Making sense out of Chaos
This is probably the most anticipated FED meeting and the probabilities of an action are all over the place. President Trump has constantly put pressure on FED to cut rates inspite of 3.6% unemployment rate .
Lets look at Market Positioning
Some technical charts
and BOFA’s cheat sheet
Interesting week ahead
This one is MUST READ for all serious investors. A HIGH TIDE is coming and it is going to sweep most assets except US Dollar.
For many, the investment world can be a confusing place. Banks, mutual finds, stocks, bonds, currencies, insurance, inflation, taxes, economies – it’s no wonder the majority have glossed eyes.
And sitting on top of this confusion pie are central banks.
Each country has its own central bank which is responsible for setting overnight interest rates and the amount of money in that country’s financial system.
Yet, there is one central bank that is the most important, sits on top of the world, and all of its actions impact not only their local country, but also every other country in the world.
This central bank is the US Federal Reserve.
In this latest IceCap Global Outlook we share how actions by the US Federal Reserve are always reactive to a crisis which, ironically, it helped create in the first place.
Today’s central banks are once again, trying to thread the financial needle, and rescue us from the crisis that was born from the depths of the 2008-09 Great Financial Crisis.
The crisis is happening, yet there is good news – the crisis is creating opportunities to not only preserve your hard earned savings, but to capitalize too.
http://icecapassetmanagement.com/wp-content/uploads/2019/06/2019.06-IceCap-Global-Outlook.pdf
By Apra Sharma
Money is most vulnerable to level of public trust. Federal Reserve under Paul Volcker restored confidence through a restrictive monetary policy that led to high interest rates which is still unparalleled today. In 2008 – 09, the tides turned as global credit crisis eroded confidence which was intact since 1980s.
As monetary asset, gold can look back on asuccessful five-thousand-year history in which it was able to maintain its purchasing power over long periods of time and never became worthless. Gold is the universal reserve asset to which central banks, investors, and private individuals from every corner of the world and of every religion and every class return again and again.
The steady buying of gold and the repatriation of central bank gold clearly indicate growing mutual distrust among central banks. An example is the recent tenfold increase in the Hungarian gold stock. The official announcement of the Hungarian central bank on its first gold purchases since 1986 states: “In normal circumstances, gold has a confidence-building feature, i.e. it may play a stabilising role and act as a major line of defence under extreme market conditions or in times of structural changes in the international financial system or deep geopolitical crises. In addition, gold continues to be one of the safest assets, which can be related to individual properties such as the limited supply of physical precious metal, which is not linked with credit or counterparty risk, given that gold is not a claim on a specific counterparty or country.”
Commodities remain the exception and still do not participate in the ‘everything bubble’. The extreme relative undervaluation of commodities compared to the stock market becomes evident in the next chart.
As long as the equity market party continues, trust in the credit-financed growth model seems intact. But how sustainable is such an upswing?Popular trust in the idea that monetary policies can sustain growth and employment and that central banks have inflation under control will be seriously tested in the next recession.
In terms of performance, USD terms gold generated an unsatisfactory return in 2018, declining by 2.1%, while it gained 2.7% in euro terms.
The world gold price is now not too far from its October 2012 high of 1,836 USD (monthly average). Spread between world gold price and the gold price in US dollars has tightened since 2017.
2018 as a whole was positive for gold in most world currencies. Only the (supposed) safe-haven currencies (USD, CHF, JPY) recorded (slight) losses. The average performance in this secular bull market remains impressive. The average annual performance 2001 to now is 9.1%. Despite significant corrections, gold was able to outperform virtually every other asset class and above all every other currency during this period. Since the beginning of 2019, the development has been relatively unspectacular. The average plus is 0.8%.
The chart also provides impressive evidence that it is advisable to regularly accumulate gold (“gold saving”) by harnessing the cost-average effect.
A strong US dollar does much less damage to the gold price than a weak US dollar does to gold. Gold always moves out of countries whose capital stock is declining and flows into countries where capital accumulation is taking place, the economy is prospering, and the volume of savings is increasing.
However, it appears that signals of a US recession are slowly increasing. The Federal Reserve’s recession indicator currently indicates a recession probability of 27.5% for April 2020.
The S&P 500 was comfortable at 9% in the first three quarters of 2018, before a sell-off started in October and culminated in December emerging as its weakest performance since the Great Depression. This seems particularly significant as Q4 usually has the best seasonal performance. On a sector basis, only 7 of the 121 industry groups in the S&P 500 reported positive performance. At the top: gold mining stocks gained 13.71%!
This comparison clearly confirms gold (and mining stocks) as a portfolio stabilizer.Gold performed poorly compared to the S&P 500 in those years when the S&P posted very high gains. Gold, on the other hand, recorded the highest relative gains compared with the S&P in those years in which the S&P did poorly – with the exception of the special year 1979.
