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Despite trade wars, central bank tightening, declining economic fundamental data, and an Emerging Market crisis, according to one survey, active US investment managers are presently more than 100% invested, on average.

Source: Dana Lyons’ Tumblr

However, while US equities continue to charge ahead, alarm bells elsewhere are ringing very loud…

Judging by the reaction in China, you would’ve thought global markets were in for a thrashing after President Donald Trump’s latest escalations on trade.

However, as Bloomberg notes, the question of why American equities keep skating past a worsening trade conflagration has been baffling for strategists.

“We’ve had more negative catalysts and more negative pull this year than we’ve had for a long time, but the positives continue to prevail in the investor’s mind,” Jeff Carbone, a managing partner at Cornerstone Wealth in North Carolina, said by phone.

“They’re shrugging off the negativity and taking the positive to a greater extent that this is not the end.”

As Bloomberg notes, the ignorance of risk is everywhere: Equity funds are only a trifle less long than at the height of January’s euphoria.

It’s in markets for call options, where individual investors are engaged in a buying binge of historic dimensions.

It’s in tech stocks (favored by short sellers), and ones with shaky balance sheets, all of which recently surged…

On the back of an historic short-squeeze…

 

In credit markets, various indicators are flashing bright red. For instance Bank Loans have been pummeled the last few days…

“The scary thing is that everyone keeps warning about leverage but then keeps reaching for the yield that BBB provides,” said Andrew Forsyth, a portfolio manager with BNP Paribas Asset Management.

 

Emerging Markets have been a bloodbath in recent weeks…

With 42 straight days without inflows for the biggest EM ETF…

 

It’s not like people haven’t been warned. They have their memories of February and March, and strategists at banks like Morgan Stanley and Goldman Sachs have repeatedly urged investors to rein in optimism, citing everything from politics to peak earnings and monetary tightening. Earlier today, Citigroup Inc. flagged a potential bubble in growth stocks.

“This is fine for now, but we think by year end such a ‘risk on’ hierarchy will be misplaced given the more uncertain outlook posed by ‘peaky’ growth rates and ever tightening financial conditions,” Mike Wilson, chief U.S. equity strategist at Morgan Stanley wrote in a note to clients Monday.

He urged investors to go defensive in anticipation of a rotation out of companies whose growth is tied to economic growth and upgraded utility stocks.

But the caveats have gone unheeded.

Wilson isn’t alone among analysts who see trouble brewing. As Bloomberg reports, the rally in growth stocks brought flashbacks of the internet bubble to Citigroup strategists led by Robert Buckland, even as valuation premiums are less than half of those from almost two decades ago.

A collapse would bode ill for a market whose gains have been increasingly anchored on tech giants such as Amazon.com Inc. and Facebook Inc.

“Price action of the U.S. growth/value trade looks ominously similar to late 1999,” the strategists wrote.

“Watch out for a growth bubble.”

With the price of call options now trading above their historic average, investors should sell them to reap extra returns in a market whose upside appears limited with valuations stretched, according to Rocky Fishman, an options strategist at Goldman Sachs. The firm predicted the S&P 500 will end next year at 3,000, or an 8 percent increase from the last close. That’d be below the 45th percentile in the index’s history over any 18-month period.

“The potential for upside surprises in U.S. equities is lower than the compensation received from elevated call prices,” he wrote in a note.

Coincidentally or not, such indications of retail euphoria flared up in January, just before the S&P 500’s first 10 percent correction in two years. It also accompanied the bull market peaks in 2000 and 2007.

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During ABCNews’ coverage of President Trump’s remarks to pool reporters earlier today, it appears the chyron operator had a sudden Trump Derangement Syndrome breakdown as they wrote the oddly specific banner below…

While many in America may hope that Trump’s former campaign manager Paul Manafort did indeed plead guilty to five charges of manslaughter, he did not (yet).

As Mediaite reports, the mistaken chyron stayed up for a seemingly never-ending seven seconds.

