Category: zerohedge

Authored by Sven Henrich via NorthmanTrader.com,

Retail investors are worshipping at the altar of FOMO (fear of missing out). It may prove to be a painful experience.

Never before has retail gotten this aggressively exposed to stocks.

Just in time when central banks and buybacks are pulling back. I talked a bit about this in the recent The Carrot Top, but I want to expand a bit on this to issue a general warning for retail: The boat is fully loaded in one direction. Be aware.

Wall Street will not warn retail, they’ll keep pushing the envelope until the very bitter end. It’s actually quite easy to be a bull. Keep raising targets, always be optimistic, and when something breaks shrug your shoulders and say: Hey what are you gonna do? Stuff happens. The Fed will come to the rescue.

And the cycle begins anew.

You know the drill:

Just remember, Wall Street will never tell you to sell.#2008forecasts http://pic.twitter.com/c664pSO1No

— Sven Henrich (@NorthmanTrader) July 14, 2017

Remember the primary job of Wall Street is to get retail to invest, and to be fair, they are doing a fabulous job.

And so every December we see the same annual ritual. Here’s the message sent to retail, we can only go higher. $SPX targets for 2018:

Here’s a visual from BAML:

The primary argument: Wall Street is not yet euphoric:

Really? What’s this:

$DJIA futures weekly RSI 86.78.
Pedal to the metal till it melts. http://pic.twitter.com/NYLFODHht7

— Sven Henrich (@NorthmanTrader) December 4, 2017

Not euphoric? Let’s dig in a bit deeper into the data.

 

You may have seen my Rydex chart indicating record bullish allocations in The Carrot Top:

Last night Jesse Felder sent me some more data points confirming the same:

More data:

The American Association of Individual Investors’ asset-allocation poll shows members’ exposure to stocks are as heavy as it was near the 2000 peak. Cash allocations fell 1.2 percentage points to 13.9%. Cash allocations were last lower in December 1999 (12.0%).

Also:

TD Ameritrade’s Investor Movement Index of retail activity “saw its largest single-month increase ever in November, increasing over 15% to hit an all-time high of 8.53. TD Ameritrade clients were net buyers for the tenth consecutive month.”

Combine it with sentiment:

Via Reuters:

“52 percent said they believed the stock market could sustain continued growth for five years without a downturn of 10 percent or more.”

Confident much?

It’s actually the perfectly logical conclusion of what central bank interventions have wrought:

The BOJ balance sheet is now at 121% of GDP the ECB’s at 41% of GDP.

The result of course is we haven’t corrected at all. We are now in the longest market period without even a 5% correction. Ever:

We haven’t had a single down month in 2017 which historically has never happened either:

And the rush into long equity funds has been unprecedented:

Get us into stocks. We can’t go down, we can only go up. FOMO.

So when I say central banks have created a monster I really mean it.

And so it’s no surprise that central bank policy is viewed by some as the greatest risk to asset prices in 2018:

Mohammed El-Erian:

“The biggest risk to asset prices and the global economy would be if the biggest institutions reduce their monetary stimulus at the same time. Rather than reflecting the prospects of individual institutions, the greatest monetary policy uncertainty facing the global economy is what would happen if all these central banks, along with the People’s Bank of China, were to decide to reduce their monetary stimulus at the same time. When it comes to central banks, this is the biggest source of risk to asset prices and the global economy, and it would call for high-frequency policy monitoring and close international consultations.”

Asset prices are a central bank planned construct that has resulted in retail being completely long and fully exposed to equities.

And I have not even addressed the trillions of dollars exposure all being long short $VIX products:

BAML has a phrase for this: “Yield starvation forces selling volatility for yield”. “Forces” being the operative word:

Note the center piece: “Unprecedented central bank policy & low growth recovery”.

By the way I’m not picking on BAML here, not at all.

But I’m highlighting that 2017 has seen an unprecedented rush by retail into the most highly valued stock market since 1900 according to Goldman, a market that remains entirely uncorrected.

But nobody is issuing any risk warnings here. Keep going long my friends we can only go higher and if there’s a dip buy it. And no doubt this strategy has worked.

My perspective remains a variant one: This singularly oriented market construct is at extreme high risk that some trigger will pop all of this.

