Authored by Chetan Ahya, Morgan Stanley Chief Economist
And so it has come to pass: The much-anticipated meeting between the US and China is over. While we await further details, here are our reactions and takeaways, as we parse the initial readouts.
This is an uncertain pause – no immediate escalation, but still no clear path towards a comprehensive deal. The US administration has indicated that it will hold off on 25% tariffs on the remaining US$300 billion imports from China. There was also an agreement that both parties will roll back some non-tariff barriers (i.e., restrictions on high-tech exports by US companies) and that China would continue to purchase agricultural products from the US. However,as things stand, we lack clarity on whether real progress was achieved on the sticking points that caused talks to break down in the first place.
Hence, our overarching conclusion is that the developments over the weekend on their own don’t do enough to remove the uncertainty created by trade tensions, which began over a year ago and remain an overhang on corporate confidence and the macro outlook.
Uncertainty is the enemy of the business cycle
Heading into the meeting, it was clear that the global capex cycle had ground to a halt. Capital goods imports, a capex proxy, began their descent in mid-2018, when trade tensions first re-emerged. In July 2018, they were tracking at 18%Y on a three-month moving average basis but plummeted to 2%Y in January 2019 and an estimated -3%Y in May 2019. In aggregate, private fixed capital formation (investments in fixed assets) in the G4 and BRIC economies fell from a peak of 4.7%Y in 1Q18 to just 2.8%Y in 1Q19.
Corporate sentiment has also declined to multi-year lows. Global PMIs for May fell in broad-based fashion, with only about one-third of the countries we track reporting a PMI above the 50 expansion threshold. In the US, our Morgan Stanley Business Conditions Index recorded its largest one-month decline ever, plunging to a level not seen since June 2008. Other business sentiment gauges, such as the regional Fed and German Ifo and ZEW surveys for the month of June, paint a fairly bleak picture too. What’s more, consumer sentiment is also starting to sour, with the Conference Board’s Consumer Confidence Index for June falling to the lowest point since September 2017.
A key reason why we worry about downside risks is that the adverse impact of trade tensions is non-linear. As earnings growth slows and uncertainty and costs rise, the levered corporate sector will face tightening financial conditions. Given higher corporate leverage, this will probably be most pronounced in the US, particularly for companies with weaker balance sheets. Defaults could accelerate, bringing corporate credit risks to the fore, thus amplifying the initial trade shock with even tighter financial conditions, which could impair lending, weaken confidence further and exacerbate the slowdown in growth.
Rekindling animal spirits will not be easy
Within the macro environment of a late-cycle expansion, reviving corporate confidence and lifting capex are of paramount importance. Unfortunately, the current backdrop of a weak starting point and lingering trade tensions does not inspire confidence.
It’s true that, by all indications, we will soon get rate cuts from the Fed, and it looks as if the ECB is contemplating extra stimulus, which may include rate cuts and perhaps a restart of QE. Meanwhile, China has renewed efforts to implement its stimulus measures. Given its overarching objective of stabilising the labour market, we expect the fiscal package to be increased to 2.25% of GDP and monetary accommodation to be provided, with a goal of 12.5-13.0%Y broad credit growth by year-end. Dovish developed market central banks and subdued inflationary pressures in emerging markets (EM) will also create room for easing by a number of EM central banks.
However, these easing efforts will impact the economy with lagged effects. Policy easing is necessary but won’t be sufficient to revive corporate confidence and engineer a strong pick-up in growth. That would require a combination of monetary easing and an all-clear signal on both trade policy and geopolitics.
Policy dominance yet again
In sum, we see the ebbs and flows of policy support determining swings in the cycle but ultimately producing sub-par growth. With the capex cycle curtailed, the runway for this global expansion is therefore shorter than it would have been absent the re-emergence of trade tensions.
Indeed, notwithstanding the resumption of talks, scope remains for re-escalation to emerge. Tracking how the talks evolve from here and in particular the critical issues related to speed of tariff removal,non-tariff barriers, intellectual property rights and amount of purchases will be key. Should we see re-escalation (i.e., the US imposes 25% tariffs on the remaining US$300 billion of imports from China and they remain in effect for 4-6 months), it would heighten the risks to the global cycle, and we could wind up in a global recession in about three quarters.
via ZeroHedge News https://ift.tt/2LsfBry Tyler Durden
Stocks have an almost mythical aura about them for many investors. Conceptually, stocks tend to produce higher returns than many other asset classes and therefore feature prominently in many retirement plans. Practically, stocks have provided terrific returns for many through their working years and into retirement.
The proposition of investing in stocks, however, has changed over the years. In many cases, perceptions have not kept up with this reality. As a result, many investors still consider stocks to be a “treasure,” while others are increasingly seeing them as “trash.”
To any analyst who follows publicly traded stocks, it is obvious that there are a lot fewer of them around than there used to be. A 2018 NBER report highlighted the phenomenon:
“There are fewer firms listed on U.S. exchanges than 40 years ago. In 1976, the United States had 4,943 firms listed on exchanges. By 2016, it had only 3,627 firms.” The report reveals that this decline is a fairly recent phenomenon. Having increased steadily through to the listing peak in 1997, the number of listed stocks has fallen sharply since then, as “the number of listings dropped every year since 1997, except for 2013.“
The reasons for the decline are also revealing. The single biggest reason has been the high level of merger and acquisition activity in recent years, but a slower pace of initial public offerings (IPOs) has also contributed. As a result of these coincident phenomena, “the size of listed firms has grown sharply.”
“The whole size distribution of listed firms has shifted so that average market capitalization and median market capitalization accounting for inflation increased by a factor of 10 from 1975 to 2015.“
Not only are public firms much larger than they used to be, fewer of them have long roads of growth still ahead of them.
This matters because stock returns are asymmetric. While you can lose all your investment, you can only lose the amount of that investment. On the other hand, it is possible to make many, many times the size of an original investment on the upside. As a result, it is quite possible that one or two big winners in a portfolio can more than compensate for several underperformers.
For this reason, the big winners over time have become legendary for their contributions to outperformance. Tom Braithwaite touched on this in the Financial Times where he recounted the example of Cisco going public in 1990 with less than $100m of revenues. It then went on to become the first company to reach $500bn of market capitalization. Early investors in Microsoft, Apple and Amazon had similar experiences. Just one or two of these stocks could overcome a lot of weak performers in a portfolio.
Recent vintage IPOs, however, are featuring companies that mostly have waited much longer to go public and therefore afford less opportunity for growth for public shareholders. Braithwaite notes, “Today, with the help of a vast influx of sovereign wealth money and mutual funds not wanting to overpay at IPO, companies can delay until they are big enough to command the sort of valuation that Snap achieved this year $20bn.”
The recent IPO of Uber is emblematic of the trend. Just ahead of its IPO, the company reported revenues of $11.27 billion in 2018, a level that amounts to over 110 times as much as Cisco had when it went public.
