Collapsing Dollar Liquidity Sends Dire Signal For Stocks

With the ECB today confirming that its bond purchase program will end in less than three weeks, it is worth reminding readers that the world is now crossing that critical threshold where the consolidated global central bank balance sheet is shifting from a source of liquidity to a drain on the global (and fungible) monetary system. And as the chart below shows, every single time the total change in net central bank assets has dipped into the red, it lasted only briefly before some financial crisis typically ensued, forcing central banks to resume liquidity injections to maintain market stability.

Yet while much of the investing public appears to have forgotten about the danger from balance sheet shrinkage, instead focusing on such interim distractions as trade war, peak earnings or rising rates, it is only a matter of time before the need for continued "flow" (not "stock)" of liquidity manifests itself in sharply lower asset prices.

Confirming this, is a new note by Nedbank, whose analysts Neels Heyneke and Mehul Daya warn that "equity markets are vulnerable" and caution that "it is time for central banks or governments to step up to the plate to help these markets" reminding readers that "in 2008, the Fed underestimated the size of the shadow-banking system, and the rest is history."

To underscore this point, the analyst duo shows the following key chart which makes it unambiguously clear that there is a strong relationship between the change in global USD-liquidity (in the form of M1) and the performance of the global stock market, where liquidity leads the stock market by an average of eight months.

And since the rate of change in liquidity is now the lowest it has been since the financial crisis, absent a fresh boost to global $-liquidity, Nedbank expects this relationship to hold and "as a result the risk of further downside potential for stock markets across the world remains intact."

One place where the shortage of liquidity is already manifesting itself, Nedbank claims, is in the rising spread of USD-denominated Emerging Market corporate debt, where the spread is close to a breakout level. To Nedbank,"this is the "canary in a coal mine for risk assets."

To be sure, the numbers are staggering and suggest a continued need for liquidity injections as USD-denominated debt of EM corporates has grown from $650Bn in 2009 to the current $3.2Trillion and, as the IMF has pointed out, there are significant mismatches i.e. USD-denominated debt as a percentage of GDP is 70% and as a percentage of reserves is 75%.

What about equities?

Here too the picture is quite bearish, and not only from a fundamental liquidity standpoint, but from a technical one as well as the failure by markets to remain above the (red) resistance line through the tops is in itself a sell signal. According to Nedbank, "if the world index remains below the (blue) support line at 1,984 over the coming days, it will likely be just a matter of time before the bear trend accelerates."

Injecting a little more chart analysis, Daya notes that according to Elliott wave rules, the correction after the completion of a five-wave structure should retrace the entire fifth wave. This would indicate a correction to the 50% retracement level at 1,454.

If that forecast is accurate, and if the S&P reconverges with the MSCI World, from which it decoupled for much of 2018, it would imply that the S&P500 has to drop over 700 points, sliding as low as 1900.

One thing is certain: whatever the "Powell Put" is today, it will certainly be triggered should the stock market crash by that much, not only ending any Fed tightening plans, but also launching a new round of QE.

Fonte: qui

Market Crash? Another 'Red Card' For The Economy

A few months ago I wrote this article at the World Economic Forum called “A Yellow Card For The Global Economy“. It tried to serve as a warning on the rising imbalances of the emerging and leading economies. Unfortunately, since then, those imbalances have continued to rise and market complacency reached new highs.

This week, financial markets have been dyed red and the stock market reaction adds to concerns about a possible impending recession.

The first thing we must understand is that we are not facing a panic created by a black swan, that is, an unexpected event, but by three factors that few could deny were evident:

1. Excessive valuations after $20 trillion of monetary expansion inflated most financial assets.
2. Bond yields rising as the US 10-year reaches 3.2%
3. The evidence of the Yuan devaluation, which is on its way to surpass 7 Yuan per US dollar.
4. Global growth estimates trimmed for the sixth time in as many months.

Therefore, the US rate hikes – announced repeatedly and incessantly for years – are not the cause, nor the alleged trade war. These are just symptoms, excuses to disguise a much more worrying illness.

