Tag: Recession (page 1 of 19)

The Stage Has Been Set For The Next Financial Crisis

Authored by Constantin Gurdgiev via CaymanFinancialReview.com,

Last month, the Japanese government auctioned off some US$4 billion worth of new two-year bonds at a new record low yield of negative 0.149 percent. The country’s five-year debt is currently yielding minus 0.135 percent per annum, and its 10-year bonds are trading at -0.001 percent. Strange as it may sound, the safe haven status of Japanese bonds means that there is an ample demand among private investors, especially foreign buyers, for giving away free money to the Japanese government: the bid-to-cover ratio in the latest auction was at a hefty US$19.9 billion or 4.97 times the targeted volume. The average bid-to-cover ratio in the past 12 auctions was similar at 4.75 times. Japan’s status as the world’s most indebted advanced economy is not a deterrent to the foreign investors, banking primarily on the expectation that continued strengthening of the yen against the U.S. dollar, the U.K. pound sterling and, to a lesser extent, the euro, will stay on track into the foreseeable future. See chart 1

In a way, the bet on Japanese bonds is the bet that the massive tsunami of monetary easing that hit the global economy since 2008 is not going to recede anytime soon, no matter what the central bankers say in their dovishly-hawkish or hawkishly-dovish public statements. And this expectation is not only contributing to the continued inflation of a massive asset bubble, but also widens the financial sustainability gap within the insurance and pensions sectors. The stage has been set, cleaned and lit for the next global financial crisis.

Worldwide, current stock of government debt trading at negative yields is at or above the US$9 trillion mark, with more than two-thirds of this the debt of the highly leveraged advanced economies. Just under 85 percent of all government bonds outstanding and traded worldwide are carrying yields below the global inflation rate. In simple terms, fixed income investments can only stay in the positive real returns territory if speculative bets made by investors on the direction of the global exchange rates play out.

We are in a multidimensional and fully internationalized carry trade game, folks, which means there is a very serious and tangible risk pool sitting just below the surface across world’s largest insurance companies, pensions funds and banks, the so-called “mandated” undertakings. This pool is the deep uncertainty about the quality of their investment allocations. Regulatory requirements mandate that these financial intermediaries hold a large proportion of their investments in “safe” or “high quality” instruments, a class of assets that draws heavily on higher rated sovereign debt, primarily that of the advanced economies.

The first part of the problem is that with negative or ultra-low yields, this debt delivers poor income streams on the current portfolio. Earlier this year, Stanford’s Hoover Institution research showed that “in aggregate, the 564 state and local systems in the United States covered in this study reported $1.191 trillion in unfunded pension liabilities (net pension liabilities) under GASB 67 in FY 2014. This reflects total pension liabilities of $4.798 trillion and total pension assets (or fiduciary net position) of $3.607 trillion.” This accounts for roughly 97 percent of all public pension funds in the U.S. Taking into the account the pension funds’ penchant for manipulating (in their favor) the discount rates, the unfunded public sector pensions liabilities rise to $4.738 trillion. Key culprit: the U.S. pension funds require 7.5-8 percent average annual returns on their assets to break even on their future expected liabilities. In 2013-2016 they achieved an average return of below 3 percent. This year, things are looking even worse. Last year, Milliman research showed that on average, over 2012-2016, U.S. pension funds held 27-30 percent of their assets in cash (3-4 percent) and bonds (23-27 percent), generating total median returns over the same period of around 1.31 percent per annum.

Not surprisingly, over the recent years, traditionally conservative investment portfolios of the insurance companies and pensions funds have shifted dramatically toward higher risk and more exotic (or in simple parlance, more complex) assets. BlackRock Inc recently looked at the portfolio allocations, as disclosed in regulatory filings, of more than 500 insurance companies. The analysts found that their asset books – investments that sustain insurance companies’ solvency – can be expected to suffer an 11 percent drop in values, on average, in the case of another financial crisis. In other words, half of all the large insurance companies trading in the U.S. markets are currently carrying greater risks on their balance sheets than prior to 2007. Milliman 2016 report showed that among pension funds, share of assets allocated to private equity and real estate rose from 19 percent in 2012 to 24 percent in 2016.

The reason for this is that the insurance companies, just as the pension funds, re-insurers and other longer-term “mandated” investment vehicles have spent the last eight years loading up on highly risky assets, such as illiquid private equity, hedge funds and real estate. All in the name of chasing the yield: while mainstream low-risk assets-generated income (as opposed to capital gains) returned around zero percent per annum, higher risk assets were turning up double-digit yields through 2014 and high single digits since then. At the end of 2Q 2017, U.S. insurance companies’ holdings of private equity stood at the highest levels in history, and their exposures to direct real estate assets were almost at the levels comparable to 2007. Ditto for the pension funds. And, appetite for both of these high risk asset classes is still there.

The second reason to worry about the current assets mix in insurance and pension funds portfolios relates to monetary policy cycle timing. The prospect of serious monetary tightening is looming on the horizon in the U.S., U.K., Australia, Canada and the eurozone; meanwhile, the risk of the slower rate of bonds monetization in Japan is also quite real. This means that the capital values of the low-risk assets are unlikely to post significant capital gains going forward, which spells trouble for capital buffers and trading income for the mandated intermediaries.

Thirdly, the Central Banks continue to hold large volumes of top-rated debt. As of Aug. 1, 2017, the Fed, Bank of Japan and the ECB held combined US$13.8 trillion worth of assets, with both Bank of Japan (US$4.55 trillion) and the ECB (US$5.1 trillion) now exceeding the Fed holdings (US$4.3 trillion) for the third month in a row.

Debt maturity profiles are exacerbating the risks of contagion from the monetary policy tightening to insurance and pension funds balance sheets. In the case of the U.S., based on data from Pimco, the maturity cliff for the Federal Reserve holdings of the Treasury bonds, Agency debt and TIPS, as well as MBS is falling on 1Q 2018 – 3Q 2020. Per Bloomberg data, the maturity cliff for the U.S. insurers and pensions funds debt assets is closer to 2020-2022. If the Fed simply stops replacing maturing debt – the most likely scenario for unwinding its QE legacy – there will be little market support for prices of assets that dominate capital base of large financial institutions. Prices will fall, values of assets will decline, marking these to markets will trigger the need for new capital. The picture is similar in the U.K. and Canada, but the risks are even more pronounced in the euro area, where the QE started later (2Q 2015 as opposed to the U.S. 1Q 2013) and, as of today, involves more significant interventions in the sovereign bonds markets than at the peak of the Fed interventions.

How distorted the EU markets for sovereign debt have become? At the end of August, Cyprus – a country that suffered a structural banking crisis, requiring bail-in of depositors and complete restructuring of the banking sector in March 2013 – has joined the club of euro area sovereigns with negative yields on two-year government debt. All in, 18 EU member states have negative yields on their two-year paper. All, save Greece, have negative real yields.

The problem is monetary in nature. Just as the entire set of quantitative easing (QE) policies aimed to do, the long period of extremely low interest rates and aggressive asset purchasing programs have created an indirect tax on savers, including the net savings institutions, such as pensions funds and insurers. However, contrary to the QE architects’ other objectives, the policies failed to drive up general inflation, pushing costs (and values) of only financial assets and real estate. This delayed and extended the QE beyond anyone’s expectations and drove unprecedented bubbles in financial capital. Even after the immediate crisis rescinded, growth returned, unemployment fell and the household debt dramatically ticked up, the world’s largest Central Banks continue buying some US$200 billion worth of sovereign and corporate debt per month.

Much of this debt buying produced no meaningfully productive investment in infrastructure or public services, having gone primarily to cover systemic inefficiencies already evident in the state programs. The result, in addition to unprecedented bubbles in property and financial markets, is low productivity growth and anemic private investment. (See chart 2.) As recently warned by the Bank for International Settlements, the global debt pile has reached 325 percent of the world’s GDP, just as the labor and total factor productivity growth measures collapsed.

The only two ways in which these financial and monetary excesses can be unwound involves pain.

The first path – currently favored by the status quo policy elites – is through another transfer of funds from the general population to the financial institutions that are holding the assets caught in the QE net. These transfers will likely start with tax increases, but will inevitably morph into another financial crisis and internal devaluation (inflation and currencies devaluations, coupled with a deep recession).

The alternative is also painful, but offers at least a ray of hope in the end: put a stop to debt accumulation through fiscal and tax reforms, reducing both government spending across the board (and, yes, in the U.S. case this involves cutting back on the coercive institutions and military, among other things) and flattening out personal income tax rates (to achieve tax savings in middle and upper-middle class cohorts, and to increase effective tax rates – via closure of loopholes – for highest earners). As a part of spending reforms, public investment and state pensions provisions should be shifted to private sector providers, while existent public sector pension funds should be forced to raise their members contributions to solvency-consistent levels.

Beyond this, we need serious rethink of the monetary policy institutions going forward. Historically, taxpayers and middle class and professionals have paid for both, the bailouts of the insolvent financial institutions and for the creation of conditions that lead to this insolvency. In other words, the real economy has consistently been charged with paying for utopian, unrealistic and state-subsidizing pricing of risks by the Central Banks. In the future, this pattern of the rounds upon rounds of financial repression policies must be broken.

Whether we like it or not, since the beginning of the Clinton economic bubble in the mid-1990s, the West has lived in a series of carry trade games that transferred real economic resources from the economy to the state. Today, we are broke. If we do not change our course, the next financial crisis will take out our insurers and pensions providers, and with them, the last remaining lifeline to future financial security.

http://WarMachines.com

The Coming Economic Downturn In Canada

Authored by Deb Shaw via MarketsNow.com,

  • Canadian GDP growth has outperformed this year, helping the Canadian dollar
  • As GDP growth slows and the Bank of Canada turns neutral, catalysts turning negative
  • Crude oil and real estate look set for a downturn, with negative implications for the currency

Given its natural resource-based economy, Canada is a boom and bust kind of place. This year, the country has enjoyed a significant boom. Thanks to a government stimulus program, rising corporate capital expenditures and consumer spending, Canada’s GDP growth has been nothing short of spectacular in 2017. According to Statistics Canada, the latest reading for year-over-year GDP growth is a healthy 3.5% (as of August 2017). While this is stronger than all major developed countries, growth is decelerating from its most recent peak in May 2017 (when GDP growth was an astounding 4.7%). A visual overview of historical GDP growth is shown below for reference:

Turning a corner: Canadian growth comes back down to earth

11-17-2017 CAD GDP growth

Source: Statistics Canada

Following the crude oil bust in the second quarter of 2014, Canadian growth rates cratered. While the country avoided a technical recession, the economic outlook was poor until early 2016. After crude oil returned to a bull market in the first quarter of 2016, the fortunes of the country turned. Given limited growth in 2015, the economy had no problem delivering 2%+ year-over-year growth rates in 2016. As a substantial stimulus program ramped up government spending in 2017, growth rates have continued to accelerate this year.

Storm clouds on the horizon: crude oil and real estate

While Canada has delivered exceptional growth in the last two years, the future outlook is much more challenging. Beyond the issue of base effects (mathematically, year-over-year GDP growth will be much tougher next year), key sectors including the oil & gas industry and Canadian real estate look ripe for a downturn.

Crude bull market intact today, but at risk in 2018

As WTI crude strengthens beyond $55, crude oil is clearly in a bull market today. Looking at figures from the International Energy Agency, global demand growth continues to run ahead of supply growth. Thus the ongoing bull market is supported by fundamentals. Thanks to the impact of hurricanes and infrastructure bottlenecks in 2017, US shale hasn’t entirely fulfilled its role as the global ‘swing producer’ this year. The dynamics of supply growth versus demand growth are shown below:

Who invited American shale? US supply ruins the crude oil party

10-13-2017 crude oil supply demand

Source: International Energy Agency, forward OPEC supply estimates via US EIA

Unfortunately, the status quo looks set to change as US supply returns with a vengeance. According to estimates from the IEA, supply growth will outstrip demand growth in the first quarter of 2018. Digging deeper into supply estimates, US shale is once again to blame. Our view is that this changing dynamic will lead to a new bear market in crude oil. Looking back at recent history, crude prices formed a long-term top in the second quarter of 2014 once supply growth overtook demand. Similarly, crude prices bottomed in the first quarter of 2016 once supply growth fell below demand in early 2016. Given Canada's dependence on crude oil exports, a bear market for the commodity is likely to result in a weaker currency.

As China enters its latest real estate downturn, Canada not far behind

While Canadian real estate has enjoyed a great year, the future outlook is much tougher. Similar to its peers in Australia and New Zealand, Canadian real estate prices tend to lag real estate prices in China. This is both because Canada’s economy is deeply intertwined with China, and because the country is a big destination for overseas investment from China. While overseas investors make up a relatively small portion of buyers (around 5% according to government estimates), they serve an important role by acting as the marginal buyer for prime property. A comparison of new house prices in China versus Canada is shown below for reference:

Canadian real estate boom set to run out of steam

11-17-2017 China Canada real estate

Source: Statistics Canada, China National Bureau of Statistics

As Chinese new house prices accelerated significantly in early 2015, Canadian real estate prices followed in 2016. As the Chinese market is now decelerating, negative growth appears to be on the horizon. In March 2015, Chinese house price growth bottomed at -6.1%. While the Canadian bull market continues for now (September new house prices registered at 3.8%), a downturn is likely over the next 6-12 months. As real estate makes up 13% of Canadian GDP, a significant decline in the fortunes of the industry are likely to spill over to the broader economy.

Implications for the Canadian dollar

At the beginning of the year, the Canadian dollar enjoyed a wide number of bullish catalysts including accelerating GDP growth, rising rate hike expectations, a relatively strong crude oil market and speculator sentiment that was at a bearish extreme. These catalysts, and the Bank of Canada’s actions in particular, helped the currency strengthen until late September.

Today, almost every factor that drives the Canadian dollar is working against it. Future GDP growth rates are set to keep decelerating. Looking at the Bank of Canada, its outlook for future rate hikes is now “cautious”. This is a big change from its hawkish tilt earlier this year. While speculator sentiment is no longer at bullish extremes, waning interest in the Canadian dollar is weighing on the currency. The ongoing NAFTA negotiations are another source of potential political risk. Finally, an impending downturn for both crude oil and Canadian real estate further worsen the picture. Thus, our longer term outlook on the Canadian dollar is bearish.

 

http://WarMachines.com

Is America In Terminal Decline?

Authored by Raul Ilargi Meijer via The Automatic Earth blog,

John Rubino recently posted a graph from Bob Prechter’s Elliot Wave that points to some ominous signs. It depicts the S&P 500, combined with consumer confidence and savings rate. As the accompanying video at Elliott Wave, What “Too Confident to Save” Means for Stocks, shows, when the gap between high confidence and low savings is at its widest, a market crash -often- follows.

In 2000, the subsequent crash was 39%, in 2007 it was 54%. We are now again witnessing just such a gap, with the S&P 500 at record levels. Here’s the graph, with John’s comments:

Consumers Are Both Confident And Broke

Elliott Wave International recently put together a chart that illustrates a recurring theme of financial bubbles: When good times have gone on for a sufficiently long time, people forget that it can be any other way and start behaving as if they’re bulletproof. They stop saving, for instance, because they’ll always have their job and their stocks will always go up. Then comes the inevitable bust. On the following chart, this delusion and its aftermath are represented by the gap between consumer confidence (our sense of how good the next year is likely to be) and the saving rate (the portion of each paycheck we keep for a rainy day). The bigger the gap the less realistic we are and the more likely to pay dearly for our hubris.

