20/8/20: All Markets are Now Monetized

 

While the economy burns, the stock markets are literally going bonkers. Here are the main implied volatility options:

Which are symmetric, in so far as they treat volatility as symmetrically-valued to the upside and downside. And here is another way of looking at the same concept via repricing speed, or the rate of change in actual P/E ratios of S&P500 over longer time horizons, in this case: 20 weeks running P/E ratios change:

Source of the chart is @longvieweconomics. What does the above show? We have S&P500 at an all-time high. S&P500's PE ratio (PER) is only slightly below the 2000 peak. And, we have the fastest rate of S&P over-valuation increase in history - full 85 percentage points trough to peak. Both, the fundamentals and the momentum of their deterioration are absolutely out of control. Of course, this is just the stocks. One must never mention the massive bubble blown up by the Fed in the bonds markets. 

The 20-weeks moving change in weekly yields for Aaa-rated bonds maxed out at historical high of -44.06% (remember, lower yields = higher prices) in the week of July 31st this year. Top three historically highest rates of change took place in the three weeks of July 24th-August 7 this year. Overall range of bonds repricing is in the range of 60 percentage points in the current cycle:

This is plain horrendous: there is nothing in the macro and micro fundamentals that can warrant these changes. Except for the expectation of continued monetary accommodation of the Wall Street into the infinitely long future. 

26/5/20: Franco-German Eurobonds: A First Step on the Road to Federalism

My recent article on the Franco-German proposal for Euro bonds for The Currency: https://www.thecurrency.news/articles/17392/france-and-germany-have-proposed-a-e500m-fund-to-shield-european-economy-what-does-it-mean-for-ireland.

19/5/20: German Hawks vs ECB Doves?

My article for The Currency on the German Constitutional Court ruling regarding ECB's PSPP program: https://www.thecurrency.news/articles/17028/german-courts-are-fighting-with-the-ecb-what-does-it-mean-for-ireland.

18/3/20: Banks, The Fed and Money Markets Woes

My article for the International Banker on pre-Covid monetary policy bottlenecks in the US markets is out and available here: https://internationalbanker.com/finance/banks-the-fed-and-money-markets-woes/

16/10/2019:Corporate Bond Markets are Primed for a Blowout

My this week's column for The Currency is covering the build up of systemic risks in the global corporate bond markets: https://www.thecurrency.news/articles/1962/constantin-gurdgiev-corporate-bond-markets-are-primed-for-a-blowout.

Synopsis: "Individual firms can be sensitive to the periodic repricing of risk by the investors. But collectively, the entire global corporate bond market is sitting on a powder keg of ultra-low government bond yields, with a risk-off fuse lit by the strengthening worries about global economic growth prospects. Currently, over USD 16 trillion worth of government bonds are traded at negative yields. This implies that in the longer run, market pricing is forcing accumulation of significant losses on balance sheets of all institutional investors holding government securities. Even a small correction in these markets can trigger investors to start offloading higher-risk corporate debt to pre-empt contagion from sovereign bonds markets and liquidate liquidity risk exposures."

31/7/19: Canary in the Treasuries mine

Judging by U.S. Treasuries, things are getting pretty ugly in the economy:

The gap between long-dated bond yields and short-dated paper yields has accurately predicted/led the last three recessions (the latter are marked by red averages in the chart).

2/7/19: Inverted Yield Curve

Inverting U.S. yield curve is one of the best early indicators of recessions. Or at least it used to be... before all the monetary policy shenanigans of the last 11 years. Regardless, the latest U.S. Treasury yields dynamics are quite disquieting:

12/6/19: Credit Markets vs Banks Loans: Europe vs US

Related to the earlier post on investment markets composition by intermediary (see: https://trueeconomics.blogspot.com/2019/06/12619-investment-intermediaries-europe.html), here is more evidence, via @jerrycap of the massive share of intermediated debt / banks dependency in European markets:

A caveat worth noting: European data includes the UK, where equity markets and hybrid financing are both more advanced than in the Continental Europe, which suggests that the share on non-bank share of debt markets is even smaller than the 25% currently estimated.