As the Uber example also plainly reveals, when firms go public today, they are increasingly doing so without any profits to show. While the companies that do IPO may be leaders in their field, they are still unseasoned and subject to substantial risks. TheFT reported on a study by Jay Ritter, a business professor at the University of Florida, which noted,
“in 1980 only 25 per cent of US companies had negative earnings when they came to market. Last year, it was 80 per cent.“
The trend in lack of profitability has also permeated the markets more broadly. To be sure, it is normal that some group of companies will be unprofitable for various reasons such as cyclical downturns, idiosyncratic events, or new business launches. However, the NBER report shows that the current prevalence of unprofitable companies is unusually high:
“The fraction of firms with earnings losses in a given year has increased substantially. In 1975, 13 percent of firms had losses. In contrast, 37 percent of firms had losses in 2016.“
All of this has led to a market that is considerably more concentrated than it used to be. The NBER report continued:
“As a result, earnings have become more concentrated. In 2015, the top 200 firms by earnings had total earnings exceeding the total earnings of all public firms combined. In other words, the total earnings of the 3,281 firms that were not in the top 200 firms by earnings were negative.”
The net result is an almost shocking lack of diversity of profits.
In aggregate, the data reveal striking changes in the composition of the market. There are a lot fewer public companies to choose from, a much higher proportion of them lose money, IPOs don’t provide anywhere near the same type of upside potential, and aggregate earnings are massively concentrated. In short, the Economist reports,
“A smaller number of older, bigger firms dominate bourses.”
Many of the compositional changes also go hand in hand with a weaker competitive landscape. The Economist highlighted the persistence of unusually high profits as one important signal of trouble:
“High profits across a whole economy can be a sign of sickness. They can signal the existence of firms more adept at siphoning off wealth than creating it afresh, such as those that exploit monopolies. If companies capture more profits than they can spend, it can lead to a shortfall of demand.” Rising profits, then, “coupled with an increasing concentration of ownership … means the fruits of economic growth are being hoarded.”
There are plenty of other signs of weaker competitive conditions if one cares to look. For example, one would expect relatively high returns in an uncompetitive economy and lower returns in a very competitive one. The data reflect poorly on US businesses:
“Though American companies now make a fifth of their profits abroad, their naughty secret is that their return-on-equity is 40% higher at home.”
In addition, there are indications that competition has also been stunted by way of laws and regulations. The Economist notes that “business spending on lobbying doubled over the period [1997 to 2012] as incumbents sought to shape regulations in ways that suited them.” Sometimes, big firms have simply leveraged their ability to “influence and navigate an ever-expanding rule book.
“Regardless, the effect has been to reduce “the rate of small company creation in America … close to its lowest mark since the 1970s.”
Weaker competition gets manifested in other ways too. “In some industries – banking is a case in point – rent-seeking will result in high pay to an employee elite instead.” Sometimes lower accountability results. Historically, when chief executives have gotten sacked, it has been for poor performance. More recently, however, the FT reports that an unusually high “39 percent of departures of chief executives] were due to ethical issues.”
A good summary of the trend comes from another NBER report: “After 2000 … the evidence suggests inefficient concentration, decreasing competition and increasing barriers to entry, as leaders become more entrenched and concentration is associated with lower investment, higher prices and lower productivity growth.”
“The obvious conclusion,” the Economist reports, “is that the American economy is too cosy for incumbents.” For all the legendary importance of Adam Smith’s “invisible hand” of competition, the report states that it is “oddly idle” in America. As a result, power has shifted from away from shareholders of public companies.
This suggests something even more important is happening. Gillian Tett at theFT goes so far as to call into question the very purpose of public capital markets:
“In the 20th century, it was often assumed that public markets were the epitome of financial capitalism; indeed, the idea was so deeply ingrained that policymakers and financiers tended to assume that financial evolution went in one direction: from private to public.
But today the trend towards private finance is being driven by ‘pull’ and ‘push’ factors. On the one hand, private equity, real estate and debt investments have often offered better returns than public equity in the past decade … At the same time, the raison d’etre for public markets is faltering. They used to be seen as a more democratic and inclusive form of capitalism.“
“Mr Mauboussin notes that 40 years ago a pension fund could get full exposure to the economy by owning the S&P 500 index and betting on a venture-capital fund to capture returns from startups. Now a fund needs to make lots of investments in private firms and in opaque vehicles that generate fees for bankers and advisers. “
“Ordinary Americans are being deprived of opportunities to invest early in the next big winners … But only wealthy individuals can invest in individual private companies before the IPO.” In other words, the opportunities that used to be shared widely across public markets are now the reserve of the privileged few.
One can argue that the democratic aspect of public markets is more than just challenged; in many ways a mockery is being made of it. Steve Case, the founder of AOL and CEO of Revolution, a venture capital company, noted in the FT, “companies used to go public to actually raise operating capital.” Since companies needed scarce capital in order to grow, raising that capital normally sent a signal that attractive growth potential existed.
Now, however, “the goal of an IPO is all too often for investors to ‘exit’ with as high a valuation as possible.” As such the signal provided by an IPO is almost exactly the opposite. Now an IPO signals the end of a growth thrust, not the beginning of one, and it is pawned off on the least discriminating of investors, i.e., public ones.
These insights facilitate a vastly different narrative for the stock market. What was once a reasonably accessible and diversified universe of companies that provided good exposure to a strong economy has now devolved into something considerably less attractive. Now the universe is comprised of a combination of old companies trying to hive off the greatest possible profits from dying industries and younger companies taking flyers on unproven and unprofitable businesses with shareholder money.
Additionally, given that these changes have occurred at the same time as passively managed funds have massively increased their share of the market, it is hard to escape the possibility that passive investing has at least exacerbated some of these developments. The lack of meaningful pushback by passive shareholders against management teams creates a vacuum of accountability from which many forms of bad behavior can thrive.
In light of all the changes that have occurred in the stock market over the last few decades, it is very fair to say that it is much less attractive than it used to be. But it is also possible to speculate further. What if public stocks now are the leftovers, the dregs that nobody else wants? What if public stocks have become the detritus of the investment world?
To be fair, the claim is extreme. There are still good public companies out there, although many of the stocks are overvalued. Nonetheless, such a consideration has significant implications for investors.
One is that things change. As attractive as stocks may have been forty years ago, they represent a different proposition today, especially at today’s record high valuations. As such, it does not make sense to treat them as static entities in a portfolio context.
Relatedly, the constantly changing market creates an opportunity for active management and a risk for passive management. As history shows in abundance, stock returns are not magical entitlements. Some periods are great while others are devastating. Investors who do not adapt to changing conditions put themselves at great risk.
Finally, part of the aura associated with public markets has been due to their strong link with the economy. As the NBER report states, however,
“Large firms no longer employ all that many people in America: The domestic employee base of the S&P 500 is only around a tenth of total American employment.”
As a result, the real economic impact of public firms has moderated considerably. Investors now need to consider a broader set of signals in order to get a good pulse on the overall economy.
