Tag: news

Authored by Robert McKeown via The Mises Institute,

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Yesterday’s US equity market collapse and simultaneous bond market bloodbath was the biggest combined loss since December 2015, but perhaps more ominously, the week’s combined loss in bonds and stocks was the worst since Feb 2009.

Many suggested that Friday’s slump was GOP-memo-related, and it may well have removed some froth, but judging by the major correlation regime shift between stocks and bonds that started on Monday, we suspect this is something considerably more worrisome for investors.

Even JPMorgan admits that the bond market sell-off gathered pace over the past week raising concerns about its impact on equity markets. This is especially because the bond-equity correlation, which has been predominantly negative since theLehman crisis, has started creeping up towards positive territory.

The 90-day correlation between stock (SPY) and bond (TLT) markets has surged ominously in the last few weeks…

In turn this raises concerns about de-risking by multi-asset investors who depend on this correlation staying in negative territory such as risk parity funds and balanced mutual funds? How worried should we be about de-risking by these two types of investors?

Very.

Judging by the impact on Risk-Parity funds yesterday (worst single-day performance since August 2015’s flash-crash)…

And this week (worst weekly drop in Risk-Parity funds since June 2013’s Bernanke Taper Tantrum)…

As mentioned above, these types of investors benefit from the structurally negative correlation between bonds and equities as this negative correlation suppresses the volatility of bond/equity portfolios allowing these investors to apply higher leverage and thus boost their returns. But, as JPMorgan points out, the opposite takes place when this correlation turns positive: the volatility of bond/equity portfolios increases, inducing these investors to de-lever.

In the past, just as we have seen this year, these risk-parity-correlation tantrums have been cushioned by equity market inflows, and we note that, in particular, YTD equity ETF flows have surpassed the $100bn mark, a record high pace.

If these equity ETF flows, which JPMorgan believes are largely driven by retail investors, start reversing, not only would the equity market retrench, but the resultant rise in bond-equity correlation would likely induce de-risking by risk parity funds and balanced mutual funds, magnifying the eventual equity market sell-off.

Which could be a problem…

Yesterday was the first day of the year when equity ETFs saw significant outflows of $3.7bn.

While JPMorgan states that they are “reluctant to attach too much importance to the outflows of only one day,” the risk of a more significant equity market correction will naturally rise if these outflows extend into next week.

Put more simply – either we get a major equity ETF inflow to offset the risk parity hit, or markets are going a lot lower, a lot faster as the forced deleveraging accelerates.

Even Bloomberg is worried, looking at the week’s drumbeat, you can’t help but wonder, is this the start of something big? Warnings about valuations have been pouring forth from bears for so long that barely anyone listens anymore. With the S&P 500 up almost 50 percent in less than two years, some see the end of the blissfully easy money that equities have spewed out for 13 straight months.

“It’s the turning point of volatility,” said Jeffrey Schulze, chief investment strategist at Clearbridge Investments, which manages $137 billion. “We were all very fortunate to go through a year like 2017. But there’s a number of different dynamics this year that will make volatility more part of the equation than it has been in quite some time.”

The problem is likely not helped by record-high valuations (but as Yellen says “don’t call it a bubble”)…

And record-high leveraged positioning…

“The list of growing challenges have caught up to stocks,” said Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management LLC. “We probably need a valuation correction for both stocks and bonds to be more appropriately priced for an economy now growing at 3% real/5% nominal at full employment with rising labor costs and capital costs.”

And the potential for a quant-fund-driven forced-liquidation is growing every day with bond-stock correlations.

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Authored by Mark Jeftovic via Guerilla Capitalism blog,

The Gartner Group is widely credited with formulating the “Hype Cycle”, a trend curve that is said to model the adaptation of a new technology or paradigm.

Simply put it looks like this:

It certainly seems to have held sway regarding the Internet revolution, where the Peak of Inflated Expectations culminated in the Nasdaq blow-off-top of 2000 and the ensuing “Tech Wreck” crash. I remember that well, for a number of reasons including that my co-founders and I were still in “start-up” mode with our company, easyDNS.  I remember profoundly misunderstanding what was happening in those final few months.

I remember thinking, literally “this is an entirely new economy, it’s not about running profitable businesses anymore, it’s about running up your stock price.” There was a Sun Microsystems commercial that was near music video length, set to the soundtrack of the iconic rock track “Hocus Pocus” whose sole call-to-action at the end of the ad was the “SUNW” ticker symbol. And then it all imploded. That was when I started seriously learning about economics, history and finance.

I remember sitting in a diner one night having a coffee with a friend, mere months before the crash. Bullshit .COM’s were getting funded all over the place and everybody else, except me it seemed, were becoming millionaires overnight.

