Watch Live: Trump Signs Executive Orders To Reign In Foreign Trade Abuses

Update:

After very quick statements from President Trump, Wilbur Ross, Peter Navarro and Vice President Pence, here were the key headlines:

  • TRUMP VOWS LEVEL PLAYING FIELD FOR U.S. WORKERS
  • TRUMP SAYS WILL INVESTIGATE ALL TRADE ABUSES
  • TRUMP: WILL GET `BAD TRADE DEALS STRAIGHTENED OUT’
  • TRUMP SAYS WILL GET DOWN TO SERIOUS BUSINESS AT CHINA MEETING
  • TRUMP ACTION CALLS FOR EXAMINATION OF TRADE-DEFICIT CAUSES
  • TRUMP ACTION STRENGTHENS ENFORCEMENT OF ANTI-DUMPING PENALTIES

* * *

One week ahead of his highly anticipated first meeting with Chinese President Xi Jinping next week at Mar-A-Lago, Trump took to twitter yesterday to set a fairly aggressive tone on trade discussions, saying “we can no longer have massive trade deficits and job losses. American companies must be prepared to look at other alternatives.”

“The meeting next week with China will be a very difficult one in that we can no longer have massive trade deficits and job losses. American companies must be prepared to look at other alternatives.”

 

In just a few moments, Trump is set to sign a pair of executive orders which will initiate a ‘yuge’ review of America’s trade deficits and look to impose restrictions on countries that perpetually “cheat on trade”, as the President would say.  Per CNN:

President Donald Trump on Friday will make the next move in his bid to reshape US trade policy, signing two executive orders aimed at combating foreign trade abuses that contribute to the US’s half-trillion-dollar trade deficit.

 

Trump’s executive orders will initiate a large-scale review of the causes of the US’s trade deficits with some of its largest trading partners and order stricter enforcement of US anti-dumping laws to prevent foreign manufacturers from undercutting US companies by selling goods at an unfair price. They show the administration’s ongoing efforts to shift toward policies aimed at bolstering US manufacturing and making good on Trump’s campaign rhetoric decrying other countries for taking advantage of the US’s free trade policies.

Tune in below for the Friday fireworks:

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Official Law of Georgia is Copyrighted, and the State Enforces That Copyright

A district judge has ruled that the Official Code of Georgia Annotated (OGCA), the official state law of Georgia, was subject to copyright, and that its dissemination was not covered by fair use, Ars Technica reports.

Open-records activist Carl Malamud purchased a hard copy of the OGCA for $1,207.02 (with shipping) from Lexis-Nexis (which compiles the OGCA for Georgia) and subsequently sent digital copies on USB drives to the state house speaker and a number of other Georgia politicians and lawyers and posted it on Public.Records.org, Ars Technica explains.

The state of Georgia, and the Code Revision Commission (CRC), a government body, brought a lawsuit against the website, accusing it of violating copyright. Attorneys for the website argued the lawsuit should be dismissed because the OCGA, as the official state law of Georgia, was not copyrightable, and that even if it were, public dissemination would fall under fair use.

The judge, Richard Story, disagreed, ruling that even though the OCGA is the official state law of Georgia, the annotations in it were copyrightable because the Copyright Law includes annotations as copyrightable material. He further dismissed the argument that disseminating the OCGA to the public fell under fair use, because the use was not “transformative” and because, even though it was non-commercial, courts have ruled that non-profit use of copyrighted material could yield “profits” such as “an indirect economic benefit or a non-monetary, professional benefit.”

The CRC, as Story noted, “has ‘the ultimate right of editorial control.” The lawsuit was brought by the commission, not Lexis-Nexis, the company the CRC hires to produce the official law of the state of Georgia. The commission receives royalties from sales of the CD-ROM and physical copies of the OCGA, and it collected $85.747.91 in fiscal year 2014. The purpose of copyright is supposed to be to “promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.” Contemporary copyright law already stretches the understanding of “limited time” to time periods generally greater than human lifespans. In this case, the promotion of progress is completely indiscernible. After all, would the commission and Georgia’s lawmakers in the legislative and judicial branches stop their work if it weren’t enforceable by copyright?

Read the opinion, via Ars Technica, here.

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RBC Warns “Beware ‘The April Effect’… Risk Of A Nasty ‘Double Whammy'”

RBC's head of cross asset strategy Charlie McElligott dons his full wonksh equity analyst hat today, exposing "The April Effect," and the specific risk of "nasty double whammy" of levered long-short unwinds should momentum stall.

Quick note of warning as we transition into the new quarter, with potential for major thematic / sector / factor reversals in stocks.  The following observation regarding April seeing a seasonal ‘momentum’ factor market-neutral strategy unwind is ‘equities wonk-ish,’ but with real potential cross-asset impact.  As we know, the Fed watches equities because there are potential implications with regards to broad US ‘financial conditions’ on consumer and economic confidence.  Thus, the scale of potential equities volatility does matter across macro, especially in light of general buyside portfolio ‘crowding’ / ‘high beta’ exposure (into ‘growth’ right now especially) which could exacerbate the dynamic.