With many having not seen the humor in this mistake, ABC News PR quickly took to Twitter to apologize profusely,

Statement from @ABC News: We regret and apologize for the false lower third graphic that aired during our special report. We are investigating how incorrect information was in our system and how and why it was allowed to air. (1/2)

— ABCNews PR (@ABCNewsPR) June 20, 2018

(cont.) We apologize to our viewers and to Mr. Manafort. There simply is no excuse for this sort of mistake. (2/2)

— ABCNews PR (@ABCNewsPR) June 20, 2018

The #Resistance seems well-embedded at ABC News too.

Of course, it could have been worse…

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Until recently, Deustche Bank was best known for being the worst managed megabank in the world, for having attempted rigging and manipulating virtually every single market (and getting caught doing it), for having been “secretly” added to the Fed’s “troubled bank” watchlist, for having been told by the ECB to simulate a “crisis scenario“, for “accidentally” transferring 28 billion euros to an outside account, and of course, having some $50 trillion in gross notional derivatives on its books.

As of today it is also known for having reckless traders on “full tilt” who go all in, bet the house, and lose.

As first noticed by Bloomberg, and disclosed publicly in a May 7 Federal Financial Institution filing, unknown Deutsche Bank traders suffered a staggering one-day loss in the first quarter that was almost 12x VaR, or 12 times what DB’s risk officers have estimated for regulatory purposes it might lose on a typical day.

“Even a loss of two or three times VaR on a given day is unlikely. Twelve times VaR is extraordinarily unlikely,” MIT finance professor Andrew Lo told Bloomberg.

This loss, which is unrivaled in either Deutsche Bank history, or in other banks’ first quarter reports – was oddly left out of Deutsche Bank’s earnings report, and as BBG notes, “raises questions about U.S. regulators’ ability to have an accurate picture of a foreign bank’s operations if metrics such as value-at-risk, or VaR, show only a fraction of potential trading exposure.” It also confirms that the Fed has ample reasons to be worried about a bank which is willing to not only gamble the house on some wild trade, but also lose as a result.

The staggering, record Q1 loss is more than 6x greater than the next largest disclosed VaR exception, that of BNP Paribas. Most banks were well under VaR as they should.

“Such a high trading loss is off the charts,” said Gregor Weiss, a professor at Leipzig University and an expert in financial risk management. “It’s definitely something a supervisor will look into.”

And they did: the issue of the giant loss, and subsequent attempted cover up (or at least lack of disclosure) is particularly stark at Deutsche Bank, which has increased capital levels at its U.S. business after multiple failed stress tests and cease-and-desist orders. More from Bloomberg:

Multiple U.S. regulators, including the Federal Reserve, inquired about the outsized loss, according to a person with knowledge of the discussions. Eric Kollig, a Fed spokesman, and Richard Loconte, a spokesman for New York’s Department of Financial Services, which supervises part of Deutsche Bank’s U.S. business, declined to comment

While Deutsche Bank didn’t disclose the size of the loss, one can back into it based on the disclosed average regulatory value-at-risk during the period which was was $30.8 million, which would imply that the total loss was roughly $400 million, although as Bloomberg caveats, because daily variations in the figure aren’t disclosed, it’s impossible to know what the exact loss was.

And since the gargantuan one-day loss took place in a quarter in which DB reported trading revenue of negative $64 million, indicating losses on trading positions – while the Barclays and Credit Suisse each reported more than $100 million of positive revenue – we can be further assured that this was indeed some spectacular trading blow.

According to Bloomberg calculations, the extreme day was one of four in the first quarter in which Deutsche Bank’s U.S. traders had a loss that surpassed the firm’s regulatory VaR estimate, however it is unlikely that any of the other three came even remotely close to 12x VaR.

Others did much better:

no other bank required to file quarterly reports with the Fed detailing significant trading activities had more than two such days, and none had a daily loss that even doubled its estimate, according to a review of the 33 filings from U.S. lenders and the local units of foreign firms. Deutsche Bank had just one such day all of last year. Exceeding the estimate too often causes a bank’s capital requirements to rise.

Needless to say, it’s been a tumultuous year for Frankfurt-based Deutsche Bank, which following a series of unfortunate events, reported the latest abysmal quarter. Days after the quarter closed, Deutsche Bank named Christian Sewing – previously its deputy chief of risk – to take over as chief executive officer.

If only more risk managers were at the bank at the time its traders were taking on 12x VaR risk positions, the quarter may not have been that terrible.

