Category: zerohedge

By Chris Metli, Executive Director in Morgan Stanley’s Institutional Equity Division

Buying the dip has been the right trade for so long that it has become ingrained in investors’ psyche.  Ample liquidity in the QE era provided the ammunition, and with robust earnings growth investors learned that selling into a downturn was the wrong trade, particularly during 2016 and 2017 (think the Brexit and US election selloffs and sharp rebounds).  Even corporates have learned to buy the dips.

The problem is that the world is changing, and the environment is shifting from one where dips should be bought to one where rallies should be sold.  1) QE has ended and global central banks are withdrawing liquidity, 2) earnings growth is set to slow from recent tax-cut fueled highs, and 3) poor performance and volatility is limiting risk appetite – as portfolios are whipsawed investors will slowly learn that dips are no longer meant to be bought.

Price action in 2018 already shows that ‘buy the dip’ is on its way out.  Buying the S&P 500 after a down week was a profitable strategy from 2005 through 2017, and buying these dips fueled most of the post-crisis S&P 500 gains (relative to buying after the market rallied).  But in 2018 ‘buying the dip’ has been a negative return strategy for the first time in 13 years.

This shift is occurring in part because central banks are withdrawing liquidity and hiking rates, meaning there is less cheap money available to buy assets – both for investors and for corporates.  And now this tightening in financial conditions is occurring as strength in earnings growth is starting to be questioned.

But the dynamic that will ultimately convince investors to stop buying the dip is performance.  P/L for active managers (both HFs and MFs) is poor, which limits risk appetite, particularly at this time of the year.  While some investors have tried to buy the dips this month, the market has not been able to hold onto rallies (nor can single names that beat, i.e. NFLX).  This sends a signal that demand is not what it used to be, and as investors lose money buying dips their behavior will change.

So far, investors have been managing risk in this selloff by putting on shorts while not necessarily selling their core longs (i.e. the crowded Tech and Growth names).  The pain may not stop until the ‘rolling bear market’ as MS Equity Strategist Mike Wilson notes (see Dead Cat Bounce; Risk Reward Remains Unattractive for US Equities; Risk Premium Q&A Oct 22 2018) takes out the final holdouts, and forces a proper de-grossing of those positions.

The deterioration in ‘buy the dip’ also extends to shorter time horizons as well, with the market seeing relatively larger ‘gaps’ and momentum during the trading day.  The below chart shows how S&P 500 futures prices are either mean reverting or trending intraday (it plots the correlation of front futures prices one second to the next, with negatives indicating more mean reversion and positives indicating more intraday momentum, or ‘gaps’ in price).  There is a general trend higher in momentum / towards less mean reversion over time.  And importantly on each volatility spike there is relatively more momentum and gap risk intraday – February 2018 looked a lot like 2008 on this metric, despite the VIX only rising half as much.

The above dynamic likely has more to do with market structure issues than changing behavior of most fundamental and discretionary investors.  But it contributes to a deterioration in liquidity and increase in volatility, giving discretionary investors less confidence to buy the dip, which feeds back into liquidity withdrawal, creating more gaps in the market, etc.  At the end of the day ‘buying the dip’ is very similar to ‘liquidity provisioning’ and a decline in one leads to a decline in the other.

Less dip buying would increase the marginal impact of short gamma volatility control funds, including annuities, risk parity funds, etc.  As QDS has noted before fundamental investors have largely learned to handle these flows over the last few years, which in part means they’ve learned to buy into the weakness vol control funds create.  If those dip buyers are not there, systematic strategies will come to have larger and more sustained impacts.

As a final consideration, it’s worth noting there has been negative correlation in SPX returns day-over-day since 1998 (i.e. mean reversion), but prior to then returns tended to be positively correlated (i.e. gains followed by gains and losses followed by losses – momentum).  Coincidently or not, 1998 was also the time when stock-bond correlation turned from positive to negative.  While this may be a little conspiratorial, the parallels are notable, and raises the question whether an end to ‘buy-the-dip’ that comes alongside higher rates would help end the structural diversification of stocks and bonds.  QDS has written at length about the risks from such a shift (see Is this Starting to Remind you of Something? Oct 4 2018 and Don’t Fear A Little Inflation, Yet Feb 26 2018).