COMMENTARY: I have been monitoring a phenomenon seen in recent years (notably of escalating ‘violence’) where ‘momentum’ factor market-neutral strategies experience tremendous volatility / drawdown.  Huh?  Basically this is saying that “the stuff that’s been working” over the prior trail 12 months—both long and short—experiences a significant unwind.  The Dow Jones Momentum M/N index has been -1.8% on average over the past five years and down -2.6% on average over the trailing 15 years…while the three year trailing average in the month of April is an absolutely brutal -4.5%.

Why does this unwind occur?  For sure there are idiosyncratic macro factors at play at times throughout this window (i.e. you can probably ‘throw out’ the -27.2% strategy return in April ’09 as markets violently reversed off the crisis lows, or the recovery in crude post Yellen’s ‘weak USD policy dovish pivot’ last year swinging-us from deflation favorite ‘anti-beta’ to cyclical beta ‘value’ during this same period)…but it would seem that there is a ‘signal’ being generated in the market (perhaps it’s an expression of rotating into laggards ahead of “sell in May”?) which is driving a quantitative strategy factor rotation with strong seasonality into the quarter-change.

So if this phenomenon were to occur again, what are the implications?  We’d need to watch both the ‘high flyers’ and ‘biggest losers’ over this 12 month period for reversals.  On a generic GICS sector level, that would mean that Financials (+30.4% over trailing 1 year period), Tech (+23.2%), Materials +17.1%), Industrials (+16.0%), Consumer Discretionary (+11.6%) and Energy (+11.1%) could be exposed from the long-side (for underperformance risk), while Healthcare, Utes, Consumer Staples, REITS and Telcos would be the sectors to watch from the short side (potential outperformance).  Obviously from the long-side, the 12m window captures a lot of the run which ‘value’ saw last year (cyclicals, inflation)…so with regards to current portfolio allocation, ‘growth’ would then seemingly be most dangerously positioned for a drawdown, especially ‘secular growers’ (MS pointing out that Tech has accounted for ~50% of the S&P’s return YTD, with those 5 FAANG stocks at 30% of the index return!). 

Why is this EXTRA critical into this upcoming April?  Well, “factor exposures”…that’s why.  AlphaBetaWorks and their recent analysis of 4Q16 hedge fund 13F’s shows us that “…nearly 70% of the hedge fund industry’s long equity risk comes from factor crowding.”  And of all of those potential factor inputs, the data shows us that 50% of HF relative factor variance is your ‘Beta’ or ‘Market’ exposure…a.k.a. hedge funds’ ‘long’ equity portfolio characteristics are of exceedingly ‘high beta’ right now.  As such, “HF Aggregate thus partially behaves like a leveraged market ETF, outperforming during bullish regimes and underperforming during bearish ones.”

Right-o.  So basically, there is risk of a nasty “double-whammy,” because IF this momentum long-short were to unwind with violence, not only would popular longs get hit and popular shorts rip higher….but because the ‘longs’ are ‘high beta’ and the ‘shorts’ are ‘low beta,’ you’d get that ugly ‘leveraged’ market impact as well!

DOW JONES ‘MOMENTUM’ MARKET NEUTRAL SEASONALITY SHOWS AN UGLY APRIL ‘UNWIND’ TREND: -1.8% on average over the trailing 5 years, -2.6% over the trailing 15 years and most-acutely, -4.5% over the past 3 years.

‘HIGH BETA’ (‘MARKET’ FACTOR) IS THE MOST CROWDED HF FACTOR: i.e. Equity HF’S are running very ‘high beta’ long portfolios.  As such, a potential factor reversal in ‘momentum’ could see a painful ‘shakeout’ of this crowding.

Below chart and table from AlphaBetaWorks:

And now a final thought – perhaps the macro data divergence between ‘animal spirits’ soft data (beating at a 2 z-score rate) vs relatively ‘benign’ hard data (avg of housing & real estate, industrial sector, labor mkt, personal  household sector and retail & wholesale ‘surprise’ indices z-scores essentially running ‘slight beat’) will ‘true-up’ come April, which could then act as the ‘macro trigger’ to exacerbate this dynamic further?

‘HARD-‘ VS ‘SOFT-‘ DATA MEAN-REVERSION IMMINENT?  2 Z-SCORE AVG BEAT IS TOP OF 10 YEAR RANGE: Potential catalyst?  Trump “animal spirits” fade in coming months with no further clarity on tax policy until Summer ‘deadline.’

