Goldman: “Investors Are Increasingly Concerned About An S&P Drawdown”

One day after covering its long-standing long dollar call (coincidentally, just one week after former Goldman COO Gary Cohn urged Trump to flip on his own “strong dollar” policy), Goldman has gotten even more cautious and in a note released this morning it warns that “Investors are increasingly concerned about an S&P drawdown.” Here’s why:

The 10% rise in the S&P index since the US election was catalysed by a surge in optimism surrounding US policy. While the hoped-for policy changes now appear less likely, ‘soft’ data have shown continued strength, leaving the S&P index hovering just under 2400 as investors wonder whether economic activity can catch up to sentiment and support another leg higher in asset prices. While opinions on that question remain split, what is clearer is that, as investors continue to wait for the global economy to ‘show me the activity’, they have become increasingly nervous about the prospect of a large, sharp S&P drawdown: the VIX index, which had remained around 12 through much of 2017Q1, now stands close to 15.

However, while the S&P is clearly long overdue for a correction, Goldman cautions that an even greater threat faces emerging markets because “EM assets have not faced a true test in 2017: a
large S&P drawdown and a spike in volatility and investor concern.” Some more thoughts on the potential spillover effects from a US correction on emerging markets from Goldman.

How concerned should EM investors be if the S&P were to see a large reversal of its post-election gains? On the one hand, the ongoing improvement in macro fundamentals has contributed to a surprising resilience of EM assets to a wide range of external shocks in recent months, including fluctuations in US policy perceptions (“Benchmarking the EM asset recovery post the ‘Trump Tantrum’“, Global Markets Daily, February 23, 2017), DM rates and commodity prices. More specifically, Exhibit 2 shows that, in 2017, both EM equity indices and EM currencies have been far less sensitive than usual to shifts in the S&P index.

Exhibit 3 makes clear, however, that EM assets have not faced a true test in 2017: a large S&P drawdown and a spike in volatility and investor concern (the upper-left tip of the S&P’s ‘volatility smile’). Indeed, it has been more than a year since the S&P has seen a 10% drawdown, and volatility (both realised and implied) remained near historical lows for much of 2017Q1. Each of these trends was supported by rising momentum in survey-based measures of activity that – even if ‘hard’ data were to pick up – would be difficult to match in the remainder of 2017.

Goldman’s conclusion:

If the market is forced to wait much longer for a follow-through in activity data, and the VIX continues to rise, EM investors should not be complacent: despite improving macro fundamentals, an S&P drawdown when the VIX index has reached high levels would likely be painful, especially given that investors have continued to build EM positioning. Exhibit 4 shows that the sensitivity of EM assets to the S&P index is, unsurprisingly, far higher when the VIX is elevated.

And with that we shift our attention to the market where we find, surprisingly, that the latest VIX slamdown was just unleashed, and the dollar is rising, making a mockery of yet another Goldman warning.

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Alternative to Opioid Addiction Policies: New at Reason

There is the alarming rise in the number of chronic pain patients who have become addicted to opioids. And the explosion, in recent years, of opioid prescriptions by health care providers now under government pressure to curtail their prescribing.

This pressure has driven many opioid addicts to the illicit drug market to avoid the pains of withdrawal. There, according to the Centers for Disease Control and Prevention (CDC), they often find opioid heroin cheaper and sometimes more readily available despite a 50-year “War on Drugs.” Thus they become heroin addicts.

Media hysteria begets calls to action. Politicians and the administrative state devise new laws to control this “evil plague.” As a surgeon who regularly prescribes painkillers for patients suffering from postoperative pain or painful conditions, I see a painful cognitive dissonance.

Harm reduction, reducing the physical harm an addict does to himself, is preferable to the criminalizing policies of government, surgeon and Cato Institute scholar Jeffrey Singer writes.

View this article.

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May Wins UK Parliament Vote To Allow June 8th Snap Election

As totally expected, Theresa May – following a contentious debate – won the UK parliament vote to allow a June 8th snap election by a count of 522 to 13, well above the two-thirds majority needed.

