Tag: finance

Submitted by John Hussman of Hussman Funds,

Investors who believe that history has lessons to teach should take our present concerns with significant weight, but should also recognize that tendencies that repeatedly prove reliable over complete market cycles are sometimes defied over portions of those cycles. Meanwhile, investors who are convinced that this time is different can ignore what follows. The primary reason not to listen to a word of it is that similar concerns, particularly since late-2011, have been followed by yet further market gains. If one places full weight on this recent period, and no weight on history, it follows that stocks can only advance forever.

What seems different this time, enough to revive the conclusion that “this time is different,” is faith in the Federal Reserve’s policy of quantitative easing. Though quantitative easing has no mechanistic relationship to stock prices except to make low-risk assets psychologically uncomfortable to hold, investors place far more certainty in the effectiveness of QE than can be demonstrated by either theory or evidence. The argument essentially reduces to a claim that QE makes stocks go up because “it just does.” We doubt that the perception that an easy Fed can hold stock prices up will be any more durable in the next couple of years than it was in the 2000-2002 decline or the 2007-2009 decline – both periods of persistent and aggressive Fed easing.  But QE is novel, and like the internet bubble, novelty feeds imagination. Most of what investors believe about QE is imaginative.

As Ray Dalio of Bridgwater recently observed,

“The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

While we can make our case on the basis of fact, theory, data, history, and sometimes just basic arithmetic, what we can’t do – and haven’t done well – is to disabuse perceptions. Beliefs are what they are, and are only as malleable as the minds that hold them. Like the nearly religious belief in the technology bubble, the dot-com boom, the housing bubble, and countless other bubbles across history, people are going to believe what they believe here until reality catches up in the most unpleasant way. The resilience of the market late in a bubble is part of the reason investors keep holding and hoping all the way down. In this market cycle, as in all market cycles, few investors will be able to unload their holdings to the last of the greater fools just after the market’s peak. Instead, most investors will hold all the way down, because even the initial decline will provoke the question “how much lower could it go?” It has always been that way.

The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blaring red since late-2011.

As a result, the Shiller P/E (the S&P 500 divided by the 10-year average of inflation-adjusted earnings) is now above 25, a level that prior to the late-1990’s bubble was seen only in the three weeks prior to the 1929 peak. Meanwhile, the price/revenue ratio of the S&P 500 is now double its pre-bubble norm, as is the ratio of stock market capitalization to GDP. Indeed, the median price/revenue ratio of the S&P 500 is actually above the 2000 peak – largely because small cap stocks were much more reasonably priced in 2000 than they are today (not that those better relative valuations prevented wicked losses in small caps during the 2000-2002 decline).

Despite the unusually extended period of speculation as a result of faith in quantitative easing, I continue to believe that normal historical regularities will exert themselves with a vengeance over the completion of this market cycle. Importantly, the market has now re-established the most hostile overvalued, overbought, overbullish syndrome we identify. Outside of 2013, we’ve observed this syndrome at only 6 other points in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention).

These concerns are easily ignored since we also observed them at lower levels this year, both in February (see A Reluctant Bear’s Guide to the Universe) and in May. Still, the fact is that this syndrome of overvalued, overbought, overbullish, rising-yield conditions has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 25.

 

2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.

 

3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 55.2% vs. 15.6%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.

 

4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below depict the complete set of instances since 1970 when these conditions have been observed.

Our investment approach remains to align our investment outlook with the prospective market return/risk profile that we estimate on the basis of prevailing conditions at each point in time. On that basis, the outlook is hard-defensive, and any other stance is essentially speculative. Such speculation is fine with insignificant risk-limited positions (such as call options), but I strongly believe that investors with a horizon of less than 5-7 years should limit their
exposure to equities. At this horizon, even “buy-and-hold” strategies in stocks are inappropriate except for a small fraction of assets. In general, the appropriate rule for setting investment exposure for passive investors is to align the duration of the asset portfolio with the duration of expected liabilities. At a 2% dividend yield on the S&P 500, equities are effectively instruments with 50-year duration. That means that even stock holdings amounting to 10% of assets exhaust a 5-year duration. For most investors, a material exposure to equities requires a very long investment horizon and a wholly passive view about market prospects.