12/6/19: Investment Intermediaries: Europe vs U.S.

Investment markets intermediaries by type and origin (via @schuldensuehner):

Caveat: In the case of Ireland and Switzerland, the data is not representative of the domestic markets.

Loads of interesting insights, but one macro-level important is the role of the non-banking investment players, especially domestic ones, in the economies of the U.S. and Germany, Italy, Spain and France. This highlights the huge role of direct investment channels (equity, debt, hybrids) in the U.S. market and the corresponding weight of intermediated bank debt in Europe. We highlight this anomaly and the failures of the EU to diversify capital funding channels

• In our paper here: Gurdgiev, Constantin and Lyon, Tracy Lee and Cohen, Alexandra and Poda, Margaret and Salyer, Matthew, Capital Markets Union: An Action Plan of Unfinished Reforms (March 21, 2019). with Tracy Lee Lyon, Alexandra Cohen, Margaret Poda and Matthew Salyer (Middlebury Institute of International Studies at Monterey (MIIS); GUE/NGL Group, European Parliament, Policy Analysis Paper, March 2019. Available at SSRN: https://ssrn.com/abstract=3357380 and 
• In a recent article for the LSE Business Review here: https://trueeconomics.blogspot.com/2019/05/27519-lse-business-review-capital.html. 

2/4/19: World Economic Conditions and Yield Signals

Global divergence...

... until global convergence?

More likely, the latter: https://www.reuters.com/article/us-ecb-policy-rates-idUSKCN1R81B3. 

22/2/19: Deutsche Bank's New Old Losses: When a Candy Bites Back

Our good old friends at @DeutscheBankAG have been at it again... this time (h/t to @macromon) raking in $1.6 billion of freshly announced losses from pre-Global Financial Crisis trades in municipal bonds. Story at WSJ: https://www.wsj.com/articles/deutsche-bank-lost-1-6-billion-on-a-bond-bet-11550691086 (gated)

In summary: "This transaction was unwound in 2016 as part of the closure of our Non-Core Operations", according to the spokeswoman email to the WSJ. DB ca $7.8 billion portfolio of 500 municipal bonds back in 2007. The bonds were insured by specialised mono-line insurers to protect against default. In March of 2008, the bank followed up the trade by buying additional default protection from Berkshire Hathaway for $140 million. Insure-and-forget, right?By the end of 2011, the bank had a little over $115 million of reserves set aside to cover potential losses on the trade. That figure rose to over $1 billion at the start of 2016. By May 2016, the bank calculated an additional loss of $728-$768 million on a potential sale of the portfolio net of the loss protection from Berkshire.

Per WSJ, this loss - previously unreported - amounts to ca x4 times DB's 2018 profits.

The champs!

20/2/19: Crack and Opioids of Corporate Finance

More addictive than crack or opioids, corporate debt is the sand-castle town's equivalent of water: it holds the 'marvels of castles' together, util it no longer does...

Source: https://twitter.com/lisaabramowicz1/status/1098200828010287104/photo/1

Firstly, as @Lisaabramowicz correctly summarises: "American companies look cash-rich on paper, but average leverage ratios don't tell the story. 5% of S&P 500 companies hold more than half the overall cash; the other 95% of corporations have cash-to-debt levels that are the lowest in data going back to 2004". Which is the happy outrun of the Fed and rest of the CBs' exercises in Quantitive Hosing of the economies with cheap credit over the recent years. So much 'excessive' it hurts: a 1 percentage point climb in corporate debt yields, over the medium term (3-5 years) will shave off almost USD40 billion in annual EBITDA, although tax shields on that debt are likely to siphon off some of this pain to the Federal deficits.

Secondly, this pile up of corporate debt has come with little 'balancesheet rebuilding' or 'resilience to shocks' capacity. Much of the debt uptake in recent years has been squandered by corporates on dividend finance and stock repurchases, superficially boosting the book value and the market value of the companies involved, without improving their future cash flows. And, to add to that pain, without improving future growth prospects.