Rising inflation rates generally mean a positive environment for the gold price, while falling but positive rates (disinflation) represent a negative environment. Rising price inflation coupled with mounting economic risks would probably mean the perfect storm for gold: stagflation. At the moment, however, the consensus view is that this seems an almost impossible scenario.
Like any price, the price of gold depends on the assessments of market participants. Gold, in its capacity as a hedge against crises oftrust is directly dependent on the level of public trust. The value of the US Treasury’s gold holdings has historically traded in a band between 20 and 140 percent of the monetary base. Currently, the percentage stands at 9%, which clearly indicates an extreme undervaluation of gold. If you look at the gold bull markets of the last 50 years, you can see that even in its weakest upward period, gold was able to gain 71%.
Technical analysis shows that the impulsive rise from USD 280 to USD 1,920 has been corrected since 2011. As part of this corrective movement, an impressive inverse shoulder-head-shoulder formation has been forming since 2013, which could explosively resolve upwards.Currently, however, the price has already failed several times on the neck line in the resistance range of USD 1,360-1,400. If the gold price were to break through this resistance zone, the next target would be almost USD 1,800, as calculated on the basis of the distance from the head to the shoulder line, projected upwards.
A rising stock market usually goes hand in hand with a falling gold/silver ratio, i.e. an outperformance of silver compared to gold. However, in 2012 this correlation broke down.
The silver price could also be interpreted as a sentiment indicator for gold.Strong bull markets for silver usually only happen in the course of risinggold prices, because investors seek higher leverage and end up with mining stocksor silver. With the gold movement still meandering, silver is likely to wait for thenext breakout attempt of the gold price before gaining trend strength and relativestrength to gold. The ratio of 88 clearly shows that sentiment in the precious metals space is currently at rock bottom.
The above chart shows that the G/S ratio is subject to large fluctuations over time. Around 1980 we can see a low point at a ratio of 16, while in 1991 it almost reached the 100 mark. At the moment, it seems that the ratio wants to test the highs from 2008 at around 87. The risk of price declines appears to be limited at this historically extreme relative valuation.However, silver remains dependent on the price movements of gold, and bullish momentum seems unlikely in the medium term.
The past 12 months have shown that the seemingly invulnerable economic upswing has begun to crack deeply.The worldwide boom, driven by low interest rates and a ceaseless expansion of credit and money, now stands on feet of clay. In our opinion, the currentlyhigh trust granted into the skills of central bankers and the supposed strength ofthe US economy are the main reasons for the somewhat weak development of theyellow metal. If the omnipotence of the central banks or the credit-driven recordupswing are called into question by the markets, this will herald a fundamental change in global patterns of thinking and help gold to old honours and new heights.
Key highlights of the fortnight:
The non-food credit growth for the fortnight ending May 31 moderated slightly due to NBFC liquidity issue. As per April data, credit to industry remained stable at 6.9% yoy but credit to services (mainly banks lending to NBFCs) moderated. We expect liquidity measures from RBI (through OMOs and FX swaps) whereby the system liquidity could move from a deficit to a positive
The bond market reacted positively to the election results which handed over decisive mandate to the incumbent government. We expect government to continue with the reform agenda and prudent fiscal management.A slowdown in growth was anticipated in view of weak high frequency growth indicators. The GDP growth of 5.6% yoy for quarter ending March 2019 was meaningfully on the downside. We expect monetary policy easing and fiscal policy measures will boost the growth in coming quarters. Going forward RBI will be data dependent with a cautious eye on geo-politics and the price of crude oil
Central government achieved its revised F2019 fiscal deficit target at 3.4% of GDP. The expenditure moderated in F2019 to 7.9% yoy from 8.5% yoy in FY 2018. The moderation was driven by a slowdown in revenue expenditure.Encouragingly, capital expenditure held up with 14.9% yoy growth vs a contraction in F2018. Now that the elections are behind us we expect government spending to kick start post the union budget.
The US payroll data came out today and it was bad. Although Jobless rate is still respectable at 3.6% the new Job creation has virtually come to a halt. Markets are now pricing three FED rate cuts this year with some investment bankers sticking their neck out for a rate cut as early as this month. In LIGHT of weakening US data I thought I should put down some thoughts on “ The next recession”
The next recession
DoubleLine Capital CEO Jeffrey Gundlach held a recent webcast with investors in which the self-described “Bond King” said U.S. GDP growth relies almost “exclusively” on rising government, corporate and mortgage debt, and there is a 50% chance the economy sinks into recession in the next year. “Nominal GDP growth over the past five years would have been negative if U.S. public debt had not increased,” Gundlach said. Over the past five years, the nominal GDP grew by 4.3%, while public debt grew by 4.7%, higher than the entire country’s GDP.
Condition Comparison
Conditions today are radically different than in 2007 and 2000.
The Fed re-blew a housing price bubble but the number of jobs tied to construction, sales, CDOs, agents and even the impact on banks is a shell of what happened in previous recession.Technology is bubbly, but not like 2000.
