Wednesday, February 10, 2016

$INDU--If we get below 15,766

If we get below 15,766, that will confirm our wave count--that we are in minute wave 5 of minor wave 1 of intermediate wave (3), which should take us to 15,372 at least to complete minor wave 1.  Let's see if that happens.  GL

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Debt will sink us

Former BIS Chief Economist On Coming Crash: “Will Be Uncomfortable For People Who Think They Own Assets That Are Worth Something”

Submitted by IWB, on February 10th, 2016

“This will be uncomfortable for a lot of people who think they own assets that are worth something”…

Submitted by Larry White:

Last month we ran this article which quoted former Bank for International Settlements (BIS) Chief Economist William White as saying that the global debt problem is so severe that “it will become obvious in the next recession that many of these debts will never be serviced or repaid.” If that isn’t enough coming from a former BIS Chief Economist, he added “this will be uncomfortable for a lot of people who think they own assets that are worth something.
We try here to be non sensational in covering the issues. We try not to use hyperbole or overhype the potential for serious economic problems. In this case we have an extremely credible former key official with years experience inside the system making some very strong statements in public. In order to explore these comments more in depth, we will look at a recently released two part article on the Cobden Centre web site that is an interview with William White. We strongly encourage readers here to read Part I and Part II of this interview fully. Below are some key quotes selected from the interview. After that we will add a few comments.

———————————————————————————————————

Max Rangeley: “Well, thank you very much for being on the call today, Bill. That’s really great. So I’ve got a few questions here, which I thought we could go through. First, now that QE has started in Europe is this likely to cause further distortions rather than stimulate the economies of Europe, especially will it favour large corporations at the expense of small businesses, do you think?”

William White:To be honest, I’m not sure it’s going to do anything – certainly, anything that’s good. The fundamental problem here, as I see it anyway, is that the European banking system is still broken. As you know, the European economy is heavily reliant on small and medium-sized enterprises, and they are reliant in turn on bank financing. Unfortunately, it is these firms that are not getting the bank financing that they need. Until that gets fixed, we will continue to have a huge problem in Europe.    . . . . . .

In any event, here in the euro zone bond yields are incredibly low already although one cannot rule out that this was in anticipation of QE. So my general sense is that I don’t think QE was needed and I am dubious that it will work in stimulating aggregate demand as intended. Moreover I remain worried that its implementation might bring with it other unintended and undesirable consequences that we haven’t even thought about. All that said, I think the ECB was under such pressure to act further that it had little choice but to do what it did. And that, in itself, I think, is really unfortunate, because it just drags another important central bank still deeper and deeper into this malaise of central bank over extension.”

Sean Corrigan: “As you say, I couldn’t agree more. It’s a question of dysfunctional banking and also of the debt hangover, which we haven’t addressed. And to me, QE is self-deceiving in that the liquidity issue, as you say, was the first rationale in the aftermath of the Lehman collapse was one thing, but to then try and use it as a macro tool when what you’re trying to do is make borrowing more attractive for people who have just been burnt by over borrowing seems”

William White:Mad. It’s mad here and it’s mad everywhere. It’s more of what got us into trouble in the first place.

Sean Corrigan: “We’re trying to fix banks but now we’re destroying their net interest rate margins, by trying to work this way as well. We’re also destroying all the other financial institutions like insurance and pension companies that must be bleeding everywhere.”

MORE:

http://www.silverdoctors.com/former-bis-chief-economist-on-coming-crash-will-be-uncomfortable-for-people-who-think-they-own-assets-that-are-worth-something/

Tuesday, February 9, 2016

Financial Collapse Coming

Day Of Reckoning: The Collapse Of The Too Big To Fail Banks In Europe Is Here

By Michael Snyder, on February 8th, 2016

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Europe Lightning - Public DomainThere is so much chaos going on that I don’t even know where to start.  For a very long time I have been warning my readers that a major banking collapse was coming to Europe, and now it is finally unfolding.  Let’s start with Deutsche Bank.  The stock of the most important bank in the “strongest economy in Europe” plunged another 8 percent on Monday, and it is now hovering just above the all-time record low that was set during the last financial crisis.  Overall, the stock price is now down a staggering 36 percent since 2016 began, and Deutsche Bank credit default swaps are going parabolic.  Of course my readers were alerted to major problems at Deutsche Bank all the way back in September, and now the endgame is playing out.  In addition to Deutsche Bank, the list of other “too big to fail” banks in Europe that appear to be in very serious trouble includes Commerzbank, Credit Suisse, HSBC and BNP Paribas.  Just about every major bank in Italy could fall on that list as well, and Greek bank stocks lost close to a quarter of their value on Monday alone.  Financial Armageddon has come to Europe, and the entire planet is going to feel the pain.

The collapse of the banks in Europe is dragging down stock prices all over the continent.  At this point, more than one-fifth of all stock market wealth in Europe has already been wiped out since the middle of last year.  That means that we only have four-fifths left.  The following comes from USA Today

The MSCI Europe index is now down 20.5% from its highest point over the past 12 months, says S&P Global Market Intelligence, placing it in the 20% decline that unofficially defines a bear market.

Europe’s stock implosion makes the U.S.’ sell-off look like child’s play. The U.S.-centric Standard & Poor’s 500 Monday fell another 1.4% – but it’s only down 13% from its high. Some individual European markets are getting hit even harder. The Milan MIB 30, Madrid Ibex 35 and MSCI United Kingdom indexes are off 29%, 23% and 20% from their 52-week highs, respectively as investors fear the worse could be headed for the Old World.

These declines are being primarily driven by the banks.  According to MarketWatch, European banking stocks have fallen for six weeks in a row, and this is the longest streak that we have seen since the heart of the last financial crisis…

The region’s banking gauge, the Stoxx Europe 600 Banks Index FX7, -5.59% has logged six straight weeks of declines, its longest weekly losing stretch since 2008, when banks booked 10 weeks of losses, beginning in May, according to FactSet data.

The current environment for European banks is very, very bad. Over a full business cycle, I think it’s very questionable whether banks on average are able to cover their cost of equity. And as a result that makes it an unattractive investment for long-term investors,” warned Peter Garnry, head of equity strategy at Saxo Bank.

Overall, Europe’s banking stocks are down 23 percent year to date and 39 percent since the peak of the market in the middle of last year.

The financial crisis that began during the second half of 2015 is picking up speed over in Europe, and it isn’t just Deutsche Bank that could implode at any moment.  Credit Suisse is the most important bank in Switzerland, and they announced a fourth quarter loss of 5.8 billion dollars.  The stock price has fallen 34 percent year to date, and many are now raising questions about the continued viability of the bank.

Similar scenes are being repeated all over the continent.  On Monday we learned that Russia had just shut down two more major banks, and the collapse of Greek banks has pushed Greek stock prices to a 25 year low

Greek stocks tumbled on Monday to close nearly eight percent lower, with bank shares losing almost a quarter of their market value amid concerns over the future of government reforms.

The general index on the Athens stock exchange closed down 7.9 percent at 464.23 points — a 25-year-low — while banks suffered a 24.3-percent average drop.

This is what a financial crisis looks like.

Fortunately things are not this bad here in the U.S. quite yet, but we are on the exact same path that they are.

One of the big things that is fueling the banking crisis in Europe is the fact that the too big to fail banks over there have more than 100 billion dollars of exposure to energy sector loans.  This makes European banks even more sensitive to the price of oil than U.S. banks.  The following comes from CNBC

The four U.S. banks with the highest dollar amount of exposure to energy loans have a capital position 60 percent greater than European banks Deutsche Bank, UBS, Credit Suisse andHSBC, according to CLSA research using a measure called tangible common equity to tangible assets ratio. Or, as Mayo put it, “U.S. banks have more quality capital.”

Analysts at JPMorgan saw the energy loan crisis coming for Europe, and highlighted in early January where investors might get hit.

“[Standard Chartered] and [Deutsche Bank] would be the most sensitive banks to higher default rates in oil and gas,” the analysts wrote in their January report.

There is Deutsche Bank again.

It is funny how they keep coming up.