“I suppose if we hit the jackpot and got rich tomorrow, I’d probably think I was a master of the universe and crash and burn with drugs and booze”, I conceded (having recently gotten clean and sober). He said “For that reason alone it’s probably best for you if you don’t become wealthy until your sobriety can handle it.” Then he told me the story of the Roman Triumphs, which I never knew about beforehand.

When a Roman consul returned home after a particularly spectacular military campaign abroad, a “Triumph” was held – which was a parade through the streets Rome celebrating his accomplishments. But there was an additional component that (as it was told to me then), a slave would be put in the chariot beside the consul, who’s sole job throughout the Triumph was to whisper into the victorious leader’s ear “Remember, thou art mortal”.

I’ve never seen an original source for this, it’s been attributed to Julius Caesar, to Tiberius and to Marcus Aurelius. Or it’s possibly even apocryphal – but one thing I know for sure, there was nobody nearby whispering “Remember, thou art mortal” to any crypto-millionaires over the course of 2017.

 

“Dude. Get over yourself”.

This is the “gotcha” peculiar to success and good fortune. The illusion of invincibility. Infallibility. Omnipotence. It can happen to individuals and it can happen at a collective, archetypal or sub-cultural level.

When I sat down to finally write this (I went on record saying this would be the year Bitcoin enters the Trough of Disillusion on New Year’s Day) and researched a bit, I found that “The Trough of Disillusionment” for Bitcoin has been called almost as often as the Bubble Top was over this unprecedented price run since Bitcoin’s inception.

The similarities between the DotCom top and 2017/December were striking.

The “ICO Craze” were the pets.com and boo.com’s of the day.  I honestly don’t understand most ICO models: they’re not equity. You’re not getting a piece of the company, and they’re not debt, so there’s no yield. They’re for the most part utility tokens. Many with the flimsiest utility value. I mean if you’re going to shoehorn a utility token representing a banana into an ICO and raise funds selling them, people are going to buy them because they think what? That the price of bananas is going to moonshot? It doesn’t make any sense.

I understand the “kickstarter” analogy to ICOs, people want what you plan to create and they fund you by prepaying it, ok that part I get. But why am I, as an investor going to buy a given utility token unless I plan to consume a lot of your utility. Looked at this way, Basic Attention Token (BAT) makes sense if one has high hopes for the Brave browser (as I do) and wants to be in a position to participate in that ecosystem early. I also understand the impetus toward “tokenization” which I credit Adam Levine at Tokenly for seeing it coming early.

But in 2017  all that devolved, rapidly, into a bullsh*t money raising racket. It reflected badly on much of the space and to mainstream commentators it made everybody in it look like charlatans and hucksters.

Then there were the Ponzis

I hadn’t heard about Bitconnect until the day they shut down (exited?) But anybody who went through the Digital Gold Currency (DGC) era who looked at Bitconnect would have instantly recognized it as a “High Yield Investment Program” a.k.a  “HYIP”. We got wise to those early enough in the days when easyDNS was accepting e-gold to specifically ban them from our service. In this incarnation they are being touted as “Crypto Lending Programs”. Make no mistake…

 

…as soon as you see “daily interest” you know you’re dealing with a HYIP. Especially after 10 years of ZIRP and NIRP, anybody who is guaranteeing you 40% interest per month is running a ponzi.

Apparently bitconnect resurfaced long enough to float (get this), an ICO….

 

But seem to be gone again. There are more out there.

Probably everything listed in this site is a ponzi. If it says “daily interest”, it’s a ponzi, if it says “guaranteed” it isn’t.

If you have any funds in any of those sites and they are still up and running, stop what you are doing, and go cash out, at any price, right now.

Why This Time May Have Been “The Secular Top”

When people get excited about something, and I’m as guilty as anybody of succumbing to this, they tend to get myopic about it.

Example from outside the space: During the heyday of the domain name aftermarket, the “Tea Party” political movement in the US started looking like it was picking up steam and people speculated that the rock band from Windsor, Ontario, “The Tea Party“, who owned “TeaParty.com” were about to become very rich selling their domain name. (They ended up not selling it and they still operate from there to this day).

This was back when .com’s could still sell for millions. Here we were heading into the 2012 election cycle with a “dark horse” political movement coming out of left field (sorry, I guess that would be right field) and the domainers were enthusiastically predicting outlandish valuations for the domain name. I can’t find the thread now but one prognosticator was putting a value of 1 billion dollars to the name.

That was plain delusional, but a good example of what happens to the mind under the spell of an asset-bubble induced tunnel vision. At the time I did some searching and realized that valuing a single domain name at $1 billion would have exceeded the total cost of an entire presidential campaign run by 2X or 3X.  That’s when you know your price targets are out of whack.