What we are experiencing is the evidence of the saturation of excesses built around central banks’ loose policies and the famous “bubble of everything”. And therein lies the problem. After twenty trillion dollars of reckless monetary expansion, risk assets, from the safest to the most volatile, from the most liquid to the unquoted, have skyrocketed with disproportionate valuations.

(courtesy Incrementum AG)

Therefore, a dose of reality was needed. Monetary policy not only disguises the real risk of sovereign assets, but it also pushes the most cautious and prudent investor to take more risk for lower returns. It is no coincidence that this policy is called “financial repression“. Because that is what it does. It forces savers and investors to chase beta and some yield in the riskiest assets.

Three examples of the market lunacy: Iraq, a country that has been all but devastated and in constant turmoil, issues a 2028 bond at 5.8% yield, lower than some developed markets only six years ago.

Argentina issued a 100 year bond  with an 8.5% yield. A country that in the previous 100 years before issuing this bond defaulted more than eight times. The $2.5bn issue was oversubscribed 3.5 times, which shows how credit investors are more than hungry for any kind of yield, as global negative yield bonds currently surpass the $6.5 trillion figure. With Europe and Japan giving negative nominal and real yields, and central banks buying a combined $200 bn a month of assets, there was massive real demand for some yield.

None of the eurozone countries’ sovereign debt yields show a realistic combination of risk and return. With 19 countries yielding negative real returns, the evidence that there is no real demand for those bonds at these levels is that the ECB is considering an “operation twist” to avoid the inevitable reckoning of rising real yields as the quantitative easing unwinds.

In Europe, no investor would buy bonds of the eurozone states with these coupons in a normalized environment. This has led to higher risk assets in fixed income discounting a spread of only 290 basis points over a sovereign bond that is already massively inflated. That is the creation of a huge bubble instigated by central banks with its reckless policy of ignoring the risks that they encourage in the markets.

With more than 6.5 trillion dollars in bonds with a negative yield, the global bubble remains huge. Stock markets on fire, infrastructure multiples soaring, junk bonds at the lowest yields in thirty-five years… 

And it burst. 

China reminded us that the tale of synchronized growth was false and that what we have been seeing in recent years has been synchronized growth … of debt .

(courtesy IIF)

When China devalues the yuan and introduces the biggest tax cut in 38 years and a constant monetary stimulus to bail out its banks, what is it really telling us? That everything is fine? No, that things are not going well with the Asian giant  No economy launches a massive undercover bailout of the financial sector, cuts rates and implements huge tax cuts as well as devaluing if everything goes smoothly.

The realization of the fallacy of synchronized growth has also brought down expectations of global growth. And with it, corporate profit estimates.

Markets, suddenly, look as expensive as many have warned when the combination of China devaluation and soaring US yields shows the extent of the accumulation of risk of the past years.

The cracks in the building always appear first with currencies. Countries that have become accustomed to the idea that “this time is different” and that debt does not matter, started to multiply their indebtedness in foreign currency. Debt in dollars from emerging countries soared to 41% of their total debt.

In the first three months of 2018, global debt rose 11% to a record of 247 trillion dollars (according to the IIF), and that of emerging markets soared by 2.5 trillion to an all-time high of 58.5 trillion. .

When the lowest risk bond, the United States 10-year, went to 3.1%, the synchronized growth and complacent veil lifted, and t many assets showed how risky they truly are.

Markets woke up to a reality that we had decided to ignore. That rates do rise. And if the safest bond gives a return of 3.2% … Am I willing to buy bonds from much riskier countries with negligible spreads?

Add to that “sobriety” effect, another one. The inevitable devaluation of the yuan , which soared to almost 7 against the dollar. Am I willing to buy emerging markets and commodities when China exports its imbalances sending disinflationary pressure to the rest of the world?

One, the US 10-Year, shows us the risk in the assets that we perceive as “safe”. And the other, the yuan, reminds us that China exports global disinflation and warns of impossible growth expectations.

This reminds us that this time is not different. It is the same as all the previous ones. A bubble created from monetary policy gives way to a deep hangover .