Just like subprime mortgage debt triggered the last recession, in my view corporate debt will trigger the next one. This may start a liquidity crisis and create havoc in all sorts of “unrelated” markets.
The chart below explains the weakening credit profile of US corporate sector.
Few Pointers on Impact
New tools to counter next recession
There is also a new economic theory taking shape to fight next recession i.e “MMT” Modern Monetary Theory. This theory talks about increasing government spending to fight the next recession but with a twist that all government borrowing will be funded by Central Bank printing (effectively creating money out of thin air). This radical step is already being discussed among economist because traditional monetary easing has failed in either lifting GDP or Inflation.
Albert Edwards Ice Age theory for US and Rohit ” India’s Economic Winter is not over” are not too different. I have myself studied Kondratieff winter and believe there is no way to avoid it.
Rohit writes in Indiacharts
After writing the Modi bubble 2.0, I have some skeptics now, and with good reason. A strong government should be able to solve all our problems. Last week I sent out a very deep interview with two men from the debt markets and I hope you watched it. It touched upon everything that is going on without bias. Even as I do not speak there on the topics that interest me. Here are links to the two part interview
Back to the point it was not more than a week ago that Anil Ambani was quoted in the ET stating that India’s NBFC sector was in the ICU and needed more than just a pain killer. And you still doubt that we are in an economic winter? The reason for doubt only comes from looking at the Nifty. But maybe also because we are in an unusual period of time, one that you will only experience once in your lifetime.
The Kondratieff cycle is a generational cycle so you will go through this season only once in your life. And since you did not live in the last one there is no reference point. As a student of the cycle I use it to forecast economic events that will follow. But I have no past experience of it and cannot because the last time this may have happened was 70-100 years ago. So while an Economic Autumn is a bull market in consumption aided by cheap credit, an economic winter is the unwinding of over indebtedness of an entire society. The level at which these extremes ar reached is not fixed.
So while most will consider my winter call as a perma-bearish stance they will miss out on the utility of that view in asset allocation. I have found my niche in commodities and related sectors in this time.
That said it does not change that our non government debt/gdp ratio is over 100%. This is big by any standard. Getting the economy to then grow requires an ever increasing stimulus of new money. The reason why the market faces a dilemma in accepting the winter theory is that for some reason the Autumn cycle of consumption and the unwinding of debt ended up happening at the same time. So it is a tug of war between two worlds. The indices were restructured in good time to reflect the upside from growth sectors. The government did its bit by using OMOs, the pay commission, MSPs, and low interest rates with demonetisation, to allow the ever expanding pent up demand in consumption to exhaust itself.
Did I say exhaust? I mean there is a limit to how many cars I can buy. After 2 by the time I think of a third orr a switch to the latest model maybe my kids grew up and their education expenses took a front row seat. How many biscuits can you consume. You should know that the largest margin expansion in FMCG comes from the contribution margin which is price increases. In the late 90s the same companies suffered from down pricing. But eventually the inflation cycle kicked in and profits exploded. But inflation is also a cycle and there is a limit. No wonder that today post elections on the first RBI meet expectations are built in for a 50bps rate cut to save the nation. But will the additional savings translate into consumption? In the para above note that I brought a demographic angle into the discussion. Unfortunately we do not have data on all fronts in India else it should be easy to map it. Demographics change the consumption behaviour of a generation. The same generation that was buying homes and second homes will now find other uses for their money. Maybe retirement planning and education for their kids.
In the meantime this does nothing for our debt burden sitting on bank balance sheets. If RBI had not pushed it in 2015, till 2014 nobody even agreed with me that we had an NPA problem. Then NBFCs were the hottest sector. Even today some analysts in media believe that the NBFC crisis this time cannot be compared to that of the 1990s. Yes it cannot, exactly. It is different but it is not small. In fact my sense is that we are only skimming the surface. As below the government knows it. In fact this piece below sounds like we are discussing the Lehman crisis. Who is too big to fail? But Lehman was the one let go.
The reason I posted the video links above is for you to understand the inter linkages that exist in the financial sector. Contagion is a word that is real. One one firm fails it has a multiplier effect. And they it is game over. The negative sentiment on investment flows can quickly suck up liquidity from the system. For long this was debated with ILFS and banks were not marking it down as bad debt.
The side effects are still a work in progress like below.
But the real talk of town today is DHFL, a payment delay at the lender followed by a debt downgrade has suddenly made its NCDs marked down and illiquid.
Meaning that a lot of mutual funds that hold debt from the lender have to mark it down and face losses. And if that gets followed by redemption pressures it will be something to watch on how the demands are fulfilled. If this is not contagion what is
All this while growth in key sectors like Autos have finally hit the wall.