In a world where nothing has mattered and corrections have disappeared altogether it may be a fair question to ask what such a trigger may be. I’ll leave that for a future post, but I will say this: Triggers are often the excuse to assign cause after the fact. But it is the construct itself that seeds the depth of the ultimate unwind.

Worshippers at the altar of FOMO have come accustomed to no dip ever lasting. Will they find themselves slow to react when one does?

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In an announcement that brings the federal government to the verge of a weekend shutdown, Nancy Pelosi said Democrats won’t support a Republican bill for a two-week funding extension because almost none of their demands have been met.

Meanwhile, Speaker Paul Ryan says he feels confident about the vote count for the Republican’s short-term extension that would kick in after a continuing resolution approved in September to fund the government through midnight, Friday expires.

According to Bloomberg, the bill is a “waste of time” that doesn’t include funding for combating the opioid crisis, among other priorities like enshrining DACA provisions into law, something Pelosi has said must happen before the end of the year.

Pelosi added that she hopes she and Chuck Schumer, her counterpart in the Senate, can work out a deal suitable to both parties when they meet with President Donald Trump later today.

The House Rules committee last night approved a rule change to allow Republican leaders to bring the bill to a vote Thursday.

The decision on a stopgap bill with a Dec. 22 end-date came after Ryan and his leadership team held discussions on overall budget strategy with the leaders of the restive House Freedom Caucus. A formal check of how members would vote came back showing widespread support, said Representative Dennis Ross, a member of the vote-whipping team.

As we pointed out yesterday, the continuing resolution that's been funding the government for the last two months, and yet many battles over a host of intractable issues are still being fought. At this point, passing something by midnight Friday – when the continuing resolution expires -is looking increasingly problematic.

As the Wall Street Journal pointed out, GOP lawmakers are also divided over when to tackle the Dreamers issue.

President Donald Trump in September ended an Obama-era program shielding the children of undocumented immigrants from deportation, with the protections beginning to expire in early March, giving Congress six months to pass legislation protecting them.
 

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Yesterday, following the “retirement” of John Conyers (D-MI), the chants for Senator Al Franken to follow suit reached a fevered pitch on the suggestion that anything less would simply be racist.  The chaos gradually escalated throughout the day with Minnesota Public Radio eventually “confirming” that Franken would resign today…a confirmation that Franken subsequently denied (we covered the chaos here). 

Now, The Hill is seemingly once again “confirming” an imminent resignation by reporting that Minnesota Governor Mark Dayton would likely tap Lt. Governor Tina Smith to replace Franken should he choose to resign in the wake of sexual misconduct allegations.

Alas, the back and forth suspense over Franken’s future in the Senate has nearly come to an end as he is set to deliver a speech on the Senate floor at 11:45AM EST.

Senator Franken is scheduled to deliver a speech from the Senate floor at 11:45 AM ET.

— Sen. Al Franken (@SenFranken) December 7, 2017

So what say you?  Will Franken remain defiant amid growing calls for his resignation or step down in disgrace?  Tune in below to find out…

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It is undisputed that the last 2 quarters have demonstrated an impressive jump in corporate earnings growth, if mostly due to a beneficial base effect from plunging 2016 earnings which pushed them below levels reached in 2014. And naturally, this rebound has been more than priced into a market which has seen substantial multiple expansion since the Trump election to boot. But what is much more important for the market is what corporate earnings look like in the future, and it is here that Bank of America has just raised a very troubling red flag.

According to BofA’s Savita Subramanian, in November the S&P 500’s three-month earnings estimate revision ratio (ERR) fell for the fourth consecutive month to 0.99 (from 1.03), indicating that for the first time in seven months, there were more negative than positive earnings revisions, needless to say a major negative inflection point in the recent surge in profits. The bank’s more volatile one-month ERR also weakened to 0.94 (from 1.16).

A breakdown of EER by sector showed a sudden and broad-based deterioration, as the three-month ERR weakened across eight of the 11 sectors, with Materials, Health Care, and Financials seeing the biggest declines while, not surprisingly, Tech and Energy have the highest three-month ERRs, with Energy’s ERR expanding the most on the back of rallying oil prices. Meanwhile, Telecom, Real Estate, and Discretionary have the weakest ratios, and November saw a drop in the Health Care and Industrials’ EER ratio below 1.0 (meaning more cuts than raises to earnings forecasts) for the first time since March. Furthermore, while two sectors have been “improving” in recent months: namely Energy and Tech whose ERRs have been rising; all other sectors have seen their ERRs roll over.

