The fiscal year for retailers ended in January with nothing like what it was supposed to be. Still, as always, the suggestions remained that a rebound in consumerism would be before too long. If it wasn’t to be evident right away in February, the start of the 2016 fiscal year was at least supposed to be back in the plus column. Last week, Thomson Reuters noted the starting weakness and all the hoped for blizzard implications.
The American retail shopper still isn’t in a free-spending mood. The Thomson Reuters Same Store Sales (SSS) Index forecast for February 2016 indicates a small gain of 0.5%. Excluding the drug store sector, the SSS growth rate is expected to fall to an estimate 0.3%.
A year ago, the final February SSS index registered a much healthier gain of 1.2% and the ex-drug indicator was up 0.6%. However, a 3.0% increase is considered a sign of a robust retail economy.
At least the SSS index is expected to be in positive territory, compared to January’s negative results, partly thanks to an improvement in winter weather. [emphasis added]
Among the many prominent victims of the “unexpected” weakness was Macy’s. Not only have same store comps declined four straight quarters, it has left the company with enormous inventory stocks –historically so.
Although the retailer beat its earnings estimate, the most worrisome metric from this iconic company is inventory days. During the fourth quarter ended Jan. 31, this key figure went from 172 to 192 days, its highest level since we started tracking this metric in 1991. It’s also much higher than the industry average median of 114.1, which means that a lot of Macy’s merchandise is sitting on the shelves. The retailer also reported a Q4 same store sales (SSS) result of -4.3% — the fourth straight quarter of negative SSS.
In other words, retailers are stuck at almost a contradiction. They want robust sales growth, and analysts are expecting that to come in relatively short order, but in order for the retail sector to get there it will need to clear inventory likely at significant (further) discounts in order to rebalance. And they need consumers to cooperate by being especially interested in all this discounted merchandise.
January is usually clearance month for retailers seeking to attract shoppers again after the busy holiday season. This year, it looks like weakness in the December scene carried over into the New Year. The Thomson Reuters Same Store Sales Index forecast for January 2016 is for 0.2% growth overall and for 0.0% growth excluding the drug store sector. Both figures are significantly lower than the January 2015 actual retail growth rate of 1.5% overall and 0.6% ex-drug.
We are seeing that slow holiday sales added more clearance merchandise to January’s inventory. In addition, when cold weather finally arrived in the northeastern U.S. (along with a huge blizzard), it kept shoppers at home and hurt mall traffic in January, particularly at brick-and-mortar retailers.
January same store sales did not grow at all, instead declining rather sharply by 1.1%!
Instead of +0.5% same store growth in February (which would have been, again, atrocious) the nearly final tally for retailers shows flat in February. In other words, after seriously shrinking sales in January there wasno rebound at all in February discounts or not. Retailers are in trouble, and it seems as if the difficulties are only lingering and increasing (NOTE: the chart below was from March 1 and includes the +0.5% SSSI estimate for February rather than the current update of 0.00%).
Since 2005, 44% of retailers, on average, beat their same store estimates each month. In February, only 14.3% did. Instead, 71.4% missed compared to the historical average of 54.5%. The weather may have improved, at least so far as an absence of big storms and snow-blown excuses, but shopping did not. That means that the retail environment, as far as sales are concerned, is worse than first believed and showed no improvement at all December to January to February.
In short, as with the Census Bureau’s version of overall retail sales, there is a clear consumer problem with implications spread across not just the US economy but overseas (China) perhaps more so.Despite all that, however, the BLS somehow suggests US retailers are hiring at maybe an historic pace and even accelerated hiring greatly in February. The discrepancy is so large as to be mutually exclusive. It is all the more so given that robust hiring in general always leads to more spending, so if there is no spending growth then that already suggests something else about hiring. There is no spending growth.
Last week, we learned that vehicle leasing as a percentage of monthly light-vehicle sales hit a record in February at 32.3%.
In other words, a third of the over 1 million cars and light trucks “sold” during the month were leases, according to J.D. Power.
This is indicative of what is now a long-term trend. Have a look at the following chart from WSJ, which shows that since 2009, the share of monthly auto leases as a percentage of vehicle sales well more than tripled:
Of course the thing about leased vehicles is that they come back, and as WSJ wrote last week, “about 3.1 million vehicles will return to dealer lots off leases this year, up 20% from 2015 [and] the number will climb to 3.6 million in 2017 and 4 million in 2018.”