So, time flies, things change, and investors have a choice. They can either look backwards and revel in the “glory days” of stocks or they can adapt to a new reality in which publicly traded stocks are just far less attractive than they used to be. Things will change again and someday there will be another golden age for stocks. For now, however, it is best to be extremely discriminating.
via ZeroHedge News https://ift.tt/2FCXXh5 Tyler Durden
Every six month or so, the Bank of International Settlements, also known as the central banks’ central bank, publishes some dire warning about the increasingly precarious state of the global financial system – largely as a result of an unprecedented monetary experiment that is now pushing on a string – and every six months or so the world’s most important central bankers congregate on 18th floor of the circular BIS tower in Basel where they decide to ignore all the warnings and double-down on policies that haven’t worked in a decade, with the expectation that they will work this time (or at least make the world’s richest even richer, while destroying the middle class).
Well, today is one of those days, because at midnight on June 30, the BIS published it Annual Economic Report for the year 2019, and of course, this report too and the speech delivered alongside the Annual General Meeting in Basel by Agustin Carstens, will be summarily ignored by those who matter, until the next financial crisis strikes and everyone is shocked how there were no signals indicating the arrival of what will soon be the greatest financial catastrophe in world history.
Of course, the BIS won’t make any such dire predictions – the last thing it needs is to be accused of sowing the panic that unleashes a crisis – it will however warn that after a failed attempt by central banks to renormalize monetary policy, governments must step in to stimulate their economies and fix policy imbalances that have forced central banks to use up most of their firepower: “The continuation of easy monetary conditions can support the economy, but make normalization more difficult, in particular through the impact on debt and the financial system,” the BIS warned.
As a result of central banks going all in again in what some have dubbed the last rate to the bottom, “the narrow normalization path has become narrower.”
If that wasn’t enough, in his speech, Carstens explicitly brought attention to this critical issue:
While the near-term outlook is still good, there are many vulnerabilities further out. For the global economy to remain on course towards clear skies, other policies need to play a bigger role and policymakers must take a longer-term perspective. In particular, a better mix is required between monetary policy, fiscal policy, macroprudential measures and structural reforms. And navigating the way to clear skies also means balancing speed with stability as well as conserving some fuel to cope with possible headwinds. This matters all the more given the many uncertainties and risks we face today.
The above excerpt comes from the speech by BIS general manager Agustin Carstens who urge politicians to “ignite all engines” to overcome a global soft patch, which can no longer be punted on central banks in hopes that lower rates will stimulate the global economy for one simple reason: with rates at all time lows, there is virtually nothing left to cut. Worse, rates are now so low that – at least the BIS admits – banks are now suffering as a result of monetary policy:
Price stability – central banks’ key mandate – naturally reinforces the case for maintaining policy accommodation, or easing further, as inflation is below target. Closely related is the need to bring inflation expectations back towards target. This approach is even more compelling if financial markets look fragile, as they appeared late last year, and could impact the economy adversely. The greater the uncertainty about conditions in the financial system and the macro economy, the stronger the case for a more gradual strategy.
At the same time, the gains from such a strategy could be associated with costs and less room for policy manoeuvre in the future. The possible costs arise mainly through financial channels. The historically low-for-long interest rates tend to compress banks’ margins, lower profits and hence reduce banks’ ability to build up capital, essential for a productive economy.
And here is the #timestamp for you warning, so that the next time banks complain that nobody could have possibly seen the catastrophe coming, one can counter that their very supervisor warned them (and again, and again), of what was coming:
Very easy financial conditions may boost growth in the near term but may further build up vulnerabilities. And persistently low rates may undermine efficient resource allocation and productivity
Under such circumstances, the BIS warns, the future room for policy manoeuvre could shrink for two reasons:
To the extent that normalization does not end up weakening economic activity, a more gradual approach would reduce policy space directly.
More subtly, the side effects of very accommodative policies might themselves sap the economy’s ability to withstand higher rates, making any normalisation harder.
Meanwhile, since monetary policy has been “unconventional” for more than a decade, the BIS also points out that in addition to the conventional recent bogeymen of trade protectionism and China’s deleveraging, as a result of the prolonged period of easy financial conditions “many vulnerabilities have built up and could throw the global economy off course,” i.e. there are now bubbles everywhere, including household debt, the leveraged loan market, and emerging markets feasting on USD-denominated debt:
One such vulnerability is high household debt in many advanced economies, especially those not directly affected by the Great Financial Crisis. These historically high debt levels limit the scope for households to drive economic activity.
Another vulnerability is clear signs of overheating in the corporate sector in a number of advanced countries. Following high growth, the leveraged loan market is now some USD 3 trillion in size, comparable to the collateralised debt obligations that amplified the subprime crisis. Structured products such as collateralised loan obligations (CLOs) have surged. Credit standards have been declining as investors have searched for yield. Should the leveraged loans sector deteriorate, the economic impact could be amplified through the banking system and other parts of the financial system that hold leveraged loans and CLOs. There could be sharp price adjustments and funding tensions. These risks should be seen in the broader context of the longer-term deterioration in credit quality and the generally high corporate leverage in many advanced economies.
High levels of debt also point to vulnerabilities in a number of emerging market economies (EMEs). In some cases, these are in the household sector. Most often, they are in the corporate sector, not least as foreign currency debt has expanded strongly since the crisis. The current vulnerabilities reflect in part spillovers from prolonged accommodative monetary policies in advanced economies, as EMEs are especially vulnerable to capital flow reversals and exchange rate fluctuations.
Meanwhile, even as central bank ammunition has dwindled to almost nothing, global growth is slowing: “If anything, the slowdown appears to be worsening and spreading since the Report went to press. There are signs of weaker consumption and investment.”
Not only that, but as the BIS also warns, significant near-term risks exist. Notably, the trade tensions that contributed to the slowdown could flare up again, even as financial conditions are undergoing major shifts.
Other threats include political economy risks in some countries. China’s deleveraging is not complete. And if past experience is anything to go by, the contraction phase of the financial cycles under way in many countries is likely to act as a headwind for global growth.
The BIS’ bottom line, with monetary policy now helpless, structural reforms are vital and fard as it is politically, it is essential to revive the flagging efforts to implement structural policies designed to boost growth. These days, policies to adapt economies to rapid technological and other structural changes are especially important.
Clear skies may be over the horizon, but we have yet to cross it. Many risks and vulnerabilities exist, and political uncertainty is high. The course towards normalisation has called for some deviations. A sustainable flight path requires the long-overdue full engagement of all four policy engines, rather than short-term turbo charges. By taking a longer view, one can better balance the needs of today with the needs of tomorrow.
The punchline: “hard as it is politically, it is essential to revive the flagging efforts to implement policies designed to boost growth… Monetary policy can no longer be the main engine.”
via ZeroHedge News https://ift.tt/2JgyvPl Tyler Durden
The recent announcement of the Libra consortium, distributed ledger and currency initiated by Facebook has led to much discussion and debate.
Some view it as an extension of the surveillance capitalism model of Facebook. Others view it as a pipe dream that can’t possibly work. Having dug into the technical details and the wider global changes with which this intersects, we believe there is potential for Libra to change the world – in ways most don’t expect.
A coin and a chain.
To start out, it is worth noting that there are 3 major elements to the proposal with very similar names.
1. The first of this is the Libra coin, which represents a basket of sovereign bonds and similar instruments.
2. The second is the Libra infrastructure, which is a distributed ledger secured by the various participants in the Libra ecosystem (known as validators).
