Payrolls In The US

 The Bureau of Labor Statistics announced its loooong awaited non-farm payroll numbers today, delayed due to the government shutdown.  Here is the most relevant chart:

My observation: looking at the 3- month numbers (most relevant because of the long shutdown), it's all about (a) the loss of government jobs and (b) the gain in just one category, private education and health services.  Bottom line: jobs are significantly stronger than the headline number where it really matters, the private sector.

The Fed will be looking very carefully at this, I'm sure.

High Prices For US Stocks

Something has been bugging me for several weeks now: prices for US listed stocks are very high.  I mean absolute prices, not valuations based on P/E, P/B, etc. For example, yesterday's price of a single Tesla share was $475, likewise for Microsoft, also at $475, Meta was $647, etc.  Doing a bit of quick research, the median price for S&P 500 stocks recently was approx. $120 and for NASDAQ 100 it was $245.

By comparison, a study by the Fed showed that in 2000 the equivalent median prices were $29 and $25.

Does this mean anything practically? Yes, and no.  No, because it is the total market cap that really matters.  And yes, because the higher they fly the longer the way down.  Meaning, the absolute losses for a shareholder are now potentially significantly bigger.

Was there a similar past occurrence in US markets? Yes, in 1929: for example, the price of RCA (aka "radio") was around $550 in September 1929.  It ended up at $15 in 1932.

I don't mean anything by the above, it's just a weird observation.

Bank Required Reserves For US Banks? Zero

 A kind reader (thanks AKOC) asked what are the required reserves for US banks - ie deposits at the Fed or currency in their vaults.  As of 2020 the answer is..zero.

Here is a helpful chart.

So, why zero?  Because except for macroprudential reasons, holding reserves doesn't truly provide any benefit.  Instead, banks must conform to a Liquidity Coverage Ratio - to hold high quality liquid reserves assets (HQLR) in amounts that allow them to pass liquidity stress tests.  Such assets are short term TBills and reverse repos, etc.  If you want more info on what are considered HQLR assets, see here.

So, even though "reserves" as such are no longer required it doesn't mean that banks can operate at full-risk-tilt.

 

Canary In The Mine

 Back to sudden debt.. lots and lots of zooming debt, and potentially in lots of trouble.

Open AI has borrowed $96 billion up to now, with major lenders being SoftBank, Oracle and a bunch of private debt funds. But, it turns out that Open AI is being rapidly overtaken by Google - not exactly a surprise, given Google’s massive data supremacy.

Taking a look at SoftBank and Oracle stocks… they are down sharply from their recent bubbly tops: SoftBank is down 30% and Oracle 45% while our blast-from-the-past 5 year CDS (Credit Default Swap) for Oracle has gone from 45 to 125 recently. Likewise, SoftBank CDS jumped from 200 to 300 in the last two months.  Note that Oracle's debt is rated BBB and Softbank's BB+, not exactly stellar ratings.

And there is a lot of AI credit exposure to shadow banking out there, too.  But just because it’s in the shadows doesn’t mean the “real” banking world is immune. In the end, all banking is connected, one way or another.

The Ultimate Meme

One chart best captures the AI meme stock nature of equity markets right now: SoftBank owns a considerable chunk of OpenAI equity, currently unlisted.

Before pulling back recently, SoftBank stock zoomed from $20 to $88 in just six months. It is currently trading at $55.

PS If all AI data centers announced for the US are actually built, their electrical power requirements will reach ca. 30-50 GW by 2030. To put this number into perspective, that’s a minimum of 10 new Palo Verde nuclear plants. Palo Verde is, by far, the largest nuclear plant in the US. It took 12 years to build and cost $6 billion.

Today, an equivalent plant will cost at least $35 billion due to inflation and additional regulatory demands. So… a MINIMUM of $350 billion and at least a decade to build. That’s before NIMBY even comes into play.

So… how realistic are AI growth projections? I’m speaking as an engineer here…

Bitcoin and S&P 500

 In these frothy days I view cryptos and stocks as two sides of the same risk coin - pardon the pun.  I'm pretty sure that many risk-hungry speculators are leveraging one position against the other.  Therefore, performance in one drives performance in the other.

