The following is part of Pivotal Events that was published for our subscribers September 17, 2014.
Signs Of The Times
"So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The answer lies in the private sector's dramatic increase in the willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money."
- St. Louis Fed, CNBC, September 2
Emphasis added: Voluntary hoarding of cash drove policymakers mad in the last post-bubble contraction.
In 1920, hoarding of commodities blew out and crashed. Think 1980 this time around. Hoarding of financial assets ended with the 1929 Crash. Think 2007 this time around. Hoarding of cash prevailed during the 1930s.
At the moment, cash hoarding is being used to explain another failure of interventionist theories that easy money forces GDP growth. Not when the public wants to speculate in financial assets such as now.
Cash hoarding has yet to become really serious.
"Buy The Setbacks"
- Wells Fargo Advisors, BNN, September 8
"Italy's Ferrari Reports Record First-Half Revenues"
- Yahoo! News, September 11
"Sales of collateralized loan obligations, or CLOs, have surged to their highest level in seven years."
- Financial Times, September 9
"The U.S. Government probe into auto loans made to people with spotty credit is doing little to derail sales of bonds backed by the debt."
- Bloomberg, September 10
"The riskiest borrowers are leading the busiest September in at least six years for speculative-grade bond sales in the U.S. As Moodys warns that protection in the debt are declining."
- Bloomberg, September 11
"By fostering risk-taking and the search for yield, accommodative monetary policies thus continued to contribute to an environment of elevated asset price valuations and exceptionally reduced volatility."
- BIS Quarterly Revue, Business Insider, September 14
Is the BIS, the central banker's banker, advising to go long volatility?
Indirectly, the BIS is suggesting the trade as the main message is that senior central banks have not been just been hosting the party, they've been imbibing as well. They do not have the integrity or nerve to discipline themselves. Selfishly, policymakers remain determined to get GDP growth via depreciation. They still believe interventionist theories to be sound.
VIX doesn't do volatility at bottoms, but it registered a Sequential Buy in July. The low was 10.28 and it jumped to 17.57 in August with a high RSI. The decline was to 11.24 and the rebound has made it to 14.17 and is not overbought.
We are watching this as an indicator. It will take a quarter of a year before the BIS can again admonish foolish central bankers.
Saturday's special edition "Bonds: Euphoria to Revulsion" outlined the mania as the greatest in financial history. By various measures, the best was accomplished for junk (JNK) in July. The initial hit was followed by a strong test of the high and the action is rolling over.
That the ECB was in the wings to begin buying bonds as the Fed ended its buying program drove European yields to unprecedented lows. As represented by the German 10-Year note, the decline in yields registered a Weekly Downside Capitulation. This is stretched momentum.
Also generated was a Weekly Sequential Buy (on the yield), which is pattern.
Such signals in the past have been reliable and this one has the added consideration of seasonal risk. Fall is the traditional time for the rapid discovery of bad trading and bad banking. This one includes the potential for the discovery of bad central banking.
At 9.82%, Russian yields are close to the break out level at 9.90%.
Discussion about negative interest rates in Europe and Japan has been widespread. We've taking it as a measure of the intensity of central bankers arbitrary intrusions.
Perhaps the best way to look at it is within our review of the behaviour of real long-dated interest rates through the completion of a financial bubble. Adjusted for inflation, real rates have declined to negative in the year a bubble completes.
First of all, real rates set a significant low in the year a financial mania blows out.
Reaching for yield drives nominal rates down as stocks and real estate soar. The rate of CPI inflation goes up, but not to the degree seen in the preceding mania in commodities.
Then in the contraction the CPI inflation declines as nominal rates go up - driving the real rate up.
In 2007 real long rates in the senior currency declined to minus 1.5%. During the worst financial storm since the 1930s and despite massive injections of liquidity, the rate increased to the 6% level. The increase was some 7 percentage points. On the first business cycle out of the crash, the real yield has declined from 6% to 1%.
This will likely increase on the next contraction.
When the senior currency was convertible (on a gold standard) real yields went minus as a bubble climaxed. In the 1873 example it fell to -8.8% and in the crash it soared to 8.7%.
In 1825 the low was -5% and the crisis high was 5.7%. In the 1772 Bubble the low was - 6.8% and in the panic the high was 5.7%. In 1720 the numbers were 0.7% and 11%.
The typical increase has been 12 percentage points. This seems to be Mother Nature's way of ending the extraordinary abuse of the credit markets, otherwise known as a "New Financial Era".
In this pattern, 1929 seems to be somewhat outside of the range. The low was 4.5% and the high was 14.9%, making the increase some 10 percentage points.
Now at record lows, nominal rates has everyone thinking basis points or "beeps". In which case, the typical increase in a severe contraction becomes 1.2 x 103 beeps.
In each case, the rise was accomplished through a decline in CPI inflation and an increase in nominal rates. Weakening producer prices is not good.
Using Germany as the example of extreme lows, the rate has increased from 88 beeps in late August to 106. This has had a couple of modest corrections and rising through 115 would set the uptrend.