So look at 2017.We have Bitcoin starting the year with a 10 – 15 Billion dollar market cap, and then pulling into December well north 100 billion, 200 billion, 300 billion! While the total crypto-currency space peaking at close to 750 Billion, that’s three-quarters of a trillion dollars.

What felt different about this spike high was that this time was the first time that Bitcoin fever truly broke outside of the crypto-currency space and out into the wider public consciousness. Sure, people were hearing about it before, but this time, people were getting pulled in.

For months leading up to December all anybody wanted to talk to me about was Bitcoin. Most of them didn’t even know I was “into Bitcoin”,  just that I was a technology guy. In December it got manic. A friend of a friend got my cell number and called me wanting to meet up and literally hand me a briefcase of cash for some bitcoin, right now! I was getting emails from people I hadn’t heard from in years wanting to hire me for consultations on getting into Bitcoin.

It’s about the technology, not the price

At the time I wrote “This time is Different”, Part 1 & Part 2 I did try to stress that what was exciting and revolutionary about Bitcoin was the technology and disruptive ramifications moreso than the price action. I admit I was being dismissive of the price action, and not fully cognizant of the spike-high/bubble aspect until it seemed to reach a crescendo in December.

Then after correspondence with Mike Swanson of WallStreetWindow, who I’ve been following for a long time (over a decade) I realized that yes, he was probably right that this was a blow-off top. Mike is more skeptical of the underlying technology than I am, hell, I’m a believer, he isn’t. But I was also a believer in internet technology – I owe my livelihood to it – and know from experience that technology revolutions do go through these cycles.

The big question then remains: Is this really a technology revolution going through this Hype Cycle? Or is it e-gold and Digital Gold Currencies of yesteryear, which showed promise but ultimately went bust?

I think it’s the former, in fact I’m almost certain of it for many reasons. Bitcoin has demonstrated that anti-fragility, no matter how badly it gets mangled or maligned, it’s that “honey badger” of technologies and it just keeps marching forward and coming back stronger than ever.

When Mt Gox crashed I said it was a victory for the space precisely because there was no central authority, it put everybody on notice that the Saviour State wasn’t going to step in and clean up our messes, and that meant that people had to do real honest due diligence and they had to take personal responsibility for their actions.

It’s the exchanges that are still the Achilles Heel of all this. Those are the choke points for getting into or out of the crypto space and over this last stage of the blow-off they did not fare well. Freezes on new accounts were one thing, but freezes on withdrawals are another and there have been rumours that some exchanges were using new deposits to cover withdrawals.

Exchanges are allowing margin trading. Even if your personally eschew margin, keeping  your funds in an exchange that is allowing margin trading may see your balance being de-facto rehypothecated. If any meaningful portion of the participants move toward the exits at a given time that can be a huge problem.

The structural design of the exchanges and the overall governance systems of the coins themselves will need to step up to the next level in order for the space to ascend that “Slope of Enlightenment” and attain the “Plateau of Productivity”.

All of these bullsh*t ICO’s, sh*tcoins and ponzis need to be cleared out, the exact same way pets.com, boo.com and all those other dot bombs had to be cleared out as well. That sets the stage for…

What happens next:

(a.k.a “what a secular bear market in crypto-currencies might look like)

We’re constrained by the minuscule time crypto-currencies have been in existence, so my thoughts are drawn via inferences from history outside the space.

My working theory right now is that a secular bull market in crypto-currencies from 2008 to 2018 has completed. That’s a 10 year bull market and probably the highest yielding bull run of any asset in history. Even if Bitcoin drops 80% from here (call it from ~ $9,500 USD/BTC down to ~ $1,900 USD/BTC) then Bitcoin would still be up 90% from a year ago. That still just boggles my mind. By comparison, the S&P500, in the same year went to all-time highs with a gain of 18%.

If Bitcoin et al are, to quote Vitalik Buterin “are a fundamentally new class of cryptoeconomic organisms” – in other words, a new asset class, then I would expect them to display the characteristics that all other assets display:

Cycles:

Secular ones, counter-cyclical ones. In stocks and commodities, a secular bull market can last 8 to 20 years. Secular bears are typically shorter, they can last 3 to 8 years but there have been some that lasted 20 years and even more (Japanese equities, nearly 30 years in…).

Keep in mind that secular bear markets don’t just fall downward for their entire length, they go sideways and whipsaw everybody until capitulation or some other form of maximum pessimism occurs. And to be absolutely clear here: I don’t think we are anywhere close to capitulation or maximum pessimism in the Bitcoin space.