Again, our approach is to align our outlook with the prospective return/risk profile we estimate at each point in time. That places us in a defensive stance. Still, we’re quite aware of the tendency for investors to capitulate to seemingly relentless speculation at the very peak of bull markets, and saw it happen in 2000 and 2007 despite our arguments for caution.

As something of an inoculation against this tendency, the chart below presents what we estimate as the most “optimistic” pre-crash scenario for stocks. Though I don’t believe that markets follow math, it’s striking how closely market action in recent years has followed a “log-periodic bubble” as described by Didier Sornette (see Increasingly Immediate Impulses to Buy the Dip).

A log periodic pattern is essentially one where troughs occur at increasingly frequent and increasingly shallow intervals. As Sornette has demonstrated across numerous bubbles over history in a broad variety of asset classes, adjacent troughs (say T1, T2, T3, etc) are often related to the crash date (the “finite-time singularity” Tc) by a constant ratio: (Tc-T1)/(Tc-T2) = (Tc-T2)/(Tc-T3) and so forth, with the result that successive troughs come closer and closer in time until the final blowoff occurs.

Frankly, I thought that this pattern was nearly exhausted in April or May of this year. But here we are. What’s important here is that the only way to extend that finite-time singularity is for the advance to become even more vertical and for periodic fluctuations to become even more closely spaced. That’s exactly what has happened, and the fidelity to the log-periodic pattern is almost creepy. At this point, the only way to extend the singularity beyond the present date is to envision a nearly vertical pre-crash blowoff.

So let’s do that. Not because we should expect it, and surely not because we should rely on it, but because we should guard against it by envisioning the most “optimistic” (and equivalently, the worst case) scenario. So with the essential caveat that we should neither expect, rely or be shocked by a further blowoff, the following chart depicts the market action that would be consistent with a Sornette bubble with the latest “finite time singularity” that is consistent with market action since 2010.

To be very clear: conditions already allow a finite-time singularity at present, the scenario depicted above is the most extreme case, it should not be expected or relied on, but we should also not be shocked or dismayed if it occurs.

Just a final note, which may or may not prove relevant in the weeks ahead: in August 2008, just before the market collapsed (see Nervous Bunny), I noted that increasing volatility of the market at 10-minute intervals was one of the more ominous features of market action. This sort of accelerating volatility at micro-intervals is closely related to log-periodicity, and occurs in a variety of contexts where there’s a “phase transition” from one state to another. Spin a quarter on the table and watch it closely. You’ll notice that between the point where it spins smoothly and the point it falls flat, it will start vibrating uncontrollably at increasingly rapid frequency. That’s a phase transition. Again, I don’t really believe that markets follow math to any great degree, but there are enough historical examples of log-periodic behavior and phase-transitions in market action that it helps to recognize these regularities when they emerge.

Risk dominates. Hold tight.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/B_0XVe8QLF0/story01.htm Tyler Durden

Submitted by John Hussman of Hussman Funds,

Investors who believe that history has lessons to teach should take our present concerns with significant weight, but should also recognize that tendencies that repeatedly prove reliable over complete market cycles are sometimes defied over portions of those cycles. Meanwhile, investors who are convinced that this time is different can ignore what follows. The primary reason not to listen to a word of it is that similar concerns, particularly since late-2011, have been followed by yet further market gains. If one places full weight on this recent period, and no weight on history, it follows that stocks can only advance forever.

What seems different this time, enough to revive the conclusion that “this time is different,” is faith in the Federal Reserve’s policy of quantitative easing. Though quantitative easing has no mechanistic relationship to stock prices except to make low-risk assets psychologically uncomfortable to hold, investors place far more certainty in the effectiveness of QE than can be demonstrated by either theory or evidence. The argument essentially reduces to a claim that QE makes stocks go up because “it just does.” We doubt that the perception that an easy Fed can hold stock prices up will be any more durable in the next couple of years than it was in the 2000-2002 decline or the 2007-2009 decline – both periods of persistent and aggressive Fed easing.  But QE is novel, and like the internet bubble, novelty feeds imagination. Most of what investors believe about QE is imaginative.

As Ray Dalio of Bridgwater recently observed,

“The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

While we can make our case on the basis of fact, theory, data, history, and sometimes just basic arithmetic, what we can’t do – and haven’t done well – is to disabuse perceptions. Beliefs are what they are, and are only as malleable as the minds that hold them. Like the nearly religious belief in the technology bubble, the dot-com boom, the housing bubble, and countless other bubbles across history, people are going to believe what they believe here until reality catches up in the most unpleasant way. The resilience of the market late in a bubble is part of the reason investors keep holding and hoping all the way down. In this market cycle, as in all market cycles, few investors will be able to unload their holdings to the last of the greater fools just after the market’s peak. Instead, most investors will hold all the way down, because even the initial decline will provoke the question “how much lower could it go?” It has always been that way.

