Category: zerohedge

Make no mistake, investors didn’t need any more reasons to be bearish on Chinese equities.

Mainland markets are veritable casinos dominated by retail investors who until last summer, were enthralled with the prospect of easy riches in an environment where shares only seemed to know one direction: up.

All of that changed last June when a dramatic unwind in the half dozen backdoor margin lending channels that helped to fuel the rally triggered an epic rout that became self-fulfilling once the retail crowd (which accounts for 80% of the market) became rip sellers rather than dip buyers.

Since then, successive efforts on the part of the CSRC to stabilize the situation by pouring CNY1.5 trillion into A-shares has met with limited success as periods of calm are interrupted by violent bouts of selling like those we saw earlier this month when China tried and failed to implement a circuit breaker.

Throw in the ongoing yuan deval fiasco and there’s every reason not to be involved in Chinese stocks.

But when it rains it pours, and now, analysts say margin calls on SCLs are the next landmine that may pose a “systemic risk” for China’s battered markets.

“Some companies that had pledged shares as collateral for loans are now faced with a stark choice – dump them under pressure from impatient brokers and banks and book a loss, or stump up fresh cash or other assets to make up for the difference in value,” Reuters writes.

This is a rather large problem. Over half of all listed companies have their shares pledged. As BofA notes, “1,411 A-share companies have had some of their shares been pledged for SCLs by their major shareholders, representing 50.2% of the total number of A-shares. The value of stocks pledged for SCLs has been rising consistently – from Rmb2.36tr on 1 July 2015 to Rmb3.05tr by 1 Jan 2016, i.e., up by 29% in 2H15.”

In short, the steep decline in margin financing paints an incomplete picture when it comes to understanding how much leverage is in the system. 

On one hand, the headline figure on margin financing suggests quite a bit of deleveraging has taken place since things hit peak absurdity last spring. Here’s a look at how quickly the unwind materialized once things began to get dicey:

But as the SCL chart shown above demonstrates, the decline in headline margin debt only tells part of the story. Indeed, BofA says even the CNY3.05 trillion number for SCLs may be underestimate the amount of leverage in the market. “Our SCL data might have under-estimated the true extent of such activities because 1) only major shareholders, i.e., those who own more than 5% of a company’s stocks, are obliged to disclose their SCL activities; and 2) we have assumed a 12-month duration for the 2,889 deals, 44% of the total, that have no ending date disclosed vs. over 16 months on average for those that have,” the bank writes. 

Where things get truly frightening is when one looks under the hood on these deals. 

Have a look at the following table which shows that of companies with pledged shares, an astonishing 82% were trading at a multiple of 50X or more at the time of their pledging:

“The collateral value,” BofA says dryly, “is far from solid.”

“If the market continues to fall, equity pledging-related selling pressure could increase significantly,” Gao Ting, head of China strategy with UBS warns. 

To let BofA tell it, fully a third of SCLs will face margin call pressure and some 371 of the 1,411 stocks pledged have already hit their triggers. “Assuming 40% loan-to-asset value at the time of SCL granting, our analysis suggests that by now, 371 stocks, worth Rmb641bn based on their current market values, have seen their share prices reached the stop-loss levels; and additional 281 stocks, worth Rmb310bn, the warning levels.”

What happens when the margin calls start you ask? Well, nothing good.

“When a position has to be closed for transactions using floating shares as collateral, the pledger sells on the secondary market, putting further pressure on the stock market,” Ting cautions.

Right. Which means stocks fall further and trigger more margin calls which means more forced liquidations in a never-ending, self reinforcing loop. Or, as Reuters puts it: “[It’s] a vicious cycle where further share price drops are likely to trigger more margin calls and threaten further forced sales.“

And this isn’t some hypothetical – it’s already started. “On Jan 18, some stocks of a company used as collaterals for a SCL were liquidated by the lender, which prompted its share price to limit down the next day,” BofA recounts. “The stock had been suspended from trading since then. So far, at least 11 A-shares have been suspended as their prices approached the cut-loss levels.”

“On Thursday, trading in shares of Maoye Communication and Network Co Ltd was halted after it said it received notice that its controlling shareholder faces margin calls, one of at least eight companies that have made similar announcements so far this year,” Reuters adds.

Note that if this entire thing were to unwind it would be larger than if every bit of margin debt were squeezed out of the system. BofA figures the  average loan-to-asset value is about 40%. Apply that to the CNY3.05 trillion pile of collateralized stocks and you’ve got the potential for a CNY1.22 trillion unwind.

And it gets still worse. Remember China’s multi-trillion yuan black swan, the WMP industry? Well the WMPs are involved here too. Here’s an example, again from BofA:

We cite a recently reported example involving the controlling shareholder of Guangxi Future Technology. According to articles by Securities Times (Jan 19) and 21st Century Business Herald (Jan 20), in December 2015 Pudong Development Bank set up a WMP called Tebon Huijin No.1 Asset Management Plan to fund the shareholder’s purchase of its own company’s shares. Essentially, the WMP buyers, as the senior tranche investors, lent money for the shareholder to buy their own stock. Similar to other structured WMPs, this product has a stop-loss clause, and the company’s share price dropped below the stop-loss level on Jan 18. As the controlling shareholder did not put up additional margin, Pudong Development Bank liquidated all stock in the plan (equivalent to 2.13% of the company’s outstanding shares). This is the first case of forced liquidation by such products but in our view there could be additional cases given how sharply the market has declined in recent weeks.