The August 27th Pivot included charts on credit spread widening. This is updated and follows. At 152 bps now, breaking above 154 bps would set the uptrend towards trouble.
"U.S. corporations are buying their own shares at the briskest pace since 2007."
That was reported in yesterday's Wall Street Journal and it makes a lot of sense.
Borrowing tons of money at, say 4%, and boosting your stock price is a great way to increase the returns from compensation packages. By this policy the stock symbol becomes as important as the logos for products or services.
Share buybacks and margin are at the highest since 2007 and could be trying to tell us something. So have been sentiment numbers and then there is the rare Monthly Upside Exhaustion on the S&P which registered at the end of August.
These indicate the degree of speculation which is spectacular, and the question is about the lead time to denouement.
In 2007, margin peaked in July and stocks peaked in October. In 2000, margin peaked in March right with the high for the S&P at 1553. The failure did not start until the test failed at 1530 on September 1st.
This time around, margin peaked in February, declined for a couple of months and the rebound into June seems like a test. The July number is the latest available and it was down a little.
Over in Europe, the STOXX set its high at 3325 in June with the slump taking out both the 50-Day and 200-Day moving averages. The rebound and test has been vigorous making it to 3287 on September 3rd. It has since slipped to 3221. There is a fair amount of support at 3200 and it is uncertain if rising rates in Europe will drive funds into equities or impair the charms of the stock markets.
In Asia, the Hang Seng (HWF) reached a Daily RSI of 77 in late July. This compares to 71 reached in late September 2007. Four corrections since April found support at the 50- Day ma. This week it was taken out. Now at 21.5, taking out 20.5 would turn Hong Kong down.
In getting this far last night it was hoped that some thoughts today would provide a wrap for this page. The Wall Street Journal has:
"Venture Capital Risk Taking and Cash Burn Rates Unprecedented Since 1999; 47% of Nasdaq in Bear Market"
"In '01 or '09, you wouldn't take a job at a company that's burning $4 million a month. Today everybody does it without thinking."
Just when the stock markets gets priced to perfection, everyone gets a chance to reappraise conventional wisdom.
Most commodities are telling us some interesting things. One is that the long-championed link between Fed recklessness and soaring commodities seems elusive. Another is that the global demand for commodities has been waning. And then there is the hitherto impossible condition of a rising dollar.
On the trading side, wheat became very oversold in July and accomplished a weak and brief rebound. Now, it and the agricultural index (GKX) have dropped to new lows for the bear market that started in 2011. The equivalent oversold on our "Rotation" prompted a tradable rally from January to the end of April. They became overbought.
Similarly, base metals enjoyed a good rally and became overbought at 376 in July. After finding support at the 50-Day ma, the test made it to 377 last week. After providing support on each setback since April, this week's decline has taken it out. Yesterday's rebound seems a normal reaction.
Mining stocks (SPTMN) became overbought at 954 in late July and the decline seems to have been anticipating weakness in metal prices. Two weeks ago we noted that the sector was vulnerable.
Traditionally, mining stocks have led the swings in metal prices. There could be support at the 200-Day ma, which is at 840. The index is now at 865. Last week we noted that copper can be seasonally weak into late in the year.
Crude oil became oversold at 92.50 in late August and bounced to 95.83. Last week it slipped to 90.43. Yesterday a wave of buying came into many markets and could have something to do with a special effort being made or intended by policymakers.
This week, central bankers are renewing their pledges to depreciate and it sparked the markets. We don't see any reason for a material advance in most commodities.
One of the interesting things about stock market history is that phases of forced liquidation typically occur from an oversold condition. The ChartWorks (September 12) big chart on the Dollar Index shows that exceptional rallies in the DX can occur from an overbought condition.
The latter occurred with the failure of the commodity bubble in 1981. Another was in the late 1990s and the pattern is poised now.
Going the other way, Russia's deputy finance minister advised "Don't panic". The ruble has been very weak.
Our comment that the Canadian dollar could trade around 92 did not work out.
The rally in crude started and failed and drove the C$ down 90.1 on Monday. It has bounced to 91.3 today.
The key moving averages that might have provided support now become overhead resistance.
Even very oversold conditions seem unable to prompt significant rallies. The course of the Canadian unit is down and the target becomes around 85.
Pimco Emerging Market Debt Price: 1997 to 2014
- The setback in 1998 was the LTCM Crisis, which in real time was a severe shock. Citi crashed 40%.
- The notations such as "9" or "13" at the tops are Sequential Sells.
- The blue circles are Downside Capitulations.
- The crash into 2002 was associated with the crash of the Tech Bubble. For both it was a cyclical event.
- The crash into 2008 was also cyclical.
- The pending convulsion in speculative-grade credit instruments will likely be described as secular.
Credit Spreads: Reversal is Progressing
- So far the change is impressive.
- This, the correction and extension of the trend were critical in 2007 and 2000.
- The key to this chart is that the reversal is occurring in the fifth year since the last panic ended in March 2009. If the speculation is going to fail, this is the season for it.
Spread Reversal: Summer 2007
Spread Reversal: Spring 2000