Like so many things in The World of Finance, we’re all numb to Chinese Credit data:
Behind every consequential Bubble is an inflation in underlying Credit.
It’s not the first time that a non-farm payrolls rally wiped away inklings of market anxiety. Coming early in the month – and on Fridays – the jobs report typically makes for interesting trading dynamics.
Now that was one eventful week.
It’s been only two weeks, yet 2017 is off to an interesting start. It’s certainly quite a contrast to last year’s “worst market start in decades.”
When looking back on a year, it’s only natural that events later in the year receive added emphasis. The DJIA made it within 23 points of the 20,000 benchmark as the year wound down. All major U.S. equities indices posted all-time highs in December – the Dow, S&P500 and Nasdaq, as well as small and mid-cap indices. After trading as low as 667 back in March 2009, the S&P500 closed out 2016 at 2,239. Over this period the small cap Russell 2000 inflated about four-fold to end the year at 1,357.
The broader market shined in 2016, with the small cap Russell 2000 and S&P400 Mid-Cap indices gaining 18.7% and 19.5%, respectively. Also outshining the S&P500, junk bonds enjoyed their best performance since 2009, with the HYG (high-yield ETF) returning 13.4%. The TLT (long-term Treasury ETF) eked out a 1.0% gain for the year, while the LQD (investment-grade corporate ETF) returned 6.1%.
The S&P500 rallied almost 10% post-election, with the small caps doubling that percentage gain. Trump trepidation may have temporarily pushed the DJIA down almost 1,000 points election night, but post-election optimism rallied right along with market prices. Reagan-style deregulation, along with tax reform, fiscal stimulus, infrastructure spending and trade reform are viewed as ushering in a fundamentally improved environment for corporate America and the U.S. economy overall.
Importantly, the economic backdrop was supportive of market optimism. At 3.5%, Q3 GDP was the strongest in two years. GDP has shown strong momentum, rising from Q1’s 0.8% and Q2’s 1.4%. At 4.6%, November’s unemployment rate was the lowest going back to boom-time August 2007. On the back of surging stock prices, consumer confidence jumped to the highest level since August 2001. Auto sales were on track to reach an annual record 17.5 million units. Home prices have returned to record levels, with existing home sales the strongest since 2007.
It’s reasonable to posit that U.S. lending conditions have become the loosest since (at least) 2007, helping to explain the strength in auto and home sales along with the general economy. It’s worth noting that the 2016 U.S. fiscal deficit rose a third to $587 billion, or 3.2% of GDP. Revenues increased 1%, while spending jumped 5%.
As of the end of Q3, the U.S. economy was on track for the strongest Credit growth since 2008. Q3 seasonally-adjusted and annualized (SAAR) Non-financial Credit growth reached $2.679 TN (about $2.375 TN SAAR over three quarters) the strongest expansion since 2007’s record $2.503 TN. Household mortgage Credit has been expanding the most rapidly since 2007. M2 “money” supply increased over $900bn in 2016, expanding about 8.0%. Clearly, U.S. rates have been held way to too low for way too long.
Ultra-loose finance was a global phenomenon. According to the Financial Times, global debt issuance reached an all-time high $6.60 TN, surpassing 2006’s record. Global corporate issuance was up 8% from 2015 to $3.60 TN. The year supported the view that things tend to get crazy near the end of epic Bubbles.
A summarizing December 30th Bloomberg headline: “A Year in China Markets: Yuan Down, Stocks Down, Bonds Faltering.” For the year, China’s currency declined 6.6%, “the most in two decades.” The yuan began the year weak and end the year weaker. “Money” flooded out of China at the beginning of 2016, then somewhat stabilized before the floodwaters began to rise again during the fourth quarter.
Chinese stocks also had a rough year. The Shanghai Composite dropped 11.3%, with the CSI Smallcap 500 Index down 17.8%. China’s growth-oriented ChiNext index was hit even harder, sinking 27.7%. Chinese international reserves dropped another $280 billion during the year to $3.330 TN. Reserves have declined a stunning $940 billion since the June, 2014 peak.
With year-end optimism dominating, it’s easy to forget that China was in the process of bringing global markets to their knees early in the year. According to the Financial Times, global markets lost $4.0 TN in the first ten trading sessions of 2016 – the “worst-ever” start to a trading year. The Shanghai Composite sank a quick 25% in January, with fears of a bursting Chinese Bubble hammering global markets. The S&P500 dropped 11%, the worst start to a year in decades. The Nasdaq Composite fell 16%. By early February, crude was already down almost 30%. The GSCI commodities index lost 14%, trading to a low going all the way back to 2004.
As fears rose of a bursting global Bubble, bank stocks fell under heavy selling pressure. U.S. banks (BKX) and broker/dealers (XBD) were each down over 20% in the year’s initial weeks. The Hang Seng China Financials index sank almost 25%. Japanese banks were under even more intense selling pressure, with the TOPIX-Banks Index falling 35%. European stocks (STOXX 600) dropped almost 30%. By mid-February, Germany’s behemoth Deutsche Bank was sporting a y-t-d loss of almost 40% – and it was making folks nervous.
