All measures of liquidity continue to tighten…
All of our measures of liquidity have continued to weaken over the last two months. This applies to public sector liquidity, which has now declined to ~3% (vs 16%+ growth in ‘16 and ‘17)...
... US$ liquidity is negative (vs growth of ~5%- 6% in ‘17) and money supply (down to 4-5% vs double-digit growth in late ‘17).
G5+China M2 has fallen over the last four months by over US$2 trillion. At the same time, CBs are gradually pushing up the cost of capital.
While investors have already witnessed several tremors (VIX volatility in Feb’18, massive explosion of basis points and TED and US Libor in Mar-Apr’18, DXY acceleration and attack on the most vulnerable of EMs in Jul-Sep’18), the degree of dislocation has thus far been contained. For example, EM FX volatility rates have recently again eased and the same applies to EM high-yield corporate debt...
... while both OIS Libor and TED spreads remain relatively placid, and the US high-yield market continues to enjoy some of the lowest ever spreads (~3.2%). It applies even for CCC & below debt (~6.6%).
... but complacency keeps returning as inflation remains subdued
Although one could highlight some specific measures (e.g. IMF rescue of Argentina or tightening in Turkey), we believe that returns to complacency are primarily due to a deeply held view that CBs would never allow any meaningful break-out of volatilities, and would step-in with either liquidity supports and/or end of tightening while as long as the US domestic economy is strong, the risk appetite is expected to prevail. If we dig deeper, investors seem to agree with us that overleveraging, lack of clearance of past excesses & disruption are generating such strong headwinds, that break-out of excessive wage inflation is unlikely, even as markets tighten. This in turn, limits the degree of damage to margins or rise in the cost of capital, except for the most marginal of cases.
We worry about the next six months; but 2019-20 might not be bad
Our concern remains one of accumulation of policy failures, as CBs and investors understate the degree of linkages between asset classes. For example as 30Y mortgages touch 4.7%, there are already signs of tightening. Similarly rising short-term rates are bound to impact car loans & credit cards, while more vulnerable EMs could infect stronger EMs, causing a more robust contraction at the time when OECD leading indicators are already easing.
The role of the Fed and China is particularly important. It seems that the Fed is only focusing on domestic strength, while ignoring global tightening. As long as it continues to view the world through one-dimensional lenses, the non-US world runs a risk of significant contraction, which in turn would return to haunt US. Similarly, while recent actions have stabilized China’s credit impulse, it does not yet represent a substantive policy shift. While most investors worry about ’19-20, we remain far more concerned what would happen over the next six months. Either the Fed stops and China stimulates, or accidents happen. EMs still look very vulnerable; but ‘19-20 might not be bad years, as either normality returns or Fed pulls back. Systemic failure is not an option.
Submitted by Viktor Shvets of Macquarie
Fonte: qui
Marty Feldstein Warns "Another Recession Looms..." And The Fed's Out Of Ammo
And unlike in the past, the Federal Reserve has little room to encourage growth by reducing rates...
Ten years after the Great Recession’s onset, another long, deep downturn may soon roil the U.S. economy. The high level of asset prices today mirrors the earlier trend in house prices that preceded the 2008 crash; both mispricings reflect long periods of very low real interest rates caused by Federal Reserve policy. Now that interest rates are rising, equity prices will fall, dragging down household wealth, consumer spending and economic activity.
During the five-year period before the last downturn, the Fed had decreased the federal-funds rate to as low as 1%. That drove down mortgage interest rates, causing home prices to rise faster than 10% a year. When the Fed raised rates after 2004, the housing-price bubble burst within two years.
As housing prices plummeted, homeowners with highly leveraged mortgages found themselves owing substantially more than their homes were worth. They defaulted in droves, causing lenders to foreclose on their properties. Sales of the foreclosed properties forced prices even lower, leading the national house-price index to decline 30% in three years.
Banks that held mortgages and mortgage-backed bonds saw their net worths decline sharply. A total of 140 U.S. banks failed in 2009, and those that survived were terrified by how much further the market might slide. To avoid risky bets, they shied away from lending to businesses and home buyers and refused to lend to other banks whose balance sheets were also declining.
The fall in home prices from 2006-09 cut household wealth by $6 trillion. Coinciding with a stock-market crash, the erased wealth caused consumer spending to drop sharply, pushing the economy into recession. The collapse of bank lending deepened the decline and slowed the recovery to a sluggish pace.
Fast forward to today.
