Tag: finance

Authored by Lance Roberts via RealInvestmentAdvice.com,

During the past couple of weeks, I have discussed the rising levels of bullishness in the markets. We have pointed to indicators like extreme investor positioning, put/call ratios, etc. However, the current surge in margin debt also confirms market exuberance.

First, we have to step back a bit. We previously discussed why the 35% decline in March was only a “correction” and not a “bear market.” As noted in “March Was Only A Correction,” there is a significant difference.

“The distinction is essential.

• ‘Corrections’ generally occur over short time frames, do not break the prevailing trend in prices, and are quickly resolved by markets reversing to new highs.

• ‘Bear Markets’ tend to be long-term affairs where prices grind sideways or lower over several months as valuations are reverted.

Using monthly closing data, the “correction” in March was unusually swift but did not break the long-term bullish trend. Such suggests the bull market that began in 2009 is still intact as long as the monthly trend line holds.

Margin debt also confirms the correction and the recent exuberance.

Everything Is At An All-Time High

Before we dig further into what margin debt tells us, let’s begin with where we are currently. Greg Feirman recently summed it up nicely.

“Friday was an absolute breakout to new ATHs-fest (All-Time Highs). The S&P closed at a new all-time high just below 3,700. The Russell tacked on another 2.37% and closed just below 1900. Junk bonds and regional banks are super strong. Of course, if the indexes are breaking out, so are a lot of individual stocks.”

He is correct. As we discussed in “Sign, Sign, Everywhere A Sign,” investors are now “all in” in terms of portfolio risk.

As Howard Marks noted in a recent Bloomberg interview:

“Fear of missing out has taken over from the fear of losing money. If people are risk-tolerant and afraid of being out of the market, they buy aggressively, in which case you can’t find any bargains. That’s where we are now. That’s what the Fed engineered by putting rates at zero.

“,,,we are back to where we were a year ago—uncertainty, prospective returns that are even lower than they were a year ago, and higher asset prices than a year ago. People are back to having to take on more risk to get return. At Oaktree, we are back to a cautious approach. This is not the kind of environment in which you would be buying with both hands.

The prospective returns are low on everything.”

The Issue Of Margin Debt

This exuberance requires “fuel,” which brings us to margin debt. As I explained previously:

“Margin debt is not a technical indicator for trading markets. What margin debt represents is the amount of speculation that is occurring in the market. In other words, margin debt is the ‘gasoline,’ which drives markets higher as the leverage provides for the additional purchasing power of assets. However, ‘leverage’ also works in reverse as it supplies the accelerant for more significant declines as lenders ‘force’ the sale of assets to cover credit lines without regard to the borrower’s position.”

The last sentence is the most important. The issue with margin debt, in particular, is that the unwinding of leverage is NOT at the investor’s discretion. It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) When lenders fear they may not recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once, as falling asset prices impact all lenders simultaneously.

Margin debt is NOT an issue – until it is.

Event Risk

It is when an “event” causes lenders to “panic” that margin becomes problematic.

We have seen margin liquidation events twice in the last 15-years. The first was during the 2008 financial-crisis that forced Lehman into bankruptcy.

The second time was in March of this year.

How do we know that March was a “Margin Call?”

There are two reasons.

1. The Fed rushed to the rescue of the banks (again) as credit risk went parabolic; and, 

2. The chart below of “free credit” balances shows the massive liquidation of margin debt as brokerage firms called in credit lines. 

Free credit balances are crucial as it is the difference of “unused margin plus cash,” which gets subtracted from “outstanding margin.” In other words, like a credit card with a zero balance, when the lined gets paid off, there is a positive free cash balance; when it is negative, it shows the utilization of the “credit.”

The chart below overlays the two:

1. The actual level of margin debt, and;

2. The level of “free cash” balances.

The sharp reversal of margin debt from the March lows shows the speculation level, which has ensued in the markets due to the Fed’s interventions. (Margin debt lags by 2-months, so I have used the average margin debt growth rate from March to estimate the last 2-months. Given the rapid surge in the market in November, I am probably underestimating current levels.)