Opposition leader, Jeremy Corbyn welcomed the poll but accused the PM of changing her mind and breaking promises on a range of issues.

The result triggers what will be an intense seven-week campaign in which the U.K.’s relationship with the EU will be the focus.

No reaction in the pound so far…

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Our Intellectual Bankruptcy: The “Religion” Of Economics, UBI, & Medicare For All

Authored by Charles Hugh-Smith via OfTwoMinds blog,

Clinging to magical-thinking fixes that change nothing on the fundamental level hastens collapse.

Here we stand on the precipice, and all we have in our kit is a collection of delusional magical thinking that we label "solutions." We are not just morally and financially bankrupt, we're intellectually bankrupt as well.

Here are three examples of magical thinking that pass for intellectually sound ideas:

1. Mainstream neo-classical/ Keynesian economics. As economist Manfred Max-Neef notes in this interview, neo-classical/ Keynesian economics is no longer a discipline or a science–it is a religion.

It demands a peculiar faith in nonsense: for example, the environment–Nature– is merely a subset of the economy. When we've stripped the seas of wild fish (and totally destroyed the ecology of the oceans), no problem–we'll substitute farmed fish, which are in economic terms, entirely equal to wild fish.

In other words, the natural world cannot be valued in our current mock-science religion of economics.

Other absurdities abound. Stripping the seas of wild fish adds to GDP, so it's all good, right? Dismantling newly constructed buildings and building a replacement structure also adds to GDP, so it's an excellent source of "growth."

As Max-Neef points out, conventional economists have absolutely no understanding of poverty. If you need a sobering account of just how this abject willful ignorance works in the real world, I recommend reading The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good.

Gail Tverberg (among others) has shown how the existing economic model no longer makes sense of the actual economy we inhabit: The Economy Is Like a Circus.

As for rising wealth/income inequality–there is a cure for that, but it's not in mainstream econ textbooks: The Only Thing, Historically, That's Curbed Inequality: Catastrophe Plagues, revolutions, massive wars, collapsed states—these are what reliably reduce economic disparities.(via Arshad A.)

2. Universal Basic Income. As noted in yesterday's essay, wages are no longer an adequate means of distributing the dwindling surplus of advanced economies. Wages as a share of GDP have been declining for decades, and only click up temporarily during massive speculative bubbles. Once these bubbles pop, which they inevitably do due to their instability and unsustainability, wage earners' share of GDP plummets to a new low.

The mainstream is enthusing about the "solution": Universal Basic Income (UBI). The solution to low pay and scarcity of middle-class paid work is to give everyone a basic income for doing nothing.

Delusional academics anticipate a flowering of creative talent akin to a new Renaissance as people are freed from work by robots and automation. But if we look at people already receiving the equivalent of "free money" UBI–disability– studies find recipients are simply watching more TV and YouTube videos and pursuing opioids, not writing poetry and composing concertos.

They are not volunteering in their community or engaging their communities in any positive fashion. What actually happens with UBI is recipients become isolated and miserable because UBI strips their lives of meaning, purpose and the need to contribute to a community.

The real purpose of UBI is to chain every household to the state, and drain all social relations between the isolated "consumer" and the state.

As tragic as the delusion of UBI is to individuals, it is unworkable financially because profits will fall as automation becomes commoditized, and the surplus available to distribute to every household will diminish.

I explain this at some length in my books Why Our Status Quo Failed and Is Beyond Reform and A Radically Beneficial World: Automation, Technology & Creating Jobs for All.

Much of what is passed off as "corporate profits" is accounting fraud and the monetization of what was once free. For example, all that customer labor: now that we pump our own gasoline, check and pack our own purchases, do our own banking–who's skimming the output of our labor? Yup, the corporations.

Commoditization of software and tools + the Internet = loss of monopoly. This is a problem, for the core function of the state-cartel version of capitalism we inhabit is the state enforces a cartel-monopoly structure to guarantee steady surpluses it can tax for its own expansion.