In short, this is a house of cards built on a still enormous amount of leverage. At the risk of mixing metaphors, the problem here is that once the dominos start to fall, it will be impossible to stop the downward momentum.

The takeaway: “we’re going to need a bigger plunge protection team”…

via Zero Hedge http://ift.tt/1JNjvpG Tyler Durden

Submitted by Clare Bernishvia TheAntiMedia.org,

The World Health Organization announced it will convene an Emergency Committee under International Health Regulations on Monday, February 1, concerning the Zika virus ‘explosive’ spread throughout the Americas. The virus reportedly has the potential to reach pandemic proportions — possibly around the globe. But understandingwhy this outbreak happened is vital to curbing it. As the WHO statement said:

“A causal relationship between Zika virus infection and birth malformations and neurological syndromes … is strongly suspected. [These links] have rapidly changed the risk profile of Zika, from a mild threat to one of alarming proportions.

 

“WHO is deeply concerned about this rapidly evolving situation for 4 main reasons: the possible association of infection with birth malformations and neurological syndromes; the potential for further international spread given the wide geographical distribution of the mosquito vector; the lack of population immunity in newly affected areas; and the absence of vaccines, specific treatments, and rapid diagnostic tests […]

 

“The level of concern is high, as is the level of uncertainty.”

Zika seemingly exploded out of nowhere. Though it was first discovered in 1947, cases only sporadically occurred throughout Africa and southern Asia. In 2007, the first case was reported in the Pacific. In 2013, a smattering of small outbreaks and individual cases were officially documented in Africa and the western Pacific. They also began showing up in the Americas. In May 2015, Brazil reported its first case of Zika virus — and the situation changed dramatically.

Brazil is now considered the epicenter of the Zika outbreak, which coincides with at least 4,000 reports of babies born with microcephaly just since October.

When examining a rapidly expanding potential pandemic, it’s necessary to leave no stone unturned so possible solutions, as well as future prevention, will be as effective as possible. In that vein, there was another significant development in 2015.

Oxitec first unveiled its large-scale, genetically-modified mosquito farm in Brazil in July 2012, with the goal of reducing “the incidence of dengue fever,” as The Disease Daily reported. Dengue fever is spread by the same Aedes mosquitoes which spread the Zika virus — and though they “cannot fly more than 400 meters,” WHO stated, “it may inadvertently be transported by humans from one place to another.” By July 2015, shortly after the GM mosquitoes were first released into the wild in Juazeiro, Brazil, Oxitec proudly announced they had “successfully controlled the Aedes aegypti mosquito that spreads dengue fever, chikungunya and zika virus, by reducing the target population by more than 90%.”

Though that might sound like an astounding success — and, arguably, it was — there is an alarming possibility to consider.

Nature, as one Redditor keenly pointed out, finds a way — and the effort to control dengue, zika, and other viruses, appears to have backfired dramatically.

The particular strain of Oxitec GM mosquitoes, OX513A, are genetically altered so the vast majority of their offspring will die before they mature — though Dr. Ricarda Steinbrecher published concerns in a report in September 2010 that a known survival rate of 3-4 percent warranted further study before the release of the GM insects. Her concerns, which were echoed by several other scientists both at the time and since, appear to have been ignored — though they should not have been.

Those genetically-modified mosquitoes work to control wild, potentially disease-carrying populations in a very specific manner. Only the male modified Aedes mosquitoes are supposed to be released into the wild — as they will mate with their unaltered female counterparts. Once offspring are produced, the modified, scientific facet is supposed to ‘kick in’ and kill that larvae before it reaches breeding age — if tetracycline is not present during its development. But there is a problem.

According to an unclassified document from the Trade and Agriculture Directorate Committee for Agriculture dated February 2015, Brazil is the third largest in “global antimicrobial consumption in food animal production” — meaning, Brazil is third in the world for its use of tetracycline in its food animals. As a study by the American Society of Agronomy, et. al., explained, “It is estimated that approximately 75% of antibiotics are not absorbed by animals and are excreted in waste.” One of the antibiotics (or antimicrobials) specifically named in that report for its environmental persistence is tetracycline.

In fact, as a confidential internal Oxitec document divulged in 2012, that survival rate could be as high as 15% — even with low levels of tetracycline present. “Even small amounts of tetracycline can repress” the engineered lethality. Indeed, that 15% survival rate was described by Oxitec:

“After a lot of testing and comparing experimental design, it was found that [researchers] had used a cat food to feed the [OX513A] larvae and this cat food contained chicken. It is known that tetracycline is routinely used to prevent infections in chickens, especially in the cheap, mass produced, chicken used for animal food. The chicken is heat-treated before being used, but this does not remove all the tetracycline. This meant that a small amount of tetracycline was being added from the food to the larvae and repressing the [designed] lethal system.”

