STALL SPEED : Any Geo-Political, Economic or Financial Event Could Trigger a Market Clearing Fall
As we reported last month, Global Economic Risks have taken a noticeable and abrupt turn downward over the last 60 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggested the global economic condition is at a Tipping Point. Though we stated "Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses" nothing has occurred even after the 19th disappointing EU Summit to address the EU Crisis. Some event is soon going to push the global economy over the present Tipping Point unless major globally coordianted policy initiatives are undertaken. The IMF recently warned and reduced Global growth to 3.5%. This is just marginally above the 3% threshold that marks a Global recession. This would be the first global recession ever recorded. The World Bank is "unpolitically'projecting 2.5%. The situation is now deteriorating so rapidly, as to be impossible to hide anylonger.
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MONETARY MALPRACTICE : Moral Hazard, Unintended Consequences & Dysfunctional Markets - Monetary Malpractice has had the desired result of driving Investors into becoming Speculators and are now nothing more than low-odds Gamblers. There is a difference between investing, speculating and gambling. At one time these lines were easy to comprehend and these distinctive groups separated into camps with different risk profiles in which to seek their fortunes. Today investing has become at best nothing more than speculating and realistically closer to outright gambling.
The reason is that vital information is either opaque, hidden or manipulated. Blatant examples such as: the world of off balance sheet debt, Contingent Liabilities, Derivative SWAPS, Special Purpose Vehicles (SPV), Special Purpose Entities (SPE), Structured Investment Vehicles (SIV) and obscene levels of hidden leverage make a mockery out of public Financial Statements. Surely if we get our ego out of this for a moment we can see that stockholders are now nothing more than gamblers? What is worse is that the casino is rigged. With Monetary Policy now targeting negative real interest rates, it is forcing the public out of interest bearing savings and investing, and into higher risk vehicles they would have shunned historically. They have no choice as the Monetary Malpractice game is played against them.
There is an old poker player adage: "when you look around the table and can't determine who the patsy with the money is, it is because it is you." MORE>>
The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. - The "Peek Inside" shows the detailed coverage available this month.
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The majority of the debt 'reduction' for the third year running is due to debt discharge, i.e., forced reductions in debt arising out of default, bankruptcy and other contract termination events, and not due to actually generating incremental equity (cash) used to repay debt.
Consumers may be getting their mortgages and credit cards discharged, because these are non-recourse, and the only trade off is a hit to one's credit rating, but their student loans keep piling up, and according to the Fed was just shy of $1 trillion at the end of Q2, a number which has since surpassed the psychological barrier.
Note the surge in HELOC delinquencies now that the HELOC product is no longer a fad, and consumers can't wait to stop paying back debt which will never be worth even one cent courtesy of the secular loss of real estate value and pervasive underwater prices. The flat line is student loan delinquencies. Soon to quite soon the black line will start imitating the red one. At that moment, run.
State insurance regulators are considering changes that would require U.S. insurers to hold more capital against some of the riskier mortgage bonds they have been scooping up lately as high-yielding investments. The moves under discussion could increase by billions of dollars the total amount industrywide that insurers must hold to protect policyholders.
Strong investor demand for those securities recently helped the Federal Reserve Bank of New York to profitably sell two large portfolios of subprime and other mortgage bonds it acquired in the 2008 bailout of AIG.
Many insurers "are looking for ways to enhance yield" and mortgage-bond yields are very attractive relative to other assets.
regulatory capital treatment is "important" in insurers' decision to buy these securities.
In 2011, insurers invested over $26 billion in residential mortgage-backed securities that aren't guaranteed by government agencies
the appeal of the mortgage bonds is
their high yield in today's low interest-rate environment,
discounted prices and
potential for gains in a housing recovery.
At the end of 2011, the insurance industry held $3.2 billion in capital to back a total of $123.2 billion in residential mortgage bonds, according to NAIC data. If the old credit ratings-based system were in place, insurers would have needed $18.3 billion in capital for those same bonds.
18.3/123.2 = 1 to 6.7 or 15% coverage versus 3.2/123.2 = 1 to 38.5 or 3% coverage
A succinct primer on how broken the status quo is and the 'euphoric' economy that very few could see through their Keynesian "debt doesn't matter" blinders, Steve Keen's introductory lecture at UWS is perhaps the most complete soup-to-nuts discussion we have seen recently. From the OECD's total ignorance to Bernanke's 'Great Moderation' miss; from economic 'religion' to science; and from Keynes to Minksy, Keen explains, in language even Chuck Schumer could understand, how more debt doesn't solve too much debt, how stability breeds instability, and why the US won't be finished deleveraging until 2025 (at this rate).