The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blaring red since late-2011.

As a result, the Shiller P/E (the S&P 500 divided by the 10-year average of inflation-adjusted earnings) is now above 25, a level that prior to the late-1990’s bubble was seen only in the three weeks prior to the 1929 peak. Meanwhile, the price/revenue ratio of the S&P 500 is now double its pre-bubble norm, as is the ratio of stock market capitalization to GDP. Indeed, the median price/revenue ratio of the S&P 500 is actually above the 2000 peak – largely because small cap stocks were much more reasonably priced in 2000 than they are today (not that those better relative valuations prevented wicked losses in small caps during the 2000-2002 decline).

Despite the unusually extended period of speculation as a result of faith in quantitative easing, I continue to believe that normal historical regularities will exert themselves with a vengeance over the completion of this market cycle. Importantly, the market has now re-established the most hostile overvalued, overbought, overbullish syndrome we identify. Outside of 2013, we’ve observed this syndrome at only 6 other points in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention).

These concerns are easily ignored since we also observed them at lower levels this year, both in February (see A Reluctant Bear’s Guide to the Universe) and in May. Still, the fact is that this syndrome of overvalued, overbought, overbullish, rising-yield conditions has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 25.

 

2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.

 

3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 55.2% vs. 15.6%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.

 

4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below depict the complete set of instances since 1970 when these conditions have been observed.

Our investment approach remains to align our investment outlook with the prospective market return/risk profile that we estimate on the basis of prevailing conditions at each point in time. On that basis, the outlook is hard-defensive, and any other stance is essentially speculative. Such speculation is fine with insignificant risk-limited positions (such as call options), but I strongly believe that investors with a horizon of less than 5-7 years should limit their exposure to equities. At this horizon, even “buy-and-hold” strategies in stocks are inappropriate except for a small fraction of assets. In general, the appropriate rule for setting investment exposure for passive investors is to align the duration of the asset portfolio with the duration of expected liabilities. At a 2% dividend yield on the S&P 500, equities are effectively instruments with 50-year duration. That means that even stock holdings amounting to 10% of assets exhaust a 5-year duration. For most investors, a material exposure to equities requires a very long investment horizon and a wholly passive view about market prospects.

Again, our approach is to align our outlook with the prospective return/risk profile we estimate at each point in time. That places us in a defensive stance. Still, we’re quite aware of the tendency for investors to capitulate to seemingly relentless speculation at the very peak of bull markets, and saw it happen in 2000 and 2007 despite our arguments for caution.

As something of an inoculation against this tendency, the chart below presents what we estimate as the most “optimistic” pre-crash scenario for stocks. Though I don’t believe that markets follow math, it’s striking how closely market action in recent years has followed a “log-periodic bubble” as described by Didier Sornette (see Increasingly Immediate Impulses to Buy the Dip).

A log periodic pattern is essentially one where troughs occur at increasingly frequent and increasingly shallow intervals. As Sornette has demonstrated across numerous bubbles over history in a broad variety of asset classes, adjacent troughs (say T1, T2, T3, etc) are often related to the crash date (the “finite-time singularity” Tc) by a constant ratio: (Tc-T1)/(Tc-T2) = (Tc-T2)/(Tc-T3) and so forth, with the result that successive troughs come closer and closer in time until the final blowoff occurs.

Frankly, I thought that this pattern was nearly exhausted in April or May of this year. But here we are. What’s important here is that the only way to extend that finite-time singularity is for the advance to become even more vertical and for periodic fluctuations to become even more closely spaced. That’s exactly what has happened, and the fidelity to the log-periodic pattern is almost creepy. At this point, the only way to extend the singularity beyond the present date is to envision a nearly vertical pre-crash blowoff.

So let’s do that. Not because we should expect it, and surely not because we should rely on it, but because we should guard against it by envisioning the most “optimistic” (and equivalently, the worst case) scenario. So with the essential caveat that we should neither expect, rely or be shocked by a further blowoff, the following chart depicts the market action that would be consistent with a Sornette bubble with the latest “finite time singularity” that is consistent with market action since 2010.