And Scooters
Another angle to the story is that overconsumption has lead to a drop in the savings rate. The side effect of that has been a spike in the credit deposit ratio. In the video above “Ananth” mentioned it to be well above 100%. With that we are still asking for credit growth to pick up and the panacea is supposed to be lower interest rates? Like that will push up savings. Macro economic factors are a complex matrix. For every pro there is a con. And we can play with the numbers as long as we can but at some point of time we have to face the old adage of “Mean Reversion”
And let me end by saying that many trends are global, the fall in Auto sales is now a worldwide phenomena over the last 2 years. And the negative impact of the NBFC crisis is seen in rising bond market spreads both in India,
and likely in the US, for completely different reasons. An earnings recession at a time when wage inflation is eating into margins. Hitting profit growth and thus raising risk for high yields debt. Its funny whether you like it or not many of the trends we witness now days are global.
I am well aware that everything I am writing here is the negative side of the story. A new strong government at the helm. A 100,000 crore spending plan and a 50-75bps rate cut is going to solve all our problems in the months ahead. That keeps the tug of war between the Autumn and Winter cycles going on a little longer. There is only one thing I can tell you with certainty. Winter always follows the Autumn and not the other way around. You can push it but just this far. My warnings about the debt cycle have proven true over the last 10 years even as markets have risen, this has shown up in every debt crisis one after the other during this time. That gives me no reason to discard the theory or the anticipation of what lies next. I think we will go from one NBFC to the Dirty Dozen pretty soon, and not necessary that all are listed entities. This keeps me on my toes for what follows and in search of the right opportunities for these confusing times. This is not a time cycle that you can put a date upon. It is a cycle of events that follow one another no matter how slowly they do so. The economic winter in India is real be aware and prepared, An economic slowdown would exacerbate the problems and bring more skeletons out of the cupboard. It is in the interest of the government to keep that from happening. But we are pushing on a string. You can spend too much and trigger higher interest rates or inflation. It is going to be a tight rope walk and hoping that the wind does not blow.
My two cents
I completely agree with Rohit assessment and India is getting into debt trap which policy makers are not even noticing. The tools applied by G-7 central bankers did not add GDP but added indebtedness with financial markets as the main beneficiary. This only widened the gap between Rich and Poor. It is naïve to believe that the same tools of monetary easing will work in India. We have postponed our problems for so long that they are no more cyclical but have become structural . There are two choices in front of India, either rapidly devalue the currency and inflate away the debt ( which US might not allow this time) or create conditions for attracting foreign capital to fund the countries infrastructure which will ultimately grease the economic wheel.
India spend writes…..
With 80% of districts in Karnataka and 72% in Maharashtra hit by drought and crop failure, 8.2 million farmers in these two states struggle to survive. More than 6,000 tankers supply water to 4,920 villages and 10,506 hamlets or settlements (bastis) in drought-hit Maharashtra daily, as a conflict brews between the two states over common water resources.
Further south, the Tamil Nadu government sanctioned Rs 233 crore for several emergency water projects, as the water supply in four reservoirs supplying water to Chennai dropped below 1% of their capacity, causing an acute water crisis, which shut down Chennai’s metro system. With piped water cut by 40%, people line up in queues for water tankers. They also complain of foul-smelling water, as if it were mixed with sewage.
Districts in Karnataka have shut schools for an extra week due to water scarcity. Short duration summer crops in Tamil Nadu and Maharashtra are taking a hit.
The situation is similar across India as the country is currently experiencing an acute water crisis, as we explain later. There is no respite in sight anytime soon as the southwest monsoon this year, responsible for 80% of India’s rainfall, is projected to be delayed and below normal in north and south India.
As of May 30, 2019, more than 43.4% of the country was reeling under drought, according to the Drought Early Warning System (DEWS), a real-time drought monitoring platform. And failed monsoon rains are the primary reason for the current situation. India has been experiencing widespread drought every year since 2015, with the exception of 2017, IndiaSpend reported on April 3, 2019.
The north-east monsoon, also known as ‘post-monsoon rainfall’ (October-December) that provides 10-20% of India’s rainfall, was deficient by 44% in 2018 from the long-term normal of 127.2 mm, as per data from the India Meteorological Department (IMD). This compounded the rainfall deficit in the southwest monsoon (June-September), which fell short by 9.4% in 2018–close to the 10% deficit range when the IMD declares a drought, said the IndiaSpend report.
The pre-monsoon rainfall (March 1-May 31) in 2019 was the lowest in 65 years.
Read Full article below
https://www.indiaspend.com/worldenvironmentday-600-million-indians-face-acute-water-crisis/
via Almost Daily Grant
Change is afoot. Across venture capital, high-end real estate and the retail sector of the stock market, investor behavior has seen a notable shift recently. A trio of sightings:
The Wall Street Journal reports today that SoftBank Group Corp. (9984 on the Tokyo Stock Exchange) has been “met with a chilly reception” in efforts to raise capital for a sequel to the $100 billion Vision Fund.