In the U.S., the collapse of the price of oil is pushing energy company after energy company into bankruptcy.  This has happened 42 times in North America since the beginning of last year so far, and rumors that Chesapeake Energy is heading that direction caused their stock price to plummet a staggering 33 percent on Monday

Energy stocks continue to tank, with Transocean (RIG) dropping 7% and Baker Hughes (BHI) down nearly 5%. But those losses pale in comparison with Chesapeake Energy (CHK), the energy giant that plummeted as much as 51% amid bankruptcy fears. Chesapeake denied it’s currently planning to file for bankruptcy, but its stock still closed down 33% on the day.

And let’s not forget about the ongoing bursting of the tech bubble that I wrote about yesterday.

On Monday the carnage continued, and this pushed the Nasdaq down to its lowest level in almost 18 months

Technology shares with lofty valuations, including those of midcap data analytics company Tableau Software Inc and Internet giant Facebook Inc, extended their losses on Monday following a gutting selloff in the previous session.

Shares of cloud services companies such as Splunk Inc and Salesforce.com Inc had also declined sharply on Friday. They fell again on Monday, dragging down the Nasdaq Composite index 2.4 percent to its lowest in nearly 1-1/2 years.

Those that read my articles regularly know that I have been warning this would happen.

All over the world we are witnessing a financial implosion.  As I write this article, the Japanese market has only been open less than an hour and it is already down 747 points.

The next great financial crisis is already here, and right now we are only in the early chapters.

Ultimately what we are facing is going to be far worse than the financial crisis of 2008/2009, and as a result of this great shaking the entire world is going to fundamentally change.

Monday, February 8, 2016

GLD:DUST--Ready for rest and consolidation

Such a stupendous rally needs a break--but don't worry, it's not over--not by a long shot.  GL

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XLY:XLP--Looks like a Bear Market

With discretionary spending down 17% against necessary spending, we don't have far to go.  GL

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$COMPQ--No bottom in sight

Though we are very oversold, there does not appear to be a bottom nearby.  This afternoon's rally attempt all be guarantees a continuation of downside.  Almost sold my TVIX today but held on--maybe tomorrow--because eventually there will be some kind of rally.  You can't suppress delusion forever.  GL

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Bank Weakness in Europe Scary

Global Geopolitics

All Politics is now Global

RSS

Why a selloff in European banks is ominous

Posted by aurelius77 on February 8, 2016

https://i1.wp.com/ei.marketwatch.com//Multimedia/2016/02/07/Photos/ZH/MW-EF025_euro_b_20160207131311_ZH.jpg

Dark clouds are gathering around Europe’s banking sector.

Europe’s bank index has posted its longest weekly string of losses since 2008

European banks have been caught in a perfect storm of market turmoil, lately.

“The current environment for European banks is very, very bad. Over a full business cycle, I think it’s very questionable whether banks on average are able to cover their cost of equity. And as a result that makes it an unattractive investment for long-term investors,” warned Peter Garnry, head of equity strategy at Saxo Bank.

The doom-and-gloom outlook for banks comes as the stock market has had an ominous start to the year.

East or west, investors ran for the exit in a market marred by panic over tumbling oil prices and signs of sluggishness in China. But for Europe’s banking sector, the new year has started even worse, sending the bank index down 23% year-to-date, compared with 13% for the broader Stoxx Europe 600 index.

So what happened? At the end of last year, banks were singled out as one of the most popular sectors for 2016 because of expected benefits from higher bond yields, rising inflation expectations and improved economic growth. That outlook, however, was before the one-two punch of plunging oil and a slowdown in China sapped investor confidence world-wide.

Garnry said the slump in bank shares is “a little bit odd” given the recent growth in the European economy and aggressive easing from the European Central Bank. Normally, banks benefit from measures such as quantitative easing, but it’s just not doing the trick in Europe.

“And its worrisome, because banks are much more important for the credit mechanism in the economy here in Europe than it is in the U.S. There, you have a capital market where it’s easier to issue corporate bonds and get funding outside the commercial banking system. We don’t have that to the same extent in Europe, and therefore [the current weakness] is a little bit scary,” he said.

Full article: Why a selloff in European banks is ominous (MarketWatch)

What? Even Greece

Global Geopolitics

All Politics is now Global

RSS

Greek stocks fall sharply on banking sector meltdown

Posted by aurelius77 on February 8, 2016

Athens (AFP) – Greek stocks tumbled on Monday to close nearly eight percent lower, with bank shares losing almost a quarter of their market value amid concerns over the future of government reforms.

The general index on the Athens stock exchange closed down 7.9 percent at 464.23 points —a 25-year-low — while banks suffered a 24.3-percent average drop.

Top companies such as the Public Power Corporation, the Piraeus Port Authority and prominent construction firms lost between four and and 12.5 percent.

The downturn came amid a general European stock market slump as investors cashed out of banking shares following recent poor earnings, with worries over China’s economy and falling oil prices also weighing on sentiment.

But in Greece investors had additional reasons to head for the exits, with the government seen to be facing an impossible choice between further austerity and social unrest.

The Athens stock exchange had already lost 9 percent of its value last week, with the banking index taking a beating with a drop of over 24 percent.

Full article: Greek stocks fall sharply on banking sector meltdown (Yahoo!)

Fear over European Banks Grows

Deutsche Bank at record low as fear over European banks grows

Feb 8 2016, 14:24 ET | About: Deutsche Bank AG (DB) | By: Carl Surran, SA News Editor

It is the European banks and contagion concerns that are freaking out the markets today - not just the Fed, China and crude oil - according to David Rosenberg, noting that some of the European banks are trading at 2008 crisis levels after the group has tumbled 18% YTD vs. 11% for the STOXX 600 index.

European financial firms are taking a beating amid fears of "a chronic profitability crisis that makes it impossible for banks to build up barely-adequate capital bases," WSJ reports.

Deutsche Bank (DB -9.8%) is down another ~10%, bringing its YTD loss to nearly 40% while its valuation has fallen to ~30% of book value, and its credit default swaps spiked to their highest levels since 2012.

News of major withdrawals out of Credit Suisse (CS -4.2%) caused its shares to sink 11% last week, hitting a 24-year low, and Santander (SAN -6.2%), BBVA (BBVA -5.4%), and UniCredit (OTCPK:UNCFF -5.5%) are down to lows seen during the last eurozone financial crisis.

"Oil and the flatter yield curve alone do not explain the 12% plunge we have seen in S&P Financials so far this year," Rosenberg says, adding that BofA (BAC-6.1%), Citigroup (C -6.2%) and Wells Fargo (WFC -3.5%) all briefly touched 52-week lows last week - "an ominous signpost."

Financial Meltdown Coming

Deutsche Bank is shaking to its foundations – is a new banking crisis around the corner?

Submitted by IWB, on February 6th, 2016

by Secular Investor

Deutsche Bank Image

The earnings season has started, and several major banks in the Eurozone have already reported on how they performed in the fourth quarter of 2015, and the entire financial year. Most results were quite boring, but unfortunately Deutsche Bank once again had some bad news.

Just one week before it wanted to release its financial results, it already issued a profit warning to the markets, and the company’s market capitalization has lost in excess of 5B EUR since the profit warning, on top of seeing an additional 18B EUR evaporate since last summer. Deutsche Bank is now trading at less than 50% of the share price it was trading at in July last year.

Deutsche Bank chart

Source: stockcharts.com

And no, the market isn’t wrong about this one. The shit is now really hitting the fan at Deutsche Bank after having to confess another multi-billion euro loss in 2015 on the back of some hefty litigation charges (which are expected to persist in the future). And to add to all the gloom and doom, even Deutsche Bank’s CEO said he didn’t really want to be there . Talk about being pessimistic!

Right after Germany’s largest bank (and one of the banks that are deemed too big to fail in the Eurozone system) surprised the market with these huge write-downs and high losses, the CDS spread  (‘Credit Default Swap’) started to increase quite sharply. Back in July of last year, when Deutsche Bank’s share price reached quite a high level, the cost to insure yourself reached a level of approximately 100, but as you can see in the next image, the CDS spread started to increase sharply since the beginning of this year. It reached a level of approximately 200  in just the past three weeks, indicating the market is becoming increasingly nervous about Deutsche’s chances to weather the current storm.