To be very clear: conditions already allow a finite-time singularity at present, the scenario depicted above is the most extreme case, it should not be expected or relied on, but we should also not be shocked or dismayed if it occurs.

Just a final note, which may or may not prove relevant in the weeks ahead: in August 2008, just before the market collapsed (see Nervous Bunny), I noted that increasing volatility of the market at 10-minute intervals was one of the more ominous features of market action. This sort of accelerating volatility at micro-intervals is closely related to log-periodicity, and occurs in a variety of contexts where there’s a “phase transition” from one state to another. Spin a quarter on the table and watch it closely. You’ll notice that between the point where it spins smoothly and the point it falls flat, it will start vibrating uncontrollably at increasingly rapid frequency. That’s a phase transition. Again, I don’t really believe that markets follow math to any great degree, but there are enough historical examples of log-periodic behavior and phase-transitions in market action that it helps to recognize these regularities when they emerge.

Risk dominates. Hold tight.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/B_0XVe8QLF0/story01.htm Tyler Durden

With global financial company stock prices soaring, analysts proclaiming holding bank shares is a win-win on rates, NIM, growth, and “fortress balance sheets”, and a European stress-test forthcoming that will ‘prove’ how great banks really are; the question one is forced to ask, given the ruling below, is “Why is ISDA so worried about derivatives-based systemic risk?“

 

As DailyLead reports,

…regulators from the U.S., U.K., Germany and Switzerland have asked ISDA to include a short-term suspension of early-termination rights in its master agreement when it comes to bank resolutions. Many derivatives market participants oppose the move.

 

The regulators say the suspension, preferably no more than 48 hours, gives resolution officials time to switch derivatives contracts to a third party or bridging entity, when necessary.

 

We are sure that creditors will be ‘fine’ with this.. and that banks will not use this loophole to hive off all their ‘assets’ into a derivative vehicle protected ‘temporarily’ from the effects of a bankruptcy…

So the question is – what are they so worried about?

ISDA Statement on Letter from Major Resolution Authorities

NEW YORK, November 6, 2013 – The International Swaps and Derivatives Association, Inc. (ISDA) today issued the following statement:

 

“ISDA supports efforts to create a more robust financial system and reduce systemic risk.  Toward that end, we have, over the course of 2013, discussed with policymakers and OTC derivatives market participants issues related to the early termination of OTC derivatives contracts following the commencement of an insolvency or resolution action. We have developed and shared papers that explore several alternatives for achieving a suspension of early termination rights in such situations.

 

“One of those alternatives, which is supported by a number of key global policymakers and regulatory authorities, would be to amend ISDA derivatives documentation to include a standard provision in which counterparties agree to a short-term suspension.  Developing such a provision that could be used by counterparties will continue to be a primary focus of our efforts in this important area of regulatory reform.  We are committed to working with supervisors and regulators around the world to achieve an appropriate solution that will contribute to safe, efficient markets.”

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Sl1bReAUYGI/story01.htm Tyler Durden

With global financial company stock prices soaring, analysts proclaiming holding bank shares is a win-win on rates, NIM, growth, and “fortress balance sheets”, and a European stress-test forthcoming that will ‘prove’ how great banks really are; the question one is forced to ask, given the ruling below, is “Why is ISDA so worried about derivatives-based systemic risk?“

 

As DailyLead reports,

…regulators from the U.S., U.K., Germany and Switzerland have asked ISDA to include a short-term suspension of early-termination rights in its master agreement when it comes to bank resolutions. Many derivatives market participants oppose the move.

 

The regulators say the suspension, preferably no more than 48 hours, gives resolution officials time to switch derivatives contracts to a third party or bridging entity, when necessary.

 

We are sure that creditors will be ‘fine’ with this.. and that banks will not use this loophole to hive off all their ‘assets’ into a derivative vehicle protected ‘temporarily’ from the effects of a bankruptcy…

So the question is – what are they so worried about?

ISDA Statement on Letter from Major Resolution Authorities

NEW YORK, November 6, 2013 – The International Swaps and Derivatives Association, Inc. (ISDA) today issued the following statement:

 

“ISDA supports efforts to create a more robust financial system and reduce systemic risk.  Toward that end, we have, over the course of 2013, discussed with policymakers and OTC derivatives market participants issues related to the early termination of OTC derivatives contracts following the commencement of an insolvency or resolution action. We have developed and shared papers that explore several alternatives for achieving a suspension of early termination rights in such situations.