3. Finally there is Calibra, a theoretically walled-of subsidiary of Facebook that’s building an interface for Facebook users to be able to use Libra.
The Libra coin has attracted much of the attention, as that is the popular understanding of what a “cryptocurrency” is. This is also what has alarmed regulators as it appears that, if successful, this might take monetary sovereignty away from countries as an alternative currency becomes available, not subject to central bank policy.
This fits with much of the language around the launch – that of banking the 1.7 billion unbanked and bringing a stable alternative to them. This has been pitched in a similar vein to classical crypto, not fitting within existing regulations per se, but looking to create a driving force to mold and change them as we have seen with the popularity of Bitcoin and other crypto-assets.
Of course, regulatory arbitrage is nothing new for tech giants, especially those that “move fast and break things”, but there is a question mark over what Facebook actually intends to do, as it appears that the regulatory hammer may be falling upon them due to nefarious use of their existing network. This is where the composition of the Libra consortium and the infrastructure they will be building becomes interesting.
While distributed ledgers come in all shapes and sizes that can befuddle even the most technically-adept individual, the best way to think of these is as a shared, virtual, computer run by lots of other computers (nodes). There is an application layer where the virtual computer does certain things, from something as simple as addition, to running entire applications, a networking layer to communicate changes in the virtual computer to other nodes and a consensus layer to make sure they’re all on the same page.
Libra is similar to Bitcoin, Ethereum and others in this regard, but does some things quite differently. Rather than burning energy in “Proof of Work” to ensure every node is on the same page and there are no nefarious actors, it uses a mechanism that requires two thirds of a set of validators, the consortia members, to be honest in order for transactions to be settled and finalised.
The specific implementation of this is an adaptation of a well known mechanism known as Tendermint and the test network and initial code that we have point to a network that has been designed specifically to transmit tokenised value and steadily gain more and more validators to decentralise further.
This is what’s behind Facebook’s comments that it will be only one of a hundred voters in how this develops, making it not a “Facebook” chain, but shared infrastructure. This is also why we see a range of participants already, from the likes of Visa and PayPal (who would seem to be threatened by this), to eBay and Uber.
Libra’s impressive stack of Founding Members’
But why decentralise?
To understand why Facebook has set things up in this manner, we need to look at how their business model has evolved and the growing threats to it.
Facebook looked to map your real world social network, extend it and monetise through serving you appropriate ads inserted into the news feed that captured your attention. As the population moved to mobile, Facebook also tilted, with 92% of its advertising revenue from mobile in 2018 versus 11% in 2012.
As Facebook looks forward, there are moves to break up its monopoly on our eyes, as the network has been used in deeply political ways and there are concerns over the centralisation of data that they have.
It is also topping out on growth as its growth markets are in areas such as India, where average revenue per user is a tenth or less of that of a Western consumer, and advertisers have much smaller revenues. Libra is a direct response to this, as it extends the strategy of native payments that we have seen emerge on Instagram.
A Libra infrastructure with on-ramps across the world would allow Facebook, via its Calibra subsidiary, to start monetising its users in ways that don’t necessarily involve advertising and in ways that do not actually compromise user privacy. This is because the actual number of data points needed to target an individual is quite low, with Facebook’s treasure trove of historical data allowing it to know you better than you know yourself with just a few indications.
This repository of big data analytics and understanding of human psychology can be used to connect users of Calibra and the associated infrastructure to valuable products and services without necessarily connecting them to their Facebook profiles and/or mining that user specific data.
Indeed, with regulations like GDPR coming into force, Facebook has realised that user data is increasingly being pushed out of silos and under the purview of the user themselves. Facebook is looking to take advantage of this with its new strategy, escaping the impending regulatory hammer as responsibility is devolved down to the individual and local partners, away from Facebook for managing user data. The Calibra infrastructure will be the easiest to use, lowest friction on ramp to the emergent ecosystem and it is looking to aggregate demand for financial products and value in this manner to increase its addressable market and revenue per user.
Going under the hood.
To see how it can do this, we can dig further into the technology and understand that Libra has been set up by taking the best bits of many existing distributed ledgers to create an optimal system for distributing value.
The Libra coin is the first asset to be issued on the ledger, which has a programming language that is more expressive than Script (Bitcoin), but not as open-ended and potentially insecure as Solidity (Ethereum).
This sets the basis for programmable money, something we alluded to in our Future of Asset Management piece, where, using the latest in privacy technology, transfers of value of arbitrary assets can occur with only the minimal amount of information needed being exchanged. This sets the basis for a dramatic expansion in capital fluidity, as more forms of collateral become available.
While faster than Bitcoin and Ethereum at 10 transactions per second, the initial 1,000 transactions per second of Libra also sounds low versus Visa in the thousands and Alipay in the hundreds of thousands. However, the nature of the infrastructure means that each of the validators could potentially run their own sub networks using the same consensus algorithm that are compatible with the main network. This means that Calibra or Visa could theoretically run their own, faster or customised instance and an asset on Calibra could migrate via the main Libra chain to Visa with an assurance that it is a unique Libra coin, tokenised equity or other asset.
This is important as the interoperability and adaptability are what could make this consortium work, mirroring in some ways the evolution of Visa in the early days.
As the data structures are defined and have been made relatively open, we can expect a repeat of the expansion of an ecosystem we saw with other Facebook open source software such as React, a framework that enabled thousands of app developers to easily develop for Android and iOS at the same time.
In particular, we expect local providers and infrastructure to develop in each country where Facebook and its consortia partners operates, accelerated by the potential of accessing billions of customers and Facebook’s 7 million advertising clients.
Enter the competition.
But why is this important and why bother with a distributed ledger? Centralised systems such as Swift will always be faster than decentralised systems due to the overhead inherent in replicating activity across multiple parties.
The advantages in general are the ability to minimise the need to trust counterparties, censorship-resistance in the case of Bitcoin and a few others and a level of standardisation of data types for most consortia-type distributed ledgers, making everyone’s life easier.
In the case of Libra there is a more pressing concern and that is the technological excellence of the associations Chinese counterparts.
Alipay and WeChat Pay now transact larger dollar volume than Visa and Mastercard combined at hundreds of thousands of transactions per second. Each of the digital RMB that are bouncing back and forth is backed by a real RMB at the Central Bank of China, as of last year. These groups have aggressive expansion and distributed ledger plans that will effectively export the Chinese payments ecosystem out of China, where saturation points are being met in many areas. This is the digital analogue (pardon the oxymoron) of One Belt One Road, augmented by Chinese advances in mobile technology and AI.
The target market here is the same market that Facebook and its allies are targeting as their main source of growth from here.
The appeal of the Chinese ecosystem is clear for low and even middle income nations. It is battle-tested, works and could mean that your country is the recipient of Chinese state largesse or even a portion of the huge levels of Chinese citizen savings looking for returns. Against this, in developed markets the only real alternative is to take advantage of the culture of innovation to build a constantly evolving open ecosystem, as we saw with iOS, Windows or Android for example.