Again, year-end optimism clouds our memories and interpretations of early-year market behavior. But my view at the time was that the global Bubble was faltering. The great Chinese Bubble was at serious risk of implosion, with stocks crashing, the economic boom faltering, bond defaults multiplying and “money” trying to exit as fast as possible. In short, China’s debt Bubble was at acute risk of crashing, imperiling some of that nation’s largest banks – huge institutions that now populate the top of the list of the world’s largest banks.
While they surely received zero consideration, I’d award global central bankers “2016 Person of the Year.” Understandably, most see “The Year of Donald Trump” or “The Year of Global Populism.” Yet from my analytical perspective it was “Yet Another Year of Desperate Central Bankers.” Recall that market sentiment early in the year held that central banks had largely expended their ammo. There was even talk of “quantitative tightening.” The Fed had commenced a tightening cycle and EM central banks were under pressure to sell Treasuries and other reserve assets to help stabilize their currencies. Meanwhile, the BOJ and ECB had already pushed rate cuts and QE to their limits – or so it seemed. Ominously, markets were faltering in the face of, seemingly, peak “whatever it takes.”
With Japanese unemployment at 3.3%, the Bank of Japan on January 29th did the previously thought impossible (and something Kuroda had said the prior week was not even being considered) – rates were pushed into negative territory with a warning that they could go even lower. Reuters: “BOJ stuns markets with surprise move to negative interest rates.” BOJ Governor Haruhiko Kuroda, responding to unstable global markets: “What’s important is to show people that the BOJ is strongly committed to achieving 2% inflation and that it will do whatever it takes to achieve it.”
Reuters: “Kuroda said the world’s third-biggest economy was recovering moderately and the underlying price trend was rising steadily. ‘But there’s a risk recent further falls in oil prices, uncertainty over emerging economies, including China, and global market instability could hurt business confidence and delay the eradication of people’s deflationary mindset,’ he said.”
Draghi’s ECB entered the fray on March 9th. Determined to “beat market expectation,” ECB doves pushed the hawks completely out of the way to boost monthly QE by 20bn euros (second increase in three months), slash rates, introduce a new LTRO lending program, and add corporate debt to its buy list. Mario Draghi rather proudly stated: “We have shown that we are not short of ammunition.”
The FOMC refrained from rate normalization during January and March meetings, as the tone was set for “whatever it takes” central banking worldwide. The subsequent global market rally was interrupted by the previously thought impossible, a majority in the UK voting on Thursday, June 23rd to exit the EU.
A shocked market pounded the pound down more than 10%, before the British currency ended that Friday’s session down 8.3%. The euro fell 3%, while EM currencies were under heavy selling pressure. Safe haven assets surged. Treasury yields sank to 1.41%, the yen jumped 3.8% and gold rose 4%. Meanwhile, global equities erased $2.0 TN of value. Italian and Spanish stocks were down about 12%, with losses of about 6% for German and French equities. European bank stocks were crushed. The DJIA dropped 611 points on June 24th trading. The Nasdaq Composite was down 202 points, or 4.1%, its worst showing since 2011. Crude sank 5%. It would prove a great buying opportunity for almost all global risk assets.
On August 4th, the Bank of England (with unemployment at 4.9% and market yields collapsing) moved forward with “whatever it takes,” cutting rates and reviving QE. From the UK Guardian: “Carney rebuffed suggestions the Bank was over-reacting to the Brexit vote and implied the UK would fall into recession without the new measures. ‘There is a clear case for stimulus, and stimulus now, in order to have an effect when the economy really needs it,’ he said.” The FTSE 100 ended the year up 14.4% at an all-time high. Not faring as well, the British pound dropped 16.3% versus the dollar.
By August markets took serious comfort from “whatever it takes.” And when it came to global reflation and reversing faltering market Bubbles, global central bankers had received extraordinary assistance from Beijing. Panicked Chinese officials had imposed a series of extreme measures to bolster liquidity and market prices, while adopting various control measures that restricted “money” leaving the country. The so-called “national team” had become an aggressive buyer of Chinese equities. Most importantly, a surge in state-directed lending saw Total Social Financing jump an incredible $525bn in January, spurring what would be a record $1.5 TN of first-half Credit growth – and full-year 2016 Credit expansion approaching an unmatched $3.0 TN.
When it comes to major Credit Bubbles, there’s inherently a fine line between a bursting Bubble and a perilous amplification of Terminal Phase Excess. It’s worth recalling that previous Chinese official efforts to rein in overheated real estate (apartment) markets worked to push excess liquidity into increasingly speculative stock markets. Trading around 2,200 in mid-2014, the Shanghai Composite surged to a peak Bubble 5,380 by mid-2015. Ironically, efforts this year to stabilize faltering equities, mounting Credit stress and a rapidly slowing economy incited a precarious liquidity (speculative blow-off) stampede into real estate and bond Bubbles.