CDS Deutsche Bank

Source: Boursorama.com

Let’s now take a step back and explain why the problems at Deutsche Bank could have a huge negative impact on the world economy. Deutsche has a huge exposure to the derivatives market, and it’s impossible, and then we mean LITERALLY impossible for any government to bail out Deutsche Bank should things go terribly wrong. Keep in mind the exposure of Deutsche Bank to its derivatives portfolio is a stunning 55B EUR, which is almost 20 times (yes, twenty times) the GDP of Germany and roughly 5 times the GDP of the entire Eurozone! And to put things in perspective, the TOTAL government debt of the US government is less than 1/3rd of Deutsche Bank’s exposure.

Oops.

Indeed, oops. And the worst part of all of this, is the fact the problems at Deutsche Bank are slowly penetrating the other major financial institutions. Have a look at the CDS spread of Banco Santander (from 109 in December to 170 now).

CDS Banco Santander Deutsche Bank

Source: ibidem

And Intesa Sanpaolo? From 82 in November to 147 right now.

CDS Intesa Deutsche Bank

Source: Ibidem

Something is rumbling in Europe’s intestines, and Deutsche Bank is leading the pack towards another huge financial crisis. The CDS spreads of literally ALL major European banks have posted huge changes in the past 3-4 weeks, and if you throw in the most recent messages from Citibank, stating the world economy is trapped in a death spiral, you might want to think about protecting yourself against yet another financial meltdown.

Go FED—from Hussman

When Stocks Crash And Easy Money Doesn't Help

Feb. 8, 2016 8:39 AM ET

John Hussman

John Hussman

Despite short-term interest rates being only a whisper above zero, we increasingly hear assertions that “financial conditions have tightened.” Now, understand that the reason they’ve “tightened” is that low-grade borrowers were able to issue a mountain of sketchy debt to yield-seeking speculators in recent years, encouraged by the Federal Reserve’s deranged program of quantitative easing, and that debt is beginning to be recognized as such. As default risk emerges and investors become more risk-averse, low-grade credit has weakened markedly. The correct conclusion to draw is that the consequences of misguided policies are predictably coming home to roost. But in the labyrinth of theoretically appealing but factually baseless notions that fill the minds of contemporary central bankers, the immediate temptation is to consider a return to the same misguided policies that got us here in the first place, just more aggressively.

Credit default swaps continued to soar last week, particularly among European banks. Given that risks surrounding China and the energy sector are widely discussed, European banks continue to have my vote for “most likely crisis from left field.”

With regard to the stock market, I suspect that the first event in the completion of the current market cycle may be a vertical loss that would put the S&P 500 in the mid-1500’s in short order. That area is a widely-recognized “role-reversal” support level matching the 2000 and 2007 market peaks, and would at least bring our estimates of prospective 10-year S&P 500 nominal total returns to about 5%, which seems a reasonable place for value-conscious investors to halt the initial leg down. I’ve often noted the historical signature of market crashes: a sustained period of overvalued, overbought, overbullish conditions that is then coupled with a clear deterioration in market internals and hostile yield trends, particularly in the form of widening credit spreads. See my comments from the 2000 and 2007 market peaks about the identical syndrome at those points. Historically, what we know as “crashes” have followed only after a compressed, initial market loss on the order of about 14%, a recovery that retraces 1/3 to 2/3 of the initial decline; and finally a break below that initial low. That threshold is currently best delineated by the 1800-1820 level on the S&P 500.

Emphatically, I would reel back the urgency of all of these concerns if market internals were to improve materially. When investors are risk-seeking, they tend to be indiscriminate about it. So favorable market internals, as discussed below, are indicative of risk-seeking preferences among investors. Understand now that given any set of conditions (e.g. valuations, leading economic data, Fed action), the markets and the economy respond differently to those conditions depending on whether people are inclined toward risk-seeking or instead risk-aversion. In a risk-seeking environment, investors incorrectly “learn” that historically reliable valuation measures are worthless, that every dip is a buying opportunity, that economic deterioration can be ignored, and that Fed easing always makes stocks go up. In an environment of risk-aversion, all of that incorrect “learning” is punished with a vengeance.

In the fixed income market, we wouldn’t touch low-grade credit at present. Once credit spreads widen sharply, the default cycle tends to kick in several quarters later. The present situation is much like what we observed in early 2008, when we argued that it was impossible for financial companies to simply “come clean” about bad debts, because then as now, the bulk of the defaults were still to come (see How Canst Thou Know Thy Counterparty When Thou Knowest Not Thine Self?).

As economic conditions have weakened, Treasury debt has been a safe-haven. Last week, the 10-year Treasury yield dropped to about 1.8%. My view is that a U.S. recession remains likely (see From Risk to Guarded Expectation of Recession and An Imminent Likelihood of Recession). Coupled with widening credit spreads, that supports the expectation for even lower yields. But as yields become compressed, Treasuries bonds often become vulnerable to short-term yield spikes that can easily wipe out a year or two of prospective income in a few days. For that reason, our view on bonds remains constructive but not aggressive, and our inclination would be to reduce duration exposure as yields fall and extend it in the event of those spikes.

That brings us to precious metals. As I noted in the 1990’s, the strongest performance from gold stocks is generally associated with periods when 1) the year-over-year CPI inflation rate is higher than 6 months earlier; 2) Treasury yields are lower than 6 months earlier; 3) the ratio of spot gold to the XAU is greater than 4.0, and; 4) the ISM Purchasing Managers Index is below 50. All of those conditions have been present for the past couple of months, and gold stocks have staged a slightly delayed spike higher.

That said, I should also note that in recent years, precious metals shares have periodically been hit hard despite the presence of three or all four of these conditions. The reason, I think, has been the recurring specter of global deflation. A useful way to pick up that risk is to be somewhat more cautious on this sector if the U.S. dollar index and credit spreads are both rising while inflation is still below about 2%. Unlike 2008 when the dollar started at a somewhat undervalued level on the basis of our joint-parity estimates, the U.S. dollar has already been steeply bid up as a result of continuing QE in Europe and Japan. With the dollar treading water at these heights, and the rate of inflation hovering close to 2%, we don’t observe a clear deflationary signal that might otherwise be a warning on gold. Overall, conditions support a positive outlook for precious metals shares, but we’d hesitate to be too aggressive in the absence of higher inflation or a retreat in the value of the U.S. dollar.

Wu-Xia and the shadow rate

In addition to observing widening credit spreads and other signs of increasing financial stress, we’re hearing assertions that the Federal Reserve made a “policy error” by raising rates in December. A historically-informed perspective is useful here, lest one mistakenly draws the impression that untethered monetary easing is the cure rather than the disease. The fact is that the benefits of years of quantitative easing, as well as the potential costs of the December rate hike, both pale in comparison to the damage that the Fed has effectively baked in the cake through years of financial distortion. As I noted last month in Deja Vu: The Fed’s Real Policy Error Was To Encourage Years of Speculation:

“Based on a broad range of economic factors, our economic outlook has shifted to a guarded expectation of recession. Now, if there was historical evidence to demonstrate that activist Fed policy had a significant and reliable impact on the real economy, and didn’t result in ultimately violent side-effects, we would argue that a Fed hike here and now might be a ‘policy error.’ In reality, however, decades of economic evidence demonstrate that activist monetary interventions (e.g. deviations from straightforward rules of thumb like the Taylor Rule) have unreliable, weak, and lagging effects on the real economy.

“Moreover, as we should have learned from the global financial crisis, when the Fed holds interest rates down for so long that investors begin reaching for yield by speculating in the financial markets and making low-quality loans, the entire financial system becomes dangerously prone to future crises. The fact is that a quarter-point hike comes too late to avert the consequences of years of speculation, and while the hike itself will have little economic effect, the timing is ironic because a recession is already likely. The main effect of a rate hike will be to add volatility to an already speculative and now increasingly risk-averse market. The Fed’s real policy error, as it was during the housing bubble, was to hold interest rates so low for so long in the first place, encouraging years of yield-seeking speculation and malinvestment by doing so.”