John is mostly right. But not entirely. Not that I don’t think he knows, he simply forgets to mention it. What I mean is his suggestion that people stop saving because they’re confident, bullish. To understand where and why he slightly misses, let’s turn to Lance Roberts. Before we get to the savings, Lance explains why the difference between the Producer Price Index (PPI) and Consumer Price Index (CPI) is important to note.

Summarized, producer prices are rising, but consumer prices are not.

You Have Been Warned

There is an important picture that is currently developing which, if it continues, will impact earnings and ultimately the stock market. Let’s take a look at some interesting economic numbers out this past week. On Tuesday, we saw the release of the Producer Price Index (PPI) which ROSE 0.4% for the month following a similar rise of 0.4% last month. This surge in prices was NOT surprising given the recent devastation from 3-hurricanes and massive wildfires in California which led to a temporary surge in demand for products and services.

 

Then on Wednesday, the Consumer Price Index (CPI) was released which showed only a small 0.1% increase falling sharply from the 0.5% increase last month.

 

Such differences have real life consequences. In Lance’s words:

This deflationary pressure further showed up on Thursday with a -0.3% decline in Export prices. (Exports make up about 40% of corporate profits) For all of you that continue to insist this is an “earnings-driven market,” you should pay very close attention to those three data points above. When companies have higher input costs in their production they have two choices: 1) “pass along” those price increase to their customers; or 2) absorb those costs internally.

 

If a company opts to “pass along” those costs then we should have seen CPI rise more strongly. Since that didn’t happen, it suggests companies are unable to “pass along” those costs which means a reduction in earnings. The other BIG report released on Wednesday tells you WHY companies have been unable to “pass along” those increased costs.

 

The “retail sales” report came in at just a 0.1% increase for the month. After a large jump in retail sales last month, as was expected following the hurricanes, there should have been some subsequent follow through last month. There simply wasn’t. More importantly, despite annual hopes by the National Retail Federation of surging holiday spending which is consistently over-estimated, the recent surge in consumer debt without a subsequent increase in consumer spending shows the financial distress faced by a vast majority of consumers.

That already hints at what I said above about savings. But it’s Lance’s next graph, versions of which he uses regularly, that makes it even more obvious. (NOTE: I think he means to say 2009, not 2000 below)

The first chart below shows a record gap between the standard cost of living and the debt required to finance that cost of living. Prior to 2000(?!), debt was able to support a rising standard of living, which is no longer the case currently.

The cut-off point is 2009, unless I miss something in Lance’s comment. Before that, borrowing could create the illusion of a rising standard of living. Those days are gone.

And it’s very hard to see, when you take a good look, what could make them come back.

Not only are savings not down because people are too confident to save, they are down because people simply don’t have anything left to save. The American consumer is sliding ever deeper into debt. And as for the Holiday Season, we can confidently -there’s that word again- predict that spending will be disappointing, and that much of what is still spent will add to increasing Consumer Credit Per Capita, as well as the Gap Between Real Disposable Income (DPI) And Cost Of Living.

The last graph, which shows Control Purchases, i.e. what people buy most, a large part of which will be basic needs, makes this even more clear.

With a current shortfall of $18,176 between the standard of living and real disposable incomes, debt is only able to cover about 2/3rds of the difference with a net shortfall of $6,605. This explains the reason why “control purchases” by individuals (those items individuals buy most often) is running at levels more normally consistent with recessions rather than economic expansions.

If companies are unable to pass along rising production costs to consumers, export prices are falling and consumer demand remains weak, be warned of continued weakness in earnings reports in the months ahead. As I stated earlier this year, the recovery in earnings this year was solely a function of the recovering energy sector due to higher oil prices. With that tailwind now firmly behind us, the risk to earnings in the year ahead is dangerous to a market basing its current “overvaluation” on the “strong earnings” story.

“Prior to 2009, debt was able to support a rising standard of living..” Less than a decade later, it can’t even maintain the status quo. That’s what you call a breaking point.

To put that in numbers, there’s a current shortfall of $18,176 between the standard of living and real disposable incomes. In other words, no matter how much people are borrowing, their standard of living is in decline.

Something else we can glean from the graphs is that after the Great Recession (or GFC) of 2008-9, the economy never recovered. The S&P may have, and the banks are back to profitable ways and big bonuses, but that has nothing to do with real Americans in their own real economy. 2009 was a turning point and the crisis never looked back.

Are the American people actually paying for the so-called recovery? One might be inclined to say so. There is no recovery, there’s whatever the opposite of that is, terminal decline?!. It’s just, where does that consumer confidence level come from? Is that the media? Is The Conference Board pulling our leg? Is it that people think things cannot possibly get worse?

What is by now crystal clear is that Americans don’t choose to not save, they have nothing left to save. And that will have its own nasty consequences down the road. Let’s raise some rates, shall we? And see what happens?!

One consolation: Europe, Japan, China are in the same debt-driven decline that Americans are. We’re all going down together. Or rather, the question is who’s going to go first. That is the only hard call left. America’s a prime candidate.

http://WarMachines.com

Unbridled Exuberance…

Authored by James Stack via InvesTech.com,

From public confidence to bullish sentiment to the normally mundane employment data, the U.S. economy and stock market are reaching historic levels not seen in decades.  Last month, consumer confidence hit its highest level since December 2000.  The percentage of bullish investment advisors recently touched lofty levels that were last reached in January 1987.  And this month, the U.S. Department of Labor announced that job layoffs dropped to a 44-year low!

This might all sound like great news, and on the surface it obviously is.  But what is forgotten in today’s exuberant celebrations – and the above statistics – is that both the economy and stock market historically peak when skies are blue and no storm clouds are in sight: December 2000 was just 3 months before the start of the 2001 recession. January 1987 was 9 months before Black Monday struck. And 44 years ago (1973), the stock market was about to suffer its worst annual loss in 35 years! If the S&P 500 closes higher in November, it will have posted a positive total return for 13 consecutive months, surpassed only once in 90 years – 1959.  The next year (1960) the economy entered a recession.

We’re not sharing these insights because we have turned bearish in our market outlook.  We haven’t.  Most technical evidence and virtually all macroeconomic data still point to new bull market highs immediately ahead.  However, it is becoming increasingly important to remember that trees do not grow to the sky, and bull markets do not last forever.  And don’t forget that virtually every bear market except one (1956) has repossessed or taken back roughly one-half or more of the previous bull market’s gain. 

Today, that would equate to 8,500 DJIA points!

Unbridled Exuberance… While the Novice Make Merry, the Seasoned are Wary

One of the most apparent examples of investors’ increased appetite for risk lies in the “FANG” stocks.  These modern day “four horsemen” of technology and consumer stocks –Facebook, Amazon, Netflix, and Google– are considered leaders in the emergent areas of today’s economy.  Because of their outsized estimates for future growth, this narrow group of stocks has radically outperformed the S&P 500 since the beginning of 2015.

However, value-conscious investors have had difficulty justifying ownership of this speculative quartet due to valuation risk.

They trade at a combined P/E ratio of 48.5 based on trailing earnings – nearly twice that of the S&P 500.

Enthusiasm for the FANG stocks has reached such a feverish pitch that Wall Street is creating new products to tap into the public’s insatiable appetite for these exciting invest ments.  The four FANG stocks are joined by six other hot tech names to form the NYSE FANG+ Index.  Futures contracts on this Index began trading on the Intercontinental Exchange (ICE) last week.   Investors can now “Trade the Top of Tech” in the futures market to quickly increase or decrease their exposure to these speculative companies.

In past market tops of the late 1990s and 2007 we exposed the danger of investor and consumer exuberance along with the “boom” headlines that typically accompany a cyclical peak.  This is not an infallible relationship, however, so the appearance of the above headlines today does not necessarily mean the market top is in place.  Rather, it reinforces the need to maintain professional skepticism and an emphasis on risk management, which can be in short supply at this stage in the market cycle.

Nowhere is the bullish consensus more obvious than in the Advisors Sentiment Survey tracked by Investors Intelligence (graph below).  While the percentage of bears is typically considered a more reliable contrarian indicator at extreme readings, we find it interesting to note that the percentage of bullish advisors recently hit the highest level since January 1987 – only nine months before the 1987 Crash…

Valuation risk remains an overarching concern for today’s aging bull market.  Although the leading economic evidence remains overwhelmingly positive, U.S. stocks are not cheap by historical standards.  The current P/E ratio of the S&P 500 based on trailing earnings is 24.8, which is well above the 90-year average, as shown in the graph below. 

How expensive is the S&P 500 today?  The P/E for this popular Index has exceeded 24.0 just over 10% of the time since 1928, as shown by the dark blue bars on the graph at right.  The light blue bars eliminate the distortions from the Technology Bubble of the late 1990s and the Financial Crisis in 2008-09 when corporate earnings evaporated.  If we exclude those extreme periods, the S&P 500 P/E ratio has been in the rarified range above 24.0 less than 3% of the time. 

Lofty valuations do not cause bear markets, and stocks can remain overvalued for very long periods of time.  However, high valuations increase downside risk and diminish the margin of safety so essential to successful long-term investing.  Consequently, it is particularly important now to employ a safety-first strategy and avoid overvalued momentum stocks, as they will undoubtedly fall the hardest when a bear market does arrive. 

A Potential Warning in the Technical Evidence…

Sometimes it’s striking how quickly the technical picture can shift in an aging bull market.  Take the three graphs below, for instance.  When we last published this trio of charts in early October, all three were hitting new highs in unison.   Now both the Dow Jones Transportation Average (DJTA) and the small-cap Russell 2000 Index are starting to diverge substantially from the blue chip DJIA, which is sitting just below its recent all-time high.

Major peaks in the DJIA are usually preceded by a top in one or more of the economicallysensitive secondary indexes, but not every divergence necessarily signals trouble ahead.

When both the secondary indexes shown here diverge simultaneously, however, it’s a significant development, and time for heightened vigilance.

NLC:  Is Distribution Imminent?

Our Negative Leadership Composite (NLC) shown below remains steadfast on the surface with the bullish “Selling Vacuum” [*1] at +4 and no visible sign of “Distribution” [*2 – shaded region]…  yet! 

Even so, careful analysis of the underlying leadership data since mid-October shows a steady deterioration in the internal numbers.

Sometimes it’s striking how quickly the technical picture can shift in an aging bull market.  Take the three graphs at right, for instance.  When we last published this trio of charts in early October, all three were hitting new highs in unison.   Now both the Dow Jones Transportation Average (DJTA) and the small-cap Russell 2000 Index are starting to diverge substantially from the blue chip DJIA, which is sitting just below its recent all-time high.

Major peaks in the DJIA are usually preceded by a top in one or more of the economically-sensitive secondary indexes, but not every divergence necessarily signals trouble ahead. 

When both the secondary indexes shown here diverge simultaneously, however, it’s a significant development, and time for heightened vigilance.

Selling pressure is stealthily creeping upward, and it appears to be broad-based. If the current trend continues, we could start to see Distribution in our NLC by the time our December issue goes to press.  If Distribution appears and subsequently drops below -50, then bear market risk will become elevated and that could warrant a more defensive stance

 

http://WarMachines.com

The Great Retirement Con

Authored by Adam Taggart via PeakProsperity.com,

Frankly put: retirement is now a myth for the majority…

 

The Origins Of The Retirement Plan

Back during the Revolutionary War, the Continental Congress promised a monthly lifetime income to soldiers who fought and survived the conflict. This guaranteed income stream, called a "pension", was again offered to soldiers in the Civil War and every American war since.

Since then, similar pension promises funded from public coffers expanded to cover retirees from other branches of government. States and cities followed suit — extending pensions to all sorts of municipal workers ranging from policemen to politicians, teachers to trash collectors.

A pension is what's referred to as a defined benefit plan. The payout promised a worker upon retirement is guaranteed up front according to a formula, typically dependent on salary size and years of employment.

Understandably, workers appreciated the security and dependability offered by pensions. So, as a means to attract skilled talent, the private sector started offering them, too. 

The first corporate pension was offered by the American Express Company in 1875. By the 1960s, half of all employees in the private sector were covered by a pension plan.

Off-loading Of Retirement Risk By Corporations

Once pensions had become commonplace, they were much less effective as an incentive to lure top talent. They started to feel like burdensome cost centers to companies.

As America's corporations grew and their veteran employees started hitting retirement age, the amount of funding required to meet current and future pension funding obligations became huge. And it kept growing. Remember, the Baby Boomer generation, the largest ever by far in US history, was just entering the workforce by the 1960s.

Companies were eager to get this expanding liability off of their backs. And the more poorly-capitalized firms started defaulting on their pensions, stiffing those who had loyally worked for them.

So, it's little surprise that the 1970s and '80s saw the introduction of personal retirement savings plans. The Individual Retirement Arrangement (IRA) was formed by the Employee Retirement Income Security Act (ERISA) in 1974. And the first 401k plan was created in 1980.

These savings vehicles are defined contribution plans. The future payout of the plan is variable (i.e., unknown today), and will be largely a function of how much of their income the worker directs into the fund over their career, as well as the market return on the fund's investments.

Touted as a revolutionary improvement for the worker, these plans promised to give the individual power over his/her own financial destiny. No longer would it be dictated by their employer.

Your company doesn't offer a pension? No worries: open an IRA and create your own personal pension fund.

Afraid your employer might mismanage your pension fund? A 401k removes that risk. You decide how your retirement money is invested.

Want to retire sooner? Just increase the percent of your annual income contributions.

All this sounded pretty good to workers. But it sounded GREAT to their employers.

Why? Because it transferred the burden of retirement funding away from the company and onto its employees. It allowed for the removal of a massive and fast-growing liability off of the corporate balance sheet, and materially improved the outlook for future earnings and cash flow.

As you would expect given this, corporate America moved swiftly over the next several decades to cap pension participation and transition to defined contribution plans.

The table below shows how vigorously pensions (green) have disappeared since the introduction of IRAs and 401ks (red):

(Source)

So, to recap: 40 years ago, a grand experiment was embarked upon. One that promised US workers: Using these new defined contribution vehicles, you'll be better off when you reach retirement age.

Which raises a simple but very important question: How have things worked out?

The Ugly Aftermath

America The Broke

Well, things haven't worked out too well.

Three decades later, what we're realizing is that this shift from dedicated-contribution pension plans to voluntary private savings was a grand experiment with no assurances. Corporations definitely benefited, as they could redeploy capital to expansion or bottom line profits. But employees? The data certainly seems to show that the experiment did not take human nature into account enough – specifically, the fact that just because people have the option to save money for later use doesn't mean that they actually will.

First off, not every American worker (by far) is offered a 401k or similar retirement plan through work. But of those that are, 21% choose not to participate (source).

As a result, 1 in 4 of those aged 45-64 and 22% of those 65+ have $0 in retirement savings (source). Forty-nine percent of American adults of all ages aren't saving anything for retirement.