None of this is to say that equities can’t bounce sharply on short covering from current oversold conditions – the point is simply that bounces going forward are more likely to be short-lived and should be sold into rather than chased.

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Authored by Paul Volcker, op-ed via Bloomberg.com,

False precision can lead to dangerous policies.

In 1996, Federal Reserve Chairman Alan Greenspan had an exchange with Janet Yellen, then a member of the Fed’s Board of Governors, that presaged a major – and, I think, ill-advised – change in the central bank’s approach to managing the economy.

Yellen asked Greenspan: “How do you define price stability?”

He gave what I see as the only sensible answer: “That state in which expected changes in the general price level do not effectively alter business or household decisions.”

Yellen persisted: “Could you please put a number on that?”

Since then, under the chairmanship of Ben Bernanke and then under Yellen, Alan’s general principle — to me entirely appropriate — has been translated into a number: 2 percent. And more recently, a remarkable consensus has developed among central bankers that there’s a new “red line” for policy: A 2 percent rate of increase in some carefully designed consumer price index is acceptable, even desirable, and at the same time provides a limit.

I puzzle about the rationale. A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be both a target and a limit at the same time. And a 2 percent inflation rate, successfully maintained, would mean the price level doubles in little more than a generation.

I do know some practical facts. No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year. Moreover, as an economy grows or slows, there is a tendency for prices to change, a little more up in periods of economic expansion, maybe a little down as the economy slows or recedes, but not sideways year after year.

Yet, as I write, with economic growth rising and the unemployment rate near historic lows, concerns are being voiced that consumer prices are growing too slowly – just because they’re a quarter percent or so below the 2 percent target! Could that be a signal to “ease” monetary policy, or at least to delay restraint, even with the economy at full employment?

Certainly, that would be nonsense. How did central bankers fall into the trap of assigning such weight to tiny changes in a single statistic, with all of its inherent weakness?

I think I know the origin. It’s not a matter of theory or of deep empirical studies. Just a very practical decision in a far-away place.

New Zealand is a small country, known among other things for excellent trout fishing. So, as I left the Federal Reserve in 1987, I happily accepted an invitation to visit. It turns out I was there, in one respect, under false pretenses. Getting off the plane in Auckland, I learned the fishing season was closed. I could have left my fly rods at home.

In other respects, the visit was fascinating. New Zealand economic policy was undergoing radical change. Years of high inflation, slow growth, and increasing foreign debt culminated in a sharp swing toward support for free markets and a strong attack on inflation led by the traditionally left-wing Labour Party.

The changes included narrowing the central bank’s focus to a single goal: bringing the inflation rate down to a predetermined target. The new government set an annual inflation rate of zero to 2 percent as the central bank’s key objective. The simplicity of the target was seen as part of its appeal — no excuses, no hedging about, one policy, one instrument. Within a year or so the inflation rate fell to about 2 percent.

The central bank head, Donald Brash, became a kind of traveling salesman. He had a lot of customers. After all, those regression models calculated by staff trained in econometrics have to be fed numbers, not principles.

I understand reasonable arguments can be made for 2 percent as an upper limit for “stability.” There is a body of analysis that suggests official price indexes typically overstate increases by failing to account for improvements in the quality of goods and services over time. The point is also made that expectations and behavior are determined by the price of goods, where productivity gains and strong competition restrain price increases, rather than by the cost of services like education and medical care, where productivity gains are slow.

But it is also true, and herein lies the danger, that such seeming numerical precision suggests it is possible to fine-tune policy with more flexible targeting as conditions change. Perhaps an increase to 3 percent to provide a slight stimulus if the economy seems too sluggish? And, if 3 percent isn’t enough, why not 4 percent?

I’m not making this up. I read such ideas voiced occasionally by Fed officials or economists at the International Monetary Fund, and more frequently from economics professors. In Japan, it seems to be the new gospel. I have yet to hear, in the midst of a strong economy, that maybe the inflation target should be reduced!

