despite surprisingly strong 2018 results and 2019 estimates out of General Motors last week, it’s becoming clearer that a recession in the U.S. auto industry is already underway. All one has to do is look around: factories are closing, shifts are being truncated and thousands of layoffs have taken place.

Meanwhile, Detroit is showing increasingly more signs that it is in the midst of a recession as demand for sedans has collapsed. This collapse has been the result of most consumers moving to sport utility vehicles and pick-ups. In fact, the models that used to be the lifeblood of the car industry, sedans like the Honda Accord and Ford Fusion, only made up 30% of US sales in 2018.

Sedans are estimated to sink to 21.5% of the US market by the year 2025, according to research from LMC Automotive. That will leave car manufactures with extra factory capacity that will be capable of producing some 3 million more vehicles than buyers want. This type of overcapacity has resulted in losses and has catalyzed past recessions for the industry.

Jeff Schuster, senior vice president of forecasting at LMC Automotive, simply told Bloomberg: “You could classify this as a car recession.”

As a result, the mood at the upcoming North American International Auto Show in Detroit this week should be a key indicators. The car show is being moved to the summer next year in an attempt to try and re-establish its relevance, as car dealers who are attending this January won’t include once notable attendees as Mercedes-Benz, BMW and Audi. Why? Perhaps because Morgan Stanley analyst Adam Jonas recently predicted that manufacturers will use the Auto Show as an opportunity to lower guidance. 

Meanwhile, as we said last Friday when GM raised its guidance, we were skeptical about any material upside, and we remain skeptical. 

“We’re not sure if Barra is only raising guidance now to (double) cut it later, or perhaps betting on a timely resolution to the trade war (or maybe both), but it’s tough to feel like there isn’t much more here than what meets the eye,” we noted on Friday. The total overcapacity by US auto makers is the equivalent of 10 extra plants, according to Bloomberg. This would account for at least 20,000 potential jobs being scrapped; this means that more cuts are on their way. Jeff Schuster continued: “GM has taken some actions, but they still have some well-underutilized plants. So we may not be done with this yet.”

Traditionally when this kind of problem has arisen, automakers have taken sedans and stuffed them into rental lots and commercial fleets. Now, that tactic is only serving to add to the current capacity crisis. Fleet channels are already stuffed: these sales helped inflate the market over the last few years, even though individual retail sales peaked three years ago.

Mark Wakefield, head of the automotive practice at distressed turnaround consultant AlixPartners stated: “The car recession and the retail recession have already arrived in the sense that retail sales peaked in 2015 and have gone down ever since. Cars have just been crushed.”

And again, crossover SUVs are getting the blame. Some of the issue is attributed to the fact that SUVs now get almost as good of fuel mileage as sedans. The Chevy Equinox, for instance, only gets one mile less per gallon than the Chevy Malibu, a popular sedan.

But outside of Detroit, executives at companies like Toyota are sticking out with sedans. Jim Lentz of Toyota North America said:  “We are not going to get out of that business [making sedans]. We still see an opportunity there.”

Interestingly, the wide adoption of sedans was a result of the last automotive recession. When gas prices were much higher and the industry last had to go through layoffs and plant closings, many of the Detroit factories changed from making SUVs to making sedans, using gas mileage as a selling point.  But now, with fuel costs no longer a prohibitive factor, that cycle has turned once again.

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Goldman Warns Earnings Growth In 2019 Could Collapse By 85%

With Q4 earnings season officially kicking off this week when the big money center banks report Q4 results, concerns about the economy and the Fed will take a back seat to what companies say about the current state of the economy, and not so much their numbers for the just concluded quarter but how they see the economic environment ahead.

And, as we discussed last week, so far it’s not shaping up to be a pretty 2019 because the recent various warnings, guidance cuts and layoff announcements to date have been nothing short of dismal. Here is a quick summary of what we have observed in just the last week:

  • Apple cut revenue guidance (for the first time in 16 years)
  • Macy’s cut profit guidance, sending its shares plunging the most on record
  • Barnes and Noble cut profit guidance
  • FedEx cut profit guidance
  • American Airlines cut guidance
  • Delta cut profit guidance
  • Kohl’s reported a plunge in comp store sales
  • Ford announced it will cut thousands of jobs in Europe
  • Jaguar announced it will cut 10% of its workforce
  • Blackrock announced it will cut 500 jobs
  • State Street announced it will cut 15% of its senior management
  • AQR announced it will cut dozens of jobs
  • United Technologies ended sale of Chubb fire-safety as bids were too low.

It is in this context that, as Goldman’s David Kostin writes, “the outlook for earnings has taken center stage for equity investors” because weak guidance from several notable companies such as Apple and Macy’s “have heightened the focus on S&P 500 earnings growth.” Indeed, whereas earnings was one of the clear bright spots for US equities throughout much of 2018, some investors are now questioning whether after hitting a peak late last year as the Trump tax cuts are now officially rolling off the year-over-year calendar, profits can continue to grow in 2019. One can see Q4 EPS growth with and without the benefit of taxes in the following chart from Credit Suisse.