Contributing factors, per the Journal, include the fact that the larger investment firms generally have the capability to invest in start-ups directly and are thus reluctant to pay an additional round of fees, as well as concerns over the Vision Funds’ “lack of transparency.” Cantor Fitzgerald, L.P., tasked with raising funds for the project, approached would-be investors for commitments of as little as $50 million, a move which “tends to be a last resort for firms raising big investment pools. . . in part because of the cost of servicing multiple accounts.” Cantor scrapped the strategy “after [SoftBank] objected.”
Not just for SoftBank (termed “the epitome of the cycle in the Dec. 15, 2017 edition of Grant’s Interest Rate Observer) does the environment appear less hospitable. Last week, The Real Deal reported that Secured Capital Partners LLC., which owns a 157-acre land parcel in Beverly Hills, filed for Chapter 11 bankruptcy protection in Los Angeles federal court. Secured Capital listed the property for a record-breaking $1 billion last summer. Finding no takers, the list price was dropped to $650 million in February.
In its bankruptcy filing, Secured Capital listed $50 million to $100 million in liabilities, and assets of between $500 million to $1 billion (that was revised from less than $500,000 initially, an apparent typo). Ronald Richards, the fund’s lawyer, asserted in the filing that “the property will be sold or refinanced utilizing the best value the market or lending environment will bear.” The inability of this asset-rich, cash-poor borrower to extend terms on its debts may be a new development in this cycle.
While the winds seem to be shifting in the V.C. and real estate realms, a key corridor of the economy has fallen into deep freeze, if the stock market is any guide. Thus, independent retail analyst Mitch Nolen notes on Twitter today that apparel retailers have logged a brutal recent stretch, with each of the 24 clothing store stocks he tracks falling last month, with all but three absorbing double-digit declines in May.
More broadly, trouble in the apparel sector has spared neither the established players nor high-flying newcomers. Last week, industry mainstays Gap, Inc. and Abercrombie & Fitch Co. shares plunged 10% and 27%, respectively, after reporting weaker than expected sales in the most recent quarters. At the luxury end of the spectrum, Canada Goose Holdings, Inc. absorbed a 27% selloff last Wednesday after missing revenue expectations for the first time since its 2015 IPO. Since ripping higher by 450% from March 2017 to November of last year, GOOS shares have since lost more than 50%
Doug Noland writes…..
May 31 – Bloomberg (Felice Maranz): “President Trump’s promise to impose tariffs on goods until Mexico halts a flow of undocumented immigrants is being panned by analysts and economists… Here’s a sample of the latest commentary: MUFG, Chris Rupkey: ‘If you are going to turn the world upside down with these America First trade sanctions against imports from China, car imports from Europe, and now immigration from Mexico, you risk turning the economy upside down… Keep your eye trained on stock market valuations as the magnitude of the decline will tell you when investors have had enough and are rushing to the safety of cash in an increasingly dangerous and uncertain world.’ Cowen, Chris Krueger: ‘In the space of a few hours last night, Trump overturned all we thought we understood about the near term direction of the Administration’s trade strategy’… The president ‘unveiled a one-two punch that we believe will make USMCA extremely hard to pass in both Mexico and the U.S.’ ‘When Tariff Man returned on a rainy Sunday (May 4) to announce tariff escalations on China, we detected a consensus that this was merely a negotiating tactic… In the 27 days that have followed, no public talks have been held and the tariff escalation for goods in-transit along with China’s escalation on $60 billion in U.S. exports is hours away.’ AGF Investments, Greg Valliere: ‘These tariffs break new ground’ …because ‘they’re political, a punishment to Mexico for not stopping the surge of immigrants from Central America.’ He listed five ‘enormous implications’: Damage to USMCA ratification process; potential that a ‘slumbering’ Congress may awaken; Trump may not be finished with new tariffs, triggering higher prices for products…; Trump doesn’t seem to be listening to advisers, appears unconcerned by market and economic damage; Federal Reserve may now be forced to cut rates, but that may not be enough to reverse the damage.’”
May 31 – Bloomberg (Michelle Jamrisko and Enda Curra): “Prospects for a U.S.-China trade deal just became even more remote after President Donald Trump whacked tariffs that could rise to 25% on Mexico until that country stops immigrants from entering the U.S. illegally. ‘A U.S.-China trade deal will be even less likely,’ said Khoon Goh, head of research at Australia & New Zealand Banking Group… ‘At the end of the day, what’s the point of doing a deal if the U.S. can just impose tariffs arbitrarily?’ Investors are already bracing for a prolonged economic stand-off between the world’s two biggest economies. One potential beneficiary of the impasse was likely to be Mexico as companies considered shifting supply chains away from China toward lower-cost markets closer to American consumers. The latest escalation of Trump tariffs threatens that process.”
May 31 – Bloomberg (Michael Sin): “‘Trade policy and border security are separate issues. This is a misuse of presidential tariff authority and counter to congressional intent,’ U.S. Senate Finance Committee Chairman Chuck Grassley (R-Iowa) says… ‘Following through on this threat would seriously jeopardize passage of USMCA.’”