Homes aren’t as overvalued as they were in 2006, so there’s little chance of an exact replay of the 2008 crisis. The principal risk now is that a stock-market slowdown could shrink consumer spending enough to push the economy into recession. Share prices are high today because long-term interest rates are extremely low. Today the interest rate on 10-year Treasury notes is less than 3%, meaning the inflation-adjusted yield on those bonds is close to zero. The hunt for higher yields drives investors toward equities—driving up share prices in the process.
But long-term rates are beginning to rise and are likely to increase substantially in the near future. Though the 3% yield on 10-year Treasurys is still low, it’s still twice as high as it was two years ago. It will be pushed higher as the Fed raises the short-term rate from today’s 2% to its projected 3.4% in 2020. Rising inflation will further increase the long-term interest rate as investors demand compensation for their loss of purchasing power. And as annual federal spending deficits explode over the coming decade, it will take ever-higher long-term interest rates to get bond buyers to absorb the debt. It wouldn’t be surprising to see the yield on 10-year Treasurys exceed 5%, with the resulting real yield rising from zero today to more than 2%.
As short- and long-term interest rates normalize, equity prices are also likely to return to historic price-to-earnings ratios. If the P/E ratio of the S&P 500 regresses to its historical average, 40% below today’s level, $10 trillion of household wealth would be wiped out. The past relationship between household wealth and consumer spending suggests such a decline would reduce annual spending by about $400 billion, shrinking gross domestic product by 2%. Add in the effects on business investment, and this spending crunch would push the economy into recession.
Most recessions are short and shallow, with an average of less than a year between the start of the downturn and the beginning of the recovery. That’s because the Fed usually responds to recessions by cutting the federal-funds rate substantially. But if one hits in the next few years, the Fed will not have enough room to cut rates, as the fed-funds rate is expected to rise to only 3% by 2020. There also won’t be much room for a major fiscal intervention. Federal deficits are expected to exceed $1 trillion annually in the coming years, and publicly held federal debt is predicted to rise from 75% of GDP to nearly 100% by the decade’s end.
This means a downturn brought on in the next few years by rising long-term interest rates would likely be deeper and longer than your average recession. Unfortunately, there’s nothing at this point that the Federal Reserve or any other government actor can do to prevent that from happening.
Fonte: qui
Fasanara Capital: "Nobody Cares About Market Valuations These Days"
Submitted by Francesco Filia of Fasanara Capital
How Expensive Is The Equity Market In The US
The biggest equity bubble out there is in the US: the Nasdaq and the S&P. This is no news, few disagree in market chatters. Nobody is positioned for it, though. Looking at valuation metrics, there is not the shadow of a doubt: Shiller P/E, Hussman P/E, P/Sales, P/Book, EV/EBITDA, Cash Flow Yield, Forward P/E.
At Fasanara, we add to the list the ‘Peak PEG Ratio’ (read here a full working definition), a measure of how expensive a stock is relative to its ability to generate earnings. In single stocks, the PEG ratio is commonly used, as is rationale for investors to have the will to pay higher multiples for stocks capable of generating high growth. Yet, for indexes, this is rarely done. If and when you do, this is the incontrovertible result:
We consider cyclically-adjusted earnings, like Prof Shiller institutionalized (and won a Nobel doing). To counter one of its most frequent critics, to have included non-normal conditions during the Lehman crisis, we just consider the two top quarters in earnings in the last 40. In spite of that, the resulting pic is still a NASA Space Shuttle that left the orbit.
The cartel of ZIRP, 5trn US QE, 5trn US Buybacks, and now late-cycle 1.4trn tax cuts sugar-rush did not go unnoticed in markets. The S&P qualifies as the most expensive in history and pre-history. When compared to potential economic growth, multiples on the S&P500 exceed even those seen during the Tech Bubble in 2000. When measured against potential growth, even against its peak earnings in 10 years, the S&P has never before been this expensive before. It is approx. 60% above its historical average fair value.
How Expensive Is The Bond Market In Europe
The biggest bond bubble out there is in Europe, where real and nominal rates are still negative in spite of ebullient global equities. Bond yields are historically aligned with growth and inflation rates, according to basic valuation models. Why not, then, draw their historical simple relationship to them, in ratio format. This is what the ‘Real Rate to Growth Ratio’ does (read here a full definition), no more no less. And this is the self-explanatory Chart that results:
When compared to trend growth, government bonds in core Europe have rarely been as expensive as they are today. They are 250/300 basis point away from equilibrium.