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Venezuela Bonds Crash As Political Situation Turns “Explosive”

Venezuela sovereign bonds crashed on Friday as a result of soaring political tensions after the annulment of the country’s legislature by its high court on Wednesday, a move that ignited protests, invoked international condemnation and prompted the opposition to call for a military response to what it deemed a “coup.”

One day after our report on the latest attempt by Maduro to seize unilateral control of the government and to isolate the opposition, the political situation turned “explosive” on Friday when Venezuela’s powerful attorney general Luisa Ortega broke ranks with President Nicolas Maduro’s government after the Supreme Court annulled congress, a rare show of internal dissent as protests and international condemnation grew. As a reminder, the pro-Maduro Supreme Court on Wednesday said it was assuming the legislature’s functions because it was in “contempt” of the law. The opposition promptly slammed the decision as a “coup” against an elected body.

Luisa Ortega, appointed attorney general in 2007 and a staunch ally of the Socialists who have ruled for the last 18 years, made an unexpected ideological U-turn and rebuked the Supreme Court’s controversial move to take over the opposition-led National Assembly’s functions.

In a speech before reporters, Ortega said Wednesday’s ruling against the congress “violates the constitutional order.” She was speaking at a scheduled briefing on the state of her office. “It’s my obligation to express my great concern to the country.” Ortega added that she was speaking in the name of her office’s 10,000 workers and 3,000 prosecutors. “We call for reflection, so that you take democratic paths that respect the constitution” and “guarantee peace,” she said, receiving a standing ovation

At that moments, state television immediately cut off transmission of her talk but other private media outlets continued to carry her remarks, which were quickly picked up by social media.

Venezuelan Attorney General as seen Friday on state-owned VTV television
broadcast before the channel pulled the plug on her criticism of the Supreme
Court’s move against congress

While various prominent political figures have leveled criticism after leaving the government, it is extremely rare for a senior Venezuelan official to criticize Maduro in this manner. One person who has known Ortega for years said it was not the first time she had expressed dissent within government, though never so publicly.

“Luisa has suffered a lot of threats from all sides for her principled actions,” the person said quoted by Reuters, asking not to be named for fear of reprisals.

Ortega had carefully toed Maduro’s line for years, jailing his opponents on trumped-up charges and declining to prosecute cases of endemic corruption the WSJ added. In recent months, however, she had distanced herself from the government, issuing release orders for detained opposition activists and meeting secretly with opposition leaders. Ortega’s speech could trigger even more defections within Venezuela’s sprawling bureaucracy and armed forces, said retired Maj. Gen. Cliver Alcalá, a top confidant of Mr. Chávez who broke ranks with Mr. Maduro last year  the WSJ added.

The military and bureaucrats have up to now maintained a show of iron unity in the face of the spiraling economic and political crisis, however in the most troubling development since the start of Venezuela’s crisis, the army may soon turn against Maduro, effectively leading to a presidential coup.

“The Armed Forces are part of Venezuelan society and as such have an obligations to put themselves in defense of the constitution,” Gen. Alcalá said.

The opposition alliance has lauded Ms. Ortega’s speech and called Venezuelans to a campaign of civil disobedience to prevent what they call the country’s slide into dictatorship. The opposition plans to march in Caracas Saturday.

* * *

Meanwhile, throughout Friday, pockets of protesters blocked roads, unfurled banners and chanted slogans against Maduro’s unpopular government. In Caracas, several dozen students marched to the Supreme Court, but were pushed back by soldiers with riot shields.

Some protesters also briefly blocked highways in the capital, holding banners reading: “No To Dictatorship.”

Police moved them on, and several were detained, according to a local human rights group. “We have to demand our rights, in the streets, without fear,” said opposition lawmaker Miguel Pizarro, who led a knot of demonstrators into a subway train. In volatile western Tachira state, several dozen demonstrators tore up copies of court sentences in front of local judicial buildings.

* * *

While some government critics were skeptical of Ortega’s criticism, speculating her comments may have been a show to feign separation of powers and give the government an excuse to tweak the controversial decision, the market disagreed and in response to the political situation which appeared on the verge of collapse, the price on Venezuela’s 9.25% bonds of September 2027 fell by more than 3.5 cents to around 46.4 cents on the dollar, the yield surging to 23%, the highest since last August. It was the largest one-day rise in yield since October.

Longer-dated bonds plunged even more: the more illiquid 7% of March 2038s were bid at 40 cents on the dollar, down from 42.6 cents on Thursday. Their yield rose to 18.22% from 17.17%.

It is unclear how much downside Venezuela’s sovereign debt has should the already explosive political situation escalate further, leading to the ouster of Maduro.  And perhaps an even more relevant question is what wil happens to the price of crude should this more dire scenario play out.

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American Healthcare – A Racket Of Rackets

Authored by James Howard Kunstler via Kunstler.com,

If you thought banking in our time was a miserable racket – which it is, of course, and by 'racket' I mean a criminal enterprisethen so-called health care has it beat by a country mile, with an added layer of sadism and cruelty built into its operations.