So what does that mean for dealers? Deflation.
And what does that mean for the automakers? Hefty losses.
Nothing about this is hard to understand. You get a supply glut causing pricing assumptions for your existing inventory to prove wildly optimistic and you end up with giant writedowns.
This has happened before. "The auto industry expanded the use of leasing in the mid-1990s, helping to fuel retail sales of new vehicles," WSJ recounts. "Eventually, a glut of off-lease cars sent resale values down and auto lenders who had bet residuals would remain high ended up racking up billions of dollars in losses, having to sell the cars for much less than they anticipated."
Right. Nothing difficult to grasp about that. But the especially silly thing about the dynamic with auto leases is that it was the dealers and the automaker-affiliated financing companies that made the leases in the first place. In other words, it's not like this was some supply shock that couldn't have been forecast ahead of time. In fact, they knew exactly when the off-lease deluge would start, so it's not entirely clear why they would have set optimistic residual assumptions.
Anyway, the cracks are already starting to show.
The Manheim Used Vehicle Value Index posted its largest Y/Y decline in over two years last month, falling -1.4% and -1.5% M/M. We're now 3.5% below the peak.
"All else equal, it puts pressure on lease residuals - though we note most fincos had assumed declining used vehicle prices in their lease writing," Goldman said, earlier today. "Second, while improving inventory acquisition cost for the dealers, it may put downward pressure on the value of existing dealer inventories, which can be negative for used margins."
Well yes, declining used vehicle prices "may" be a "negative for used margins" - in fact that's almost a tautology.
And of course falling used car prices means pressure on new car prices as well, which would be a shock to America's booming auto market.
Obviously, the scariest part about all of the above is that consumers still have the pedal to the metal (pun fully intended) when it comes to leases, which means there's no end in sight to the off-leases and thus no way to determine, at this juncture, how big the residual writedown wave and deflationary auto industry calamity will ultimately end up being.
So, you know... "buckle up."
* * *
Bonus chart: largest used car price decline for any February since 2008
Worst.Case.Scenario. In 24 years, the ratio of wholesale inventories to sales has only been higher than the current 1.35x once - at the peak of the recession in the last financial crisis. Wholesale sales tumbled 1.3% MoM (worse than the -0.3% exp) and inventories rose 0.3% MoM while expectations were for a drop of 0.1% (inventories over sales difference rose from $143.6BN to $151.2BN in one month, a new record high.) And finally, automotive inventories rose to 1.78x sales - the highest since the crisis.
Keep stacking, despite tumbling sales...
Which leaves us firmly in the "recession imminent" section of the business cycle...
And there has never been a wider absolute spread between inventories and sales...
And as far as the automotive sector - that bubble may have a problem...
This cannot end well.
TIPPING POINTS, STUDIES, THESIS, THEMES & SII
COVERAGE THIS WEEK PREVIOUSLY POSTED - (BELOW)
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Mar 6th, 2016 to Mar 12th, 2016
TIPPING POINTS - This Week - Normally a Tuesday Focus
RISK REVERSAL - WOULD BE MARKED BY: Slowing Momentum, Weakening Earnings, Falling Estimates
In order to offset the lack of loan creation by commercial banks, the "Big 4" central banks - Fed, ECB, BOJ and BOE - have had no choice but the open the liquidity spigots to the max. This has resulted in a total developed world "Big 4" central bank balance of just under $10 trillion, of which the bulk of asset additions has taken place since the Lehman collapse.
How does this compare to what China has done? As can be seen on the chart below, in just the past 5 years alone, Chinese bank assets (and by implication liabilities) have grown by an astounding $15 trillion, bringing the total to over $24 trillion, as we showed yesterday. In other words, China has expanded its financial balance sheet by 50% more than the assets of all global central banks combined!
And that is how - in a global centrally-planned regime which is where everyone now is, DM or EM - your flood your economy with liquidity. Perhaps the Fed, ECB or BOJ should hire some PBOC consultants to show them how it's really done.
To give a sense of perspective of the numbers involved, we showed the following chart:
To be sure, since November 2013, all those numbers have grown substantially, especially at the ECB and BOJ but nowhere more so than in China, where a little over a year later, a famous study by McKinsey showed that not only has the world not delevered, but that the global "debt creation dynamo" was none other than China...
... whose debt/GDP has since grown to an even more astronomical 350% (and rising exponentially).
