Nowhere To Hide In Europe – Equity Correlations Are Historically High

Submitted by Eric Bush via Gavekal Capital blog,

Equity correlations have spiked to the highest level in years presumably thanks to Brexit. The 20-day correlation between the GKCI DM index and the MSCI World Index is at the highest level since 2011.

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The correlation between EM and DM stocks is at its highest level since 2010.

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And the 20-day correlation between UK, French, and German stocks and the MSCI World Index is at the highest level we have ever seen going back to 2001, surpasing levels experienced during the European debt crisis. The same is true for the entire region as a whole actually.

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Lastly, the 65-day correlation for UK stocks and the MSCI World Index is also at the highest level on record going back to 2001.

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Driver Of Self-Driving Tesla Was Watching Harry Potter At Moment Of Death

In what turned out to be a case of morbid irony, last night we reported that Josh Brown, the 40 year old (non) driver of the Tesla which fatally crashed into a truck on May 7 in Florida while in self-driving mode when the car’s cameras failed to distinguish the white side of a turning tractor-trailer from a brightly lit sky and didn’t automatically activate its brakes, had as recently as a month earlier praised his “Tessy’s” autopilot feature in a YouTube clip.

Tesla Model S autopilot saved the car autonomously from a side collision from a boom lift truck. I was driving down the interstate and you can see the boom lift truck in question on the left side of the screen on a joining interstate road. Once the roads merged, the truck tried to get to the exit ramp on the right and never saw my Tesla. I actually wasn’t watching that direction and Tessy (the name of my car) was on duty with autopilot engaged. I became aware of the danger when Tessy alerted me with the “immediately take over” warning chime and the car swerving to the right to avoid the side collision.

He was so enamored with the feature, in fact, that as AP reported overnight, he was watching TV at the moment of the deadly crash.

Frank Baressi, 62, the driver of the truck and owner of Okemah Express LLC, said the Tesla driver was “playing Harry Potter on the TV screen” at the time of the crash and driving so quickly that “he went so fast through my trailer I didn’t see him.”

“It was still playing when he died and snapped a telephone pole a quarter mile down the road,” Baressi told The Associated Press in an interview from his home in Palm Harbor, Florida. He acknowledged he couldn’t see the movie, only heard it.


Frank Baressi, 62, was the driver of the truck that was hit by a Tesla that

Joshua D. Brown was operating in self-driving mode.

As AP adds, the Florida Highway Patrol said on Friday that it found an aftermarket digital video disc (DVD) player in the wreckage of the car.  “There was a portable DVD player in the vehicle,” said Sergeant Kim Montes of the Florida Highway Patrol in a telephone interview with Reuters.

Brown’s published obituary described him as a member of the Navy SEALs for 11 years and founder of Nexu Innovations Inc., working on wireless Internet networks and camera systems. In Washington, the Pentagon confirmed Brown’s work with the SEALs and said he left the service in 2008.

According to preliminary reports indicate the crash occurred when Baressi’s rig turned left in front of Brown’s Tesla at an intersection of a divided highway where there was no traffic light, the National Highway Traffic Safety Administration said. Brown died at the scene of the crash, which occurred May 7 in Williston, Florida, according to a Florida Highway Patrol report. The city is southwest of Gainesville.

By the time firefighters arrived, the wreckage of the Tesla — with its roof sheared off completely — had come to rest in a nearby yard hundreds of feet from the crash site, assistant chief Danny Wallace of the Williston Fire Department told The Associated Press. The driver was pronounced dead, “Signal 7” in the local firefighters’ jargon, and they respectfully covered the wreckage and waited for crash investigators to arrive.

The Tesla death comes as NHTSA is taking steps to ease the way onto the nation’s roads for self-driving cars, an anticipated sea-change in driving where Tesla has been on the leading edge. Self-driving cars have been expected to be a boon to safety because they’ll eliminate human errors. Human error is responsible for about 94 percent of crashes. 

This is not the first time automatic braking systems have malfunctioned, and several have been recalled to fix problems. In November, for instance, Toyota had to recall 31,000 full-sized Lexus and Toyota cars because the automatic braking system radar mistook steel joints or plates in the road for an object ahead and put on the brakes. Also last fall, Ford recalled 37,000 F-150 pickups because they braked with nothing in the way. The company said the radar could become confused when passing a large, reflective truck.

The technology relies on multiple cameras, radar, laser and computers to sense objects and determine if they are in the car’s way, said Mike Harley, an analyst at Kelley Blue Book. Systems like Tesla’s, which rely heavily on cameras, “aren’t sophisticated enough to overcome blindness from bright or low contrast light,” he said. Harley called the death unfortunate, but said that more deaths can be expected as the autonomous technology is refined.