Chinese mortgage finance Bubble excess this year pushed China’s housing Bubble to a state of being completely out of control. Year-over-year prices surged 46% in Shanghai, 35% in Beijing, 51% in Shenzhen and 49% in Nanjing. Despite mounting defaults and Credit stress, the over-abundance of cheap liquidity ensured that Chinese companies continued their aggressive leveraging. Growing another 16.5% during 2016, China now takes claim to the third-largest global bond market. Total repo financing is said to now exceed the amount of available outstanding bonds, in the face of an ongoing rapid expansion of “Shadow Finance” and speculative leveraging.
Total Chinese debt now easily exceeds 250% of GDP. It was also a record year for Chinese outbound M&A – $219 billion (Dealogic). As the year progressed, rapid Credit growth fueled rises in consumer and producer inflation: China’s November PPI was up 3.3% y-o-y, the strongest rise since 2011
As 2016 came to an end, Chinese officials appeared to recognize the dilemma they faced. The talk was how surging home prices posed a risk to social stability, and of the need for more aggressive measures to thwart Bubbles. In particular, “shadow banking” and speculation appear to be in official crosshairs.
The Shanghai Composite dropped 6.4% in December. More ominously, China’s bond markets turned increasingly unstable. Ten-year Chinese government yields surged 50 bps in several weeks (to 3.32%), before a year-end rally had yields closing 2016 at 3.04%. Year-end funding pressures were even more intense than usual. More importantly, increasingly conspicuous cracks are forming in China’s corporate financing markets. Liquidity, default, fraud and counter-party issues are taking a rising toll. Desperate measures in 2016 to mask systemic debt problems with record amounts of new debt and market intervention will have dire consequences.
It’s that ominous dynamic of rapidly rising Credit necessary to stimulate even declining economic growth. But massive Credit did stabilize Chinese economic activity in 2016, playing a major role in the stabilization of global crude and commodity prices – price recoveries that were instrumental in stabilizing global debt concerns that were spreading from commodity-related companies, countries and regions.
It’s worth noting that the popular U.S. high-yield bond ETF (HYG) was down almost 7.0% by mid-February. Emerging market stocks and bonds were trading at multi-year lows. Key EM currencies, including the Mexican peso, South Korean won, South African rand, Indian rupee, Russian ruble, and Turkish lira, were under heavy selling pressure. Remember the fears for Glencore and other companies highly leveraged to commodities?
Well, Glencore’s stock ended 2016 up over 200%. U.S., European and Asian junk debt, for the most part, enjoyed a banner year. The HYG returned 13.4% in 2016, ahead of the 9.3% gain for the EMB (EM bond ETF). EM stocks (EEM) rose 11.7%. The GSCI Commodities Index jumped 27.9%, led by a 45% increase in crude prices. Stocks in Brazil gained 38.9%, Russia 26.8% and Mexico 6.2%. Down a quick 12% to start the year, Canadian stocks ended 2016 with a 17.5% gain, the “Developed World’s Top Market.”
Who back in February would have forecast oil, junk, Brazil and Russia at the top of the 2016 leaderboard? Who would have predicted Friday’s AP headline? “Energy Companies and Banks Led Rally on S&P 500 in 2016.” But it’s always the leveraged and finance-dependent entities “at the margin” that are most sensitive to changing financial conditions. Without extreme “whatever it takes” measures (from global central banks and China) it would be today a very different world. This year’s biggest winners – stocks, bonds, currencies, etc. – could have instead been huge losers, with the Periphery dragging down the Core.
But with global QE in the neighborhood of $2.0 TN annually and hundreds of billions flowing out of China, the vulnerable Periphery enjoyed a liquidity windfall. Global fragilities were in the short-term ameliorated by unprecedented global rate and liquidity dynamics. The year began with the world at the precipice of a bursting Bubble. The bottom line is that the global Bubble persevered and then inflated significantly.
To be sure, Global Monetary Disorder become deeply entrenched. After trading at a 13-year low $26.05, WTI crude more than doubled (“biggest annual gain since 2009”) to trade as high as $54.50 near year-end (OPEC managing the first production cut since 2008). Trading inversely to risk assets, bullion began the year at $1,061, surged to $1,375 (7/11) and then reversed course to end the year at $1,152. After starting 2016 at 111, the HUI gold equities index surged to 286 in July, before reversing course to close the year up 64% at 182. Wild moves were not limited to commodities. The British pound sank 10% versus the dollar on Brexit, to a 31-year low. The Mexican peso collapsed 14% to an all-time low on Trump’s equally stunning win. Draghi’s December move to expand and extend ECB monetary stimulus pushed the euro to a 14-year low against the U.S. currency.