How Much More Expensive Can They Get
Not much further, perhaps. This is what we find out in our studies on market structure and what we call the Tipping Points Analysis (‘TPA’). Our analysis is available in this e-Book, and is further discussed in slides 16 and 17 in this presentation.
Nobody Cares
Let’s be clear: nobody cares about valuations these days in markets. The lack of care is visible across the spectrum of investable assets, public and private: Equities, Bonds, High Yield, Emerging Markets, Venture Capital, Private Equity, Real Estate. It seems that we live through the apotheosis of what Nassim Taleb calls the ‘Bob Rubin trade’: my profit, your losses. A perverse incentive scheme is heavily skewed for money managers to not care, and moral hazard to disseminate across. Regulators, more strangely but not uncommonly to history, turn a blind eye, as ‘you cannot know a bubble, except in retrospect’, they lament. There is crowding in Academics too, Rob Arnott would probably say. Or worse, the ‘Portfolio Balance Channel Theory’ of Ben Bernanke actively goal-sought this out, as output to the experimental model. Call it the key to kick-off ‘animal spirit’ or ‘trickle-down economics’, elegantly.
As sober investors though, we should care that nobody does. Tail Risk badly needs complacency as a basic ingredient to assert itself, and compound Systemic Risks.
In Complexity Science parlance, complacency is the lack of the negative feedback loop keeping systems at bay, in stable state. Complacency is instead propelling them further out, in thin air stratosphere, where far-from-equilibrium dynamics apply.
The Critical Transformation Hypothesis
Our thoughts are expanded upon in this video slideshow. In a big long nutshell, we believe that Systemic Risk in financial markets are best analyzed through the prism of Complexity Science, using the analytical tools available to non-linear socio-ecological systems, where a shift in positive loops comes in anticipation of a dramatic transformation.
Chaos theory and Catastrophe Theory can then help shed light on the current set-up in markets. Years of monumental Quantitative Easing / Negative Interest Rates monetary policy affected the behavioral patterns of investors and changed the structure itself of the market, in what accounts as self-amplifying positive feedbacks. The structure of the marketmoved into a low-diversity trap, where concentration risks of various nature intersect and compound: approx. 90% of daily equity flows in the US is today passive or quasi-passive, approx. 90% of investment strategies is doing the same thing in being either trend-linked or volatility-linked, a massive concentration in managers sees the first 3 asset managers globally controlling a mind-blowing USD 15 trillions (at more than 20 times the entire market cap of several G20 countries), approx. 80% of index performance in 2018 is due to 3 stocks only, a handful of tech stocks – so-called ‘market darlings’ - are disseminated across the vast majority of passive and active investment instruments.
The morphing structure of the market, under the unequivocal push of QE/ZIRP new-age ideologism, is the driver of a simultaneous overvaluation for Bonds and Equities (Twin Bubbles) which has no match in modern financial history, so measured against most valuation metrics ever deemed reputable; a condition which further compounds potential systemic damages.
The market has lost its key function of price-discovery, its ability to learn and evolve, its inherent buffers and redundancy mechanisms: in a word, the market lost its ‘resilience’. It is, therefore, prone to the dynamics of criticality, as described by Complexity Science in copious details.
This is the under-explored, unintended consequence of extreme experimental monetary policymaking. A far-from-equilibrium status for markets is reached, a so-called unstable equilibrium, where System Resilience weakens and Market Fragility approaches Critical Tipping Points.
A small disturbance is then able to provoke a large adjustment, pushing into another basin of attraction altogether, where a whole new equilibrium is found. In market parlance, more prosaically, a market crash is incubating - and has been so for a while.
While it is impossible to determine the precise threshold for such critical transitioning within a stochastic world, it is very possible to say that we are already in such phase transition zone, where markets got inherently fragile, poised at criticality for small disturbances, and where it is increasingly probable to see severe regime shifts.
Fragile markets now sit on the edge of chaos. This is the magic zone, theorized by complexity scientists, where rare events become typical.
Egon von Greyerz Says Ride The Precious Metals Tide Or End Up In Financial Misery
Egon says we’re at a crossroads, where investors will either “lose it all” or benefit from the “biggest wealth transfer in history”. Here are the details…
With global investment markets standing at crossroads, investors have the option to lose it all or to benefit from the biggest wealth transfer in history. I have quoted this passage from Shakespeare’s Julius Caesar many times but it is more appropriate than ever for the situation the world is now in:
“There is a tide in the affairs of men
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their lifeIs bound in shallows and in miseries.On such a full sea are we now afloat;And we must take the current when it serves,Or lose our ventures.”