Others were more direct: Karl Brauer, a senior analyst with Kelley Blue Book, said the accident is a huge blow to Tesla’s reputation. “They have been touting their safety and they have been touting their advanced technology,” he said. “This situation flies in the face of both.”

Brauer said Tesla will have to repair the damage in two ways. First, the company needs to make sure its customers understand that autopilot is meant to assist drivers, not to fully take over for them. Second, the company should update the cars’ software so autopilot will turn off if it senses the driver’s hands aren’t on the wheel for a certain period of time. Mercedes-Benz’s driver assist system is among those that require drivers’ hands to be on the wheel.

And then there is the biggest wildcard which Tesla could have never anticipated. As AP adds, records showed 8 speeding tickets in 6 years for the now dead driver.

In other words, while autopilots are a great feature, the biggest problem is that they can never anticipate, nor correct for, either the driver’s own carelessness (or stupidity) or far worse, that of others which no autopilot can possibly account for. As a result, we expect many more “autopilot” related deaths, especially as more decide to take the opportunity to catch up on missed movies.

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Art Cashin Sums It All Up

In an interview today on CNBC, Art Cashin hits the nail on the head as he typically does when asked about the central banks, the bond market and US Treasury yields hitting new record lows.

“It’s attracting money, it’s a very powerful magnet and it’s going to keep doing that.”

 

With all apologies to Janet Yellen it’s getting to a point where it doesn’t matter what the Fed thinks, rates are going to stay low.”

On whether anything Stanley Fischer said today changes the view on that, Cashin delivers epic truthiness that nobody with a PhD sitting in the Eccles building ever wants to hear again.

“Not at all, I think the only thing I heard from him was a mild frustration that they couldn’t get things going. The market is more powerful than the Fed, that’s the problem.”

 

Or put another way (h/t @RudyHavenstein)“Let the market clear!!”

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The Anti-Globalization Brexplosion: “If You Ain’t Got Nuttin’, You Got Nuttin’ To Lose”

Authored by Yoon Young-Kwan, originally posted at Project Syndicate,

Populism, nationalism, and xenophobia all contributed to the victory of the “Leave” campaign in the United Kingdom’s recent referendum on membership in the European Union. But these forces float on the surface of a larger sea change: a fundamental shift worldwide in the relationship between the state and the market.

Since the birth of modern capitalism, these two frameworks of human activity have generally been at odds. While the market tends to expand geographically as its participants pursue economic benefits, the state seeks to keep orderly everybody and everything within the territory it controls. A merchant may recognize market opportunities in a foreign country, but he will run into the state – most immediately, that country’s immigration authorities – if he pursues them.

How to reconcile the tension between the market and the state is the central concern of political economy today, just as it was for Adam Smith in the eighteenth century, Friedrich List and Karl Marx in the nineteenth century, and John Maynard Keynes and Friedrich von Hayek in their long debate on the topic through the middle decades of the twentieth century.

Let’s consider two hypothetical extremes in the state-market relationship.

The first is a seamless global market in which individuals can maximize their material benefits without any state intervention. The problem with this scenario is that you may live in a country that is vulnerable to all the negative consequences of no-holds-barred globalization, such as currency devaluation, labor exploitation, the flouting of intellectual property laws, and so forth.

The other extreme is a world comprising entirely isolated autarchic states, where individuals are protected from external economic forces and the state has full autonomy over domestic affairs. In this scenario, you will have to forgo all the well-known economic benefits of the global division of labor.

Between these two extremes lies most of the world as it is, characterized by regional integration projects like the EU or the North American Free Trade Agreement.

We can identify important swings during the history of capitalism over the last two centuries, either toward the market or the state. For example, the repeal of the Corn Laws in the UK in 1846 favored a free market in international trade and accelerated globalization until the outbreak of World War I.

After WWI, the pendulum swung back toward the state. Financial capital in the West was weakened politically, and a mobilized working class took the opportunity to demand jobs and social-welfare programs that ran counter to the logic and rules of a globalized market. In the run-up to World War II, beggar-thy-neighbor policies and rampant protectionism ensued – with Britain leaving the gold standard in 1931 in response to a run on the pound. The Economist declared that Monday, September 21, “the definite end of an epoch in the world’s financial and economic development.” After the passage of Brexit, the same journal warned, “Britain is sailing into a storm with no one at the wheel.”

The 1944 Bretton Woods conference marked another swing back toward the market, but this time allowed for some degree of national autonomy. Until the late 1960s, a harmonious balance of international openness and national autonomy allowed for widespread prosperity.