Margin Debt Confirms The Exuberance

As noted, when markets are rising and investors are taking on additional leverage to increase buying power, margin debt supports the advance. However, the magnitude of the recent surge in margin debt also confirms the current levels of investor exuberance.

The chart shows the relationship between cash balances and the market. I have inverted free cash balances, so the relationship between increases in margin debt and the market is better represented.

Note that during the 1987 correction, the 2015-2016 “Brexit/Taper Tantrum,” the 2018 “Rate Hike Mistake,” the “COVID Dip,” the market never broke its uptrend, AND cash balances never turned positive.

Both a break of the rising bullish trend and positive free cash balances were the 2000 and 2008 bear markets’ hallmarks. Such is another reason that March was just a “correction.”

Had such occurred, the positive free cash balances, and significantly reduced valuation levels, would have supported the beginning of a longer-term bull market. However, with negative cash balances surging and extreme deviations from long-term means, investors are likely once again set up for another reversion. Such is not even to mention the long-term correlations to valuations.

As noted in “Why This Isn’t 1920,” the highest correlation between stock prices and future returns comes from valuations.

Overbought

Margin data goes back to 1959 to get a long-look at margin debt and its relationship to the market. The chart below is a “stochastic indicator” of margin debt overlaid against the S&P 500.

The stochastic indicator is a momentum indicator developed by George C. Lane in the 1950s. The chart shows the position of the most recent margin debt level relative to its previous high-low range. The indicator measures the momentum of margin debt by comparing the closing level with the range over the past 21-months.

The stochastic indicator represents the speed and momentum of margin debt level changes. Such means the stochastic indicator changes direction before the market. As such, it can be considered a leading indicator.

Currently, the indicator is back to overbought levels, which suggests market risk has risen also. Our stochastic measures of the market itself are confirming much the same.

It’s All Coincident

I want to make a critical point here. Margin debt, like valuations, are “terrible market timing” indicators and should not be used as such.

Rising levels of margin debt are a measure of investor confidence. Investors are more willing to take out debt against investments when shares are rising, and they have more value in their portfolios against which they can borrow. However, the opposite is also true as falling asset prices reduce the amount of credit available, and the liquidation of assets must occur to bring the account back into balance.

I agree and disagree that margin debt levels are simply a function of market activity and have no bearing on the outcome of the market.

As we saw in March, the double-whammy of collapsing oil prices and economic shutdown in response to the coronavirus triggered a sharp sell-off fueled by margin liquidation.

Currently, the majority of investors have forgotten about March. Or worse, assume it can’t happen again for a variety of short-sighted reasons. However, the “gas tank” is full once again as investors are more exuberant now than at the peak of the market in 2000, as noted by Sentiment Trader yesterday.

Excuses Won’t Work

Sure, this time could indeed be different. That has remained the “sirens song” of investors since March. However, as Sentiment Trader summed up the last time we wrote on this topic, such is usually not the case.

“Whenever some of this data fails to lead to the expected outcome for a few weeks or more, we hear the usual chorus of opinions about why it doesn’t work anymore. This has been consistent for 20 years, like…

• Decimalization will destroy all breadth figures (2000)

• The terror attacks will permanently alter investors’ time preferences (2001)

• The pricking of the internet bubble will forever change option skews (2002)

• Easy money will render sentiment indicators useless (2007)

• The financial crisis means relying on any historical precedents are invalid (2008)

• The Fed’s interventions mean any indicators are no longer useful (2010 – present)

All of these sound good, and for a time it seemed like they were accurate. Then markets would revert and the arguments would get swept into the dustbins of history.”

It’s not too late to take action to preserve capital now, so you have the money to invest with later.

A Lot Like Sex

While we remain long-biased in our equity portfolios, we have begun to reduce some of our big winners (take profits) and adding to our more defensive-oriented positions. While we certainly want to participate in the market’s current upside, we will also give up some gains to protect against the eventual reversion.

While it certainly may “feel” like the market “just won’t go down,” it is worth remembering the sage words of Warren Buffett.

“The market is a lot like sex, it feels best at the end.”

In the short-term, holding higher cash levels will indeed provide some drag between our portfolio and the major market index. However, when the first “cold snap” washes across the markets, our preparation should protect us against the “bite.”

