Doubled-Down

By: Doug Noland | Sat, Aug 12, 2017
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"The real trouble with this world of ours in not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait." G.K Chesterton

The S&P500 rose to a record 2,490.87 during Tuesday's session at about the same time the VIX was trading down to 9.52. The DJIA reached a record 22,179 during Tuesday trading. At 5,973, the Nasdaq100 (NDX) was on track mid-day Tuesday for a record close. Tuesday saw the bank index (BKX) trade to a five-month high, with the broker/dealers (XBD) just shy of all-time highs.

"North Korea best not make any more threats to the United States. They will be met with fire and fury like the world has never seen. He has been very threatening ... and as I said they will be met with fire, fury and, frankly, power, the likes of which this world has never seen before."

The initial market reaction to President Trump's Tuesday afternoon "fire and fury" comment was anything but dramatic. Market players have grown accustomed to bombast - apparently even when it concerns potential nuclear war. The S&P500 ended the session down about one-quarter of a percent. The VIX rose but only to 11.5. The bond market barely budged, though the already jittery currencies showed some instability.

Instead of dialing back his comments, the President Doubled-Down. The markets took notice. By Thursday the VIX had surged about 70% to trade above 17 ("Biggest weekly gain since December 2015"). U.S. and global stocks were under pressure. Junk bonds were getting hit (worst two-day decline of 2017), and even investment-grade corporates were under some pressure. In a rather unbullish development, U.S. bank stocks (BKX) sank 3.6% for the week. Broader U.S. equities indices were under pressure, with the mid-caps down 2.3% and the small-caps 2.7% lower.

All in all, it was an interesting - perhaps enlightening - week in the markets. At least this week, the U.S. dollar was notable for weakness in the face geopolitical uncertainty. The yen (up 1.4%) and Swiss franc (up 1.1%) enjoyed some of their traditional safe haven appeal. Speaking of safe havens, Gold surged $31, or 2.4%. European equities trade poorly. German stocks dropped 2.3%, with previous highflyers Spain (down 3.5%) and Italy (down 2.7%) under significant pressure. Italian 10-year sovereign spreads (to bunds) widened 10 bps.

August 9 - Wall Street Journal (Colin Barr): "Ten years ago this Wednesday, the first glimpses of the global financial crisis came into view. The French bank BNP Paribas froze three investment funds, saying a lack of trading in subprime securities made valuing them impossible. The bond market seized up, rattling investors and central bankers who previously soft-pedaled the notion that the U.S. housing bust would hit the economy. Aug. 9, 2007, marked the beginning of the most far-reaching economic disruption since World War II. The events that Thursday made clear that subprime-lending excesses wouldn't be 'contained,' as Ben Bernanke, then Federal Reserve chairman, had predicted just months earlier. Yet few people appreciated the scope of the disaster that would unfold over the next 18 months."

It's simply difficult to believe 10 years have passed since the beginning of the so-called "worst financial crisis since the Great Depression." It's not beyond imagination to believe historians might look back to this week's "fire and fury" as the start of the worst crisis in generations.

August 7 - Financial Times (John Authers and Alan Smith): "After the credit crisis began to unfold in the summer of 2007, many on Wall Street and in the City of London complained it was unprecedented and had been impossible to see coming. They were wrong. Speculative bubbles are rooted deep in human nature, and have been widely studied. History's most famous bubble took root in the Netherlands almost four centuries ago — for tulips. The common elements to speculative bubbles are: An exciting and new 'disruptive' technology that is difficult to value in the short term, and whose long-term value is uncertain. Easy liquidity of markets so that shares or other securities can change hands quickly. The provision of cheap credit to pay for it. These classic elements were visible in, for example, canals and railroads, which both enjoyed speculative bubbles in the 19th century: In the 20th century, economic history was marked by a series of huge bubbles in critical markets. All followed almost identical patterns, and had a serious economic impact."

The opening quote above - one of my old favorites - comes from Richard Bernstein's classic "Against the Gods - The Remarkable Story of Risk." The view that financial innovation and enlightened policymaking had tamed risk grew stronger throughout the nineties and mortgage finance Bubble periods. Each crisis surmounted only emboldened New Age thinking. Monetary stimulus coupled with derivatives and sophisticated financial engineering ensured that virtually any type of risk could supposedly be hedged away. And as the mortgage Bubble began inflating precariously, a powerful view took hold that "Washington would never allow a national housing bust." GSEs, MBS, ABS, repo, CDOs and derivatives, Credit insurance - all things mortgage finance Bubble - enjoyed implicit government backing.

The 2008/09 financial crisis should have concluded an incredible era of dangerous risk misperceptions and flawed calculations. But the Federal Reserve and global central bankers Doubled-Down. Instead of the markets reverting back to more traditional (stable) views of risk, massive QE liquidity injections, zero rates and aggressive market liquidity backstops pushed risk analysis and perceptions only deeper into New Age Fallacy.

These days there's virtually little in the way of risk that central bankers and government policymakers can't address. Central banks became willing to fight risk aversion by directly inflating risk market prices, while simultaneously devaluing safe haven assets (with zero rates and inflationary policies). They could eradicate liquidity risk with promises of open-ended QE and the willingness to "push back against a tightening of financial conditions." Policymakers also learned the value of concerted efforts to manage liquidity, manipulate prices, backstop markets and stabilize currency markets on a global basis.