Turbulence returned in the 1970s, however, as the slow growth and high prices of “stagflation” and a global energy crisis pushed the pendulum back toward fully liberalized markets – a shift from the Keynesian to the Hayekian world, helped along by Margaret Thatcher in the UK and Ronald Reagan in the United States.

This brings us to the present. The economic crisis of 2008, and the global economy’s failure to recover from it fully, put an end to the project begun by Thatcher and Reagan. As in the post-WWI period, workers came to see themselves as left behind by globalization, with political leaders favoring financiers and big business at their expense. In the case of Brexit, the “Leave” camp voted for more national autonomy, even though it will have a clear material cost.

An American version of Brexit may not be far behind if the next US president scraps the Trans-Pacific Partnership trade deal with 11 Pacific Rim countries, signed in February of this year. At a time when global trade negotiations are almost dead, the TPP should seem like a reasonable approach to boosting multilateral trade. And yet both presumptive US presidential candidates say they oppose it, promising what would be tantamount to an “Amexit” from the global trading system.

We are at an interregnum. Social and political discontent will continue to bubble up around the world until we return the state-market relationship to a healthy equilibrium. The problem is that no one knows how best to do this.

Some propose re-harmonizing international markets with national autonomy, as occurred under Bretton Woods. But the post-war international economic order was built for the pre-globalization age, and we cannot put the genie back in the bottle, even if it were possible to do so. Brexit marks the beginning of the end of the latest era of globalization. What comes next is anyone’s guess, but we can be certain that it won’t be the final destination.

In conclusion, we found this comment extremely pertinent (via Steve Hurst)

Its inevitable the empty wallet movement overcomes the treasure chest party at the ballot box as the number of empty wallets steadily increases driven by inequality mechanisms.

 

If you aint got nuttin you got nuttin to lose.

 

There is a welfare system in place but its effect is emasculating and longterm unemployment is correlated with psychological problems. The longterm and well established trend in growing youth unemployment is a timebomb at so many levels.

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Italy Just Bailed Out Another Failed Bank, May Use Pension Funds For Future Bank Rescues

Despite – or perhaps due to – Italy’s failed attempt to slide a state-funded €40 billion recapitalization attempt past Angela Merkel while blaming it on Brexit, and coupled with a bailout proposal to provide €150 billion in liquidity to insolvent banks, overnight we got yet another confirmation that the biggest risk factor for Europe is not Brexit but Italy, where yet another failed bank was bailed out. As the FT reports overnight, Atlante, Italy’s privately backed €5bn bank bailout fund which was created in April to stem the threat of contagion from struggling lenders and whose assets turned out to be woefully inadequate, took control of Veneto Banca after a €1bn capital increase demanded by EU bank regulators attracted zero interest.

This is good news for Veneto Banco and bad news for all other insolvent banks, because the fund, known as Atlas in English, was intended to hold up the sky for Italian banks. Instead it is now practically out of funds, having depleted more than half of its war chest after taking control of Popolare di Vicenza, another regional bank, last month.

That has left little in reserve to tackle about €200bn in non-performing loans run up during Italy’s three-year recession, of which €85bn have not yet been written down. Bad loans are weighing on bank lending and crimping an already weak recovery.

As the FT adds, Lorenzo Codogno, an economist and former treasury director-general, said: “Italian [and to a lesser extent European] banks have entered into a negative loop where they cannot ask for private capital as there is no investor appetite and without capital they cannot provision or write off NPLs.”

This means the only hope is public-funded bailouts, however that is banned by eurozone regulations.

As we reported on Monday, Renzi had hoped the turmoil touched off by the UK’s vote to leave the EU would persuade Ms Merkel to suspend state aid rules and allow Rome to lead a recapitalisation of Italy’s weakest banks . But Ms Merkel rejected the idea, saying: “We wrote the rules for the credit system. We cannot change them every two years.” The European Central Bank also opposed the idea. Benoit Couere, a board member, said suspending new rules designed to shield taxpayers from the burden of bank rescues would be the end of the single market.

Then, as we reported yesterday, in a minor concession, the European Commission signed off a separate plan on Thursday allowing Italy to help banks with short-term liquidity problems. The move is similar to arrangements already in place in several other EU countries since the 2008 financial crisis. The commission said only solvent banks were eligible for the “precautionary” scheme and that there was “no expectation” it would need to be used.

Judging by the prompt bailout of yet one more bank, the question is not if but when it will be used.