We remain “bullish” on the markets currently as momentum is still in play. However, just as any farmer is keenly aware of the signs “Winter” is approaching, we are just taking some precautionary actions.

To spin a bit of Warren’s quote:

“If you engage in the market in an unprotected fashion, you may not want the unexpected surprise.”

China has summoned the US ambassador from America’s embassy in Beijing on Tuesday, outraged over the latest Trump administration sanctions on 14 top Chinese officials over allegations they are suppressing democracy in Hong Kong.

Specifically it was the acting top US diplomat, Chargé d’Affaires Robert Forden, who Beijing lodged its protest to while vowing it will take “reciprocal” retaliation, according to Reuters.

This after China’s top diplomat Wang Yi urged for dialogue to remain open with the US at all levels, including exchanges and travel among officials.

On Monday the Department of the Treasury announced it had designated 14 individuals who are all members of China’s National People’s Congress, after last month Hong Kong’s Beijing-backed government expelled four opposition member’s from its legislature. The officials were also seen as having a direct role in the controversial national security law which paved the way for the ongoing crackdown in Hong Kong, which has also seen prominent activists flee or arrested.

The sanctioned Chinese officials are now banned from travel to the US in addition to the targeted financial measures. As Reuters underscores, “This is likely the first time that all 14 vice chairpersons of China’s lawmaking body, the National People’s Congress, have come under U.S. sanctions.”

Here’s what Chinese vice foreign minister Zheng Zeguang told the summoned US diplomat:

“U.S. barbaric actions will only invoke the intense anger of the Chinese people against anti-China forces in the United States and cause 1.4 billion Chinese people, including our compatriots in Hong Kong, to fully recognize the U.S. devious intentions and strengthen the resolve of the Chinese government in implementing the Hong Kong National Security Law,” he said.

Forden responded to the formal Chinese diplomatic protest charge that Beijing has repeatedly suppressed freedom and democracy in Hong Kong while making politically motivated unjust arrests of peaceful activists, according to a paraphrase of a US embassy statement. 

In the meantime tensions continue to spiral over the Taiwan issue, with Beijing specifically condemning continued US arms sales to the breakaway republic.

China’s Ministry of Commerce is further demanding the US reverse course on its recent move to ban Xinjiang cotton and its products based on allegations of “forced labor” related to Uighur ‘reeducation’ and labor camps which have been widely reported on.

With the FDA expected to grant emergency-use approval for the Pfizer-BionTech COVID vaccine Thursday after releasing a preliminary assessment of the trial data that the panel will use to assess the drug earlier today, the agency has admitted Tuesday that two participants in the Phase 3 trials have died. One of them was immunocompromised, according to the Jerusalem Post, citing data released earlier.

The FDA is expected to release two separate assessments of the trial data before a panel of experts meets to review the data and either approve Pfizer’s request for emergency approval, or deny it.

This also comes after the FDA warned of a “severe averse reaction” frequently seen in patients after taking the second dose.

In the US, there has been at least one other trial participant who reportedly died not long after receiving the second dose. The participant in that case was a priest in Philadelphia who participated in the Moderna trial. In the UK, two patients were seriously sickened during the trial of the AstraZeneca-Oxford vaccine (though Oxford later said the illnesses had nothing to do with the trial). While In Brazil, authorities briefly halted a trial of Sinovac’s experimental COVID vaccine after a participant died.

Israel has purchased 8 million doses of the Pfizer vaccine (enough to vaccinate 4 million people), and while some health officials have suggested that vaccinations could begin as soon as the doses arrive, Health Ministry director-general Chezy Levy told the JPost that beginning vaccination in any place ahead of FDA approval was forbidden.

To be sure, it’s unclear whether the participants who died succumbed to vaccine-related complications, or whether they even received a vaccine at all (they could have received a placebo). In the UK, which innoculated the first patients under the ’emergency use’ approval on Tuesday, a 90-year-old grandmother and 81-year-old man named “William Shakespeare” were among the first patients to receive the vaccine.

Selling in May and buying back in October may be the best calendar based strategy, but for those strapped for time, buying stocks in the month of December has been the best single-month strategy in nearly a hundred years of market data. And while December is not the best performing month on average (that would be July), December is the month when the market is up the most on average.