 

Even absent this tetracycline, as Steinbrecher explained, a “sub-population” of genetically-modified Aedes mosquitoes could theoretically develop and thrive, in theory, “capable of surviving and flourishing despite any further” releases of ‘pure’ GM mosquitoes which still have that gene intact. She added, “the effectiveness of the system also depends on the [genetically-designed] late onset of the lethality. If the time of onset is altered due to environmental conditions … then a 3-4% [survival rate] represents a much bigger problem…”

 

As the WHO stated in its press release, “conditions associated with this year’s El Nino weather pattern are expected to increase mosquito populations greatly in many areas.”

Incidentally, President Obama called for a massive research effort to develop a vaccine for the Zika virus, as one does not currently exist. Brazil has now called in 200,000 soldiers to somehow help combat the virus’ spread. Aedes mosquitoes have reportedly been spotted in the U.K. But perhaps the most ironic — or not — proposition was proffered on January 19, by the MIT Technology Review:

“An outbreak in the Western Hemisphere could give countries including the United States new reasons to try wiping out mosquitoes with genetic engineering.

 

“Yesterday, the Brazilian city of Piracicaba said it would expand the use of genetically modified mosquitoes …

 

“The GM mosquitoes were created by Oxitec, a British company recently purchased by Intrexon, a synthetic biology company based in Maryland. The company said it has released bugs in parts of Brazil and the Cayman Islands to battle dengue fever.”

via Zero Hedge http://ift.tt/1SpyzLq Tyler Durden

We’ve long known that Canada, like Sweden and Denmark, is sitting on a giant housing bubble.

Indeed we took a close look at the issue back in March of last year and have revisited in on several occasions since. Put simply, the divergence between crude prices and the country’s housing market simply isn’t sustainable a you can see from the following chart:

And while the boom is rapidly turning to bust in places like Calgary, things are humming right along in Waterloo, where Napoleon was defeated in 1815. No, wait – wrong Waterloo. This is Waterloo, Ontario, a town of 140,000 that’s being billed as “Canada’s Silicon Valley.”

As Bloomberg reports, “the town revolves around two universities and a burgeoning technology sector that’s attracted companies such as Google Inc. and dozens of startups.” Here’s a look inside the Kitchener-Waterloo Google office:

The buzz has created a “land grab” and now, condos are renting for nearly C$2,000 per month while one-bedroom units are selling for more than a quarter of a million dollars.

Vacancy rates are at 13-year lows and Google’s country manager for Canada calls the city “lightning in a bottle.”

If that sounds like a bubble to you, you’d be correct but some investors don’t see it that way.

Take Bill Ring for instance, head of operations for a property management company who Bloomberg notes drove two hours to Toronto to attend a rowdy sales pitch for condos in Waterloo put on by a Bay Street trader turned-tech investor, turned-real estate mogul. “Students are coming in and need a place to live, tech companies are opening. It’ll all drive the value up,” he says. “I don’t want to invest in stocks because they’re crazy and real estate is a solid, safe investment.“

Yes, Bill wants a “solid, safe investment” that isn’t “crazy.”

Like Canadian real estate.

Which definitely isn’t a bubble.

After all, if the housing market in Canada were overheating, you wouldn’t be able to get “bargains” like the listing shown below from Vancouver.

Good luck Bill.

via Zero Hedge http://ift.tt/1P2Geel Tyler Durden

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Over the last couple of week’s most of the weekend reading list has been attributed to the market’s stumble since the beginning of this year. Importantly, as we rapidly head into January’s close, there seems to be little to reverse the negative tide sweeping through the market.

As I wrote earlier this week, this isn’t a good thing.

“It would seem logical that a weak performance in January would lead to some recovery in February. Markets are oversold, sentiment is bearish and February is still within the seasonally strong 6-months of the year. Makes sense.

 

Unfortunately, the historical data suggests that this will likely not be the case. The chart below is the historical point gain/loss for January and February back to 1957. Since 1957, there have been 20 January months that have posted negative returns or 33% of the time.”

“February has followed those 20 losing January months by posting gains 5-times and declining 14-times. In other words, with January likely to close out the month in negative territory, there is a 70% chance that February will decline also.

 

The high degree of risk of further declines in February would likely result in a confirmation of the bear market. This is not a market to be trifled with. Caution is advised.”

In other words, there is a real probability that if the markets don’t get a lift between now and the end of the month, February could be the beginning of a technical bear market decline.

But were could that lift come from? The first is month-end window dressing by fund managers after a brutal start to the new year. After much liquidation, fund managers will need to rebalance holdings.

The second is the potential for Central Banks to intervene which could embolden the bulls as further support could temporarily delay the onset of a bear market and recession. Note: I said temporarily. Pulling forward future consumption is not a long-term solution to organic economic growth. 

Not to be disappointed, the BOJ announced a move into NEGATIVE interest rate territory to try and boost economic growth in Japan. (Interestingly, however, was the lack of increase in QE.) The announcement was a shock to the markets as the BOJ had just stated last week that negative interest rates were not being considered. Here are some early takes on the BOJ’s move:

• World shares heat up as Bank of Japan goes sub-zero (Reuters)
• Stocks Rally With Bonds as BOJ Ends Grim January on High Note (BBG)
• Japan Follows Europe Into Negative Interest Rate Territory (WSJ)
• BOJ Move Resulting In Currency Wars & Global Slowdown (ZeroHedge)

That move, on top of the latest FOMC meeting, more market turmoil and bond yields flip-flopping around 2%, has made this a most interesting week. Here are some of the things I am reading this weekend.