A further problem for Italy is that its debt capacity as a sovereign has now topped out, and any new debt incurred to bailout banks will promptly result in downgrades, and a threat to state solvency: “Any increase in government debt we see as a negative development,” said Ed Parker, head of Emea sovereign ratings at Fitch, which rates Italy at triple B+, two notches above junk. Colin Ellis, chief credit officer in Emea at Moody’s, said: “Italian debt stock is already high and it would be credit negative to add to that pile of debt. The big problem is the level of uncertainty in Italy and the wider eurozone right now.”

Meanwhile, a desperate Italy fully aware of what is coming, is considering increasing Atlante’s firepower by a further €5bn or more by drawing money from pension funds, the state or foreign investors, say bankers. Atlante is due to launch a second fund focused on buying NPLs next month. Authorities in Italy are racing to create a bigger cushion for the banks before publication of stress test results, expected at the end of July. Senior bankers fear Italian lenders will emerge poorly from the tests, triggering another slide in share prices.

Of course, if that is the only catalyst, there is no need to worry: there is no way that Mario Draghi will unleash the dominos that will topple the Italian banking system, when it was he himself who as Italy’s central banker allowed these banks to pile up the unprecedented amount of bad loans. As such expect all Italian banks to pass.

The real threat is if the local population wakes up to the risk of holding their savings in a financial system that is now teetering on the edge, something Renzi himself admitted when he said that he “hoped to use a liquidity backstop to contain investor panic, which could result in a run on deposits and affect banks’ liquidity.” Because even if it buys up every bond, loan and stock in the world, the ECB will not be able to fix the public’s loss of trust in fractional reserve banking.

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The Best And Worst Performing Assets In June And Q2

As DB’s Jim Reid says, June 2016 will always be remembered as the month when the UK voted to leave the EU and it’s fair to say that the overwhelming focus on the referendum dominated price action in markets from start to finish. Risk assets initially tumbled into mid-month as the leave campaign built momentum, however a swing back in favour for the remain campaign saw most major markets wipe out early month losses to go into the vote relatively flat. However with momentum favouring the remain camp and markets pricing in largely a remain outcome, the vote in favour to leave sparked a huge risk off move. This lasted for all of two days however before markets rebounded into month end. That said the magnitude of the post vote selloff was enough to see risk assets dominate the bottom of our June leaderboard.

So how did assets classes close out June?

In local currency terms it is equity markets that occupy the bottom. The worst performer during the month was European Banks (-18%), followed closely by the peripheral markets (Athex -15%, FTSE MIB -10% and IBEX -9%). The Nikkei (-10%) is also wedged in their which suffered with a 7% rally for the Yen. The Stoxx 600 and DAX were down -5% and -6% respectively during the month while the S&P 500 (+0.3%) just finished in positive territory on the last day of the month. The other notable underperformer during the month was unsurprisingly Sterling which tumbled just over 8%. As a result however the FTSE 100 (+5%) held in well in local currency terms, although this translates to a -4% decline and so one of the more notable underperformers when we look in USD terms.

At the top end of the leaderboard top two spots go to Silver (+17%) and Gold (+9%) which were the main beneficiaries from the risk-off moves at the end of the month. In USD terms the Bovespa actually occupies top spot however (+20%) as a result of the rally in the BRL during the month. Rates markets get an honourable mention too following the big rally in bonds in the last week. Gilts returned +6% (however -3% in USD terms) while Treasuries and other European bond markets were up between +1% and +3% (with the core outperforming the periphery). Credit markets were a bit more mixed however. In line with the wider risk off moves, higher beta credit underperformed with Eur HY and Fins Subs up to -1% lower. US HY (+1%) just stayed in positive territory while US all Corps (+2%) and Non-Fins (+3%) outperformed their EUR equivalents (+1% and +2%). GBP credit saw a similar picture with HY (-1%) and Fins subs (-1%) down but all Corps (+3%) and Non Fins (+3%) still under-performing gilts but holding in better. The latter two markets were helped by a +1.5% rally in the last week or so. It’s worth highlighting that EM bonds (+4%) and equities (+4%) had a relatively strong month all things considered.

The end of June also marks the end of Q2 and as you can see in the graphs it is commodity markets which occupy the top spots with WTI (+26%) in particular taking the top spot. Following the huge rally in June, Silver (+21%) creeps into second with Brent (+19%) and Gold (+7%) also having a strong quarter. The Yen (+9%) has continued to extend its remarkable rally. European banks (-11%) take up last spot, with Wheat (-9%), FTSE MIB (-8%), Nikkei (-7%) and Sterling (-7%) also near the bottom. 30 assets actually concluded the quarter with a positive return in cross section while 12 finished in negative territory. All credit indices finished in positive territory (in a 1-5% range) with US credit outperforming EUR indices although when we look at this in USD terms EUR credit indices actually closed slightly negative for the quarter as a result of the weaker Euro.