The US technology sector, which soared thanks to very low rates and high liquidity began to show signs of weakness, and the US market reacted by losing support levels as a continuation of the five-year lows in China and emerging markets as well as ongoing weakness in Europe, showing that the United States was not immune to the problem of excesses in other markets and that “value” in Europe or emerging markets was inexistent. These markets fell with the US -and more in some cases-. The US market might be expensive, but others are optically cheap but very expensive in reality, and as such, they fall in tandem.

What is the problem?

If we look at the 180 most important economies in the world, only six have in their estimates of 2018, 2019 and 2020 an evident improvement of their fiscal and commercial imbalances. In other words, almost no government in the world plans to reduce the rate of debt increases. If we look at the corporate sector and families, the situation is much better, because private debt is somehow more contained -except in China- and especially in terms of solvency, compared to profits and assets.

Given that it is more than likely that central banks will continue to Japanize the economies through financial repression, these “red cards” are becoming more frequent and, in addition, there comes a point at which the saturation of monetary and debt measures stops working even as a placebo.

Governments and their central banks always start from a wrong diagnosis. They always believe that the problems of their economies are due to lack of demand and that turmoils are caused by external enemies, not by their policies. By appointing themselves as a solution to the problems they create, they only perpetuate the imbalances, and the solution is increasingly complex

Above all, the tools that central banks and governments have always used (lowering rates, increasing liquidity and increasing spending), generate very evident diminishing returns. In the past eight years, for every $1 of GDP, there were $3 of debt created. 

This week’s tantrum will probably recover because the incentive to continue inflating the risky assets is high. But we already have had several warning signs and we keep ignoring them . Even worse, episodes of volatility are being used to increase imbalances and generate further problems in the long-term.

When societies are based on incentivizing spending and debt and not saving and prudent investment, we are always going to throw ourselves into a bigger problem based on the conviction that nothing is happening. When it bursts, governments and central banks will blame anyone except themselves. And repeat.

Authored by Daniel Lacalle via DLacalle.com

Has “It” Finally Arrived?

With the recent plunge in the S&P 500 of over 5%, has the long-anticipated (and long-overdue) market correction finally begun?

It’s hard to say for certain. But the systemic cracks we've been closely monitoring definitely got an awful lot wider this week.

After nearly a decade of endless market boosting, manipulation and regulatory neglect, all of the trading professionals I personally know are watching with held breath at this stage. The central banks have distorted the processes of price discovery and market structure for so many years now, that it’s difficult to know yet whether their grip on the markets has indeed failed.

But what we know for certain is that bubbles always burst. Inevitably. Each is built upon a fallacy; and when that finally becomes apparent to enough people, the mania ends.

And today, there are currently massive bubbles in stocks, bonds and real estate. Every one courtesy of the central banks (as we have written about in great detail here at PeakProsperity.com over the years).

And with no Plan B in place to gracefully exit the corner they have painted themselves -- and thereby the global economy -- into, the only option available to them is to double-down on the pretense that we'd all be screwed without their stewardship. They have to do this I suppose. To admit the truth would throw the world into panic and themselves out of a job. 

Who knows what they think privately? But in public, they give us real gems like these:

Williams Says Fed Rate Hikes Helping Curb Financial Risk-Taking

U.S. interest-rate increases will help reduce risk-taking in financial markets, Federal Reserve Bank of New York President John Williams said.

"The primary driver of us raising interest rates is just the fact that the U.S. economy is doing so well in terms of our goals,” Williams said Wednesday in a reply to questions after a speech in Bali, where the annual meetings of the International Monetary Fund and World Bank are taking place. “But I would also add that the normalization of monetary policy in terms of interest rates does have an added benefit in terms of financial risks.”

"A very-low interest-rate environment for a long time does, at least in some dimension, probably add to financial risks, or risk-taking, reach for yield, things like that," he said.

"Normalization of the monetary policy, I think, has the added benefit of reducing somewhat, on the margin, some of the risk of imbalances in financial markets."

(Source)

And with that, our award for “Finally closing the barn door after the horse left 8 years ago,” goes to John Williams of the US Federal Reserve.

Come on, Mr. Williams. Your historic 'very-low interest-rate environment' didn't merely lead to a slight degree of higher risk at the margins here.