China's - and the entire world's - debt load was very much the highlight of the latest BIS quarterly report (profiled yesterday) in which we learned that the "BIS calls time on world credit binge" and that "China’s Leaders Put the Economy on Bubble Watch" even as these same leaders just raised their budget deficit forecast to its highest ever and previewed an even faster increase in its monetary aggregates or M2, which is now supposed to pick up to 13% per year, or roughly double China's GDP growth rate.
So yes, China debt is growing well over 100% faster than its GDP, a condition which is precisely the opposite of Ray Dalio's "beautiful deleveraging", and the outcome is clear to all.
And yes, while two years ago few had a sense of the true proportion of China's debt load, now virtually everyone does, which is why its credit creation will be put under a microscope.
But what does that mean in practical terms?
Simple: recall that it was China's (and the entire EM sector) furious debt issuance spree in 2008 and onward that together with central bank QE, prevented the world from collapsing into an all out depression. But since China's exponential credit growth delayed the inevitable, it also means that any slowdown in China's credit growth (or outright debt destruction if and when the massive debt defaults and NPLs are finally recognized) will put the world right back into the deferred depression.
And here, courtesy of Macquarie's Viktor Shvets, is the best encapsulation of the predicament the world finds itself in. From volume 52 of "What Caught My Eye"
Rising leverage levels (whilst positive initially) eventually turn to “poison”, as incremental benefit diminishes and in order to maintain growth rates, economies require an ever increasing infusion of credit and ever declining cost of capital.
Although not perfect there is a well-defined relationship between the overall level of debt and velocity of money. Each economy is different (both in term of structure and efficiency) and therefore the degree of tolerance to rising debt levels and associated volatility also differs; nevertheless, as a generalization, the higher debt levels and the faster pace of debt accumulation tends to coincide with lower (and declining) velocity of money.
Then, after showing the declining velocity of money in all developed markets as leverage exploded higher, Shvets focuses on China:
The massive rise in China’s financial leverage is in a class of its own. As China embarked on a highly capital intensive growth strategy, its debt levels accelerated, driving velocity of money down. As can be seen below, China’s estimated debt burden has increased from US$1.5 trillion in 2000 to US$5.8 trillion in 2007 and exploded to over US$28 trillion by 2014 (and should have reached US$30-31 trillion in 2015).
The punchline: China's velocity of money is now the lowest in the entire world, a world in which China provided 40% of the entire credit impulse since 2008!
In the last seven years, China has accounted for around ~40% of entire global incremental debt creation. Such a rapid accumulation of debt in less than a decade, when combined with the capital-intensive nature of the economy and a less sophisticated financial sector, drove China’s velocity of money to one of the lowest levels globally (~0.5x, i.e. below that of Japan).
And while we agree with the BIS and all those others who suddenly had an epiphany and confirmed what we have been saying for years about China's debt load, the question remains: just who will propel the global debt-creation growth dynamo if China is taken out of the picture, and if 25% of the world is covered in debt-demand destroying NIRP?
We hope to get some answers just as soon as the massive short squeeze acorss global markets, the biggest in history, is over
China never had an actual economic model or growth model. It simply printed an obscene amount of money, especially after 2008, and used it to build factories, 30-story see-through apartment blocks and highways into nowhere cities, without giving much if any thought to where this would lead when their formerly rich western customers had less to spend on its ever increasing amount of ever more useless products, or when its workers would stop spending ever more on apartments as investments, or when no more roads and bridges were needed because nowhere was already in plain sight. Or all of the above. It was ‘to infinity and beyond’ from the start, but that’s a line from a kids’ fantasy story, not a 5-year plan or an economic model.
Going into its 10-day, 3,000 delegates National People’s Congress opening on Friday, China was facing -and very much still is- two major and interconnected problems. Both are problems that the country has never faced before -not a minor point to make. The first is a giant debt load, one that could easily be as high as $40 trillion, or 350% of GDP, once one includes the shadow banking system (watch the shadows!). The second is the Communist Party’s -economic- credibility.
The debt problem is impossible to solve without very far-reaching restructurings of both the debt itself and of the entire Chinese economy. There appears to be a problem within the problem, however: the Party neither looks prepared to truly tackle the debt nor does it seem to know how.
As for the credibility issue, the very fact that a 5-year plan will be unveiled is the perfect in-a-nutshell illustration of what’s ailing Beijing. Not only does it hark back to communist days of old, not exactly a confidence booster, but trying to look 5 years ahead in today’s global economy is in itself not credible. It forces the Party to make statements nobody in their right mind will believe. And to compound the issue, that is something the leadership doesn’t really seem to take seriously. President Xi Jinping, more than anything else, looks like a man in the tradition of ‘what I say is true because I say so”.