The fact is, even if it would be desirable, the tools of monetary and fiscal policy simply don’t permit that degree of precision. Yielding to the temptation to “test the waters” can only undercut the commitment to stability that sound monetary policy requires.

The old belief that a little inflation is a good thing for employment, preached long ago by some of my own Harvard professors, lingers on even though Nobel Prize–winning research and experience over decades suggests otherwise. In its new, more sophisticated form it seems to be fear of deflation that drives the argument.

Deflation, defined as a significant decline in prices, is indeed a serious matter if extended over time. It has not been a reality in this country for more than eighty years.

It is true that interest rates can’t fall significantly below zero in nominal terms. So, the argument runs, let’s keep “a little inflation” — even in a recession — as a kind of safeguard, a backdoor way of keeping “real” interest rates negative. Consumers will then have an incentive to buy today what might cost more tomorrow; borrowers will be enticed to borrow at zero or low interest rates, to invest before prices rise further.

All these arguments seem to me to have little empirical support. Yet fear of deflation seems to have become common among officials and commentators alike. (Even back in July 1984, as my Fed colleagues and I were still monitoring the 4 percent inflation rate, the New York Times had a front-page story warning about potential deflation.) Actual deflation is rare. Yet that fear can, in fact, easily lead to policies that inadvertently increase the risk.

History tells the story. In the U.S., we have had decades of good growth without inflation – in the 1950s and early 1960s, and again in the 1990s through the early 2000s. Those years of stability were also marked by eight recessions, mostly quick, that posed no risk of deflation.

Only once in the past century, in the 1930s, have we had deflation, serious deflation. In 2008–2009 there was cause for concern. The common characteristic of those two incidents was collapse of the financial system.

We can’t expect to prevent all financial excesses and recessions in the future. That is the pattern of history with free markets, financial innovation, and our innate “animal spirits.”

The lesson, to me, is crystal clear. Deflation is a threat posed by a critical breakdown of the financial system. Slow growth and recurrent recessions without systemic financial disturbances, even the big recessions of 1975 and 1982, have not posed such a risk.

The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about.

That is the basic lesson for monetary policy. It demands emphasis on price stability and prudent oversight of the financial system. Both of those requirements inexorably lead to the responsibilities of a central bank.

(This is an edited excerpt from the upcoming book “Keeping At It: The Quest for Sound Money and Good Government,” by Paul Volcker with Christine Harper.)

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As Ecuador struggles to rid itself of Wikileaks founder Julian Assange, who has become just one more annoyance for the administration of new Ecuadorian President Lenin Moreno, the country’s diplomatic service is taking another step that will help it pressure Assange into hopefully leaving its embassy in London, where he has been holed up for more than 5 years.

On Wednesday, Reuters reported that Ecuador does not plan to intervene with the British government on Assange’s behalf in talks over his situation as an asylee in the country’s embassy, according to the country’s foreign minister. During an interview with Reuters, Foreign Minister José Valencia said that Ecuador’s sole responsibility regarding Assange was securing his well-being.

Valencia said he was “frustrated” by Assange’s decision to sue the Ecuadorian government in one of the country’s court last week over new terms of his asylum.

“There is no obligation in international agreements for Ecuador to pay for things like Mr. Assange’s laundry,” he said.

This is a departure from Ecuador’s previous practice of maintaining a dialogue with British authorities over Assange’s situation since granting him asylum in 2012. Now, for the first time since Assange took refuge in the embassy in 2012, Ecuador will do nothing to help keep the British government at bay – something that is even more important after Assange lost a crucial court appeal regarding the charges of skipping bail that he is currently hiding from. the original sex crime charges brought by Swedish prosecutors were dropped back in 2017.

Ecuaor’s decision is clearly a retaliation for the Australian national’s decision to sue Ecuador over strict new “conditions” placed on his continued asylum in the London embassy, including demands that he clean his own bathroom, pay his own expenses (including medical and telephone bills), and clean up after his cat (under threat that the pet could be confiscated). Assange is also prohibited from engaging in political activities that could be construed as interfering in the affairs of other states.