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1) Why Junk Bonds Will Sink Stocks Further by Yves Smith via Naked Capitalism

“Investment lore is full of sayings as to how the bond markets can send false positives about lousy prospects for the real economy and the stock market. However, as Wolf sets forth below, a new Moody’s article makes a compelling case as to why the high risk spreads in the junk bond market bode ill for the stock market.”

 

But Also Read:  Credit Cycle In Full Collapse Mode by Myrmikan Research

And Read: We Should Be Terrified By Junk Bonds by Rana Foroohar via Time

2) If It’s A Bear Market, It Ain’t Over by Joe Calhoun via Alhambra Partners

“The real enemy of investors is not these fairly routine 10 or 20% downturns. The real enemy is the bear market that is associated with a recession or crisis, the one that knocks your equity block down by 40 or 50%. And actually it isn’t even the depth that is the real enemy. For most investors the enemy is time.”

But Also Read: El-Erian: Day Of Reckoning Coming by Mohamed El-Erian via CNBC

 

Opposing View: Don’t Do Anything, Just Stand There by Wade Slome via Investing Caffeine

And Also: What Investors Shouldn’t Do In A Bear Market by Peter Hodson via Financial Post

3) 34 Charts: This Time Is Different by Will Ortel via CFA Institute

“In October, I asked whether the market could have its cake and eat it too. The hope was for persistent low interest rates and consistently appreciating securities.

Somebody seems to have remembered cake doesn’t work that way.

 

According to some, this buying opportunity is brought to you by the letter “C”: China, commodities, and the now questionably healthy consumer. Reaching towards risk feels sensible. It’s been nearly 10 years since it wasn’t.

 

But today, growth, like certainty, is hard to come by. We hear the word “recession” again. There have been more Google searches for the phrase “sell stocks” this month than at any time since October 2008. And January is not over.

 

To some strategists, the writing is on the wall. I wrote recently that anyone who says they know exactly what will happen is wrong, cheating, or both. I still think that. So before getting into what I see, I want to tell you what to do: your homework. Now is the time to distinguish yourself as an investor. So as you read through everything below, remember: I’ll be disappointed if you wind up agreeing with everything I say.”

Also Read: Why Dip Buyers Will Get Clobbered by David Stockman via Contra Corner

Watch: Recession Fears Grow Louder by Heather Long via CNN Money

4) The Time To Sell Has Passed by Doug Kass via Yahoo Finance

“The time to sell has likely passed. Those opportunities had been in place since last spring and were the outgrowth of a deteriorating fundamental and technical backdrop that many investors ignored.

 

But while I have a more-constructive market view for the short term my confidence level isn’t high. In a fragile-growth setting, too much can upset the apple cart.”

Also Read: Sellers Are Still In Control by Michael Kahn via Barron’s

Further Read: It Wasn’t Oil, China Or The Fed by James Juliand via RTW

5) Feldstein: Let Markets Fall, Fed Should Hike Rates by Greg Robb via Market Watch

“In an interview with MarketWatch, Feldstein said stocks are overvalued. Any signal from the U.S. central bank that it may pause from its plans to continue raising interest rates would only create the impression that there is a “Fed put” on the market. A put is an option that protects an investor from losses.”

But Also Read: The Fed Doesn’t Understand Liquidity by Louis Woodhill via Real Clear Markets

And: Did The Fed Make A Huge Mistake? by Matt O’Brien via WaPo

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MUST READS

• Myth Of The 10 Best Days by Meb Faber via Faber Research
• Why The “R” Word? by John Shmuel via Financial Post
• 15 Things Productive People Do by Kevin Kruse via Forbes
• Why Does Pessimism Sound So Smart by Morgan Housel via Motley Fool
• Here’s Why All The Markets Are Falling by Tyler Durden via Zero Hedge
• Where’s The CapEx Boom? by Buttonwood via The Economist
• Don’t Say You Weren’t Warned…Again! by Michael Lebowitz via 720 Global
• Relief Rallies Truncated By Awful Losses by John Hussman via Hussman Funds
• What Follows The Most Epic Reach For Yield by Jesse Felder via The Felder Report
• Will January Volatility Wreck The Year by Dana Lyons via Tumblr
• Peak Profits by Chris Brightman via Research Affiliates

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“I can calculate the motion of heavenly bodies, but not the madness of people” – Sir Issac Newton

via Zero Hedge http://ift.tt/1nDCfyd Tyler Durden

Early in the day, VIX spiked ‘oddly’ and instanly broke the options market…

 

Prompting the start of an epic ramp in stocks:

 

Which was all good and fine, until the last minute of the US day-session today, when, as a follow up question, we have just this to ask: WTF just happened here?

 

Here is Central Bank XYZ’s VIX fat finger, zoomed in.