As BofA chief technician Stephen Suttmeier writes, seasonality back to 1928 suggests that December is the month of the year that the SPX is most likely to be up: December is up 74% of the time with an average return of 1.3% (1.5% median).

And although December has already rallied 1.8% MTD as of Dec 8, seasonality suggests that December‘s strength is back-end-loaded. The first 10 days of the month have a lackluster average return of 0.01% (0.54% median) with this period up 59% of the time. While not the case so far in December 2020, this means that December often starts with a struggle. The last 10 days of the month are much stronger with this period up 72% of the time on an average return of 1.2% (0.94% median). Based on BofA’s seasonality work, much of December’s “bullish” seasonality return occur between Christmas and New Year’s Day.

What about January

According to the BofA chartist, January tends to stay firm after an above average year. If the SPX can finish 2020 with an above average annual return – which it will absent a crash being up 14% YTD vs the average annual return back to 1928 of 7.67% – the seasonally positive month of January stays bullish. In addition, when the previous year has an above average annual return, 1Q in the following year tends to be stronger than average as well.

Finally, looking at Q1, the momentum will likely persist there too (absent another QE-enabling crisis). According to Suttmeier, when the SPX has an above average return for the year, the following year’s 1Q tends to be much stronger than average. This 1Q scenario shows the SPX up 71% of the time on average and median returns of 2.2% and 2.5%, respectively. This compares to the average 1Q return of 1.5% (1.8% median) with the SPX up 60% of the time.

Another month, another record big 3Y auction: just after 1pm the US Treasury sold another record-sized batch of 3Y notes, which at $56 billion was $2 billion more than the November auction and almost triple the average auction size for much of the 2016-2018 period.

Besides the record size, there was nothing remarkable about the ugly auction: it stopped at a yield of 0.211% which tailed the When Issued by 0.4bps, and was the 5th consecutive tail for the 3Y tenor in the past 6. That said, it was just under 4bps below the November 0.25% which was the highest since April.

The bid to cover dropped to 2.28 from 2.40 and was below the six auction average of 2.425. It was also the lowest since April.

The internal were mediocre at best, with Indirects taking down 49.3%, and with Directs taking 15.9% of the auction, which was well above the 13.3 recent average, it left Dealers with 34.9% of the auction, toward the low end of the recent average.

Overall, a mediocre, tailing auction but it could always be worse. Then again with 3Y auctions increasing by $2bn every month, we may hit the moment when it is “worse” sooner rather than later.

Authored by Steve Watson via Summit News,

Senator Rand Paul spoke out Monday against the policy of lockdowns and restrictions, declaring that there is no evidence they are having any impact on the spread of coronavirus, and that those who say they do are not paying attention.

“We ought to at least still use logic to try to figure out how we stop this …,” Paul said in an appearance on Fox News, adding “I don’t see any evidence that crowd control, hand washing, standing six feet apart, all of these things they tell you to do — closing down the restaurants, closing down the schools — there’s no real evidence that they are changing the trajectory of the disease.”

“If you look at the incidence of COVID, it’s going up … exponentially despite all the mandates. So those who say there is science [behind the restrictions] just aren’t paying attention to it,” Paul continued.

Paul, who last week slammed lockdown zealot Dr. Anthony Fauci for doing a complete 180 on schools being closed, urged that “keeping all our kids home isn’t changing the course of this disease.”

“They’ve studied this in four different country-wide studies. They’ve studied the incidence of the disease, they’ve studied the transference of the disease, and they’ve found that closing schools doesn’t work. Even the socialist [New York City Mayor Bill] de Blasio is now opening schools,” the Senator emphasised.

Paul has been calling for schools to be open since the Summer, consistently pointing out that there is no science behind the closures.

I told him this multiple times this summer. https://t.co/LspBtxtU6D

— Senator Rand Paul (@RandPaul) November 29, 2020

Paul explained that he isn’t recommending at risk people just ignore the virus, adding “But I’m also telling you that the government shouldn’t tell you you can’t go to church and the government shouldn’t tell you can’t send your kids to a religious school.”