If you want to know what a “bottom” looks like, take a look at, say… gold, which has been going up for two years, is universally despised, and even most goldbugs still think it’s going to “crash”.

From experience: bear cycles go deeper and last longer than anybody, especially me, suspects. I have personally and notoriously been “too early” calling bottoms of gold bears since 2003. Possibly profitable advice would be: wait until I call for a bottom in Bitcoin and then wait another year (buy a truck, and then after a year, back up that truck).

Mean Reversion:

Anybody who thought Bitcoin was just going to keep going, straight-up, forever was doing themselves and their readers a disservice. I am not looking forward to seeing John McAfee “eat his own dick” come 2020 when Bitcoin isn’t $1,000,000/per.

It’s tough to gauge what a rational mean would be for Bitcoin since it’s only been around for 10 years. There is also the observed phenomenon that the counter-cyclical trends in Bitcoin seem to be compressed, and occur at a faster pace. How can anybody know for sure what to expect in terms of a counter-cycle bear in terms of length and duration?

The other problem with something that has gone up this much, this fast for so long is the corollary of mean reversion which is

Mean Overshoot:

It’s not that some asset gets ahead of itself and spikes away from the mean, then blows off the top and comes off back to the mean. No sir, it overshoots the mean, many say to the same degree the spike got ahead of the mean is the degree to which the counter-move will overshoot below the mean.

 

If this is the case here I would be looking for lower lows than what we are experiencing here, so low to bring about capitulation and maximum pessimism. Remember when Businessweek magazine ran that famous “Death of Equities” cover in 1979? (Three years ahead of the 1982-2000 bull market?), we’d need to see a “Death of Bitcoin” cover  story on Bitcoin Magazine. (No, not the Economist or NYT or some publication that wants to see this stuff die, it has to be from something within the space. That’s maximum pessimism.)

Remember, we could lose another 80% from where we are today and still be roughly double over last year. In my mind that leaves an enormous amount of downside.

On the upside, there’s a lot of overhead resistance, and that will be there for a long time. I think what differentiates this spike high from the previous ones over the years was the overall lack of public participation in Bitcoin. It was still a curiosity for outsiders, so the people taking the losses were the ideologically committed HODLers. That isn’t the case now.

Finally, when all this turns around (price wise), if this really is a new asset class (like stocks, or bonds or commodities) then in the next bull cycle what often happens is

Change of leadership

That means next time up it may not be Bitcoin leading the way. It could be Ethereum, it could be some other Bitcoin derivation, or possibly something that doesn’t even exist yet. (/me *ducks*)

If I’ve learned one thing from Mike Swanson in my years of following him, it’s that successive bull markets are led by different components than the previous one. In days gone by it was the “Nifty 50”, during the the Nasdaq Bubble was the .COMs’, today most of the companies that led the .COM boom don’t even exist anymore and it’s all about the FANGs. When the stock market cycles again there will be different leadership.

If cryptos are indeed an asset class unto themselves, then I would expect a similar phenomenon to play out.

What to do about it

If you listen to Lets Talk Bitcoin (which easyDNS sponsors), they frequently say to invest in the skills and the technology not the price. Don’t spend your money on “investing” in crypto-coins, spend it on learning how to work within this still emerging technology (programming, business, law, whatever) and either develop income streams that earn crypto-currency, or figure out a way to add these streams to your existing business. This has always been my preferred way of accumulating crypto-currency (and before that DGCs) and we’ve never regretted it.

Remember the tech wreck – easyDNS enjoyed it’s fastest growth rate in the years immediately following the dotcom bust. If I’m right about any of this, and if you are serious about this space, then believe it or not you’re actually in the sweet spot.

Now is the time to hone your skills, now is the time to adapt your business to this new technology if you haven’t already. No you don’t have to regret “missing out”, if I’m right then nobody is going to experience FOMO for a very long time – and that’s the quiet period you can turn to your advantage.

Lastly, get and read Nick Gogarty’s “The Nature of Value”, it does a masterful job examining the distinct phases technology transitions go through and why the first couple phases usually end in disaster for asset allocators anyway and why the best thing you can do is take a step back and wait for an emerging space to finish going through the mania phase.

This is the Trough of Disillusionment, where the “get rich quick” people throw in the towel and move on while the serious builders and innovators get down to business.

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Mortgage lending has long been a “bread and butter” business for Wells Fargo, Warren Buffett’s favorite bank. But between the months of September and December – while the bank’s PR department was busy fending off another incipient scandal – demand for the bank’s loans declined to its weakest level since the financial crisis. While we initially pegged this as a sign that the average US consumer can’t afford to take out a loan with interest rates just 1% higher.