“Ecuador has no responsibility to take any further steps,” Valencia said. “We are not Mr. Assange’s lawyers, nor are we representatives of the British government. This is a matter to be resolved between Assange and Great Britain.”

Greg Barns, an Australian lawyer advising Assange, said that “developments in the case in recent times” demonstrated the need for Australia’s government to intervene to assist “one of its citizens who faces real danger.”

In addition to the new rules by which Assange must abide, Ecuador has also attempted to intimidate potential visitors to Assange by enforcing new “special protocols.”

What’s the special protocol?

Lawyers for Mr Assange claim the protocol:

Requires journalists, Mr Assange’s lawyers and anyone else looking to see him to disclose private or political details – such as the serial numbers and codes of their phones and tablets

The protocol says the government may “share” the information “with other agencies”

Allows the embassy to seize the property of Mr Assange or his visitors and, without a warrant, hand it over to UK authorities.

WikiLeaks said that US congressmen had written an open letter to Ecuador’s president, Lenin Moreno, about the situation.

It claims the document said that in order to advance crucial matters – such as economic co-operation, counternarcotics assistance and the possible return of a USAID mission to Ecuador – they must first resolve a “significant challenge” – the status of Mr Assange.

While Moreno has expressed respect for Assange, he has also noted that asylum isn’t supposed to last “forever.” After naming Assange a citizen in December 2017, the country tried to name him a member of its diplomatic mission – a request the UK denied. While the UK hasn’t offered a clear explanation for why it refuses to drop its pursuit of Assange, the former hacker says he fears being arrested by UK authorities and extradited to the US, where he would face charges for his work with Wikileaks, including the publication of sensitive government secrets.

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Authored by Sven Henrich via NorthmanTrader.com,

“Buy every dip” they told you all summer. Bull after bull came out and told people to buy the dip. That worked well, no really, it worked. The move to new highs looked impressive. In the headlines. And in some indices and in some stocks that is. It didn’t work in many others. At all. In fact many indices have been an absolute horror show technically and never made new highs and/or they kept dripping to new lows.

To compound the problem the same people that told you buy buy buy never told you to sell. Don’t sell new highs was the mantra. The rally is expanding. No seriously, that was the PR circus running even in early October. Most bullish period of the year is just beginning remember?

Ignored were the negative divergences, the weakness underneath, the narrowness of participation (see also: Lying Highs). All of it.

And now the “hope” is for positive seasonality into year end, buybacks coming back, etc. Which may well happen of course.

After all we are very oversold here and a rally will emerge somewhere from these conditions.

But there is a lack of accountability as to the underlying damage that is being caused here. And while there are still key individual winners in 2018 the underlying picture remains absolute horrific.

I’ve picked a few select indices and sectors that highlight the current state of affairs. Buy every dip without selling.

How did that work out for the larger investing public and hedge funds for that matter?

Banking Index $BKX:

Semis $SOXX:

Transports ($TRAN):

Homebuilders $XHB:

That latter one being a classic example of what I mentioned above.

And don’t think I’m being too selective here. Yes $NDX is still up on the year and $SPX is near flat at the time of this writing, but look at the broader market. It’s a horror show:

$NYSE:

$WLSH:

Vast technical damage incurred everywhere.

Most buyers of every dip are under water if they didn’t sell.

Wall Street didn’t tell them to sell. They never really do. And I get it, markets tend to go up in most years and in the AUM business it makes sense to keep wanting to attract new cash at all times, keep buying until the bitter end. And then buy some more.

It works until it doesn’t:

The message for investors and traders: Look beneath the headlines and the marketing and stay abreast of developments beneath the surface. Form your own opinion. Technicals matter and they signaled well in advance not to believe the hype.

*  *  *

For the latest public analysis please visit NorthmanTrader. To subscribe to our market products please visit Services.