Though central bankers and talking heads on television speak about monetary policy as if it has a large and predictable impact on the real economy, decades of evidence underscore a weak and unreliable cause-and-effect relationship between the policy tools of the Fed and the targets (inflation, unemployment) that the Fed hopes to affect. One of the difficulties in evaluating the impact of monetary policy in recent years is that one can’t observe the relative aggressiveness of monetary policy using interest rates, once they hit zero. On that front, economists Cynthia Wu and Fan Dora Xia recently described a clever method to infer a “shadow” federal funds rate based on observable variables (see this University of Chicago article for a good discussion, and the original paper if you’re one of the five geeks who enjoy Kalman filtering, principal components analysis, and vector autoregression as much as I do).

The chart below shows the Wu-Xia shadow rate versus the actual federal funds rate.

Notably, the Fed doesn’t actually “control” the shadow rate directly, as it does when the Fed Funds rate is above zero. Rather, the shadow rate is statistically inferred using factors such as industrial production, the consumer price index, capacity utilization, the unemployment rate, housing starts, as well as forward interest rates and previously inferred shadow rates.

While it’s very useful to have an estimate of what the “effective” Fed Funds rate might look like at any point in time, be careful not to misinterpret what the shadow rate measures. Again, once interest rates hit zero, the Wu-Xia shadow rate stops being a measure of something that is directly controlled by the Fed. Rather, it measures the possibly negative “shadow” interest rate that would be consistent with the behavior of other observable economic variables. Like the rate of inflation, it’s not at all clear that the Fed can actively manage a negative shadow federal funds rate in a reliably predictable way.

In any event, what’s striking from Wu and Xia’s paper is how feeble the estimated impact of QE has been on the real economy. Using vector autoregressions to estimate the trajectory of the economy under various monetary policy assumptions, Wu and Xia observe: “In the absence of expansionary monetary policy, in December 2013, the unemployment rate would be 0.13% higher... the industrial production index would have been 101.0 rather than 101.8... housing starts would be 11,000 lower (988,000 vs. 999,000).” Notably, the Wu-Xia plots of observed and counterfactual economic variables show the same result that we find in our own work: most of the progressive improvement in industrial production, capacity utilization, unemployment, and other economic variables since 2009 would have emergedregardless of activist Fed policy (see Extremes in Every Pendulum). We estimate that this also holds for the improvement in these variables since Wu and Xia's paper was published.

Put simply, the Federal Reserve has created the third speculative bubble in 15 years in return for real economic improvements that amount to literally a fraction of 1% from where we would otherwise have been.

It’s slightly amusing to hear alarm from some corners that the Wu-Xia rate has increased toward zero - as if the impact of this “tightening” on the real economy is something to be feared. That fear might be valid if there was a strong effect size linking changes in the shadow rate to changes in the real economy. But as Wu and Xia’s own work demonstrates, there is not. The entire global economy seems condemned to repeatedly suffer from deranged central bankers that wholly disregard the weak effect size of monetary policy on policy targets like employment and inflation, and equally disregard their responsibility for the disruptive economic collapses that have followed on the heels of Fed-induced yield-seeking speculation.

In short, what we should fear is not the slight impact of recent policy normalizations, but the violent, delayed, yet inevitable consequences of years of speculative distortions that are already fully baked in the cake. What we should fear are the Fed’s repeated and deranged attempts to achieve weak effects on the real economy, at the cost of speculative distortions that exact ten times the damage when they unwind. What we should fear is more of the same Fed recklessness that encouraged a yield-seeking bubble in mortgage debt, enabling a housing bubble that collapsed to create the worst economic crisis since the Great Depression. What we should fear is Fed policy that has encouraged a yield-seeking bubble in equities, debt-financed stock repurchases, and covenant-lite junk debt; that has carried capitalization-weighted valuations to the second greatest extreme in history other than the 2000 peak, and median equity valuations to the highest level ever recorded. That’s exactly what the Fed has done in recent years, and the cost of that unwinding is still ahead.

When stocks crash and easy money doesn’t help

One of the central themes that I’ve emphasized over time is how dependent various investment outcomes are on the condition of market internals, measured across a broad range of individual stocks, industries, sectors, and security types, including debt securities of varying creditworthiness. We’re often asked which “indicator” we use to gauge market internals, but to ask about a single indicator is to miss the concept. The best way to draw information from noisy data is to extract a joint signal from multiple sensors.In the financial markets, this involves the consideration of breadth, leadership, participation, correlation, dispersion, spread behavior, divergence, and other characteristics that can be measured from the co-movement of thousands of securities. Still, the central concept is very simple: when investors are inclined to embrace risk, they tend to be indiscriminate about it, so uniformity of market internals is the most historically reliable measure of risk-seeking we’ve identified.

When market internals are favorable, overvalued markets tend to be relatively stable, and are inclined to become even more overvalued. It’s when internals deteriorate that overvaluation finally exerts itself in collapsing prices.

When market internals are favorable, weak leading economic data is often reversed over the following months. Once internals deteriorate, weak leading economic data is almost always associated with recession.

Likewise, when market internals are favorable, monetary easing reliably supports speculation (see All Their Eggs In Janet’s Basket). In contrast, once a steeply overvalued market is joined by unfavorable market internals, even persistent and aggressive Fed easing is associated with market losses, on average. Investors should remember this from the 2000-2002 and 2007-2009 collapses, but somehow the simplistic idea that “Fed easing makes stocks go up” is too ingrained to consider the actual evidence.

Some of the most widely circulated charts in recent years showed two diagonal lines, one being the size of the Federal Reserve’s balance sheet, and the other being the level of the S&P 500. These charts were usually coupled with the observation that since 2009, the correlation between the two has been about 97%. The problem with such amateur statistics is that any two diagonal lines will always be nearly perfectly correlated, simply by virtue of how correlation is calculated. For example, the Fed’s balance sheet also has a 97% correlation with the price of beer in Iceland, and a 98% correlation with the number of internet users in Tuvalu, all the way to the beginning of that data in the 1990’s.

See, correlation is calculated by examining how far two variables are from their respective averages. If X is well above its average when Y is above its average, and X is below its average when Y is below its average, then you’ll get a very high correlation. But this will always be true when X and Y have diagonal trends, so that both start well below the average level and end well above the average level. Correlation is only an interesting statistic if it holds up across several cycles of fluctuation; when changes in one variable are clearly associated with changes in the other variable, regardless of the direction of change.

When we examine the data from that perspective, we observe something that many investors apparently fail to appreciate: increases in the Fed’s balance sheet have only been positively associated with increases in the S&P 500, on average, when the S&P 500 was already in an uptrend and investors werealready inclined to speculate.

There is a reason for this. Every dollar of monetary base created by the Federal Reserve has to be held by someone until it is retired. When investors are inclined to speculate, so that the allure of a higher return outweighs concerns about a capital loss, safe, low-interest liquidity is seen as an inferiorasset. Holders are inclined to pass it off to someone else in return for a riskier security. The seller, who gets the cash, then tries to pass that hot potato on to yet someone else. In contrast, when investors become risk-averse, safe, low-interest liquidity is a desirable asset, because concerns about potentially deep capital losses on risky securities outweigh the discomfort of earning a low yield on safe ones.

That’s not to rule out the possibility that central bank easing might, accompanied by other factors, encourage a shift from risk-averse to risk-seeking behavior. In March 2009, that “other factor” was the change in FASB accounting rules that abandoned mark-to-market accounting, allowed banks “significant judgment” in valuing their bad assets, and removed the specter of widespread bank defaults. Still, on average, Fed easing doesn’t help stocks when market internals are unfavorable. Don’t think for a second that it was Fed easing alone that sent stocks higher in 2009. The Fed was aggressively easing through the entire collapse, as it was during the tech collapse and the Great Depression.