In 2016, the Economic Policy Institute published an excellent chartbook titled The State Of American Retirement (for those inclined to review the full set of charts on their website, it's well worth the time). The EPI's main conclusion from their analysis is that the switchover of the US workforce from defined-benefit pension plans to self-directed retirement savings vehicles (e..g, 401Ks and IRAs) has resulted in a sizeable drop in retirement preparedness. Retirement wealth has not grown fast enough to keep pace with our aging population.

The stats illustrated by the EPI's charts are frightening on a mean, or average, level. For instance, for all workers 32-61, the average amount saved for retirement is less than $100,000. That's not much to live on in the last decades of your twilight years. And that average savings is actually lower than it was back in 2007, showing that households have still yet to fully recover the wealth lost during the Great Recession.

But mean numbers are skewed by the outliers. In this case, the multi-$million households are bringing up the average pretty dramatically, making things look better than they really are. It's when we look at the median figures that things get truly scary:

Nearly half of families have no retirement account savings at all. That makes median (50th percentile) values low for all age groups, ranging from $480 for families in their mid-30s to $17,000 for families approaching retirement in 2013. For most age groups, median account balances in 2013 were less than half their pre-recession peak and lower than at the start of the new millennium.

(Source)

The 50th percentile household aged 56-61 has only $17,000 to retire on. That's dangerously close to the Federal poverty level income for a family of two for just a single year.

Most planners advise saving enough before retirement to maintain annual living expenses at about 70-80% of what they were during one's income-earning years. Medicare out-of-pocket costs alone are expected to be between $240,000 and $430,000 over retirement for a 65-year-old couple retiring today.

The gap between retirement savings and living costs in one's later years is pretty staggering:

  • Nearly 83% of retired households have less saved than Medicare costs alone will consume.
  • One-third of retired households are entirely dependent on Social Security. On average, that's only $1,230 per month a hard income to live on. (source)
  • 34 percent of older Americans depend on credit cards to pay for basic living expenses such as mortgage payments, groceries, and utilities. (source

As for Medicare, the out-of-pocket costs could easily soar over retirement. The Wall Street Journal reports that the current estimate of Medicare's unfunded liability now tops $42 Trillion. Such a mind-boggling gap makes it highly likely that current retirees will not receive all of the entitlements they are being promised.

And the denial being shown by baby boomers entering retirement is frightening. Many simply plan to work longer before retiring, with a growing percentage saying they plan to work "forever". 

But the data shows that declining health gives older Americans no choice but to leave the work force eventually, whether they want to or not. Years of surveys by the Employment Benefit Research Institute show that fully half of current retirees had to leave the work force sooner than desired due to health problems, disability, or layoffs.

Add to this the nefarious impact of the Federal Reserve's prolonged 0% interest rate policy, which has made it extremely hard for retirees with fixed-income investments to generate a meaningful income from them.

The number of Americans aged 65 years and older is projected to more than double in the next 40 years:

Will the remaining body of active workers be able to support this tsunami of underfunded seniors? Don't bet on it.

Especially since their retirement savings prospects are even more dim. With long-stagnant real wages and punishing price inflation in the cost of living, Generation X and Millennials are hard-pressed to put money away for their twilight years:

(Source)

Public Pensions: Broken Promises

And for those "lucky" folks expecting to enjoy a public pension, there's a lot of uncertainty as to whether they're going to receive all they've been promised.

Due to underfunded contributions, years of portfolio under-performance due to the Federal Reserve's 0% interest rate policy, poor fund management, and other reasons, many of the federal and state pensions are woefully under-captialized. The below chart from former Dallas Fed advisor Danielle DiMartino-Booth shows how the total sum of unfunded public pension obligations exploded from $292 billion in 2007 to $1.9 trillion by the end of 2016:

(Source)

And the daily headlines of failing state and local pension funds (Illinois, Kentucky, New JerseyDallas, Providence — to name but a few) show that the problem is metastasizing across the nation at an accelerating rate.

Affording Your Future

The bottom line when it comes to retirement is that you're on your own. The vehicles and the promises you've been given are proving woefully insufficient to fund the "retirement" dream you've been sold your whole life.

That's the bad news.

But the good news is that the dream is still attainable. There are strategies and behaviors that, if adopted now, will make it much more likely for you to be able to afford to retire — and in a way you can enjoy.

In Part 2: Success Strategies For Retirement, we detail out these best practices for a solvent retirement, including providing 14 specific action steps you can start taking right now in your life that will materially improve your odds of enjoying your later years with grace. For far too many Americans, "retirement" will remain a perpetual myth. Don't let that happen to you. Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

 

http://WarMachines.com

Stockman Slams “The Awesome Recovery” Narrative

Authored by David Stockman via Contra Corner blog,

One of the great philosophers of recent times was surely Sgt. Easterhaus of "Hill Street Blues". As he assigned his men to their daily rounds in the crime infested streets of the Big Apple he always ended the precinct's morning call with his signature admonition:

"Let's be carful out there."

That wisdom has been long lost on both ends of the Acela Corridor. In the face of blatant dangers and even existential threats, their denizens whistle past the graveyard with alacrity. So doing, they turn a blind eye on virtually all that contradicts the awesome recovery narrative, the indispensable nation conceit and the Washington can Make America Great Again (MAGA) delusion, among countless other fantasies.

For example, the GOP should be literally petrified by an horrid fiscal scenario for the coming decade that entails Social Security going bust, another $12 trillion of current policy deficits and a prospective $33 trillion public debt by 2027. And even that presupposes a macro-economic miracle in the interim: Namely, a 207 month stretch from 2009 to 2027 without a recession—–a feat which is twice the longest expansion in recorded history

Image result for images of three monkeys of see no evil, hear no evil, speak no evil

Instead, they have passed a FY 2018 budget resolution which implicitly embraces all of the above fiscal mayhem, and then adds upwards of $2 trillion (so far and counting interest) of incremental deficits to fund an ill-designed tax cut that is inherently an economic dud and political time bomb.

As to the former, the GOP is lost in ritual incantation and foggy Reagan-era nostalgia. Unlike the giant Reagan tax cut of 1981, the pending bills do not cut marginal tax rates measurably—or even the individual income tax burden in any meaningful sense.

In fact, if you set aside the so-called pass-thru rate for unincorporated businesses (see below), the entire 10-year tax cut on the individual side amounts to just $480 billion. In the scheme of things, that's a tiny number; it represents only 2.2% of the $22 trillion CBO baseline for individual income tax collections over the next decade; and it also is equal to just 0.2% of the projected nominal GDP over the period.

By way of comparison, the Reagan tax cut amounted to 6.2% of GDP when fully effective; and the net cut for individuals taxpayers alone averaged 2.7% of GDP over a decade. In today's economy, that would amount to a tax cut of $6.5 trillion during 2018-2027 or 14X more than the $450 billion net figure estimated by the Joint Committee on Taxation.

To be sure, the abused citizens of America are more than entitled to even this tiny tax cut and much more. That is, if their elected representatives were willing to cut spending by an equal amount or even raise alternative, more benign sources of revenue (i.e. a VAT on consumers vs. the current levy on producer and worker incomes). But unless a rapidly aging society wishes to bury itself in unsupportable public debt, it simply can't afford deficit-financed tax cuts for either the principle or the politics of the thing.

Moreover, to pretend that the tax concoction fashioned by Congressman Brady—- with a pack of Gucci Gulch jackals nipping at his heels— will actually generate enough growth and jobs to largely pay for itself is to make a mockery of Sgt. Easterhaus' admonition. Rather than an exercise in fiscal carefulness, it is the height of recklessness to assume that much enhanced domestic growth, employment and Treasury receipts will result from any part of the $2.8 trillion cut for the rich and corporations that is at the heart of the GOP tax bill.

Actually, it's the heart and then some. With recent modifications (including dropping of the $150 billion corporate excise tax intended to prevent companies from hiding domestic profits via over-invoicing of imports from their own affiliates), the net revenue loss of the Brady bill is calculated at about $1.7 trillion.

That means, of course, that fully 165% of the net tax cut goes to: (1) 5,500 dead rich people's heirs per year ($172 billion for estate tax repeal); (2) 4.3 million very wealthy loophole users ($700 billion for the minimum tax repeal); and (3) the top 1% and 10% of households who own 60% and 85% of business equities, respectively, who will get most of the $1.95 trillion of business rate cuts.

In this context, we cannot stress more insistently that Art Laffer's famous napkin does not apply to business tax cuts in today's world of globalized trade and labor rates and artificially cheap central bank enabled debt and capital.

That's because the business income taxes are born by owners, not workers. The wage rates and incomes of the latter are determined in a saturated global labor market where the China Price for Goods and the India Price for internet based services sets wages on the margin.

At the same time, owners are not deterred from making investments by the proverbial "high after-tax cost of capital". That's because it isn't.

Even at the current statutory 35% tax rate (which few pay), the absolute cost of equity and debt capital is cheaper than ever before in modern history.

In fact, the after-tax cost of equity to scorched earth investment juggernauts like Amazon is virtually zero, while the cheap debt-fueled boom in conventional plant, equipment, mining, shipping and distribution assets over the last two decades has stocked the planet with sufficient capacity for decades to come.

In short, if you lower the business tax rates to 20% and 25% for corporations and pass-thrus, respectively, you will get more dividends, more stock buybacks and other returns to shareholders. Those distributions, in turn, will go to the very wealthy and to pension funds/non-profits. The latter will pay no taxes on these distributions while the former will pay 15%-20% at current law rates of o%, 15% and 20% on capital gains and dividends, which the Brady bill does not change.

In short, maybe the $2.8 trillion of tax cuts for business and the wealthy will generate a few hundred billion of reflows over the decade. And even that will not be attributable to the "incentive effect" of the Laffer Curve at all; it's just tax collection mechanics at work as between the personal and business taxing systems.

By the same token, the Sgt. Easterhaus principle is also being ash-canned by the GOP on the politics side of the tax bill, as well. In fact, Republicans have been chanting the "tax cut" incantation for so many decades that they apparently can't see the obvious. Namely, that among the middle quintile of households (about 30 million filers between $55,000 and $93,000 of AGI) the ballyhooed "tax cut" will actually be a crap shoot.

When fully effective, roughly two-thirds of filers (20 million units) would realize a $1,070 per year tax cut, while another 31% (roughly 9.5 million filers) would experience a $1,150 tax increase!

That's a whole lot of rolling dice—-depending upon family size, sources of income and previous use of itemized deductions. Yet for the heart of the middle class as a whole—-30 million filers in the aforementioned income brackets—the statistical average tax cut would amount to $6.15 per week.

That's right. Two Starbucks cappuccinos and a banana!

So we'd call the GOP's noisy advertising of a big tax cut for the middle class reckless, not careful. Indeed, the Dems will spend hundreds of millions during the 2018 election season on testimonials and tax tables which prove the GOP's claim is a pure con job.

They will also prove the opposite— that the overwhelming share of this unaffordable tax cut is going to the top of the economic ladder. After all, the income tax has morphed into a Rich Man's Levy over the last three decades. So if you cut income taxes—-the benefits inherently and mechanically go to the few who actually pay.

Thus, in the most recent year (2015), 150.5 million Americans filed for income taxes, but just 6.8 million filers (4.5% of the total) accounted for 35% of all AGI ($3.6 trillion) and 59% of taxes paid ($858 billion).

By contrast, the bottom 64 million filers reported only $928 billion of AGI, and paid just 2.2%  ($20 billion) in taxes. That is, owing to the standard deduction, personal exemptions and various credits the bottom 44% of taxpayers accounted for only 1.4% of personal income tax collections.

Even when you widen the bracket to the bottom 123 million tax filers (82%), you get $4.3 trillion of AGI and just $284 billion of taxes paid. In other words, the bottom four-fifths of filers pay only 6.6% of their AGI in tribute to Uncle Sam. They may not be getting their money's worth from the Washington puzzle palaces, but you can't get blood from a turnip, either.

In short, Flyover America desperately needs tax relief for the 160 million workers who actually do pay up to 15.5% of their wages in employer/employee payroll tax deductions. Yet by ignoring the $1.1 trillion per year payroll tax entirely and recklessly and risibly claiming that its income and corporate tax cut bill materially aids the middle class, the GOP is only setting itself up for a thundering political backlash.

Nothing makes this clearer than some recent (accurate) calculations by a left-wing outfit called the Institute for Policy Studies that boil down to the proposition that "It Takes A Baseball Team".

That is, the top 25 US persons (like the full MLB roster) on the Forbes 400 list now report about $1 trillion in collective net worth. That happens to match the net worth of the bottom 180 million (56%) Americans.

Needless to say, that egregious disproportion does not represent free market capitalism at work; it's the deformed fruit of Bubble Finance and the vast inflation of financial assets that the Fed and other central banks have enabled over the past three decades.

In terms of the Sgt. Easterhaus metaphor, monetary central planning has planted some exceedingly dangerous political time bombs in the precincts, neighborhoods, towns and cities of Flyover America. Accordingly, if the GOP succeeds in passing some version of its current tax bill, it may be what finally brings the Dems back into power on an out-and-out platform of socialist healthcare (single payor) and tax redistributionism with malice aforethought.

Even as the GOP recklessly plunges forward with gag rules and its sight unseen legislative steamroller (echoes of ObamaCare in 2010), it will never be able to hide what is buried in the bill's tax tables. Namely, an average tax cut for the top 1%—even after accounting for elimination of upwards of $1.3 trillion of itemized deductions—-that would amount to $1,000 per week.

Moreover, for the top o.1% (150,000 filers), the Dem campaign ads will show a cut of $5,300 per week; and for a subset of 100,000 of the top 0.1% filers, the GOP's tax cut would amount to $11,300 per week .

That's right. Each and every one of the very ultra rich would get a tax break equivalent to that which would accrue to every 2,000 middle bracket filers under the Brady bill.

As Sgt. Easterhaus might have said: They have been warned!

Meanwhile, at the other end of the Acela Corridor, the good precinct sergeant gets no respect, either. Indeed, gambling in today's hideously over-valued and unstable casino is exactly the opposite of being careful; it's certain to lead to severe—even fatal—financial injuries on the beat.

In this context, we have been saying right along that the essential evil of monetary central planning is that it systematically falsifies asset prices and corrupts all financial information. That includes what passes for analysis by the Cool Aid drinkers in the casino.

But when we ran across this gem from one Steve Chiavarone yesterday we had to double check because we thought perhaps we were inadvertently reading The Onion.

But, no, he's actually a paid in full (and then some) portfolio manager at the $360 billion Federated Investors group who appeared on CNBC, and then got reported by Dow-Jones' MarketWatch just in case you had the sound turned off during his appearance on bubblevision.

So here's how the bull market will remain "alive for another decade." According to Chiavarone, millenials who don't have two nickels to rub together will make it happen. No sweat.

“Millennials are entering the workforce, but their wages are going to be under pressure their whole career,” he explained to CNBC’s “Trading Nation” on Friday. “They won’t make enough money to pay down their debt, fund their life and fund retirement where there is no pension. So, they’re going to need equities.”

Then again, aspiration and capability are not exactly the same thing. In fact, the frequent yawning difference between the two puts us in mind of the Donald's characterization of his primary opponent as Little Marco Rubio. The latter never stops talking about himself as the very embodiment of the American Dream come true—-so for all we know perhaps Marco did aspire to be an NBA star.