Lots of people willingly sign onto mortgages and car loans they wouldn’t qualify for in an ethically sound society, but the interest rates and payments are generally spelled out on paper. They know what they’re signing on for, even if the contract is reckless and stupid on the parts of both borrower and lender. Pension funds and insurance companies foolishly bought bundled mortgage bonds of this crap concocted in the housing bubble. They did it out of greed and desperation, but a little due diligence would have clued them into the fraud being served up by the likes of Goldman Sachs.

Medicine is utterly opaque cost-wise, and that is the heart of the issue. Nobody in the system will say what anything costs and nobody wants to because it would break the spell that they work in an honest, legit business. There is no rational scheme for the cost of any service from one “provider” to the next or even one patient to the next. Anyway, the costs are obscenely inflated and concealed in so many deliberately deceptive coding schemes that even actuaries and professors of economics are confounded by their bills. The services are provided when the customer is under the utmost duress, often life-threatening, and the outcome even in a successful recovery from illness is financial ruin that leaves a lot of people better off dead.

It is a hostage racket, in plain English, a disgrace to the profession that has adopted it, and an insult to the nation. All the idiotic negotiations in congress around the role of insurance companies are a grand dodge to avoid acknowledging the essential racketeering of the “providers” — doctors and hospitals. We are never going to reform it in its current incarnation. For all his personality deformities, President Trump is right in saying that ObamaCare is going to implode. It is only a carbuncle on the gangrenous body of the US medical establishment. The whole system will go down with it.

The New York Times departed from its usual obsessions with Russian turpitude and transgender life last week to publish a valuable briefing on this aspect of the health care racket: Those Indecipherable Medical Bills? They’re One Reason Health Care Costs So Much by Elisabeth Rosenthal. Much of this covers ground exposed in the now famous March 4, 2013 Time Magazine cover story (it took up the whole issue): Bitter Pill: Why Medical Bills Are Killing Us, by Steven Brill. The American public and its government have been adequately informed about the gross and lawless chiseling rampant in every quarter of medicine. The system is one of engineered criminality. It is inflicting ruin on millions. It is really a wonder that the public has not stormed the hospitals with pitchforks and flaming brands to string up that gang in the parking lots high above their Beemers and Lexuses.

There are only two plausible arcs to this story.

  • One is that the nation might face the facts and resort to the Single Payer system found in virtually every other nation that affects to be civilized. There is no other way to eliminate the deliberate racketeering.
  • The other outcome would be the inevitable collapse of the system and its eventual re-set to a much less complex, cash-on-the-barrelhead, local clinic-based model with far less heroic high-tech interventions available for the broad public, but much more affordable basic care.

Both outcomes would require jettisoning the immense overburden of administrative dross that clutters up the current model, with its absurd tug-of-war between the price-gouging hospital “Chargemaster” clerks and the sadistic insurance company monitors bent on denying treatment to their sick and hapless “customers” (hostages). Be warned: these represent tens of thousands of supposedly “good” jobs. Of course, they are “good” because they pay middle class wages, of which there are fewer and fewer elsewhere in the economy. But, they are well-paid because of the grotesquely profitable racket they serve. They’ve turned an entire generation of office workers into servants of criminal enterprise. Imagine the damage this does to the soul of our culture.

My suggestion for real reform of the medical racket looks to historical precedent:

In 1932 (before the election of FDR, by the way), the US Senate formed a commission to look into the causes of the 1929 Wall Street Crash and recommend corrections in banking regulation to obviate future episodes like it. It is known to history as the Pecora Commission, after its chief counsel Ferdinand Pecora, an assistant Manhattan DA, who performed gallantly in his role. The commission ran for two years. Its hearings led to prison terms for many bankers and ultimately to the Glass-Steagall Act of 1932, which kept banking relatively honest and stable until its nefarious repeal in 1999 under President Bill Clinton — which led rapidly to a new age of Wall Street malfeasance, still underway.

The US Senate needs to set up an equivalent of the Pecora Commission to thoroughly expose the cost racketeering in medicine, enable the prosecution of the people driving it, and propose a Single Payer remedy for flushing it away. The Department of Justice can certainly apply the RICO anti-racketeering statutes against the big health care conglomerates and their executives personally. I don’t know why it has not done so already — except for the obvious conclusion that our elected officials have been fully complicit in the medical rackets, which is surely the case of new Secretary of Health and Human Services, Tom Price, a former surgeon and congressman who trafficked in medical stocks during his years representing his suburban Atlanta district. A new commission could bypass this unprincipled clown altogether.

It is getting to the point where we have to ask ourselves if we are even capable of being a serious people anymore. Medicine is now a catastrophe every bit as pernicious as the illnesses it is supposed to treat, and a grave threat to a nation that we’re supposed to care about. What party, extant or waiting to be born, will get behind this cleanup operation?