The Japanese yen has for some time been a leading funding currency for global leveraged speculation. The dollar/yen began the year at 120.22 before trading as high as 121.69 on January 29th. Fears of global de-risking/de-leveraging saw the yen rally strongly versus the dollar. This advance was capped by a Brexit induced better than 4% surge that had the dollar/yen trading below 100 on June 24th (first time below 100 since 2013). The dollar/yen began to rally in September, although it traded as low as 101.20 during chaotic U.S. election-night trading. Then an abrupt rally had the dollar/yen trade as high as 118.66 on December 15th, before closing 2016 at 116.96.
Yet nowhere was Monetary Disorder more prominent in 2016 than throughout global bond markets. When it appeared global yields could not possibly decline much more, the impossible: They sank a lot lower, hitting historic extremes in the wake of the Brexit vote. UK debt has traded for a very long time, yet never at yields as low as those of 2016. After beginning the year at 1.96%, 10-year gilt yields dropped to 1.22% in early-July. After starting 2016 at 2.27%, 10-year Treasury yields hit a record low 1.36% on July 8th. Japan’s JGB yields sank to negative 29 bps, after starting the year at positive 27 bps. Swiss 10-year yields were a negative five bps to begin the year, but then sank to an incredible negative 63 bps. Bund yields dropped to negative 19 bps (began 2016 at 63bps), as French yields fell all the way to 10 bps (99 bps). Highly indebted Italy saw its 10-year yields sink to an impossibly low 1.04% (1.60%), and Spanish yields fell to an equally incredible 0.88% (1.77%). By August, an impossible $13.4 TN of global bonds were trading with negative yields (FT).
It evolved into a spectacular market dislocation and melt-up, surely fueled by derivative-related trading and a powerful short-squeeze. Typical of blow-off tops with their abrupt reversals, market euphoria proved short-lived. From 2016 lows, Treasury yields surged 124 bps, with British gilt yields up 109 bps. From lows to highs, bund yields rose 59 bps, French yields 77 bps and Spanish yields 73 bps.
Of special note, Italian yields jumped 109 bps from earlier lows, with a year-end rally reducing the 2016 yield rise to 22 bps at 1.82%. Portuguese bonds ended the year at 3.76%, up 124 bps. Providing a good microcosm of “Periphery” instability, Greek bond yields surged to 11.57% in February only to close 2016 at 7.11%. In a few short weeks, Mexican (peso) yields surged 160 bps, with significant yield rises throughout EM.
For the year, the Argentine peso declined 18.6%, the Turkish lira 17.2%, the Mexican peso 17.0%, the Polish zloty 6.3%, the Philippine peso 5.2% and the Malaysian ringgit 4.3%. Mexico was forced to raise rates to support a rapidly sinking peso and counter prospects for an inflationary surge.
Wild markets for the most part didn’t help the struggling leveraged speculating community. A December 28th Bloomberg headline: “The Golden Era of Hedge Funds Draws to a Close With Clients in Revolt.” While most funds again underperformed expectations, the industry got through 2016 without major redemptions. This they owe to central bankers and Chinese officials. And another Bloomberg headline, this one from December 30th: “Actively Managed Funds Take a Beating.” Throughout 2016, and especially after the election, “money” literally flooded into equity index and other passively managed ETFs. Central bankers ensured that managers attentive to risk and risk management had another crummy year.
I expect future historians will see 2016 chiefly through the geopolitical perspective. How can market happenings compete against Brexit, the Trump phenomenon and Renzi’s failed political reform referendum (to name only the most obvious)? But clearly unstable markets, unsettled societies and simmering geopolitical turmoil are more than coincidental. At their roots, all can be traced to a prolonged period of unchecked finance, central bank activism and the general effects of inflationism.
Consequences were on increasing display throughout 2016. There was the rising tide of anti-establishment populism that seemingly became a global phenomenon. There was the deep discontent that led to Brexit and President-elect Trump. This was part of general instability and uncertainty that afflicted financial markets – in the process ensuring “whatever it takes” went to even crazier extremes. And, almost ironically, this is the type of mercurial social and monetary backdrop conducive to powerful markets reversals and attendant bouts of hope and optimism.
December 27 – Bloomberg (Vince Golle): “The last time Americans’ optimism about the stock market registered such a dramatic one-month surge was during the dot-com boom. As stocks reached a record, the share of households anticipating higher equity prices a year from now surged to 44.7% in December from 30.9% a month earlier, the biggest monthly advance since November 1998…”
As an extraordinary year came to an end, confidence overtook caution. Just kind of pushed it aside. Markets became willing to dismiss myriad risks – all the uncertainties associated with China, Italy, rising populism, terrorism, geopolitical, etc. It was as if everyone just turned tired of worrying. There was as well a willingness to imagine the best of President-elect Trump’s policies, while disregarding all the uncertainty that comes with such a unique personality. It’s going to be an incredibly fascinating 2017.