 

“One of those alternatives, which is supported by a number of key global policymakers and regulatory authorities, would be to amend ISDA derivatives documentation to include a standard provision in which counterparties agree to a short-term suspension.  Developing such a provision that could be used by counterparties will continue to be a primary focus of our efforts in this important area of regulatory reform.  We are committed to working with supervisors and regulators around the world to achieve an appropriate solution that will contribute to safe, efficient markets.”

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Sl1bReAUYGI/story01.htm Tyler Durden

Authored by Mohamed El-Erian, originally posted at Project Syndicate,

History is full of people and institutions that rose to positions of supremacy only to come crashing down. In most cases, hubris – a sense of invincibility fed by uncontested power – was their undoing. In other cases, however, both the rise and the fall stemmed more from the unwarranted expectations of those around them.

Over the last few years, the central banks of the largest advanced economies have assumed a quasi-dominant policymaking position. In 2008, they were called upon to fix financial-market dysfunction before it tipped the world into Great Depression II. In the five years since then, they have taken on greater responsibility for delivering a growing list of economic and financial outcomes.

The more responsibilities central banks have acquired, the greater the expectations for what they can achieve, especially with regard to the much-sought-after trifecta of greater financial stability, faster economic growth, and more buoyant job creation. And governments that once resented central banks’ power are now happy to have them compensate for their own economic-governance shortfalls – so much so that some legislatures seem to feel empowered to lapse repeatedly into irresponsible behavior.

Advanced-country central banks never aspired to their current position; they got there because, at every stage, the alternatives seemed to imply a worse outcome for society. Indeed, central banks’ assumption of additional responsibilities has been motivated less by a desire for greater power than by a sense of moral obligation, and most central bankers are only reluctantly embracing their new role and visibility.

With other policymaking entities sidelined by an unusual degree of domestic and regional political polarization, advanced-country central banks felt obliged to act on their greater operational autonomy and relative political independence. At every stage, their hope was to buy time for other policymakers to get their act together, only to find themselves forced to look for ways to buy even more time.

Central banks were among the first to warn that their ability to compensate for others’ inaction is neither endless nor risk-free. They acknowledged early on that they were using imperfect and untested tools. And they have repeatedly cautioned that the longer they remain in their current position, the greater the risk that their good work will be associated with mounting collateral damage and unintended consequences.

The trouble is that few outsiders seem to be listening, much less preparing to confront the eventual limits of central-bank effectiveness. As a result, they risk aggravating the potential challenges.

This is particularly true of those policymaking entities that possess much better tools for addressing advanced economies’ growth and employment problems. Rather than use the opportunity provided by central banks’ unconventional monetary policies to respond effectively, too many of them have slipped into an essentially dormant mode of inaction and denial.

In the United States, for the fifth year in a row, Congress has yet to pass a full-fledged budget, let alone dealt with the economy’s growth and employment headwinds. In the eurozone, fiscal integration and pro-growth regional initiatives have essentially stalled, as have banking initiatives that are outside the direct purview of the European Central Bank. Even Japan is a question mark, though it was a change of government that pushed the central bank to exceed (in relative terms) the Federal Reserve’s own unconventional balance-sheet operations.

Markets, too, have fallen into a state of relative complacency.

Comforted by the notion of a “central-bank put,” many investors have been willing to “look through” countries’ unbalanced economic policies, as well as the severe political polarization that now prevails in some of them. The result is financial risk-taking that exceeds what would be warranted strictly by underlying fundamentals – a phenomenon that has been turbocharged by the short-term nature of incentive structures and the lucrative market opportunities afforded until now by central banks’ assurance of generous liquidity conditions.

By contrast, non-financial companies seem to take a more nuanced approach to central banks’ role. Central banks’ mystique, enigmatic policy instruments, and virtually unconstrained access to the printing press undoubtedly captivate some. Others, particularly large corporates, appear more skeptical. Doubting the multi-year sustainability of current economic policy, they are holding back on long-term investments and, instead, opting for higher self-insurance.