As automation is commoditized, profits plummet as competition can no longer be controlled by cartels or even the state–just as Marx laid out.

Combine declining productivity and declining surplus (profits) (both for deeply structural reasons) and there cannot be enough money to fund UBI. Weirdly, proponents of UBI never even perform a back of the envelope calculation of cost and the source of all this free money (tax revenues and/or borrowing from future generations). Perhaps they intuit that such an exercise would reveal the bankruptcy of their magical thinking.

As we shall see below, the system can't even support the entitlements it has already promised to hundreds of millions of people, never mind an additional universal entitlement.

(Note to UBI enthusiasts: there are limits on what robots and automation can and will do: they will only perform work that is highly profitable. Since most human work is not profitable (or even paid), the idea that robots and automation will free everyone from work is delusional fantasy. I explain all this in greater detail in A Radically Beneficial World.)

3. Medicare for all. I understand the desire for a single-payer healthcare system, and have published various proposals over the years for such a system.

The latest magical-thinking "solution" attracting widespread support (again, without any basis in actual numbers) is Medicare for all. The idea is: take a system (Medicare-Medicaid) that's already bankrupting the government and the nation and expand it from 70 million people to 320 million people.

Uh, right.

Shall we consult reality before embracing delusional "solutions"? Here's a chart of the rise of administrative costs in healthcare, public and private. Proponents of Medicare for All claim admin costs are lower in Medicare, but this conveniently overlooks the estimates that 40% of Medicare costs are paper-shuffling, needless or harmful tests, procedures, etc. and outright fraud.

We know a few things as fact. One is that the populations qualifying for Medicare and Medicaid (the elderly and low-income households) are expanding at a high and very predictable rate.

The other thing we know is that the Medicare-Medicaid costs are rising at a rate far above the growth rate of the economy that supports these programs (GDP), far above the growth rate of tax revenues and far above the growth rate of wages, which matters because payroll taxes fund Medicare.

It doesn't take much to extend these lines and conclude Medicare-Medicaid alone will bankrupt the federal government and the nation. The problem is these programs are bloated by fraud, defensive medicine, predatory pricing for medications, and every other costly ill of our healthcare system.

Like every other centrally funded/regulated sector, Medicare-Medicaid is optimized for maximizing private-sector profits and increasing regulatory costs. This is one manifestation of the diminishing returns on the entire centralized-control model:

We'd all like "solutions" that don't change anything, but when the system itself is the source of our problems, changing nothing guarantees collapse. As noted in the article linked above, various inequalities and asymmetries get resolved by collapse.

Clinging to magical-thinking fixes that change nothing on the fundamental level hastens collapse. In that sense, magical-thinking fixes are "solutions," but not the sort their proponents imagined.

*  *  *

If you found value in this content, please join Charles in seeking solutions by becoming a $1/month patron of my work via patreon.com. Check out both of Charles' new books, Inequality and the Collapse of Privilege ($3.95 Kindle, $8.95 print) and Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle, $8.95 print, $5.95 audiobook) For more, please visit the OTM essentials website.

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The US vs Emerging Market Chart is Flashing a Key Signal

A major shift is taking place in global stock markets.

Let me explain…

Below is a chart of the S&P 500 priced in Emerging Market Stocks.

When the black line falls Emerging Markets are outperforming US stocks. When the black line rises, US stocks are outperforming Emerging markets.

As you can see, from 1999 until roughly 2010, Emerging markets demolished stocks by a wide margin.

This trend then reversed in 2011, with the S&P 500 dramatically outperforming Emerging markets.

However, that trend now appears to be reversing. The chart has failed to break out to new highs and is now in danger of breaking its bull market trendline.

When this happens, we will once again be entering a period in which Emerging markets outperform US stocks.

Take note, that’s when the opportunity for larger opportunities outside the US will take flight.

We outline this and two other major investment themes in our Special Report detailing the impact President Trump’s policies will have on the markets (hint, Trump is a WEAK Dollar guy… and it’s going to create opportunities in unique asset classes).