When Citi warned earlier to “Be Prepared For All Sorts Of Insanity Today“, it wasn’t kidding.

via Zero Hedge http://ift.tt/1ntEkfz Tyler Durden

Some soothing month-end meditation…

 

So let's start with today's idiocy… US equities driven by fundamentals!!

• *S&P 500 EXTENDS GAIN TO 2.1%, HEADED FOR BEST DAY SINCE SEPT.8

 

But here is some context for January's moves…

For China…

 

Worst ever…

 

For US markets – apart from 2009's collapse, this is the worst January ever…

 

But bonds had a great one!!

This is Gold's 3rd January up in a row (and 8th of the last 11 years)…

 

Across asset-classes, Bonds & Bullion did well, stocks and crude not so much…

 

Small Caps underperformed while the S&P was the least bad performer…

 

FANTAsy stocks are all down aside from FB – with TSLA and NFLX down over 20%…

 

Bond yields are down across the curve… The belly (5Y and 7Y yield) outperformed – down a stunning 40-45bps on the month…

 

So not an awsesome month but hey… what a week right!!

*  *  *

On the week…even Nasdaq managed to get green despite AAPL and AMZN collapse…

 

Bonds & Stocks were bid…

 

With Treasury yields down 12-15bps on the week (though 30Y oddly underperformed)

 

The USDollar Index soared back to unchanged on the week after BoJ's idiocy…

 

Commodities all gained on the week with crude and copper best…

 

Finally today…

Total panic buying…

 

Yeah this really happened!!! 3000 points of swing in Nikkei 225

 

Creating a giant squeeze in US equities…

 

Well it is Friday after all…

 

Charts: Bloomberg

Bonus Chart: An awkward reality check…

A year ago, Q4 Earnings for the Energy Sector were expected to be -1.8%. Today: -74.1%. #LeverageKills

— Not Jim Cramer (@Not_Jim_Cramer) January 29, 2016

via Zero Hedge http://ift.tt/1OVboGE Tyler Durden

Via Scotiabank's Guy Haselmann,

By surprising markets with a move to a negative deposit rate, the Bank of Japan gave investors temporary reprieve, providing a much needed opportunity to pare portfolio risk at better prices.  Unfortunately, the improvement in financial asset prices will be short-lived; except, of course, for long-maturity Treasuries.

• As I wrote on January 4^th, “Investors should be careful not underestimating just how far long-maturity Treasury yields can fall”.  These conditions still exist. 

The BoJ action to drop its deposit rate from 0% to -0.10% will likely prove to be more symbolic than impactful.  However, it is understandable why the BoJ wanted to take action. In January, the TOPIX was down 10% and the traded-weighted Yen appreciated by 3.5%.  Currency strength and the fall in oil prices conspired to push Japan’s preferred inflation measure back into deflation.  However, if Japan (which only strips out food) stripped out energy from its measure (like other countries do), then its inflation measure would be above 1%.

The BoJ issued a highly informative and clear 4-page explanation of its action (China could use this clarity as an example of effective communication).  It introduced a three-tiered system for rates, similar to that used in some European countries. The BoJ made it clear that the negative rate is not applied to outstanding balances of current accounts, but rather applied only to marginal increases in current account balances.

Since the money base is growing at an annual pace of 80 trillion yen, outstanding balances of current accounts will increase on an aggregate basis.  However, in order to limit harm to earnings of financial institutions from the negative deposit rate, the BoJ will increase the tier thresholds accordingly.  In other words, the current balance to which thezero interest rate will be applied will increase, so that the threshold to which a negative interest is applied “will remain at adequate levels”.

When a central bank hits the 0% lower bound in rates, the impact of any further unconventional easing actions is felt via a weaker currency. Therefore, the diverging policy actions between the hiking Fed and the easing BOJ and ECB, means that the upward pressure on the USD versus the Euro and Yen will continue.  The effect of a stronger dollar iscounter to the perceived and kneejerk market euphoria that arose today; and which seem to arise during easing actions.  A stronger USD will act like a magnet for global deflationary forces.  Investors beware.  

A strengthening USD has numerous consequences. The Yuan‘s peg to the USD has certainly damaged China’s competitiveness.  The trade-weighted Yuan has dropped by over 25% during the past three years.  Moreover, Chinese wages have risen considerably in the past decade, further lowering their competitiveness.  China is no longer viewed as the world’s low-cost producer.  China is currently trying to find the tricky balance between finding new sources of growth, remaining competitive, stabilizing financial markets, and limiting capital flight.

The move by the BoJ makes this balance more difficult. It increases the pressure on China to devalue its currency further.  However, with China’s rise as the world’s second largest economy and its acceptance into the IMF SDR basket, its global responsibility has escalated accordingly.   Currency devaluation by China (or by Japan for that matter) steals growth from the rest of the world; such action is clearly non-beneficial to US risk assets.

• A strengthening US dollar has already damaged US corporate earnings – around 50% of S&P 500 earning comes from overseas (and global trade has dropped ominously).