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Last month ago, we summarized  the September Beige Book by saying that shortly after the March inflationary panic, the one thing, perhaps the only thing, that was fascinating companies was the continuing threat of trade wars. In fact, we said that the “quick and dirty summary” for the May Beige Book, when economic activity continued to expand “at a modest to moderate pace across the 12 Federal Reserve Districts”, would, in a word literally, be “tariffs” and here’s why:

• March Beige Book instances of word “tariff”: 0
• April Beige Book instances of word “tariff”: 36
• May Beige Book instances of word “tariff”: 22
• July Beige Book instances of word “tariff”: 31
• September Beige Book instances of word “tariff”: 41

Fast forward to today when fears of trade wars have unmoderated (no pun intended) and there were no less than 51 instances of the word “tariff” in the just released, October Beige Book.

Despite the ongoing tariff fears, the U.S. economy is expanding at a “modest” to “moderate pace”, and echoing previous reports, the Fed warned of tight labor market conditions and rising input costs partly due to trade disruptions as uncertainties over trade and labor shortages put pressure on firms. New York and St. Louis indicated slight growth, overall, while Dallas reported robust growth driven by strong manufacturing, retail, and nonfinancial services activity.

“Several districts indicated that firms faced rising materials and shipping costs, uncertainties over the trade environment and/or difficulties finding qualified workers” the report said.

Several Fed districts reported that firms faced rising materials and shipping costs, uncertainties over trade and difficulty finding qualified workers. Employment expanded modestly/moderately across the US, as employers throughout the country continued to report tight labor markets and difficulties finding qualified workers, including highly skilled engineers, finance and sales professionals, construction and manufacturing workers, IT professionals, and truck drivers.

And while wage growth was characterised as “modest to moderate”, paradoxically, the Beige Book, based on anecdotal information collected by the 12 regional Fed banks through Oct. 15, continued to show that companies are generally not responding to the tightening labor market with significantly higher wages. Almost as if the labor market slack is far, far greater than the BLS or the administration will want us to believe.

In lieu of higher wages, some firms offered signing bonuses, flexible hours and more vacation time in order to attract and retain workers.” Most businesses also expected wage gains to remain “modest to moderate” over the coming six months.

The report also pointed to widespread labor shortages that were “linked to wage increases and/or constrained growth.” In the Philadelphia district, one firm noted difficulty launching a third shift because of a lack of workers while another was planning to add robots. In fact, there were two mentions of the word “robots” in this beige book.

To underscore the severity of the labor shortage, the St. Louis fed notes that “one contact reported the launch of programs that teach foreign-born workers English to prepare them for jobs in the medical field and in manufacturing.“

Falling back to the generic concerns, the Beige Book highlighted anxiety among U.S. firms over the ongoing trade dispute with China with manufacturers reporting they were raising prices out of necessity as tariffs drove up the cost of raw materials, including metals.

“New car prices are also expected to increase significantly to cover the burden of recently implemented tariffs,” the Boston Fed reported.

Separately, anecdotes on housing were mixed with homebuilders in Cleveland reporting a modest fall in demand because of decrease in affordability.

The Dallas district, which includes many areas benefitting from higher energy prices, continued to be a particularly bright spot with “solid” growth in manufacturing, retail and nonfinancial services.

Below, courtesy of Bloomberg, are selected anecdotes from the latest Beige Book:

 

• Boston: Three manufacturing firms faced higher input prices due to tariffs on Chinese goods and services that were not readily substitutable, and the firms expected to pass on (or had already passed on) to consumers at least some of the tariff burdens
• New York: Broadway theaters reported continued growth in both attendance and revenues, both of which were running well ahead of comparable 2017 levels
• Philadelphia: Several key industrial suppliers believe their clients placed excessive orders to boost inventories in advance of tariffs and now expect that demand will be lower over the next six months to a year
• Cleveland: Auto retailers noted that new vehicle sales have declined slightly because of rising interest rates and increased unit prices
• Richmond: Farmers in North Carolina lost crops and livestock to flooding from Hurricane Florence
• Atlanta: Contacts remained concerned about tariffs and trade conflicts although there was some optimism concerning the newly agreed upon United States-Mexico-Canada Agreement
• Chicago: Residential and commercial construction contacts said that a lack of workers was slowing the completion of projects: One contact reported a delay of 6 weeks because they couldn’t find an elevator installer.
• St. Louis: One contact reported the launch of programs that teach foreign-born workers English to prepare them for jobs in the medical field and in manufacturing
• Minneapolis: A producer of dry beans reported that a large regular annual order from European Union countries was cancelled due to tariffs
• Kansas City: A majority of respondents reported higher commercial vacancy rates for the first time since the end of 2016
• Dallas: Most staffing firms reported surging demand for their services over the reporting period, noting strength in all markets, both geographically and by industry
• San Francisco: Contacts in Northern California reported that sales of semiconductors were brisk, driven in part by strong global demand.