As for the consequences… “The firm finished a months-long strategy review shortly thereafter, announcing U.S. operations would significantly shrink as part of a global overhaul.”

Some 10,000 workers are expected to be fired; it is unclear just how much of a factor that spectacular trading loss was in the CEO’s decision to cut headcount by 10%.

As Bloomberg concludes, “a number of leaders and dealmakers in the U.S. have left the bank amid the shakeup. In a letter to staff this month, Sewing said the firm has taken steps to reorganize its business, bolster capital and reduce risks.”

“Many of you are sick and tired of bad news,” he admitted.

And now there’s more.

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The Spanish government’s decision to accept a boat carrying more than 600 migrants, a boat that was refused permission to dock by both Italy and Malta, has backfired on a group of students in the city of Alicante, who have been asked to leave their dorms within 24 hours to make room for the refugees. According to RT, Pedro Sanchez, Spain’s newly appointed socialist prime minister who replaced Mariano Rajoy following a no-confidence vote earlier this month, agreed to shelter the passengers of the Aquarius, a group of migrants from sub-Saharan Africa who were rescued from rickety vessels in the Mediterranean by the ship. After declaring that “the good times for illegals are over”, Italy’s newly installed anti-immigration government blocked the ship and urged its neighbor, Malta, to accept the migrants. Malta also declined, prompting Spain and its new left-wing government to intervene.

Now, several hundred students, who are paying 750 euros a month to live in the La Florida dormitory in Alicante, must leave to make room for children aged 12 to 17 who are being brought to the dormitory via bus following the ship’s arrival in Spain on Sunday. The authorities explained that the eviction was necessary given the “emergency situation” caused by the migrants’ arrival.

One students’ mother told local media that the students were asked to leave because the incoming refugees would have “many diseases” and possibly pose a “health risk.” And while students said they’re “not against helping those in need” they’re worried about how they will finish their studies.

“We’re not against helping those in need, but it isn’t fair for my son to be removed from his residence and left on the street in the middle of his studies,” one woman said, adding that her son needed to complete his course in German in order to qualify for a new job in that country.

The provisional government has assured inquiring media outlets that it will cover the students’ expenses and find new temporary accommodations for them. We would advise the rest of Spain’s college students to consider packing a “go-bag”, because the Italian government over the weekend refused permission to dock to two Dutch-flagged ships carrying migrants, which are now sitting off the coast of Libya. That means more migrants could be on their way to Spain in the near future.

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Having explained in May why “there won’t be a trade war anytime soon” and shrugging off trade war anxiety “because of the wisdom of Chinese leaders,” it appears Bridgewater’s Ray Dalio is shifting his position.

Today he tweeted a more anxious-sounding message…

Trump is playing chicken with China. It will be important and telling to see how this plays out.

— Ray Dalio (@RayDalio) June 20, 2018

And in a LinkedIn post this week,  he explained Chinese-American misunderstandings, disputes, and wars…

A wise Chinese leader who I will keep unnamed told me that it pays to negotiate by finding out what the other party wants most and try to give it to them and to have them reciprocate rather than to find out what will hurt the other party and give that to them because little wars have a tendency to quickly get out of control to become big wars and anyone who has ever gotten into a big war wishes that they hadn’t because they are so horrible. He referred to World War I as the classic example, while noting that it was true for most wars. He hopes that the Chinese-US trade disagreement doesn’t move from a dispute to a war of any sort.

What is moving the disagreement from a dispute to a war is the fact that there are no international rules or international organizations (like WTO) that the disagreeing parties are willing to go to for binding arbitration, so they use carrots and sticks to test each other’s strengths, pushing each other until one backs down. Because Chinese and American leaders have all sorts of carrots and sticks (e.g., economic, military, cyber, etc.) that they can use, they are now determining which ones to use, how far to push the testing, and how far the other will go in inflicting pain and enduring it. The escalations come in the form of tit-for-tats—i.e., a series of escalations that can become progressively larger and more painful, and that take different forms that can extend beyond trade (e.g., to include capital wars). It’s this series of escalations that the wise Chinese leader that I referred to conveyed can easily get beyond anyone’s control.