This brief lecture seems extremely apropos given we appear to be on the eve of yet another embarkation on the Keynesian 'stimulate' experiment - as everyone waits with baited breath for the next morsel of Fed/ECB/BoE/BoJ/PBOC juice...
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - August 16th - Sept. 1st, 2012
The chart only includes the periphery, the UK and Germany but that’s where most of the NPLs are right now. The total from 2010 was 965 billion euros. In 2011 it was 1.048 trillion euros.
Some of these countries are clearly underreporting their NPLs. But, as a whole 1 trillion euros is a lot of bad loans to cover. That’s one reason European bank shares are so depressed. And as the current deflationary policy path has continued, expect these numbers to get even bigger in 2012 and 2013.
Paul Krugman said he would be concerned if government spending hit 50% of GDP. The trend does not look good, but by Krugman's measure there is a ways to go.
Nonetheless, I think we should be concerned now. The numbers ignore exploding national debt and interest on national debt. Interest on national debt will skyrocket if rates go up or growth estimates penciled in do not occur. Both of those are likely, although Japan proves that amazingly low interest rates can last longer than anyone thinks.
I will point out that those liabilities are not debt yet. So might Krugman. However, I am comfortable in reducing benefits and slashing spending while Krugman is not.
Clearly there are many ways to spin this data but please note that government spending in France exceeds 50% of GDP. Also note that French unemployment is 10.2% and Hollande is poised to hike the top marginal tax rate to 75%.
Many industries have massive excess capacity - after years of aggressive expansion that ran way ahead of demand growth - which eventually has to be eliminated. This process will take some time, during which faster depreciation in the form of deleveraging and consolidation will be unavoidable; and while expectations of an imminent hard landing may be overdone, the landing will nevertheless be multi-year and bumpy in their view.
According to the China Banking Regulatory Commission (CBRC), total NPLs at China's commercial banks reached CNY 456.4bn at end-Q2, 4.2% qoq and up 11.9% (or CNY 48.6bn) from the trough in Q3 11. The NPL ratio was unchanged at 0.9%, due to a similar pace of loan growth. However, special-mention loans that are doubtful but still performing increased to CNY 1.5tn, while the total loan loss reserves set aside were CNY 1.3tn.
The number of stories on companies in default or with severe cash flow problems has surged since early Q2.
The economic slowdown does not seem to be the only cause, and, in many cases, not even the major one. The common mistakes include
involvement in speculative activities (eg. property speculation or commodity trading),
massive capacity expansion (eg. shipbuilding and solar panel manufacturing),
outsized commitments to complicated webs of mutual loan guarantees and
High exposure to underground banking (eg. many SMEs in Zhejiang).
The history of banking crises suggests there is no definitive linear correlation between the peak of NPL ratios and the scale of the pre-crisis credit boom, as it also depends on how the situation is contained and resolved. In the sample of 42 crisis episodes complied by Laeven and Valencia (2008), average annual credit growth to GDP prior to the crisis was about 8.3%. Between 2009 and 2010, this same ratio for China reached 27.8% and 20%, respectively. It is hard to see how China’s NPL ratio could stay at the current level.
There is also a structural element in China’s NPL cycle. Many industries have massive excess capacity after years of aggressive expansion that ran way ahead of demand growth. Eventually, China has to eliminate these inefficient capacities. This process will take some time, during which faster depreciation in the form of deleveraging and consolidation will be unavoidable (and margin compression has already begun).
Acute agony or chronic pain
The exact trajectory and the end point of the NPL issue will be difficult to predict. Economies with less government intervention, such as the US, usually see NPLs peaking one or two quarters after growth troughs. In contrast, Japan was very slow in recognising and resolving its NPL problem – a problem which started in the early 1990s. The NPL ratio didn’t peak until 2002, and much damage was done in the meantime to the banking system and indeed to the overall economy. China, where the government is even more involved in the economy, is running a clear risk of a prolonged NPL cycle. Local governments have poured millions of capital into rescuing failing corporates.
We think, at the end of the day, the central government will have to take the burden onto its own balance sheet as the NPL cycle reaches its final days of reckoning. The fiscal cost will only be higher the longer the process drags on, and a bigger concern is that more resources may be locked in these non-performing assets.
China has two problems... well more than two we are sure, but these seem critical.
First, there is a significantly slowing economy that 'desperately' needs the hand-of-god Central-Banker to stimulate it with free-money - but is hand-cuffed by the huge disconnect between 'apparently' low CPI and extreme highs in food and energy prices which will only exaggerate spending retrenchment should any money-printing be enabled.
and with Corn stocks at a stunningly low level (lowest since 1995 and nearing 1975 levels) things are only going to get worse...