May 31 – Bloomberg (Michael R. Bloomberg): “President Donald Trump’s approach to trade policy had set new benchmarks of incoherence and irresponsibility even before his threat to impose escalating tariffs on imports from Mexico — but this latest maneuver takes the cake. The administration plans to harm businesses north and south of the border, and to impose additional new taxes on U.S. consumers, not to remedy a real or imagined trade grievance but to force Mexico to curb migration to the U.S. This is a radical and disturbing development. The administration is invoking a law that allows it to impose emergency economic sanctions. It’s safe to say that Congress never envisaged that those powers would be used in a case like this.”
According to CNBC reporting (Kayla Tausche and Tucker Higgins), the President’s Mexico tariff move was “spearheaded by advisor Stephen Miller.” That the decision was made despite opposition from both Treasury Secretary Mnuchin and Trade Representative Lighthizer is only more troubling to the markets (and the world more generally). Has the President “gone off the rails”? CNBC: “The surprise decision to announce the tariff plan came as Trump was ‘riled up’ by conservative radio commentary about the recent surge in border crossings… As the tariff plan was formulated, top advisors, including Vice President Mike Pence, who was traveling, and Larry Kudlow, who was undergoing surgery, were away.”
“‘Unreliable’ Trump Throws Markets Into Tizzy as Traders Scramble,” read a Friday afternoon Bloomberg headline. With the S&P500 index wobbling just above the key 200-day moving average, traders had been looking for a supportive tweet. Who would have expected it to be the President to nudge markets toward the cliff’s edge? Meanwhile, increasingly anxious currency traders hit a landmine, as the Mexican peso was slammed 2.4% in Friday trading (2.9% for the week). Mexico’s S&P IPC equities index dropped 1.4%. As if awakening to how incredibly uncertain the backdrop has become, gold surged $21 this week. Seemingly experiencing nightmares of global depression, WTI crude collapsed 8.7% for the week.
For a day, dramatic threats of Mexico tariffs almost took the spotlight off the rapidly escalating China-U.S. trade war. Almost.
May 31 – New York Times (Alexandra Stevenson and Paul Mozur): “The Chinese government said on Friday that it was putting together an ‘unreliable entities list’ of foreign companies and people, an apparent first step toward retaliating against the United States for denying vital American technology to Chinese companies. China’s Ministry of Commerce said the list would contain foreign companies, individuals and organizations that ‘do not follow market rules, violate the spirit of contracts, blockade and stop supplying Chinese companies for noncommercial reasons, and seriously damage the legitimate rights and interests of Chinese companies.’”
This is turning serious. The “Unreliably Entities List” follows reports earlier in the week that China is preparing to restrict the export of rare earth minerals. Friday from the New York Times: “As China Takes Aim, Silicon Valley Braces for Pain.” Another Friday headline, “U.S. is Dependent on China for Almost 80% of Its Medicine,” played into the narrative that the trade war is suddenly appearing much more complex and ominous than previously envisioned. China clearly has the capacity to play hardball; preparations have commenced.
May 29 – Reuters (Ben Blanchard, Michael Martina and Tom Daly): “China is ready to use rare earths to strike back in a trade war with the United States, Chinese newspapers warned… in strongly worded commentaries on a move that would escalate tensions between the world’s two largest economies… In a commentary headlined ‘United States, don’t underestimate China’s ability to strike back’, the official People’s Daily noted the United States’ ‘uncomfortable’ dependence on rare earths from China. ‘Will rare earths become a counter weapon for China to hit back against the pressure the United States has put on for no reason at all? The answer is no mystery,’ it said. ‘Undoubtedly, the U.S. side wants to use the products made by China’s exported rare earths to counter and suppress China’s development. The Chinese people will never accept this!’ the ruling Communist Party newspaper added. ‘We advise the U.S. side not to underestimate the Chinese side’s ability to safeguard its development rights and interests. Don’t say we didn’t warn you!’”
I’ll assume the Mexican tariff issue is resolved relatively soon, while the trade war with China appears poised to be a major and protracted problem. As I’ve highlighted in previous CBBs, this confrontation comes at a tenuous juncture for China’s financial system and economy. The assumption – for the markets and, apparently, within the administration – has been that fragilities would incentivize Beijing to play nice and succumb to a deal.
The Trump administration pushed aggressively, and the deal blew apart. And the longer conciliatory tones go missing from both sides, the more likely it is that the Rubicon has been crossed. This significantly increases the likelihood that China is heading into a crisis backdrop, with Beijing enjoying a larger-than-life “foreigner” “bully” to blame, berate and villainize before a population with expectations perhaps as great as the challenges they now confront.
What could be the most consequential story of the past week received little press attention in the U.S. – and maybe even less in China.