That may have worked for a long time inside the country, but the desire to be part of the global economy means the ‘because I say so’ attitude is now being questioned by people Xi can neither bully nor bend into submission. Something he doesn’t seem to have clued into yet. Surrounded as he will be over these ten days by people who’ll say Yes at any appropriate and inappropriate instance, and laugh at anything he says that might be construed as a joke, Xi won’t come out any the wiser. He’d probably be better off spending those days with someone like Kyle Bass, but he’s not doing that.
Everybody, including most NPC delegates, knows that China’s grossly overleveraged, overproducing and overcapacitated economy needs another round of mass layoffs. Some initial numbers relating to job losses have been ‘leaked’ prior to the Congress. First, it was 1.8 million jobs cut in the coal and steel sectors, and a few days later that became 6 million. But that can only possibly be just a start.
It’s all in the numbers. China has something in the order of a billion workers, give or take 100 million or so. Even with the largest mass migration in human history, in which 100s of millions moved from the countryside to the cities, there are still an estimated 300 million people working in agriculture. That’s the entire US population. It’s also 30% of the Chinese workforce. In the US just 2 or 3% work in farming.
But that still leaves 700 million Chinese in other jobs. Many of these jobs were ‘invented’ in the past 20 years, as China’s ‘miracle growth’ transformed it first into the world’s no. 1 trinket producer, then into a kind of powerhouse that built highways to nowhere cities, and today a powerhouse with a fast plummeting global consumer base.
Many millions of Chinese workers produce things that can’t be sold. This is by no means confined to just coal and steel. The sharply dropping Chinese import and export numbers, as well as the purchasing indices, tell a bleak story. It’s evident that China must re-invent itself. And while that may be exactly what it claims it’s doing, the -alleged- transition to a service- and/or consumer economy may sound good, but its practical success is far from guaranteed.
Transforming a factory worker into a service sector employee is not a matter of flicking a switch. Repeating this 10 million times over, or 20 or 30 million, is a nightmare in an economy that is seeing its growth rates plummet while at the same time needing to deleverage its debt levels.
What are all these people going to do that produces actual economic value? And what will be the character of the companies they produce this value at? China is still dominated by state-owned enterprises, with workers relying on the faith that Beijing will always make everything right that goes wrong.
Losing that faith may have far-reaching consequences. At the same time, China cannot get the international economic status it so desperately seeks if so many de facto work for the government.
Though most tend to forget this, China was in a similar situation not so long ago:
In the late 1990s, China drastically restructured its state-owned enterprises, privatizing some and shutting down others. The result: from 1995 to 2002, over 40 million jobs in the state sector were cut, along with nearly 30 million jobs lost in the manufacturing, mining, and utilities sectors.
Although many of these workers were able to pick up jobs in the newly-growing private sector, the societal and cultural shift entailed in the restricting should not be underestimated. Prior to that wave of reforms, state sector employees (the vast majority of China’s workforce) enjoyed the benefits of an “iron rice bowl,” absolute job security along with social benefits (such as healthcare and pensions) provided by the state.
70 million – unproductive- jobs cut in 7 years. An average 10 million per year. A problem the country ‘solved’ by throwing tens of trillions (in US dollars) into overleveraged overproduction at exports-driven manufacturing enterprises. And by moving hundreds of millions of people into the cities that housed the enterprises.
15 years later, many of these newly created jobs have in their turn become unproductive. And the country may have to start the same process all over again. With probably tens of millions more jobs to replace. Question is, how will it fare this time around? Will people accept it as obediently as 15 years ago?
The reforms of the 1990s resulted in massive lay-offs. Overnight, tens of millions of workers lost their “iron rice bowls.” There were people who didn’t want to accept it, even those who actively resisted, but the government ruled with an iron fist and eventually the reforms went through. Even today, some of these people have grown old on the edge of poverty. On a certain level, we sacrificed them in exchange for huge reforms to the economic system.
But before wondering about civil obedience, let’s ask again: what are all these people going to do that produces actual economic value? Service economy? Consumer economy? There is no move available this time into another giant and overleveraged export industry. They’re at the end of the -debt- line.