Of course, all problems would quickly disappear if central banks were to succeed in delivering a durable economic recovery: sustained rapid growth, strong job creation, stable financial conditions, and more inclusive prosperity. But central banks cannot do it alone. Their inevitably imperfect measures need to be supplemented by more timely and comprehensive responses by other policymaking entities – and that, in turn, requires much more constructive national, regional, and global political paradigms.

Having been pushed into an abnormal position of policy supremacy, central banks – and those who have become dependent on their ultra-activist policymaking – would be well advised to consider what may lie ahead and what to do now to minimize related risks. Based on current trends, central banks’ reputation increasingly will be in the hands of outsiders – feuding politicians, other (less-responsive) policymaking entities, and markets that have over-estimated the monetary authorities’ power.

Pushed into an unenviable position, advanced-country central banks are risking more than their standing in society. They are also putting on the line their political independence and the hard-won credibility needed to influence private-sector behavior. It is in no one’s interest to see these critical institutions come crashing down.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-wSx_D7BDa4/story01.htm Tyler Durden

Authored by Mohamed El-Erian, originally posted at Project Syndicate,

History is full of people and institutions that rose to positions of supremacy only to come crashing down. In most cases, hubris – a sense of invincibility fed by uncontested power – was their undoing. In other cases, however, both the rise and the fall stemmed more from the unwarranted expectations of those around them.

Over the last few years, the central banks of the largest advanced economies have assumed a quasi-dominant policymaking position. In 2008, they were called upon to fix financial-market dysfunction before it tipped the world into Great Depression II. In the five years since then, they have taken on greater responsibility for delivering a growing list of economic and financial outcomes.

The more responsibilities central banks have acquired, the greater the expectations for what they can achieve, especially with regard to the much-sought-after trifecta of greater financial stability, faster economic growth, and more buoyant job creation. And governments that once resented central banks’ power are now happy to have them compensate for their own economic-governance shortfalls – so much so that some legislatures seem to feel empowered to lapse repeatedly into irresponsible behavior.

Advanced-country central banks never aspired to their current position; they got there because, at every stage, the alternatives seemed to imply a worse outcome for society. Indeed, central banks’ assumption of additional responsibilities has been motivated less by a desire for greater power than by a sense of moral obligation, and most central bankers are only reluctantly embracing their new role and visibility.

With other policymaking entities sidelined by an unusual degree of domestic and regional political polarization, advanced-country central banks felt obliged to act on their greater operational autonomy and relative political independence. At every stage, their hope was to buy time for other policymakers to get their act together, only to find themselves forced to look for ways to buy even more time.

Central banks were among the first to warn that their ability to compensate for others’ inaction is neither endless nor risk-free. They acknowledged early on that they were using imperfect and untested tools. And they have repeatedly cautioned that the longer they remain in their current position, the greater the risk that their good work will be associated with mounting collateral damage and unintended consequences.

The trouble is that few outsiders seem to be listening, much less preparing to confront the eventual limits of central-bank effectiveness. As a result, they risk aggravating the potential challenges.

This is particularly true of those policymaking entities that possess much better tools for addressing advanced economies’ growth and employment problems. Rather than use the opportunity provided by central banks’ unconventional monetary policies to respond effectively, too many of them have slipped into an essentially dormant mode of inaction and denial.

In the United States, for the fifth year in a row, Congress has yet to pass a full-fledged budget, let alone dealt with the economy’s growth and employment headwinds. In the eurozone, fiscal integration and pro-growth regional initiatives have essentially stalled, as have banking initiatives that are outside the direct purview of the European Central Bank. Even Japan is a question mark, though it was a change of government that pushed the central bank to exceed (in relative terms) the Federal Reserve’s own unconventional balance-sheet operations.

Markets, too, have fallen into a state of relative complacency.

Comforted by the notion of a “central-bank put,” many investors have been willing to “look through” countries’ unbalanced economic policies, as well as the severe political polarization that now prevails in some of them. The result is financial risk-taking that exceeds what would be warranted strictly by underlying fundamentals – a phenomenon that has been turbocharged by the short-term nature of incentive structures and the lucrative market opportunities afforded until now by central banks’ assurance of generous liquidity conditions.

By contrast, non-financial companies seem to take a more nuanced approach to central banks’ role. Central banks’ mystique, enigmatic policy instruments, and virtually unconstrained access to the printing press undoubtedly captivate some. Others, particularly large corporates, appear more skeptical. Doubting the multi-year sustainability of current economic policy, they are holding back on long-term investments and, instead, opting for higher self-insurance.