Which leaves the PBOC somewhat powerless to do the kind of massive stimulus hole-digging-and-re-filling that is required to plug the economic demand slack.
Second, it seems for many investors the writing is on the wall as money is flowing out of the world's growth engine faster than oil from a wok. While at the surface USDCNY appears to be doing its 'stable' thing - the PBOC is soaking up unprecedented amounts of CNY as the market 'sells' out.
This chart (that we previously discussed in detail here) shows the difference between market-driven movements in USDCNY (red) and PBOC-driven (blue) - clearly the market is selling its CNY and running away and while we are sure China would like a lower Yuan (to help exports etc.) it is nevertheless band-ridden and needs to maintain some stability or trade-wars or worse will escalate - so the PBOC is soaking up massive amounts of Yuan (and selling out its USD?) to maintain that illusion of control...
These 'adjustments' which are now on an unprecedented scale started right after LTRO2 ended and are accelerating...
which is leading to forward-Yuan trading at post-crisis high discounts...
This combination of slowing (and seemingly unstoppable) economic trajectory with significant negative money-flows is a vicious circle - evidenced by the efforts of the PBOC with stealth reverse repos and the 'easing' of their Yuan trading bands (chart below - as per Bloomberg's Chart of the Day) as perhaps they revert back to a weaker Yuan policy (and implicit strong USD mercantilist vendor-financing model).
China’s Ministry of Commerce blamed the increase in vegetable prices on “strong winds and rainfall in the country’s eastern regions” that “disrupted production and logistics.” Nevertheless vegetable prices are up 15.4% over the past four weeks.
China Daily: – The wholesale prices of 18 types of vegetables in 36 cities rose for the fourth consecutive week, up 2.9 percent week-on-week and 15.4 percent cumulatively over the past four weeks, according to the MOC.
A Bloomberg article this week even suggested that China may postpone some policy easing due to renewed inflationary concerns .
Bloomberg: – China’s slower-than-forecast cuts in banks’ reserve requirements show authorities are reluctant to shake their concern inflation will quicken, three months after Premier Wen Jiabao shifted priorities to boosting growth.
China has left the reserve ratio for the biggest banks at 20 percent since mid-May while lowering interest rates in June and July, bucking forecasts from HSBC Holdings Plc and Societe Generale SA that the government would build on three ratio reductions since Nov. 30.
There are some new patterns in the employment trends that suggest we may be going through a generational transformation, led by both demographics and technology. And while it is ultimately positive, the transition will be harder on some groups than others.
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7 - Chronic Unemployment
FOOD STAMPS - Program Reflects Real Inflation & Cost of Living Increase
Consumer confidence missed big in August falling to 60.6.
The reading is the lowest since November 2011. Meanwhile, July's reading was revised down to 65.4.
"Consumers were more apprehensive about business and employment prospects, but more optimistic about their financial prospects despite rising inflation expectations," according to Lynn Franco, Director of Economic Indicators at The Conference Board.
"Consumers' assessment of current conditions was virtually unchanged, suggesting no significant pickup or deterioration in the pace of growth."
But the number is still above 60, showing the report wasn't a complete disaster. Here are some highlights from the report:
The percent saying business conditions are "good" climbed to 15.2 percent, from 13.7 percent.
The percent saying business conditions are "bad" was unchanged at 34.4 percent.
The percent saying jobs are "plentiful" fell to 7 percent, from 7.8 percent.
The percent saying jobs are "hard to get" eased to 40.7 percent from 41 percent.
The percent of consumers expecting business conditions to improve over the next six months fell to 16.5 percent, from 19 percent.
The percent jobs to increase in the months ahead declined to 15.4 percent from 17.6 percent.
The percent expecting fewer jobs climbed to 23.4 percent from 20.6 percent.
This chart from Eric Platt shows consumer confidence is at its lowest since November 2011:
Expectations: The Conference Board's consumer confidence index is expected to ease slightly to 65.8 in August, from 65.9 in July.
The link between nominal interest rates, inflation breakevens, and stocks has changed; especially with regard the last few years' seemingly increased dependence on the Central Bank to keep an anti-deflationary floor on breakevens (or conversely the Bernanke Put under stocks). UBS' macro team, while humbly professing not to be experts in corporate earnings (which have been dismal) or balance sheet ratios (which are positive but have deteriorated in recent months) believe in a big picture macro perspective that we have been vociferously commenting on for a year or two now.