The S&P500 declined 1.1% (up 9.5% in 2016), and the Dow dipped 0.9% (up 13.4%). The Utilities were little changed (up 13.2%). The Banks gave back 1.4% (up 25.6%), and the Broker/Dealers sank 2.2% (up 15.3%). The Transports lost 1.6% (up 20.4%). The S&P 400 Midcaps slipped 0.8% (up 18.7%), and the small cap Russell 2000 declined 1.0% (up 19.5%). The Nasdaq100 dropped 1.5% (up 5.9%), and the Morgan Stanley High Tech index fell 1.3% (up 12.3%). The Semiconductors fell 2.3% (up 36.6%). The Biotechs sank 3.3% (down 19.4%). With bullion recovering $18, the HUI gold index rallied 7.9% (up 64%).
Three-month Treasury bill rates ended the week at 50 bps. Two-year government yields slipped a basis point to 1.19% (up 14 bps for 2016). Five-year T-note yields fell 10 bps to 1.93% (up 18bps). Ten-year Treasury yields dropped nine bps to 2.45% (up 20bps). Long bond yields declined five bps to 3.07% (up 5bps).
Greek 10-year yields dropped 22 bps to close the year at 7.02% (down 30bps in 2016). Ten-year Portuguese yields added two bps to 3.75% (up 123bps). Italian 10-year yields slipped a basis point to 1.81% (up 31bps). Spain’s 10-year yields increased one basis point to 1.38% (down 39bps). German bund yields slipped a basis point to 0.20% (down 42bps). French yields declined one basis point to 0.68% (down 31bps). The French to German 10-year bond spread was unchanged at 48 bps. U.K. 10-year gilt yields dropped 11 bps to 1.24% (down 73bps). U.K.’s FTSE equities index jumped 1.1% (up 14.4%).
Japan’s Nikkei 225 equities index dropped 1.6% (up 0.4% for 2016). Japanese 10-year “JGB” yields declined a basis point to 0.04% (down 22bps). The German DAX equities index added 0.3% (up 6.9%). Spain’s IBEX 35 equities index slipped 0.2% (down 2.0%). Italy’s FTSE MIB index declined 0.6% (down 10.2%). EM equities were mixed. Brazil’s Bovespa index surged 4.0% (up 38.9%). Mexico’s Bolsa gained 1.0% (up 6.2%). South Korea’s Kospi declined 0.5% (up 3.3%). India’s Sensex equities index rallied 2.2% (up 1.9%). China’s Shanghai Exchange slipped 0.2% (down 12.3%). Turkey’s Borsa Istanbul National 100 index jumped 1.5% (up 8.9%). Russia’s MICEX equities index rallied 2.7% (up 26.8%).
Junk bond mutual funds saw inflows of $592 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates added two bps to a 27-month high 4.32% (up 31bps y-o-y). Fifteen-year rates rose three bps to 3.55% (up 31bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 4.37% (up 27bps).
Federal Reserve Credit last week expanded $3.7bn to a nine-week high $4.427 TN. Over the past year, Fed Credit contracted $27.4bn (down 0.6%). Fed Credit inflated $1.616 TN, or 58%, over the past 216 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $8.0bn last week to $3.180 TN. “Custody holdings” were down $144bn y-o-y, or 4.3%.
M2 (narrow) “money” supply last week added $1.3bn to $13.236 TN. “Narrow money” expanded $909bn, or 7.4%, over the past year. For the week, Currency increased $0.3bn. Total Checkable Deposits gained $8.8bn, while Savings Deposits declined $6.3bn. Small Time Deposits slipped $1.3bn. Retail Money Funds gained $1.2bn.
Total money market fund assets jumped $15.9bn to $2.728 TN. Money Funds declined $31bn y-o-y (1.1%).
Total Commercial Paper surged $20.5bn to $987bn. CP declined $70bn y-o-y, or 6.7%.
December 29 – Wall Street Journal (Lingling Wei): “China’s central bank is adjusting the mix of foreign currencies used in setting the yuan’s official daily value… Starting Jan. 1, the central bank will expand the number of currencies in the basket uses to calibrate the yuan’s value to 24 from 13 and reduce the weighting given to the U.S. dollar to 22.4%, from 26.4%… China wants a slightly weaker currency to help exporters and maintain competitiveness with other economies as the dollar rises, but it doesn’t want to lose control. By diluting the dollar’s share and bringing in currencies from the Korean won to the Saudi riyal and Swedish krona, the People’s Bank of China is giving itself more room to maneuver to keep the yuan from falling too fast, analysts said.”