May 28 – Bloomberg: “Is it the start of a new era for China’s $42 trillion financial industry, or a one-time shock that will be quickly forgotten? Five days after the first government seizure of a Chinese bank in 20 years, investors are still grasping for answers. The takeover of Baoshang Bank Co. — announced with scant explanation on Friday night — left China watchers guessing at whether it marks an end to the implicit backstop for banks that has served as a linchpin of the country’s financial stability for decades. Regulators have said they’ll guarantee Baoshang’s smaller depositors, and while they’ve warned some creditors of potential losses, they haven’t said what the final payouts could be or given public guidance on whether the takeover will be a blueprint for other lenders. Complicating matters is the fact that Baoshang has been linked to a conglomerate under investigation by Chinese authorities.”
It’s a testament to the incredible growth of China’s banking system (from about $7 TN to $40 TN since the ’08 crisis) that Baoshang, with its mere $80 billion of assets, is one of a very large group of “small banks.” Along with most “small” Chinese banking institutions, Baoshang tapped the “money” markets for much of its gluttonous financing needs. It issued institutional negotiable certificates of deposit (NCD) and aggressively borrowed in the interbank lending market. The first Chinese government bank seizure in 20 years is further notable for Beijing’s decision to impose losses on some Baoshang creditors. While retail depositors are to receive 100% of their funds, corporate and financial creditors face painful haircuts.
May 29 – Reuters (Cheng Leng, Zheng Li and Andrew Galbraith): “Chinese regulators have issued instructions for the repayment of debts owed by China’s beleaguered Baoshang Bank that could see larger debts facing haircuts of as much as 30%, two sources with knowledge of the matter told Reuters. According to oral instructions detailed by the sources, regulators will guarantee the principal but not the interest on interbank debts between 50 million yuan and 100 million yuan. Debts of more than 5 billion yuan ($723.47 million) will have no less than 70% of their principal guaranteed, the sources said. For debts between 100 million and 2 billion yuan, regulators will guarantee no less than 90% of principal, and for debts of 2 billion yuan to 5 billion yuan, no less than 80% of principal will be guaranteed.”
May 31 – Bloomberg: “Holders of bankers’ acceptances worth more than 50m yuan ($7.2m) issued by Baoshang Bank will be repaid at least 80% of the principal, said people familiar with the matter. Investors were told on Friday that while they will be repaid 80% initially, they may still have recourse to the rest of the repayment as regulators progress in resolving Baoshang’s finances…”
Beijing has moved to invalidate the implicit 100% state guarantee of all large bank liabilities – deposits, NCDs, bankers’ acceptances, interbank loans, etc. Such a critical issue should have been decisively addressed years ago – certainly long before China’s Bubble inflated in “Terminal Phase” excess. Now, with the colossal sizes of China’s banking system and money market complex – coupled with rapidly expanding problem loans – a banking crisis would add Trillions (U.S. $) to the central government’s debt load. Bank losses will have to be shared by the marketplace, a prospect few to this point have been willing to contemplate. Going forward, investors will increasingly question the perceived “money-like” attributes of safety and liquidity for Chinese financial instruments.
Baoshang is part of an organization controlled by a Chinese tycoon under criminal investigation. While not a typical bank, its vulnerable financial structure is typical of scores of Chinese financial institutions whose breakneck growth was financed by cheap loans readily available for all from China’s booming (“shadow”) money market. Reminiscent of America’s GSE experience, it was all made possible by implied government guarantees Beijing was for too long content to empower. Beijing has now moved to adjust the rules of the game, with major ramifications for China’s fragile historic Bubble – right along with world markets and the global economy more generally.
May 28 – Bloomberg (Ina Zhou): “Pressure is building in a corner of Chinese lenders’ offshore debt after the nation’s first government seizure of a bank in about two decades. Loss-absorbing bonds, known at Additional Tier 1 instruments or AT1s, plunged across several small lenders on Tuesday after a sell-off on Monday. Huishang Bank Corp.’s 5.5% AT1s sank by a record 3 cents on the dollar Tuesday, while Bank of Jinzhou Co.’s 5.5% note fell most since July and China Zheshang Bank Co.’s 5.45% bond had the steepest drop in a year.”
The Shanghai Composite jumped 1.6% this week, while China’s currency was down only slightly (.07%). Superficially, it was easy to dismiss the Baoshang seizure as “no harm, no foul.” Thank the PBOC.
May 29 – Reuters (John Ruwitch and Simon Cameron-Moore): “China’s central bank made its biggest daily net fund injection into the banking system in more than four months on Wednesday, a move traders saw as an attempt to calm the money market after the rescue of a troubled bank. The government announced its takeover of Baoshang Bank on Friday… Worries that Baoshang’s plight might herald wider problems among China’s regional banks had driven money market rates higher, until the People’s Bank of China (PBOC) delivered a mighty infusion of cash on Wednesday.”
The PBOC’s $36 billion Wednesday injection raises a crucial question: What will be the scope of liquidity needs when a major bank finds itself in trouble – when escalating systemic stress begins fomenting a crisis of confidence? It’s worth noting that Chinese sovereign CDS jumped six bps this week to 59 bps, the high since January. Overnight repo and interbank lending rates rose, along with Chinese corporate bond yields. According to Bloomberg, issuance of negotiable certificates of deposit slowed sharply this week. Chinese finance is tightening, an ominous development for a fragile Bubble.