It’s titled How to Profit From the Trump Trade and we are giving away just 1,000 copies for free.

Today there are a mere 19 left.

To pick up one of the remaining copies, swing by

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Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

 

 

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National Hotel Lobbyists Backed the Local Wars on Airbnb, Documents Reveal

Last summer, Chicago became the first major American city to declare war on short-term rental services like Airbnb.

The complicated ordinance passed by the city council and signed by Mayor Rahm Emanuel imposed new taxes on short-term rentals, required Airbnb users to open their homes to inspection even without any suspicion of wrongdoing, and gave landlords and condo associations the authority to ban Airbnb rentals by registering with the city.

Lobbyists from the hotel industry were behind it all.

Later in the year, when New York Gov. Andrew Cuomo signed into law new rules that curtailed short-term rentals in multi-home dwellings and made it illegal to even advertise those rentals, the same lobbyists from the hotel industry were the driving force once again.

And when some states tried to go in the opposite direction—like Tennessee, which earlier this year attempted to pass a law prohibiting local governments from banning Airbnb within their jurisdictions—the hotel industry and their teams of lobbyists were there once again, putting a stop to pro-roomsharing rules that would undercut hotel profits and open up more competition in the lodging marketplace.

Even Sen. Elizabeth Warren (D-Massachusetts), famous among progressives for her skeptical view of capitalism and her critiques of the influence of big business in government, was co-opted into the anti-Airbnb campaign by those same hotel lobbyists.

At least that’s what top trade association for the hotel industry, the American Hotel and Lodging Association, is telling its members behind closed doors, according to documents leaked from a November conference of the AHLA and first reported by The New York Times on Monday. Some of the same documents obtained by Reason show the trade group patting itself on the back for scoring “notable accomplishments” in local fights to limit or ban Airbnb in Chicago, New York, San Francisco, and elsewhere during 2016.

In New York, where the Airbnb advertising ban was signed into law last year, the documents show that AHLA “provided resources and support to the Hotel Association of New York City and other parties advocating for this legislation.” In Chicago, where the anti-Airbnb ordinance was championed by a city official with long ties to the hotel industry, the AHLA “played a pivotal role in the passage” of an ordinance that “heavily regulates” short-term rentals.”

At the federal level, the hotel industry claims to have acquired a powerful ally by recruiting Warren to their side. The Democratic senator from Massachusetts wrote a letter (along with fellow Democratic Senators Brian Schatz of Hawaii and Dianne Feinstein of California) to the Federal Trade Commission last year asking for an investigation into the business practices of short-term rental platforms.

“Senator Warren’s status as one of the more prominent lawmakers among progressive activists has helped mobilize additional grassroots and political support,” the AHLA documents note.

Reason has previously reported on the alliance between the hotel industry and groups on the left, which seem to be a key element of the AHLA’s anti-Airbnb strategy. Last year, the New York Motel and Hotel Trades Council, which represents some 35,000 hotel workers in the city, wrote a $100,000 check to the Hotel Association of New York City to support the organization’s effort to pass the new short term rental restrictions.

Airbnb has grown quickly since its founding in 2008. By the end of last year, Airbnb had more than 3 million listing in more than 65,000 different cities around the globe, according to the company’s website. It raised more than $1 billion in a recent round of funding, according to multiple media reports in March, and SEC filing from earlier this year say Airbnb is worth approximately $31 billion, which would make it the second most valuable start-up in the United States, trailing only fellow sharing economy wonderkind Uber.

As it has grown (along with other, smaller roomsharing services like HomeAway and VRBO), Airbnb has become a greater threat to the hotel industry that for decades has dominated the market for lodging.

Vijay Dandapani, chief executive of the Hotel Association of New York City, told The New York Times this week that Airbnb has brought hotel pricing down in many places during holidays, conventions and other big events when room rates should be at their highest and the industry generates a significant portion of its profits.