In response to the US putting on its $50 billion of tariffs, the Chinese responded saying, “the Chinese side doesn’t want to fight a trade war, but facing the shortsightedness of the US side, China has to fight back strongly. We will immediately introduce the same scale and equal taxation measures, and all economic and trade achievements reached by the two sides will be invalidated.” The Trump administration threatened to retaliate to that by adding another $100 billion of tariffs. Right now, these numbers are very small in relation to the US’s nearly $20 trillion economy and China’s economy, which is of comparable size in purchasing power terms, so that the shots that have been fired have been more of symbolic and political significance than of material economic significance. For that reason, it’s too early to get excited about them though, as the previously referred to Chinese leader said, they can escalate to become very serious, so we are all watching intently.

While I and people who are more knowledgeable than I believe the trade-balance issue can be solved so that everyone is better off, the more challenging disputes revolve around how the two countries believe their countries should be run and how that affects their perceptions of what “fair trade” is and how their companies should be supported.

The Fundamental Differences in Values and Approaches

A different wise and high-ranking Chinese official told me the most important cultural difference between Americans and the Chinese arises from the fact that to Americans the individual is of paramount importance while to the Chinese the family is most important.

He explained that these deep-seated differences extend to how Americans and the Chinese run their governments, noting that the two characters that make up the word country in China are “state” and “family.” As a result of these deep-seated differences in views about what is best, leaders in China seek to run the country the way a family head would run a family, from the top down, putting the collective interest ahead of the individual’s self-interest, with each member knowing their place so the system works in a harmonious way. 

In the US, the opposite is true. Individuals are of paramount importance so the country is run from the bottom up, putting the interests of the individual ahead of the interests of the collective, with more open conflict and less respect for authority considered preferable. 

These differences become manifest in all sorts of ways. For example, when a highway needs to go through personal property, individual property rights will more likely stand in the way of that happening in the US than in China, and when leaders are chosen, it’s more from the top down in China while it’s more bottom up in the US. Similarly, leaders in China manage the companies in key industries more from the top down in support of the national interests, whereas the opposite is true in the US, where how companies are managed comes from the bottom up. That’s where the rub lies.

From the US perspective, there are three major criticisms:

1. The Chinese government pursues a wide range of evolving interventionist policies and practices aimed at limiting market access for imported goods, services, and businesses, thus protecting its domestic industries by creating unfair practices.

2. The Chinese offer significant government guidance, resources, and regularly support Chinese industries, most notably including policies designed to extract advanced technologies from foreign companies particularly in sensitive sectors.

3. The Chinese are stealing intellectual property and/or not adequately protecting it—some of which is believed to be state-sponsored and some of which is believed to be outside the government’s direct control.

In other words, the Chinese government is helping its companies compete in ways that the US doesn’t do and doesn’t like, and it is making plans to do that (e.g., the China 2025 plan) while the US doesn’t make such plans and objects to China making them. While these different approaches exist in most areas, they are especially important in technology because both countries know that the country that is technologically strongest will be strongest in most other ways. While some of these differences can be negotiated to both countries’ mutual satisfactions, the most core ones that are extensions of what each country deeply believes is best can’t be negotiated away.

China Is Now a Competitor and Will Soon Will Be Much Stronger Than the US

While the trade-balance issue is important, the most important questions are a) how will these countries deal with each other given their different perspectives and b) which system will work best. Most likely (and hopefully) the trade dispute we are seeing won’t lead to a disruptive war so that both countries will evolve to very different places based on how effective their approaches are. That will have huge effects on their individual well-beings as well as their relative powers. For that reason, it is most important for the leaders of these countries to focus on what they need to do to get their own countries to do well.

In considering the question of how well these two different approaches will work, it’s important to recognize that both “communism” in China and “capitalism” in the US are now very different than they were 30 years ago and, as a result, they’re delivering very different results to their populations. It would be a mistake to think that China is a communist country that works similar to the way communism has classically worked around the world or in China 30 years ago—i.e., very ineffectively. Instead think of what’s happening in China as being “state capitalism,” in which strategically important companies are being supported to become very competitive while the economy has a lot of entrepreneurship and the markets have quite a lot of freedom. Though different, China is being run much more like Singapore has been run for the last 30 years than how China was run 30 years ago or than how “communist” countries have classically being run. Think of it as being capitalism with the Chinese cultural characteristics previously explained. In comparison to the US, it’s more from the top down with the paramount goal to have competent decision makers put into decision-making roles to determine what’s best for the whole and to be held accountable for accomplishing those things.