Over time, markets began to appreciate the even political and geopolitical risks had been tamed. The 2012 "European" crisis demonstrated the new post-crisis reality that financial, economic and political risks would be met first and foremost by "whatever it takes" from central bankers and their electronic printing presses. Essentially any potential risk would ensure lower rates and more "money" printing for longer. It became clear that there was only one way to bet in the markets: with central bankers.

Yet one festering risk remained seemingly outside the purview of our inflationist central bankers: geopolitical uncertainty. But even here things became clouded by a world inundated with "money" and surging securities markets. The global Bubble championed cooperation. With economic and financial fragility a global phenomenon, it was basically in each country's interest to act in ways supportive of the global recovery. Of course, promote the securities markets! And it was also not the time to embark on geopolitically risky endeavors. Indeed, a global consensus developed to use economic/financial sanctions to dissuade countries from unconstructive behavior (i.e. Russia and Iran).

A relatively benign geopolitical backdrop unfolded - with economic expansion the focal point for most leading developed and developing nations. The focus on investment, trade and attracting global flows spurred a generally cooperative post-crisis backdrop, with nations seeking active participation within the global community. Of course, the major central banks were dominating the New Global Order. And with the monetary bonanza train having left the station, it was imperative to not be left behind. In their efforts to inflate securities markets and economies, global central bankers as well fostered a relatively quiescent period geopolitically. There were small countries that refused to participate, but they were irrelevant to the new global financial and geopolitical backdrop.

With finance, the markets, economies and geopolitics so well-controlled, there should be little mystery surrounding meager risk premiums, record global stock prices and a VIX index below 10. It was certainly not sustainable, yet central bankers had succeeded in almost fully harnessing risk.

Let me try to explain why North Korea is potentially a huge market issue. It's a small and irrelevant country financially and economically. Not only does it choose not to cooperate in the New Global Order, it would take great pride in being disruptive. And, most importantly, it has nukes as well as having made major strides recently in ICBM technologies.

Risks associated with North Korea are well outside the comfortable purview of central bank monetary management/manipulation - and they're potentially catastrophic. The big problem is that market perceptions, behaviors, structures and prices have for going on a decade now been distorted by central bank's dominance over all things risk. Disregarding risk has been consistently rewarded to the point where markets have been forced to disregard potentially catastrophic risks, including a nuclear confrontation with North Korea. Moreover, years of market risk distortions have deeply impacted the structure of the marketplace (i.e. the ETF complex, derivatives and speculating directly on risk metrics).

Going into the Presidential election, I believed markets would face significant selling pressure in the event of a surprising Donald Trump victory. It was clear from the campaign that a President Trump would be unconventional and not bound by traditional mores and behavior. He would be unpredictable like no President in modern times. And Trump was going to be tough, and likely bombastic and impulsive. No matter what, he would take great pains in doing things his way. For an already divided nation and a world of festering geopolitical instability, a Trump presidency came with extraordinary uncertainty and risk. As it turned out, over-liquefied and speculative markets were in the mood to disregard risk.

Let's pray there's a very low probability of a nuclear confrontation with North Korea. Hopefully, over time some diplomatic solution will be found where North Korea halts development of nuclear and ICBM technologies. But I would argue that even this best-case scenario is problematic for the markets.

Key market vulnerabilities are being exposed. There's a major problem for highly inflated and speculative markets when it comes to hedging against risk - especially this type of undefinable risk. Indeed, this week provided a wake-up call for those that have been making a fortune writing variations of risk ("flood") insurance during a period of over-liquefied financial markets (a risk "drought"). And the upshot of this mania in the "insurance" market has created a seemingly endless supply of cheap risk protection - readily available hedging vehicles that have kept players aggressively speculating in the markets.

I appreciated a Friday article by Gillian Tett of the Financial Times: "The Next Crash Risk is Hiding in Plain Sight."

"Sometimes, market shocks occur because investors have taken obviously risky bets — just look at the tech bubble in 2001. But other crises do not involve risk-seeking hedge funds, or products that are evidently dangerous. Instead, there is a ticking time bomb that is hidden in plain sight, in corners of the financial system that seem so dull, safe or technically complex that we tend not to focus attention on them. In the 1987 stock market crash, for example, the time bomb was the proliferation of so-called portfolio insurance strategies — a product that was supposed to be boring because it appeared to protect investors against losses. In the 1994 bond market shock, the shocks were caused by interest rate swaps, which had previously been ignored because they were (then) considered geeky."

Tett doesn't believe the "financial system faces an imminent threat of another 'boring' time bomb causing havoc." Her article did, however, mention the $4.0 TN ETF industry. And Marko Kolanovic, a senior JPMorgan strategist, estimates that "passive and quantitative investors now account for about 60% of the US equity asset management industry, up from under 30% a decade ago."

When it comes to today's global government finance Bubble, I would argue that "ticking time bombs" are more associated with risk misperceptions and "moneyness" (on an unprecedented global scale) than exotic debt instruments and egregious leverage. The collapse in the mortgage finance Bubble was not about subprime - but with the unappreciated risks embedded within Trillions of perceived pristine "AAA" mortgage securities and derivatives. The subprime crisis was in full bloom ten years ago today. Yet the S&P500 went on to all-time highs, with the systemic crisis not unfolding until about a year later.