William Shakespeare
Sadly, very few will take the correct current and that is why the majority of people will end in shallows and miseries. The wealthy will lose the majority of their fortunes and many of the poor be exposed to poverty and famine. I know this sounds like another prophecy of doom and gloom but we don’t need to go further than Venezuela, with inflation reaching 1 million percent and the currency collapsing by 99.9% this year to understand what can happen. A cup of coffee costs 2 million Bolivars and most Venezuelans can neither get hold of nor afford sufficient food for their family. A major part of the adult population has lost 25 pounds (11kg) in weight.
BE PREPARED
In most countries in the West, it is still not too late to prepare a wealth preservation plan. People who have savings and investments have a lot more to lose relatively than the poor but for the less well off it will be a matter of survival just like for the Venezuelans.
There are many survival guides as regards all aspects of life. Jim Sinclair has for example written an excellent “Be Prepared” series that covers many of these aspects.
Probably less than 1% of investors will take the tide which “leads to fortune”. What most people won’t understand is that the Central Bank credit expansion bonanza is now coming to an end. The exponential moves up in stocks, bonds and property prices, will turn to catastrophic falls that will destroy most of the wealth in the world.
In the next 3-7 years, it is not going to be a question of making a fortune but to lose as little as possible.
So let’s look at the major risks and the best financial protection.
FAANGTASTIC TECH TO CRASH
The bubble assets will of course be the most vulnerable. If we start with the Nasdaq, it is up by over 700% since 2009, driven by the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google ). So since the 2009 bottom, a $10,000 investment in 2009 would today be worth $70,000 by just buying the index, a 24% annual growth rate.
The Dow and S&P indices have gone up slightly less but are still at all time highs due to the massive liquidity created by central banks since the 2007-9 crisis.
At the same time as most stock markets are greatly overvalued there are markets that are severely undervalued and ignored by most investors.
Commodities are at historical lows against stocks and due for a substantial revaluation. As the chart above shows, stocks are today in a historical bubble and at a 50 year high against commodities. The moves down in stocks and up in commodities will be massive. It is a virtual certainty that the ratio will go back to the 1990 level which would mean a 90% fall of stocks against commodities.
PRECIOUS METALS – TO OUTPERFORM ALL ASSETS
Although we are going to see commodities outperforming all asset markets, it will be critical to pick the right ones. Gold, Silver, Platinum and Precious Metal Stocks are of course the obvious choice. Not only is the precious metal complex extremely oversold against all the bubble assets but it is also the ultimate wealth preservation asset.
To understand the underperformance of the precious metals, let’s look at some enlightening charts:
Since 2010 the Dow is up 700% against the XAU Gold & Silver Index. A move back to the 2010 level is a minimum. That would be an 88% decline. But bearing in mind the extreme undervaluation of the XAU stocks and overvaluation of the Dow, a fall of 97% to the early 1980 level is more likely.
The Nasdaq’s relative overvaluation is even more extreme:
The Nasdaq is up 11x or 1,000% against the XAU index since 2010. A decline back to the 2010 level is a virtual certainty but as the Nasdaq bubble bursts and the precious metals surge, a fall of 98% to the early 1980s level is more likely.
The HUI Gold index has declined 76% against silver since 2003. A return to the 2003 high is possible. This would mean that the HUI Gold Stocks would outperform silver by 300%. On the same basis, the HUI would outperform gold by 400% (not shown):
Platinum has been very weak since 2008 and is soon likely to rise against gold.
Finally we have the ratio that is very significant for precious metal investors, namely the Gold-Silver ratio:
THE COMING SILVER ROCKET
Since 2003 we have seen the Gold-Silver ratio fluctuate between the 80-84 level and 30. In 2018 it has reached a new high for this century of 84. But momentum indicators are not confirming this high which is bullish for silver. A return to the 2011 level of 30 is very likely and probably to the historical average of 15. Reaching 15 would mean that silver will move almost 6 times faster than gold. If gold for example reached $10,000, silver would be $666. An almost 5000% increase sounds incredible today but once the manipulation and Comex fails, there will be little to stop silver.
Whatever level the precious metal sector reaches is at this point irrelevant. The purpose of the graphs above is to show that precious metals are likely to vastly outperform ordinary stocks. They will also outperform most other bubble assets such as property and bonds. And as I have shown many times including in last week’s article, precious metals are the best protection against the collapsing currencies.