China and Emerging economies were growing above 10% in 2010, but are growing at less than 4%.  Clearly, the global economy has lost an important engine of growth.  Moreover, the world has never been more indebted and the developed world demographics are simply terrible. For several years, China’s debt has been growing at the unsustainable rate of over 2 times its GDP.  Enormous indebtedness has borrowed too much from the future. High indebtedness and low rates globally means there is far less fiscal slack or monetary ammunition with which to respond.

The savings rate in China is 40% to 50%.  This is partially due to a lack of confidence in the future, but mainly due to China’s very poor retirement and health care programs. After several decades of the one-child policy, many Chinese are not just trying to save for their own retirements, and potential future health care costs, but are saving for two sets of grandparents who did not receive the benefits of recent wage hikes.

Low interest rates initially cause investors to desperately search for yield.  However, eventually risk assets become too mispriced (and thus skewed to the downside).  When this occurs, portfolio preferences switch to cash alternative or ‘return of capital’ strategies.  During such an environment, the pressure on savers to save more to reach retirement goals intensifies.  If, for example, interest rates fall from 4% to 3%, an investor would have to increase savings by more than 20% each year to reach the same goal over 30 years.

I maintain that central banks are miscalculating the non-linear cost-benefit equation of their policy actions.  Prudent investors should use today’s month-end BoJ gift to pare portfolio risks and to buy long-dated Treasuries.

“The change, it had to come / We knew it all along / We were liberated from the fold, that’s all…” – The Who

via Zero Hedge http://ift.tt/20bRcZx Tyler Durden

Going down? To The White House… or The Big House

 

 

Source: Investors.com

via Zero Hedge http://ift.tt/1OVbmyx Tyler Durden

Submitted by Pater Tenebrarum via Acting-Man.com,

An Imaginary Bogeyman

What’s a Keynesian monetary quack to do when the economy and markets fail to remain “on message” within a few weeks of grandiose declarations that this time, printing truckloads of money has somehow “worked”, in defiance of centuries of experience, and in blatant violation of sound theory?

In the weeks since the largely meaningless December rate hike, numerous armchair central planners, many of whom seem to be pining for even more monetary insanity than the actual planners, have begun to berate the Fed for inadvertently summoning that great bugaboo of modern-day money cranks, the “ghost of 1937”.

 

The bugaboo of Keynesian money cranks – the ghost of 1937.

 

 

As the story goes, the fact that the FDR administration’s run-away deficit declined a bit, combined with a small hike in reserve requirements by the Fed “caused” the “depression-within-the-depression” of 1937-1938, which saw the stock market plunging by more than 50% and unemployment soaring back to levels close to the peaks seen in 1932-33.

This is of course balderdash. If anything, it demonstrates that the data of economic history are by themselves useless in determining cause and effect in economics. It is fairly easy to find historical periods in which deficit spending declined a great deal more than in 1937 and a much tighter monetary policy was implemented, to no ill effect whatsoever. If one believes the widely accepted account of the reasons for the 1937 bust, how does one explain these seeming “aberrations”?

 

The DJIA in 1937 (eventually, an even lower low was made in 1938, see also next chart) – click to enlarge.

 

As we often stress, economics is a social science and therefore simply does not work like physics or other natural sciences. Only economic theory can explain economic laws – while economic history can only be properly interpreted with the aid of sound theory.

Here is how we see it: If the authorities had left well enough alone after Hoover’s depression had bottomed out, the economy would have recovered quite nicely on its own. Instead, they decided to intervene all-out. The result was yet another artificial inflationary boom. By 1937 the Fed finally began to worry a bit about the growing risk of run-away inflation, so it took a baby step to make its policy slightly less accommodative.

Once the artificial support propping up an inflationary boom is removed, the underlying economic reality is unmasked. The cause of the 1937 bust was not the Fed’s small step toward tightening. Capital had been malinvested and consumed in the preceding boom, a fact which the bust revealed. Note also that a huge inflow of gold from Europe in the wake of Hitler’s rise to power boosted liquidity in the US enormously in 1935-36, with no offsetting actions taken by the Fed.

Moreover, the Supreme Court had just affirmed the legality of several of the worst economic interventions of the crypto-socialist FDR administration, which inter alia led to a collapse in labor productivity as the power of unions was vastly increased, as Jonathan Finegold Catalan points out here. He also notes that bank credit only began to contract after the stock market collapse was already well underway – in other words, the Fed’s tiny hike in the minimum reserve requirement by itself didn’t have any noteworthy effect.

On the other hand, if the Fed had implemented the Bernanke doctrine in 1937 and had continued to implement monetary pumping at full blast in order to extend the boom, it would only have succeeded in structurally undermining the economy and currency even more. Inevitably, an even worse bust would eventually have followed.

 

A chart pattern comparison: the S&P 500 Index in 1937 (black line) vs. today (red line) – click to enlarge.

 

Disappointed Liquidity Junkies

Nevertheless, the establishment-approved version of history is that the crucial mistake the central planners made at the time was that they “tightened too early”. This view is definitely shared by the bureaucrats at the helm of the the Fed. After the market swoon of early January and the string of horrible economic data released in just the past few weeks, the January Fed meeting therefore promised to provide Kremlinologists with an FOMC statement full of delightful verbal acrobatics.