But when he famously couldn't reach his water bottle from atop a stool during his nationwide TV rebuttal of an Obama SOTU speech a few years back, it was evident that NBA stardom wasn't ever meant to be.

Nor during the coming decade of stagnant wages and rising interest rates is it any more obvious how millennials will beg, borrow or steal their way to massive purchases of equities. That is, how they will finance what will actually be an avalanche of stock sales by 80 million fading baby boomers who will need the proceeds to pay their nursing home bills.

But never mind. MarketWatch caught the full measure of  what shines on the inside of Mr. Chiavarone's financial beer goggles:

 The risk is not being in this market,” says Chiavarone, who helps run the Federated Global Allocation Fund. The firm’s current price target is for 2,750 on the S&P by the end of next year and 3,000 for 2019.

 

“We are probably frankly low on both of them,” he said. “Tax reform could push up the markets.” That’s not to say there won’t be some pain along the way, specifically the potential for a recession in 2020 and 2021, according to Chiavarone.

 

What’s an investor to do in that case? “Buy the recession,” he said.

Indeed, it doesn't come any stupider than the market blather that is constantly published on MarketWatch. Today it also informs us that not only have US earnings been galloping forward in recent quarters, but its actually a global trend:

However, this is hardly a U.S.-only story. Corporate earnings have been improving globally, and some of the fastest growth has come from international companies, as seen in the following chart from BlackRock, which looks at U.S. growth against the globe, excluding the U.S.

The chart below is supposed to be the evidence, but we are still scratching our heads looking for the point. It seems that global corporate earnings ex-US based companies have surged…..all the way back to where they were in 2011!

You can't make this stuff up. Did these geniuses notice that China just went full retard in credit expansion to insure that the coronation of Mr. Xi was the greatest since, apparently, the Ming Dynasty invited the civilized world (not Europe) to the coronation of its fourth emperor in 1424?

In fact, the 19th Party Congress is now over, and the Red Suzerains of Beijing are back to the impossible task of reining in the massive malinvestment, housing, debt and construction bubbles which have turned China's economy into a $40 trillion powder keg. So right on cue it reported a sharp cooling of its red hot pre-coronation economy last night.

Thus, value-added industrial output, a rough proxy for GDP, expanded by just 6.2% in October compared to double digit increases a few months back.

Likewise, fixed-asset investment climbed 7.3% in the January-October period from a year earlier. Notably, that's way down from high double digit rates during most of the century, and, in fact, is the slowest pace since December 1999.

Needless to say, the latter data point amounts to a clanging clarion. At the end of the day, the ballyhooed Chinese growth miracle is really a story of construction and debt-fueled asset investment gone wild. And that party is now over.

So whatever Sgt. Easterhaus actually meant during the seven seasons of "Hill Street Blues" which always started with his famous admonition, we are quite sure that today it would not have meant buying the dips in a casino that is rife with unprecedented danger.

Finally, when it comes to real danger we think the most precarious spot along the Acela Corridor is about one mile from Union Station. We are speaking, of course, of the Oval Office and the Donald's questionable tenure therein.

Even as he meandered around Asia double-talking about trade and basking in the royal reception put on by his duplicitous hosts in Tokyo, Seoul and most especially Beijing, the Donald did manage to hit a fantastic bull-eye stateside.

Indeed, his takedown of the three stooges—Brennan, Clapper and Comey—–of the Deep State's spy apparatus will be one for the ages. Not since Jimmy Carter has a president even vaguely admonished the intelligence agencies, but as it his wont, the Donald held nothing back—naming names and drop-kicking backsides good and hard:

“And then you hear it’s 17 agencies. Well, it’s three. And one is Brennan and one is whatever. I mean, give me a break. They’re political hacks. So you look at it — I mean, you have Brennan, you have Clapper, and you have Comey. Comey is proven now to be a liar and he’s proven to be a leaker,” Trump told the reporters on Air Force One…..   

Yes, the next day he backed away in what appeared to be a pro forma nod to be his own courage-challenged appointees.

We don't think so, however.

Image result for picture of brennan, comey and clapper in prison uniforms

The truth is, the Deep State is already in the precinct house. And Sgt. Easterhaus is talking to the wall.

 

http://WarMachines.com

Gold Gains As Stocks Slide, Yield Curve Crashes, & Dollar Dumps

Economic Data continues to surprise to the upside (compared to what had been terrible expectations)…is this as good as it gets?

But credit, the yield curve, and now stocks are not loving it…

 

Small Caps were the only major index green today…

 

The Dow and S&P 500- fell for the 2nd week in a row – something they haven't done for 3 months…Small Caps best on the week (followed by Nasdaq thanks to yesterday's panic buy)…

 

Futures show the crazy moves this week better..

 

VIX was slammed late on today in a desperat ebid to get the S&P green on the week…

 

But while stocks rebounded briefly, FX carry wasn't…

 

And nor was the bond market…

 

Big week for tax-related stocks…

 

SFIX went public today at $15…

 

While US HY bond prices ended the week higher (thanks to yesterday's melt up)…but still remains well below its 200DMA…

 

US HY spreads rose for the 4th week in a row…

 

European HY Fund assets crashed to their lowest since June 2016…

 

Treasuries were mixed on the week with the front-end higher in yield and back-end lower….

 

The US Treasury yield curve crashed almost 10bps this week – the biggest flattening since Dec 2016 to its flattest since Nov 2007

 

Note that is the flattest 2s10s since Oct 2007… The last 3 times it was this flat, the US economy was in recession…

 

The Dollar Index had its worst week in over 2 months, dropping to 1-month lows… (this is also the first consective weekly decline in the dollar index since July)

 

Yen and Euro strength weighed the most on the dollar this week… (AUD and CAD were weaker as oil slipped)

 

USDJPY was clubbed like a baby seal this week (worst in 2 months) – (today was USDJPY's worst drop since May). It seems 114.000 to 112.00 is the corridor…

 

Gold had its best week in over a month, surging back above its 50DMA towards the $1300 level…

GOLD

 

Bitcoin had another big week – getting as close to $8000 as possible… (up 45% from its lows last weekend)…

 

Finally, we note that in the weeks since MbS launched his 'corruption' crackdown in Saudi Arabia, only one asset has really shone…

 

http://WarMachines.com

How Tax Reform Can Still Blow Up: A Side-By-Side Comparison Of The House And Senate Tax Plans

To much fanfare, mostly out of president Trump, on Thursday the House passed their version of the tax bill 227-205 along party lines, with 13 Republicans opposing. The passage of the House bill was met with muted market reaction. The Senate version of the tax reform is currently going through the Senate Finance Committee for additional amendments and should be ready for a full floor debate in a few weeks. While some, like Goldman, give corporate tax cuts (if not broad tax reform), an 80% chance of eventually becoming law in the first quarter of 2018, others like UBS and various prominent skeptics, do not see the House and Senate plans coherently merging into a survivable proposal. 

Indeed, while momentum seemingly is building for the tax plan, some prominent analysts believe there are several issues down the road that could trip up or even stall a comprehensive tax plan from passing the Congress, the chief of which is how to combine the House and Senate plans into one viable bill.

How are the two plans different? 

Below we present a side by side comparison of the two plans from Bank of America, which notes that the House and the Senate are likely to pass different tax plans with areas of disagreement (see table below). This means that the two chambers will need to form a conference committee to hash out the differences. There are three major friction points:

  1. the repeal of the state and local tax deductions (SALT),
  2. capping mortgage interest deductions and
  3. the delay in the corporate tax cut.

The House seems strongly opposed to fully repealing SALT and delaying the corporate tax cuts and the Senate could push back on changing the mortgage interest deductions. Finding compromise on these issues without disturbing other parts of the plan while keeping the price tag under the $1.5tn over 10 years could be challenging.

Here are the key sticking points per BofA:

  • Skinny ACA repeal: The repeal of the individual mandate is back on the table. It would free up approximately $300bn in revenue to pay for the tax plan. But this likely means no Democratic Senator will support the bill. This could prove costly as the Republicans can only afford to lose 2 votes and several Republican Senators are already on the fence on the tax plan.
  • Byrd Rule means tax plan might not hatch: Reconciliation directives allow the tax plan to add $1.5tn to the deficit in the first 10 years (See appendix for breakdown of the cost of each plan). However, rules in the Senate state that any bill passed under reconciliation has to be revenue neutral beyond the 10 year budget window. Given that the Republicans are hoping to make the corporate tax cuts permanent, it would mean that they would need to find additional revenue in the out years while sunsetting all other tax cut provisions (e.g. personal tax cuts). This will mean the personal tax code at best will revert back to current law or at worst roll back the cuts and preserve the repeal of the deduction which would amount to a tax increase on households after ten years. Currently, the Senate plan would let reduction in the personal tax rates, expansions of the standard deduction and child tax credit and other provisions expire after 2025. The court of public opinion could threaten the tax plan.

And while it remains to be seen if tax reform will pass the Senate, or like Obamacare repeal, it will get shot down by the like of McCain (and perhaps Corker), another key question, is whether the US even needs tax reform at this point – the Fed certainly could do without the added inflationary pressure – and whereas former Goldman COO and Trump’s econ advisor, Gary Cohn certainly thinks so, his former boss, Lloyd Blankfein disagrees. So does Bank of America, which maintains that at this stage of the business cycle, tax cuts are not needed to sustain the current expansion. Nevertheless, BofA concedes the passage of a comprehensive tax plan would likely lead to a short term boost to growth which would translate to further declines in the unemployment rate and higher inflation.

Then, as the economy begins to heat up, the Fed will likely lean against the economy by implementing a faster hiking cycle than currently projected, which will ultimately spark the next market crash, recession and financial crisis. Ironically, the seed of Trump’s own destruction would be planted by his biggest political victory yet (assuming tax reform passes, of course).

* * *

As a bonus, here is a simulation BofA ran using the Fed’s FRB/US model to calculate the potential costs of the tax plans. BofA ran its simulations assuming model consistent expectations for all sectors of the economy and using the inertial Taylor rule to set the path of the federal funds rate: “o simulate the impact of the fiscal stimulus brought on by the tax cuts, we make the fiscal setting exogenous during the first 10 year period and adjust the path for corporate and personal income taxes to take into account the government revenue effects from the tax plan.”

Costs aside, to get a sense of the economic impact from the two tax plans, BofA similarly models the two plans’ outcomes using the FRB/US macroeconomic model. The simulation results suggest under the House plan, the US would see a boost to aggregate demand as growth would be approximately 0.4pp higher relative to baseline in 2018 and 0.3pp higher in 2019. Better aggregate demand would reduce the unemployment rate by 0.3pp by 2019 and put upward pressure on inflation. These growth and price dynamics would lead the FOMC to raise rates an additional 1 to 2 hikes over the next two years. The economic impact from the Senate plan would be slightly more modest but in the same ballpark as the House plan. Under the Senate plan, the model predicts growth to be approximately 0.3pp higher in both 2018 and 2019 and similar dynamics for the unemployment rate and inflation as seen in the House plan, leading the FOMC to tighten quicker than the current baseline path.

There is also an “alternative” scenario where we a watered down version of the tax plan passes (i.e. modest tax cuts for middle-income households and a corporate tax cut near 25-28% that is deficit increasing by $600bn-$800bn on a static basis). Under the “alternative” scenario, we would see approximately half the economic impact that is seen under the House plan. Given that such a plan would likely only generate modest inflationary pressures, the Fed’s response likely would be relatively muted and it would likely stay on its baseline path.

http://WarMachines.com

Frontrunning: November 16

  • Senate Panel Approves Tax Plan as GOP Leaders Gird for Fight (BBG)
  • U.S. towns, cities fear taxpayer revolt if Republicans kill deduction (Reuters)
  • After House Victory, Tax-Overhaul Fight Now Goes to Senate (WSJ)
  • Analysts flee Wall Street with gallows humor as research changes loom (Reuters)
  • Tesla Unveils ‘World’s Fastest Production Car’ and Electric Big Rig (BBG)
  • Bitcoin Emerges as Crisis Currency in Hotspots (BBG)
  • Ivanka Trump and the fugitive from Panama (Reuters)
  • Murdoch Empire in Play as Suitors Line Up for 21st Century Fox Assets (WSJ)
  • Franken Case Puts Both Parties in Bind on Misconduct Response (BBG)
  • Crime Wave Engulfs Sweden as Fraud, Sexual Offenses Reach Record (BBG)
  • Google Has Picked an Answer for You—Too Bad It’s Often Wrong (WSJ)
  • Saudi Arabia swapping assets for freedom of some held in graft purge: sources (Reuters)
  • Metal recyclers prepare for electric car revolution (Reuters)
  • Despite Big Push From Beijing, Electric Cars Struggle in China (WSJ)
  • Harvard’s Days as the World’s Richest School May Be Numbered (Reuters)
  • Sears Dials Up Discounts to Record Levels as It Copes With Slump (BBG)
  • Zimbabwe’s Mugabe Makes First Public Appearance Since Military Takeover (WSJ)
  • Hassett Bets on 3% U.S. Growth That Summers Sees in Fairyland (BBG)
  • Two Weeks of Frenzied Negotiations Led to Bank-Relief Deal (WSJ)

 

Overnight Media Digest

WSJ

– The House of Representatives passed a bill that would usher in the most far-reaching overhaul of the U.S. tax system in 31 years, a plan that would reduce the corporate tax rate to its lowest point since 1939 and cut individual taxes for most households in 2018. on.wsj.com/2j1JjUr

– New suitors are circling Twenty-First Century Fox Inc , affirming that the media empire built by Rupert Murdoch is now in play. Comcast Corp has approached the media company. Verizon Communications Inc and Sony Corp are also kicking the tires. on.wsj.com/2j0i38O

– A federal judge declared a mistrial in the corruption trial of U.S. Sen. Bob Menendez, giving the Democrat a political lifeline and preserving his party’s control of the seat for the near future. on.wsj.com/2j1LebB

– Meredith Corp has made a takeover bid for storied magazine publisher Time Inc in the range of $17 to $20 a share, according to people familiar with the situation. on.wsj.com/2j0Ht6p

– An activist investor in Barnes & Noble Inc has proposed a transaction that would take the bookseller private with the help of current shareholders and a hefty dose of borrowings, an effort that could face formidable obstacles. on.wsj.com/2j0EvP6

– Emerson Electric Co boosted its takeover offer for Rockwell Automation Inc, ratcheting up an effort to bring its reluctant rival to the negotiating table and forge a new giant in industrial automation. on.wsj.com/2j21qd2

 

NYT

– With 227 Republican votes, the House passed the most sweeping tax overhaul in three decades on Thursday as U.S. lawmakers seek to enact $1.5 trillion in tax cuts for businesses and individuals and deliver the first major legislative achievement of President Donald Trump’s tenure. nyti.ms/2hDqQRs

– The cable company Comcast Corp is in preliminary talks to buy entertainment assets owned by Twenty-First Century Fox Inc, including a vast overseas television distribution business. nyti.ms/2hxkbof

– Tesla Inc has aimed to reinvent the automobile and the way electricity is generated for homes. In a presentation by its chief executive, Elon Musk, Tesla unveiled a prototype for a battery-powered, nearly self-driving semi truck that the company said would prove more efficient and less costly to operate than the diesel trucks that now haul goods across the country. nyti.ms/2zJPgzU