 

Needless to say, as long as employers continue to complain about lack of skilled workers instead of materially hiking wages, the status quo in which the Fed will remain confused by the “mysterious” lack of inflation, will continue.

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Semis, FANGs, all getting slaughtered as Nasdaq tumbles 2.6% on the day to its lowest in almost 6 months…

A brief post-EU close bounce has been eviscerated as stocks are collapsing…

‘Chipwreck’ continues with SOX at 13-mo lows – confirming that double top… (worst month in 6 years)

S&P’s tech back at 6-month lows…

FANG stocks tumbled to 6-month lows… (down 17% from the July highs)

Nasdaq blew through its 200DMA and never looked back…

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When it comes to sleepless night involving the great unknowns locked in the Pandora’s box that was created by central bankers and which will be unleashed during next financial crisis, one nightmare is among the most recurring: what happens when the ETFs, which have been buying stocks for the past decade, begin to sell?

The answer, according to JPMorgan, would be nothing short of catastrophic.

According to a new report from JPM equity strategist, Eduardo Lecubarri, passive investing (i.e., ETFs and index funds) – which was not a big driver of equity returns in the last recession as it accounted for less than 30% of the AUM in actively managed funds back then, “should bring big selling pressure to large caps and US small and mid caps during the next downturn”, Lechubarri writes, as a result of the staggering increase in Passive AUM over the past decade which, as a % of active AUM, has nearly reached parity, and was around 83% as of 2018; Passive AUM is widely expected to surpass Active AUM over the next two years.

How much selling pressure? JPMorgan calculates that some $7.4 trillion in stocks would be subject to forced selling by passive funds during the next downturn.

“This is something worth noting at this late stage of a cycle given that passive investing seems to be trend following, with inflows pushing equities higher during bull markets, and outflows likely to magnify their fall during corrections” Lechubarri warns.

Lecubarri also notes that passive investing is far more skewed to Large-Caps than what their market caps would command, “making this asset class far more exposed to momentum selling during market downturns.”

So what does JPM do with this information? Simple: it tells clients to sell all those names, industries and geographic regions which are overexposed to passive investors:

We find Real Estate, Telecom, Utilities, Financials, and Industrials are most exposed to passive investing within US SMid-Caps, while Healthcare and Energy are the most clear safe havens. As for SMid outside the US, all sector exposure to passive investing is within a tight range, and thus unlikely to be a key driver of relative returns.

Of course, while JPM may have come up with some hiding places ahead of the ETF liquidation deluge, the truth is that if and when some $7.4 trillion in selling starts without central bank backstops to soak it all up, there will be no place to hide.

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Authored by Jeffrey Snider via Alhambra Investment Partners,

For days after China shocked the world in August 2015, “devaluing” its currency seemingly out of nowhere, there was only confusion as to what had just happened. Going by nothing more than the mainstream media and economic narrative fed to it by central bankers and Economists (redundant), you wouldn’t have known anything was wrong at all. Manipulating currency for an unfair advantage, probably.

The US economy was booming. The oil price crash that had similarly appeared out of nowhere was a good thing, they said, a tax cut-like effect that would only make the good times better. Never mind the appearance of “overseas turmoil”, that was someone else’s problem.

None of that was true, obviously, and if you were paying attention you could see it coming. There were warnings all over the place, consistent in their direction (deflation, not inflation) spreading throughout markets. CNY wasn’t an outlier, it was perfectly consistent. I wrote on August 14, 2015, just a few days after:

That does not mean, however, that all this is over; far from it. These tremors are warnings that the “dollar” system’s decay is reaching critical points. The mainstream will tender that this is really no big deal, just a tantrum of spoiled markets unwilling to easily treat the coming end of ZIRP and accommodation; that is simply and flat out false. There is a systemic liquidity problem that is and has been fatal, exposed to a greater degree by the continued withdrawal of eurodollar bank participation – the real “printing press.”