But as the CEO of Quicken Loans revealed today during a conversation with Crain’s Detroit Business, another factor might also be at play.

Sales figures released by Quicken show that it surpassed Wells Fargo in volume of mortgage originations during the fourth quarter of 2017, bolstering the lender’s claim that it is a viable alternative to the banks that have traditionally dominated the business (and also leveraged it to blow up the US economy a decade ago).

Quicken revealed that it originated $25 billion in home loans during the quarter, compared with Wells Fargo’s $23 billion in home mortgages. Wells is the country’s leading bank in home mortgages; Bank of America and JP Morgan Chase & Co. reported $13 billion and $11 billion that quarter, respectively. 

“I don’t think we set out to close $25 billion – we just set out to do what we always do, which is take care of our clients and take care of our team members,” Quicken Loans CEO Jay Farner said Thursday in an interview with Crain’s.

Still, Farner disclosed that Wells’ $114 billion in loans for 2017 surpassed the Quickens’ full-year total. Quicken, which was founded by billionaire Dan Gilbert, is privately held, and doesn’t disclose its annual earnings.

Per Crain’s, Quicken has become an increasingly nettlesome challenger for industry leader Wells and other home-mortgage lenders, thanks to the company’s primary innovation: Rocket Mortgage – its online loan application system. The business has swelled thanks to a savvy marketing that has featured high-profile Superbowl adds. The company is planning to air a new spot during Sunday’s championship game between Atlanta and the Patriots.

In 2017, Quicken Loans began shifting to marketing what its CEO calls the Rocket Mortgage “experience” instead of the Quicken Loans brand in its advertising.

“I think you’ll see it more and more, because it’s the way we talk about this innovation in this space,” Farner said of using the Rocket Mortgage brand in company advertising. “The Quicken brand is a foundational brand.”

The new Super Bowl ad will be used to launch an advertising campaign that “will continue through the greater part of 2018,” Farner said.

While Quicken’s performance is admirable, the real story here, of course, is Wells’ fluctuating position within the home loan market. Banks are increasingly finding it difficult to keep up with the “FinTech revolution” that has spurred other online lending platforms like SoFi and Lending Tree.

And judging by the nominal value of loans in Wells’ all-important loan origination pipeline, there’s reason to believe that the slump in loan originations isn’t over.

The lagging mortgage originations number, which usually trails the pipeline by 3-4 quarters, was nearly as bad, plunging 39% sequentially from $72 billion to only $44 billion, “due to higher rates and seasonality.” Since this number lags the mortgage applications, we expect it to post fresh post-crisis lows in the coming quarter.

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On MSNBC, Rachel Maddow was literally laughing. Over on Fox News, Sean Hannity put up his dukes.

At 9 last night, Axios points out that you could just flip between the two and see an encapsulation of our two Americas – total dismissal of the memo’s import, versus the assertion that it’s “only about 15 percent of what’s coming.”

So, Rachel, how was your day?

“This thing?! This was two weeks of: This memo is going to end everything. This memo, have you heard about the memo? Hashtag: Release the memo! This memo will make Donald Trump innocent. This memo will put Robert Mueller in jail. It will abolish the FBI. The Justice Department will have to rename itself the Donald J. Trump & Family Private Security Task Force.”

“I mean, I can’t believe this is it.”

“I don’t really believe in the whole Cable News Wars idea. I know people who work across the street at the Fox News Channel. I’ve got friends that work there. I think we’re all doing our own thing in our own way best we can.”

“But, oh my God, right? … [T]his … hyping and huffing and puffing and working their audience up into a frenzy for two solid weeks.”

“And apparently, despite all of that, … they either didn’t know or they didn’t notice that this thing they have been clamoring for and hyping for two solid weeks, … it actually disproves their whole point.”

“They release this memo to prove that the dossier started everything. The memo says the dossier didn’t actually start anything.”

*  *  *

What’s up, Sean?

 

“[W]hen you put all this information together, here’s what it all means. The FBI misled and purposely deceived a federal court while using an unverified, completely phony opposition research bought and paid for by Hillary Clinton.”

“We have never, ever in history seen anything like this, and it was spearheaded not by rank-and-file members of the FBI intelligence community and Department of Justice. No. High-ranking officials: James Comey, Andrew McCabe, Rod Rosenstein, Peter Strzok, Lisa Page, likely Loretta Lynch.”

“But here’s the bottom line: Crimes have been committed. There is no way that they did not know that the FBI was lying to a FISA court in order to spy on an opposition campaign during an election year. They have aided and abetted what is a massive constitutional violation.”

“Comey, McCabe, Rosenstein and others all need to be investigated and, in many cases, prosecuted to the fullest extent of the law.”