“There’s good advice and you can take advice and you can give advice. But once you mandate it, it doesn’t become advice. It becomes a form of tyranny,” the Senator asserted.

“So I think the government should not be in the form of mandating these things, because sometimes the science isn’t clear and sometimes they change their mind on the science month to month and week to week,” Paul added.

Senator Paul has vowed to do everything in his power to resist Joe Biden’s “forever lockdowns”.

“He’s going to ruin the country. Lockdowns don’t work. And in fact, all of the evidence on mandatory masks show that they don’t work either,” the Senator urged in an interview last month.

In September, we noted how California saw a staggering 72% decline in Pandemic Unemployment Assistance (PUA) applications after the state started cracking down on suspected scammers.

Yet despite the state’s efforts, Bank of America on Monday estimated that fraud in California’s unemployment benefits system could total $2 billion across 640,000 accounts which have exhibited suspicious activity, and which should be investigated according to the LA Times – which adds that this is “the highest estimate of fraud yet in a system that has paid $110 billion since the COVID-19 pandemic triggered a wave of joblessness in California beginning in March.”

Red flags include claims filed in the names of infants, children and centenarians – along with people living in other states, according to a bank official.

Fraudsters typically apply for unemployment debit cards under false pretenses, then immediately withdraw the funds via ATMs as soon as they hit the accounts, officials told Patch.com in September.

“Due to the pandemic, we have seen a dramatic increase in unemployment fraud through EDD,” the Torrance Police Department told Patch, adding that they saw an increase in EDD debit-card scams in September.

“It is outrageous,” said Jon Coupal, president of the Howard Jarvis Taxpayers Association. “We understand that there was an effort to push as much money into the economy as possible but there has got to be some controls. Here it is like they have opened up a bag of cash in the middle of a tornado and hoped that it ends up someplace where it is supposed to be.”

BofA arrived at their estimates after working with the state Employment Development Department (EDD) to institute various fraud prevention measures designed to detect fraud, according to the bank’s director of California government relations, Brian Putler.

“As a result of these efforts, we have identified more than 640,000 accounts for EDD to evaluate as to whether they are fraudulent and the associated card should be frozen or account closed,” he said, adding “Our assessment is that there is activity consistent with fraud in those accounts on the order of approximately $2 billion.”

Putler noted in a letter to lawmakers that while other states experience unemployment fraud, “The scale of program fraud in California is unique.”

The accounts identified as suspicious include 76,000 benefits cards sent to people in states that do not border California, which are deemed more likely to involve fraud than adjacent states that might temporarily host out-of-work Californians.

The bank said there were also “numerous cases” in which multiple cards, including hundreds in some instances, have been sent to a single mailing address.

Other issues identified include multiple cards using a common contact phone number or address, and benefits issued to infants or children as well as centenarians or other elderly people not likely to be working, Putler wrote.

He said the scope of potential fraud is coming into better focus from an examination of 345,000 debit cards already frozen because of suspicious activity. –LA Times

The assessment was conducted after the BofA CEO Brian Moynihan received a letter from 59 state legislators seeking answers on the question of fraud in the system run by the EDD following the freezing of 350,000 debit cards over suspicious activity. Apparently flood of legitimate customers who had their accounts frozen swamped lawmakers, who in turn wrote to Moynihan on Nov. 24.

News of the suspicious accounts comes just days after California officials admitted that $400 million in unemployment benefits were improperly paid to people who filed under the names of prison imates.

A group of nine district attorneys warned Gov. Gavin Newsom last week that they have received unverified information that some $1 billion in benefits has been paid on claims filed by people outside the state, including claimants outside the country.

Putler warned lawmakers on Monday that the fraud problem has implications far beyond the loss of taxpayer funds.

He cited conclusions by third-party security experts in the U.S. that organized crime rings may be using unemployment funds to support other criminal enterprises, including illicit arms purchases and terrorist activities. –LA Times

Bank of America, meanwhile, has beefed up its staff to handle EDD claims, and has proposed that a dedicated call center be funded to help authenticate blocked and frozen accounts belonging to legitimate claimants.

“We share with you and with EDD the objective of ensuring that legitimate claimants get the benefits they deserve while mitigating the impact of the unprecedented fraud being experienced,” wrote Putler.