Just ten days later, on Monday, August 24, Wall Street flash crashed. It was, for that day, a gruesome session. True to form, the mainstream downplayed it. Here’s but one contemporary example.

Stock markets around the world recorded dramatic declines. It’s ugly. But before you panic, let’s put this in perspective. This is hardly the worst day ever for stocks. This pullback also comes after six years of stellar stock market gains.

Like 2008, it is absolutely stunning how anyone can realize “markets around the world” all doing the same thing at the same time and not wonder about the connection. And then falling only two weeks after CNY, the dots should’ve been quite easy to connect.

One way to have connected them was with something like gold. The precious metal had been falling for years by then, admittedly, which made it easy to dismiss and ignore. Still, in the months leading up to summer 2015 there was a whole bunch of interesting fireworks in the pits.

From March on through August, the PBOC had pegged CNY making it seem like all that noise in 2014 had been skillfully handled. But from mid-June 2015 forward, gold markets signaled another deflationary wave, likely originating in stalled collateral flow blocked by restricting balance sheet capacity (swap spreads turning negative was pretty conclusive evidence in that regard). Going back to what I wrote on the 14th:

In short, the actions of the PBOC, seen in light of what was a convertibility mini-crisis, a “run” of sorts, make sense where the yuan fix as some kind of “stimulus” in devaluation does not (or is at least far too inconsistent to be explanatory). The PBOC held the yuan steady to a near plateau for five months hoping for cessation of “dollar” pressure, but, like a coiled spring, it only intensified until there was no holding back anymore.

That was the message from the gold market – only, after the “devaluation” the direction completely changed. Instead of continuing its deflationary move lower, gold popped.

A rising gold price is often considered an inflationary, or reflationary, sign. In this case, however, the jump especially during that particular two-week period was hardly of the same variety. It was raw, unadulterated fear permeating the entire global system. Something snapped and though it was never written into the conventional record it still happened all the same.

It was in this window that America finally noticed “overseas turmoil” in their 401k’s.

Then, as if to prove these points, the process was repeated in almost exactly the same fashion a second time in a matter of mere months. And to further demonstrate how clueless and useless central bankers are and can be, the Federal Reserve actually kicked off its “rate hike” program in the middle of all this still at that late date believing in that earlier “strong” economy fairy tale.

This second deflationary wave ultimately proved more devastating than the first, even if Wall Street never fully accounted for it. In Asia as in other far-flung economies, the eurodollar damage was so severe that they still haven’t recovered from it even after suffering 2008-levels of contraction and shrinking. In many ways, the US economy hasn’t either (labor market, corporate profits), no matter how much the current economy is called strong.

This review is made relevant by gold’s behavior over the past two weeks.

After being pounded all year, collateral, gold is up sharply since a few days after China reopened from its National Day Golden Week – under liquidation. For good measure, the PBOC has been practically begging markets to understand its continued dollar warnings.

The collateral part, deflation, is easy. All that re-emerging “overseas turmoil” in emerging markets set off a chain reaction against all collateral forms (haircuts and transformations, EM corporates in particular). Gold stabilized in mid-August and then finally jumps in the middle of October.

Is that the end of the deflation for 2018? Or is it, like August 2015, the transition from cursory warnings to more comprehensively negative signals? Systemic fear in sentiment eventually overcoming the mechanics of collateral in gold.

“Markets around the world” might wish to make that determination. Something, something liquidity. From today’s roller coaster trading session:

At its session lows, the Dow had fallen 548.62 points, while the S&P 500 and Nasdaq had lost more than 2 percent each… The S&P 500 posted its fifth straight decline and briefly dipped below the lows hit earlier in October during this ongoing sell-off. The major indexes are all down at least 4.8 percent for October.