– The senior American diplomat at the United Nations climate talks in Germany told world leaders on Thursday that the United States would remain engaged in global climate change negotiations even as it planned to exit the Paris agreement “at the earliest opportunity.” nyti.ms/2ySE1Bd

– The Federal Communications Commission voted on Thursday to allow a single company to own a newspaper and television and radio stations in the same town, reversing a decades-old rule aimed at preventing any individual or company from having too much power over local coverage. nyti.ms/2zN7YpA


Britain

The Times

* Prudential Plc is scaling up its ambitions in Asia with plans to open a fund management venture in China and to double in size in the region every few years. bit.ly/2jxRjAk

* WPP said it was prepared to increase its stake in Asatsu-DK, one of the largest marketing services companies in Japan, to about a third after requests from other shareholders. bit.ly/2jwULvg

The Guardian

* The business secretary, Greg Clark, has been urged by the GMB union to block the proposed merger of German energy group Innogy’s British unit, npower with SSE’s British retail supply business .bit.ly/2jxZCMG

* The chief executive designate of GKN, Kevin Cummings, has been ousted from the FTSE 100 company weeks before he was due to take up the top job at the aerospace and engineering firm. bit.ly/2jz3GvX

The Telegraph

* Jaguar Land Rover has quietly started testing driverless cars on British roads that are simultaneously being used by the general public, in a clear indication that Britain’s biggest manufacturer is determined the country will play a leading role in the race to develop autonomous vehicles. bit.ly/2jyNx9Z

* The Serious Fraud Office has made its first charges against Unaoil employees in relation to a corruption scandal that has engulfed the oil and gas industry. bit.ly/2jy7he2

Sky News

* The boss of U.S. investment bank Goldman Sachs, Lloyd Blankfein, has used his latest Twitter post on Brexit to suggest a second referendum is held. bit.ly/2jyVwnr

* The GMB union’s Scotland secretary, Gary Smith, has told Sky News a dispute threatening 1,400 jobs is a battle for the future of skilled manufacturing in Scotland. bit.ly/2jy60U4

The Independent

* Rail passengers on the UK’s leading long-distance network face disruption and cancellations after Virgin Trains staff belonging to the RMT union voted to strike by a majority of 10 to one. ind.pn/2jvIwil

* Retail sales continued to grow in October according to the latest official data, easing some of the fears of a plunge in consumer spending. A survey of retailers by the CBI had suggested the fastest rate of decline in sales in October since the UK’s last recession in 2009. ind.pn/2jyWfFb

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Mueller Subpoena Spooks Dollar, Sends European Stocks, US Futures Lower

Yesterday’s torrid, broad-based rally looked set to continue overnight until early in the Japanese session, when the USD tumbled and dragged down with it the USDJPY, Nikkei, and US futures following a WSJ report that Robert Mueller had issued a subpoena to more than a dozen top Trump administration officials in mid October.

And as traders sit at their desks on Friday, U.S. index futures point to a lower open as European stocks fall, struggling to follow Asian equities higher as the euro strengthened at the end of a tumultuous week. Chinese stocks dropped while Indian shares and the rupee gain on Moody’s upgrade. The MSCI world equity index was up 0.1% on the day, but was heading for a 0.1% fall on the week. The dollar declined against most major peers, while Treasury yields dropped and oil rose. 

Europe’s Stoxx 600 Index fluctuated before turning lower as much as 0.3% in brisk volumes, dropping towards the 200-DMA, although about 1% above Wednesday’s intraday low; weakness was observed in retail, mining, utilities sectors. In the past two weeks, the basic resources sector index is down 6%, oil & gas down 5.8%, autos down 4.9%, retail down 3.4%; while real estate is the only sector in green, up 0.1%. The Stoxx 600 is on track to record a weekly loss of 1.3%, adding to last week’s sell-off amid sharp rebound in euro, global equity pullback. The Euro climbed for the first time in three days after ECB President Mario Draghi said he was optimistic for wage growth in the region, although stressed the need for patience, speaking in Frankfurt. European bonds were mixed. The pound pared some of its earlier gains after comments from Brexit Secretary David Davis signaling a continued stand-off in negotiations with the European Union.

In Asia, the Nikkei 225 took its time to catch up to the WSJ report that US Special Counsel Mueller has issued a Subpoena for Russia-related documents from Trump campaign officials, although reports pointing to North Korea conducting ‘aggressive’ work on the construction of a ballistic missile submarine helped the selloff. The Japanese blue-chip index rose as much as 1.8% in early dealing, but the broad-based dollar retreat led to the index unwinding the bulk of its gains; the index finished the session up 0.2% as the yen jumped to the strongest in four-weeks. Australia’s ASX 200 added 0.2% with IT, healthcare and telecoms leading the way, as utilities lagged. Mainland Chinese stocks fell, with the Shanghai Comp down circa 0.5% as the PBoC’s reversel in liquidity injections (overnight net drain of 10bn yuan) did little to boost risk appetite, as Kweichou Moutai (viewed as a bellwether among Chinese blue chips) fell sharply. This left the index facing its biggest weekly loss in 3 months, while the Hang Seng rallied with IT leading the way higher. Indian stocks and the currency advanced after Moody’s Investors Service raised the nation’s credit rating.

The dollar was pressured even as tax reform moved a step forward given Trump-Russia probe came back into focus. Two-year Treasury yield hit a fresh high and bonds slipped. The euro stayed on course to its best week in two months as Draghi remains bullish on prospects of higher wages; the kiwi hit its lowest level since June 2016.

Meanwhile, the U.S. Treasury yield curve remained on investors’ radar, reaching its flattest levels in a decade, reflecting a belief that the Federal Reserve will continue to raise interest rates.

The U.S. House of Representatives passed a tax overhaul expected to boost share prices if it becomes law. The legislative battle now shifts to the Senate. As Bloomberg notes, as “Washington took one step closer to tax reform and China’s central bank injected the most cash since January into its financial system this week, investors have been trying to decide if resilient global growth and strong earnings forecasts warrant sticking it out in equities. Lofty valuations contributed to fund managers paring back some exposure after global shares reached record highs earlier this month.”

As earnings season drew to a close with 90 percent of U.S. and European companies having reported, analysts said results were supportive but weaker than the previous quarters. “While they look good overall, the strong momentum apparent since Q1 is now fading,” said Societe Generale analysts, adding that consensus earnings estimates are no longer being raised for U.S. or euro zone stocks.

As also reported on Thursday, Fed’s Williams suggested that central banks should consider unconventional policy tools for use in the future, including higher inflation targets and income targeting. Williams also suggested that negative rates need to be on list of potential tools if the US enters a recession, even as he said that a December hike, followed by 3 hikes in 2018 is perfectly reasonable. “What really matters is gradual normalisation not timing, should raise rates to around 2.5% in the next couple of years” he said adding that “Low inflation in a way is lucky as it allows strong growth, however, if it does not pick up over the next few years he will re-think the rate path.”

Oil prices were on track for weekly losses, slipping from two-year highs hit last week on signs that U.S. supply is rising and could potentially undermine OPEC’s efforts to tighten the market. U.S. light crude stood at $55.53 a barrel, up 0.7 percent on the day but still within its trading range in the past couple of days. It was down 2.1 percent on the week. Brent futures hit a two-week low of $61.08 a barrel but last stood 0.3 percent higher at $61.53. It was down 3.1 percent for the week.

Economic data today includes housing starts, building permits.

Market Snapshot

  • S&P 500 futures down 0.1% to 2,583.25
  • STOXX Europe 600 down 0.2% to 384.06
  • MSCI Asia up 0.4% to 170.15
  • MSCI Asia ex Japan up 0.5% to 558.90
  • Nikkei up 0.2% to 22,396.80
  • Topix up 0.1% to 1,763.76
  • Hang Seng Index up 0.6% to 29,199.04
  • Shanghai Composite down 0.5% to 3,382.91
  • Sensex up 0.8% to 33,377.55
  • Australia S&P/ASX 200 up 0.2% to 5,957.25
  • Kospi down 0.03% to 2,533.99
  • German 10Y yield rose 1.1 bps to 0.387%
  • Euro up 0.2% to $1.1795
  • Brent Futures up 0.7% to $61.78/bbl
  • Italian 10Y yield rose 0.2 bps to 1.572%
  • Spanish 10Y yield rose 0.6 bps to 1.548%
  • Brent Futures up 0.7% to $61.78/bbl
  • Gold spot up 0.3% to $1,282.59
  • U.S. Dollar Index down 0.3% to 93.69

Top Overnight News

  • House Republicans pass tax bill, while Senate Finance Committee approves different version
  • Special Counsel Robert Mueller is said to have served President Donald Trump’s election campaign a subpoena in mid-October seeking documents related to Russia contacts
  • ECB President Mario Draghi said he was confident for wage growth in the euro area
  • While U.K. Brexit Secretary David Davis said there would be some clarity on the Britain’s divorce bill with the European Union in a “a few more weeks,” there are signs that talks with EU leaders are in a new stand-off
  • Japanese PM Shinzo Abe says he will push through initiatives to boost productivity and compile a new economic policy package next month
  • Canada is open to a Mexican proposal to review the North American Free Trade Agreement every five years instead of ending the deal automatically if not renegotiated, which the U.S. had demanded, Reuters reports, citing two unidentified government sources
  • Senate Panel Approves Tax Plan as GOP Leaders Gird for Battle
  • Murdoch Has His Pick of Suitors as He Ponders Fox’s Fate; Sky Rises Most Since June on Interest From Comcast, Verizon
  • Chinese Stocks Tumble as State Media Warning Triggers Selloff
  • India’s First Moody’s Upgrade in 14 Years Bets on Reforms
  • Draghi Says Confidence on Inflation Will Help Drive Wage Gains
  • China Issues Draft Rules to Curb Asset Management Product Risks
  • Bitcoin Flirts With Record $8,000 High, Leaving Sell-Off Behind
  • PDVSA Looks Like a ‘Zero’ to Man Who Ran Elliott’s Argentina Bet
  • Manafort Spent Millions on Home Updates But Numbers Don’t Add Up
  • Tesla Seals Order From Michigan Grocery Chain for Semi Trucks
  • Luxoft Holding Second Quarter Adjusted EPS Beats Estimates
  • JPMorgan’s Gu Sees ‘Very Robust’ Pipeline for Hong Kong IPOs

In Asia, the Nikkei 225 took its time to catch up to a report suggesting that US Special Counsel Mueller has issued a Subpoena for Russia-related documents from Trump campaign officials, although reports pointing to North Korea conducting ‘aggressive’ work on the construction of a ballistic missile submarine probably helped the selloff. The Japanese blue-chip index rose as much as 1.8% in early dealing, but the broad-based dollar retreat led to the index unwinding the bulk of its gains; the index finished the session up 0.2%. Australia’s ASX 200 added 0.2% with IT, healthcare and telecoms leading the way, as utilities lagged. Mainland Chinese stocks fell, with the Shanghai Comp down circa 0.4% as the PBoC’s injections have done little to underscore risk appetite, as Kweichou Moutai (viewed as a bellwether among Chinese blue chips) fell sharply. This left the index facing its biggest weekly loss in 3 months, while  the Hang Seng rallied with IT leading the way higher. The PBoC injected a net CNY 810bln this week, against a net drain of CNY 230bln last week. Japanese PM Abe promised to rid the country of deflation once and for all. He pledged to use all policy tools, including tax reforms and deregulation, to push up wages in order to put an end to the country’s persistent deflation he also noted that he wants to increase pressure on North Korea along with the international community. Japanese Finance Minister Aso stated that Japan is to continue to firmly escape deflation. South Korea’s FX authority warned that the pace of the KRW’s gains has been fast. A BoK official warned that the KRW has appreciated fast in a short time, and reiterates that FX authorities are monitoring the situation. Moody’s raised India’s sovereign rating to Baa2 from Baa3, outlook to stable from positive.

Top Asian News

  • India Rating Raised by Moody’s as Reforms Boost Growth Potential
  • China to Rein Risks in Asset Management Industry
  • China Warning Wipes $6 Billion From Stock Loved by Goldman
  • Erdogan Says Turkey Has Withdrawn Troops From NATO Exercise
  • China Stocks Cap Worst Week Since August as Moutai Battered

European bourses trading modestly lower this morning, with downbeat earnings weighing sentiment, while the spill-over from a soft Asian session has dented risk in Europe. Vivendi shares had been lower as much as 2% after a weak earnings update. FTSE 100 slipping slight amid the strength in GBP, which is back above 1.32 against the greenback. Comments from ECB’s Draghi have sparked some additional movement, as while largely sticking to the post-October 26 policy meeting presser he appeared more confident about the growth and inflation outlook (economic activity more self-propelling, underlying inflation to converge with headline etc). Hence, a decline in Bunds below parity to a 162.50 low, but again not yet posing a real threat to more substantial downside targets/supports. Market contacts suggest that 162.48 needs to be breached from an intraday chart perspective to bring Thursday’s 162.38 Eurex base into contention, and recall there are more/bigger stops anticipated below 162.36. On the upside, assuming 162.48 holds, yesterday’s 162.82 session high is the first proper line of resistance. Gilts have also retreated into negative territory alongside Bunds and USTs, to 124.45 vs 124.77 at best and their 124.72 previous settlement.

Top European News

  • We’ll Wait for U.K. Brexit Concessions, EU Leaders Tell May
  • From EON to Fortum: How to Save Nasdaq’s Fading Power Market
  • Carige Talks With Underwriters Continue as Deadline Looms
  • Elior Plunges Most on Record as Hurricane Irma Wrecks Party
  • Norway Idea to Exit Oil Stocks Is ‘Shot Heard Around the World’

In FX, the USD is down again, but off worst levels seen so far this week as the Index holds within a 93.500-93.900 broad range. Some respite for Dollar from progress on the tax reform bill, but another Russian-related probe into Trump’s election campaign has capped the upside. The Euro was underpinned by upbeat comments from ECB President Draghi, and holding close to 1.1800 vs the Usd. Hefty option expiries still in play from 1.1790-1.1800 through 1.18250 and up to 1.1840-50. The Yen regaining a safe-haven bid amid the latest US political challenge against the President, with Usd/Jpy down to new multi-week
lows sub-112.50. AUD/NZD is the biggest G10 losers on broad risk-off sentiment and the recovering Greenback, with Aud/Usd back below 0.7600 and Nzd/Usd even weaker under the 0.6800 handle. Note, cross flow also weakening the Kiwi as Aud/Nzd trades back at 1.1100+ levels.

In commodities, Brent and WTI crude futures trading higher by 0.4% and 1.3% respectively, the latter making a break above yesterday’s at USD 55.59, however has met resistance at the USD 56 handle. Iraq/Kurd oil flow to Ceyhan rises to 254k bpd, according to Port Agent

Looking at the day ahead, a slightly quieter end to the week although the ECB’s Draghi is due to give a keynote address on “Europe into a new era – how to seize the opportunities”. The Bundesbank’s Weidmann is also slated to speak while the Fed’s Williams speaks in the evening. US housing starts for October and the Kansas City Fed’s manufacturing activity index for November are the data highlights.