Those people that had some money have lost a lot -and will lose much more- in equities and housing markets. Moreover, the government’s attempts to make them feel more secure about their old age would take decades to convince the people. So those who have something to save will do just that. So.. what consumer economy?
Service economy? Much of that in China is in financial services. Which has no future. So what else is there? How about the US model of burger flippers? That looks like a winner…
It looks like subprime derivatives on steroids: China hopes to bundle together billions of dollars worth of non-performing loans and eventually sell them to global investors Such a massive securitisation programme would represent the latest tactic in China’s campaign to lift one of the biggest shadows cast over its slowing economy -a debt pile that is as big as 230% of GDP. It would whittle back debts at Chinese banks and move some of the risk outside the domestic financial system.
According to official figures, such debts at the banks have reached Rmb1.27tn ($194bn), while analysts estimate the real number is likely to be many times higher. Chinese media has reported that the regulator has granted a total of Rmb50bn for the first wave of products. Demand for the scheme, however, is expected to be significantly more modest than supply. “How many global investors have been interested in the traditional [bad debt in China]?” asked one Hong Kong-based investor with experience buying distressed debt in Asia. “Not many.. is a more complicated version of this going to change that soon? No.”
This’ll be great, as great as the western approach to drowning in debt. Mind you, the Chinese haven’t even started talking about ‘recovery’ like we have, they’re still thinking -or propagandizing- that they’re on an ever upward trail. Well, they’re not. One of the early notes coming out of the People’s Congress was this: “China Says Will Keep Yuan Basically Stable Against Basket Of Currencies ..”
That’s not happening. They know it, we know it, and Kyle Bass knows it. Perhaps once the Congress is over, they’ll come clean? Hard to say. What’s certain is that global markets WILL force a substantial re-adjustment of the yuan, and there’s nothing Xi or the entire Communist Party can do to prevent it. And then, after a 30% readjustment, take another look at that dollar-denominated debt!
And they’ll have to cut many millions of jobs, and try to ‘pacify’ the newly unemployed, and deleverage the insane debt levels they’ve created, and find a way to explain to their people where it all went so wrong.
China no longer lives in a kids’ fantasy Toy Story.
The BIS’ Claudio Borio was vindicated in January - and it was a long time coming.
When last we checked in with Claudio, it was December and the bank’s Head of the Monetary and Economic Department was busy explaining what may befall $3.2 trillion in EM USD debt in the persistently strong dollar environment. “The stock of dollar-denominated debt, which has roughly doubled since early 2009 to over $3 trillion, is still there [and] in fact, its value in domestic currency terms has grown in line with the US dollar's appreciation, weighing on financial conditions and weakening balance sheets,” he warned.
We also laid out the progression of Borio’s most recent warnings as delineated in the banks’ widely-read, if on occasion perfunctory, quarterly reports. Below, is a brief review.
From 2014, warning about the market’s dependence on central bank omnipotence:
To my mind, these events underline the fragility - dare I say growing fragility? - hidden beneath the markets' buoyancy. Small pieces of news can generate outsize effects. This, in turn, can amplify mood swings. And it would be imprudent to ignore that markets did not fully stabilise by themselves. Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets' buoyancy hinges on central banks' every word and deed.
From March of 2015, speaking out about the dangers of increasingly illiquid secondary markets for corporate bonds:
As a result, market liquidity may increasingly come to depend on the portfolio allocation decisions of only a few large institutions. And, more broadly, investors may find that liquidating positions proves more difficult than expected, particularly in the context of an adverse shift in market sentiment.
What do the changes in market-making described here mean for markets and policy? There are at least two key issues. First, reduced market-making supply and increased demand imply upward pressure on trading costs, reduced secondary market liquidity, and potentially higher financing costs in new-issue markets. Second is the question of how markets will behave under stress - that is, whether they will be able to function in an orderly fashion in response shocks or broad changes in market sentiment...
Hence a world in which debt levels are too high, productivity growth too weak and financial risks too threatening. This is also a world in which interest rates have been extraordinarily low for exceptionally long and in which financial markets have worryingly come to depend on central banks' every word and deed, in turn complicating the needed policy normalisation. It is unrealistic and dangerous to expect that monetary policy can cure all the global economy's ills.
Right. So pretty much everything Claudio could be worried about, Claudio was worried about, and the most amusing thing about his concern over undue central banker influence is that the BIS board looks like this:
Well in any case, Borio is back at it and now he can say "I told you so." In the BIS' latest quarterly report, the bank wastes no time in describing the first two months of the year: "uneasy calm gives way to turbulence."