Source: DB

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Dow Tops 18,000: Erases Nearly All Brexit Losses (As Bond Yields Hit Record Lows)

See, Brexit was nothing… just like every establishment despot told us…right?

Just as we sarcastically noted earlier…

Following the panic-bid into the close last night, this morning sees every one and their pet rabbit piling into high-beta momo (Trannies and Small Caps ripping)…

 

In a non-stop, volumeless, VIX-crushing (over 26 to 14 handle in 4 days), short-squeezing rally, US equity markets have managed to erase almost every memory of Brexit and its potentially catastrophic consequences…

 

11 more Dow points and Brexit is a thing of the past…

And the reason is simple… central banks.

This is the best week for the S&P since October 2014's Bullard Bounce idiocy… when he also mentioned QE4.

We do note that futures are still off their pre-Brexit highs…

 

So there is another target for the machines to hit.

Finally there's this…

 

With Gold, Silver, Bonds, and Stocks all soaring, it appears the market is betting on QE4 coming soon… but that won't happen unless stocks crash??!!

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Bob Janjuah Explains All That Is Wrong With The Financial System (And Remains Bearish)

In the latest update from Nomura’s Bob Janjuah, the traditionally bearish strategist justified his nickname, and when previewing his exposure to the market, says that “I generally want to be long bonds, especially long US duration, I want generally to be long the USD (as the least bad), and I generally want to be flat/short equities as equity valuations are not in my view supported by growth or earnings but rather only through heavily distorted markets/policy and financial engineering of EPS.”

But before laying out his full note, here is a segment which he hope all central bankers in the world will some day read as it explains everything that is wrong with both the global economy and financial system today:

The big driving forces we need to think about are globalisation, technological advancement, excessive indebtedness, stifling (but probably necessary) financial sector regulation and rapidly deteriorating demographics. These factors are largely deflationary and are here to stay, Brexit or no Brexit. Globalisation in particular has been wonderful at a global level as it has helped reduce global poverty greatly over the last two to three decades. But the price has been stagnant-to-falling real incomes and standards of living in the developed world, covered up by significant and still growing indebtedness. Fiscal policy options and flexibility have been severely hit by the choice policymakers took back in 2008 and the years that followed to bail out the financial sector – this fiscal spend has resulted in little, no or even negative multipliers in the last 5+ years. For sure, policymakers were faced with stark choices at the time, but I maintain the view I voiced at the time back in 2008-09, that the hit from the failure of the financial system should have been spread more among financial sector bond and equity investors rather than the policies of austerity and financial suppression which have sought to socialise the cost largely among the bottom 90% of the population. As such, fiscal policy has failed the real economy, particularly in developed markets, for nearly a decade. And by dumping the responsibility for the heavy lifting for growth on central banks, we have ended up with asset bubbles, rampant speculation, lack of investment in productivity and in the real economy, significant levels of financial engineering to artificially boost earnings, and merely the (now failed) hope that “trickle down” still works. The outcome has been almost unprecedented levels of rising inequality in the global economy. I suspect that it is this inequality that was behind a fair chunk of last week’s Brexit outcome and which has driven the rise of extremism across other important nations/blocs. History tells us that such trends can lead to adverse outcomes particularly where large numbers of the population feel disenfranchised from the political classes. Thus, Brexit!

Since we have said precisely the same for about 7 years, we agree.

His full note below

“Bob’s World – Bob’s World: Keep buying duration”

1 – This is not going to be a Brexit note. I am writing instead because one of my trigger levels based on the weekly closing level for the cash S&P500 index has been activated. In my last note I concluded by saying that once the S&P saw a weekly close above 2040, it would then trade in a narrow range of 2040 and 2136. This index, as a proxy for global risk-on/risk-off, has since early April stayed stuck in this range until last Friday, when post-Brexit it broke down below 2040.

2 – In my previous note I also highlighted my ongoing concerns with respect to weak global growth, deflation/disinflation still running rampant through the global economy, weakness in earnings, and the ongoing policy of FX wars driven by central banks (which I see as zero-sum in nature) providing merely temporary and illusory gains for individual nations/blocs at the expense of sustainable global growth. My view all year (and in fact since early 2014) has been to be long core government bond duration and short equities. Long-end bond yields are 100-150bp lower over the last 18/24 months in developed core markets. The Eurostoxx index peaked over a year ago and is now below the levels of 18/24 months ago, ditto the MSCI World index. Brexit had nothing to do with this view and has little or nothing to do with the fact that I continue to back this overall macro investment strategy for the foreseeable future. Central bankers, including the Fed, were in my view never going to embark on any serious tightening cycle and, as I mentioned in April, more easing/more attempts to devalue were to be expected (as we have seen), including a reversal by the Fed. Watch this space, but I suspect markets will be forced to park Brexit in the pending box if my concerns around potential recession and higher unemployment in the US become a reality. No doubt Brexit will be blamed for the world’s next set of growth concerns and be used to justify the next set of easings/devaluation attempts – but this ignores totally the fact that Brexit is a symptom and not a cause of the globe’s growth, earnings and deflation problems. And as such, my concern is that we pursue even more of the wrong policy choices that have been in place since 2008.