The following charts offer some visual perspective on this point. While we get stronger results using our own broad measures of internals, I chose to measure market action here using only the position of the S&P 500 versus its 200-day average, so that others can easily replicate these results if they wish. The first chart shows the scenario that investors seem to carry in their minds about recent years. Since mid-2008, when the S&P 500 has been above its 200-day moving average at the beginning of any 3-month period, quarterly changes in the monetary base have been positively related, on average, to changes in the S&P 500. It’s not a tight relationship by any means (R-squared of 0.0867 means that quarterly changes in the monetary base explain only 8.67% of the quarterly variation in returns, and implies a correlation of just 0.29), but at least the relationship is positive.

In contrast, the next chart shows the relationship between the monetary base and the S&P 500 since mid-2008 in 3-month periods when the S&P 500 wasbelow its 200-day average at the beginning of the period. The relationship is steeply negative and explains 43% of the variation in returns (correlation -0.66). Put simply, the faster the S&P 500 fell, the more the Fed eased. Conversely, the more the Fed eased, the faster the S&P 500 fell.

The direction of causality isn’t clear. While steep market losses can certainly panic the Fed into massive but futile attempts to ease monetary policy, it’s not implausible that Fed easing could also accelerate losses in a declining stock market. Fed easing is accomplished by buying up Treasury securities, and paying for them by creating currency and bank reserves. When stocks plunge in a weakening economy with low inflation, bonds typically advance in price, which creates a particularly useful kind of diversification. By removing those bonds from circulation, Fed easing in that environment actually increases the aggregate risk profile of private investor portfolios, which could provoke even greater selling pressure. In any case, Fed easing doesn’t help stocks in an environment where investors are risk-averse. The same result holds in market cycles across history.

Interestingly, when we examine the change in the monetary base in one quarter versus the change in the S&P 500 the following quarter, the relationship is actually negative regardless of whether the S&P 500 was rising or falling at the start of the quarter, but it’s a much stronger negative relationship if the S&P 500 was already in a downtrend.

To summarize all of this, Fed easing certainly deserves the principal blame for both the housing bubble and the recent QE bubble. But the story is more nuanced than the popular belief that Fed easing somehow just makes stocks go up. Investors should recognize the pattern of activity that produced those bubbles.

Specifically, in periods when investors were already inclined to speculate, as indicated by favorable market action as of the beginning of the period, Fed easing was associated with concurrent gains in stocks. The magnitude of the easing wasn’t tightly related to the magnitude of the gains, but the impact on stocks was clearly positive, on average. That said, because the Fed encouraged speculation at rich valuations, more aggressive easing in one quarter tended to be associated with consolidation the next, unless the Fed maintained its aggressiveness.

In contrast, in periods where investors had shifted to risk-aversion, as indicated by unfavorable or divergent market internals at the beginning of the period, the magnitude of Fed easing was significantly correlated with the magnitude of market losses. That is, Fed easing not only failed to help stocks, but actually mirrored the steepness of the collapse. If the Fed had eased aggressively in the preceding quarter, but market internals were still unfavorable at the end of that quarter, stocks typically lost additional ground over the following 3-month period.

During the period from 2009 to 2014, it was precisely the untethered, deranged monetary aggressiveness of a dogmatic Ben Bernanke that allowed the market to persistently advance, despite the repeated emergence of extreme overvalued, overbought, overbullish syndromes that had reliably been followed by market losses in prior cycles across history. Our main challenge in this period was that we responded directly to those overvalued, overbought, overbullish syndromes, as the historical record had encouraged. But in the face of yield-seeking speculation supported by QE, one had to wait until market internals deteriorated explicitly before taking a hard-negative outlook on stocks. We had to make adaptations on that front, and I incorporated that restriction into our own work in mid-2014 (see A Better Lesson Than “This Time Is Different”). Since then, internals have deteriorated badly. Understand that the risk-seeking conditions that deferred downside consequences during most of the period from 2009 through mid-2014 are no longer present.

Again, as usual, I'll emphasize that the immediacy of our downside concerns would ease if market internals were to improve materially. We see exactly the opposite here. Recall that the main consideration driving my shift to a hard-negative outlook at both the 2000 and 2007 market peaks was an extended period of overvalued, overbought, overbullish conditions had been joined by deterioration in market internals. We moved to recession warnings in October 2000 and November 2007 as well. Every market cycle is different, but I simply don’t observe historically relevant differences that are likely to make the consequences of the recent bubble much less unpleasant than the other two.

My hope is that, by now, you've taken the opportunity to ensure that your investment exposures would allow you to tolerate a further 40-50% market retreat without abandoning your discipline (even if that discipline is a passive buy-and-hold strategy). A market loss in that range would be a fairly run-of-the-mill completion to the current cycle given recent valuation extremes. SeeRarefied Air: Valuations and Subsequent Market Returns if such losses seem preposterous to you. I suspect that it will shortly be too late to reduce market exposure at advantageous levels. I'm convinced that the completion of this market cycle will provide significant opportunities to build exposure at valuations that imply far stronger long-term return prospects.

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.

Delusions Bursting—sent by aaajoker

Dot-Com Bubble 2.0 Is Bursting: Tech Stocks Are Already Down Half A Trillion Dollars Since Mid-2015

By Michael Snyder, on February 7th, 2016

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Tech Bubble 2.0Do you remember how much stocks went down when the first dot-com bubble burst?  Well, it is happening again, and tech stocks are already down more than half a trillion dollars since the middle of 2015.  On Friday, the tech-heavy Nasdaq dropped to its lowest level in more than 15 months, and it has now fallen more than 16 percent from the peak of the market.  But of course some of the biggest names have fallen much more than that.  Netflix is down 37 percent, Yahoo is down 39 percent, LinkedIn is down 60 percent, and Twitter is down more than 70 percent.  If you go back through my previous articles, you will find that I specifically warned about Twitter again and again.  Irrational financial bubbles like this always burst eventually, and many investors that got in at the very top are now losing extraordinary amounts of money.

On Friday, tech stocks got absolutely slammed as the bursting of dot-com bubble 2.0 accelerated once again.  The following is how CNBC summarized the carnage…

The Nasdaq composite fell 3.25 percent, as Apple and theiShares Nasdaq Biotechnology ETF (IBB) dropped 2.67 percent and 3.19 percent, respectively.

Also weighing on the index were Amazon and Facebook, which closed down 6.36 percent and 5.81 percent, respectively.

LinkedIn shares also tanked 43.63 percent after posting weak guidance on their quarterly results.

Overall, LinkedIn is now down a total of 60 percent from the peak of the market.  But they are far from the only ones that have already seen their bubble burst.

Many of the biggest names in the tech world have gotten mercilessly hammered over the past six months of so.  Just look at some of the famous brands that have already lost between 20 and 40 percent of their market caps…

Yahoo (YHOO) shares are off 39%, and Netflix (NFLX), the best-performing stock in the S&P 500 last year, is now off by37% from its 52-week high.

Likewise, Priceline.com (PCLN) is off 31% and eBay (EBAY),22%.

But there are other very big tech companies that have seen stock collapses that completely dwarf those numbers.  Here are some more absolutely stunning statistics from USA Today

Twitter and Groupon are the biggest dogs of this boom, both off70% from 52-week highs and well below their IPO prices.

FitBit shares have collapsed 70%, while Yelp’s valuation has shrunk by two-thirds.

Box, which has the distinction of posting quarterly net losses in excess of revenue, is down by half.

Match.com, the holding company for dating sites owned by parent Interactive Corp. that went public late last year, is down39% from its high.

When your stock loses 70 percent of its value, that is a complete and utter collapse.

In the past, I have specifically singled out Twitter, Yelp and LinkedIn as tech stocks that were irrationally priced.

Hopefully people listened to those warnings and got out while the getting was good.

At the top of this article, I mentioned that tech stocks have already fallen in value by more than 500 billion dollars.  The financial crisis that began in the middle of last year is now greatly accelerating, and Wall Street is starting to panic.

As stocks crash, many hedge funds are being absolutely pummeled.  The following are just a few of the high profile names that are experiencing massive losses right now

Some of the biggest names to get trounced include:

►Pershing Square Capital Management, the publicly traded investment vehicle of billionaire hedgie Bill Ackman, fell 11% last month following a 20% decline last year, data from the web site shows.

►Larry Robbins’ Glenview Capital, famous for picking stocks that could benefit from Obamacare, dropped 13.65% in January following a decline of 18% last year, according to data from HSBC’s Hedge Weekly report, a copy of which was obtained by USA TODAY.