“Now, of course, Comey is running scared. He’s out of his mind right now, now that he is exposed with this memo.”

“[T]he special counsel must be disbanded immediately.”

“And, by the way — nobody else will say this — all charges against Paul Manafort and General Michael Flynn need to be dropped. It’s that simple.”

“This scandal is only in Phase 1. … Stay tuned! Tick tock! “

Source: Axios

“>

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According to Fasanara Capital, which has long argued  that the market’s systemic fragility is approaching its breaking point, markets stand at a critical juncture, ready to snap, as the following note from Fasanara’s Francesco Filia lays out.

* * *

The Market System Is Tight In All Directions

The Four Pillars Holding Markets Up Are Strained, All At The Same Time

Viewed as a combination of intertwined components, each component is showing growing signs of pressure and seem to be running out of road for further advancing. The synchronicity of them, more than any single component taken independently, is what should draw attention, as it compounds systemic risk.

Here are the four components, characterizing the basin of chaotic attraction for markets nowadays:

What happens when the system is tight in its key possible directions of expansion? That it expands no more. Stochastically, on one of the components a tipping point is reached, which jumpstarts the autolytic effect, spreading back through the vectors of the complex system, and snapping the unstable equilibrium into an alternative stable state. That is our thesis.

In this recent interview, we discuss the impending tipping points for markets due to a synchronicity of excess valuations, excess indebtedness, excessively low cash balances and a drawback in excessive public flows.

Let’s give a cursory look across the four components. Again, the list is by no means exhaustive, but rather a work-in-progress (seemingly endless) collecting of data points, following on to our previous work of ‘a long list of anomalies’ here and here.

* * *

1. VALUATIONS: stretched, filled with anti-gravity anomalies, across Bonds and Equities

Several European BBB-rated bonds trading at negative yields

• In November 2017, Veolia successfully issued a 3-year EUR denominated bond with a negative yield of -0.026%, the first time for a BBB rated issuer (source: MarketsInsiders)
• In Jan 2018, Auchan rated BBB+, issued a 2year floating rate note was priced at a yield of -29basis points, currently trading at -28bps (source: Grant’s)
• Anglo American 2020 bond (rated BBB-), currently trading at 14bps, after having spiked up to 14% just two years ago
   

The 2 year Greek Government Bond is now trading almost 100bps lower than the 2year US yield. Greece is rated B- by Fitch and US is rated AAA by the same agency

Is all this due to Central Bank flows? Yes of course. Make sense? Of course not. Indication of a sensible and sustainable market? Probably not. Probability that insanity (and instability) permeates to nearby asset classes, i.e. equity? High.

Cov-lite leveraged loan issuance at all-time highs

​
Covenant-lite is becoming not the exception but rather the norm in the Leveraged Loan markets, across the US and Europe.
Not only yields are minuscule, but the kind of investor protection at those yield is minimal by historical standards.
Counterintuitively, cov-lite are not even signature features of best borrowers: instead, defaults happen mostly within the cov-lite space.

The beauty of the New Economy: Netflix vs General Electric

Netflix gained 52% in January 2018 alone. With the result that Netflix is now days away from crossing General Electric in market cap, despite the latter being 10X larger in revenues.

Wait.. the Old Economy is even better! The chart shows valuation metrics (Enterprise Value on Revenues) for four old economy stocks: Mc Donald’s, Caterpillar, Boeing and 3M

​The narrative being that valuations are oftentimes high because one has to pay for growth

Except, for these four stocks, valuations are double as high as the peak of the past decades, while revenues are falling. Caveat emptor.

P/E Ratios, for smaller caps, are more than double the levels seen in Feb 2000, just before the burst of the Tech Bubble

As shown in our latest FASANARA COOKIE, bond yields have just broken multi-decades downtrend lines. Dividend yields are now below bond yields. The rally in equities compressed dividend yields, all the while as bond yields rose to recent highs, resulting in the two crossing over for the first time in 10 years. In the chart below, current dividend yields are compared to near term yields obtainable on Treasuries. CAPE-projected Earning Yields are now also close to bond yields. The reverse of Shiller P/E, or CAPE, can be seen as a prospective Earning Yield for stocks. This yield is currently approaching bond yields of a comparable tenor. In the chart below, prospective earning yields are compared to long end yields obtainable on Treasuries.​

Recently, we are also seeing more and more evidence of complacency extremism from investor legends:

• Ray Dalio, from Davos, stated: ‘If you’re holding cash, you’re going to feel pretty stupid‘
• Larry Fink, two day later, ‘cash is killing your investment account’
• Leon Cooperman: Why I’m a bull (this one is from August 2007, though)