3 – The big driving forces we need to think about are globalisation, technological advancement, excessive indebtedness, stifling (but probably necessary) financial sector regulation and rapidly deteriorating demographics. These factors are largely deflationary and are here to stay, Brexit or no Brexit. Globalisation in particular has been wonderful at a global level as it has helped reduce global poverty greatly over the last two to three decades. But the price has been stagnant-to-falling real incomes and standards of living in the developed world, covered up by significant and still growing indebtedness. Fiscal policy options and flexibility have been severely hit by the choice policymakers took back in 2008 and the years that followed to bail out the financial sector – this fiscal spend has resulted in little, no or even negative multipliers in the last 5+ years. For sure, policymakers were faced with stark choices at the time, but I maintain the view I voiced at the time back in 2008-09, that the hit from the failure of the financial system should have been spread more among financial sector bond and equity investors rather than the policies of austerity and financial suppression which have sought to socialise the cost largely among the bottom 90% of the population. As such, fiscal policy has failed the real economy, particularly in developed markets, for nearly a decade. And by dumping the responsibility for the heavy lifting for growth on central banks, we have ended up with asset bubbles, rampant speculation, lack of investment in productivity and in the real economy, significant levels of financial engineering to artificially boost earnings, and merely the (now failed) hope that “trickle down” still works. The outcome has been almost unprecedented levels of rising inequality in the global economy. I suspect that it is this inequality that was behind a fair chunk of last week’s Brexit outcome and which has driven the rise of extremism across other important nations/blocs. History tells us that such trends can lead to adverse outcomes particularly where large numbers of the population feel disenfranchised from the political classes. Thus, Brexit!

4 – Regarding Brexit I will let others provide the detailed coverage and analysis. For my part, I believe good sense and compromise will prevail over time and I really do believe that all of Europe – whether in the EU or not, or in the eurozone or not – will be better off as a result of Brexit and (hopefully) the ensuing sensible negotiations. The core eurozone federalists (and the only sustainable eurozone in the long run is one with fiscal, political and banking, as well as monetary union) can proceed unimpeded by the UK, and Europe will as a whole survive as an open trading zone, albeit with changes. None of this will be easy or risk-free. It will take time, and we will likely see plenty of conflicting headlines (just think about the eurozone and Greece over the past five years!) over the coming weeks and months, but pragmatic compromise is a common mutual trait among most people in Europe. In markets we must remember that the eurozone and the EU have shown over the last 5+ years a willingness to talk tough and draw many “lines in the sand” but ultimately, after listening to the many interested parties, pragmatism tends to prevail. I expect the UK to be “punished” publicly and lots of talk about cast iron principles, but I also expect compromises by all. An EU which attempts to punish the UK will be shooting itself in the foot, and it seems that the real leaders of Europe understand this and for the need for the EU to change. The concept of Mutually Assured Destruction (MAD) is alive and well. But equally the UK can’t expect to get everything for nothing. Hence, I expect compromise and pragmatism, even if some media headlines suggest otherwise. It is also very encouraging to see that, after the initial tantrum, which was largely driven by the excessive run-up in markets in the 48/72 hours before the results pointing the other way became clear, markets have behaved quite calmly and rationally. Of course, one thing we need to remember is that “expert” opinion needs to be taken with a pinch of salt. Just ask yourself how many times experts at the big global institutions and central banks have told us over the last 5/10 years that growth was about to take off, that inflation and thus higher policy rates were on their way, that there would be no bailouts, that there would be no monetisation, that there would be no defaults. I have never seen myself as an expert but the “pinch of salt” warning applies as much to me as anyone! The truth is that at best we tend to make educated guesses and tend to seek comfort in the herd (including the contrarian herd), even if it proves to be spectacularly wrong. And just to clarify, I think both sides of the Brexit debate were over-hyped. The aim of the next few months and years is to avoid mutual destruction and thus to seek pragmatic compromise. I fully understand the post-Brexit concerns about growth, about the financial services sector, about the need for FDI flows to offset the current account deficit. But surely for the last few years in the UK growth has been a concern, over-concentration in financial services (and excessive inequality) has been a concern and we have been told for years that the UK needs to manufacture and export more and import/consume less. Who knows, but over time maybe Brexit will turn out to be the jolt the UK needs. Equally, the UK will need to remain an open global economy and a place where people want to live and invest. So we come back to those words – pragmatism and compromise. Divorces tend to be grounded in some reality but can sometimes generate excessive levels of hatred, anger, angst, depression and vilification at some point during the actual process. But most divorces end with compromise, a feeling that neither side won/lost overall, that the right thing should be done for the kids, and by and large better relationships in the long run. Most times people get remarried, even sometimes to a former spouse!