This also allows us to look at the discussions around monetary sovereignty in a different light. The reserve backing of Libra coin is to be determined, but the nature of the network means that it could be made so that as fiat, such Indian rupees, are exchanged for Libra, the Libra network turns around and buys that same amount of Indian government bonds, issued on Libra (new or tokenising existing bonds), which could even come at a discount to the market rate today. Any Libra user could suddenly buy those bonds too, as all of the friction has been removed, increasing the government’s ability to spend. The amount of tokenised bonds held on Libra could be dynamically adjusted to the total float of Libra within that country, meaning there is minimal monetary impact.
This type of approach shows how Libra could be a balancing infrastructure against Chinese tech expansion, but also embed the association in a regulatory-compliant umbrella that allows them to outcompete legacy players. This is why we see Visa, Vodafone (owners of m-Pesa) and others in the consortium, as it is better to be inside than out.
Change is coming.
We‘ve been saying for some time that the crypto space is about moving towards a common standard, echoing the evolution of the early internet with the rise of HTTP. Could Libra be the roots of such a standard protocol, one that’s a compelling alternative to the Chinese payment behemoths?
Libra is still in its infancy and there are several changes that will likely occur before it goes live next year, if indeed it does go live in its current format. Some of the criticisms of the current iteration are valid, but there are some very interesting elements that could lead to a profound change in the status quo and some solid technological underpinnings behind it.
via ZeroHedge News https://ift.tt/2FIsZUV Tyler Durden
On Mount Everest the Death Zone is the altitude above 8,000 meters above which climbers cannot survive for an extended period of time without oxygen (speak: artificial help). In the Death Zone “most climbers have to carry oxygen bottles to be able to reach the top. Visitors become weak and have inability to think clearly and make decisions, especially under stress“. It is my assertion that investors and traders are confronted with a similar situation as the S&P500 is approaching its own version of the Death Zone, the Sell Zone, in the vicinity of the 3,000 level.
Why? Because stock buyers can’t sustain themselves above 3,000 without artificial help (central banks), the rallies keep getting weaker on an equal-weight basis, and investors are experiencing dizziness and find it difficult to think clearly in an environment where fundamentals and bond markets scream recession yet stock markets keep climbing to new highs.
In this week’s edition of the Weekly Market Brief, I’ll outline what I consider to be a major Sell Zone for markets and will also make clear where/when I think I’m wrong, meaning central banks once again retain control over the price equation irrespective of fundamentals.
Let’s speak plainly and realistically.
Market prices in June were again all about central banks:
Indeed 2019 has been all about the Fed:
It’s NOT been about fundamentals as bond yields have collapsed and yield curves have inverted:
While freight shipments have collapsed:
While manufacturing has been declining to levels not seen since the 2007 recession:
While earnings estimates have dropped nearly 7% over the past 12 months:
No, let’s be very clear here: Central banks have capitulated because bears have been right. January 2018 was a global blow-off top, the trillions upon trillions of monetary stimulus since 2008 were able to bring growth only so far because it all turned south on the slowing of such stimulus. After all the Fed tried to raise rates, the ECB ended QE and everything fell apart only to require again central bank dovishness.
But be clear, central banks have once again shown to be in control of prices. While officially never targeting equity prices they remain the single largest driver of the same:
And yet now it is dawning on everybody: Without cheap money, low to zero or negative rates the global debt construct cannot sustain itself. Zero rates forever.
Why? Because Mount Everest is staring everyone in the face:
It’s an admission of a bankrupt system, a system that cannot do without artificial stimulus and cheap money.
Stock markets are driven by 2 factors only at the moment: Optimism & hope. Optimism that a trade deal with China will magically solve all growth concerns. Hope that central banks will cut rates and keep the boogeyman at bay.
On the trade deal front the problem is that there is no trade deal. The G20 announcement was simply to restart talks, but the resumption of talks came at a price:
Translated: He had to make 3 concessions to get trade talks started again. https://t.co/DSWLVE42a3
Reality check: Trump’s on a 2020 clock, the Chinese are not. He has to win an election, the Chinese do not. In May they walked away, Trump raised tariffs and cut off Huawei only to now backtrack by not following through on new tariffs on consumer sensitive products, on now allowing Huawei to purchase US goods and easing on Chinese VISA issues. The implications are clear: Trump caved because he had to, he is the one that needs a deal and the Chinese know it and called his bluff and won in the process. As I’ve said before: Why would the Chinese agree to a deal they consider to be bad for them? They won’t. And so Trump has boxed himself into a corner and lost face, a potentially disastrous strategic move as now the prospects for an actual substantive move have diminished greatly.
The implication: Any deal that may come may be PR fluff as opposed to substance. Last time I checked PR fluff does not produce growth, a relief rally perhaps, but nothing sustainable. As it stands there is no deal, but there is optimism. Again. With no actual progress to measure.
And there is hope, hope that the Fed will cut rates and it is this hope that has come on the heels of complete capitulation of central banks that has stocks back to the brink of the sell zone.
So this coming month of July is shaping up to be an epic battle for control in the Sell Zone: Hope and optimism versus the reality of earning reports telling a different story.
What is the Sell Zone precisely? When do we know that central banks will have rendered the Sell Zone null and void? What is the technical target of the Sell Zone?
Please see the video discussion for the details:
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Global hedge fund liquidations exceeded launches for the third straight quarter as a result of a tougher capital raising environment, according to Bloomberg.
During the first quarter of this year, about 213 funds closed compared to 136 that opened. Liquidations remained steady from the quarter prior and launches were up about 23%.
But hedge fund startups remain under pressure due to poor performance and investors grappling with high fees. $17.8 billion was pulled from hedge funds during the first 3 months of the year, marking the fourth consecutive quarterly outflow. Additionally, the industry has seen a number of funds shut down or return capital, including Highbridge Capital Management and Duane Park Capital.
The average management fee for funds that launched in the first quarter was down 10 bps to 1.19%, while the average incentive fee increased to 18.79% from 17.9% in 2018.
Hedge funds on average were up 3% in the first quarter on an asset weighted basis, which lagged the S&P index by a stunning 10.7% with dividends reinvested over the same period.
In May we had noted that the broader S&P 500 had trounced the average hedge fund, returning 18% YTD, and charging precisely nothing for this outperformance.
Also in late May, we documented shocking losses from Horseman Global. The fund’s losses more than doubled in April, when the fund was down a was a staggering 12%, which brought its total loss YTD to more than 25%.
In early June, we wrote about Neil Woodford, the UK’s equivalent of David Tepper, blocking redemptions from his £3.7bn equity income fund after serial underperformance led to an investor exodus, “inflicting a serious blow to the reputation of the UK’s highest-profile fund manager.”
via ZeroHedge News https://ift.tt/2RKqcz8 Tyler Durden
This week, CNN reported on how, in spite of all the talk about job growth in recent years, wealth accumulation and incomes have been significantly and negatively impacted for many groups in the United States.
Much of what the article explored has been emphasized ever since the Great Recession started. The impact on younger earners, for example, has long been noted: “people entering the labor market during recessions have lower lifetime earnings.”