►Marcato International, a well-known activist fund run by Ackman protege Mick McGuire, fell 12.1% last month following a 9% loss last year, according to HSBC.

When you lose more than 10 percent of your money in a single month, that is not good.

And if I am right, this is just the beginning of our troubles.

And of course I am far from the only one warning that big problems are on the horizon.  In fact, analysts at Citigroup just made international headlines by warning that the global economy was now trapped in a “death spiral”

Some analysts — including those at Citi — have turned bearish on the world economy this year, following an equity rout in January and weaker economic data out of China and the U.S.

The world appears to be trapped in a circular reference death spiral,” Citi strategists led by Jonathan Stubbs said in a report on Thursday.

Stronger U.S. dollar, weaker oil/commodity prices, weaker world trade/petrodollar liquidity, weaker EM (and global growth)… and repeat. Ad infinitum, this would lead to Oilmageddon, a ‘significant and synchronized’ global recession and a proper modern-day equity bear market.”

Signs of a significant economic downturn are all around us, and so many of the exact same patterns that played out during the last two stock market crashes are happening again, and yet most people continue to refuse to acknowledge what is taking place.

If you are waiting for this new dot-com bubble to crash, you can stop waiting, because it has already happened.

When your stock falls by 50, 60 or 70 percent, the game is already over.

But just like 2001 and 2008, many people out there will end up being paralyzed by indecision.  Once again the mainstream media is insisting that there is no reason for panic and that everything will be just fine, and once again millions upon millions of ordinary Americans will be wiped out as the financial markets implode.

This is now the third time this has happened since the turn of the century.

How clueless have we become?  The exact same thing keeps happening to us over and over and yet we still don’t get it.

Only this time around there isn’t going to be any sort of a “recovery” afterwards.

This is essentially our “third strike”, and the years ahead are going to be extremely bitter and painful for most people.

But if you want to believe that one of these politicians is going to come along and save America, you go ahead and keep on believing that.

Most people believe what they want to believe, and the capacity that many Americans have demonstrated for self-delusion is absolutely remarkable.

Sunday, February 7, 2016

Antidote to Stockman Shrill

Fabius Maximus website

David Stockman explains “Why The Bulls Will Get Slaughtered”

Summary: Americans are so often ignorant because we learn from clickbait, as seen in this exciting but misleading article by David Stockman about yesterday’s jobs. When we decide to get information from boring but reliable sources we will have taken a big step to again governing America.  {2nd of  2 posts today.}

clickbait

Clickbait rule #4: when you have nothing to say about new economic numbers, attack the seasonal adjustments.

From David Stockman today (bold in the original): “Why The Bulls Will Get Slaughtered“. Reposted, of course, at Zero Hedge. Opening…

Needless to say, none of that stink was detected by Steve Liesman and his band of Jobs Friday half-wits who bloviate on bubblevision after each release. This time the BLS report actually showed the US economy lost 2.989 million jobs between December and January. Yet Moody’s Keynesian pitchman, Mark Zandi described it as “perfect”

Yes, the BLS always uses a big seasonal adjustment (SA) in January — so that’s how they got the positive headline number. But the point is that the seasonal adjustment factor for the month is so huge that the resulting month-over-month delta is inherently just plain noise.

To wit, the seasonal adjustment factor for the month was 2.165 million. That means the headline jobs gain of 151k reported on Friday amounted to only 7% of the adjustment amount!

Any economist with a modicum of common sense would recognize that even a tiny change in the seasonal adjustment factor would mean a giant variance in the headline figure. So the January SA jobs number cannot possibly reveal any kind of trend whatsoever — good, bad or indifferent.

… Actually, it proves none of those things. For one thing, the January NSA (non-seasonally adjusted) job loss this year of just under 3 million was 173,000 bigger than last January — suggesting that things are getting worse, not better. In fact, this was the largest January job decline since the 3.69 million job loss in January 2009 during the very bottom months of the Great Recession.

This technically correct but misleading, a nice demonstration of how clickbait makes its readers dumber. Seasonal adjustments are large in volatile data like payrolls, difficult but necessary adjustments to the monthly numbers. Also, it is difficult to see the trend amidst the tiny monthly changes in the large US workforce.

There is an easy alternative to ranting: look at the percent changes in the non-seasonally adjusted year-over-year change (the population grows, so percent moves better show the comparable changes).  The graph shows a clear picture…

FRED-: January 2016 NonFarm Payroll NSA YoY % change

This matches most of the other data about the US economy: an acceleration of growth in 2014, an deceleration in 2015 — continuing in January. “Deceleration” meaning growth continues but at a slower rate, but still faster than during the first four years of the recovery.

Stockman goes on to make a great many other points, in a jumble. Some are valid. Yes, this is a weak recovery that has done little for most Americans. (But then America’s CEOs and politicians don’t work for us, so why should we expect more?) And he rails against the U3 definition of unemployment (Yes, there is no one magic number, which is why DoL provides six such measures).

The truth about economics is not exciting. It’s not supposed to be fun, just valuable information about our world. Stick to boring and reliable sources; find your entertainment in fiction — not the news.

This is a follow-up to Surprises in the January jobs report.
For More Information

Please like us on Facebook, follow us on Twitter. See my articles about the US economy here and at Seeking Alpha…

Friday, February 5, 2016

New Low—again—BDI

As BDI Drops Below 300, Bulk Firms' Paths Diverge

DianaFile image

By MarEx 2016-02-04 16:30:07

In trading Thursday, the benchmark Baltic Dry Index continued its fall with another record low at 298, its first value ever below three hundred points. Capesize and supramax day rates were down, while panamax vessels traded slightly higher. The worsening market is forcing an increased volume of vessel and enterprise sales, and, for well-positioned buyes, creating an opportunity to purchase at distressed-asset prices. 

In the latest sign of the trend, Norwegian owner Western Bulk has delayed payments to its creditors while seeking a reorganization, and has changed its name to Bulk Invest. Additionally, the firm announced that it has spun off subsidiary Western Bulk Chartering in a sale to investment firm Kistefos, the owner of 60 percent of Western Bulk, for a $16 million cash price, plus the transfer to Kistefos of an additional $30 million in outstanding bond obligations.

The firm announced an extraordinary general meeting for all shareholders to be held February 25 to finalize the deal and the name change.

Western Bulk CEO Jens Ismar admitted in the firm's 2015 annual report that management had misread the market, and that untimely expansion was now causing the firm significant losses, with negative cash flow in the range of five million dollars per month.

Separately, in a countercyclical move, Diana Shipping announced that it has entered an agreement to purchase three newer panamaxes from relatives of the firm's CEO, Simeon Palios, for a combined total of $40 million. The vessels, the Sunshine, Manzoni andInfinity 9, were all built by Jiangnan Shipyard, and all will be fully financed by the sellers' current creditors, with no cash outlay. Delivery is expected by the end of March 2016.

The president of Diana Shipping, Anastasios Margaronis, said that “not only has the Company been able to negotiate the purchase of these vessels at 'distressed' prices . . . but we believe that our strong balance sheet and attractive credit risk will enable us to . . . finance 100% of the purchase price that will be non-amortizing for two years.”

NYSE-listed Diana Shipping has been downgraded by many analysts in recent months to market perform or hold as the bulk sector tracks lower, but the firm may be better positioned than some rivals. Analysts Lion Square Investments suggest that it is a relatively conservative company with a strong balance sheet, little debt and reputable counterparties on its long-term charters, and well-placed to survive the market shakeout.

Consensual Hallucination

CCC-Rated Junk-Bond Yields hit 20%, Blow Past Lehman Moment, Consensual Hallucination Wanes….But There’s Still No Panic.

Submitted by IWB, on February 5th, 2016

Wolf Richter wolfstreet.com, www.amazon.com/author/wolfrichter

Late yesterday was a propitious moment. And today, when the index was updated, it became official: The average yield of junk bonds rated CCC or below, the bottom tier of the rating scale, hit 20%.