This is where the analysis turns absolutely fascinating – and becomes as important as it is chilling. The PBOC is at increasing risk of confronting the same predicament that other emerging central banks faced when their Bubbles succumbed: in the event of a mounting crisis of confidence in the stability of the financial system and the local currency, large central bank injections work to fan market fears while generating additional liquidity available to flow out of the system. “Everyone has a plan until they get punched in the mouth.”
Markets ended the week pricing in a 95% probability of a Federal Reserve rate cut by the December 11th meeting. Ten-year Treasury yields sank 20 bps this week to 2.12%, falling all the way back to the lows from September 2017 (2.57% 30-yr yield to pre-2016 election level). German bund yields dropped nine bps to a record low negative 0.20%. Swiss yields fell five bps to negative 0.51%, with Japanese JGB yields down two bps to negative 0.10%. I view the ongoing global yield collapse as powerful confirmation of the acute fragility of Chinese and global Bubbles.
If President Trump is determined to squeeze rate cuts out of the Federal Reserve, he made impressive headway this week. This CBB began with, “So Much for the Trump Put.” As for the “Beijing put,” a $36 billion PBOC liquidity injection was indiscernible beyond Chinese markets. Investors in U.S. securities would be wise to anticipate zero favors from China.
As such, markets are left with the “Fed put.” For the most part, U.S. stocks, equities derivatives and corporate Credit have been comfortable banking on the Federal Reserve backstop. But with things turning dicey in China, risk aversion is gaining a foothold. Investment-grade funds saw outflows surge to $5.1 billion the past week (“most since 2015”). Corporate spreads and CDS prices have begun to indicate liquidity concerns. With the “Fed put” now in play, there are important questions to contemplate: Where’s the “strike price” – what degree of market weakness will it take to compel the Fed to move – and, then, to what effect? Markets, after all, have already priced in aggressive rate cuts. It could very well require some “shock and awe” central banking to reverse markets once panic has begun to set in. And it’s as if global safe haven bond markets are anticipating a bout of panic in the not too distant future.
http://creditbubblebulletin.blogspot.com/2019/06/weekly-commentary-so-much-for-trump-put.html
By Apra Sharma
The world is changing and consumers are becoming more powerful each passing day. They have the ability to throw a business in garbage or to sky rocket another.
Chobani founder Hamdi Ulukaya advocates a new way of doing business, unlike traditional breakdown of spreadsheet analysis or corporates hunting for profit or businesses trying to find a way to earn more money or as the CEO playbook says ‘shareholders’, the Anti – CEO Playbook, is as per him what we need today and in future.
As per CEO playbook communities, factories and jobs can be sacrificed but not the CEO. Their pay only goes up. “It’s time to admit that the playbook that guided businesses & CEOs for 40 years is broken”, says Hamdi.
There are people in movies who take a different path to do right things called anti – heroes, Anti – CEO playbook is what business need to do right and be right.
Hamdi was in need of a factory space for his yogurt business. In the upstate New York, he found a plant worthless being sold for minimum price, the people who were working there silently and gracefully surrendering their jobs and the CEO sitting in a tower on some goddamn floor with spreadsheets in his hand and making decisions purely in pursuit of profit.
Hamdi, by August 2005 had the keys of the factory and he decided to hire 4 of the 55 people working there before. Gradually, over the years, he hired all 55 back and they together created a business much better than they were employed for before and each had a financial stake in it too. He believed that as the number of his hires will grow from initial 55 to 100 more to 1000 more and another 1000 and so on, for every 1 job created in his factory, there were 10 new jobs in local businesses. In one year, he build a baseball field for children and 5 years later, they became the number one Greek yogurt brand in the country.
Today 30 percent of Chobani workforce are immigrants and refugees. In Idaho, their world’s largest yogurt plant, they were told by locals that they would find no trained workers there. Hamdi still built a factory space, partnered with local community college and trained people in advanced manufacturing.
He says, “Today’s playbook tells you all about business except how to be a noble leader. We need a new playbook. One that see people above and beyond profits.”
Anti – CEO playbook is about gratitude, asking communities ‘how can I help you?’, responsibility and accountability.
“Business exists to maximise profits for shareholders”, says today’s business books. Instead its time we take a reality check, businesses should take care of their employees first.
New way of business should be to search for communities you can be a part of and ask for their permission.
Businesses as citizens must pick a side because its them and not government in a position to change today’s world.
In businesses, CEO should report to consumers instead of corporate boards because that’s the reason they exist.
This new playbook would clearly highlight the difference between profit and true wealth. Anti CEO playbook is about “If you are right with your people, if you’re right with your community, if you’re right with your product, you’ll be more profitable, innovative and you would have more passionate people working for you with a community that supports you!”