5 – So from here, how to be positioned? Shorter-term headline risk will be significant and lead to lots of volatility and bouts of fear and greed. Sharp ratios are set to deteriorate on average over the next few months. To me it seems like a day-trader’s market at best. Whether thinking about markets, Brexit negotiations, US Presidential hopeful Donald Trump, global growth weakness or what policymakers can/will do next it will not be easy to deliver consistent returns on a daily, weekly or even monthly basis for the balance of 2016. So I prefer to take a longer-term view, which remains unaltered by Brexit. I generally want to be long bonds, especially long US duration, I want generally to be long the USD (as the least bad), and I generally want to be flat/short equities as equity valuations are not in my view supported by growth or earnings but rather only through heavily distorted markets/policy and financial engineering of EPS. Specifically relating to tactical equity trading in the immediate short term, if the cash S&P500 index does not close over 2026 this Friday I would lean into risk-off. A close above 2040 would suggest more caution against being too risk-off too early and tactically suggest to me to be long stocks for another run up to 2100/2135, although this would be a low conviction recommendation. And a weekly close in between would force me to the sidelines to assess news flow and price action. More broadly, I expect 10yr and 30yr UST yields to trade down to 1.25% and 2% respectively over Q3, and I’d treat equities as an occasional tactical trading asset, where weekly S&P500 closes below 2040 and above 2136 define the core range around and within which to trade this asset class.

By way of conclusion, globally the trends I saw pre-Brexit are still with us. Policymakers globally need to move fast and get aggressive with properly targeted fiscal policy instead of poorly targeted monetary policy to help the real economy – relying on trickle down from the top 10% who have seen the biggest wealth gains is a failed policy. We need real fiscal policy aimed at investment, particularly in productivity, and at fairer redistribution. Otherwise extremism and resentment will keep growing everywhere, not just the UK If this requires big central banks to explicitly monetise debt stocks as well as debt flows, then so be it – if everyone does it together markets will find it hard to punish any one participant. In the context of the UK and the EU, my core view is one which ultimately sees pragmatic compromise, with changes on both sides, as both sides can see that collapsing the UK economy will serve nobody well, least of all the EU and in particular the eurozone. But contradictory headline risk and expert opinion will abound and markets will gyrate on these headlines. So for markets, in the short term I’d focus on being as flat/as close to benchmark as possible and trade intra-day volatility. On a multi-quarter basis, being long duration, especially in USTs but also quality credit (incl. EM) is still my preferred position.

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US Manufacturing ISM Surges To 16-Month Highs (as Construction Spending Crashes)

US Manufacturing PMI fell back very modestly from its flash reading but rose MoM to 51.3 as Markit warns "producers are struggling in the face of the strong dollar, the energy sector decline and presidential election jitters." But, ISM Manufacturing surged full of hope to 53.2, above the highest analyst estimate (a 4 standard deviation beat of expectations). Every subcomponent rose aside from Prices Paid as it appears – as opposed to everything we have seen in earnings and chatter – that Brexit, election uncertainty has done nothing at all to dampen 'hope'. In the face of this seasionally-adjusted exuberance, construction spending has plunged almost 3% in the last 2 months – the biggest drop since Feb 2011.

 

Anothewr miracle of seasonal adjustment…

 

Sending Manufacturing ISM to 16 month highs…

 

ISM Components – all up but Prices Paid…

  • New orders rose to 57 vs 55.7
  • Employment rose to 50.4 vs 49.2
  • Supplier deliveries rose to 55.4 vs 54.1
  • Inventories rose to 48.5 vs 45.0
  • Customer inventories rose to 51.0 vs 50.0
  • Prices paid fell to 60.5 vs 63.5
  • Backlog of orders rose to 52.5 vs 47.0
  • New export orders rose to 53.5 vs 52.5
  • Imports rose to 52.0 vs 50.0

Thanks to the miracle of seasonal-adjustments… New Orders worst since Feb but adjusted to best since March…

And respondents were decidedly mixed…

"We are gaining new customers through better sales management." (Food, Beverage & Tobacco Products)

 