Since Airbnb has added to the supply of lodging, it’s made it harder for hotels to jack-up prices when demand is high.

“The hotels that used to be able to gouge you by taking the price way up, because of limited supply, don’t have that same ability anymore because of the additional inventory that Airbnb has brought online,” Steve Hafner, CEO of travel booking website Kayak.com, told Bloomberg last year.

Data provided by Airbnb suggests hotels are right to be worried, according to data provided by Airbnb. The homesharing service claims to have helped lower lodging prices during major events like New Year’s Eve and this year’s Super Bowl.

That’s good for travelers who get more options and potentially lower prices because of Airbnb’s competition with hotels. The hotels, though, don’t like it, and the AHLA documents show that the industry is fighting back by leveraging the power of government to drive Airbnb and other forms of roomsharing out of the market.

“This is rent-seeking at its worst. Rather than compete fairly, hotel lobbyists are scrambling for the chance to use government force to benefit themselves and outlaw their competition,” says Christina Sandefur, vice president of the Goldwater Institute, the Arizona-based free market think tank that has teamed up with the Illinois-based Liberty Justice Center to challenge Chicago’s Airbnb rules.

“These anti-home-sharing laws benefit the most politically well-connected at the expense of most hardworking or the most needy,” she told Reason via email.

And the documents suggest the fight is only just beginning.

For 2017, the AHLA outlined a lengthy agenda, including plans to “actively coordinate with state and local hotel associations, along with affordable housing, neighborhood and tenant groups, consumer groups, labor, and others to drive common sense laws forward in key cities and states.” The trade group also plans to push federal legislative efforts and to “work with attorneys general to encourage action and/or enforcement in their jurisdictions.”

The federal legislative effort will lean rely on regulations like the Americans with Disability Act to subject “operators of short-term rentals to ADA requirements.” The AHLA also wants to see Airbnb rentals held to the same fire safety standards as hotels and plans to pressure Congress to prohibit federal workers from staying in short-term rentals.

In other places, “primarily those with Republican legislative majorities,” the AHLA is focused on stopping Airbnb’s efforts to pass laws prohibiting local officials from banning Airbnb. Florida is currently engaged in a legislative fight over exactly such a bill, as Reason has previously reported.

At the local level, the trade group says it plans to focus on five cities—Los Angeles, San Francisco, Boston, Washington, D.C., and Miami—and other places where “the right political conditions exist for us to push legislation across the finish line.”

Throughout the leaked documents, the AHLA maintains that their goal is to “level the playing field” to ensure that Airbnb and other roomsharing apps are abiding by the same rules hotels must follow.

Sandefur says that’s not really true, in practice. In Chicago, for example, the anti-Airbnb ordinance requires homeowners to pay the city hotel tax and an extra 4 percent tax that does not apply to hotels.

“It’s clear that these special interests aren’t interested in ‘leveling the playing field’ so much as they are seeking to use the power of the government to crush their competition,” she says. “This discrimination is not only unfair policy; it’s unconstitutional.”

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Earth Day Dopes: New at Reason

Alarmists claim they’re for “science,” but what they’re really for is a left-wing religion.

John Stossel writes:

Expect more craziness this weekend. Earth Day is Saturday. This year’s theme: Government must “do more” about climate change because “consequences of inaction are too high to risk.”

They make it sound so simple:

1) Man causes global warming.

2) Warming is obviously harmful.

3) Government can stop it.

Each claim is dubious or wrong.

View this article.

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Chinese Carmakers, Volkswagen, BMW Roll Out “Tesla Killers”

The much anticipated Tesla Model 3 has yet to be released and already a groundswell of electric car competition is forming to challenge Elon Musk’s upcoming offering. Start in China, where the Model 3 is not due to arrive until next year, but already Chinese-funded, smart, connected plug-in car start-ups are scrambling to launch “Tesla killer” cars to go head-to-head against Tesla “mass market” sedan.