Importantly, subprime tumult was the upshot of initial de-risking and de-leveraging behavior. The more sophisticated market operators began responding to a deteriorating macro backdrop and escalating risk. Their moves to de-risk altered the market liquidity and pricing backdrops that led eventually to systemic crisis. As is typically the case, full-fledged systemic crisis erupted where price and liquidity risks were perceived to be miniscule - with a crisis of confidence in the money markets. In the case of 2008, panic unfolded in (the belly of the beast) the "repo" market.

Hopefully the North Korean situation will be resolved relatively quickly - perhaps mediated by the Russians and Chinese. A quick resolution would allow the markets to remain in this phenomenal backdrop of risk ignorance. But the longer this drags out the more problematic it becomes for the markets. This unfolding geopolitical crisis illuminates a major type of risk that's been disregarded in the marketplace. If this illumination initiates de-risking/de-leveraging dynamics, this could mark an important inflection point for the risk markets. Rather than just waiting to see how this plays out, I would expect the more sophisticated players to take some risk off the table.

It's worth noting that safe haven Treasury bonds rallied little in the face of a bout of "Risk Off" behavior. Not much "hedging" value left there. And in the event of a major military escalation, I'm not convinced that derivatives markets will function effectively. Reducing risk may (for a change) require liquidating holdings - stocks and corporate debt. And losses in equities and corporates would test the unprecedented trend-following flows that have chased inflating securities markets.

For a number of years now, I've referred to the "Moneyness of Risk Assets" issue - the perception of central bank-ensured safety and liquidity - that has been instrumental in Trillions of flows into ETFs and other "passive" strategies. It is Here Where the Wildness Lies in Wait. I wouldn't bet on a continuation of low market volatility.

 


For the Week:

The S&P500 declined 1.4% (up 9.0% y-t-d), and the Dow fell 1.1% (up 10.6%). The Utilities slipped 0.3% (up 9.5%). The Banks sank 3.6% (up 2.1%), and the Broker/Dealers lost 2.9% (up 10.9%). The Transports declined 0.8% (up 1.7%). The S&P 400 Midcaps dropped 2.3% (up 3.0%), and the small cap Russell 2000 sank 2.7% (up 1.3%). The Nasdaq100 lost 1.2% (up 19.9%), and the Morgan Stanley High Tech index fell 1.7% (up 23.3%). The Semiconductors declined 1.2% (up 17.6%). The Biotechs dropped 2.9% (up 24.7%). With bullion surging $31, the HUI gold index rallied 3.2% (up 8.5%).

Three-month Treasury bill rates ended the week at 102 bps. Two-year government yields declined six bps to 1.30% (up 11bps y-t-d). Five-year T-note yields dropped seven bps to 1.74% (down 18bps). Ten-year Treasury yields fell seven bps to 2.19% (down 26bps). Long bond yields declined six bps to 2.79% (down 28bps).

Greek 10-year yields rose 10 bps to 5.51% (down 151bps y-t-d). Ten-year Portuguese yields slipped a basis point to 2.85% (down 89bps). Italian 10-year yields added a basis point to 2.03% (up 22bps). Spain's 10-year yields dipped three bps to 1.46% (up 8bps). German bund yields dropped nine bps to 0.38% (up 18bps). French yields fell seven bps to 0.68% (unchanged). The French to German 10-year bond spread widened two to 30 bps. U.K. 10-year gilt yields sank 11 bps to 1.06% (down 17bps). U.K.'s FTSE equities index sank 2.7% (up 2.3%).

Japan's Nikkei 225 equities index declined 1.1% (up 3.2% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.06% (up 2bps). France's CAC40 dropped 2.7% (up 4.1%). The German DAX equities index fell 2.3% (up 4.6%). Spain's IBEX 35 equities index sank 3.5% (up 10%). Italy's FTSE MIB index lost 2.7% (up 11%). EM equities were mostly lower. Brazil's Bovespa index added 0.7% (up 11.8%), while Mexico's Bolsa declined 1.3% (up 11%). South Korea's Kospi sank 3.2% (up 14.5%). India's Sensex equities index dropped 3.4% (up 17.2%). China's Shanghai Exchange lost 1.6% (up 3.4%). Turkey's Borsa Istanbul National 100 index fell 1.5% (up 36.9%). Russia's MICEX equities index slipped 0.4% (down 12.9%).

Junk bond mutual funds saw inflows of $124 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates dipped three bps to 3.90% (up 45bps y-o-y). Fifteen-year rates were unchanged at 3.18% (up 42bps). The five-year hybrid ARM rate slipped a basis point to 3.14% (up 40bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.03% (up 45bps).

Federal Reserve Credit last week increased $2.2bn to $4.428 TN. Over the past year, Fed Credit expanded $0.5bn. Fed Credit inflated $1.618 TN, or 58%, over the past 248 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt expanded $2.9bn last week to $3.316 TN. "Custody holdings" were up $136bn y-o-y, or 4.2%.

M2 (narrow) "money" supply last week declined $8.7bn to $13.612 TN. "Narrow money" expanded $695bn, or 5.4%, over the past year. For the week, Currency increased $2.0bn. Total Checkable Deposits fell $6.8bn, and Savings Deposits declined $5.1bn. Small Time Deposits added $0.7bn. Retail Money Funds increased $0.8bn.