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The First Quarter is in the Books: Here Are the Winners and Losers

Year to date, the Dow is higher by 4.8%, S&P 500 +6% and the fag-heavy Nasdaq +10%. The top 5 performing sectors were Home Improvement stores ($BLDR, $LL, $LOW, $HD), Nuclear ($URRE, $UUUU, $UEC, $URG), Aluminum ($AA, $CENX), Semi Equipment ($AEHR, $LPTH, $COHU, $BRKS) and Hospitals ($CYH, $JYNT, $SSY, $THC)

The losers were Department Stores ($BONT, $JCP, $KSS, $SHOS), Oil and Gas Drillers ($NADL, $PACD, $PES, $BBG), Apparel Stores ($SMRT, $SSI, $CBK, $ASNA), Home Furnishing ($TPX, $FLXS, $HOFT, $ETH), Pollution and Treatment Controls ($CECE, $ERII, $HCCI, $FTEK).

The great thing about Presidential elections is the predictability of the policies and how they might affect share prices.

Take, for example, $PRSC. This is literally a play on American welfare and entitlements.

The Providence Service Corporation, through its subsidiaries, provides critical healthcare and workforce development services in the United States and internationally. It operates through three segments: Non-Emergency Transportation Services (NET Services), Workforce Development Services (WD Services), and Health Assessment Services (HA Services). The NET Services segment offers covered healthcare related transportation services for individuals with limited mobility and/or people with financial resources that hinder them from accessing necessary healthcare and social services. The WD Services segment offers workforce development and offender rehabilitation services, including employment preparation and placement, apprenticeship and training, and other health related services comprising employee assistance programs for unemployed, disabled, and unskilled individuals, as well as individuals coping with medical illnesses. The HA Services segment provides care optimization and delivery solutions, including comprehensive health assessments, as well as in-home and community-based care management offerings. The company was founded in 1996 and is headquartered in Tucson, Arizona.

When Obama took office, the share price was under $2. By the end of his term, it was north of $50. I found the stock during Obama’s second term, when it was $15. Regrettably, I never held my position long enough to benefit from their growth.

On the currency side, Bitcoins rose by 10% and the Mexican peso by 10% — recovering some the losses it endured during the American elections.

Lumber is up 20%, Palladium +16% and Lead +16%, while Orange juice dropped by 20%, Natural Gas by 14% and Sugar by 14%.

Going forward, providing Trump isn’t impeached and removed from office, expect more of the same — bullish on infrastructure, commodities and nuclear, while bearish on retail, big pharma, and anything environmental.

Content originally generated at iBankCoin.com

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Goldman’s ‘Analyst Index’ Tumbles In March As ‘Soft’ Survey Data Rolls Over

Since the election, talking heads have crowed about improving economic data (macro- and micro-). However, what they have failed to mention is all of the improvements have been in 'soft' survey and sentiment data, not 'hard' economic figures; and now, judging from the plunge in Goldman Sachs Analyst Index, soft data is starting to lose faith rapidly.

The Goldman Sachs Analyst Index (GSAI) declined by 5.2pt to 51.5 in March, but remains above 50, a level we have found represents trend growth. Underlying components also edged lower, though the month-over-month decline in the headline index was primarily driven by declines in materials prices and sales and shipments indexes. Consistent with the February survey, analyst commentary remains optimistic about the pace of growth in business activity this year, but some sector analysts suggested a few potential headwinds remain.

We construct the headline GSAI using the following weights: 30% for new orders, 25% for sales/shipments, 20% for employment, 15% for materials prices, and 10% for inventories. These weights parallel the Institute for Supply Management’s pre-2008 practice, substituting our materials prices index for their supplier deliveries index. The GSAI includes service as well as manufacturing industries.

On balance, regional manufacturing and non-manufacturing surveys were softer in March.

The Philly Fed, Dallas Fed, and Empire State manufacturing surveys all declined after improvements in February.

Overall, survey or “soft” data have retraced a bit in March after increasing sharply over the prior few months, converging toward the trend in hard data that would suggest a more moderate pace of expansion.

The GSAI’s underlying components generally moved lower in March as well. The sales and shipments index declined by 7.6pt to 53.8, but still continues to indicate expansion. The exports component declined by 3.2pt to 58.3, following a 19.5pt gain in January. While the new orders index edged down by 2pt to 50.6, the inventories index weakened by a larger 7.1pt to 40.0.

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LIBOR Pains

Authored by Pater Tenebrarum via Acting-Man.com,

Wrong Focus

If one searches for news on LIBOR (=London Interbank Offered Rate, i.e., the rate at which banks lend dollars to each other in the euro-dollar market), they are currently dominated by Deutsche Bank getting slapped with a total fine of $775 million for the part it played in manipulating the benchmark rate in collusion with other banks (fine for one count of wire fraud: US$150 m.; additional shakedown by US Justice Department: US$625 m., the price tag for a deferred prosecution agreement).