18/2/19: U.S. Treasuries: Not Finding Much Love in Foreign Lands

In recent months, I have been warning about the cliff of new bonds issuance that is coming for the U.S. Treasuries in 2019, pressured by the declining interest in U.S. debt from the rest of the world. December 2018 figures are a further signal reinforcing the importance of this warning (see U.S. yields comparatives here: http://trueeconomics.blogspot.com/2019/02/15219-still-drowning-in-love-for-debt.html).

In December 2018, foreign buyers cut back their purchases of the U.S. Treasuries by the net USD77.35 billion, following a net increase in purchases in November of USD13.2 billion. December net outflow was the largest since January 1978. On a positive note, Chinese holdings of U.S. Treasuries increased in December, after declining for six straight months. China held USD1.123 trillion in U.S. Treasuries in December, up from USD1.121 trillion in November.

Here is the historical chart, including 4Q 2018 estimate:

Not quite an armageddon, but statistically, foreign holdings of the U.S. Treasuries remained basically flat from 1Q 2014. Which would be fine, if (1) U.S. new net issuance was to remain at zero or close to it (which is not the case with accelerating deficits: http://trueeconomics.blogspot.com/2019/02/15219-nothing-to-worry-about-for-those.html), (2) U.S. Fed was not 'normalizing' its asset holdings (which is not the case, as the Fed continues to reduce its balance sheet - see next chart).

Note: January 2019 saw a decline in the benchmark U.S. Treasuries (10 year) yield, compared to 2018 annual yield:

15/2/19: Nothing to Worry About for those Fiscally Conservative Republicans

H/T to @soberlook:

U.S. Federal deficit was up $192 billion y/y in December 2018. Nothing to worry about, as fiscal prudence has been the hallmark of the Republican party policies since... well... since some time back...  That, plus think of what fiscal surplus will be once Mexico pays for the Wall, and Europeans pay for the Nato.

Soldier on, Donald.

11/1/19: Herding: the steady state of the uncertain markets

Markets are herds. Care to believe in behavioral economics or not, safety is in liquidity and in benchmarking. Both mean that once large investors start rotating out of one asset class and into another, the herd follows, because what everyone is buying is liquid, and when everyone is buying, they are setting benchmark expected returns. If you, as a manager, perform in line with the market, you are safe at the times of uncertainty and ambiguity. In other words, it is better to bet on losing or underperforming alongside the crowd of others, than to bet on a more volatile expected returns, even though these might offer a higher upside.

How does this work? Here:

Everyone loves Corporate debt, until everyone runs out of it and into Government debt. Everyone hates Government debt, until everyone hates corporate debt. It's ugly. But it is real. Herding is what drives markets, even though everyone is keen on paying analysts top dollar not to herd.

22/12/18: Chile on course for a higher credit rating

My recent comment on improving credit conditions in the case of Chile via Euromoney: https://www.euromoney.com/article/b1by3mb0pskp43/chile-on-course-for-a-higher-credit-rating.

19/12/18: From Goldilocks to Humpty-Dumpty Markets

As noted in the post above, I am covering the recent volatility and uncertainty in the financial markets for the Sunday Business Post : https://www.businesspost.ie/business/goldilocks-humpty-dumpty-markets-2018-433053.

Below is the un-edited version of the article:

2018 has been a tough year for investors. Based on the data compiled by the Deutsche Bank AG research team, as of November 2018, 65.7 percent of all globally-traded assets were posting annual losses in gross (non-risk adjusted) terms. This marks 2018 as the third worst year on record since 1901, after 1920 (67.6 percent) and 1994 (67.2 percent), as Chart 1 below illustrates. Adjusting Deutsche Bank’s data for the last thirty days, by mid-December 2018, 66.3 percent of all assets traded in the markets are now in the red on the annual returns basis.