Instead, it has lead to an explosion of excessive risk everywhere today, including:

• Junk bonds trading near their most expensive prices ever
• Covenant lite loans out the wazoo
• The highest levels of corporate debt ever
• The most expensive stock markets ever, by several measures
• The highest margin debt on record
• Real estate bubbles across the globe
• Pensions highly exposed to the stock market

And the central banks' policy over the past decade hasn't merely been to create a “very low interest rate environment”. It has been nine long years of intense and deliberate financial repression.

The resultant risk-taking didn’t happen “in some dimension”. It happened right here on Planet Earth, in real time, and in public and private portfolios alike, across the globe.

Pensions have been monkey-hammered by this policy, forced to throw away 100 years of accumulated investment wisdom and flip from traditional allocations of 60/40 bonds-to-stocks to the opposite in a desperate chase for yield.

The mathematically-certain insolvency of much of the pension system lies on your shoulders Mr. Williams. And those of your other Fed colleagues. 

Moreover, the other malignant market responses to the Fed’s distorting policies didn’t “probably add to financial risks”. It absolutely guaranteed a future crisis -- one that will dwarf any prior.

In my assessment, the biggest crime of the Fed was the decision under Greenspan to try to eliminate the business cycle by replacing it with a credit cycle. Here’s what that looks like in chart form:

If you can't clearly spot the absurd Fed-blown asset bubbles in the above chart, you may as well stop reading here. With that kind of blindness, nothing can help you plan for what's coming next.

Now, why would central banks prefer credit cycles? Easy! They're a lot more fun. When they're expanding, everybody loves you. You get invited to Davos and people love celebrating you at parties.

Just as good, when the bubbles burst, as they always must, you get to ride to the rescue and play the role of savior. And when the dust settles, you get feted as a “hero” by the mainstream media (even though you were no better than an arsonist putting out his own fire).

Case in point:

Yes, I blame the central banks for the breakdown about to come. They are the villain to blame for their horse-whipping of stocks, bonds and real estate into dangerously over-valued asset price bubbles. Nobody else.

Former Fed chairs Greenspan, Yellen and Bernanke have to shoulder nearly all of the culpability. It remains to be seen what Powell does, but so far he seems less interested in bailing out stock market declines than his predecessors. If indeed so, he’s an enormous improvement.

Already, under Powell, for the first time in a decade, we are emerging out from underneath the miserable thumb of financial repression, the key cornerstone of which is having to accept negative real yields on saved money.  Today the rate of interest on a 3-Mo T-bill is higher than the (stated) rate of inflation. It’s also higher than the dividend yield on US equities. So savers finally have an option that doesn't unjustly punish them.

If we can thank Powell for that, then he’s already done more good than all three of his predecessors combined. And if he allows this last ill-conceived credit cycle to finally die of its own accord, he'll actually deserve that "hero" accolade. Especially because doing so will not only be the right thing to do, it will be deeply unpopular with the Powers That Be, and require an inordinate amount of courage to effect.

Heck, Trump was already gunning for Powell on Wednesday after just the first -3% decline:

“The Fed is making a mistake, they’re so tight. I think the Fed has gone crazy.”

~ Donald Trump, 10/10/18

But if Trump was concerned on Wednesday, he must have been spitting nails on Thursday as the market carnage continued:

Is this really it?

Has the worm really turned?  Is it not possible that the authorities will once again rescue these “markets” driving them ever higher in their quest for printed-up prosperity?

Again, anything is possible, but our view is that until and unless the central banks decide to reverse their QE wind-down operations the faux gains that resulted from the money flood will evaporate as well.

Our view is that things progress from “the outside in” reflecting the fact that it is always the cash strapped zombie company that fails before the AAA rated company, and it is the weaker emerging market economy that suffers before the core OECD economy.

This table of various year to date stock market returns perfectly illustrates that the “outside in” dynamic has been in place for a while.

It’s not a perfect detection mechanism certainly (Germany is down 4x more than Portugal?) but the pattern is more than directionally adequate.  The money flood has reversed and we’re seeing that in the losses that have been mainly concentrated at the periphery --  but are fast rippling into the strongest "core" markets

Time For Safety

Admittedly, we’ve been mostly out of the markets for a long while, preferring cash, gold, some core real estate holdings; while slowly building a small short position.