Total money market fund assets jumped $33.05bn to $2.693.47 TN. Money Funds fell $51.3bn y-o-y (1.9%).

Total Commercial Paper jumped $10.6bn to $980.2bn. CP declined $43bn y-o-y, or 4.2%.

Currency Watch:

August 9 - New York Times (Peter S. Goodman): "It is the closest thing to a certainty in the global economy. When trouble flares and anxiety mounts, people who manage money traditionally entrust it to a seemingly indomitable refuge, the American dollar. Yet on Wednesday, in the hours after President's Trump's threat to unleash 'fire and fury' on North Korea if it continued to menace the United States, global investors sold the dollar. The same dynamic played out in June, as Saudi Arabia and other Arab nations imposed an embargo on Qatar, delivering a fraught crisis to the oil-rich Persian Gulf. And the dollar dipped in July after President Vladimir V. Putin of Russia expelled 755 American diplomats, ratcheting up tensions between the two nuclear powers. Since the beginning of the year, the dollar has surrendered nearly 8% against a basket of major currencies."

The U.S. dollar index declined 0.5% to 93.069 (down 9.1% y-t-d). For the week on the upside, the yen increased 1.4%, the Swiss franc 1.1%, the euro 0.4%, the Swedish krona 0.3%, the Mexican peso 0.3% and the Norwegian krone 0.2%. On the downside, the Brazilian real declined 1.9%, the South Korean won 1.6%, the New Zealand dollar 1.3%, the Australian dollar 0.4%, the Canadian dollar 0.3%, the British pound 0.2% and the South African rand 0.1%. The Chinese renminbi increased 1.0% versus the dollar this week (up 4.22% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.4% (down 3.9% y-t-d). Spot Gold jumped 2.4% to $1,289 (up 11.9%). Silver rallied 5.0% to $17.07 (up 6.8%). Crude fell 76 cents to $48.82 (down 9%). Gasoline dropped 2.0% (down 4%), while Natural Gas rallied 7.5% (down 20%). Copper added 0.9% (up 16%). Wheat rallied 2.7% (up 15%). Corn declined 1.6% (up 7%).

Trump Administration Watch:

August 8 - Bloomberg (Jeff Daniels): "President Donald Trump's 'fire and fury' warning on Tuesday may contribute to mixed messages to North Korea and U.S. allies in Asia — increasing the risk of miscalculation on the Korean Peninsula, according to U.S. experts. National security and foreign policy experts say it is critical for the administration to maintain a consistent message on North Korea since wavering on different viewpoints risks alienating key allies South Korea and Japan. 'You have a danger of miscalculation and a danger of escalation,' said Bruce Klingner, former deputy division chief for Korea at the Central Intelligence Agency..."

August 8 - CNBC (Sarah O'Brien): "Despite facing September deadlines to increase the debt ceiling and pass a new federal budget, Republican congressional leaders have made it clear that tax reform will be their legislative priority when they return from their August recess. Yet exactly what's in their plan remains unclear. And based on a joint White House-GOP statement — which outlines a philosophical approach to changing the U.S. tax code but includes no specifics — even lawmakers are unsure what they will begin debating next month with the goal of passing a bill before the end of the year. 'One big challenge they face is that there's no clear starting point,' said Kyle Pomerleau, director of federal projects for the Tax Foundation."

August 7 - New York Times (Edward D. Kleinbard): "Sometime in October, the United States is likely to default on its obligation to pay its bills as they come due, having failed to raise the federal debt ceiling... The debt ceiling is politically imposed, and the decision not to raise it, and therefore to choose to default, is also political. It's something America has avoided in the past. This time, though, will be different. This country has hit the debt ceiling once, in 1979, and then largely by accident and only to a minor extent. But even that foot fault was estimated to cost the United States about 0.6% in higher interest costs for an indefinite period. More recently, congressional debt ceiling brinkmanship in 2011 led Standard & Poor's to downgrade the credit rating of the United States. An increase in Treasury interest rates of just 0.2% a year would cost the government about $400 billion over the next 10 years."

China Bubble Watch:

August 8 - Bloomberg: "China's much-vaunted campaign to tackle its leverage problem has captured headlines this year. But to understand why they're taking on the challenge -- and the threat it could pose to the world's second-largest economy -- you need to dig into the mountain. Characterized in state media as the 'original sin' of China's financial system, leverage has swelled over the past decade -- partly because policy makers were trying to cushion a slowdown in growth from the old normal of 10% plus. What's fueled the leverage has been a rapid expansion in household and corporate wealth looking for higher returns in a system where bank interest rates have been held down. The unprecedented stimulus unleashed since 2008 effectively brought to life the 'monster' China's leadership is now trying to tackle, says Andrew Collier, managing director of Orient Capital Research Ltd. in Hong Kong and author of 'Shadow Banking and the Rise of Capitalism in China.'"

August 7 - Financial Times (Gabriel Wildau): "China's capital flow turned positive in the first half of 2017, a reversal from unprecedented outflows during the previous two years that sparked worries over financial stability. Data... indicate that Beijing's support for the renminbi and a crackdown on foreign dealmaking and other outflow channels have largely succeeded in curtailing capital flight. China ran a $16bn surplus over the first half of this year... compared with a $417bn deficit in 2016... The figures also showed that China added to its foreign exchange reserves on a valuation-adjusted basis in the second quarter for the first time since early 2014."