"Slower shipments because of weather related flooding." (Chemical Products)

 

"Conditions have remained steady from [the] past month and are in line with our forecast." (Computer & Electronic Products)

 

"Very good start of summer for business levels/orders." (Fabricated Metal Products)

 

"Business is steady with some signs of increase." (Machinery)

 

"Business is still strong, but slowing slightly." (Transportation Equipment)

 

"Business conditions are good, production and demand are stable." (Miscellaneous Manufacturing)

 

"Orders are slowing from China. American customers still steady." (Primary Metals)

 

"Demand continues to be robust." (Plastics & Rubber Products)

 

"Business is still slower than expected." (Nonmetallic Mineral Products)

However, as Markit notes,

Producers are struggling in the face of the strong dollar, the energy sector decline and presidential election jitters. With companies craving certainty, heightened tensions between the UK and the European Union are likely to unsettle the global business environment further in coming months, and therefore risk dampening growth in the US and export markets. The data flow in the next two months will therefore be critical to policymakers in gauging the appropriate outlook for interest rates.”

While that is all very exciting, it appears the construction industry just hit a wall…

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Lending Club’s Biggest Fund Slammed With Redemptions For 58% Of Assets, Posts First Ever Negative Month

We first warned that the Peer-2-Peer lending industry is poised for major trouble in May of 2015, when we predicted that not only are write-off rates set to surge, but that as the resulting struggling lenders seek to entice new borrowers they would have to push rates higher eating up profitability, as demand for future loans slides and as the firm is forced to remark the value of existing loans. This was confirmed in February of this year when the now infamous, and recent frontrunner in the space, LendingClub announced write-offs had surged, doubling forecasts as US consumers were struggling with repaying loans. We don’t have to remind readers about the subsequent scandal that engulfed LendingClub in early May when as a result of an unexpected exit of former CEO Renaud Laplanche , the stock crashed and suddenly everyone else gave the P2P model a much closer, second look.

What they have found is troubling.

As the WSJ reports, a five year old fund managed by LendingClub that invests in the company’s online consumer loans and which is the largest in-house portfolio run by LendingClub unit LC Advisors LLC and has regularly returned about 0.5% a month or more, just hit a brick wall: it is now expected to report its first-ever negative month, after 63 consecutive months of positive returns. As Peter Rudegeair adds, “the unusual result shows how a confluence of negative trends is hitting performance for the unsecured personal loans held in LendingClub’s Broad Based Consumer Credit (Q) Fund. Performance for the roughly $800-million fund in June “is likely to be negative,” LendingClub CEO Scott Sanborn wrote in a letter to investors Tuesday.”

What caused this unprecedented shift? The very same factors we warned about first over a year ago: “the fund has been under pressure as defaults have risen and LendingClub has taken steps to manage them. In March,the fund returned only 0.05%, following a 0.13% gain in December.”

The CEO added in the letter to investors Tuesday that the June returns have been weighed down by a series of increases on borrower interest rates designed to entice new investments. Although the higher rates will ultimately lead to higher yields for fund investors, under accounting rules LC Advisors must mark down the value of existing loans the fund holds that carry lower coupons.”

The damage control followed promptly: “It is important to remember that these markdowns are not reflective of the expected cash flow performance of underlying loans held by the Fund,” Sanborn wrote. Of course, what the fund expects and what actually happens are as of this moment unknown, with the company forced to dramatically change strategy.

A just as signficiant problem for Lending Club is that as of June 17, the credit fund had received $442 million in redemption requests, or 58% of its overall assets. As a result LendingClub gated investor withdrawals and said it would consider a potential wind-down of the fund, The Wall Street Journal reported earlier this week.

The flurry of redemptions was unleashed when LendingClub said in a recent filing that LC Advisors had not followed standard accounting rules when it was determining the value of the loans in its portfolio as well as their monthly returns, leading to further questions about the company’s “projections.” Before his departure, Mr. Laplanche served on the investment policy committee of LC Advisors along with LendingClub Chief Financial Officer Carrie Dolan and General Counsel Jason Altieri. Ms. Dolan and Mr. Altieri remained at the company.

Sanborn said in an interview this week that the company is considering a plan for LC Advisors over the next two months that will be in the best interest of investors that want to stay as well as those that want to leave. “The issue this revolves around is confidence in LendingClub and that’s what we need to rebuild,” he said. “The asset itself is continuing to perform and it’s my belief we can rebuild that confidence over time.”

Who knows, maybe some clueless Chinese investors will swoop in and bailout the company’s troubled shareholders, buying up what little assets the company has left in the ongoing Chinese rush to disguise outbound capital flight as offshore M&A.  They better do it fast.

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