US Event Calendar

  • 8:30am: Housing Starts, est. 1.19m, prior 1.13m; MoM, est. 5.59%, prior -4.7%
  • 8:30am: Building Permits, est. 1.25m, prior 1.22m; MoM, est. 2.04%, prior -4.5%
  • 10am: MBA Mortgage Foreclosures, prior 1.29%; Mortgage Delinquencies, prior 4.24%
  • 11am: Kansas City Fed Manf. Activity, est. 20.5, prior 23

DB’s Jim Reid concludes the overnight wrap

Maybe the S&P 500 will be the new hard currency of the world as nothing seems to break it at the moment. After a very nervous last week (longer in HY and EM) for markets, the S&P 500 closed +0.82% last night (best day since September 11th) and for all the recent fury and angst is only 0.34% off its’ all-time closing high. The Nasdaq gained 1.30% to a fresh all time high and the Stoxx 600 was also up for the first time in eight days. The positive reaction seems to have started in Asia yesterday, in part as commodity prices stabilised somewhat and news that China’s PBoC injected cash with the largest reverse repo operation since January. Then US markets got an additional boost from Cisco guiding to its first revenue gain in eight quarters and Wal-Mart posting its strongest US sales in more than eight years. There was also a little sentiment boost from the House passing its tax bill.

This morning in Asia, markets are strengthening further. The Nikkei (+0.11%), Hang Seng (+0.78%) and Kospi (+0.28%) are all modestly up while the Shanghai Comp. is down 0.55% as we type. Moody’s upgraded India’s sovereign bond rating for the first time since 2004. It’s one notch higher to Baa2/Stable (also one notch higher than S&P’s BBB-) with the agency citing ongoing progress in economic and institutional reforms. India’s 10y bond yields is down c10bp this morning to 6.96%. Elsewhere, UST 10y has partly reversed yesterday’s moves and is trading c2bp lower.

Now back to US tax reforms, which is a small step closer to resolution. The House has voted (227-205) to pass its version of the tax reform bill despite 13 Republicans dissenting. President Trump tweeted “a big step toward fulfilling our promise to deliver historic tax cuts…by the end of the year”. Notably, the more challenging task may now begin in terms of passing the Senate’s version where fiscal constraints are tighter and the Republicans only have 52 of the 100 seats in the Chamber. Overnight, the Senate Finance Committee voted to approve its revised tax package, so a full chamber vote could come as early as the  week after Thanksgiving. If passed, the two versions of the tax bill will need to be somehow reconciled. Our US economist believes there is a decent chance that some version of tax reform can be achieved, but this is likely to be a Q1 event with potential stumbling blocks along the way.

Turning to the various Brexit headlines, PM May flew out last night to Sweden for an informal summit with European leaders seeking to kick start the stalled Brexit talks. She is expected to meet with the Swedish Premier and Irish counterpart before meeting with EU President Tusk on Friday. Following on, the Brexit Secretary Davis noted that we have to “wait a few more weeks” for clarity on how much UK is willing to pay in the divorce settlement. Elsewhere, Goldman Sachs CEO Blankfein tweeted “many (fellow business leaders) wish for a confirming vote on (Brexit)…so much at stake, why not make sure consensus still there?”

Moving onto central bankers’ commentaries. In the US, the Fed’s Mester sounded reasonably balanced and remains supportive of continued gradual policy tightening. She noted “anecdotal feedback from business contacts suggest they are increasing wages”, but it’s going to be hard to see strong wage growth because productivity growth is low. Overall, she sees “good reasons” that inflation will rise back to 2% goal, but “it’s going to take a little longer…”

The Fed’s Williams noted one more rate hike this year and three more in 2018 remains a “reasonable guess” subject to incoming data. Finally, the Fed’s Kaplan  reiterated the Fed would continue to make progress towards achieving its 2% inflation target, but noted that the neutral fed funds rate is “not that far away”.

In the UK, BOE Governor Carney reiterated that interest rates would probably rise “a couple of times over the next few years” if the economy evolved in line with the Bank’s projections, but also cautioned that the fundamental economic impacts of Brexit will only be “known over a very long period of time”. That said, he noted the BOE will remain nimble and support the economy no matter what the result of the Brexit negotiations will be. Elsewhere, Chancellor Hammond has confirmed that the Treasury does not plan to change the inflation gauge that the BOE targets from CPI to CPIH – which includes owner occupied housing costs and is the new preferred price measure by the Office for National Statistics.

Now recapping other markets performance yesterday. Within the S&P, only the energy and utilities sector were modestly in the red (-0.58%), partly weighed down by Norway’s sovereign wealth fund plans to sell c$40bln of energy related stocks to make it less vulnerable to the sector. Elsewhere, gains were led by telco, consumer staples and tech stocks. European markets were all higher, with the DAX and CAC up c0.6% while the FTSE 100 was the relative underperformer at +0.19%. The VIX index dropped 10.4% to 11.76.

Over in government bonds, UST 10y yields rose 5.3bp following the House’s approval of the tax plans and a solid beat for industrial production, while Gilts also rose 2.3bp, in part due to slightly stronger retail sales figures. Other core bond yields were little changed (10y Bunds flat, OATs -0.4bp), while Italian yields marginally underperformed (+0.5bp), partly reflecting that Banca Carige has failed to get banks to underwrite its planned share sale – making a bail in more likely, as well as recent polls (eg: Ipsos) showing the 5SM party taking a modest lead versus peers. Elsewhere, some of the recent pressure in the HY space appears to be reversing with the Crossover index 9.2bp tighter.

Key currencies were little changed, with the US dollar index up 0.13% while Sterling gained 0.18% and Euro fell 0.18%. In commodities, WTI oil dipped 0.34% yesterday but is trading marginally higher this morning after Saudi Arabia reaffirmed its willingness to extend oil cuts at the November 30 OPEC meeting. Elsewhere, precious metals were slightly higher (Gold +0.03%; Silver +0.54%) while other base metals continue to softened, although losses are moderating (Copper -0.17%; Zinc -0.84%; Aluminium -0.35%).

Away from the markets, our US economists have published their latest outlook for the US economy. They note the US economy is on good footing for continued above-trend growth in 2018 and beyond. Overall, they believe private sector fundamentals are broadly sound, the labour market has more than achieved full employment and financial conditions are highly supportive of growth. On real GDP growth, their forecast for 2018 is unchanged at 2.3%, but 2019 is up a tenth to 2.1% while growth in 2020 is expected to slow to 1.5% as monetary policy tightening gains traction. The Unemployment rate is expected to fall to 3.5% by early 2019, so although inflation should remain low through year-end, our team’s medium-term view that core inflation should normalise is intact. Hence, in terms of rates outlook, they still expect the next rate increase in December, followed by three hikes in 2018 and four more in 2019. Elsewhere, tax reform is a wild card, though it faces significant political challenges. Conversely, potential disruptions to trade policy would be a negative development. For more detail, refer to their note.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the October IP was above expectations at 0.9% mom (vs. 0.5%) and 2.9% yoy – the highest since January 2015, in part as the post storm recovery efforts gets underway. Aggregate capacity utilization was also beat at 77% (vs. 76.3% expected) – highest since April 2015 and the NAHB housing market index was also above at 70 (vs. 67) – highest since March. Elsewhere, the November Philly Fed index was slightly below expectations but still solid at 22.7 (vs. 24.6 expected), with both the new orders and employment indices above 20. Finally, the weekly initial jobless claims was slightly higher (249k vs. 235k expected), perhaps impacted by the delayed filings following the storms and the Veteran’s day holiday, while continuing claims fell to a new 44 year low (1,860k vs. 1,900k expected).

In the UK, core retail sales (ex-auto fuel) for October slightly beat expectations, at 0.1% mom (vs. flat expected) and -0.3% yoy (vs. -0.4% expected). In the Eurozone, the final reading for October CPI was unrevised at 0.1% mom and 1.4% yoy, but France’s 3Q unemployment was slightly higher than expected at 9.7% (vs. 9.5%).

Looking at the day ahead, a slightly quieter end to the week although the ECB’s Draghi is due to give a keynote address on “Europe into a new era – how to seize the opportunities”. The Bundesbank’s Weidmann is also slated to speak while the Fed’s Williams speaks in the evening. US housing starts for October and the Kansas City Fed’s manufacturing activity index for November are the data highlights.

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Fed Officials Push Radical Change In Monetary Policy As Powell Takes Over

Oh no…with the Federal Reserve in a state of flux as one Chairman prepares to step down and another (shock horror, who is not an economist) takes over, some of his colleagues who think they’ve found the “Holy Grail” of monetary policy are agitating for change. And, dare we say it, hoping it will raise their own prestige no doubt. We are specifically referring to John Williams, President and CEO of the San Francisco Fed, but it’s not just him. What they have in their crosshairs is the Fed’s 2% inflation target. It’s too low. According to Bloomberg.

Federal Reserve officials are pushing for a potentially radical revamp of the playbook for guiding U.S. monetary policy, hoping to seize a moment of economic calm and leadership change to prepare for the next storm. While the country is enjoying its third-longest expansion on record, inflation and interest rates are still low, meaning the central bank has little room to ease policy in a downturn before hitting zero again. With Jerome Powell nominated to take over as Fed chairman in February, influential officials including San Francisco Fed chief John Williams and the Chicago Fed’s Charles Evans have taken the lead in calling for reconsidering policy maker’s 2 percent inflation target.

It looks like they’ve got the backing of a recent Fed appointee (June 2017) as the report continues.

“It’s a good time given the shift in leadership,” Atlanta Fed President Raphael Bostic told reporters on Tuesday in Montgomery, Alabama. “The new guy comes in and they are able to really think about, how should this work, how do I think this should work, and is it compatible with where we’ve been and where we are trying to get to?”

The justification for the policy changes these Fed officials are advocating boils down to what Williams refers to as a “Low R-star World”, i.e. one where the natural rate of interest is very low.

The problem with what they have in mind is the Fed’s explicit 2% inflation target. However, it’s a relatively recent adoption, so Williams and Evans have to tread carefully, so as not to offend too many incumbents.

The Fed in 2012 officially settled on 2 percent inflation as an explicit target for the price stability half of its dual mandate from Congress. The other goal is maximum sustainable employment. The move formalized a policy they’d been following in practice for several years, and it was backed by careful logic: 2 percent is high enough to ensure that workers continue to get raises and to give the Fed some cushion against deflation. Other advanced economies aim for a similar level. Yet Fed officials, most loudly Williams, have been urging the policy-setting Federal Open Market Committee to revisit that approach. The reason? The target was settled at a time when officials thought they’d have no problem in lifting interest rates to 2 percent or higher without choking off growth. But fundamentals in the economy have changed since the crisis. Growth and productivity have been tepid. As a result, the so-called neutral level of interest rates — which neither speeds up or slows the economy – is very low by historic standards, leaving the Fed with less wiggle room.

What it boils down to is these senior Fed officials want to let the inflation genie out of the bottle just that little bit more…let the economy run “hot” for a while, without losing control, of course. Then they can cut rates more aggressively in the next downturn and “save us”.

Allowing prices to rise slightly higher would give the Fed more scope to ease in the next downturn. The federal funds rate is quoted in nominal terms, or not adjusted for inflation. So if neutral stands at 0.5 percent, in real terms, and prices are rising at a 3 percent pace, the Fed can get rates as high as 3.5 percent before policy would be restrictive. If inflation were only 2 percent, that level in nominal terms would be 2.5 percent.

Which sounds like a policy of less adherence to price stability, although we could be mistaken. Meanwhile, Williams is trying not to be too brazen and is advancing his ideas cautiously.

Williams told reporters in early November that he favors discussing a new framework now, though he doesn’t want to tie the talks to near-term strategy. “It would be optimal to have a decision around what’s the best framework that we should be using well before the next recession,” he said, because it will “take some time” for officials to hammer out such an important policy. Alternative approaches could include allowing prices to overshoot for the same amount of time they undershot — commonly called price-level targeting — or even raising the desired inflation goal to 3 percent.

There we have it, just more confirmation that central bankers are, at heart, inflation junkies. Yep…we knew it all along, of course, but it’s fascinating to watch them articulate it in an innocent manner. As Bloomberg informs us, yet another Fed Governor, Harker, is ready to overhaul policy when Powell sits in the Chairman’s chair.

“There’s a host of possible options, and I have not settled on any one of those yet,” but it merits a discussion “now,” Philadelphia Fed President Patrick Harker said in an interview with Bloomberg News earlier this month.

 

“This is a discussion we’re going to have to have within the Fed, and within the broad economic community."

 

There’s good reason to discuss the future of monetary policy now. The unemployment rate is low and growth is humming along steadily, and though inflation remains below target, officials expect it to pick up in coming months.

 

In this period of economic calm, economists can debate the merits of different approaches slowly and carefully. “Developing a new framework prior to the next zero-lower bound episode allows time for a shift in the nature of forward guidance — and communications more generally,” Evans said Tuesday in Frankfurt. The policies would then be better understood, better refined, and “therefore, likely be more effective,” he said.

So we need to prepare for a change in Fed policy and one that justifies a higher inflation target. Were they to achieve this target, it will obviously be bad news for the 80% of American’s whose incomes are already trailing the cost of living as we discussed.

But being stupid in an intellectual way is a defining characteristic of this generation of central bankers.

 

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Fed Hints During Next Recession It Will Roll Out Income Targeting, NIRP

In a moment of rare insight, two weeks ago in response to a question “Why is establishment media romanticizing communism? Authoritarianism, poverty, starvation, secret police, murder, mass incarceration? WTF?”, we said that this was simply a “prelude to central bank funded universal income”, or in other words, Fed-funded and guaranteed cash for everyone.

On Thursday afternoon, in a stark warning of what’s to come, San Francisco Fed President John Williams confirmed our suspicions when he said that to fight the next recession, global central bankers will be forced to come up with a whole new toolkit of “solutions”, as simply cutting interest rates won’t well, cut it anymore, and in addition to more QE and forward guidance – both of which were used widely in the last recession – the Fed may have to use negative interest rates, as well as untried tools including so-called price-level targeting or nominal-income targeting.

The bolded is a tacit admission that as a result of the aging workforce and the dramatic slack which still remains in the labor force, the US central bank will have to take drastic steps to preserve social order and cohesion.

According to Williams’, Reuters reports, central bankers should take this moment of “relative economic calm” to rethink their approach to monetary policy. Others have echoed Williams’ implicit admission that as a result of 9 years of Fed attempts to stimulate the economy – yet merely ending up with the biggest asset bubble in history – the US finds itself in a dead economic end, such as Chicago Fed Bank President Charles Evans, who recently urged a strategy review at the Fed, but Williams’ call for a worldwide review is considerably more ambitious.

Among Williams’ other suggestions include not only negative interest rates but also raising the inflation target – to 3%, 4% or more, in an attempt to crush debt by making life unbearable for the majority of the population – as it considers new monetary policy frameworks. Still, even the most dovish Fed lunatic has to admit that such strategies would have costs, including those that diverge greatly from the Fed’s current approach. Or maybe not: “price-level targeting, he said, is advantageous because it fits “relatively easily” into the current framework.”

Considering that for the better part of a decade the Fed prescribed lower rates and ZIRP as the cure to the moribund US economy, only to flip and then propose higher rates as the solution to all problems, it is not surprising that even the most insane proposals are currently being contemplated because they fit “relatively easily” into the current framework.