After all, the official line is currently that “everything is fine” and that monetary policy can and will be “normalized” – whatever that means. Note that it actually doesn’t mean much; the Fed has hiked the federal funds rate, which applies to a market that has become utterly zombified. Transaction volumes have collapsed, as banks are drowning in excess reserves thanks to QE.

Moreover, in the pre-QE era, the FF rate target did influence money supply growth indirectly. This is no longer the case. Since the Fed will continue to replace maturing securities in its asset portfolio, the only factor that matters is the mood of commercial bankers – if they tighten lending standards, money supply growth will falter (and the opposite will happen if they become more reckless).

The task the bureaucrats faced this week was how to credibly keep up their pretend-confidence, while concurrently conveying a thinly veiled promise of more easy money, so as not to invite renewed waves of selling in the stock market and to prevent a further strengthening of the dollar. The result can be seen by looking at the WSJ’s trusty Fed statement tracker, which compares the verbiage of the new statement to that of the preceding one.

Considering that absolutely no action was taken at the January meeting, there has been an unusual amount of tinkering with the statement. The bone specifically thrown to the increasingly nervous punters on Wall Street consisted of the following sentence:

“The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.”

This sounds a bit as though the Yellen put has just been put in place. Alas, the wording of the rest of the statement was apparently considered way too sunny by assorted liquidity junkies hoping for an instant bailout.

 

At first blush, the FOMC statement was considered wanting by punters in the casino – click to enlarge.

 

Imploding Debtberg

Money supply growth remains fairly brisk by historical standards, but as we have recenty pointed out, there are strong indications that the slowdown that has been in train since late 2011 is set to resume. One has to keep in mind that without QE, only an increase in credit and fiduciary media issued by private banks can lead to money supply growth. However, there is a big problem now: the corporate bond market is increasingly under stress. One would think that this has to affect bank credit as well – and this is indeed the case.

The amount of debt issued by the energy sector alone in recent years has been staggering. In the meantime, bonds of energy companies represent roughly 13.5% of all outstanding corporate bonds in the US. The average debt/EBITDA ratio of US energy companies has risen 10-fold since 2006, to never before seen levels. Not surprisingly, a huge number of energy sector bonds is in by now in distress – and emerging market corporate bonds have followed suit.

 

Distressed energy sector debt compared to other industries – click to enlarge.

 

EM corporate debt – distress levels have jumped threefold in just the past six months – click to enlarge.

 

The entire corporate sector is in fact leveraged to the hilt. In the US, the ratio of corporate debt to earnings across all sectors of the economy has reached a 12-year high in 2015. It is fair to assume that the situation is even worse in a great many emerging markets. In China it is probably a lot worse.

 

The corporate debt-to-earnings ratio in the US reaches a 12 year high – click to enlarge.

 

The point we are trying to make here is the following: it probably no longer matters what the Fed says or does. The situation is already out of control and has developed its own momentum. The mistakes made during Bernanke’s echo boom cannot be “unmade” retrospectively. Capital that has been malinvested due to ZIRP and QE and the unsound debt associated with it will have to be liquidated – and the markets are telling us that this process has begun.

 

US corporate junk bond yields – black line: overall index (Merrill Master II); red line: worst rated bonds (CCC and below) – click to enlarge.

 

From the perspective of assorted armchair planners, the Fed is now seen as akin to Nero, fiddling while Rome burns. These range from the FT’s Martin Wolf, who has never encountered a printing press he didn’t like, to hedge fund manager Ray Dalio, whose “all weather” portfolio is suddenly stuck in inclement weather that has reportedly proved unpalatable to it (maybe it should be renamed the “almost all weather” portfolio). Evidently they aren’t getting yet that it is probably already too late for interventions to alter the trend.

 

The Pace of the Manufacturing Sector’s Demise is Accelerating

Just one day after the FOMC (which remains firmly focused on the most lagging of economic indicators, namely the labor market) vainly attempted to spread some more cheer about the state of the economy, new data releases have confirmed that a recession has already begun in the manufacturing sector.

Durable goods orders for December – admittedly a highly volatile data series – collapsed unexpectedly by a rather stunning 5.1%. Core capital goods orders (excl. defense and aircraft) were down 4.3%. Such an acceleration in the downtrend of new orders for capital goods is usually only seen shortly ahead of recessions. The chart below compares the Wilshire 5000 Index to the y/y rate of change in total business sales and the y/y rate of change in new business orders for core capital goods.

 

The Wilshire total market index (red) vs. the annual rate of change in total business sales (black) and new orders for core capital goods (blue). The acceleration in the rate of change of the latter series is consistent with a recessionary reading – click to enlarge.

 

In terms of the business cycle this confirms that the liquidation phase is indeed beginning. The price distortions of the boom period have begun to reverse. As an aside, this should be very bearish for the stock market, which has been at the forefront of said price distortions.

Given the lag with which money supply growth and gross market interest rates affect bubble activities in the real economy, there is nothing that the central bank can possibly do to stop this process from unfolding in the near to medium term.

We have recently come across a video in which an analyst proclaims that “the Dow will go to 25,000 because QE 4 is coming”. Such faith in the Fed’s magical powers is incredibly naïve. Consider for instance that Japan is currently engaged in QE 6 or 7 (we have lost count) and the Nikkei Index is still more than 50% below the level it reached 26 years ago.