* * *

2. CASH BALANCES / POSITIONING: stretched.

CASH LEFT TO RETAIL

“Equity investors are already near maximal allocations.‘’ There is only so much the market can rally if equity investors are already near maximal allocations. The table summarizes equity positioning of various types of institutional, as well as retail investors. These allocations are near historical highs, not leaving much room for further increases. Numbers are shown as historical ‘percentiles’. Starting with retail investors one can notice that margin debt (measured as percentage of market capitalization) is at its highest point ever, which includes the 2000 tech bubble episode. The percentage of US household wealth in equities is in its 94th percentile and above its 2007 peak, but slightly below 2000 levels. Sovereign wealth funds and US mutual funds are also near record levels. Pension Fund allocations appear to be in the 88% percentile, although there is some uncertainty around this number in adjusting for private asset and HF holdings. Global Hedge Funds’ allocation (as measured by equity beta) are also near record highs, and Equity Hedge funds’ allocation in their 93rd percentile (since 2005).’’ Marko Kolanovic, J.P. Morgan, 22 November 2017

 

Merril Lynch’s clients allocation to cash as % of AuM is lowest in over a decade. We also know of anecdotal evidence of large private banking teams with 1% of clients’ money left in cash

There has been a clear divergence between cash and stock holdings in the private sector as a percentage of financial assets

What matters is cash vis-a-vis financial assets. The valuation of “cash on the sidelines” works through stock prices. As prices move up and cash prices stay the same, cash naturally becomes a smaller part of the asset allocation mix of households and companies.

Cash today (green line below) makes up only 17% of the average private sector portfolio, almost half of what seen at the beginning of the 80s and close to the all-time lows of 15% experienced at the end of the nineties.

The US personal saving rate dipped below levels last seen at the end of 2007, before the GFC started.

​Few days ago, David Rosenberg noted the decline in savings rate from 3.3% to 2.6%. If it had stayed the same, real PCE would have been 0.8% (annualized) instead of 3.8% and GDP would have been 0.6% instead of 2.6%. Numbers can look even worse if we consider last reading at 2.4%

It now takes the average worker 129 hours to purchase the index level of the S&P.

​That is the highest multiple of all-time, exceeding the previous peak of 108 hours when the tech bubble was fully inflated in March 2000.

* * *

CASH LEFT TO INSTITUTIONAL INVESTORS

Mutual Funds cash balances are at all time lows of 3.3%

The ratio between the S&P and money markets is at all time highs

​The stock to cash ratio at 4.62 is the highest on record, well exceeding 2000 and 2007

As we learn from Jim Grant, last month Calpers (US largest pension Fund with over $346bn portfolio) increased its allocation to both equities and bonds, and its cash holdings dropped from 4% to just 1% of total portfolio. The only dissenter in the vote, board member JJ Jelincic “has advocated for a higher risk portfolio,” while board member Richard Costigan concurred “I am concerned, we’re leaving money on the table.’’

* * *

CASH LEFT TO CORPORATES

Rising cash balances mask a more than proportional rise in gross debt

Total debt outstanding for US corporates continues to rise faster than cash on corporate balance sheets, resulting in rising net debt. Credit growth will not help much today as public debt exploded already to $20tn (vs just $8tn in 2006), and gross corporate debt reached $7tn (vs just $2tn in 2006)

U.S operating cash flow growth is decreasing

​
‘’There’s been a “steady” decline in the growth of net operating cash flow in U.S. stocks, excluding the financial and energy sectors’’, SocGen strategists Andrew Lapthorne

* * *

3. DEBT/LEVERAGE: stretched, especially within pockets of the system.

The falling productivity of new credit lending (decreasing marginal effectiveness of lending) is visibly at play

​Extreme indebtedness and proximity to BIS’ debt saturation point / Rogoff’s debt tolerance limits / Minsky Moment for several subsets within the system, despite the record-low interest rates available to service such debt: China, Turkey, Japan, Italy.

Here below the case of China, one chart amongst many:

US National Debt is now above 20trillion USD, after a long run

​The list of data points for extreme indebtedness is long, not least the IIF metric of global debt on GDP of 327%, an all-time high. Here below we show graphically the exponential trajectory of US finances, just before tax cuts, infrastructure spending, rising deficit.