Our main strategy for surviving bubbles is to not get caught up in them in the first place. We've long advocated the wisdom of amassing cash, to have 'dry powder' capital to deploy at much better valuations after the bubble's bursting. In our opinion, everyone should be working on ‘buy list’ for that day.

Sadly, the expansion of the Everything Bubble has gone on for far too long as the central banks have all but destroyed true price discovery and well-informed capital allocation. Heck, most Millennial adults weren't old enough to experience the 2000 and 2008 episodes -- to them, today's Frankenmarkets are 'normal'. Most seem to have exactly zero clue of the role of the central banks have played in fostering the lion’s share of the stock and bond market gains that have occurred during their short adult lives.

The investment chat sites I lurk through to gauge the mood are awash with folks telling each other to “buy the dip” and “stand firm.”  Many are parroting the Wall Street/CNBC mantra that "This time is different!", so it’s best to just keep putting money in, staying long and fully invested.

We disagree. And we think those blindly marching to Wall Street's tune will be the first and worst victims when the next major correction hits.

Which is why we encourage everyone reading this to crash-test their portfolio with their professional financial advisor. If indeed we're entering another 2008-style correction, how will your current holdings fare? How risk-managed are your positions? Are your potential losses hedged to the downside? And once the dust settles, what's your plan for re-entering the market?

These are critical questions to be asking right now. And the time to address them may indeed be very scarce (the Dow has dropped another 100 points as I've been writing this).

If you don't have a financial advisor, or are having difficulty finding one willing to address the risks discussed here, consider scheduling a portfolio crash-test consultation (it's completely free) with the advisor Peak Prosperity endorses.

Just please, whatever you do, make sure you've taken prudent steps to prepare for a major market downturn. Don't leave your hard-earned wealth exposed, unless that's an intentional decision on your part.

Conclusion

The recent market sell-off was not at all unexpected by us. We began observing the first tremors at the periphery many weeks ago.

Last week, on October 5^th, we sent out a market warning to our premium subscribers under the banner The Markets Are Suddenly Looking Very Sick.

Whether the central banks blink here and ride to the rescue is the big question.

While we'll have to wait and see to learn the answer, in all of our interviews with experts (e.g. Axel Merk) who know the Fed and its staffers personally, the consensus is that Powell is a different animal from his predecessors. He'll tolerate quite a lot of stock weakness before he's moved to act.  Is his line in the sand -20%?  -30%? 

Whatever it is, it’s likely a lot more than the -6% we’ve seen so far.

Further, the ECB is in a bind because it, too, are publicly committed to tapering its balance sheet expansions to zero by the end of 2018. And as the EU is also locked in a budget battle with Italy, and it would be very politically difficult for the ECB to both play dove and hawk at the same time by bailing out the markets with more QE while also not buying any more Italian government debt or helping Italian banks.

The Bank of Japan is pretty much done, too. It has recently even (gasp!) shrunk its balance sheet a few times in recent months.

China is busy fighting its own battles with slowing growth and history's largest ever-real estate bubble. It's also in very delicate trade negotiations with the US, complicated enormously recently with the revelation that the Chinese PLA had a role in inserting hardware hacks (chips) onto high tech products supplied to the US.  So the PBoC is probably not going to be in the business of doing anything dramatic in terms of balance sheet expansion right now.

Add it all up, and the “outside in” contagion we’ve been observing over the past few months seems to have finally reached the core.

12/10/2018

Fonte: qui

In Part 2: Preparing For The 'Big One' we examine what a true market "crash" would look like.  We’ll be looking at bonds, stocks, gold, the gold miners, currencies as well as discussing potential candidates to consider for your post-crash 'buy list'.

Ready or not, developments are escalating. Be as ready as you can for what's coming.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access

Global Liquidity Is Eroding Fast... But Nothing Is Breaking Yet

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

Authored by Martin Feldstein, op-ed via The Wall Street Journal,

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…

by Egon von Greyerz of Gold Switzerland

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 life

Is 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.

Egon von Greyerz

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