It Ain’t Over Until It’s Over

Markets are getting a chilly feeling down their spine these days.  Over-confident of humanity’s victory over the viral world, they are ridiculously over-extended to a degree never seen in history, when adjusted for risk. For share valuations to make any sense at all everything must go 100% right, and right away: COVID, inflation, geopolitical tensions, all must end, now!!

Professional money managers are always cautious under normal circumstances, carefully assessing the risk-reward balance. But they are not the ones driving the market now: it’s the very young, very clueless speculators who know nothing but momentum. And when upward momentum shifts, as it always does, what will happen? 

Pros will certainly not try to catch a falling knife, so no buying from there. Will the young and the clueless jump in? Some will see a drop as a buying opportunity and jump in - this is exactly what has been happening in the last 3-6 months, with varying degrees of success:  Equities were ok, but cryptos not.

I see cryptos as the leading indicator of market mania, the canary in the mine. And the canary is very much in trouble, if not quite dead - yet.

And The Oscar Goes To…

 I’m willing to bet that when the dust settles the Oscar for worst performance in history as Fed Chairman will go to Mr. Jerome Powell.  One picture (snicker) tells the whole story…

 Consumer core inflation has just reached 4.5% year over year - the highest level in 30 years - while Fed Funds are stuck at 0.05% AND the Fed continues to pump some $120 billion in freshly printed dollars every month.

But, hey, it will all go away soon. Won’t it?

China Loosens, Why?

 In a surprise move, China reversed its recent monetary policy-tightening and is now geared towards loosening.  What do they know?  Apparently, a lot.  Their economic recovery is not as steep as they liked, yes, but my guess is that they see the Delta variant as a real game changer for the global economy.

The UK is in the midst of a sharp upturn in cases and so are various other European countries. Should Delta make its way to China (it will, its only a matter of time) things could turn really challenging.  And when it really hits the under-vaccinated and way overconfident US… well…. It could be ugly.

In other news, I’m on vacation mode so expect fewer and shorter posts. Later….

A Must Read By Roubini

 By far the most cogent and well reasoned analysis of the current quandary, plus a scary prediction for stagflation leading to global depression. I hasten to add that Nouriel Roubini was 100% accurate about the Debt/Asset Bubble crash of 2006-08 (I was in good company 😜).

https://www.project-syndicate.org/commentary/stagflation-debt-crisis-2020s-by-nouriel-roubini-2021-06

Herd Immunity And Vaccines - A Useful Chart

 With new variants popping up and various vaccines being administered around the world, the following chart is quite interesting. I won’t comment further, for explanation read the note at the bottom of the chart.

Some Historical Perspective

 One chart… SP500 in log scale, annotated with four seminal tops and crashes in the last 40 years.

The current run is by far the longest and has an unprecedented climactic extension, as trillion$$ have been pouring in - an unintended (?) effect of pandemic cash.

The recovery from the debt crisis took huge, coordinated cash injections from most all central banks, which continued for years and fueled markets with negative real interest rates.  Until the pandemic hit and central banks made the previous cash torrent look like a drip.  Predictably, but definitely not necessarily, markets have gone - literally - ballistic.

Valuations of everything, from lumber to junk bonds, have become manic.  It remains to be seen how central banks react to the next crash… print even more?

Dying Brea(d)th

 The US stock market is making new highs, but if you look closely it is doing so with diminishing breadth.  The number of new highs minus new lows is very weak, meaning that new highs are achieved through fewer and fewer index heavy stocks. For the benchmark S&P 500, yesterday there were only 36 more highs than new lows - chart below.

Interestingly, it looks to me that one of the major “culprits” in shaping (window-dressing?) the capitalization-weighted S&P is Tesla, which is now #8 on the list and accounts for 1.45% of  its total performance.  In days when top shares like Apple and Amazon are down or flat, in comes Tesla charging with 4-6% gains and, voila, new highs.  I’ve been noticing such shenanigans for weeks now.

For example, #1 Apple, which accounts for 6% of the index, has been just oscillating around its 90 day moving average for almost a year now.

Same thing is going on in Amazon, #3 on S&P accounting for 4.2% of the index.  Going nowhere for 12 months, also just oscillating around its 90 day moving average.

Notice how daily trading volume has also subsided for both.

But Tesla? It is sitting right at its 90 day moving average after a previous massive 350% 12 month rally. 

Conclusion? This market is getting very narrow (fewer new highs) and thinning out (lower volume).  Both are signs of internal weakness, no matter what the index headline is doing.

PS As of yesterday the top 10 companies in S&P 500 accounted for 28% of the index value. That’s 2% of the companies… talk about a narrow market 😱

Yield Curve Gazing

Today,  a chart comparing the Treasury yield curve changes in just the last 21 days (chart below).

The curve has flattened out, seemingly only a bit, pivoting at exactly the "belly" point of just under 6 years which, by the way, is the average maturity of the entire US federal debt. 

However, the linear scale of the Y axis above does not show the real magnitude of the change - so here's the same chart in log scale.

We can immediately grasp the significant rise in short term interest rates in the money market end of the yield curve,i.e. exactly where the "real" economy operates (trade financing, letters of credit, etc), and where financial markets get almost 100% of their day to day funding for their securities' inventory.  Those costs just jumped by 5-8 basis points.  I know it doesn't seem like a lot but, in fact, it is significant.