In taking on the monopoly, yet cash-burning premium electric car juggernaut that is Tesla, the key for leading Chinese electric vehicle start-ups such as Future Mobility, WM Motor and Singulato Motors, is that they will produce their cars locally, making them better able to match the Model 3’s price, Reuters notes. Tesla is expected to price its Model 3 from $35,000 in the United States. Buyers in China would expect to add 25% to that in import tariffs.

The Chinese strategy is simple: beat the Model 3 in China by making their cars more premium but cheaper than Tesla’s mass-market all-electric battery car. The three start-ups see Tesla’s weakness in its inability to produce cars in China, the world’s leading market for plug-in cars.

Speaking to Reuters, the founders and CEOs of Future Mobility, WM Motor and Singulato acknowledged the Model 3 is the car to beat. The first vehicles they aim to launch in the next couple of years will be priced around 300,000 yuan (roughly $43,500) or below, they said ahead of the Shanghai auto show, which opens to the public on Friday. “Between 200,000 yuan and 300,000 yuan,” said Singulato’s co-founder and CEO Shen Haiyin.

Daniel Kirchert, president and co-founder of Future Mobility, says his company plans to launch three models. The first, a premium midsize crossover sport-utility vehicle (SUV), will arrive “before 2020”, followed within three years by a sedan and a 7-seater multi-purpose vehicle (MPV).

 

All will be based on the same vehicle underpinning architecture and share major components, “to achieve this very attractive entry price of about 300,000 yuan,” Kirchert told Reuters in a telephone interview. 

 

“It’s a bit more than $40,000, a very competitive price positioning … because Tesla customers buying the Model 3 in China would have to shoulder the cost of a 25 percent import tariff on the car”, unless it’s produced in China, he said. “We will be competitive because we produce the car locally,” he added.

For now Tesla has denied recent talk in China that it was considering manufacturing its cars locally. “Tesla is deeply committed to the Chinese market, however these rumors are not true,” the company said. However, even without local production, Tesla will be no pushover. It this month overtook GM and Ford Motor in market value as investors focus on the “story”, ignore the soaring cash burn and embrace Elon Musk’s strategy of offering stylish, high performance cars that are continually upgraded (if delayed) with features that rival automakers are still only testing.

Tesla has to date competed only in premium price classes at relatively low volumes. The Model 3 will need to appeal to more price-sensitive consumers to reach its projected annual sales of 500,000 vehicles.

The Chinese automakers are winning to accept the challenge. As well as making its car in China, at a planned assembly plant in Nanjing, Kirchert said Future Mobility plans to make the SUV bigger than the Model 3 and more luxurious. “In the end, it’s really about how premium you are. That’s the real challenge.”

Singulato Motors unveiled its first “mass-production” car, also a crossover SUV, in Beijing last week, and says it will be priced below 300,000 yuan. It has started taking pre-orders for a limited period from customers willing to put down a deposit of 2,017 yuan.

WM Motor plans to launch its first car, an electric plug-in crossover SUV, in the second half of 2018, again priced to compete with the Model 3, co-founder Freeman Shen told Reuters. The car will be the first of three electric vehicles the Shanghai-based firm plans to launch by 2020, by which time Shen says WM Motor should be selling around 100,000 cars a year.

* * *

It’s not just Chinese competition that is coming: Germany’s biggest carmaker Volkswagen, which plans to roll out four affordable electric vehicles in the coming years, also unveiled a battery-powered crossover at the Shanghai Auto Show. A mix between a four-door coupe and a sports utility vehicle, the new I.D. Crozz SUV is the third model which will be sold under the I.D. sub-brand.

The crossover will compete with Tesla’s Model X, which the US manufacturer started delivering in 2015. According to the head of the VW marque’s electric car project Christian Senger, the company has made “huge progress” in reducing production costs of its all-electric vehicles. VW has pledged that the I.D. line will cost about the same as its diesel models.

“Offering our electric cars for prices similar to combustion engine vehicles really is a game changer,” Senger said. “We’re using the need to step from combustion engine to electric cars to reinvent VW brand.”