The U.S. dollar index slipped 0.6% to 102.4 (up 3.8% y-t-d). For the week on the upside, the South African rand increased 1.9%, the Swedish krona 1.1%, the New Zealand dollar 0.9%, the Swiss franc 0.7%, the Norwegian krone 0.7%, the Canadian dollar 0.7%, the Brazilian real 0.6%, the euro 0.6%, the British pound 0.5% and the Australian dollar 0.5%. For the week on the downside, the Mexican peso declined 0.6%, the South Korean won 0.4% and the Taiwanese dollar 0.3%. The Chinese yuan was little changed versus the dollar (down 6.6%).
The Goldman Sachs Commodities Index jumped 1.7% (up 27.9% in 2016). Spot Gold rallied 1.6% to $1,152 (up 8.6%). Silver gained 1.4% to $15.98 (up 15.8%). Crude rose 81 cents to $53.83 (up 45%). Gasoline added 1.9% (up 32%), and Natural Gas gained 1.7% (up 60%). Copper rose 1.1% (up 17%). Wheat jumped 3.7% (down 13%). Corn recovered 1.8% (down 2%).
December 26 – Reuters (Silvia Aloisi and Stephen Jewkes): “The European Central Bank has told Monte dei Paschi it needs to plug a capital shortfall of 8.8 billion euros ($9.2bn), higher than a previous 5 billion euro gap estimated by the bank… Last Friday the Italian government approved a decree to bail out Monte dei Paschi after Italy’s No. 3 lender failed to win investor backing for a desperately needed 5 billion euro capital increase. The bank said on Monday it had officially asked the ECB last Friday for go ahead for a ‘precautionary recapitalization’.”
December 26 – Reuters (Maria Sheahan): “European Central Bank policymaker Jens Weidmann said plans for a state bailout of Italian bank Monte dei Paschi di Siena should be weighed carefully as many questions remain to be answered… ‘For the measures planned by the Italian government the bank has to be financially healthy at its core. The money cannot be used to cover losses that are already expected,’ Bild quoted Weidmann as saying…”
December 27 – Reuters (Maria Sheahan): “Germany’s Bundesbank has this year taken back more of its gold than planned as it moves towards hoarding half of the world’s second-largest reserve at home, Bundesbank President Jens Weidmann told German daily Bild. ‘We brought back significantly more gold to Germany in 2016 again than initially planned. By now, almost half of the gold reserves are in Germany,’ the paper quoted Weidmann… In the wake of the euro zone crisis, many ordinary Germans want to see more of the 3,381 tonnes of gold in vaults at home.”
China Bubble Watch:
December 22 – Bloomberg: “President Xi Jinping said China should deflate property bubbles and regulate the market for rental housing to better meet people’s residential needs, reinforcing the objectives outlined last week at an annual gathering of the country’s top economic leaders. ‘The country should accurately understand the residential feature of housing’ and create a better system for purchases and rentals to better serve new urban populations, Xi said… ‘The market will play the leading role in catering to multi-layered demand, while the government will take care of basic housing demand.’”
December 25 – Bloomberg: “China Guangfa Bank Co. said Monday that documents and seals for a letter claiming to guarantee bond payments by the lender were forged, in the second such incident in the nation this month, raising concern about transparency in the world’s third-biggest bond market… ‘Over the past few years, business growth of financial institutions has outpaced their capability to boost internal controls and also gone beyond the radar of regulators,’ said He Xuanlai… analyst at Commerzbank AG… A lack of transparency and protection in bond documentation are adding to angst among investors after Sealand Securities Co. said earlier this month a former employee was found to have forged a seal to conduct bond trading. Concern about China’s bond market has been climbing after at least 28 onshore notes defaulted this year amid an economic slowdown, jumping from seven in 2015.”
December 28 – Bloomberg (Justina Lee): “China bulls could be facing a grim New Year’s eve. The first day of 2017 is when an annual $50,000 quota to convert the yuan into foreign exchange resets, stoking concern there will be a rush to sell the local currency. With tax payments and a regulatory assessment also tightening liquidity in the money market toward year-end, January may bring scant relief as lenders prepare for stronger cash demand before Lunar New Year holidays, which are only a month away. China’s markets are seeing renewed pressure this month as the Federal Reserve projects a faster pace of rate increases for 2017 and its Chinese counterpart tightens monetary conditions to spur deleveraging and defend the exchange rate. The declines are capping off a tough year for investors during which bonds, shares and currency all slumped.”
December 27 – Bloomberg: “The onshore yuan’s surging trading volume is another piece of evidence that capital is fleeing China at a faster pace. The daily average value of transactions in Shanghai climbed to $34 billion in December as of Monday, the highest since at least April 2014… That’s up 51% from the first 11 months of the year. The increase suggests quickening outflows, given that data in recent months showed banks were net sellers of the yuan, according to Harrison Hu, …chief greater China economist at Royal Bank of Scotland… This month’s jump in trading volume signals sentiment has kept deteriorating since November, when the nation’s foreign-exchange reserves shrank by the most since January.”