It is certainly possible for a central bank to vastly inflate stock prices. All it needs to do is to utterly destroy the currency it issues. However, investors will then be in a situation akin to that Zimbabwean investors experienced a few years ago. They made trillions in the Harare stock market. Unfortunately, all they could afford with their massive stock market gains were three eggs, as Kyle Bass once remarked.

 

New orders for capital goods, quarterly change annualized: from bad to worse – click to enlarge.

 

Conclusion

The Fed’s “forward looking” monetary policy is in reality backward-looking. Not that it really matters: central planning and price fixing cannot possibly work anyway. Neither the intentions and/or the intelligence of the planners, nor the quality of the data policy decisions are based on matter in this context. Even under the most generous and heroic assumption that the planners are all angels with nothing but society’s well-being on their mind, they would still be attempting to do what is literally impossible. It is therefore a complete waste of time and effort to propose allegedly “better plans” to them as the endless parade of armchair planners mentioned above keeps doing day in day out.

 

Looking forward, Fed style.

 

The end of QE 3 has led to a slowdown in money supply growth, and more and more bubble activities have become unsustainable as a result. Given the associated time lag, recent economic trends are set to continue and are highly likely to spread to more and more sectors of the economy.

The energy and commodities bust is not going to remain “contained”. The Fed’s assessment of the state of the economy – which is usually not much to write home about even at the best of times – seems increasingly divorced from reality. This is likely to exacerbate the speed and extent of the unfolding bust.

As Jim Rickards recently pointed out to us (readers will be able to read all about it in detail next week, when we will post the transcript of the most recent Incrementum advisory board discussion), the Fed’s hands are moreover tied due to the fact that 2016 is an election year in the US. The monetary bureaucracy will be hesitant to take any actions that could be interpreted as supportive of a specific candidate or party.

One thing seems therefore almost certain: we can probably look forward to even more tortured verbal acrobatics in upcoming FOMC statements.

 

via Zero Hedge http://ift.tt/1P2s1xX Tyler Durden

When stripping away all the philosophy, the pompous rhetoric, and the jawboning, all central banks do, or are supposed to do, is to influence capital allocations and spending behavior by adjusting the liquidity preference of the population by adjusting interest rates and thus the demand for money.

To be sure, over the past 7 years central banks around the globe have gone absolutely overboard when it comes to their primary directive and have engaged every possible legal (and in the case of Europe, illegal) policy at their disposal to force consumers away from a “saving” mindset, and into purchasing risk(free) assets or otherwise burning through savings in hopes of stimulating inflation.

Today’s action by the Bank of Japan, which is meant to force banks, and consumers, to spend their cash which will now carry a penalty of -0.1% if “inert” was proof of just that.

Ironically, and perversely from a classical economic standpoint, as we showed before in the case of Europe’s NIRP bastions, Denmark, Sweden, and Switzerland, the more negative rates are, the higher the amount of household savings!

 

This is what Bank of America said back in October: “Yet, household savings rates have also risen. For Switzerland and Sweden this appears to have happened at the tail end of 2013 (before the oil price decline). As the BIS have highlighted, ultra-low rates may perversely be driving a greater propensity for consumers to save as retirement income becomes more uncertain.”

Bingo: that is precisely the fatal flaw in all central planning models, one which not a single tenured economist appears capable of grasping yet which even a child could easily understand.

This is how Bank of America politely concluded that NIRP is a failure:

For now, negative rates as a policy tool remain a “work in progress”, judging by the current inflation levels across Europe. But the rise in household savings rates amid so much central bank support is paradoxical to us, and mimics what we highlighted in the credit market earlier this year. Companies in Europe are deleveraging, not releveraging, and are buying back bonds not stock.

One can now add Japan to the equation.

And soon the US, because as the chart below shows, the Fed has likewise dramatically failed in shifting the liquidity preference of US investors. First, here is what Bank of America finds when looking at recent fund flows:

4 straight weeks of robust inflows to govt/tsy bond funds; 19 straight weeks of muni bond inflows; since 2H’15, cash has been the most popular asset class by far ($208bn inflows – Chart 1) vs a lackluster $7bn inflows for equities & $46bn outflows from fixed income (dogged by redemptions from credit)

And here is the one chart which in our opinion virtually assures that the Fed will follow in the footsteps of Sweden, Denmark, Europe, Switzerland and now Japan.

Since the middle of 2015, US investors have bought a big fat net zero of either bonds or equities (in fact, they have been net sellers of risk) and have parked all incremental cash in money-market funds instead, precisely the inert non-investment that is almost as hated by central banks as gold.

To Yellen, this behavior will have to stop, and she will make sure it does sooner rather than later. Just ask Kocherlakota.

Will this crush money markets as we know them, and unleash even more volatility and havoc around the world?

Absolutely. But at this point, when evey other central bank has lost credibility, to paraphrase Hillary Clinton loosely, “what differnce will it make” if the Fed joins the party on the central bank Titanic?

via Zero Hedge http://ift.tt/1PnJLaJ Tyler Durden