This time it is, apparently, “rising global tensions” rather than overseas turmoil. No matter, it’s all the same thing underneath. It should be clear by now that something’s off about 2018. It can’t be rate hikes, there were those in 2017, too. The question going forward toward 2019 is whether what’s not right is itself evolving even more unfavorably.

The three stages of gold: reflation, collateral, fear. The last does seem more consistent with overseas turmoil that isn’t so far away.

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Volkswagen shares tumbled as much as 6% on Wednesday, after the President and CEO of Volkswagen China told Nikkei that the company will likely end the year with flat or lower sales volume in China compared to last year. Previously, Volkswagen had expected 4% growth in China this year; the sharp downward revision makes Volkswagen the latest in a line of car manufacturers and dealers to paint a dismal demand picture in the global automotive industry. 

China is the Volkswagen’s largest single market, contributing more than 40% to global sales last year, inclusive of Hong Kong.

Jochem Heizmann, CEO of Volkswagen China, tried to make the point that the automobile market in China was still a ways from hitting its ceiling, saying that low single digit growth, should it occur, still represented a significant amount of business for any carmaker in such a large country. The company’s shareholders did not agree.

Speaking to Bloomberg, Heizmann said that “hopefully, the decline of the market in connection with the China-U.S. problems is temporary.” Because if it’s not, the world’s auto OEMs will have major problems.

He then stated that he thought VW had “good chances” to grow faster than the industry for the rest of the year on account of its numerous coming SUV launches. 

These concerns about China echo concerns Renault raised on its recent earnings report. Renault just posted a larger drop in third-quarter sales than analysts expected. Renault blamed the poor numbers on a global slowdown in sales in places like China and Iran, as well as on new emissions standards.

Needless to say, if virtually every single automaker is now cursing they day they decided to expand into China, one can only imagine what China’s real, not fabricated 6.5%, GDP number must be if the middle class, at least as measured by its auto purchases, has hit a brick wall.

Meanwhile, just yesterday, we discussed  how the U.S. automobile industry decline was accelerating during the month of October. 

Scott Adams, the owner of a Toyota dealership in Lee’s Summit, Missouri, told CNBC: “We are definitely seeing business pull back. September was off some, but this month our car sales are down 12 percent and our truck sales are down 23 percent.”

Mark Scarpelli, president of Raymond Chevrolet and Kia in Antioch, Illinois stated that “Customer traffic has moderated. There is a little bit more of a pause because of the higher interest rates.” He said that although sales are keeping pace with the prior year, people are taking longer to buy.

So between sharp declines in auto demand in China, Europe and the US, how long before the phrase “automotive recession” becomes watercooler talk.

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With roughly one week left before the US reimposes sanctions on Iranian exports that could hamper Iranian crude-oil exports, Hassan Rouhani, the president of the Islamic Republic, accused the US of officially sanctioning the murder of Saudi journalist-turned-critic Jamal Khashoggi, arguing that no country would carry out such a heinous crime “without the protection of America.”

While the US probably won’t bother to dignify Rouhani’s allegations with a response, reports that US intelligence agencies had intercepted communications about the plot to ambush Khashoggi suggest that the US had an idea that Khashoggi might be killed upon returning to the consulate. And knowing this, they did nothing to warn Khashoggi or the Saudis, despite Khashoggi’s status as a US resident writing for a prominent national newspaper. 

According to Reuters, which cited a transcript from the official Iranian news agency, Rouhani said that such a brutal killing taking place at a foreign consulate was almost “unthinkable”.

“No one would imagine that in today’s world and a new century that we would witness such an organized murder and a system would plan out such a heinous murder,” Rouhani said, according to IRNA.

“I don’t think that a country would dare commit such a crime without the protection of America.”

And as Rouhani pointed out, US protection has allowed KSA to continue its brutal bombing campaign in Yemen, while Crown Prince Mohammad bin Salman has engaged in an authoritarian crackdown on domestic dissent.

“If there was no American protection, would the people of Yemen still have faced the same brutal bombing?” Rouhani said.

On a separate note, Rouhani declared that Iran would “defeat” US sanctions on Iranian exports.

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