There is no doubt that China’s culture/approach has worked remarkably well and is rapidly getting better. When I first went there in 1984, I gave heads of companies $10 calculators, which they thought were amazing, and people in Beijing and Shanghai lived in what most people would consider slums without hot running water, adequate heat, and basic appliances like washing machines and TVs. Now it is as or more advanced than the US in many ways, and improving faster. There should be no doubt that the Chinese culture/system has been very effective. The chart below shows what has happened and what we expect will happen based on our leading indicators of what make countries succeed and fail (see “Why countries succeed and Fail; Productivity and Structural Reforms”).

While China is a competitor and will soon be significantly larger than the US, and while such rivalries in the form of the Thucydides Trap (https://bit.ly/2th3Qtm) are dangerous, it is very doubtful that the capacities of either of these countries to inflict immeasurable harm on the other will end for a very long time frame. For these reasons, we hope and expect that rationale heads will prevail and tit-for-tat escalations won’t accelerate to produce horrible wars.

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Trump lawyer Rudy Giuliani has offered yet another update on the ongoing negotiations with Special Counsel Robert Mueller and his team over the terms of a possible presidential interview, according to the Washington Post. And Mueller likely won’t be happy. A final decision on whether Trump will assent to an interview won’t be made until mid- or late-July, Giuliani said. Although, at this point, it sometimes seems like Giuliani is just taunting and stalling, and that Trump has already decided to forgo an interview and dare Mueller to try issuing a presidential subpoena. After all, Giuliani said last week that a decision would arrive by the end of this month.

“I’m advising him to stay put, to hold our horses a little,” Giuliani told The Washington Post in an interview, about an hour after Giuliani said he spoke with Trump. “I doubt August, and I doubt too far into July. But I do think things have changed.”

“I’d like to get it done, our part over to them by July 4,” he said, but added that developments at the Justice Department could lead him to advise the president to hold off.

Of course, Giuliani and Trump obviously feel that the Inspector General’s report, which highlighted extreme anti-Trump political bias within the ranks of the FBI – though it ultimately exonerated the DOJ and the bureau’s senior leadership and opted not to impugn the Mueller probe – has bought the president some time. Last week, Giuliani said he’d use the report to undermine the special counsel’s probe. Giuliani added that, if talks collapse in the coming weeks, he’s unsure whether Mueller would try to subpoena the president, which would likely trigger a legal battle that would rise all the way to the Supreme Court.

Giuliani denied that Mueller was pressing Trump’s team to make a decision.

“We just don’t know,” Giuliani said. “They have an argument for it and against it. It could blow up in their face and they’d have to just file a report. At this point, they’re not pressing us.”

Mueller has reportedly promised that, if the president agrees to a sit-down interview, he could finish a report on whether Trump tried to obstruct the probe into Russian interference in the 2016 election within 90 days.

Then again, Giuliani has also scoffed at the suggestion that he’d let Trump sit down with Mueller.

“Do I look crazy?” Giuliani responded. “So far, you know, I still have all my senses, and I’m a heck of a lawyer. And I get drummed out of the profession if I did. I mean, the reality is, you don’t put your client in a kangaroo court.”

We imagine we’ll hear more from Giuliani next week, when he announces yet another delay on Trump’s long-awaited decision on whether to meet Mueller face-to-face.

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Just as Trump is set to concede on his crackdown on immigrant parents separated from children at the border, by signing a “pre-emptive” executive order at any moment, Europe is about to crackdown on the migrant wave unleashed by Angela Merkel (and her various unknown progressive advisors, which some have speculated includes George Soros’ Open Society) in 2015 with Germany’s “Open Door” policy, and on Sunday countries including France, Germany, Italy, Austria and other EU states will meet to try to end a deadlock on migration policy which has brought to a head bitter political divisions in the bloc, and has resulted in Brexit in the UK, a wave of nationalist governments in Central and Eastern Europe, and the first openly populist government in Italy in decades.