Why is this significant?

As BofA explains, the three-month S&P 500 ERR is used by the bank as one of its 19 key “bear market signposts”, and with the one-month ERR falling below 1.0 for the second time in six months, this marks the trigger for the 11th bear market signpost. BofA’s ERR rule is triggered when, over a six-month window, all of the following criteria are met: 1) the one-month ERR falls from above 1.0 to below 1.0; 2) the one-month ERR is below 1.0 for two or more months; and 3) the three-month ERR falls below 1.1 for at least one month.

Incidentaqlly, the hit rate of the “ERR” bear market indicator, meaning its historical accuracy in predicting a bear market is 100%, the only question is how long it takes. The last time this trigger was set was mid-2003, and here is the punchline from Bank of America:

Since 1986, a bear market has followed each time that the ERR rule has been triggered. While individual signposts may not be useful for market timing (this one was triggered several years too early in the last two cycles), prior bear markets were preceded by a broader array of signals having been triggered.

This is shown in the chart below:

Ok so one indicator out of 19 now is flashing “bear market” dead ahead. That’s hardly bad if the rest are all green, right? Well, they aren’t.

As discussed two weeks ago, Bank of America recently compiled a list of bear market signposts that have always occurred ahead of bear markets. No single indicator is perfect, and as Subramanian wrote, “in this cycle, several will undoubtedly lag or not occur at all.” And while single indicators may not be useful for market timing, they can be viewed as conservative preconditions for a bear market. In this context, the suddenly “triggered” ERR indicator is one of the bank’s 19 bear market signposts.

Here a caveat is warranted: in the last two cycles, the ERR rule was triggered several years too early (Chart 3 above), although a bear market followed each time that the ERR rule has been triggered. As for timing, the more signposts triggered, the greater the risk of an imminent bear market, in BofA’s view. And in November, the one-month ERR falling below 1.0 for the second time in six month marked the 11th trigger (out of 19). This is shown in the table below.

It also means that nearly two-thirds of Bank of America’s bear market indicators have now been triggered. As Subramanian concludes “every cycle is different, but we expect to see more signposts triggered before the eventual market peak.“

Then again, this remains a “market” where even if 12 out of the 11 indicators are triggered, it may just send the S&P limit up as there is no point in selling if all that does is guarantee another central bank bailout.

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Via The Knowledge Leaders Capital blog,

Our long-time readers are familiar with the work of Professor Baruch Lev of the NYU Stern School of Business, whose research forms the basis for the Knowledge Leaders investment strategy. In his decades-long study of financial records, Lev first discovered a link between a firm’s knowledge capital and its subsequent stock performance, ultimately identifying a market inefficiency that leads highly innovative companies to deliver excess returns. We call this market anomaly the Knowledge Effect.

In a new article in Financial Analysts Journal, Lev and co-author Feng Gu continue to advance the findings on intangibles. The article, “Time to Change Your Investment Model,”  identifies that earnings prediction has lost “much of its relevance in recent years.”

As a form of predicting corporate results, “earnings no longer reliably reflect changes in corporate value and are thus an inadequate driver of investment analysis.”

The basis for this shift, the authors explain, occurred after the emergence of the semiconductor.

“Starting in the early 1980s, investment in traditional, tangible assets (structures, factories, machinery, inventory) – considered assets by accountants and reported accordingly on the balance sheet – dropped precipitously from 15% of gross added value in 1977 to 9% in 2014, a 40% drop.

 

In contrast, the investment rate in intangible capital (R&D, patents, information systems, brands, media content, business processes) – mostly expensed in corporate income statements – increased continuously from 9% to 14% of added value, a 56% increase. This radical business model transformation came to be known as the knowledge – or information revolution, an irreversible trend in developed economies.”

As a result, for companies, “the only way to survive and prosper in such a competitive environment (is) through constant product and process innovation, achieved primarily by investing in intangible assets.” Therefore, “earnings’ usefulness to investors declines sharply for companies that increasingly rely on intangible value-creating assets.”