 

Bad, but not deadly for the wobbling banking giant. There is a far more important fact to focus on though – namely what LIBOR has actually done lately. Let us take a look:

 

Since mid 2015, 3 month LIBOR has soared from a low of approx 22.5 basis points to its current level of 115 basis points – i.e., it is now more than 5 times higher than two years ago. The “ouch” is explained further below – click to enlarge.

 

The initial surge in LIBOR was due to a combination of the Fed finally hiking rates and new rules for US money market funds taking shape, which were rightly expected to starve European banks of a major source of dollar funding. The latter continued to affect the market throughout 2016, as US MM funds indeed shifted funds from CP issued by European banks to t-bills (this has incidentally also played a major role in boosting domestic US money supply last year).

Along with the surge in LIBOR we have seen a widening in the TED spread (the spread between 3M LIBOR and the t-bill discount rate). Normally this is a sign of increasing stress in the banking system, but we are not sure if that interpretation is currently applicable. The absolute size of the spread is still a far cry from what was seen during past crisis situations. The spread is also well off its 2016 spike high, which we take as an indication that the disruption caused by the retreat of US MM funds from funding European banks is abating.

 

TED spread: still high, but not as high as it was last year – click to enlarge.

 

So what is the problem? It is actually not the banking system that gives cause for immediate concern. One must keep in mind that risks in the financial system have shifted since the 2008 crisis. Eventually, these risks are still going to redound on the banking system, but it is so to speak one step removed from the currently ticking time bomb, rather than being right at its center.

 

The Nature of the Problem

As mentioned above, LIBOR is a benchmark reference rate (which explains why some banks were so eager to manipulate it). The pricing of all kinds of floating-rate debt is tied to it (corporate loans, mortgages, student loans, credit card debt, and assorted derivatives, such as currency and interest rate swaps, etc.). That has now become a problem. Before we get to that, here is some background information:

One of the components of the global debtberg that has grown at a particularly breath-taking pace in recent years is corporate debt. As we have often mentioned in these pages, we regard it as a major Achilles heel of the Bernanke echo bubble. It already looked dubious before the recent rise in rates (see “A Dangerous Boom in Unsound Corporate Debt”) and has kept growing since then.

We often post a chart that adds up outstanding corporate bonds and bank debt, but the chart actually shows less than half of total US corporate liabilities, which currently amount to more than $18 trillion. There are also the “forgotten” $3 trillion in off-balance sheet operating leases, which are currently only known to avid readers of footnotes found in earnings reports, as Bloomberg recently reported.

 

Debt of US non-financial corporations: total liabilities (blue line), outstanding bonds + bank debt (red line) and the Wilshire Total Market Index (black line) – the  Wilshire Index reflects the bubble in asset prices; these are prone to suffering a “reversal to the mean”. Debt levels will remain where they are when that happens, but the collateral backing a lot of debt will be perceived to be less valuable. There is a multi-layered feedback loop between asset prices and debt that has become quite important for the economy – click to enlarge.

 

There are several points worth noting in this context: 1. corporate debt relative to assets is back at a record high (last seen at the peak of the late 1990s mania); 2.  US corporations are spending far more than they are taking in, i.e., the sum of capex, investment, dividends and stock buybacks vastly exceeds their gross cash flows – the gap is in fact at a record high, above the previous record set in 2007. 3. the return on equity of US corporations is at a record low (yes, you read that right!).

Obviously, the gap between spending and cash flows is funded with debt, which in this context probably deserves to be called Ponzi debt. Not to forget, debt is an absolute figure. The same cannot be said of income or the value of assets, both of which are moving targets. Everything is fine as long as the latter are moving up – alas, it is in their nature to occasionally misbehave.

 

The gap between non-financial corporate spending on capex/ investment/ dividends and stock buybacks vs. gross cash flows is at a new record high. Such expressions of unbridled overconfidence are usually soon punished – click to enlarge.

 

The profitability of US companies is rather underwhelming at the current juncture. It is probably not really the best moment to load up on debt:

 

US corporate profitability produces a record as well, but the wrong kind – click to enlarge.

 

Coming LIBOR Pains

This brings us back to LIBOR. As mentioned above, the rate is used in pricing a lot of variable rate debt – and as it turns out, the 1% level represents a threshold that is actually rather important for corporate debt. As a recent Barron’s article informs us:

“The rate hasn’t climbed above 1% since prior to the financial crisis. Most corporate loans have so-called Libor floors, so the loans wouldn’t reset higher until the 1% mark had been breached. Now that it has, with each rate hike, companies will owe more on their loans. […] And there are a lot more very leveraged companies now than there were even a few years ago.