Actually, scratch that: according to Reuters we already know what will be decided – a full-blown crackdown on migration, just in time to save Angela Merkel’s job who was recently handed a 2 week ultimatum to resolve Germany immigration troubles by her coalition partner, the CSU.

• EU LEADERS TO AGREE ON SUNDAY IT IS “CRUCIAL TO FURTHER REDUCE ILLEGAL MIGRATION TO EUROPE AS WELL AS SECONDARY MOVEMENTS” INSIDE EU – DRAFT STATEMENT

The official purpose of Sunday’s meeting is to explore how to prevent migrants from moving around the European Union after claiming asylum in one of the Mediterranean states of arrival, although those states now exclude Italy, which following the League/5-Star government has made it clear it will no longer accept immigrants.

Such secondary movements are illegal under EU law but have been widespread since immigration to Europe peaked in 2015, when more than a million refugees and migrants arrived from the Middle East and Africa. More importantly, the bloc has since been bitterly at odds over how to share out the responsibility of taking care of them.

As a result, Sunday’s meeting will seek to avert a possible clash on the issue at a June 28-29 EU summit, where leaders will try to agree a joint migration policy.

Some states, such as Austria, are already bracing for the worse, and in advance of failing to reach common ground, Austrian Chancellor Sebastian Kurz said he would push on Sunday for rapid action on migration, and suggested Austria might go it alone on creating asylum centres outside the European Union if the deadlock continued for months.

Of course, if there is indeed no deal by June 29, Merkel’s government could no longer exist come July 1: Horst Seehofer, CSU leader and Germany’s interior minister, is one of the most outspoken voices behind the migration initiative; the German wants to turn away migrants who have already registered in other EU states, even as Merkel opposes any unilateral move to reverse her 2015 open-door policy and undermine her authority.

That, however, is no longer an option:

“We can no longer look on as this refugee tourism across Europe happens,” Bavaria’s CSU interior minister, Joachim Herrmann, told German broadcaster Deutschlandfunk.

* * *

Ironically, Europe’s crackdown against illegal immigrants comes at a time of international outcry over the Trump administration’s policy of separating migrant families at the Mexican border.

The reason why is clear: just like in the US, immigration is increasingly shaping politics in most European countries, even the rich one. The fact that asylum applications to OECD countries fell 25% in 2017 from a record 1.64 million a year earlier and applications to EU member states nearly halved, has not helped, especially since the bulk of Europe’s refugees recipients are also its poorest states.

Ironically, it is in ground zero of Europe’s progressive, liberal elite, as well as EU’s wealthiest economy, that migration is threatening to wreck German Chancellor Angela Merkel’s relationship with her CDU’s Bavarian sister party, part of her coalition.

The virtue signalling literally reached the very top earlier today, when Pope Francis told Reuters in an interview that populists were “creating psychosis” on the issue of immigration, while aging societies like Europe faced “a great demographic winter” and needed more immigrants. Without immigration, Europe “will become empty”, he said, ignoring the fact that the bulk of terrorist attacks and rising crimes have been attributed largely to said migrants.

The European Union is also bitterly divided. It has struggled to reform its internal asylum rules, which broke down in 2015, and has instead tried to tighten its borders and prevent new arrivals. To that end, it has given aid and money to countries including Turkey, Jordan, Libya and Niger.

Meanwhile, Europe’s hypocrisy has been on full display as eastern EU states led by Poland and Hungary were forced, but now refuse to host new arrivals to ease the burden on coastal Italy and Greece while sparing the rich countries like Germany, where most migrants want to go.

* * *

The EU summit’s draft joint statement, seen by Reuters, called for more work to combat secondary movements. It also proposed looking into creating “regional disembarkation platforms” outside of the EU where asylum requests would be assessed before claimants get to Europe.

In typical fashion, the always outspoken Hungarian regime meanwhile approved a package of bills that criminalizes some help given to illegal immigrants, defying the EU and human rights groups who have called the measure arbitrary and vague.

And speaking of minor at the border, Denmark and Norway said they were working on creating a centre in Kabul where unaccompanied Afghan minors who have been denied asylum can be sent back, even though the U.N.’s Children’s Fund UNICEF said minors should not be returned to Afghanistan as security had worsened there.

Shockingly, there has been no mass media outrage – or even mention – of the Scandinavian countries’ decision.

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