For these reasons, “GAAP-based reported earnings no longer reflect the periodic value changes (growth) of most business enterprises, and thus conventional earnings-based security analysis has lost much of its usefulness for investors in recent years.”

In summary, the authors observe:

“The disappointing returns on managed funds in recent years should raise doubts about the continued usefulness of conventional security analysis. Our extensive empirical evidence on the loss of relevance of GAAP numbers, in both this article and our recent book, confirms these doubts. Certain major investors have already departed from the status quo. … We propose a different course: Rather than replace analysts with robots, substitute an improved investment methodology for an outdated one.”

If you’re interested in reading Lev and Gu’s article, download it here. Stay tuned for more on Professor Lev’s research in early 2018 and an in-depth Q&A on his latest research on intangible capital.

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As we countdown to the launch of bitcoin futures trading on the CBOE (10 December) and CME (18 December), the big banks – via the Futures Industry Association – have suddenly got cold feet about the risks. We don't blame them, somebody's going to get hurt, the only question is who. The banks are worried it could be them. The FIA’s “primary” members include all of the usual suspects like JPM, Goldman, Citi, Bank of America, Morgan Stanley, etc. The risk they are most concerned about relates to clearing houses which, ultimately, they stand behind. The problem, of course, boils down to Bitcoin’s volatility, something we flagged after the CME announced circuit breakers early last month.

Having taken a gamble on bitcoin futures, which are set to begin trading by the end of the year, the CME is now seeking to avoid the consequences of what has emerged as both the cryptocurrency's best and worst selling point: its unprecedented volatility…While the CME already uses daily vol limits on most other markets, including crude, gold and market futures, to temporarily halt trading when price swings get out of control, the CME has never before dealt with something like bitcoin

In June, Bloomberg showed how Bitcoin’s 30-day volatility had risen to 100%, which was comparable (at the time) with one of the most volatile financial instruments they (and we) could probably think of – a three-times levered ETF in junior gold miners.

The CME has proposed three trading limits for Bitcoin futures, 7%, 13% or 20% up or down from the previous day’s closing price. The first two thresholds, for 7% and 13% moves, are “soft” limits, which would trigger a two-minute pause in trading of bitcoin futures. The 20% limit would be a hard stop after which trading would be halted. In the first ten months of Bitcoin trading in 2017, Coindesk calculated there had been 69 days in which Bitcoin moved at least 7%, 11 days in which it moved 13% and two days in which it moved 20%. In fact, we had another 20% intra-day move on 29 November 2017.

As the Financial Times reports, the banks – via the Futures Industry Association – is sending a letter to the CFTC which it will publish today.

The world’s largest banks are pushing back on the introduction of bitcoin futures, raising concerns with US regulators that the financial system is ill-prepared for the launch of the contracts as the value of the volatile cryptocurrency has soared. On Wednesday, the price of bitcoin climbed to a fresh record high of more than $14,000. Institutional investors have been keen to trade the asset but only via a regulated market.

However, the planned launch in the next 10 days of futures contracts by the Chicago exchanges CME Group and CBOE Global Markets, given a green light from the Commodity Futures Trading Commission last week, has prompted a backlash among the major brokers who backstop trading across the industry. The Futures Industry Association, the main futures industry lobby group, plans to send a letter to the CFTC that will be published on Thursday.

We could be forgiven for thinking this is all very “last minute”. The CME announced its launch of Bitcoin futures trading back in October and had been canvassing opinion from market participants, including the banks, for months beforehand. The FT confirms that it was seen a draft of the FIA’s letter in which the latter states that the introduction of Bitcoin futures “did not allow for proper public transparency and input”. This is self-evident, resulting from the launch of futures trading contracts being fast-tracked by all parties after Bitcoin’s price rose parabolically this year. As part of this fast track process, the CME and CBOE adopted a “self-certified regime” for the contracts, meaning that the normal regulatory oversight didn’t take place. As the FT notes, the FIA is belatedly calling for a review.

Using it (self-certified regime) for “these novel products does not align with the potential risks that underlie their trading and should be reviewed”, the draft reads. The CFTC warned last week during its approval process that the emerging cryptocurrency markets were largely unregulated and the agency had “limited statutory authority”. “It is also our understanding that not all risk committees of the relevant exchanges were consulted before the certification to launch these products,” the letter added.