(emphasis added)

This is inter alia going to impact the leveraged loan market. In mid March Fitch weighed in on that particular problem:

“Subsequent rate hikes would expose leveraged loan issuers to reset risk that could pressure credit profiles and cash flow generation. This risk is most acute for deeply speculative-grade credits with large amounts of floating rate debt, already large interest burdens, and limited to negative free cash flow.

 

Near-term interest rate risk is most evident for leveraged issuers who took advantage of longstanding favorable market conditions to issue large amounts of floating-rate debt, but whose credit profiles deteriorated due to secular challenges or idiosyncratic issues that resulted in higher leverage, depressed cash flows and limited liquidity.”

(emphasis added)

We admire the agency’s ability to somehow still sound a hopeful note by stressing that only really bad companies facing “secular challenges” or “idiosyncratic issues” are going to be affected. Everybody else will be immune! Barron’s echoes this sentiment by pointing out that investors in these loans are actually going to enjoy an income bump – with a small, but not unimportant qualifier:

“Of course, investors who own corporate loans (whether in a fund, a business development company (BDC) or a collateralized loan obligation (CLO) can benefit from the higher interest payments — as long as the issuer can afford the rising cost.

(emphasis added)

Investors are actually quite likely to get burned down the road. In order to comply with new regulations, banks have shed a lot of risk-weighted assets, including their proprietary corporate bond trading portfolios. This has shifted a lot of risk to investors, who have loaded up on all sorts of risky debt in the incessant and frankly utterly absurd “hunt for yield” central banks have provoked with their ultra-loose monetary policy.

Of course, banks are lending a bunch of money to investors, which enables them to boost returns via leverage. Banks create CLOs, but are increasingly forced to shed them from their own books on regulatory grounds. Hedge funds have been offered generous incentives to invest in these instruments in order to keep CLO production going at rates the banks have become accustomed to. We mentioned this some time ago in “Embracing Leverage Again” – an excerpt from a WSJ article that appeared at the time provides interesting details:

Banks have offered to lend some investors as much as $9 for every dollar that the buyers invest in CLOs, say traders and strategists. Others are being offered $8 for every $2. An investor in a triple-A-rated CLO earning 1.50 percentage point over the London interbank offered rate—using 10% of his or her own money and paying 0.80 percentage point over Libor for the financing—could earn about 8% in a year.

 

That compares with annual interest rates near 2% on a standard triple-A CLO. Citigroup researchers in a mid-April note to clients predicted that the new source of financing could help drive up prices of triple-A-rated CLOs.”

(emphasis added)

The opportunity to make a paltry 8% per year on an investment that is leveraged 10:1 was apparently considered such a great deal that it was expected to trigger sufficient demand for these securities to drive up their prices – in spite of the fact that banks no doubt were and are producing them by the wagon-load. That is certainly testament to the insanity of the echo bubble. However, banks are lately becoming reluctant to boost their own lending to corporations further:

 

Corporate & Industrial loans, y/y growth rate. Growth in bank lending to companies has slowed from an interim peak of 13.30% in 2015 to 3.16% currently (“cold feet syndrome”). In the absence of QE, this slowdown in credit growth affects money supply growth, which in turn increases the probability that asset prices will fall – click to enlarge.

 

As an aside, since the next crisis is far more likely to be focused on corporate debt rather than mortgage debt, it is irrelevant that CLOs have held up better than CDOs during the GFC. Similarly, triple-A ratings of structured credit products can quickly become meaningless in a credit crisis. CLOs repackage junk and make it fit for top ratings by means of overcollateralization rather than the creation of tranches of different seniority, but ultimately this is exactly the same trap in different clothing.

 

Conclusion – A Bug Waiting for a Windshield

We don’t expect this first round of debt repricing to necessarily trigger a crisis – we don’t know what the threshold will be. We note though that demand for corporate debt and in particular junk debt has been enormous, and corporations have obviously sated it by producing more debt than ever before (with covenants becoming progressively less stringent). The liquidity of many of these debt instruments is a lot worse than it once was, as banks have vacated their previous role of market makers.

Both the companies most at risk (i.e., those mentioned by Fitch) and the most highly leveraged investors operate at the fringes of the system and occasional defaults are normally easily absorbed. Even an entire (and fairly sizable) sector getting into trouble is not necessarily a big deal as long as system-wide free liquidity remains plentiful, as was demonstrated by the energy sector’s woes in 2015. All of the above describes a latent risk, but one that keeps growing – a happy bug in search of a windshield, so to speak.

Is is also worth noting that the echo bubble doesn’t have a particular focus – it is diffuse in the sense that it has become a “bubble in everything”. This is inter alia illustrated by the median price-revenue ratio of the stocks in the S&P 500 Index shown by John Hussman not too long ago:

 

The “bubble in everything” – on a cap-weighted basis, the market was more overvalued at the peak in 2000, but from a more holistic perspective it has never been more overvalued than today – click to enlarge.