August 7 - Bloomberg: "China's foreign-exchange reserves posted a sixth straight monthly increase as the yuan strengthened and economic growth remained robust. The foreign currency stockpile climbed $23.9 billion to $3.081 trillion in July..."

August 8 - Bloomberg: "China's producer price gains held steady on surging commodity prices, as demand stayed resilient and the government's drive to reduce industrial capacity takes hold. Producer price index rose 5.5% in July from year earlier versus estimated 5.6%... The consumer price index increased 1.4%, versus forecast of 1.5%..."

August 9 - Financial Times (Lucy Hornby): "For China's ruling Communist party, its foreign exchange reserves are a symbol of national strength and are a crucial buffer against economic shocks. So the alarming announcement that forex reserves had fallen below $3tn in January marked a shift in political faultlines that is only being felt this summer. As more than $1tn left the country over the previous 18 months... Technocrats in Beijing had already prepared the ground to take action. In December, they had managed to link the phrase 'national security' to the concept of financial risk at the annual agenda-setting economic work conference. Backed with the reserves figures, they were poised to strike against what they saw as the leading culprit — the new generation of highly acquisitive private Chinese companies. These tensions within the system have exploded into the open in the past two months with the humiliation of some of China's best-known and most well-connected private companies..."

Central Bank Watch:

August 8 - Bloomberg (Carolynn Look): "A decade ago, the European Central Bank took its first step to becoming the euro area's firefighter-in-chief. Its 95 billion-euro ($112bn) emergency loan to banks on Aug. 9, 2007, was the initial response to a financial crisis that would force the... institution to expand its balance sheet by trillions of euros. The ECB -- together with international peers such as the Federal Reserve and the Bank of England -- took center stage in an unprecedented battle against bank failures, recessions and sovereign-debt turmoil that changed the economic landscape and forced a complete rethink of what monetary policy can and should do. The ECB's job was additionally hampered by an incomplete currency zone weighed down by infighting and paralysis. But with the recovery finally holding up after years of stimulus and hard-fought economic reforms, central bankers have started to contemplate a return to more normal policies. One of many milestones on that path is expected in the fall, when ECB President Mario Draghi may offer an outline of a gradual exit from a 2.3 trillion euro bond-buying plan."

Global Bubble Watch:

August 10 - Bloomberg (Cecile Gutscher and Sid Verma): "Bitcoin and other 'cryptocurrencies' are big money, virtually as big as Goldman Sachs and Royal Bank of Scotland combined. The price of a single bitcoin hit an all-time high of above $3,500 this week, dragging up the value of hundreds of newer, smaller digital rivals in its wake. Now some investors fear a giant crypto-bubble may be about to burst. It has been a year of unprecedented growth for the largely unregulated market, with dozens of new currencies appearing every month in 'Initial Coin Offerings' or ICOs. They have achieved value almost instantly, drawing in those who are eager to get in and make a quick buck. At the start of 2017, the total value - or market cap - of all cryptocurrencies in existence was about $17.5 billion, with bitcoin making up almost 90%... It is now around $120 billion... and bitcoin makes up only 46%."

August 9 - Financial Times (Kate Allen): "Nations have historically been the world's best credits — but since the global financial crisis a decade ago they have been joined by a burgeoning group of supranational organisations. Syndicated debt issuance by supranationals has more than doubled in the past decade, hitting $265bn last year, according to... Dealogic. These borrowers, such as the European Investment Bank, the EU and the International Bank for Reconstruction and Development, are backed by multiple countries and so enjoy the highest possible credit ratings. Their ranks are set to increase further with the forthcoming entry into the capital markets of the Asian Infrastructure Investment Bank — dubbed by some as China's answer to the World Bank — and the World Bank's own planned expansion in fundraising..."

August 8 - Bloomberg (Adam Haigh and Eric Lam): "The Chinese leadership has this year made its strongest commitment yet to curb financial risks and rein in spendthrift local officials, yet the campaign has spurred barely a ripple of concern among global investors. In a recent survey, China hardly registered on the list of dangers eyed by fund managers and strategists that could threaten the 'Goldilocks' boom in stocks and credit around the world. That's a big change from two years ago, when a surprise devaluation of the yuan spooked markets, all the more because it came just weeks after China's equity bubble had started to burst."

August 8 - Bloomberg (Natasha Rausch): "Ian Shepherdson, chief economist at Pantheon Macroeconomics Ltd., said investors have become too complacent as markets rallied and need to be prepared for the possibility that the Federal Reserve will follow through on its plans to raise interest rates. 'I'm nervous about pretty much everything,' Shepherdson said..., when asked where investors are being well-compensated for their risks. 'There comes a point in most investment cycles where you've got to start thinking the return on capital is rather less important than the return of capital -- just keeping your money. Not losing anything becomes important.' The economist acknowledged his view has been unfashionable lately as U.S. equities extended their years-long rally..."