After noting that January was one of the most abysmal months for stocks in market history, the bank breaks the meltdown into two distinct "phases":
At first, markets focused on slowing growth in China and vulnerabilities in emerging market economies (EMEs) more broadly. Increased anxiety about global growth drove the price of oil and EME exchange rates sharply lower and fed a flight to safety into core bond markets. The turbulence spilled over to advanced economies (AEs), as flattening yield curves and widening credit spreads made investors ponder recessionary scenarios.
In a second phase, the deteriorating global backdrop and central bank actions nurtured market expectations of further reductions in interest rates and fuelled concerns over bank profitability. In late January, the Bank of Japan (BoJ) surprised markets with the introduction of negative interest rates, after the ECB had announced a possible review of its monetary policy stance and the Federal Reserve issued stress test guidance allowing for negative interest rates.
On the back of poor bank earnings results, banks' equity prices fell well below the broader market, especially in Japan and the euro area. Credit spreads widened to a point where markets fretted about a first-time cancellation of coupon payments on contingent convertible bonds (CoCos) at major global banks.
And then came the obligatory nod to dwindling counter-cyclical capacity:
Underlying some of the turbulence was market participants' growing concern over the dwindling options for policy support in the face of the weakening growth outlook. With fiscal space tight and structural policies largely dormant, central bank measures were seen to be approaching their limits.
But the real punchline comes in the end, when the BIS touches on a topic that we've been discussing since mid-January. Namely that this seems to be the year in which the world woke up to the fact that central bankers are not, in fact, omnipotent. We went further:
That rather unpleasant revelation has in turn caused some to reconsider the wisdom of the policies that drove stocks to nosebleed levels off the 2009 lows. That is, if it’s now clear that ZIRP, NIRP, and QE have failed when it comes to stimulating global demand and trade and reinvigorating the inflationary impulse, one is left to wonder what happens when the world careens back into recession against a backdrop of extreme capital misallocation and exhausted counter-cyclical policy maneuverability.
Almost as if the BIS had simply read the quoted excerpt above and paraphrased it for their own report, here is what the central bank for central bankers says:
Underlying some of the turbulence of the past few months was a growing perception in financial markets that central banks might be running out of effective policy options. Markets pushed out further into the future their expectations of a resumption of gradual normalisation by the Fed. And as the BoJ and ECB signalled their willingness to extend accommodation, markets showed greater concerns about the unintended consequences of negative policy rates. In the background, growth remained disappointing and inflation stubbornly below targets. Markets had seemingly become uncertain of the backstop that had been supporting asset valuations for years. With other policies not taking up the baton following the financial crisis, the burden on central banks has been steadily growing, making their task increasingly challenging.
We couldn't have said it better ourselves. Except that we did.
JAPAN - DEBT DEFLATION
EU BANKING CRISIS
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Market Analytics - WEDNESDAY STUDIES
STUDIES - MACRO pdf
TECHNICALS & MARKET ANALYTICS
TECHNICALS & MARKET ANALYTICS
Jeff Gundlach, this is his favorite chart - backing his persepctive that equity markets have "2% upside and 20% downside) from here.
One week ago, when looking at the latest BofA client flow trend monitor, we noticed something strange: despite the S&P's surge higher due to either a record short squeeze or because it is merely another bear market rally, the smart money was selling.
In fact, as BofA's Jill Hall calculated, the three groups that make up the so-called "smart money" basket, hedge funds, BofA's institutional clients as well its private clients, had been selling aggressively every week for the prior five. As she explained on March 1, "last week, during which the S&P 500 climbed 1.6%, BofAML clients were net sellers of US stocks for the fifth consecutive week, in the amount of $1.5bn. This was the biggest weekly outflow since mid-December." Someone clearly was very grateful for the selling opportunity that this squeeze was providing.
Well, we can now add one more week to the total: in BofA's latest note, "last week, during which the S&P 500 rallied 2.7%, BofAML clients were net sellers of US stocks for the sixth week."
She explains that "similar to the prior week, hedge funds, institutional clients, and private clients were all net sellers, though sales last week were led by private clients (vs. hedge funds the week prior). Our hedge fund clients remain the biggest net sellers of US stocks year-to-date."
The full breakdown below:
Clients were net sellers of stocks in five of the ten sectors last week and net buyers of the remaining five, as well as ETFs. Tech and the commodity-oriented sectors of Industrials and Materials saw the largest net sales, while Financials and Utilities saw the largest net buying... All three client groups sold stocks last week, led by private clients."