December 29 – Bloomberg: “China pledged more proactive fiscal policy in 2017 while vowing to enhance control over local government debt, as policy makers in the world’s second-largest economy seek to sustain steady growth while defusing risks. Fiscal policy will be more proactive and effective next year, and more tax cuts will be rolled out… China will ‘reasonably’ expand expenditures and improve efficacy, while strengthening management of local government debt, it said.”
December 28 – Bloomberg: “China’s requirement for how much cash banks must hold as reserves is ‘very high’ and should be reduced at an ‘appropriate time,’ a senior banking regulator said… Other financing tools can be used to manage the money supply after easing the required reserve ratio, China Banking Regulatory Commission official Yu Xuejun said… New monetary tools such as the medium-term lending facility are best used after a cut… The People’s Bank of China has held the RRR at 17% since February after four cuts last year.”
Global Bubble Watch:
December 27 – Financial Times (Eric Platt): “Global debt sales reached a record in 2016, led by companies gorging on cheap borrowing costs that are now threatened by Donald Trump’s pledge to fire up the US economy. The bond rally that dominated the first half of the year helped entice borrowers that issued debt via banks to take on just over $6.6tn, according to… Dealogic, breaking the previous annual record set in 2006. Companies accounted for more than half of the $6.62tn of debt issued, underlining the extent to which negative interest-rate policies adopted by the European Central Bank and the Bank of Japan, as well as a cautious Federal Reserve, encouraged the corporate world to increase its leverage. Corporate bond sales climbed 8% year on year to $3.6tn… The year’s debt sales were buoyed by China and Japan-based issuers, up 23 and 30% respectively, from a year earlier.”
December 19 –Reuters (Marc Jones): “The number of firms worldwide that have defaulted this year has reached 150, up more than 40% year-on-year, making 2016 the worst year for corporate stress since the height of the global financial crisis, ratings firm Standard and Poor’s said. S&P data showed that two defaults last week by U.S.-based firms had brought up the milestone and taken the U.S.-only count to 99, or two-thirds of the overall total. Just over 40%, or 63, had been by oil and gas firms, with 50 of those also in the United States. Emerging markets had accounted for 28 defaults overall, followed by Europe on 12.”
December 29 – Financial Times (Arash Massoudi, James Fontanella-Khan and Don Weinland): “A final flurry of large takeovers during the last months of 2016 lifted global dealmaking to its second-best annual level since the financial crisis as appetite for corporate acquisitions continued in spite of political turmoil and heightened regulatory scrutiny. Merger and acquisition activity in the fourth quarter reached $1.2tn, the busiest period for dealmaking in 2016… In total, the volume of global M&A was $3.6tn in 2016, a 17% drop from last year’s record $4.37tn but enough to make the year the second highest for dealmaking since 2007… Chinese companies became a major force in cross-border M&A in 2016, accounting for $220bn of transactions — almost double the amount of 2015.”
December 28 – Bloomberg (Tom Metcalf and Jack Witzig): “In a year when populist voters reshaped power and politics across Europe and the U.S., the world’s wealthiest people are ending 2016 with $237 billion more than they had at the start. Triggered by disappointing economic data from China at the beginning, the U.K.’s vote to leave the European Union in the middle and the election of billionaire Donald Trump at the end, the biggest fortunes on the planet whipsawed through $4.8 trillion of daily net worth gains and losses during the year, rising 5.7% to $4.4 trillion by the close of trading Dec. 27, according to the Bloomberg Billionaires Index.”
U.S. Bubble Watch:
December 27 – Bloomberg (Michelle Jamrisko): “Consumer confidence climbed in December to the highest level since August 2001 as Americans were more upbeat about the outlook than at any time in the last 13 years, according to the… Conference Board. Measure of consumer expectations for the next six months rose to 105.5, the highest since December 2003, from 94.4…”
December 26 – Wall Street Journal (Corrie Driebusch and Aaron Kuriloff): “Corporate stock repurchases are on the upswing once again, wrong-footing skeptics who predicted 2016 would mark the beginning of the end of a postcrisis spending spree. Through Dec. 16, companies this month have stepped up their buybacks by nearly two-thirds over the same period last year, according to Goldman Sachs… Repurchases have been a major contributor to the nearly eight-year stock rally. From the start of 2009 to the end of September 2016, companies in the S&P 500 spent more than $3.24 trillion repurchasing shares… In the first three quarters of the year, companies in the S&P 500 spent just over $400 billion on stock buybacks, down from the $426 billion in the same period last year…”
December 27 – Bloomberg (Vince Golle): “The last time Americans’ optimism about the stock market registered such a dramatic one-month surge was during the dot-com boom. As stocks reached a record, the share of households anticipating higher equity prices a year from now surged to 44.7% in December from 30.9% a month earlier, the biggest monthly advance since November 1998, the Conference Board’s report… showed…”
December 29 – Reuters (Swetha Gopinath): “U.S. shale drillers are set to ramp up spending on exploration and production next year as recovering oil prices prompt banks to extend credit lines for the first time in two years. The credit increase is small, but with major oil producers worldwide aiming to hold down production in 2017, U.S.-based shale drillers are looking to boost market share to take advantage of higher prices, and greater availability of capital will make that easier.”