August 9 - Bloomberg (Justina Lee): "The Hong Kong dollar carry trade, which has produced steady returns for seven straight months, suffered a rare setback on Wednesday as the currency abruptly strengthened the most since February 2016. Its 0.1% gain against the U.S. dollar may have been tiny by global standards, but it jolted investors who had positioned for declines by borrowing in Hong Kong to invest in higher-yielding American assets. The trade had been a consistent winner this year after interest rates in the U.S. rose and those in the former British colony held near rock-bottom levels. But now the tightly-managed exchange rate is turning more volatile..."

August 9 - Bloomberg (Catherine Bosley): "The Swiss National Bank's U.S. equity holdings gained almost 5% in value to hit a fresh record in the second quarter, thanks to a buoyant stock market. The portfolio increased to $84.3 billion from $80.4 billion at the end of March..."

Fixed Income Bubble Watch:

August 8 - Bloomberg (Claire Boston): "Subprime auto loans may be suffering from higher delinquencies, but investors are still clamoring for bonds backed by the debt, according to Wells Fargo analysts. An $800 million subprime auto bond sale from Westlake Financial Services Inc. last week was priced at some of the highest valuations... since 2014... The portion of the security rated BB, or two steps below investment grade, offered the least additional yield for a deal of its size and rating on record. Demand for the offering was strong enough to increase its size from a planned $700 million. Insatiable demand for investment-grade and junk bonds has sent investors searching for better deals in the market for asset-backed securities. The newfound interest means risk premiums for structured bonds are plummeting too."

August 10 - Bloomberg (Cecile Gutscher and Sid Verma): "When Alan Greenspan warned about a bond bubble in a recent interview, he may well have been thinking about European junk bond yields. The former Federal Reserve chairman, who famously coined the term 'irrational exuberance,' would find ample grist for worry looking at the average rates of euro-denominated debt rated 'BB.' For the first time ever, bonds issued by junk-rated companies with weaker balance sheets are trading in line with debt from the U.S. government. Meanwhile, more than 20 billion euros ($23bn) of Italian government bonds pay less than their U.S. counterparts. Bank of America Merrill Lynch strategists call it a bubble, echoing investors from Deutsche Asset Management and JPMorgan Asset Management who are scaling back their exposure to euro junk."

August 6 - Bloomberg (Tracy Alloway): "Trading in an obscure corner of the credit-derivatives market shows that some investors are preparing for a looming sell-off in corporate bonds. About $10.3 billion worth of options on Markit's CDX North American Investment Grade Index -- a basket of credit default swaps on 125 North American companies -- have been switching hands daily over the past week... About 80% of the volume is in put options, a bearish bet against the performance of corporate credit. The figure is more than twice the $4.9 billion in average credit-index options traded over the past year, when bearish put options averaged 65% of total volume, the bank said."

August 8 - Bloomberg (Jennifer Surane): "Jamie Dimon is siding with the bond-market bears. 'I do think that bond prices are high,' the chief executive officer of JPMorgan Chase & Co. said... 'I'm not going to call it a bubble, but I wouldn't personally be buying 10-year sovereign debt anywhere around the world.'"

Federal Reserve Watch:

August 8 - Bloomberg (Steve Matthews and Matthew Boesler): "Two Federal Reserve officials said soft U.S. inflation was a problem as they played down the risk of market disruption when the central bank starts shrinking its balance sheet. The comments on Monday by St. Louis Fed President James Bullard and Minneapolis's Neel Kashkari, two of the Fed's more dovish policy makers, line up with expectations that officials will keep interest rates on hold when they meet next month and announce the start of a gradual process to trim their holdings of Treasuries and mortgage-backed securities. 'I am ready to get going in September,' Bullard said... arguing that the balance-sheet unwind 'is going to be very slow and I don't think there will be a lot of impact on the markets.'"

U.S. Bubble Watch:

August 8 - Financial Times (Robin Wigglesworth): "The inexorable uptick in the US national debt clock in midtown Manhattan, first erected in 1989 by real estate magnate Seymour Durst, will soon accelerate sharply again. The US budget deficit has been gradually crimped since the financial crisis, thanks to the economic recovery and the government reining in spending since a 2011 budget stand-off. But it has begun widening again this year, and Goldman Sachs forecasts it will top $1tn by 2020. That would be more than double the $439bn deficit in 2015. Combined with the Federal Reserve's plans to begin pruning its balance sheet, gradually removing one of the biggest buyers of US government debt from the market, this will challenge the US Treasury's borrowing plans."

August 6 - Bloomberg (Cecile Vannucci): "Bets against volatility are back. Never mind strategists warning of a potential VIX rebound, or historical data showing the index tends to jump the most in August. The number of short positions on VIX futures has hit a fresh peak, and an exchange-traded fund that benefits when volatility falls just saw its biggest weekly inflows since June... That's even as the CBOE Volatility Index hovers within 1 point of its record-low close."

August 8 - Bloomberg (Sid Verma): "The markets are alive with the sound of 'zzzzzz' as the latest trading session marks yet another record low for volatility gauges. Bank of America's MOVE Index, which gauges volatility in the U.S. Treasury market, has tumbled to an unprecedented 46.9 at the close of Monday's trading session. The move means investors in the world's largest bond market are shrugging off the potential for price swings, even as two titans of the industry up their bets on an uptick in U.S. inflation."