What was most interesting about the CNN article, however, was its admission that a persistent low-interest rate policy — one pursued by the central bank since the 2008 financial crisis — brings with it a serious downside. In a section titled “The mixed blessing of low interest rates” author Lydia DePillis discusses how low-interest rates have reduced the standard of living for those on mixed incomes, and has destabilized pension funds. Low rates have also made big firms even bigger at the expense of smaller firms:
But just like taking painkillers for too long can have side effects, the Fed’s monetary policy remedy gave rise to some unintended consequences. For example, low bond yields led the big funds that control trillions in investment to put their money into private equity and hedge funds that paid high rates. As a result, initial public offerings, which allow a wider group of people to benefit from the creation of new businesses, virtually dried up.
Meanwhile, low interest rates have been bad news for pension funds, which mostly depend on bond yields in order to remain solvent. Public pensions’ assets amounted to just 66% of their liabilities in 2016, down from 86% in 2007,according to the Pew Charitable Trusts . For the 100 largest private pensions, that ratio was 87.1% in 2018, according to the actuarial firm Milliman, compared to 105.7% in 2007.
For retirees counting on fixed-income securities like government bonds, low interest rates can also mean a lower standard of living.
“Low interest rates, while they have a lot of benefits, have a lot of costs for society as well,” said
Kevin Kliesen, an economist at the Federal Reserve Bank of St. Louis.
And that’s just short-term rates, which the Fed controls directly. Long-term interest rates were in decline before the financial crisis, and the ensuing recession depressed them even further; Fed officials are now struggling to nudge inflation up to their 2% target.
Those low interest rates may be sapping the economy of its vitality. One study published this year found that they give larger firms a greater incentive to invest than smaller ones. That fuels market concentration and reduces business dynamism — that is, the ability of startups to disrupt incumbents.
“As interest rates go down, they disproportionately favor market leaders as opposed to market followers,” said Atif Mian, a finance professor at Princeton University who coauthored the study. That effect, he found, “is large enough for low interest rates to not have any expansionary effect on the economy any more.”
Thre are three big takeaways here, and it’s surprising CNN has mentioned them.
Low interest rates have produced a quest for yield that favors the wealthy over the middle class.
Low interest-rate policy hurts regular people who depend on fixed incomes and low-risk sources of interest income.
Low interest rates favor large established firms over startups.
In other words, low interest rates favor the rich over the middle class, while widening income gaps.
Although critics of markets and so-called “neoliberalism” insist on ignoring the destructive power of central banks, the fact remains expansionary monetary policy serves to increase income inequality while favoring the already-wealthy. In other words, central banks are the cause of so much that capitalism is blamed for.
How Central Banks Destroy Wealth
Central-bank policy is problematic in a variety of ways. One of them — not mentioned by the CNN report — is the Cantillon effects brought about through the creation of money which is used first by financial institutions closer to the central bank and the easy-money spigots.
A second problem results when a “yield famine” results from low-interest-rate policy, but regular people can’t afford fancy yield-chasing investment products that are available to the wealthy.
Thus, ordinary people are left trying to gain interest income from government bonds, savings accounts, and CDs. In many cases, this strategy may not even allow the investor to keep up with price inflation.
A third problem stems from issues on the production side of the economy.
The CNN story notes a recent report suggesting large firms benefit more from low rates than small firms. The report, titled “Low Interest Rates, Market Power, and Productivity Growth” (by Ernest Liu, Atif Mian, and Amir Sufi) found that “the gap between the leader and follower increases as interest rates decline, making an industry less competitive and more concentrated.” In other words, low interest rates reduce competition and increase monopoly power of a small number of firms.
Moreover, the authors conclude their report
introduces the possibility of low interest rates as the common global “factor” that drives the slowdown in productivity growth. The mechanism that the theory postulates delivers a number of important predictions that are supported by empirical evidence. A reduction in long term interest rates increases market concentration and market power in the model. A fall in the interest rate also makes industry leadership and monopoly power more persistent.
The rise of low-interest-rate-induced monopoly power then stifles innovation, leading to lower productivity, and slower global economic growth. According to Liu, et al, this is not limited to the United States. It can be observed as a result of central-bank policy worldwide.
Last year, analyst Karen Petrou described how low rates have favored large companies.
As our research shows, QE exacerbates inequality because it takes safe assets out of the U.S. financial market, driving investors into equity markets and other financial assets not only to place their funds, but also in search of yields higher than those possible with ultra-low rates. The Fed hoped that soaking up $4.5 trillion in safe assets would stoke lending, and to a limited degree it did. However, new credit largely goes to large companies and other borrowers who have used it for purposes such as margin loans and stock buy-backs, not investment that would support strong employment growth. Growing household indebtedness in the U.S. is principally consumption or high-price housing driven and thus also a cause – not cure – of inequality.
Far from propelling middle class consumers to ever-higher levels of prosperity, low-interest rate policy is leading either to stagnation of losses in wealth.
But these revelations should not be shocking.
After all, Edward Wolff’s 2014 article “Household Wealth Trends in the United States, 1962-2013” suggests that our low-interest-rate world has done little to increase economic well being or counteract the effects of recessions:
From 2007 to 2010, house prices fell by 24 percent in real terms, stock prices by 26 percent, and median wealth by a staggering 44 percent. Median income also dropped but by a more modest 6.7 percent and median non-home wealth plummeted by 49 percent. The share of households with zero or negative net worth rose sharply from 18.6 to 21.8 percent.
However, from 2010 to 2013, asset prices recovered with stock prices up by 39 percent and house prices by 8 percent. Despite this, both median and mean wealth stagnated, while median income was down by 1.3 percent but mean income rose by 0.9 percent. The percent of households with zero or negative net worth remained unchanged.
According to Wolff in this 2017 follow-up, as of 2016, “median wealth was still down by 34 percent.”
The evidence is mounting against the usual narrative which states that low-interest rate policy has been a clear good because it has stimulated demand and consumption.
On the contrary, there is reason to believe low-interest rate policy has lowered productivity, lessened economic growth, and favored large firms at the expense of small firms and innovation.
Median incomes have also suffered.
But central banks are clearly afraid to do anything but kick the low-interest can down the road. The Fed’s multi-trillion-dollar balance sheet isn’t going anywhere, and the Fed has no appetite for raising rates. But when the next recession hits, it’s likely the Fed and the world’s central banks will dish up more of the same: near-zero rates in the name of recovery and wealth creation. But this strategy’s record of delivering has been questionable at best.
via ZeroHedge News https://ift.tt/2Jgq1rt Tyler Durden
History was made Sunday when Trump became the first US president in history to step onto North Korean soil; however, on the sidelines of his meeting with North Korean leader Kim Jong Un some serious jostling among the press corps present resulted in an “all out brawl” involving the new White House press secretary Stephanie Grisham.
Trump and Kim had reportedly been talking privately at the time in a meeting room in the demilitarized zone complex. As American and North Korean reporters then hustled in to get the best view of the summit, that’s when the chaos unfolded, involving the US press secretary scuffling with North Korean officials, part of which was captured by a local Korean news crew:
According to CNN, Grisham was “bruised” in the scuffle, the details of which were reported as follows:
The new White House press secretary, Stephanie Grisham, got into a brawl with North Korean officials on Sunday outside a meeting room where US President Donald Trump and North Korean leader Kim Jong Un were talking privately in the demilitarized zone between North and South Korea on Sunday.