FINANCIAL SURVIVAL INSURANCE
But even the expected precious metals’ outperformance is not what will be important in the next 3-7 years. Much more important is the preservation of capital. It will also be vital to protect against counterparty risk in coming years. Any major assets within the financial system is in my view an unacceptable risk. If you hold precious metal stocks, it must be done with direct registration which in some countries is difficult to achieve.
Physical precious metals held outside the financial system is the best form of wealth preservation as long as they are held in the right jurisdiction with direct control and access.
The King of wealth preservation is of course gold. From a historical perspective gold must form the bottom of the wealth pyramid and be the biggest holding. Even if silver and platinum are likely to appreciate more than gold, they are much more volatile and we would therefore recommend less allocation to these metals. They are wonderful when they go up but corrections can be vicious and testing for a nervous investor.
Although the precious metal stocks look extremely attractive, remember that even with direct registration, they are paper assets and therefore not a proper wealth preservation investment.
For the investor who understands the unprecedented risks in the financial system, the next few years could turn a massive potential loss to economic peace of mind and financial security.
What is so sad is that less than 1% of investors will realise this before it is too late.
Founder and Managing Partner
Matterhorn Asset Management
Zurich, Switzerland
Phone: +41 44 213 62 45
Upside Down World: Junk Bonds Set For Record Winning Streak As High Grade Suffers Worst Year Since 2008
For the latest confirmation of the upside down market, look no further than corporate bonds where the riskiest, CCC-rated junk bonds are set to make a positive return for the 3rd consecutive year, the longest winning streak since records began in 1997.
Not only have the lowest quality junk bonds, those rated CCC or lower, generating respectable absolute returns of 5.8% YTD, they have also outperformed higher quality debt with a 1% total return so far this month, according to Bloomberg and ICE data. Additionally, the lowest rated junk bonds have also outperformed the broader junk bond index, which has returned 1.9% YTD.
And while the key contributor to the outperformance of lowest-rated bonds is demand for, well, higher yielding paper as investors continue to chase returns, a key structural issue has been the lack of HY supply, which at $150 billion YTD is the lowest since 2009.
Meanwhile, as investors scramble for any paper that promises a material yield, regardless of underlying fundamentals, investment grade corporate bond returns have, in the worlds of Bloomberg's James Crombie "fallen from darling to deadbeat."
Continuing a theme we first highlighted in June, when we showed the "odd divergence" of IG bonds spreads widening even as junk bond spreads touched record lows...
... junk bonds have continued to enjoy unprecedented demand (and the abovementioned record winning streak) while high grade corporate bonds are set for their worst year since 2008, with returns for the space down 2.34% so far in 2018.
As shown in the chart above, while high-grade bond returns have been mostly positive since the financial crisis, the increasingly hawkish Fed has taken its toll this year, and with three rate hikes in the rear-view mirror and more to come, investors are getting out of low-yielding fixed-rate bonds - which traditionally underperform in rising rate environments as yields increase across the board - choosing either junk bonds or floating rate loans. No surprise then that the best performing asset classes in credit include high-risk, high-yield CCC debt and floating-rate leveraged loans.
Curiously, the negative returns for IG bonds - which have been largely used to finance another year of record mergers - haven't resulted in lower demand or slowed new issuance: according to Bloomberg, September was the highest volume month of 2018, with $122.7 billion pricing so far.
As Crombie summarizes these trends, "investors are like all others - they pursue returns. That means more money chasing a limited supply of increasingly risky bonds, and probably an uglier end to this credit cycle."
His Bloomberg macro commentator partner, Seb Boyd adds that "if the Fed halts rate rises, and corporate decision makers collectively take a sober decision to invest in long-term organic growth, then investment-grade corporates will benefit."
However, if extra Treasury sales push up yields, or late-cycle CEOs look at PE valuations and decide this is a good moment to go shopping, then high-rated bonds are best avoided.
Meanwhile, as junk bond supply remains subdued, the ongoing record wave of mergers, most of which are funded with IG debt, will see no shortage of lower-yielding paper; additionally high grade bonds will increasingly face a lot of competition, especially if the Fed keeps hiking rates and shrinking its balance sheet. This will continue until, eventually, the Fed triggers an "event" that forces a broad market repricing, one which see staggering losses in junk, and forces yield chasers into more safe places along the capital structure.
Fonte: qui
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