August 7 - New York Times (Nathaniel Popper): "The cautionary words of American regulators have done little to chill a red-hot market for new virtual currencies sold by start-ups. The Securities and Exchange Commission late last month issued its first warning for the many entrepreneurs who have been raising money by creating and selling their own virtual currencies... At that point, hundreds of projects had raised more than $1 billion. Yet even after the commission said it was looking closely at projects that may violate its rules, programmers are still embarking on new offerings at a torrid pace. Most of the offerings have little legal oversight... 'The broader detail and the silences in the report should give many people pause and that doesn't seem to have happened yet,' said Emma Channing, the general counsel at the Argon Group... 'I don't understand why everyone isn't as concerned as I am.' Since the guidance was released on July 25, 46 new coin offerings have been announced and an additional 204 are moving toward fund-raising..."

August 8 - Bloomberg (Martin Z Braun): "Seven years ago, California was 'the next Greece.' Today, the state's bonds are trading better than AAA. As the Golden State benefits from record-breaking stock prices, Silicon Valley's boom and a resurgent real estate market, demand for tax-exempt debt in the state with the highest top income tax rate in the U.S. is 'insatiable,' said Nicholos Venditti, a portfolio manager for Thornburg Investment Management. Spreads are so tight that Venditti has stopped buying California bonds for his national fund. 'They've gone to a level that just seems ridiculous,' Venditti said. 'It just seems unsustainable for any long period of time.' ... An investor Tuesday bought about $1.1 million of state general obligation bonds maturing in six years at a yield of 1.33%, or 4.3 bps below AAA rated bonds with the same maturity. California bonds are rated AA- by S&P Global Ratings and Fitch Ratings and Aa3 by Moody's..."

August 10 - Bloomberg (Oliver Renick): "A yawning divide is opening between the stock market's biggest players when it comes to risk tolerance. On one side are long-only mutual fund managers, burdened with keeping up with the S&P 500 as it marched to 30 different records this year. Measured by their ownership of stocks with the highest volatility, they're sitting on some of the most aggressive bets in three years... On the opposite end are long-short hedge funds, paid as much to dodge bear markets as they are to pile on gains. Using a value known as net leverage that counts up bets that shares will rise, they're plumbing depths of defensiveness rarely seen since 2005. A divergence this wide has occurred just twice in the last decade..."

August 8 - New York Times (Binyamin Appelbaum): "It's basically the opposite of a major government infrastructure program. Government spending on transportation and other public works is in decline as federal funding stagnates and state and local governments tighten their belts. Such spending equaled 1.4% of the nation's economic output in the second quarter of 2017, the lowest level on record... In West Virginia, where President Trump on Thursday touted a vague $1 trillion infrastructure plan, public works spending has fallen for five straight years."

August 9 - Wall Street Journal (Alison Sider): "Investors are getting nervous about the Permian. The problem? Too much natural gas. The west Texas oilfield is the epicenter of U.S. drilling activity and is expected to drive the country's growth in oil production in the coming years. Investors have grown accustomed to companies reliably beating expectations there-producing ever greater amounts of oil and slashing costs. So they became alarmed when a handful of Permian producers reported more lackluster results last week."

August 8 - Bloomberg (Sarah Jones): "With private equity firms sitting on a record amount of cash they're struggling to invest, their clients are turning to exchange-traded funds for relief. BlackRock Inc. and State Street Corp., two of the world's biggest providers of ETFs, say an increasing number of institutional investors are using their products to park money earmarked for private funds. These investors -- pension plans, foundations and endowments that are under pressure to meet obligations -- are trying to eke out an extra return on cash that would otherwise languish in a money market fund."

Brexit Watch:

August 6 - Bloomberg (Hannah George and Cat Rutter Pooley): "U.K. consumers cut back on spending for a third month in July as house-price growth slowed sharply, dealing yet another blow to the economy... The latest figures leave both household expenditure and the property market at their weakest in more than four years. A report from IHS Markit and Visa showed that consumer spending dropped 0.8% year-on-year... Home-price increases weakened to an annual 2.1% in the past three months..."

Japan Watch:

August 7 - Reuters (Leika Kihara): "The Bank of Japan should dial back its massive stimulus before inflation hits its 2% target, a leading candidate to become the next governor said, raising questions about the efficacy of the BOJ's radical approach... The proposal by former BOJ Deputy Governor Kazumasa Iwata goes against the central bank's pledge that it will maintain its stimulus program until its elusive inflation goal is met. Calling for a change of strategy by the BOJ, Iwata criticized the central bank's price forecasts as too optimistic... His comments, the strongest criticism on the BOJ's policies to date by a former deputy governor, underscore growing concern over the strains the BOJ's prolonged ultra-easy policy is putting on the country's banks and financial market."

EM Bubble Watch:

August 6 - Bloomberg (Ben Bartenstein): "The case against emerging markets is gaining steam in one corner of the bond world. Investors yanked out $680 million from the iShares JPMorgan USD Emerging Markets Bond exchange-traded fund last month, the biggest-ever flows reversal. Traders are concerned that after an 18-month rally, rising yields in developed markets from the U.S. to Germany could wreak havoc across emerging markets similar to the taper tantrum of 2013..."

August 7 - CNBC (Fredi Imbert): "Venezuela could face a full-fledged civil war if military support for dictator Nicolas Maduro erodes. Venezuelan authorities arrested seven men over the weekend whom they claimed took part in an attack on a military base outside of Valencia... The strike took place after a video made the rounds on social media Sunday featuring men in military fatigues calling for a rebellion against Maduro."