First, some background on what Wall Street expects: for 4Q 2018. consensus forecasts 12% EPS growth. According to Goldman, if realized, S&P 500 EPS growth will have equaled 22% in 2018, the fastest annual pace of growth since 2010.  Consensus also expects 52 bp of margin expansion (to 10.8%) in the fourth quarter, which is a boost from the 14% reduction in federal statutory corporate tax rates.

Let’s not forget the massive stock buybacks in 2018: in Q4, stock repurchases will add nearly 2% in EPS growth.

And while consensus also forecasts 6% sales growth in 4Q, Goldman expects fewer sales beats than the historical average (36%) given the close relationship between top-line beats and changes in the trade-weighted US dollar. The dollar has become a modest headwind to companies (+4% year/year) and could weigh on sales results.

Drilling down on specific sectors, Energy (+64%) and Financials (+20%) are expected to post the strongest EPS growth in 4Q according to Goldman, while consensus forecasts EPS will decline in two sectors: Utilities and Consumer Staples:

Results in Consumer Staples are still distorted by the reclassification of CVS following its merger with AET. After accounting for this reshuffling, EPS growth in the sector would equal +4%. Margins are expected to grow in every sector except for Communication Services.

So far so good; the problem is company guidance about 2019 where as noted above, the mood is far more somber, and Kostin’s latest weekend piece certainly reflects that.

As the Goldman strategist writes, looking forward into 2019, Goldman’s baseline estimate is for 6% S&P 500 EPS growth (to $173), which however assumes average annual real US GDP growth of 2.6%, real World GDP growth of 3.8%, Brent oil prices of $77 per barrel, and a slightly weaker trade-weighted USD (-1.3%). It also expects S&P 500 profit margins will be roughly flat through 2020, given rising wages and other inputs costs. This means that positive sales growth, roughly in line with nominal GDP growth, will drive nearly all earnings growth; this also suggest that absent top-line increases, or the continuation of a strong US economy, profits will decline.

Indeed, this is where the potential problem emerges because as Kostin admits, recent weakness in the macro landscape could drive up to $5 of potential downside to Goldman 2019 EPS estimate (to $168), for the following reasons:

Our economics team now forecasts average annual real GDP growth of 2.4% for the US (-20 bp vs. baseline) and 3.5% for the world (-30 bp vs. baseline). These slower growth estimates would lower our S&P 500 EPS by roughly $2. The other major development has been the 25% decline in Brent oil prices since the start of 4Q. The futures market implies Brent oil will average $58 per barrel in 2019, $19 below our baseline. The decline in oil prices could lower our 2019 EPS estimate by as much as $2 as the hit to Energy earnings is partially offset by the benefit to consumers and corporate profit margins. Lower bond yields, lower inflation, and a slightly stronger dollar could represent modest downside to our baseline estimate ($1 in total).

This downside scenario EPS estimate of $168 implies just 3% growth vs. the 22% growth in 2018, an 85% drop in profit growth y/y, although here too there is a footnote with Goldman cautioning that the recent volatility of oil prices underscores the uncertainty around 2019 estimates this early in the year. Some additional considerations regarding the price of crude, via Goldman:

lower oil prices is one of the primary sources of downside risk to earnings at the moment. But Energy accounts for a much smaller share of S&P 500 EPS today than in the past. In 2014, before the subsequent 75% drop in Brent oil prices, Energy accounted for 12% of S&P 500 EPS. Today that share stands at just 5%, limiting the downside to aggregate earnings from lower oil prices.

It’s not just Goldman that is turning cautious on 2019 earnings: consensus itself has seen a significant rerating lower, with Wall Street estimates for 2019 S&P 500 EPS trimmed by 4% ($8) from the peak in August. Consensus bottom-up estimates for 2019 S&P 500 EPS reached a peak of $179 in August 2018 but currently stand at $171 (+6% growth). The majority of revisions this year have come through lower margin estimates, as sales growth is still expected to be strong (+7%). Consensus bottom-up forecasts now imply a 20 bp margin contraction in 2019.

To be sure, none of this should come as a surprise to the market, as equity prices have tracked negative earnings revisions tick for tick, with the drop in the S&P Y/Y corresponding to the EPS revisions sentiment, defined as the number of positive EPS revisions less the number of negative EPS as a share of total revisions, and which has also slipped into negative territory. As shown in the chart below, the path of S&P 500 returns has generally tracked this revision sentiment (Exhibit 3).

This, in a nutshell, is why after the December turmoil and January Fed relent, the next big “litmus test” for the near-term path of the market will come from earnings season: should more negative surprises a la Apple emerge, expect EPS revisions to take another sharp leg lower, and drag stocks with them, especially after AAPL’s guidance set in motion further negative revisions, with sentiment declining from –14% to –23% in the past week.

On the other hand, with no nascent signs of slowing negative revisions, the strength of 4Q results and management commentary around the outlook for 2019 will take on heightened importance for whether earnings estimates (and returns) stabilize in the near term.