Getting into the “nitty gritty”, even though the banks have been discussing the specification of the contracts for about six months (according to the CME), as the moment of truth approaches, they’ve “zeroed in” on the fragility of clearing houses. With so much Bitcoin trading occurs on other exchanges and outside the hours of CME/CBOE (even if they trade Sundays), the banks have realised their vulnerability.

Futures brokers are worried they will bear the brunt of the risk associated with bitcoin futures, because the margin that backstops the contract is placed in a clearing house. Clearing houses stand between two parties in a trade, managing the risk to the rest of the market if one side should default. They are mutually funded in part by banks to guard against the failure of their largest members. Several brokers among the top 10 largest providers have privately confirmed to the Financial Times that they will not clear the products immediately.

One clearing broker said that it would be open-minded about cryptocurrencies, as they were US dollar products, but only if they were “properly controlled and regulated”. However he added: “We’d still be on the hook in a worst-case scenario as we are exposed as members of the clearing house.”

Sometimes “old heads” are useful in these circumstances. Speaking on Bloomberg TV, Royal Bank of Scotland Chairman, Howard Davies, said he would advise the CME and CBOE against launching Bitcoin futures.

"I’m not quite sure that they know enough about what the underlying is, about the nature of the supply and demand of the underlying. I think it would be a very risky move for them in reputation terms. This is irrational exuberance. This is a very, very unusual market, that shows we’re not in a normal two- way trading market. Blockchain is much more interesting. The idea of a distributed ledger, which makes transactions and payment systems much cheaper and faster in real time is a good one. Blockchain, I think, has got life in it.”

Thomas Peterrfy, the founder, Chairman and CEO of Interactive Brokers (the one who fronts the company’s slightly irritating TV ads) is one of the “giants” of electronic trading in US financial markets. The FT noted Interactive Brokers' stance.

”Thomas Peterffy, a pioneer of electronic trading and head of Interactive Brokers, has warned that the introduction of bitcoin futures into a clearing house could increase systemic risk. On Wednesday Interactive said its clients would be unable to short the bitcoin futures market because of the extreme volatility of bitcoin.

It looks like the banks have realised Peterffy might be right in limiting trading of Bitcoin futures.

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The chaotic trading in cable continues, this time spiking to the upside after Bloomberg reports that the EU and U.K. have reached an agreement on the sensitive issue of the role of the European Court of Justice after Brexit, according to two people familiar with the matter.

The agreement on the court leaves the Irish border as the only obstacle to talks moving on to the future relationship.

As a reminder, EU leaders are due to decide whether talks can move on at a summit on Dec. 14-15.

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The unemployed in America are telling Bloomberg that they have not been more comfortable since April 2001…

Is that a good thing?

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Via Dana Lyons' Tumblr,

After a record run of muted movement, will recent volatility send negative shock waves through stock market?

The recent uptick in stock volatility has some investors on edge (OK, it is mostly just financial news editors on edge). The truth is, while volatility over the past week has seen an increase, it is not all that far away from the historical norm. Last Thursday through Monday, for example, the Dow Jones Industrial Average (DJIA) experienced 3 straight “volatile” days, with daily ranges of between 1% and 1.6% on all 3 days. Looking historically, however, we find that the average daily range in the DJIA over the last 90 years is 1.6%. Even during the current bull market since 2009, the average range is 1.08%. Thus, the recent action should hardly be characterized as volatile.

The reason it perhaps seems so tumultuous is because we are emerging from a long stretch of calm in the market – record calm, at that. Prior to Thursday, the DJIA had gone 72 days without experiencing a daily range as wide as 1%. If that sounds like a long stretch, it’s because it is a record. In fact, the record prior to this recent streak was just 49 days in a run that ended in late February of this year. And prior to 2016, the record going back to 1928, according to our database, was a mere 32-day streak back in 1944 – less than half the recent streak.

Furthermore, historically, there have been just 16 streaks that have lasted as long as 21 days, i.e., 1 month.

Interestingly, this recent streak is the first of any of the 16 that saw 3 straight 1% daily ranges immediately following its culmination. So is mean-reversion starting to rear its volatile head here following the record calm? And is there a nefarious message to the sudden uptick in volatility?