Responding to the bank’s letter, Assemblyman Jim Patterson (R-Fresno) sympathized with unemployed Californians with frozen accounts, writing: “Identifying fraud must be a priority, but Californians with no income cannot be sacrificed on the altar of incompetence.”

The berserk stock market frenzy resumed on Tuesday on the back of what Charlie McElligott calls “weaponized gamma” only instead of SoftBank ramping stock prices by forcing a dealer short gamma squeeze, this time it appears to be retail behind the burst higher as a result of what the Nomura quant calls “absolutely absurd” volumes in short-dated Calls in RobinHood YOLO names: TSLA saw ~950k Calls trade, PLTR ~700k, NIO ~425k….while the “lowly” SPX only saw 350k Calls traded.

As McElligott puts it, “this is a ‘real thing’ with the Retail hordes on Reddit/WSB intentionally creating negative convexity events for Dealers in short-dated out-of-the-money upside Calls in these single-name high-flyers.”

And with the TSLA momentum frenzy temporarily halted following today’s $5BN ATM stock offering, the euphoria has shifted to other daytrading YOLO names such as recently IPOed cloud-computing newcomer Snowflake, whose shares continued their surge on Tuesday, sending its market valuation above both IBM and AMD.

Putting the move in context, IBM, which is expected to generate $74 billion in revenue this year, has a market cap of $112 billion, while AMD, with nearly $10 billion in projected sales, weighs in at $111 billion. Snowflake, by comparison, should hit $578.2 million in revenue this year.

So if it’s not fundamentals, what is it? Simple: everyone is once again scrambling into calls, with the total call option volume on Tuesday exceeded the 20-day average less than an hour into trading, and is set to outpace put options by a rate of almost 3-to-1.

Hopes of a bipartisan stimulus deal faded on Tuesday after failing to resolve several remaining stumbling blocks on Monday – including Senate Majority Leader Mitch McConnell’s refusal to endorse a $908 billion bipartisan proposal as a basis for talks.

McConnell has also insisted on applying broad federal limits on COVID-19 related lawsuits against businesses – for which Democrats are offering a six-month moratorium.

“Drop the all-or nothing tactics,” McConnell said of Democrats during a Monday Senate floor speech in which he called on Senate Minority Leader Chuck Schumer to allow a vote on a targeted bill which would provide extended unemployment insurance, along with small business assistance and funding for vaccine distribution.

Senators from both sides of the aisle concluded that the prospects for a $908 billion compromise that Republican and Democratic negotiators are hashing out will come down to McConnell’s decision. Several GOP members have endorsed or been open to the plan, and top White House economic adviser Larry Kudlow said President Donald Trump would likely sign it. McConnell is engaging the negotiators even though he hasn’t budged. –Fortune

In addition to gridlock over liability protection for businesses, Republicans and Democrats are butting heads over aid for states and localities – which has been House Speaker Nancy Pelosi’s line in the sand for months.

“Those are coupled together,” said Texas Republican Senator, John Cornyn, referring to the liability protection and funding for states and municipalities. “There’s either going to be none for both of those, or both of those that are going to be provided for. My hope is we’ll do both.”

Republicans claim that state assistance is a scheme to bail out poorly-run Democratic areas, while Democrats have refused to shield employers from lawsuits for failing to protect employees who contract COVID-19.

Meanwhile, lawmakers are in even deeper gridlock on the omnibus spending bill – which includes disputes over further border wall funding, money for police anti-racism training (!?) and other measures.

Speaking about the Covid-19 relief proposal, McConnell said it’s getting “down to the wire.“

Schumer blamed his GOP counterpart for stalling the compromise effort. He and Pelosi publicly endorsed the $908 billion plan last Wednesday, after having made a new pitch to McConnell two days before. They previously sought a $2.4 trillion bill.

“We want the leader to sit down and negotiate so we can come up with a bipartisan proposal that can pass the House and the Senate,” Schumer said on the Senate floor. He highlighted that some economists are warning of a double-dip recession if Congress fails to pass a deal. –Fortune

On Tuesday, GOP leaders plan to discuss the situation with Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark Meadows. In particular, they will seek a separate COVID-19 relief initiative.