Here is a one year chart of relative performance of BTC (purple solid line) and SPX (bars).  Recent weakness in BTC is not reflected in SPX, at least not to any great extent.  BTC is down 9% while SPX is up almost 9%.  I expect this 18% spread to narrow. 

 

Market Rout? Really??

 Yesterday S&P 500 fell a mere 0.92% - and yet the news today talk about a "market rout".  What does this mean to me?  That "investors" (ie speculators) have become completely used to a market that always goes up and any drop, no matter how minor, is considered an abnormal, extreme move.

Another sign of froth..

Treasury Basis Trade

The US Treasury basis trade consists of buying a Treasury bond in the cash market and selling the underlying futures contract. The difference in returns, the arbitrage, is the “basis”.

The cash bond position is financed via  overnight repo, while the futures contract has its own leverage built in.

Because the basis spread is very small these positions are in the hundreds of millions, even billions.  Therefore, huge leverage is applied 10X, 20X even 50X. The basis trade has become a staple for dozens of hedge funds, most all of them based in the Cayman Islands.

Here’s a chart with ESTIMATED amounts, put together by AI from various sources.

In just 5 years the basis trade has apparently grown tenfold! Is this concerning? Yes, it is. The amount of Treasury debt utilized in basis arbitrage is now huge and helps absorb part of increased Treasury issuance - but it can evaporate in short notice. For example, repo rates could rise, or futures margin requirements  increase.

For sure, if the basis arbitrage becomes unprofitable then a huge supply of Treasury bonds will have to find alternative investors.

PS  Read the following write up by the Fed  - they estimate the size of the basis trade to be around $1.8 trillion.

The Pools of 1929

 In the months before the Crash of 1929 the phenomenon of “bull pools” gained great popularity. A bunch of wealthy individuals would pool their money and proceed to pump up stocks on the NYSE, often with the cooperation of the floor specialists.  The manipulation was rampant and, astonishingly, often public: many pools were announced in the press in advance in order to induce wide participation by the gullible public.  It was a kind of Ponzi scheme, where those who got in early and got out in time made money.  After the pump came the dump, of course, and the rest lost everything.  Think "meme stocks".

What is today's equivalent?  To me, at least, the constant announcement of enormous triangular AI investments between the usual suspects looks like bull pool redux.  Time will tell.

From TIME magazine, May 30, 1932

Pools. Any Wall Streeter knows, but few Senators do, how pools are run. Because the risks are great, the pool’s sponsor usually invites only his richest friends to form a syndicate. Each shares in the profits (or losses) in proportion to his subscription. Each usually makes a cash deposit for the pool manager to use as margin in his trading operations. Each is pledged to strict secrecy. With dictatorial powers, the pool manager begins accumulating stock, buying a little more each day than he sells. Stock is dumped if the price rises noticeably. When the manager has the stock he wants, publicity is shot out, bullish rumors about the company appear, the stock is “tipped,” for it is now advantageous to whisper the existence of the pool. The stock is churned over & over, bought & sold to attract attention. When outside buying begins, the pool manager drives up the price by concentrated buying. Outside enthusiasm grows, amateur traders hear a big rise is in prospect. Most pools do not play for large advances but for small profits on large blocks of stock. When the profit in sight seems satisfactory, the pool manager starts selling more than he buys, transactions increase by leaps & bounds. Canny chart readers sell too, for they readily spot the end of a pool movement by very heavy turnover with little change in price.

Sociopolitical Risks

 Following the Democratic sweep in yesterday’s elections, it is a good time to ponder socioeconomic risks facing the US and their likely impact on markets.

In a nutshell, America has never been more politically divided and economically polarized than today. Mr. Trump’s presidency is not its cause but a result of this division, a result of decades of drawing apart. On could even say that this era is reminiscent of the time before the Civil War.

I believe markets have not taken into account the risk of a sudden Black Swan appearing over America. And we do know that Mr. Trump is especially fond of “swan barbecue”…