*  *   *

If you’re interested in the “all-access” version of our charts and research, please check out The Lyons Share. Find out what we’re investing in, when we’re getting in – and when we’re getting out. Considering that we may well be entering an investment environment tailor made for our active, risk-managed approach, there has never been a better time to reap the benefits of this service. Thanks for reading!

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A consultant who worked with the highly politicized Consumer Financial Protection Bureau (CFPB) claims the organization funneled a large portion of over $5 billion in collected penalties to "community organizers aligned with Democrats" as part of a giant slush fund, the Post reports. 

[The CFPB] Funneled a large portion of the more than $5 billion in penalties collected from defendants to community organizers aligned with Democrats — “a slush fund by another name,” said a consultant who worked with CFPB on its Civil Penalty Fund and requested anonymity.

Created six years ago as the brainchild of Senator Elizabeth Warren and slipped into the Dodd Frank bill before it was passed by Congressional Democrats, the CFPB became one of the most powerful agencies in D.C., with the ability to exercise enormous power over the U.S. economy while its budget remained unencumbered by congressional oversight. As one Hill writer put it:

The problem is that this agency and its director were set up to be free from the control of the Congress. Congress’s fundamental obligation to oversee and fund such bureaus or agencies is short-circuited when it comes to the CFPB. In structuring it in the manner written by now-Sen. Warren (D-Mass.), the law abrogated the idea of a government by the people, for the people and of the people.

 

Instead, it established an autocratic and unaccountable power center for people of Warren’s ideological persuasion — those who view our market economy as an enemy that must be managed by a chosen few. The creation of the CFPB as a rogue agency with a dictatorial leader is one of the most significant acts of malfeasance perpetrated on the American constitutional system since the Sedition Acts of 1798. 

The reins of the CFPB were handed over to Trump appointee Mick Mulvaney last week following the resignation of Director Richard Cordray, but not before Deputy Director Leandra English's unsuccessful attempt to block Mulvaney's appointment in a complaint filed against Trump and Mulvaley in a DC court. 

After a Federal judge ruled that Mulvaney is now acting director of the CFPB – his first order of business was to institute a 30-day freeze on all new hiring and regulations. 

The Consumer Financial Protection Bureau, or CFPB, has been a total disaster as run by the previous Administrations pick. Financial Institutions have been devastated and unable to properly serve the public. We will bring it back to life!

— Donald J. Trump (@realDonaldTrump) November 25, 2017

Both President Trump and Mick Mulvaney have had strong opinions about the CFPB in the past, with Mulvaney saying “It is a completely unaccountable agency, and I think that’s wrong,” and adding “If the law allowed this place not to exist, I’d sit down with the president to try to make the case that other agencies can do this job well if not more effectively.” Mulvaney also called the agency "a sad, sick joke." 

Aside from the $5 billion "slush fund" detailed in the Post, the CFPB has also engaged in the following: 

• Bounced business owners and industry reps from secret meetings it’s held with Democrat operatives, radical civil-rights activists, trial lawyers and other “community advisers,” according to a report by the House Financial Services Committee.
• Retained GMMB, the liberal advocacy group that created ads for the Obama and Hillary Clinton presidential campaigns, for more than $40 million, making the Democrat shop the sole recipient of CFPB’s advertising expenditure, Rubin says.
• Met behind closed doors to craft financial regulatory policy with notorious bank shakedown groups who have taken hundreds of thousands of dollars in federal grant money to gin up housing and lending discrimination complaints, which in turn are fed back to CFPB, according to Investor’s Business Daily and Judicial Watch.

Moreover, the CFPB secretly assembled several massive consumer databases which raise privacy and corporate liability concerns. "One sweeps up personal credit card information and another compiles data on as many as 230 million mortgage applicants focusing on “race” and “ethnicity.”" reports The Hill. Another database contains over 900,000 unvetted grievances against financial companies, points out Alan Kaplinsky, lead regulatory attorney for Ballard Spahr LLP.

Think a database of google's depth, but used solely by the government.

In this context, Mick Mulvaney appears to be the right tool for the President's vow to "put the regulations industry out of business," which he says will lead to higher employment and higher wages. 

“If you’re wondering about his commitment to deregulation, don’t,” Mulvaney said in front of a libertarian gathering a few months ago, “because this is one of the things he pounds on again and again and again.”

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