CHART 1: Percentage of Assets with Negative Total Returns in Local Currency

Source: Deutsche Bank AG

Note: The estimates are based on a varying number of assets, with 30 assets included in 1901, rising to 70 assets in 2018

Of the 24 major asset classes across the Advanced Economies and Emerging Markets, only three, the U.S. Treasury Bills (+19.5% YTD through November 15), the U.S. Leveraged Loans (+7.45%), and the U.S. Dollar (+0.78%) offer positive risk-adjusted returns, based on the data from Bloomberg. S&P 500 equities are effectively unchanged on 2017. Twenty other asset classes are in the red, as shown in the second chart below, victims of either negative gross returns, high degree of volatility in prices (high risk), or both.


CHART 2: Risk-Adjusted Returns, YTD through mid-December 2018, percent

Source: Data from Bloomberg, TradingView, and author own calculations

Note: Risk-adjusted returns take into account volatility in prices. IG = Investment Grade, HY = High Yield, EM = Emerging Markets

The causes of this abysmal performance are both structural and cyclical.


Cyclical Worries

The cyclical side of the markets is easier to deal with. Here, concerns are that the U.S., European and global economies have entered the last leg of the current expansion cycle that the world economy has enjoyed since 2009 (the U.S. since 2010, and the Eurozone since 2014). Although the latest forecasts from the likes of the IMF and the World Bank indicate only a gradual slowdown in the economic activity across the world in 2019-2023, majority of the private sector analysts are expecting a U.S. recession in the first half of 2020, following a slowdown in growth in 2019. For the Euro area, many analysts are forecasting a recession as early as late-2019.

The key cyclical driver for these expectations is tightening of monetary policies that sustained the recovery post-Global Financial Crisis and the Great Recession. And the main forward-looking indicators for cyclical pressures to be watched by investors is the U.S. Treasury yield curve and the 10-year yield and the money velocity.

The yield curve is currently at a risk of inverting (a situation when the long-term interest rates fall below short-term interest rates). The 10-year yields are trading at below 3 percent marker – a sign of the financial markets losing optimism over the sustainability of the U.S. growth rates. Money velocity is falling across the Advanced Economies – a dynamic only partially accounted for by the more recent monetary policies.

CHART 3: 10-Year Treasury Constant Maturity Rate, January 2011-present, percent

Source: FRED database, Federal reserve bank of St. Louis. 

Structural Pains

While cyclical pressures can be treated as priceable risks, investors’ concerns over structural problems in the global economy are harder to assess and hedge.

The key concerns so far have been the extreme uncertainty and ambiguity surrounding the impact of the U.S. Presidential Administration policies on trade, geopolitical risks, and fiscal expansionism. Compounding factor has been a broader rise in political opportunism and the accompanying decline in the liberal post-Cold War world order.

The U.S. Federal deficit have ballooned to USD780 billion in the fiscal 2018, the highest since 2012. It is now on schedule to exceed USD1 trillion this year. Across the Atlantic, since mid-2018, a new factor has been adding to growing global uncertainty: the structural weaknesses in the Euro area financial services sector (primarily in the German, Italian and French banking sectors), and the deterioration in fiscal positions in Italy (since Summer 2018) and France (following November-December events). The European Central Bank’s pivot toward unwinding excessively accommodating monetary policies of the recent past, signaled in Summer 2018, and re-confirmed in December, is adding volatility to structural worries amongst the investors.

Other long-term worries that are playing out in the investment markets relate to the ongoing investors’ unease about the nature of economic expansion during 2010-2018 period. As evident in longer term financial markets dynamics, the current growth cycle has been dominated by one driver: loose monetary policies of quantitative easing. This driver fuelled unprecedented bubbles across a range of financial assets, from real estate to equities, from corporate debt to Government bonds, as noted earlier.

However, the same driver also weakened corporate balance sheets in Europe and the U.S. As the result, key corporate risk metrics, such as the degree of total leverage, the cyclically-adjusted price to earnings ratios, and the ratio of credit growth to value added growth in the private economy have been flashing red for a good part of two decades. Not surprisingly, U.S. velocity of money has been on a continuous downward trend from 1998, with Eurozone velocity falling since 2007. Year on year monetary base in China, Euro Area, Japan and United States grew at 2.8 percent in October 2018, second lowest reading since January 2016, according to the data from Yardeni Research.