Of course, all problems would quickly disappear if central banks were to succeed in delivering a durable economic recovery: sustained rapid growth, strong job creation, stable financial conditions, and more inclusive prosperity. But central banks cannot do it alone. Their inevitably imperfect measures need to be supplemented by more timely and comprehensive responses by other policymaking entities – and that, in turn, requires much more constructive national, regional, and global political paradigms.

Having been pushed into an abnormal position of policy supremacy, central banks – and those who have become dependent on their ultra-activist policymaking – would be well advised to consider what may lie ahead and what to do now to minimize related risks. Based on current trends, central banks’ reputation increasingly will be in the hands of outsiders – feuding politicians, other (less-responsive) policymaking entities, and markets that have over-estimated the monetary authorities’ power.

Pushed into an unenviable position, advanced-country central banks are risking more than their standing in society. They are also putting on the line their political independence and the hard-won credibility needed to influence private-sector behavior. It is in no one’s interest to see these critical institutions come crashing down.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-wSx_D7BDa4/story01.htm Tyler Durden

JPM’s “flows and liquidity’ expert Nikolaos Panigirtzoglou, who last week spotted the “most extreme ever excess liquidity” bubble, has just noticed yet another indication that not even corporations believe in further equity upside.

While on one hand it has been well-known that during the entire Fed-driven equity bubble, corporate insiders have been aggressive sellers of equity, either through automatic selling programs or more recently, on a discretionary basis, and locking in profits, it was corporations that, under activist duress or otherwise, had opted to engage in shareholder friendly stock activities such as buybacks. In fact, netting equity withdrawal and injections, in the form of equity offerings, had resulted in a consistently negative print ever since the Lehman crisis meaning companies were net buyers of their own stock.

The simplest explanation is that flush with record amounts of cash, the best “investment” for the corporate world was not investing in long-term growth via CapEx spending or hiring (perhaps because said “growth” never appears to actually materialize, five years into the Fed’s grandest of all monetary experiments), and certainly not raising equity to fund such projects, but through (mostly levered) buybacks and dividends, which provided the biggest bang for the near-term buck. Another implication of this is that corporate treasurers, not as investors but as fiduciaries, had perceived stocks as cheap in a low-rate environment, as otherwise they would not have been repurchasing their own equities hand over fist.

Said otherwise, this means that for the first time since the Lehman crisis, non-financial corporations within the entire developed, G-4 (US, Europe, Japan and UK) world, have shifted from net buyers of stock to net sellers, as net “equity withdrawal” have just turned positive.

This has now changed and as JPM summarizes, “The G4 non-financial corporate sector appears to have stopped withdrawing its own equity in Q2.” JPM continues:

The latest release of Euro area Flow of Funds for the second quarter allows us to get a more complete picture about the behavior of non–financial corporations across the whole of the G4, i.e. the US, Euro area, UK and Japan. The big surprise in these data was a collapse of G4 net equity withdrawal to zero for the first time since the Lehman crisis (Figure 1). That is, at face value, Figure 1 suggests that for the first time since the Lehman crisis, the G4 non financial corporate sector stopped withdrawing its own equity on net.

This is shown visually below:

JPM’s explanation of the chart above:

1) The decline of the blue line in Figure 1 is driven by non-US net equity issuance, which reversed from negative (i.e. from net withdrawal) to positive (i.e. to net supply) in Q2, both in the raw data and our seasonally adjusted figures. The problem with non-US net equity issuance data is that they are typically a lot more volatile than their US counterparts and similar spikes in the blue line in the past were quickly reversed and not sustained.

 

2) Net equity withdrawal is almost exclusively a US phenomenon. Figure 1 shows that the blue (G4) and black lines (US) are very closely aligned (in $bn) suggesting that the non-US component, although volatile, is on average very small. And the net equity withdrawal by US non financials corporations (the black line in Figure 1) held up well in Q2. In fact it increased slightly in Q2.