Here's an example: a broker/dealer in Treasurys, MBS, or corporates will almost always "carry" his inventory, also known as his "book", by borrowing in the money market, usually overnight (or tom-next to account for settlement dates).

So, the dealer is carrying a book that yields, say, an average 1.0% and until last week it was being financed at 0.01%, for a net profit of 0.99%.  As of today, this cost has jumped to at least 0.06%, for a net of 0.94%, i.e. a 0.05% rise in his/her carry cost has resulted in a profit decline of 5.05%. And that's on a gross basis; when you look at the result on a dealer's equity capital return the effect could be much greater, depending on his book's leverage. Given that dealers routinely employ 10x and often 20x leverage, the negative effect on his firm's equity bottom line could be painful. 

That's a pretty simplistic example, of course. Dealers employ all sorts of hedging strategies to protect from market risk, to an extend. All of those strategies, however, come at a cost which reduces gross return, so no matter how you slice it a funding cost increase will always lead to lower carry profits, all other things being equal.

Savvy professionals keep a hawk eye on two markets, in that order: (a) the money market (ie interest rates and liquidity for up to maximum 1 year) and (b) the note/bond market.  

No matter what Mr. Powell says, therefore, what REALLY matters is what he does, observed and understood not by the hoi polloi, but only by the "worker bees" in the front lines.

Lest We Forget, Oh Debt!

 This blog was started in order to record the huge amounts of debt being created in the US and many other countries back in the mid to late 2000s.  In turn, this debt fueled a massive bubble in real estate and other financial assets which rather quickly resulted in a crash.  

The world hasn’t been the same since, as central banks and governments intervened in unprecedented fashion to save banks, investors/speculators and the wider economy. Even some PIGS were “saved”, some more than others (Greece was disgracefully forced to default on its debt and went into a state of prolonged penury which persists to this day).

So, central banks are now anointed  Salvator Economia, no longer limited to safeguarding monetary probity.  Instead, they have usurped the role of elected politicians, wielding enormous fiscal power via the printing press.  Think of this alone: each month the Fed increases debt, mostly federal, by $120 billion. That’s $1.44 trillion of added debt per year - and Congress does not even get to vote on it! Inflation, the stability of the dollar? Congress, ie the voting public, is not consulted in the least. Just a dozen or so unelected bankers decide on what is the largest ever addition to the people’s debt burden in History.

And this is happening all over the world, not just the US (China is more circumspect, very pointedly).  Global debt has now spiked to $285 trillion, or 355% of global GDP - chart below.  A lot of this burden on the “real” economy  has been added in just one year, during 2020 (red line)  - and it keeps growing at a record pace in 2021, too.  That’s the very definition of Sudden Debt.

Governments and central banks are furiously trying to throw the wool over peoples’ eyes by claiming there is nothing to worry about - just as “analysts” did  back in 2006-07.  Only this time the burden is even  greater and asset valuations even more extreme and delusional in nature (cryptos, meme stocks, NFTs).

All the while, the chorus of serious financiers warning of impending trouble keeps getting bigger (Mr Bury of Big Short fame just warned of “country-sized” losses), but no one with the authority to do something seems to be listening.

To paraphrase Kipling, “lest we forget, Oh debt” (from his poem aptly called Recessional). In this case it may end up as Deeply Depressional, I’m afraid.

PS Wink to AKOC and his poetic references 😄

The Case For An Immediate Taper

 The Fed is buying $120 billion in Treasurys, MBS etc debt every month, ie it is monetizing (printing) about that much monthly, ballooning its balance sheet by the same amount. The Fed’s reasoning is that the economy is still not healthy enough, yet it is obvious to anyone who can fog a mirror that the main result is a manic bubble in everything from stocks and real estate all the way to NFTs.

Naturally, everyone is trying to guess when the punch bowl will be removed, even partly, aka taper the purchase program.  I strongly believe that the Fed should do so right away, and here are two related charts to support my opinion.

In the first chart we see that the Treasury’s account at the Fed (basically, the governments “wallet”) has been emptying fast as the money it “printed” is sent to just about every American - helicopter money.  The decline is approx. $900 billion.  That money immediately finds its way into the money market as bank deposits and money market fund assets. But, banks and funds can’t find enough actual demand for loans/securities, at least not enough that meets their credit criteria.

So, what do they do with the flood of money? They give it back to the Fed as an overnight reverse repo at 0.05% (just raised from 0%). This amount just hit yet another record today at $765 billion, second chart. 

By accepting all this enormous amount of cash, the Fed is tacitly admitting that its  QE is no longer needed since the $765 billion is 6.5 months worth of QE that can’t find any use in the real economy. And there is more cash coming from the Treasury too, as it continues to draw down its account. It's a mess created by the Fed and the Treasury and it needs to be dealt with, right away. 

Think of all this cash as a lake of highly combustible fuel.  We already see the flames of nearby fires (commodity, transport and asset inflation)... how long before it reaches the lake and sets consumer inflation raging?

My bet/hope is that the Fed is looking at all this money coming right back at it and is wondering… ummmm, do I still need to print so much of the stuff? What’s the use?

Someone is throwing around taper dates and numbers at the Fed, for sure. Soon, too, I hope.