Meanwhile, monetary, fiscal and economic policies of the first two decades of this century have failed to support to the upside both the labour and technological capital productivity growth. In other words, the much-feared spectre of the broad secular stagnation (the hypothesis that long-term changes in both demand and supply factors are leading to a structural long-term slowdown in global economic growth) remains a serious concern for investors. The key leading indicator that investors should be watching with respect to this risk is the aggregate rate of investment growth in non-financial private sector, net of M&As and shares repurchases – the rate that virtually collapsed in post-2008 period and have not recovered to its 1990s levels since.

The second half of 2018 has been the antithesis to the so-called ‘Goldolocks markets’ of 2014-2017, when all investment asset classes across the Advanced Economies were rising in valuations. At the end of 3Q 2018, U.S. stock markets valuations relative to GDP have topped the levels previously seen only in 1929 and 2000. Since the start of October, however, we have entered a harmonised ‘Humpty-Dumpty market’, characterised by spiking volatility, rising uncertainty surrounding the key drivers of markets dynamics. Adding to this high degree of coupling across various asset classes, the recent developments in global markets suggest a more structural rebalancing in investors’ attitudes to risk that is likely to persist into 2019.

19/12/18: Debt-Debt-Baby: BBB-rated & lower 'bump'

Gradual deterioration in the quality of corporate debt traded in the markets has been quite spectacular over 2018:

The above chart shows that at the end of 3Q 2018, the market share of BBB and lower-rated corporate  credit is now in excess of 50%, in excess of USD4.4 trillion, matching prior historical record set at 4Q 2017-1Q 2018. BIS' Claudio Borio was quick out on the rising risks: https://www.bis.org/publ/qtrpdf/r_qt1812_ontherecord.htm, saying "...the bulge of BBB corporate debt, just above junk status, hovers like a dark cloud over investors. Should this debt be downgraded if and when the economy weakened, it is bound to put substantial pressure on a market that is already quite illiquid and, in the process, to generate broader waves. ... What does this all mean for the prospects ahead? It means that the market tensions we saw during this quarter were not an isolated event. ... Faced with unprecedented initial conditions - extraordinarily low interest rates, bloated central bank balance sheets and high global indebtedness, both private and public - monetary policy normalisation was bound to be challenging especially in light of trade tensions and political uncertainty. The recent bump is likely to be just one in a series."

You can read my views on the latter aspect of the markets dynamics in the post that will follow.

19/10/18: There's a Bubble for Everything

Pimco's monthly update for October 2018 published earlier this week contains a handy table, showing the markets changes in key asset classes since September 2008, mapping the recovery since the depths of the Global Financial Crisis.

The table is a revealing one:

As Pimco put it: "The combined balance sheets of the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China expanded from $7 trillion to nearly $20 trillion over the subsequent decade. This liquidity injection, at least in part, underpinned a 10-year rally in equities and interest rates: The S&P 500 index rose 210%, while international equities increased 70%. Meanwhile, developed market yields and credit spreads fell to multidecade, and in some cases, all-time lows."

The table points to several interesting observations about the asset markets:

1. Increases in valuations of corporate junk bonds have been leading all asset classes during the post-GFC recovery. This is consistent with the aggregate markets complacency view characterized by extreme risk and yield chasing over recent years. This, by far, is the most mispriced asset class amongst the major asset classes and is the likeliest candidate for the next global crisis.
2. Government bonds, especially in the Euro area follow high yield corporate debt in terms of risk mis-pricing. This observation implies that the Euro area recovery (as anaemic as it has been) is more directly tied to the Central Banks QE policies than the recovery in the U.S. It also implies that the Euro area recovery is more susceptible to the Central Banks' efforts to unwind their excessively large asset holdings.
3. U.S. equities have seen a massive valuations bubble developing in the years post-GFC that is unsupported by the real economy in the U.S. and worldwide. Even assuming the developed markets ex-U.S. are underpriced, the U.S. equities cumulative rise of 210 percent since September 2008 looks primed for a 20-25 percent correction. 