So, like last week, we again know who is selling but what about the other side: was it just shorts covering who are providing the bid? The answer is no: "buybacks by corporate clients accelerated last week to their highest level since August, and are tracking above levels we saw this time last year, though below levels we observed in 2014 (see chart below). Clients sold both large and small caps last week, but continued to buy mid-caps—which have seen the most persistent buying by our clients over the last several years despite being crowded and expensive."
In retrospect, this makes a lot of sense: with the debt market for all but the moost pristine issuers jammed up, corporations who have relied on debt-funded buybacks to push their price higher have had to step on the accelerator in their buyback activity, to give the impression that the market is back to stable, which in turn could thaw the frozen debt market, allowing them to issue even more debt, whose proceeds they would then use to buy back even more stock. Indeed, the lower the market dropped, the greater the buyback activity had to be to offset the natural selling by the smart money.
This is what we said one week ago:
In other words, buybacks are on pace to surpass buyback records, and since the debt issuance pipeline has to be unclogged or else risk the failure of hundreds of billions in bond bond refinancings in the coming months not to mention the collapse of the bond-buyback pathway, companies have scrambled to put a "risk on" mood on the market by repurchasing their stock, so that these same companies can issue more debt, so that they can buyback even more debt in the future.
Since then absolutely nothing has changed, and here we are now: 6 weeks of consecutive derisking and selling by hedge funds, institutions and private clients soaked up by what is now a record short squeeze, as well as a near record buyback spree to mask the fact that the "smart money" is bailing.
We leave it up to readers to decide just how healthy is this "rally" if the smart money has been selling for nearly 2 months, and where the two primary buying groups are corporations themselves, and shorts squeezed into covering positions.
COMMODITY CORNER - AGRI-COMPLEX
THESIS - Mondays Posts on Financial Repression & Posts on Thursday as Key Updates Occur
FRA Co-Founder Gordon T.Long and Dan Amerman have an in-depth conversation covering various topics such as financial repression, quantitative easing, devious actions of the Fed and much more. Daniel R. Amerman is a Chartered Financial Analyst, author, and speaker, with BSBA and MBA degrees in Finance, and over 30 years of professional financial experience. As an investment banking vice president in the 1980s he did groundbreaking work in the security originations and asset/liability management areas, including CMO/REMIC originations as part of portfolio restructurings for financial institutions, as well as the creation of synthetic securities for institutional clients. As an independent quantitative analyst in the 1990s and 2000s, he structured mortgage-backed bond financings and provided analytical services for real estate acquisitions by multifamily and commercial real estate owners, investment banks, and tax-exempt issuers.
Mr. Amerman is the creator of a number of DVDs and books on finance, including two books published by McGraw-Hill (and subsidiary):Mortgage Securities, and Collateralized Mortgage Obligations: Unlock The Secrets Of Mortgage Derivatives. He has been a speaker and workshop leader for sponsors including The Institute for International Research, New York University, and many banking groups.
Mr. Amerman has spent a number of years in researching alternatives. Drawing upon his background outside the individual investor industry, he has developed an interrelated group of non-traditional solutions – including asset/liability management strategies – for such concerns as financial crisis, inflation, inflation taxes, low economic growth rates, and pervasive low yield markets.
REVISiTING THE EXPANSION OF FIAT CURRENCY
The bigger issue is that we had a change in the national debt super cycle. As of 1947 due to the expense of WWII, the outstanding US debt was approximately equal to the size of the total economy. This is as toxic for a country back in 1947 as it is today.
Historically the growth rate of heavily indebted countries is much slower. It is a slow economic growth and a high interest rate risk environment. This was not just the US alone, this was most definitely global. What world leaders did as a result was get together, and yes Bretton Woods was part of this and they agreed to put rigid financial controls on the population. Effectively the size of national debt was held down for approximately 25 years while the economies experiences periods of substantial growth. Eventually these national debts as a percent of the economy had dropped down to below 30%.
This decline promoted a rapid growth environment, free market interest rate, removal of capital controls, and lifted the limitations on private ownership which we have had since 1973; individuals in the US could not hold gold for investment purposes.
“You’re not going to keep up with inflation and there is not much you can do about it. That’s the point of ring fencing.”