CNN reported citing a source at the scene saying, Grisham got in “an all-out brawl” with North Korean officials.
Grisham was bruised a bit in the scuffle, the source added.
Tensions among the press pull were on full display prior to this when Trump and Kim first greeted each other along the DMZ.
As various reporters scrambled to get close, secret service personnel and other officials forcefully pushed some of the journalists back.
Wow the Press are some kind of people “vultures” when it comes at special events! Here is the White House press secretary pushing and pulling every camera and video crew out of the way, and security of Kim Jong Un pushing these same people also away. #DMZ#NorthKorea#SouthKoreapic.twitter.com/VduMEDakyE
During the melee involving Grisham, reporters had been attempting to enter the ‘Freedom House’ on the southern side of Panmunjom where the Trump-Kim meeting was in progress.
Upon being prevented entry by what were reported to be North Korean guards, Grisham can be seen pushing her way past the guards with the press corps in tow.
via ZeroHedge News https://ift.tt/2RKJOTC Tyler Durden
On Thursday and Friday, the markets mustered a “Pre-G20 rally” in anticipation of a positive outcome from the meeting between President Trump and Xi. I will discuss the outcome of this meeting in just a moment.
The good news is that June was one of the best performing months for the Dow Jones Industrial Average over the past 80-years.
That certainly was an impressive rally if you bought into the markets on June 1st.
Unfortunately, what the headlines don’t tell you is that the “strongest June rally in the last 80 years” failed to recover the losses from one of the worst May months on record as well.
In other words, most investors simply recovered previous losses.
However, as noted, the rally was something we had expected and discussed repeatedly in this weekly missive.
“In the very short-term, the markets are oversold on many different measures. This is an ideal setup for a reflexive rally back to overhead resistance.”
The question now is “how much more rally is there to go?”
“Steve Deppe also made an important observation Twitter that when the S&P 500 has gained at least 2% in a week and finished at a new weekly high — the case on Friday — the S&P was lower six weeks later 70% of the time.”
Much like an engine, markets operate on “fuel.” In other words, when there is a lot of “pent up” demand for equities, prices rise as demand is filled, and buyers are willing to pay higher prices to “get in.” The opposite is also true.
Also, prices are also confined by long-term moving averages. These moving averages, act like gravity, so when prices deviate by more than 5% from the long-term averages, reversions tend to occur.
As shown in the chart below, the market is currently very overbought, little pent-up demand, and is more than 6% above its 200-dma.
““From a portfolio management standpoint, the reality is that markets are very extended currently and a decline over the next couple of months is highly likely. While it is quite likely the year will end on a positive, particularly after last year’s loss, taking some profits now, rebalancing risks, and using the coming correction to add exposure as needed will yield a better result than chasing markets now.”
Since May:
The economic backdrop has weakened materially.
Earnings expectations continue to fall. .
While asset prices are near record highs, corporate profits are the same level as in 2014.
The Fed has NOT cut rates yet and is still reducing their balance sheet.
Global economic growth continues to weaken.
Existing tariffs are continuing to work their way through the system
Recession risks have risen markedly in recent months.
In other words, the supportive backdrop for equity investors is hinged on the “hope” of the Fed cutting rates and a resolution to the “trade war.”
Monday is that start of Q3 for money managers so a rally is expected that could well push markets to new highs temporarily.
This is why we remain long equities currently, we are hedged with an overweight position in cash, are maintaining our fixed income exposure and have recently added plays to participate with a “steepening”yield curve.
However, there are bigger risks still at play and worth watching.
Art Of The Deal Versus The Art Of War
This weekend, all eyes are focused on the meeting between President Trump and President Xi Jinping. If this were a pay-per-view event, it might well rival the “Silva vs. Franklin” matchup at UFC 147 for total viewership. (That’s a joke, it was one of the lowest viewed PPV ever for the UFC)
Kidding aside, there was a tremendous amount of “hope” currently built into the market for a “trade war truce” this weekend. However, as we suggested previously, the most likely outcome was a truce…but no deal.
“Both sides confirmed in separate comments that they did not plan to levy any new tariffs against each other’s products at the present time. For one, Chinese state-run press agency Xinhua described the meeting result as the presidents agreeing ‘to restart trade consultations between their countries on the basis of equality and mutual respect.’
Speaking after the bilateral, Trump said it had gone as well as it could have, and that negotiations with China would continue. ‘We are right back on track,’ the president said.”
While the markets will likely react positively next week to the news that “talks will continue,” the impact of existing tariffs from both the U.S. and China continue to weigh on domestic firms and consumers.
More importantly, while the continued “jawboning” may keep “hope alive” for investors temporarily, these two countries have been “talking” for over a year with little real progress to show for it outside of superficial agreements.
Importantly, we have noted that Trump would eventually “cave” into the pressure from the impact of the “trade war” he started.
This was evident in this weekend’s agreement:
By agreeing to continue talks without imposing more tariffs on China, China gains ample running room to continue to adjust for current tariffs to lessen their impact. More importantly, Trump gave up a major bargaining chip – Huawei.
“One of the things I will allow, however, is — a lot of people are surprised we send and we sell to Huawei a tremendous amount of product that goes into a lot of the various things that they make— and I said that that’s OK, that we will keep selling that product.”
No, a lot of people weren’t surprised, just Trump as there has been pressure applied by U.S. technology firms to lift the ban on Huawei. While he may have appeased his corporate campaign donors for now, Trump gave up one of the more important “pain points” on China’s economy.
This gives China much needed room to run.
Let’s review what we said a couple of months ago as to why their will ultimately be no deal.
“The problem, is that China knows time is short for the President and subsequently there is ‘no rush’ to conclude a ‘trade deal’ for several reasons:
China is playing a very long game. Short-term economic pain can be met with ever-increasing levels of government stimulus. The U.S. has no such mechanism currently, but explains why both Trump and Vice-President Pence have been suggesting the Fed restarts QE and cuts rates by 1%. (Update: Trump says the U.S. should have Mario Draghi at the helm of U.S. monetary policy.)
The pressure is on the Trump Administration to conclude a “deal,” not on China. Trump needs a deal done before the 2020 election cycle AND he needs the markets and economy to be strong. If the markets and economy weaken because of tariffs, which are a tax on domestic consumers and corporate profits, as they did in 2018, the risk off electoral losses rise. China knows this and are willing to ‘wait it out’ to get a better deal.
As I have stated before, China is not going to jeopardize its 50 to 100-year economic growth plan on a current President who will be out of office within the next 5-years at most. It is unlikely, the next President will take the same hard line approach on China that President Trump has, so agreeing to something that is unlikely to be supported in the future is unlikely. It is also why many parts of the trade deal already negotiated don’t take effect until after Trump is out of office when those agreements are unlikely to be enforced.
In the meantime, as noted in #3 above, corporate profits continued to come under pressure. As noted previously, corporate profits have declined over the last two quarters and are at the same level as in 2014 with the stock market higher by almost 60%.