Leveraged Speculation Watch:

August 9 - Bloomberg (Dani Burger): "For computerized strategies that are supposed to be making people obsolete, quants are looking decidedly human in 2017. Program-driven hedge funds are stumbling, a promising startup has closed, and once-reliable styles are showing weakening returns. A handful of investment factors, the wiring of smart-beta funds, have gone dormant. This isn't just normal volatility confined to a single month, according to Neal Berger, the founder and chief investment officer of Eagle's View Asset Management... Returns have been decaying for a year, suggesting the rest of the market has figured out what the robots are doing and started taking evasive action, Berger said. June was the worst month on record for Berger's fund, as usually robust strategies lost their footing and the firm fell 2.4%. The worst pain has been among quants in the market-neutral equity space..."

Geopolitical Watch:

August 8 - CNBC (Jacob Pramuk): "North Korea has successfully created a miniaturized nuclear weapon designed to fit inside its missiles, NBC News confirmed Tuesday, citing a U.S. intelligence official... The development marks a major step in the isolated nation's push to become a nuclear power. Miniaturizing a weapon does not necessarily mean that North Korea has an accurate nuclear-equipped intercontinental ballistic missile, yet. It raises the stakes for President Donald Trump and other world leaders, who already faced difficult and limited options in dealing with Pyongyang's aggression."

August 9 - CNBC (Christine Wang): "The Department of Defense would deploy B-1B bombers in a pre-emptive attack on North Korea if the commander-in-chief ordered such a strike, NBC News reported... The officials told NBC that the attack would originate from the Andersen Air Force Base in Guam. Multiple people told NBC that the strike would target roughly two dozen missile-launch sites in North Korea. On Tuesday, President Donald Trump said that the rogue state would face 'fire and fury' if it continued to threaten the United States. NBC's report comes after a state-media outlet said Pyongyang was 'seriously considering' an attack on Guam."

August 9 - Reuters (Idrees Ali and Ben Blanchard): "A U.S. Navy destroyer carried out a 'freedom of navigation operation' on Thursday, coming within 12 nautical miles of an artificial island built up by China in the South China Sea, U.S. officials told Reuters. The operation came as President Donald Trump's administration seeks Chinese cooperation in dealing with North Korea's missile and nuclear programs and could complicate efforts to secure a common stance... China has territorial disputes with its neighbors over the area. It was the third 'freedom of navigation operation' or 'fonop' conducted during Trump's presidency."

August 5 - PTI: "China is planning a small-scale military operation to push back Indian troops from the Doklam area within two weeks, according to a report in a state-run daily... The two countries have been locked in a standoff in the Sikkim sector since June 16 after Chinese troops began constructing a road near the Bhutan tri-junction. 'China will not allow the military standoff between China and India in Doklam to last for too long, and there may be a small-scale military operation to expel Indian troops within two weeks," Hu Zhiyong, a research fellow at the Institute of International Relations... was quoted... Bhutan has opposed the road saying the area belongs to Thimpu and has accused Beijing of violating agreements that aim to maintain the status quo until disputes over boundary are resolved. India says the Chinese action to construct the road was unilateral. The Sikkim sector is the only gateway to India's northeastern states and New Delhi fears the road would allow China to cut off that access."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
Credit Bubble Bulletin

Doug Noland

I just wrapped up 25 years (persevering) as a "professional bear." My lucky break came in late-1989, when I was hired by Gordon Ringoen to be the trader for his short-biased hedge fund in San Francisco. Working as a short-side trader, analyst and portfolio manager during the great nineties bull market - for one of the most brilliant individuals I've met - was an exciting, demanding and, in the end, a grueling and absolutely invaluable learning experience. Later in the nineties, I had stints at Fleckenstein Capital and East Shore Partners. In January 1999, I began my 16 year run with PrudentBear, working as strategist and portfolio manager with David Tice in Dallas until the bear funds were sold in December 2008.

In the early-nineties, I became an impassioned reader of The Richebacher Letter. The great Dr. Richebacher opened my eyes to Austrian economics and solidified my lifetime passion for economics and macro analysis. I had the good fortune to assist Dr. Richebacher with his publication from 1996 through 2001.

Prior to my work in investments, I worked as a treasury analyst at Toyota's U.S. headquarters. It was working at Toyota during the Japanese Bubble period and the 1987 stock market crash where I first recognized my love for macro analysis. Fresh out of college I worked as a Price Waterhouse CPA. I graduated summa cum laude from the University of Oregon (Accounting and Finance majors, 1984) and later received an MBA from Indiana University (1989).

By late in the nineties, I was convinced that momentous developments were unfolding in finance, the markets and policymaking that were going unrecognized by conventional analysis and the media. I was inspired to start my blog, which became the Credit Bubble Bulletin, by the desire to shed light on these developments. I believe there is great value in contemporaneous analysis, and I'll point to Benjamin Anderson's brilliant writings in the "Chase Economic Bulletin" during the Roaring Twenties and Great Depression era. Ben Bernanke has referred to understanding the forces leading up to the Great Depression as the "Holy Grail of Economics." I believe "The Grail" will instead be discovered through knowledge and understanding of the current extraordinary global Bubble period.

Disclaimer: Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.

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