I split it into two ways. The first is capital controls and second, forcing intermediaries to participate in financial repression. Another component as well is repressing the ownership of precious metals so people do not have an alternative protection from inflation. What’s surprising is that the term financial repression has a conspiracy theory connotation associated with it, when in fact financial repression is an integral part of macroeconomics. It has been a core part of managing financial systems over a long period of time. What’s surprising is that the term financial repression has a conspiracy theory connotation associated with it, when in fact financial repression is an integral part of macroeconomics. It has been a core part of managing financial systems over a long period of time.
In the US in a relatively short period of time, particularly in 2010 all these elements were released for the first time since the 1970s. Interest rates were forced down below inflation by massive government intervention, quantitative easing and forms of capital controls all came out together and as a result dominated the markets ever since. The fascinating part is that there has been a series of developments over the last few months which may be the biggest round of financial repression that we have seen since 2010.
“Ring fencing which I consider as the third pillar is the forced participation of financial intermediaries in the name of public safety. Two key developments were what came out in 2015 was that the Fed has a part of the financial stability board. This board is the G20, the IMF, World Bank combined and all simultaneously agreed to change their money fund policy as well as their margin rules.”
Ring fencing which I consider as the third pillar is the forced participation of financial intermediaries in the name of public safety. Two key developments that came out in 2015 was that the Fed has a part of the financial stability board. This board is the G20, the IMF, World Bank combined and all simultaneously agreed to change their money fund policy as well as their margin rules. They changed regulation on money funds which are apparently done in the name of public safety such that it was an expensive burden for any funds to use anything other than federal debt for their money funds. Effectively creating an enormous financial advantage.
“This is a classic scenario. Take a financial intermediary and in the name of public safety make them hold US government debt.”
This is a classic scenario. Take a financial intermediary and in the name of public safety make them hold US government debt. In doing this you have expanded the market for government debt by whatever the net change is. Essentially locking in an additional trillion dollars of funding for the debt.
“A key thing to make note of is that these are all financial intermediaries, so when people ask who is funding the debt, the answer is all of us are.”
We are essentially financing the government through an intermediary. By changing regulations they are both increasing the relationship and locking into it. At this short term end of the yield curve we are doing this for virtually no yield whatsoever. We are providing the money to the federal government through an intermediary whose participation is forced.
FORCED MACROPRUDENTIAL POLICIES
“They are forcing ever lower interest rates on more of the population. This is providing larger low-cost funds to the government in an ever more constrained manner where it becomes harder for people to escape.”
On Nov 12, 2015 the financial stability board agreed to implement margin rule changes. They were talking about it being a blast from the past, it was what central banks used to do in the 1970s. This is now brought back out, but in this case it is also an expansion of the mandate of the Fed. Where we are with these changes is that the Fed will be without active congress and expanding their control over the US markets to all investment firms to participate in some sort of secured lending.
Financial firms often need cheap money on a short term basis. They can sell a treasury security to someone else at a given price and agree to buy it back at a higher price; in effect it becomes a short term loan. The difference in price is the interest rate that they are paying, this can be done without an actual sale and instead with the pledge of the securities as collateral.
“Central banks are concerned that these low quality collateral loans are now considered to be at risk for triggering a new financial crisis. That’s why they’re changing the regulations where they have the ability to change margin rules at will.”
The best known forms of margin deal with stock ownership where your borrowings become limited. If this was raised to 60% or 70% to bring down stock values, people will have to scramble to sell these securities or they will have to come up with the additional cash through some other means, otherwise there will be a forced liquidation.
What has been created is a major incentive to use US treasuries securities as collateral for repurchase agreements. Once everyone does this then you get a situation where the Fed is no longer in control of leverage in the market.
PREPARING FOR THE FUTURE
Funding for US national debt has just increased by $2.5 trillion. This is very similar to something that is far controversial and that is quantitative easing. Total US treasuries securities held by the Fed are between 2.4 to 2.5 trillion. They are holding this approximate level because they say they are not doing quantitative easing and rather doing purchases every time they take principal to keep at that level. This was major news and made headlines throughout the world, yet something just as big happened and nobody noticed; this is a forced funding of the federal debt that is just as large as what happened with QE.
“The Fed is in the process of deploying two massive stabilizers. Why are they doing this in 2016 when they hadn’t done so in 2010?”
The logical interpretation would be they are very concerned of what’s to unfold in the future. They are pre-emptively moving major stabilizers in place.
Gordon T Long is not a registered advisor and does not give investment advice. His 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. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.
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