SPX (green) vs 10Y Treasury rates (red) and 10Y TIPS Breakevens (blue-dots)
As official policy rates are frozen near zero and the Fed is likely to keep them there for at least two more years, one would need to look for different indicators quantifying market expectation of a future success or failure of the Fed’s stimulative effort. Breakeven inflation is a good candidate. The logic is pretty straightforward: we have been living in the low inflation environment for the past several years, and the Fed is quite intent on preventing deflation, so “successful” monetary policy should boost future inflation. The TIPS market reflects changing inflation expectations by repricing breakevens. Breakevens have reacted to the introduction of traditional and non-traditional policy measures, from new bond purchase announcements to extending the language regarding super low policy rates.
Specifically, they have noticed a potentially curious link between the way the market interpreted monetary policy signals and the large cap stocks in the US: the breakeven inflation rate on 10yr TIPS has tracked the S&P 500 very closely this year.
When the Fed is perceived to be successful in stimulating the economy, stocks benefit and breakevens also rise.
When the Fed’s potency is called into question, stocks fade and breakevens decline.
We have checked historical data to see if a similar pattern existed for the relationship between SPX and the nominal 10y Treasury yield in 2012. We found that relationship to be very statistically weak. We can point out to a pair of dates in 2012 when the 10y benchmark yield was essentially the same (1.83% vs.1.88%) while the S&P500 was 158 points higher on one date than the other.
Nominal Treasury rates have lost their 'signal' as UBS agrees with the point we have been making for a long time: central bankers and politicians, not economic fundamentals and inflation expectations, currently drive the nominal rate and equity markets.
Since bond yields are already at record lows, could it be that Fed officials have concluded that the only transmission mechanism they have left between monetary policy and the economy is the stock market? Recall that the Fed Chairman mentioned stock prices twice in his 11/4/10 Washington Post op-ed explaining why the Fed implemented QE2 the day before: “Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. … And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
If nothing is done by Congress to avert the fiscal cliff at the start of next year, the Congressional Budget Office (CBO) projects a recession during the first half of next year, with the unemployment rate remaining above 8% through 2014: “The increases in federal taxes and reductions in federal spending, totaling almost $500 billion, that are projected to occur in fiscal year 2013 represent an amount of deficit reduction over the course of a single year that has not occurred (as a share of GDP) since 1969. ... Real GDP is projected to fall at an annual rate of 2.9 percent in the first half of next year and then to rise at an annual rate of 1.9 percent in the second half.”
“The magnitude of the slowdown we’re discussing next year is significant,” CBO Director Douglas Elmendorf said at a morning briefing yesterday. He warned that going over the cliff could cost the nation about 2 million jobs.
"The latest FOMC minutes noted: “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” There was no similar comment about taking action "fairly soon" in the minutes of the previous meeting during June 19-20."
I think there’s a chance that he might announce during his August 31 speech at Jackson Hole that the Fed will launch an open-ended QE3 program with the hope of turbocharging the economy so that it can leap over the cliff. San Francisco Fed President John Williams, a voting member of the FOMC, was the first to advocate this stunt in an interview reported in the 7/23 FT.
He floated the idea again in an interview reported in the 8/10 issue of the San Francisco Chronicle. When he was asked whether QE3 should be saved to cushion the fall off the cliff early next year, if necessary, he responded: "We want to position the economy to be strong in advance of that. If you are really worried about running out of ammunition, you want to act more aggressively, more quickly and better prepare yourself for that eventuality."
Boston Fed President Eric Rosengren, who is a non-voting member of the FOMC, seconded Williams’ motion for open-ended QE3 in an interview reported in the 8/7 WSJ. According to the minutes of the July 31-August 1 FOMC meeting, released yesterday, "Many participants expected that such a [QE] program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly."
WILL IT WORK?
Michael Oliver, a seasoned stock market technician and a good friend, asks an interesting question about Bernanke’s highly anticipated stunt: “Prior [Fed] interventions came at market lows when the technicals were oversold, hence ripe for some upside relief. So, with that ‘difference’ this time around, with the market if anything technically stretched and measurably overbought on the upside, will a new QE work or blow up in their face?”
Great question. All the more reason to save the big QE3 stunt for early next year, if necessary, in my opinion. For now, why not just extend NZIRP until the unemployment rate drops below 7%? The FOMC discussed such a policy option at its last meeting:
“Given the uncertainty attending the economic outlook, a few participants questioned whether the conditionality of the forward guidance was sufficiently clear, and they suggested that the Committee should consider replacing the calendar date with guidance that was linked more directly to the economic factors that the Committee would consider in deciding to raise its target for the federal funds rate, or omit the forward guidance language entirely.”
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