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Bolton Had Pentagon Draw Up “Far-Reaching Military Options To Strike Iran”

The Wall Street Journal published an Iran bombshell Sunday morning, confirming the White House had the Pentagon prepare “military options” to strike Iran last year. The sudden request, seen as an unprecedented Iraq-style “shock and awe” attack on Iran, caught the Pentagon off guard, to the point that “State Dept. and Pentagon officials were rattled by the request” which officials further told the WSJ was “mind-boggling” and “cavalier” in terms of how brazen it was. 

The request for military options came in early September after the United States accused Iran-backed militias in Iraq of firing three mortars at the US Embassy and diplomatic compound in Baghdad, and at a time that riots and political instability were spreading throughout some major cities in Iraq, especially in the south. It was also an opportunity for noted Iran hawk and national security advisor John Bolton to push for “far-reaching military options to strike Iran” — a regime change project he’s pushed in public many years prior to taking his White House post last April.

Prior to entering the Trump White House, John Bolton was a frequent keynote speaker at Iranian opposition MEK-sponsored events. 

The WSJ reports: 

The request, which hasn’t been previously reported, came after militants fired three mortars into Baghdad’s sprawling diplomatic quarter, home to the U.S. Embassy, on a warm night in early September. The shells—launched by a group aligned with Iran—landed in an open lot and harmed no one.

But they triggered unusual alarm in Washington, where Mr. Trump’s national security team led by John Bolton conducted a series of meetings to discuss a forceful American response, including what many saw as the unusual request for options to strike Iran.

Though it’s unclear if the strike options ended up on President Trump’s desk following the formal request from the National Security Council, or if they were ever seriously considered by the White House, “It definitely rattled people,” one former senior U.S. administration official described. “People were shocked. It was mind-boggling how cavalier they were about hitting Iran,” the source said. 

The WSJ report confirms through admin officials that Bolton has, alongside Secretary of State Mike Pompeo, stuck by his prior public stance of seeking regime change in Tehran, even though Bolton has also acknowledged regime change in Tehran is not part of the president’s agenda. 

The report continues: 

In talks with other administration officials, Mr. Bolton has made it clear that he personally supports regime change in Iran, a position he aggressively championed before joining the Trump administration, according to people familiar with the discussions.

As a think-tank scholar and Fox News commentator, Mr. Bolton repeatedly urged the U.S. to attack Iran, including in a 2015 New York Times op-ed titled, “To stop Iran’s bomb, bomb Iran.”

…Mr. Bolton has said that his job is to implement the president’s agenda, which doesn’t include regime change in Tehran. The State Department declined to comment

Notably the plans for “military options” requested of the Pentagon included strategies for striking Syria as well.

In the months following September, just prior to Trump’s announced US troops pullout of Syria, the State Department and Pentagon began articulating the US mission in Syria as to “counter Iran” now that ISIS forces had been largely defeated. 

Perhaps knowing that Trump was leaning toward an eventual full Syria exit, Iran hawks within his own administration were possibly going “rogue” — as Bolton himself has recently been accused of. 

The strike plans were reportedly so wide-ranging that they encompassed targeting pro-Iranian elements in Iraq as well, according to the WSJ:

Alongside the requests in regards to Iran, the National Security Council asked the Pentagon to provide the White House with options to respond with strikes in Iraq and Syria as well, according to people familiar with the talks.

In one meeting, Ms. Ricardel described the attacks in Iraq as “an act of war” and said the U.S. had to respond decisively, according to one person familiar with the meeting.

Following the Sept. 6 mortar attack on the embassy by unknown militants, but which US officials described as Iran-backed groups, the White House issued an official statement on Sept. 11 that appeared to warn of a possible military action: “The United States will hold the regime in Tehran accountable for any attack that results in injury to our personnel or damage to United States government facilities,” the White House said.

In a follow-up interview about the incident weeks later, Pompeo expressed willingness to target Iran for terrorist actions its proxy groups conduct in neighboring Iraq: “Iran will be held accountable for those incidents,” he said in a Sept. 21 CNN interview. “Even militarily?” questioned CNN’s anchor during the interview. “They’re going to be held accountable,” Mr. Pompeo replied, and followed with, “If they’re responsible for the arming and training of these militias, we’re going to go to the source.”

And as recently as this month, administration officials led by Pompeo have accused Iran of using its space satellite launch program to shield a developing nuclear ballistic missile program.

On Jan. 3rd the Secretary of State threatened Iran via a Twitter statement over plans to fire off Space Launch Vehicles that possessed, as Pompeo claimed, “virtually the same technology as ICBMs” in a “defiant” launch that will “advance its missile program.” He added, “We won’t stand by while the regime threatens international security.”

The WSJ described the embassy mortar attack incident as eliciting little coverage in international and US media. Given this, and that it took place in Iraq, yet was still enough for the NSC under Bolton to draw up major military strike plans on Iran, it seems clear that the hawks in the administration are ready to launch the next big regime change war on the smallest provocation. 

Might Iran be proven to be behind a more direct attack on American assets abroad (as opposed to accusations against alleged proxies), could the “strike options” fast be put into effect? 

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