December 28 – Wall Street Journal (Kirsten Grind and Peter Rudegeair): “This is a great time to be in the house-flipping business. The number of investors who flipped a house in the first nine months of 2016 reached the highest level since 2007. About one-third of the deals were financed with debt, a percentage not seen in eight years. Now Wall Street, which was nearly felled by real-estate forays almost a decade ago, is getting back into the action. A number of banks are arranging financing vehicles for house-flippers, who buy and sell homes in a matter of months.”
December 27 – Dow Jones: “Brazil’s government deficit widened to 9.28% of gross domestic product in the 12 months through the end of November, compared with 8.83% through the end of October… The primary budget balance, which excludes interest payments and is a measure of the government’s ability to reduce its debt, increased to 2.50% of GDP…”
Leveraged Speculator Watch:
December 28 – CNBC (Jeff Cox): “Hedge funds have jacked up their bets on the stock market to their highest levels of 2016 and cut back on short positions to a three-year low amid a blistering post-election rally. For the fourth quarter, the $3 trillion industry increased its net exposure — the difference between short and long positions — to 63%, a level that equates to a net $656 billion, according to Bank of America Merrill Lynch data. Hedge funds were last this optimistic in the fourth quarter of 2015.”
December 27 – Reuters (J.R. Wu and Ben Blanchard): “China’s sole aircraft carrier has arrived at a naval base on the southern Chinese province of Hainan, a senior Taiwanese military officer said…, after drills that took it around self-ruled Taiwan, an island China claims as its own. Taiwan warned on Tuesday that ‘the threat of our enemies is growing day by day’, as Chinese warships led by the carrier sailed towards Hainan through the disputed South China Sea.”
December 28 – Reuters (Ben Blanchard): “Quoting a poem by the founder of Communist China Mao Zedong, China’s government said… that the efforts by Hong Kong and Taiwan independence supporters to link up were doomed to fail, as they would be dashed to the ground like flies. Chinese leaders are increasingly concerned about a fledgling independence movement in the former British colony of Hong Kong, which returned to mainland rule in 1997 with a promise of autonomy, and recent protests in the city. China is also deeply suspicious of Taiwan President Tsai Ing-wen, elected earlier this year, who Beijing suspects is pushing for the self-ruled island’s independence.”
December 22 – Financial Times (Tom Mitchell and Demetri Sevastopulo): “China has warned Donald Trump that ‘co-operation is the only correct choice’ after the US president-elect tapped a China hawk to run a new White House trade policy office. The appointment of Peter Navarro, a campaign adviser, to a formal White House post shocked Chinese officials and scholars who had hoped that Mr Trump would tone down his anti-Beijing rhetoric after assuming office. Mr Navarro… is the author of Death by China and other books that paint the country as America’s most dangerous adversary.”
December 29 – Reuters (Jeff Mason): “President Barack Obama… authorized a series of sanctions against Russia for intervening in the 2016 U.S. presidential election and warned of more action to come. ‘These actions follow repeated private and public warnings that we have issued to the Russian government, and are a necessary and appropriate response to efforts to harm U.S. interests in violation of established international norms of behavior,’ Obama said…’These actions are not the sum total of our response to Russia’s aggressive activities. We will continue to take a variety of actions at a time and place of our choosing, some of which will not be publicized,’ he said.”
December 19 –Reuters: “The Russian ambassador to Turkey was shot in the back and killed as he gave a speech at an Ankara art gallery on Monday by an off-duty police officer who shouted ‘Don’t forget Aleppo’ and ‘Allahu Akbar’ as he opened fire. President Tayyip Erdogan… cast the attack as an attempt to undermine NATO-member Turkey’s relations with Russia – ties long tested by the war in Syria. He said he had agreed in a telephone call with Russia’s Vladimir Putin to step up cooperation in fighting terrorism.”
Italian bank stocks (FTSE Italia bank index) declined a modest 2.3% Monday on the back of Sunday’s resounding defeat of Italian Prime Minister Renzi’s political reform referendum. The bank index then proceeded to surge 9.0% Tuesday, 4.5% Wednesday and another 3.6% Thursday, for a stunning 27% rally off November 28th trading lows. “Par for the course,” as they say.
Pre-election trepidation morphed into post-election market exuberance, in only the latest demonstration of the power of an over-liquefied market backdrop. Here in the U.S., the bullish imagination has been captivated by the Trump administration’s pro-growth agenda.
Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets–rather than lending, as would seem more natural?
“One trouble with every inflationary creation of credit is that it acts like a delayed time bomb.