Additionally, confirming that the Fed has learned nothing at all, during a Q&A in San Francisco, Williams said that “negative interest rates need to be on the list” of potential tools the Fed could use in a severe recession. He also said that QE remains more effective in terms of cost-benefit, but “would not exclude that as an option if the circumstances warranted it.”

“If all of us get stuck at the lower bound” then “policy spillovers are far more negative,” Williams said of global economic interconnectedness. “I’m not pushing for” some “United Nations of policy.”

And, touching on our post from mid-September, in which we pointed out that the BOC was preparing to revising its mandate, Williams also said that “the Fed and all central banks should have Canada-like practice of revisiting inflation target every 5 years.”

Meanwhile, the idea of Fed targeting, or funding, “income” is hardly new: back in July, Deutsche Bank was the first institution to admit that the Fed has created “universal basic income for the rich”:

The accommodation and QE have acted as a free insurance policy for the owners of risk, which, given the demographics of stock market participation, in effect has functioned as universal basic income for the rich. It is not difficult to see how disruptive unwind of stimulus could become. Clearly, in this context risk has become a binding constraint.

It is only “symmetric” that everyone else should also benefit from the Fed’s monetary generosity during the next recession. 

* * *

Finally, for those curious what will really happen after the next “great liquidity crisis”, JPM’s Marko Kolanovic laid out a comprehensive checklist one month ago. It predicted not only price targeting (i.e., stocks), but also negative income taxes, progressive corporate taxes, new taxes on tech companies, and, of course, hyperinflation. Here is the excerpt.

What will governments and central banks do in the scenario of a great liquidity crisis? If the standard rate cutting and bond purchases don’t suffice, central banks may more explicitly target asset prices (e.g., equities). This may be controversial in light of the potential impact of central bank actions in driving inequality between asset owners and labor. Other ‘out of the box’ solutions could include a negative income tax (one can call this ‘QE for labor’), progressive corporate tax, universal income and others. To address growing pressure on labor from AI, new taxes or settlements may be levied on Technology companies (for instance, they may be required to pick up the social tab for labor destruction brought by artificial intelligence, in an analogy to industrial companies addressing environmental impacts). While we think unlikely, a tail risk could be a backlash against central banks that prompts significant changes in the monetary system. In many possible outcomes, inflation is likely to pick up.

 

The next crisis is also likely to result in social tensions similar to those witnessed 50 years ago in 1968. In 1968, TV and investigative journalism provided a generation of baby boomers access to unfiltered information on social developments such as Vietnam and other proxy wars, Civil rights movements, income inequality, etc. Similar to 1968, the internet today (social media, leaked documents, etc.) provides millennials with unrestricted access to information on a surprisingly similar range of issues. In addition to information, the internet provides a platform for various social groups to become more self-aware, united and organized. Groups span various social dimensions based on differences in income/wealth, race, generation, political party affiliations, and independent stripes ranging from alt-left to alt-right movements. In fact, many recent developments such as the US presidential election, Brexit, independence movements in Europe, etc., already illustrate social tensions that are likely to be amplified in the next financial crisis. How did markets evolve in the aftermath of 1968? Monetary systems were completely revamped (Bretton Woods), inflation rapidly increased, and equities produced zero returns for a decade. The decade ended with a famously wrong Businessweek article ‘the death of equities’ in 1979.

Kolanovic’s warning may have sounded whimsical one month ago. Now, in light of Williams’ words, it appears that it may serve as a blueprint for what comes next.

http://WarMachines.com

UBS Reveals The Stunning Reason Behind The 2017 Stock Market Rally

It’s 2018 forecast time for the big banks. With Goldman unveiling its seven Top Trades for 2018 earlier, overnight it was also UBS’ turn to reveal its price targets for the S&P in the coming year, and not surprisingly, the largest Swiss bank was extremely bullish, so much so in fact that its base case is roughly where Goldman expects the S&P to be some time in the 2020s (at least until David Kostin revises his price forecast shortly).

So what does UBS expect? The bank’s S&P “base case” is 2900, and notes that its upside target of 3,300 assumes a tax cut is passed, while its downside forecast of 2,200 assumes Fed hikes in the face of slowing growth:

We target 2900 for the S&P 500 at 2018 YE, based on EPS of $141 (+8%) and modest P/E expansion to 20.6x.

 

Our upside case of S&P 500 at 3300 assumes EPS gets a further 10% boost driven by a 25% tax rate (+6.5%), repatriation (+2%) and a GDP lift (+1.6%), while the P/E rises by 1.0x. Downside of 2200 assumes the Fed hikes as growth slows, the P/E contracts by 3x and EPS falls 3%. Congress is motivated to act before midterm elections while the Fed usually reacts to slower growth; so we think our upside case is more likely.

Why is UBS’ base case so much higher than what most other banks forecast? According to strategist Keith Parker, the reason is a “Valuation disconnect”: Higher rates are priced in, while higher expected growth is not. He explains:

We model the S&P 500 P/E based on select macro drivers. The S&P P/E is 5x below the model implied level, which points to solid returns. More specifically, the 2.8% Fed rate target is priced in (worth 1.3x) but higher analyst expected 3-5yr growth is not (worth 3.7x). The P/E has been 2-4x above the implied level at the end of each bull market and the model has been a good signal for forward S&P returns (20-25% correlation). High-growth (most expensive) and deep-value (cheapest) stocks are cheap on a relative basis; the price for perceived safety is high. We focus on risk-adjusted growth + yield.

On the earnings side, this is how UBS bridges its 2018 rise to 141:

Following the 2014-16 earnings recession, S&P 500 EPS returned to growth in 2017 on the back of improved economic momentum globally, a commodity recovery, and rising margins. While a tax plan would significantly impact our growth assumptions, our base case EPS forecast excludes any tax upside given the degree of legislative uncertainty.

 

For 2018, we expect the earnings recovery to continue and forecast 8.3% EPS growth, driven by solid economic growth, offsetting margin drivers and higher interest rates. To control for the volatility and different drivers for certain sectors, we model financials and energy separately, with a buyback tailwind applied at the index level (1% assumed in 2018). 

 

We forecast S&P ex Financials & Energy earnings to grow 7% in 2018. Top-line growth is a function of 2.2% US real GDP and 3.8% RoW GDP growth, a relatively stable USD, and slightly higher growth in intellectual property products (“IPP” or tech) plus business equipment spending (less structures spending). Margins are adversely impacted by rising unit labor costs of 1.9% and boosted by a 1% improvement in productivity, with a negative net effect. Finally, flat US GDP growth means that earnings do not benefit much from operating leverage.

 

We expect Financials earnings to grow 7%, with return on assets improving on the back of a rising 3m Libor rate to 2.2% by YE 2018, two Fed hikes in 2018, a stable financing spread (delta between total bond market and Financials OAS spreads) and no rise in delinquencies (modelled using change in unemployment).  Asset growth is estimated using a beta of 1.35 to US real GDP growth.

 

We expect Energy sector earnings to continue to rebound, growing 28%. Energy accounts for less than 4% of total projected S&P 500 net income. Given the inherent volatility in earnings over recent years, we model sales growth as a function of oil and natural gas, which explains 97% of the sector’s top-line growth. We assume that margins recover as D&A and other overhead is leveraged

Here we have some bad news for UBS: none of the above will happen, for one simple reason – the driver of earnings growth in 2017, China’s record credit injections, has slammed shut, and if anything is now in reverse. This is bad news not only for China of course, but for fungible global markets, all of which are reliant on the world’s biggest marginal creator of crerdit in the financial system, Beijing. And, as we discussed yesterday, starting, well, two weeks ago, China is in active deleveraging mode. 

The implications for corporate profits will be adverse.

* * *

Yet as we stated at the beginning, none of the above is surprising, or even remotely remarkable: it’s just another bank’s forecast, and with the benefit of hindsight one year from today, we will have some laughs at its morbid, late cycle optimism.

What is very striking, however, is an little noticed analysis from UBS inside the projection, which seeks to explain where virtually all the market upside in 2017 has come from. In a statement that one would never hear on CNBC, or any other financial medium, as it destroys the narrative of new money entering the market, UBS argues that the entire 2017 rally was just one giant short squeeze! In its own words:

Short covering fuelled the YTD rally; retail and foreign should continue to buy. YTD US equity ETF+MF flows have been -$17bn as short covering in stocks and ETFs of $83bn has supported the rally.

 

 

And as the shorts get decimated, the final buyer emerges before the whole house of cards comes crashing down: the retail investor. Some more details:

US equity demand model: short covering has fuelled the 2017 rally

 

We have developed a simple model of US equity demand, from the major sources of potential buying using higher frequency data. Figure 101 shows the cumulative “demand” since 2010, and the broad US equity market has tracked the measure well. Since the beginning of the year, US equity ETF+MF flows have been -$17bn as short covering in stocks and ETFs of $83bn has supported the rally (Figure 102). We see the rally transitioning to the next phase where inflows into MFs and ETFs need to take over with short interest as a % of market cap near the lows.

 

 

Retail and foreign buyers drive the last phase of a bull market. Following on the point above that flows to MFs and ETFs need to take over, we find that the retail and foreign buyer are typically the marginal buyer during the last phases of a bull market (Figure 103). Indeed, we see that US households have been increasing their ownership of US equities (ex MFs, ETFs, pensions), which has happened at the end of prior cycles. Additionally, the foreign buyer stopped selling and could start becoming a net buyer, with Asia money flow the key with ~$40tr sitting in M2.

 

In UBS’ most bizarre admission, the Swiss bank also notes that “the last part of a bull market is typically fuelled by retail and foreign money, which has been the case of late.” And yet, even more inexplicably, UBS believes that there is enough “dry powder” behind the short squeeze to push the market to not just 2,900 but potentially 3,300.

Which, if UBS is right, means that there will be a lot of suicidal shorts in the coming months as the world’s biggest short squeeze proceeds to its inevitable conclusion. But the worst news is for the last bagholder left: Joe and Jane Sixpack, aka US retail investors, as institutions dump all their equity holdings to the last bid remaining, something JPM first warned about in February when it wrote that “Institutions, Hedge Funds Are Using The Rally To Sell To Retail” and which everyone appears to have forgotten.

http://WarMachines.com

Saudi Arabia Offers Arrested Royals A Deal: Your Freedom For Lots Of Cash

As we noted shortly after the Crown Prince’s purge of potential rivals within Saudi Arabia’s sprawling ruling family, while the dozens of arrests were made under the pretext of an "anti-corruption crackdown", Mohammed bin Salman’s ulterior motive was something else entirely: Replenishing the Kingdom’s depleted foreign reserves, which have been hammered for the past three years by low oil prices, with some estimating that the current purge could potentially bring in up to $800 billion in proceeds.

Furthermore, the geopolitical turmoil unleashed by the unprecedented crackdown helped push oil prices higher, creating an ancillary benefit for both the kingdom’s rulers and the upcoming IPO of Aramco.

Saudi Crown Prince Mohammed bin Salman

And, in the latest confirmation that the crackdown was all about cash, the Financial Times reports today that the Saudi government has offered the new occupants of the Riyadh Ritz-Carlton a way out…. and it’s going to cost them: In some cases, as much as 70% of their net worth.

Saudi authorities are negotiating settlements with princes and businessmen held over allegations of corruption, offering deals for the detainees to pay for their freedom, people briefed on the discussions say.

 

In some cases the government is seeking to appropriate as much as 70 per cent of suspects’ wealth, two of the people said, in a bid to channel hundreds of billions of dollars into depleted state coffers.

 

The arrangements, which have already seen some assets and funds handed over to the state, provide an insight into the strategy behind Crown Prince Mohammed bin Salman’s dramatic corruption purge.

The crackdown has led to the detention of hundreds of royals, ministers, officals and the country’s richest oligarchs including Prince Alwaleed bin Talal, the billionaire, Waleed al-Ibrahim, the founder of Middle East Broadcasting Center, which owns Al Arabiya, the Saudi satellite television channel, and Bakr bin Laden, chairman of the Saudi Binladin construction group and brother of Osama bin Laden.

Additionally, as we reported, the crackdown sent members of the country’s wealthy upper crust scrambling to liquidate their holdings and move their cash offshore, where they might have a better chance of keeping it away from the Saudi government.

Unsurprisingly, the Saudi "offer" is working.

Some of the suspects, most of whom have been rounded up at the Ritz-Carlton hotel in Riyadh since last week, are keen to secure their release by signing over cash and corporate assets, the FT's sources say.

“They are making settlements with most of those in the Ritz,” said one adviser. “Cough up the cash and you will go home." 

 

One multi-billionaire businessman held at the Ritz-Carlton has been told to hand over 70% of his wealth to the state as a punishment for decades of involvement in allegedly corrupt business transactions. He wants to pay, but has yet to work out the details of transferring those assets to the Saudi state.

Settlements for royals will also include pledges of loyalty as MbS prepares himself to take the Saudi throne, though his father, King Salman, has vigorously denied these rumors.

One detainee told his staff that the authorities may be looking to take ownership of his main business. Families of detained suspects have started to hire consultants to assist efforts to secure their relatives’ release and to ring fence the damage to their business interests.

“They are looking for ways to isolate the tainted shareholder and keep the business going,” said the adviser.

The settlements aim to recover billions of dollars allegedly earned through “corruption” at a time when the government is grappling with a recession triggered by prolonged low oil prices and a budget deficit that widened to $79 billion last year.

The country’s attorney-general has said he is investigating allegations of corruption amounting to at least $100 billion –    though the total value of assets seized could be as high as $800 billion. Though the Financial Times puts the high-end figure at a relatively modest $300 billion; to make up for the delta, more arrests are still expected.

Regular Saudis, who’ve seen their benefits cut and some of their jobs taken away, support MbS’s decision.  “Why should the poor take all the pain of austerity,” said one Saudi academic. “The rich need to pay their way too.”

In Saudi Arabia, they are about to do just that.

http://WarMachines.com

Goldman Reveals Its Top Trade Recommendations For 2018

It’s that time of the year again when with just a few weeks left in the year, Goldman unveils its top trade recommendations for the year ahead. And while Goldman’s Top trades for 2016 was an abysmal disaster, with the bank getting stopped out with a loss on virtually all trade recos within weeks after the infamous China crash in early 2016, its 2017 “top trade” recos did far better. Which brings us to Thursday morning, when Goldman just unveiled the first seven of its recommended Top Trades for 2018 which “represent some of the highest conviction market expressions of our economic outlook.”

Without further ado, here are the initial 7 trades (on which Goldman :

  • Top Trade #1: Position for more Fed hikes and a rebuild of term premium by shorting 10-year US Treasuries.
  • Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar.
  • Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index.
  • Top Trade #4: Go long inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation.
  • Top Trade #5: Position for ‘early vs. late’ cycle in EM vs the US by going long the EMBI Global Index against short the US High Yield iBoxx Index.
  • Top Trade #6: Own diversifed Asian growth, and the hedge interest rate risk via FX relative value (Long INR, IDR, KRW vs. short SGD and JPY).
  • Top Trade #7: Go long the global growth and non-oil commodity beta through long BRL, CLP, PEN vs. short USD.