A full charge will give the car a range of more than 300 miles. The I.D. Crozz can be charged up to 80 percent capacity from a fast charger in just 30 minutes. The vehicle can switch to an autonomous driving mode with a push on the VW badge in the middle of the steering wheel, which then folds automatically into the cockpit. The car then maneuvers around based on signals it gets via laser and ultrasonic scanners, radar sensors, and cameras.

The I.D. line models will be partly developed in China, and will also include a mid-size sports utility vehicle, a hatchback, and a sedan.

The concept of electric cars is part of Volkswagen’s new business strategy to take a leading position in the green transport niche by 2025. In the wake of its diesel emissions scandal, VW announced last year it’s phasing out up to 40 vehicle models. The company pledged to invest €10 billion into ride-sharing technology, electric cars, and automated driving. The automaker said it hopes to launch 30 new electric car models within a decade.

And then there is BMW whose “iNext” or “i5” will be a sedan sized between BMW’s 3 Series and 5 Series to compete with the Tesla Model 3 across global markets.

In short: while Musk may still enjoy a near monopoly in the premium and – soon one hopes – the highly coveted mid-range EV space, the competition is rising. Meanwhile, as the WSJ calculated over the weekend, to back into its valuation, Tesla will have to quintuple the number of cars it sells, earn margins equivalent to those of its highly efficient competitors and not sell new shares.” It is also priced to perfection: should any of these variables be adversely revised, be it lower sales, lower margin, lower selling price, and Tesla doesn’t come close to earning enough to get to 10 times the multiple of its bigger rivals by the end of 2018.

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Trump Repeatedly Calls Paul Ryan ‘Ron,’ Sessions Stalls on Picking Federal Prosecutors, San Francisco May Ban Flavored Cigarettes A.M. Links

Follow us on Facebook and Twitter, and don’t forget to sign up for Reason’s daily updates for more content.

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As French Election Looms, Risk Premia Spike Near Record Highs Across Every Market

With establishment pollsters paniccing at the closeness of the first round of the French elections, it appears investors in every market – stocks, bonds, and FX – are just as concerned with hedges and risk premia at (or near) record highs across the board.

With just a few days to go before Sunday’s first round of voting, every poll for the past month has shown independent Emmanuel Macron and the National Front’s Marine Le Pen taking the top two spots. Macron would then easily win the May 7 runoff, polls show. Yet both front-runners have been steadily slipping over the past two weeks, and Republican Francois Fillon and Communist-backed Jean-Luc Melenchon are now within striking distance.

“This situation is totally unprecedented,” said Emmanuel Riviere, managing director of Kantar Public France. “The fact that there are four potential finalists makes the situation very complex.”

Most worrying for pollsters is the level of indecision among French voters

 

Which perhaps explains the record high hedges in EURUSD (options to hedge against a collapse in the currency)…

 

Equity investors have never been so hedged against downside – more than Lehman and Brexit…

 

And bond investors have dumped OATs with both hands and feet…

 

With all these hedges on, BofA notes however, in hindsight, a large part of the risk premium in the run up to last year's events could perhaps be attributed to uncertainty, the 'unknown unknowns'. Once the event came to pass and investors overcame the initial shock of unexpected outcomes, focus shifted to the longer term strategic impact for which the market was happy to give the benefit of the doubt.

By nature, such events have consequences reaching far beyond the market's time-horizon and it is difficult to pinpoint their price impact with any degree of confidence given the number of moving parts. It is perhaps fair then to expect a similar reaction this time around should the market get caught off guard once again – immediate volatility lasting a few days, followed by some calm as the market awaits clarity on actual policy.

 

Our European Strategists expect stocks in the region to rally in the event of a Macron or Fillon win and fall by 13-23% if Le Pen wins due to higher risk of France leaving the currency union/EU. They view financials and peripherals as particularly vulnerable to a Le Pen victory. This would imply significant widening in European credit spreads. And US credit is likely to take its cue from EU spreads.

Finally, we leave it to John Oliver to explain just how important this is…

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