All of which suggests that the financial bubbles are (a) wide-spread and (b) massive in magnitude, while (c) being caused by the historically unprecedented and over-extended monetary easing. The next crisis is likely to be more painful and more pronounced than the previous one.

3/10/18: Dumping Ice bags into Overheating Reactor: Bonds & Stocks Bubbles

Wading through the ever-excellent Yardeni Research notes of recent, I have stumbled on a handful of charts worth highlighting and a related blog post from my friends at the Global Macro Monitor that I want to share with you all.

Let's start with the stark warning regarding the U.S. Treasuries market from the Global Macro Monitor, accessible here: https://macromon.wordpress.com/2018/10/03/alea-iacta-est/.  To give you my sense from reading this, two quotes with my quick takes:

"Supply shortages, induced mainly by central bank quantitative easing have been a major factor driving asset markets, in our opinion.  Not all, but a big part." So forget the 'not all' and think about risks pairings in a complex financial system of today: equities and bonds are linked through demand for yield (gains) and demand for safety. If both are underpricing true risks (and bond markets are underpricing risks, as the quote implies), it takes one to scratch for the other to blow. Systems couplings get more fragile the tighter they become.

"The float of total U.S. equities has shrunk dramatically, in part, due to cheap financing to fund share buybacks.   The technical shortage of stocks have helped boost U.S. equity markets and killed off most bears and short sellers." In other words, as I have warned repeatedly for years now, U.S. equity markets are now dangerously concentrated (see this blog for posts involving concentration risks). This concentration is driven by three factors: M&As and shares buy-backs, plus declined IPOs activity. The former two are additional links to monetary policies and, thus to the bond markets (coupling is getting even tighter), the latter is structural decline in enterprise formation and acceleration rates (secular stagnation). This adds complexity to tight coupling of risk systems. Bad, very bad combination if you are running a nuclear power plant or a major dam, or any other system prone to catastrophic risk exposures.

How bad the things are?

Since 1Q 2009, total cumulative shares buy-backs for S&P500 amounted (through 2Q 2018) to USD 4.2769 trillion.

Now, those charts.

Chart 1, via Yardeni Research's "Stock Market Indicators: S&P 500 Buybacks & Dividends" book from October 3rd (https://www.yardeni.com/pub/buybackdiv.pdf)

What am I looking at here? The signals revealing flow of corporate earnings toward investment, or, the signs of the build up in the future economic capacity of the private sector. The red line in the lower panel puts this into proportional terms, the gap between the yellow line and the green line in the top panel puts it into absolute terms. And both are frightening. Corporate earnings are on a healthy trend and at healthy levels. But corporate investment is not and has not been since 1Q 2014. This chart under-reports the extent of corporate under-investment through two things not included in the red line: (1) M&As - high risk 'investment' strategies by corporates that, if adjusted for that risk, would have pushed the actual investment growth even lower than it is implied by the red line; and (2) Risk-adjustments to the organic investments by companies. In simple terms, there is no meaningful translation from higher earnings into new investment in the U.S. economy so far in 2018 and there has not been one since 2014. Put differently, U.S. economy has been starved of organic investment for a good part of the 'boom' years.

Chart 2, via the same note:

Spot something new in the charts? That's right: buybacks are accelerating in 1H 2018, with 2Q 2018 marking an absolute historical high at USD 1.0803 trillion (annualized rate) of buybacks. Guess what does this mean for the markets? Well, this:

And what causes the latest spike in buybacks? No, not growing earnings (which are appreciating, but moderately). The fiscal policy under the Tax Cuts and Jobs Act 2017, or Trump Tax Cuts.

Let's circle back: monetary policy madness of the past has been holding court in bond markets and stock markets, pushing mispricing of risks to absolutely astronomical highs. We have just added to that already risky equation fiscal policy push for more mispricing of risks in equity markets.

This is like dumping picnic-sized bags of ice into the cooling system to run the reactor hotter. And no one seems to care that the bags of ice are running low in the delivery truck... You can light a smoke and watch ice melt. Or you can run for the parking lot to drive away. As an investor, you always have a right choice to make. Until you no longer have any choices left.