As Goldman’s Francesco Garzarelli writes, “these trades represent some of the highest conviction market expressions of the economic outlook we laid out in the latest Global Economics Analyst, as well as in our Top 10 Market Themes for 2018. Some of the key market themes reflected in our trade recommendations include:

  • Strong and synchronous global expansion. We forecast global n GDP growth of around 4% in both 2017 and 2018, suggesting that next year’s global economy will likely surprise on the upside of consensus expectations.
  • Relatively low recession risk. Given the low inflation and well-anchored inflation expectations across DM economies, we think central banks have little reason to risk ‘murdering’ this expansion with the kind of aggressive rate hikes that would have historically been warranted to fight the risk of inflation becoming entrenched.
  • But relatively high drawdown risk. Even if growth remains strong in the coming year, markets are still susceptible to temporary drawdowns, especially given the high level of valuations. We think the two most prominent risks to markets in 2018 are (1) pressures on US corporate margins from rising wages and 2) a swing in market psychology around the withdrawal of QE, which could lead to a faster re-pricing of interest rate markets than we assume.
  • More room to grow in EM.While most developed economies are currently growing well above potential, most emerging market economies still have room for growth to accelerate in 2018.

More from Goldman:

Our Top Trade recommendations reflect our Top Ten Market Themes for the year ahead. To capture the gradual normalization of the bond term premium and position for a more hawkish path of the Fed funds rate than the market currently expects, we recommend going short 10-year US Treasuries. Given our expectations of a ‘soggy Dollar’ in 2018, we think investors should position for a rotation into Euro area assets and continued Yield Curve Control from the BoJ by going long EUR/JPY. We expect EM growth to accelerate further in the coming year and suggest going long the EM growth cycle via the MSCI EM stock market index. At the same time, the EM credit cycle appears ‘younger and friendlier’ than the ageing US credit cycle, so we recommend going long the EMBI Global against US High-Yield credit. The combination of solid global growth and supportive domestic factors should help the Indonesian Rupiah, the Indian Rupee and Korean Won rally in 2018, while we expect the low-yielding Singaporean Dollar and Japanese Yen to underperform. Since the strong global demand environment should also help the commodity complex perform well but commodities as an investment carry poorly, we recommend going long BRL, CLP and PEN to gain diversified exposure to the commodities story.

And some more details on the individual trades:

Top Trade #1: Position for more Fed hikes and a rebuild of ‘term premium’ by shorting 10-year US Treasuries

Go short 10-year US Treasuries with a target of 3.0% and a stop at 2.0%.

We forecast that the yield on 10-year US Treasury Notes will head towards 3% next year, levels last seen before the decline in oil prices in 2014. By contrast, the market discounts that 10-year yields will be at 2.5% at the end of 2018, a meagre 20bp above spot levels. Our view builds on two main assumptions. First, QE and negative rate policies conducted by central banks in Europe and Japan have amplified the fall in  the term premium on bonds globally and have contributed to flatten the US yield curve this year – a central ingredient in our macro rates strategy for 2017. As a result of this, we think that US monetary conditions are too accommodative for the Fed’s comfort in light of the little spare capacity left in the jobs market. This will likely lead the FOMC to deliver policy rate hikes in excess of those discounted by the market (Exhibit 1). On our US Economists’ baseline projections, Dec 2018 Eurodollar futures, trading at an implied yield of 2.0%, will settle at 2.5%.

Second, we expect a normalization in the US bond term premium from the current exceptionally low levels over the coming quarters (Exhibit 2). This will reflect the compounding of two forces. One is an increase  in inflation uncertainty as the economic cycle continues to mature. The other reflects the interplay of the lower amount of Treasury bonds that the Fed will roll over (quantitative tightening, QT) and higher Treasury issuance. We expect these dynamics to come to the fore particularly in the second half of the year.

* * *

Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar

Go long EUR/JPY with a target of 140 and a stop at 130.

Although most economies are sharing in the upturn in global activity, there remains scope for divergence in capital flows and therefore FX performance. Among the major developed markets, we think this is particularly true for the Euro and Yen. We expect both currencies to head back to one twenty—1.20 for EUR and 120 for JPY—over the coming months. We therefore recommend that investors go long the cross, with a target of 140 and stop of 130 (Exhibit 3).

We interpreted the run-up in the Euro in 2017 as a kind of ‘short-covering’ rally. Euro area growth picked up, national politics trended in a favourable direction, and the ECB began to turn its attention away from monetary easing and towards the eventual normalisation in policy by tapering bond purchases. Against this backdrop, many investors seem to have decided that Euro shorts were no longer appropriate—especially given estimates of long-run ‘fair value’ for EUR/USD of around 1.30. Direct measures of investor positioning bear this out. For instance, net speculative Euro length in futures swung from a short of $9bn at the start of the year to a long of $12bn as of last week. These portfolio shifts seem to have more room to run: bond funds remain long USD in aggregate, and FX reserve managers have not started to  cover their substantial EUR underweight. Continued inflows into Euro area assets should support the EUR currency, even as interest rates remain low.

The opposite holds true for the Japanese Yen. Because of the Bank of Japan’s Yield Curve Control (YCC) policy, USD/JPY has remained highly correlated with yields on long-maturity US Treasuries (Exhibit 4). As a result of the recent general election—in which the LDP won another supermajority—a continuation of YCC appears very likely for the time being. Although the policy is beginning to bear fruit—in terms of improving price and wage trends—we suspect that Governor Kuroda (or his possible replacement) will judge these favourable signs as well short of what is needed to consider reversing course. Therefore, with global yields pushing higher on the back of solid growth, we think USD/JPY can again approach its cyclical highs.

* * *

Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index

Go long EM equities through the MSCI EM Index with a target at 1300 (+15%) and a stop at 1040 (-8%).

As we outline in our Top Themes for 2018, we expect strong and synchronous global growth to continue into 2018. We prefer to own growth exposure in emerging economies, which we think have more room to grow. When EM growth is above-trend and rising, equities typically outperform on a volatility-adjusted basis.

From an earnings perspective, we see much more scope for EM corporates to surprise to the upside, driving equity performance in 2018 (Exhibit 6). MSCI EM EPS have rebounded quite quickly from a six-year stagnation and, in local currency terms, EM earnings per share (EPS) has repaired the ‘damage’ of the 2010-2016 period. We expect MSCI EM EPS to rise another 10% in 2018, which should drive the bulk of the upside in this trade.

From a valuation perspective, EM equities are not cheap relative to their own history (they are currently trading in the 86th percentile of the historical P/E range), but they are cheap relative to US equities (38th percentile of historical relative P/E range), which should hopefully offer some cushion in a global risk-off event. We find that the relative valuation of EM to DM equity is largely influenced by the growth  differential between the two regions; and we forecast this differential to widen another 60bp next year, which in turn should drive EM valuations to expand relative to DM by around 3%. To be sure, a long-only EM equity trade carries significant ‘pullback risk’, especially given the current entry point. Accordingly, we have set a stop on the recommended trade at -8%, which provides enough buffer to accommodate for a shock similar to the EM equity sell-off around the US election. Although EM equities have had a good run in 2017, we do not view the asset class as over-owned. Indeed, the cumulative foreign flow into major EM equity markets is still tracking below historical averages.

* * *

Top Trade #4: Go long the inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation swaps

Go long EUR 5-year 5-year forward inflation with a target of 2.0% and a stop at 1.5%.

We recommend going long Euro area 5-year inflation 5-years forward (henceforth 5y-5y) through EUR inflation swaps, for an target of 2.0% – levels last seen in mid-2014 ahead of the fall in crude oil prices. The rationale for the trade is the following.

First, the risk premium on Euro area forward inflation is currently depressed, offering an attractive entry point. A low inflation risk premium can be inferred from the flat term structure of inflation swap yields. The difference between 5-year inflation, which is priced roughly in line with the expectations of our European Economists (Exhibit 7), and 5y-5y forward is near the lowest levels observed since the 2011 crisis.

Second, the inflation options market assigns high odds to Euro area headline inflation staying at or below 1% over the next 5 years. Against this backdrop, the ECB has reiterated its determination to keep monetary policy accommodative in order to encourage a rebuild of inflationary pressures. With the expansion in activity and job creation likely to continue, we expect the inflation risk premium to increase.

* * *

Top Trade #5: Position for ‘early vs. late’ cycle in EM vs. the US by going long the EMBI Global Index against short the US High Yield iBoxx Index

Go long EM USD credit through the EMBI Global against US High-Yield credit through the iBoxx USD Liquid High Yield Index, with a 1.5×1 notional ratio, indexed at inception to 100, with a total return target at 106 and a stop at 96.

The EM credit cycle is ‘younger and friendlier’ relative to an ageing US corporate credit cycle. With the improvement in macro fundamentals across EM, namely better current account balances, dis-inflation and FX reserve accumulation, we do not see a near-term risk of Dollar funding concerns. While EM credit spreads are not cheap per se, we see relative value against the US High-Yield market. In addition to the growing exposure of the latter to secularly challenged sectors, with the US cycle maturing and profit margins potentially eroding, we see more fundamental concerns in US High-Yield than in the EMBI (of which 70% of the constituents are sovereign bonds and the remainder in ‘quasi-sovereigns’).

Unlike most EM trades, long EM credit vs. US High-Yield has yet to fully recover from the sell-off following the US election. Since the ‘taper tantrum’, EM has generally outperformed with the exception of a few sharp risk-off events that had specific negative-EM implications (such as the sharp decline in oil prices and Russian recession in late 2014/early 2015, and the 2016 US presidential election). However, other risk- off periods, such as the Euro crisis in early 2011, saw EM credit outperform US high-yield.

The relative performance of EM vs. US High-Yield consistently tracks the EM-DM growth differential (Exhibit 10). We expect the general trend of EM outperformance to continue in a pro-risk environment and see the entry point as attractive, albeit admittedly slightly less so following the recent High-Yield sell-off. Finally, this trade is positive carry and should perform well if global spreads move sideways to tighter. We have set the stop at -4%, which coincides roughly with the bottom reached after the US election.

* * *

Top Trade #6: Own diversifed Asian growth, and the hedge the interest rate risk via FX relative value (long INR, IDR, KRW vs. short SGD and JPY)

Go long an equal-weighted basket of INR, IDR, KRW against an equal-weighted  basket of SGD and JPY, indexed at inception to 100, with a total-return target at 110 and stop at 95.

INR, IDR and KRW provide diversified exposure to the strong global growth we forecast in 2018 and specific idiosyncratic factors that should support their currencies in the year ahead. The combination of commodity exporting (IDR) and commodity importing (INR and KRW) currencies on the long leg of the recommended trade offers some protection against swings in commodity prices. By funding out of SGD and JPY, not only do we take advantage of their low yields, but JPY underperformance should also provide a hedge should the move higher in US yields lead to wobbles in the currencies where we recommend being long. The overall trade carries positively to the tune of about 4% over the year.

Country-specific factors in India, Indonesia and South Korea should boost their currencies, on top of the strong global growth environment we expect next year. Specifically:

India’s bank re-capitalization plan should impart a powerful positive impulse to investment in the coming year and should break the vicious cycle of higher non-performing loans, weaker bank balance sheets and slower credit growth. As the drags from GST implementation and de-monetization also fade, we expect growth to move from 6.2% in 2017 to 7.6% in calendar 2018. In addition to the three hikes we expect the Reserve Bank of India to deliver by Q2-2019, the high carry, FDI and equity inflows should also be supportive for the INR. We have moved our 12-month forecast for $/INR stronger to 62.

We continue to see Indonesia as a good carry market. As the drag on domestic consumption from the tax amnesty fades in 2018, we expect economic growth to move up to 5.8% in 2018 (from 5.2% in 2017), while the current account, inflation, and fiscal deficit should remain stable. We think Bank Indonesia is done easing and should move to hike rates by 50bp in H2-2018. We also expect Indonesia to be included in the Global Aggregate bond index, which could prompt one-off inflows worth US$5bn in Q1-2018 (vs. US$10bn bond inflows YTD in 2017). We have moved our 12-month forecast for $/IDR stronger to 13000. Finally, Indonesia, like India, has accumulated reserves over the past year that now stand at record high levels and should help mitigate volatility.

We expect the KRW to outperform other low-yielding Asian peers in 2018. The strong memory chip cycle should extend at least through H1-2018, while the government’s income-led growth policy provides a fiscal boost. Together with the boost from improving exports, this should allow the Bank of Korea to withdraw monetary accommodation in the face of rising financial stability concerns, with three policy rate hikes to 2.0% penciled in by the end of 2018. The thawing of China/South Korea relations and rebound in Chinese tourists should also help the travel balance. Overall, we expect the current account to remain stable at around 5% of GDP in 2018. Further deregulation in outbound capital flows could temper KRW strength over the medium term, but might not pass the National Assembly in the near future given  fragmentation in the legislative body. Our 12-month forecast for $/KRW is now stronger at 1060.

On the funding side, not only do SGD and JPY offer a low yield, we expect them to underperform in the year ahead. While we expect the Monetary Authority of Singapore to steepen its appreciation bias in October, we do not expect any significant SGD appreciation versus Asian peers given that the SGD is already trading on the strong side of the policy band. Meanwhile, we forecast USD/JPY at 120 in 12 months. With the BoJ controlling the yield curve as US rates move higher, JPY should continue to weaken, especially if US rates move higher than the forwards discount, as we expect.

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Top Trade #7: Go long the global growth and non-oil commodity ‘beta’ through BRL, CLP, PEN vs. short USD

Go long a volatility-weighted basket of BRL, CLP and PEN (weights of 0.25, 0.25 and 0.5) against USD, indexed at inception to 100, with a total return target of 108 and a stop at 96.

The ongoing strength of global growth should continue to support a rally in most industrial metal prices. Our seventh Top Trade recommendation aims to capture this dynamic by going long the ‘growth and metals beta’. All three currencies on the long side have reliably responded to upswings in global trade and external demand over the past two decades. Moreover, each has performed particularly well in the pre-crisis decade, a period that also featured strong global growth and buoyant industrial metals prices. CLP offers direct exposure to a particularly encouraging story in copper, while BRL and PEN provide more varied metals exposures. The recommended trade has a positive carry of roughly 2.5% a year, and our 12-month forecasts are stronger than the forwards in all cases: we forecast USD/BRL at 3.10 in 12 months, USD/CLP at 605 in 12 months and USD/PEN at 3.15 in 12 months.

Beyond these global factors, our recommended Top Trade allows for diversified exposure to an encouraging Latin American growth recovery. Not only should growth in Brazil pick up as it recovers from a deep recession (and a recent BRL sell-off, creating an attractive entry-point), but BRL screens as strongly undervalued on our GSFEER currency model due to a combination of contained inflation and current account rebalancing, making BRL an attractive high carry currency. Meanwhile, PEN – the low-vol ‘tortoise’ of Andean FX – offers exposure to one of the most attractive valuation stories in the EM low- to mid-yielder space. Last but not least, CLP – the ‘hare’ of Andean FX – has moved quickly in 2017, so sends a somewhat less attractive valuation signal, but provides direct exposure to our most encouraging metals view, copper, and what opinion polls suggest is likely to be a market-friendly outcome in the upcoming Chilean election.

Finally, although it is designed for our global base case of strong growth, our Top Trade #7 can perform well in other external environments, potentially including a global growth disappointment. In particular, while BRL is a high-yielding and ‘equity-like’ currency, CLP and PEN are each lower-yielding and more ‘debt-like’: they have historically shown relatively resilient performance vs. the USD during periods of both declining growth and falling core rates.

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