Do other higher-frequency data substantiate the above observations? Yes:

• What evidence do we get from higher-frequency data on announced share buybacks? Figure 3 shows a sharp slowing in announced share buybacks outside the US, but in Q3 rather than Q2! And this is the caveat with announced share buybacks: they do not necessarily reflect actual buybacks as there is typically a lag between announcements and actual stock purchases. The other problem is that while share buybacks reduce the share count of a company, they do not capture the equity withdrawal impact of M&A (to the  extent that the acquirer uses cash or debt) or LBO activities. Similarly share buybacks do not capture offsetting corporate activities such as share offerings, exchange of common stock for debentures, conversion of preferred stock or convertible securities, as well as stock options and employee stock programs.
• To address some of the above issues and better capture high-frequency corporate equity withdrawal trends, we augment the announced share buybacks with equity offerings and LBOs. Figure 4 augments announced share buybacks with LBOs, which also cause equity withdrawal, but deducts equity offerings, i.e. IPOs and secondary offerings, which increase the share count. The evolution of the red line in Figure 4 is effectively a higher-frequency proxy of the Flow of Funds equity issuance/withdrawal data of Figure 1.
• Consistent with Figure 1, Figure 4 shows that equity issuance turned a lot less supportive for equity markets (i.e. red line increased) in Q2 relative to Q1, and worsened even further in Q3. This is both because of a slowing in announced share buybacks but also an increase in IPO/secondary offering activity in Q2/Q3. Also consistent with the Flow of Funds data of Figure 1, Figure 4 suggests that equity withdrawal appears to have peaked in 2011 (red line bottomed) in terms of its pace across calendar years. This year’s pace is roughly equal on average with that of 2012. In addition, there appears to be still a long way for equity withdrawal to return to its 2007 historical peak.
• The implication of all the above evidence is that, sequentially, between 2012 and 2013, there appears to have been no improvement in the equity withdrawal/buying activity of corporates themselves. If anything, there has been a slight deterioration.

And in chart format:

In other words, thank the Fed’s lucky stars for the retail “great rotation” because not only are corporate insiders dumping their stock holdings at a historic pace, but now the very corporations themselves, record cash holdings notwithstanding, have for the first time in the past 5 years, shifted away from being a net buyer of stock to a net seller.

And who are they selling to?

Well, the vacuum tubes of course, and whoever has the misfortune of being suckered into the whole “recovery” myth (after how many years of “growth is just around the corner” will people learn?) and is the last carbon-based “retail” bagholder standing.

But don’t worry: because at the end of the day what do companies really know about the potential upside (and thus attractiveness) of their own stock? Nothing that Joe Sixpack doesn’t know from behind the comfort of the CNBC, and momentum-chasing, glow. So just ignore this latest telltale inflection point, and keep on ploughing in: after all Mr. Chairwoman’s $4 trillion balance sheet has your back and nothing can ever go wrong in centrally-planned, manipulated markets.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/tbLaZWrOWTE/story01.htm Tyler Durden

 

 

“It is no coincidence that the century of total war coincided with the century of central banking.” –Ron Paul 

 

 

To those who served honourably: Happy Veteran’s Day 2013

WB7

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/c0t0G5gK0eY/story01.htm williambanzai7

 

 

“It is no coincidence that the century of total war coincided with the century of central banking.” –Ron Paul 

 

 

To those who served honourably: Happy Veteran’s Day 2013

WB7

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/c0t0G5gK0eY/story01.htm williambanzai7

With stocks at record highs, ongoing commentary that retail is back and will lift all boats to infinity and beyond, it seems the professionals in the credit market are not amused. We have noted the ongoing divergence between the asset-classes for two weeks now but with today's ultra-low volume drift higher in stocks, the drop in high-yield bonds is even more notable. The question we have is – as we have explained in great detail before – if rates for leveraged firms is rising, how will management maintain their exuberant re-leveraging to buoy their stock prices in the face of crushing top-line deflation?

 

 

Credit is now at 4-week lows (high yields and spreads) as stocks push on – these 'decouplings' never last…

Remember corporate credit risk reflects just as much on the underlying business volatility and cashflow outlook as the equity part of the capital structure. There are periods in the credit cycle when credit will underperform as management relevers (i.e. buybacks/dividends) but that always only lasts a brief time as credit begins to penalize those actions, making the re-levering non-economic, and an over-expectant equity market reverts back to a less-levered reality.

As we noted before,

The bottom-line is that the credit-cycle cannot be hidden forever – unless we can rest assured that even if the Fed does 'Taper' it will rapidly 'un-Taper' soon after as the gross misallocations of capital (rise in liabilities – which will not drop – against an artificial rise in assets – which will fall)…

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/rC7v9QO0mjE/story01.htm Tyler Durden