Yields soar when bonds get crushed. The last time the average yield of those bonds jumped to 20%, on September 30, 2008, all heck had already broken loose. Lehman Brothers had gone bankrupt 15 days earlier. Liquidity had dried up. Banks were lining up to be toppled. Panic was breaking out.

Today, there’s no panic.

Back during the remaining QE-glory days of early summer of 2014, during four days at the end of June, the average yield of these bonds dropped below 8%. That was the precise peak of the most incredible junk bond bubble the world has ever seen. The Fed’s “wealth-effect” strategy gets much of the credit.

The BofA Merrill Lynch US High Yield CCC or Below Index shows just how much the average yield has soared since June 2014:

US-Junk-Bonds-CCC=2011_2016-02-04

At the time, oil was still selling for over $100 a barrel, though the price of natural gas had been demolished years ago. Even over-indebted, junk-rated, cash-flow negative oil & gas drillers were able to borrow, no questions asked, at super low interest rates. Investors gobbled up fancy charts and diagrams of a perfect and ultimately illusory future. It never occurred to them that there were major risks, such as that the price destruction that had already hit US natural gas as a result of the fracking boom might also hit oil. The risk was there for all to see, along with numerous other risks that come with over-indebted, junk-rated, cash-flow negative companies.

It wasn’t just in oil and gas. Other companies did the same. There was a reason why these bonds were rated CCC or below, the riskiest category on the scale, before D for default.

These bonds have a significant risk of default, and if there’s a default, recovery can be low or nil. They weren’t high-grade corporate bonds. But investors didn’t feel like looking at it. They played along, closing their eyes, hoping for the best, and going for the 8% yield. These folks willingly did what the Fed had wanted them to do.

“Consensual Hallucination” we’ve come to call it – consensual because everyone eagerly smoked the same stuff. But this hallucination is waning. Investors are coming to. And now they’re vomiting up these bonds.

The last time CCC or below junk bonds had an average yield of 20% was June 29, 2009, as the Fed was dousing the market with QE, corporate bailout programs, and emergency loan facilities. Now the Fed has raised rates one notch and is flip-flopping about raising rates further.

And the day the average CCC yield hit 20% on the way up during the Financial Crisis was September 30, 2008. Lehman Brothers had filed for bankruptcy 15 days earlier. It was the largest bankruptcy in US history. Panic was cascading through Wall Street. Credit markets dried up. CEOs were begging for bailouts and emergency loans. Those times captured by the BofA Merrill Lynch US High Yield CCC or Below Index going back to 2008:

US-Junk-Bonds-CCC-2007_2016-02-04

But these days, there is no panic. There’s “no largest bankruptcy in US history.” Bankruptcies, now a daily drumbeat, are of digestible size. The S&P 500, the Dow, and the Nasdaq are down but haven’t crashed, though many individual stocks have gotten crushed, the IPO window has just about closed, and stocks in some other markets have crashed spectacularly. But here, on the surface, calm reigns.

Moody’s warned late Monday that its “Liquidity Stress Index,” which tracks the number of companies downgraded to the lowest liquidity rating (SGL-4), had jumped from 6.8% in December to 7.9% in January, the largest one-month jump since March 2009, and the highest level since December 2009.

Moody’s wasn’t kidding. Beneath that calm surface, over-indebted, junk-rated companies are running out of oxygen.

The index for oil & gas companies rose to 21.4% in January from 19.6% in December, but still below the 24.5% of its peak in March 2009.

It wasn’t just oil & gas. That meme no longer holds. Oil & gas is just way ahead. Without oil & gas, the index rose to 4.5%, up from 3.6% in December, and the highest since November 2010. Six of the ten downgrades to SGL-4 in January were for non-energy companies.

The companies in the index, which also often have a CCC or below credit rating, are facing one heck of a time borrowing new money, or even rolling over existing debt, given that for them, the cost of borrowing may approach or even exceed 20%.

These companies are essentially locked out from the capital markets. Their bonds trade at a fraction of face value. Their banks are getting nervous. They will have difficulties refinancing their maturing debts. Some of them – as is currently happening – might not even be able to make their interest payments. The increasing difficulties and costs in raising new cash will lead to many more defaults.

In short, these over-indebted, junk-rated, cash-flow negative companies are in their own Financial Crisis that is now metastasizing by the day. Only this time, no one is talking about bailouts. And this is what happens when risk, long repressed by the Fed, reappears in its unpleasant manner.

Thursday, February 4, 2016

Careening toward deflationary collapse

The War On Savers And The 200 Rulers Of World Finance

by David Stockman • February 4, 2016

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There has been an economic coup d’├ętat in America and most of the world. We are now ruled by about 200 unelected central bankers, monetary apparatchiks and their minions and megaphones on Wall Street and other financial centers.

Unlike Senator Joseph McCarthy, I actually do have a list of their names. They need to be exposed, denounced, ridiculed, rebuked and removed.

The first 30 includes Janet Yellen, William Dudley, the other governors of the Fed and its senior staff. The next 10 includes Jan Hatzius, chief economist of Goldman Sachs, and his counterparts at the other major Wall Street banking houses.

Then there is the dreadful Draghi and the 25-member governing council of the ECB and  still more senior staff. Ditto for the BOJ, BOE, Bank of Canada, Reserve Bank of Australia and even the People’s Printing Press of China. Also, throw in Christine Lagarde and the principals of the IMF and some scribblers at think tanks like Brookings. The names are all on Google!

Have you ever heard of Lael Brainard? She’s one of them at the Fed and very typical. That is, she’s never held an honest capitalist job in her life; she’s been a policy apparatchik at the Treasury, Brookings and the Fed ever since moving out of her college dorm room.

Now she’s doing her bit to prosecute the war on savers. She wants to keep them lashed to the zero bound—-that is, in penury and humiliation—–because of the madness happening to the Red Ponzi in China. Its potential repercussions, apparently, don’t sit so well with her:

Brainard expressed concern that stresses in emerging markets including China and slow growth in developed economies could spill over to the U.S.

“This translates into weaker exports, business investment, and manufacturing in the United States, slower progress on hitting the inflation target, and financial tightening through the exchange rate and rising risk spreads on financial assets,” she said, according to the Journal, which said she made the comments on Monday.

In the name of a crude Keynesian economic model that is an insult to even the slow-witted, Brainard and her ilk are conducting a rogue regime of financial repression, manipulation and unspeakable injustice that will destroy both political democracy and capitalist prosperity as we have known it. They are driving the economic lot of the planet into a black hole of deflation, mal-distribution and financial entropy.

The evil of it is vivified by an old man standing at any one of Starbucks’ 24,000 barista counters on any given morning. He can afford one cappuccino. He pays for it with the entire daily return from his savings account where he prudently stores his wealth.

After a working lifetime of thrift and frugality his certificates of deposit now total $250,000. Yes, the interest at 30 bps on a quarter million dollar nest egg buys a daily double shot of espresso and cup of milk foam.

What kind of crank economics contends that brutally punishing two of the great, historically-proven economic virtues——-thrift and prudence—-is the key to economic growth and true wealth creation?

In this age of relentless consumption and 140 character tweets, what kind of insult to common sense argues that human nature is prone to save too much, defer gratification too long, shop too sparingly and consume too little?

Forget all of their mathematical economics and DSGE model regressions. Our 200 unelected rulers are enthrall to a dogma of debt that is so primitive that it’s just plain dumb.

By purchasing existing debt with digital credit conjured from the “send” key on central bank computers, they make room for more and more of it. And they do so without the inconvenience of deferred consumption or an upward climb of interest rates owing to an imbalance of borrowings versus savings.

Likewise, by pegging the money market rate at zero or negative, they enable even more debt creation via daisy chains of re-hypothecation. That is, the hocking of any and all financial assets that trade at virtually zero cost of carry in order to buy more of the same and then to hock more of them, still.

The truth is, the world is up to its eyeballs in debt. Since the mid-1990s, the 200 rulers have ignited a veritable tsunami of credit expansion. Worldwide public and private debt combined is up from $40 trillion to $225 trillion or 5.5X; it has grown four times more than global GDP.