But, if you think China is going to acquiesce any time soon to Trump’s demands, you haven’t been paying attention. China has launched a national call in their press to unify support behind China’s refusal to give into Trump’s demands. To wit:
“Lying behind the trade feud is America’s intention to stifle China’s development. The U.S. wants to be a permanent leader in the world, and there is no way for China to avoid the ‘storm’ through compromise.
History proves that compromise only leads to further dilemmas. During previous trade tensions between the U.S. and Japan, Japan made concessions. As a result, its political stability and economic development were adversely affected, with structural reform being suspended and hi-tech companies being severely damaged.
China, with a population of 1.4 billion, is the world’s largest manufacturing base. Industrial upgrading and hi-tech innovation are crucial to China’s economic development. China needs to leave more resources to its descendants by protecting the environment, and reaping the dividends of further opening-up. These are the core interests of China, and it will never give them up.
The only way for a country to win a war is through development, not compromise. To achieve development, China will open its door wider to the world and fight to the end.”
These are Xi Jinping’s mandates, dictated directly from his party, for the meeting with the United States president in Osaka.
The only possible outcome for Trump was exactly what happened. Nothing. Just an agreement to talk more.
“If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him. If your opponent is temperamental, seek to irritate him.Pretend to be weak, that he may grow arrogant. If he is taking his ease, give him no rest. If his forces are united, separate them. If sovereign and subject are in accord, put division between them. Attack him where he is unprepared, appear where you are not expected.“
China has been attacking the “rust-belt” states, which are crucial to Trump’s 2020 re-election, states with specifically targeted tariffs. As noted by MarketWatch:
“China has lashed back with tariffs on $110 billion in American goods, focusing on agricultural products in a direct and painful shot at Trump supporters in the U.S. farm belt.”
While Trump is operating from a view that was a ghost-written, former best-seller, in the U.S. popular press, Xi is operating from a centuries-old blueprint for victory in battle.
China clearly won this round, and the pressure is now squarely on Trump to get a deal done before the 2020 election.
That isn’t likely going to happen.
Warning Signs
While markets remain solely focused on the outcome of the G-20 meeting and expectations the Fed will cut rates at the July meeting (which is not assured by any means) warning signs of potential risk continue to mount.
One of the more important indicators we have discussed previously is the reversal of yield curve inversions. My colleague Albert Edwards confirmed that analysis this past week:
“However, while the inversion was certainly a memorable event, the question on everyone’s lips is how do risk assets perform once the curve flattens and/or inverts. According to backtests from Goldman, since the mid-1980s, significant stock drawdowns (i.e. market crashes) began only when term slope started steepening after being inverted.
Fast forward to today, when in his latest bearish missive, SocGen’s permabear Albert Edwards picks up where we left off, and in a note titled “the final recession shoe has now fallen”, he notes that while inversion of the US yield curve is seen as a reliable precursor to US recessions, “it has a long and variable lead time”, and instead “a far more immediate and present danger of recession occurs when after inversion, a rapid steepening occurs.”
Sound familiar?
In any case, as we first commented in early 2019, Edwards notes that this subsequent steepening “usually informs investors the cycle is over and it is time to flee for the hills.“
Well, for those who haven’t figured out the punchline yet, rapid curve steepening is now occurring, and as Edwards gleefully concludes, this ‘suggests recession may indeed either be imminent or else it has already arrived.’”
Another concern we have also discussed previously is the issue with margin debt.
While the consolidation of the market over the last 18-months has led to a slight reduction in the amount of outstanding margin debt, there has been very little overall deleveraging of the market.
The chart below analyzes margin debt in the larger context that includes free cash accounts and credit balances in margin accounts. The chart below is based on nominal data, not adjusted for inflation and has retained the NYSE data through November 2017 and switched to the FINRA data moving forward.
It is important to understand that leverage is a “double-edged sword.”
When markets are rising, the leverage adds to the “buying power” of investors lifting asset prices higher. However, it also works in reverse, but more like an explosion rather than a slow burn.
However, as Jesse Felder noted this past week:
“The latest margin debt figures were released last week and they show leveraged investors continue to delever. In fact, margin debt is now falling at an annual rate of 15%, a level of derisking that has always been accompanied by a minimum 20% decline in the S&P 500 over the past half century.
This makes this latest episode of derisking fairly unique. There have only been a couple of other precedents in which stocks rose or were flat year-over-year while margin debt fell at at least a 15% rate: May of 1969 (margin debt down 15%/stocks up 10%) and June of 1973 (margin debt down 18%/stocks flat). January of 2001 (margin debt down 20%/stocks down 1%) also comes very close.”
It is worth noting that those three previous periods on slightly preceded much more meaningful declines.
The 1969 event gave way to a near 40% decline in 1970-1971
1973 preceded the 1974 “black bear” market which eclipsed a 50% decline in total.
Of course, January 2001 was the precursor to the “dot.com” crash which also entailed a 50% decline.
Are you seeing a pattern here?
While the current contraction in margin debt is somewhat unique, it may only be the case temporarily. As shown in the chart below (I have inverted margin debt to the S&P 500) the amount of contraction needed to reverse the leverage in the market will require a similar 50% decline in asset prices as seen previously.
Yes, this time could absolutely be different.
But from a portfolio management perspective, it probably isn’t the best “bet” to make.
via ZeroHedge News https://ift.tt/2ZV5dfZ Tyler Durden
ATTOM Data Solutions published its 2Q19 US Home Affordability Report, which reveals median home prices last quarter weren’t affordable for the average American in 74% (353 of 480 counties) of the counties analyzed.
The most unaffordable counties, the reported noted, were in Los Angeles County, California; Cook County (Chicago), Illinois; Maricopa County (Phoenix), Arizona; San Diego County, California; and Orange County, California.
“Despite falling mortgage rates and rising wages, the cost of owning the typical home remains out of reach or a significant financial stretch for the nation’s average wage earners,” said Todd Teta, chief product office with ATTOM.
House price appreciation outpaced weekly wage growth in 40%, or 192 of the 480 counties, including Maricopa County (Phoenix), Arizona; Riverside County, California; San Bernardino County (Riverside), California; Tarrant County (Dallas-Fort Worth), Texas; and Wayne County (Detroit), Michigan.
For Americans who feel financially overwhelmed with unaffordable housing, the report does show 26%, or 127 counties examined, had affordable housing in Harris County (Houston), Texas; Wayne County (Detroit), Michigan; Philadelphia County, Pennsylvania; Cuyahoga County (Cleveland), Ohio; and Franklin County (Columbus), Ohio.
ATTOM calculated the affordability of each county by examining the amount of income needed to make monthly house payments (assume a 3% down payment and a 28% maximum “front-end” debt-to-income ratio) — including mortgage, property taxes, and insurance.
We noted in a recent report that most American renters now believe that purchasing a home is “financially out of reach.”
The most significant obstacle preventing renters from buying was “difficulty in saving for down payments and closing costs.”
So rising prices and the inability to save are the problems that have made housing unaffordable in many places across the country.
via ZeroHedge News https://ift.tt/2ZX7c3k Tyler Durden