 

On the one hand this makes it difficult to pinpoint a likely trigger – in contrast to the situation prior to the GFC. At the time it was crystal clear that a crisis would most likely be centered on the housing sector and the financial engineering associated with it (OK, it wasn’t clear to Fed officials, politicians, regulators, most mainstream economist and most of Wall Street, but it was definitely clear to people in possession of a modicum of common sense).

On the other hand, an ominous implication of the diffuse nature of the bubble is that there will be “no place to hide” when the above-mentioned latent risks materialize. If the oil sector’s problems had emerged amid a lack of system-wide liquidity, they would likely have proved contagious. Rising interest rates and a slowdown in credit growth imply that this precondition is very likely to prevail when the next batch of problems shows up.

 

Bonus Chart: Rate Comparison

The chart below shows LIBOR, interest paid on bank reserves held at the Fed and the effective FF rate:

 

LIBOR (3M) – blue line, IOR – black line, FF rate – purple line. Payment of IOR is what makes it possible for the Fed to hike rates without selling the assets it has accumulated via QE. Allegedly there is a plan to “normalize” the balance sheet, but that would shrink the money supply unless commercial banks were to vastly expand credit at the same time (read: it’s not going to happen) – click to enlarge.

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Building a Wall on the Mexican Border Is a Bad Idea. Here’s Why. (New at Reason)

A wall Building a wall on the southern border is a bad idea legally, practically, morally, and economically.

In 2006, Congress enacted a law mandating that fencing be erected along much of the United States’ southern border. There are now over 600 miles of physical barriers, but only 36 of those miles have two layers, and the majority of the fence is made up of mere concrete posts that provide obstacles for vehicles but not pedestrians.

Despite the lackluster results, construction and maintenance far overshot the budget. Some $1.2 billion was allocated in ’06. By 2015, according to the government’s own statistics, we had managed to spend $7 billion on the project. That’s “more than $11.3 million per mile per decade,” writes David Bier in the cover story of the latest issue of Reason.

Bier will appear on C-SPAN Saturday morning at 8:30 a.m. to talk about his cover story and the reasons why the wall won’t work. Tune in!

Read on for a rundown of the many, many more reasons a barrier on the southern border is a bad idea.

View this article.

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Georgia Legislature Weakens Eminent Domain Protections

Lawmakers in Georgia voted Thursday to weaken the state’s protections against eminent domain, partially undoing reforms passed in the wake of the Kelo ruling and once again allowing governments in the state to seize private property for economic development purposes.

The bill cleared both the state House and state Senate on Thursday, the final day of the legislative session in Georgia. Gov. Nathan Deal has not indicated whether he will sign it.

The Atlanta Journal-Constitution reports that the bill had “powerful backers” who helped speed it through the state legislature, including local governments who want to use eminent domain to tackle supposedly “blighted” properties and the private developers who stand to gain from making it easier for those governments to do so.

“It’s good for government, but it’s bad for citizens in my judgment. End of story,” Charles Ruffin, an Atlanta-based attorney with experience in property law, told the Journal-Constitution.

In the 2005 Kelo v. New London case, the Supreme Court said the seizure of private property counted as a legitimate “public purpose” under the Fifth Amendment if the seizure was part of a redevelopment scheme intended to benefit the community and increase the tax base. In the wake of that ruling, many states approved limitations on how eminent domain could be used. Georgia’s reforms were some of the best in the country. Passed in 2006, the law tightened the definition of “blight”—importantly, it said property could not be deemed “blighted” for purely aesthetic reasons—and prevented the state from taking property for economic development reasons. Georgia voters later approved an amendment to the state constitution requiring a public vote by elected officials before eminent domain could be used.

The bill passed Thursday would reverse the prohibition on seizing property for economic development purposes and would shorten the amount of time a government must hold the property before selling it to private developers. If the bill gets a signature from Deal, governments in Georgia would have to hold seized property for only five years instead of 20 years, as is currently required.

That length of time serves as a deterrent to keep governments from trying to “flip” property to private developers using eminent domain, said Benita Dodd, vice president of the Georgia Public Policy Foundation, a free market think tank. It’s meant to stop governments from seizing private land for a supposedly “public use” like a road or pipeline project, only to turn around a few years later and sell the land to private developers.

“We can only hope that he would side with property owners and not with the governments,” Dodd told Reason.

Eminent domain remains a hot-button issue in Georgia, more than a decade after the post-Kelo reforms were enacted. A proposed pipeline through the eastern part of the state has been held up because eminent domain requests have been blocked by a state judge. Meanwhile, the Institute for Justice is involved in a case in Elberton, Georgia, where local officials are trying to use eminent domain to bulldoze an office building so a hotel can expand.

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