Whatever has caused the growth curve of the global economy to bend toward the flat-line, it surely is not the want of cheap debt. Likewise, the recurring financial crises of this century didn’t betray an outbreak of unprecedented human greed; they were rooted in theretofore unimagined excesses of leveraged speculation.

That’s what margined CDS wraps on the supersenior tranches of portfolios of CDOs squared was all about. That’s how it happened that upwards of 10% of disposable personal income in 2007 consisted of MEW ((mortgage equity withdrawal). It’s also how the US shale patch flushed $200 billion of junk debt down drill boreholes that required $50 per barrel oil to breakeven on the return trip.

Global Debt and GDP- 1994 and 2014

Likewise, you don’t need any fancy econometrics to read this chart, either. Since 1994 US debt outstanding is up by $45 trillion compared to a $11 trillion gain in GDP. If debt were the elixir, why has real final sales growth averaged just 1.0% per annum since Q4 2007—–a level barely one-third of the peak-to-peak rates of growth historically?

If the $10 trillion of US debt growth since the eve of the Great Recession was not enough to trigger “escape velocity”, just exactly how much more would have done the job?

Our 200 financial rulers have no answer to these questions for an absolutely obvious reason. To wit, they are monetary carpenters armed with only a hammer. Their continued rule depends upon pounding more and more debt into the economy because that’s all a central bank can do; it can only monetize existing financial claims and falsify the price of financial assets by driving interest rates to the zero bound or now, outrageously, through it.

But debt is done. We are long past the peak of it. After 84 months of ZIRP, Ms. Brainard’s call for “watchful waiting” at 25bps is downright sadistic.

Where does she, Janet and the rest of their posse get the right to confiscate the wealth of savers in their tens of millions? From the Humphrey-Hawkins Act and its dual mandate?

Puleese!. It’s a content-free enabling act etched on rubber bands; it memorializes Congress’ fond hope that the people enjoy an environment of price stability, fulsome employment and kindness to pets.

This elastic language hasn’t changed since 1978, meaning that it mandates nothing. In fact, it enabled both Paul Volcker’s 21% prime rate and Yellen’s 84 months of free money to the Wall Street casino with nary a legal quibble either way.

So what is at loose on the land is not public servants carrying out the law; its a posse of Keynesian ideologues carrying out a vendetta against savers; and doing so on the preposterous paint-by-the-numbers theory that when people save too much we get too little GDP, and when we don’t have enough GDP, we have too few jobs.

That’s essentially rubbish.  Jobs are a function of the price and supply of labor and the real level of business output, not the amount of nominal expenditure or GDP. And most certainly not that arbitrarily measured GDP clustered inside the open borders of the US of A, cris-crossed as they are by a monumental flow of global trade, capital and finance.

Likewise, “savings” fund the investment component of GDP today and the growth and productivity capacity of tomorrow, not a hoarder’s knapsack of bullion.

Besides, the claim that a nation experiencing 10,000 baby boom retirements per day has too little savings is not only ludicrous; its empirically wrong.

Household savings at the recession bottom in 2009 amounted to $670 billion according to the GDP accounts. In 2014 it was nearly $50 billion or 7% lower.

During that same five year “recovery” period, consumption expenditures for owner occupied housing rose by $150 billion or 12%, and personal spending for new autos increased by $400 billion or 58%.

So “savers” didn’t get in the way of spenders, nor do these figures prove that ZIRP had anything to do with it anyway.

The $1.35 trillion spending for owner-occupied rent shown below, for example, is not a real number in the first place. Its an “imputed” estimate pulled out of BEA’s nostrils based on a half-assed survey which asks a few thousand homeowners what they would rent their castle for if they were in the landlord business.

They don’t have a clue, of course. Nor does the 7.5% of GDP accounted for in this manner actually exist anywhere in the known universe outside of the BEA’s charts of accounts and the Keynesian DSGE models which simulate them.

And the same is true for personal savings. It’s a measure of nothing real on main street—– in part because 60% of US households have zero liquid savings beyond rounding error amounts. Actually, the “personal savings” account might better be designated as the Errors and Omissions account.

That’s because the above “savings” rate is a statistical residual that falls out when the $18 trillion +/- of spending side accounts are stacked up next to a nearly equivalent pile of income side accounts. As Jeff Snider documented the other day, the numbers in both stacks are revised so much that this 3.5% crack in the GDP wall amounts to little more than noise.

Likewise, ZIRP didn’t have much to do with the fact that auto lenders—especially the legions of subprime nonbank operations that have sprung up with junk bond financing——have been extending credit to anyone who can fog a rear view mirror. Indeed, since mid-2010 when the auto recovery incepted, auto credit outstanding is up by $350 billion or by nearly 90% of the $400 billion gain in auto sales.

Needless to say, virtually 100% debt financing of an auto sales boom is no more sustainable than was the MEW financing of household consumption last time around.  Like then, the pool of credit worthy borrowers has been depleted, meaning that it is only a matter if time before the debt fueled auto boom of recent years goes pear-shaped.

Even then, what will bring on this calamity is the inexorable collapse of the used car prices, not an end to “watchful waiting” on the money market rate.

At present upwards of 80% of all new car sales are either leased or loan financed. But the economics of leasing depend heavily on the “residual” or resale value of the vehicle; and loan financing late in the sales recovery cycle depends on the ability of the marginal buyer to generate enough trade-in value to qualify for a new loan–—-even at today’s 120% LTV ratios.

And that’s where the skunk in the woodpile is hiding. During the next 5 years a veritable tsunami of used vehicles will come off lease and loan and flood the used car market, thereby reversing the virtuous cycle of debt fueled new car sales that may well have peaked last fall.

Thus, in 2009 nearly 2.5 million vehicles came off lease, but by 2012 that number was down to 1.56 million owing to the 2007-2009 auto sales collapse. By contrast, an estimated 3.1 million vehicles will come of lease in 2016, 3.4 million in 2017 and upwards of 15 million in the next four years.

In short, ZIRP didn’t trigger the auto debtathon, even as it punished savers for 7 years running. What happened, instead, is that the Wall Street junk financed boom in auto lending fueled a run-up in used car prices, thereby temporarily goosing the loan/lease residuals upon which an increasing share of US households rent their rides between visits of the repo man.

Indeed, banging the interest rate lever hard on the zero bound for so long has now taken our 200 financial rulers into truly Orwellian precincts. In the quote reproduced above, and echoed by B-Dud, Goldman’s plenipotentiary at the New York Fed, it is claimed that “tightening credits spreads” are a reason to keep the policy rate unchanged. That is, the market is doing the Fed’s job voluntarily and preemptively!

No it isn’t. Credit spreads have been wantonly and dangerously compressed by massive central bank intrusion in the financial markets. Yet now that they are twitching with the ethers of normality, the monetary politburo takes that as a sign to keep their boot on the savers’ neck.

But shown below is the lunatic extent of their misfeasance in real time. From a cold start in 2015, the assembled central banks of the world have driven nearly $6 trillion of sovereign debt into the nether world of negative yields, and with each passing day it gets more absurd.

Now well-rated corporate debt like that of Nestle is passing through the zero bound and practically all of Japan’s 10-year or under maturities are there.

These fools think this is owing to just nonsense of Brainard’s blather about “stresses in emerging markets including China and slow growth in developed economies could spill over to the U.S…….This translates into weaker exports, business investment, and manufacturing in the United States, slower progress on hitting the inflation target……etc.”

The implication, of course, is that stalling world growth requires more central bank stimulus, and even a scramble toward NIRP by central banks which have not yet joined the loony toons brigade of the ECB, Sweden, Denmark,  Switzerland, and Japan.

Not even close. The amount of debt pouring into the negative yield basket is owing to speculators buying bonds on NIRP enabled repo. Their cost of carry is nothing, and the price of NIRP bonds keep on rising.

Until they don’t. Then look out below. The mother of all bubbles—-that of the $100 billion global bond market—-will then blow sky high.

At length, savers will get their relief and the 200 financial rulers will be lucky to merely end up in the stocks at a monetary version of the Hague.

Meanwhile, the War On Savers continues to transfer hundreds of billions from savers to the casino in the US alone—–even as the global economy careens towards deflationary collapse.