 

Floating-Rate Debt

​Goldman estimates that more than 40% of the debt of Russell 2000 companies is floating (so dependent on Libor). Recent steep increase on the 3month Libor should command some attention

Rising rates in Emerging Markets

​Everybody is currently focused on interest rates in EU and US which are at multi-year breakage point. But EM is where we are seeing the real action: China 4%, Brazil 10%, India 8%

* * *

4. QE FLOWS/ PFL: stretched, and reversing.

QE tide is receding

What fuelled positive feedback loops in the last years is going to go in reverse in the next years. Asset purchases by major Central Banks (excluding China) are forecast to shrink by more than 70% this year, setting up a large mismatch between supply and demand in global debt markets​,

It is reasonable to expect more than $1tn in liquidity to be withdrawn from the global financial system in 2018 alone

Only when the liquidity tide goes off do you see who has been swimming naked

CONCLUDING REMARKS:

What happens when the system is tight at the same time across VALUATIONS, DEBT/LEVERAGE, CASH BALANCES, FLOWS? The system is tight in all directions, across all modules, which are also tightly intertwined. The probability of a critical transitioning is high when no modules within the system can pick up the slack and stabilise the equilibrium after perturbations.. Analysed through the lenses of Complex Theory, this may qualify as a phase transition zone, where a dramatic regime shift is impending.

Markets are in an uncomfortable spot, where not much escape is available via new lending, not much escape via higher valuations, not much escape with new QE, not much escape with more leverage, not much escape with more cash to deploy.

No escape does not necessarily imply a crash. However, treading water on the ‘edge of chaos’ is dangerous, as any small perturbation has the potential to trigger a critical transformation. An exogenous or endogenous trigger can easily push the equilibrium out of its small basin of attraction. A new equilibrium may be waiting to assert itself, nearby, through chaos.

We are in a phase transition zone, where financial markets are fragile and sit on the ‘edge of chaos’. This is the zone where rare events become typical.

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Two years after your chancellor decides to admit over 1 million undocumented middle-eastern immigrants to boost the economy and instead gets a series of terrorist attacks in return, this is the outcome: “Germans are taking up arms of angst.”

According to Handelsblatt, demand in Germany for non-lethal weapons, including gas pistols, flare and stun guns, as well as pepper spray is on the rise. While in the US, the German magazine notes, every mass shooting is followed by yet another heated gun debate. in Germany gun-related crime is comparatively rare, but the issue of guns is increasingly in the forefront of political discussions.

That’s because sales of freely available arms are booming. The number of applications for small arms permits has set new records. In 2017, 557,560 people obtained such a license. In January 2016, only 300,949 people had a permit. This means ownership soared by a staggering 85% in just under two years.

Following the Paris terror attacks in 2015 and the sexual assaults on women on New Year’s Eve in Cologne the following month, demand for deterrent devices has taken off. “After the attacks in Paris on the Bataclan music venue in November 2015, a wave of uncertainty spilled over to Germany,” said Ingo Meinhard, director of the German association of gunsmiths and gun dealers.

Why the scramble for self-defense? “The fact that Germans are arming themselves might be rooted in a sense of deteriorating safety” Handelsblatt philosophically observes.

There is a growing feeling that the state cannot sufficiently protect its citizens and therefore they must protect themselves. Recent cuts to the police force contributed to the problem.

And, of course, there is the refugee problem. Some see the influx of refugees and migrants to Germany since 2015 as a trigger to a worsening security situation. The number of crime suspects classed as immigrants – including asylum seekers, refugees and illegal immigrants – rose to 174,438 in 2016, an increase of 52.7 percent from the previous year. Interior Minister Thomas de Maizière said.

“This can’t be sugar-coated.”

Others are blaming, what else, “fake news.”

Some experts beg to differ. Although the increasing demand for small firearms proves that citizens feel unsafe, a lot of it comes down to distorted or exaggerated media reports and social media posts by populists, argued André Schulz, head of the Criminal Police Association. It’s not rationally justified and does not reflect the “objective risk situation,” he said.

At least they haven’t blamed Putin yet for Germany’s weaponization scramble.

As discussed previously, while Germany has strict gun control laws, it’s not difficult to obtain a license for non-lethal weapons. The applicant has to be at least 18 years old, though convicted felons, alcohol or drug addicts and people with a record of mental illness are barred. “The authorities examine the applicants thoroughly,” said Mr. Meinhard. “No one should be afraid of these people.”

However, Holger Stahlknecht, state interior minister in Saxony-Anhalt, isn’t convinced. He worries about the current trend and warns that arming oneself with small weapons can lead to a false sense of security. “Obviously, people believe they are buying safety with a small gun license,” he said.

“However, this sense of security is deceptive, since these weapons could escalate a situation and could even be used against the owner.”

One thing is clear: Germany is becoming increasingly militant in response to what many thought was a problem that ended when Merkel ended her “closed door” policy. And while for now the spike in self-defense measures is confined to non-lethal means, a few more terrorist attacks and this too will surely change.

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Authored by Chris Martenson via PeakProsperity.com,

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