Not the most bullish looking start to 2014.
“The only thing that worries me is that there isn’t anything that you can worry about…” market pundit, CNBC, December 31, 2013
“They’re [the Fed] stopping asset purchases. You can take that to the bank.” Laurence Meyer, former Federal Reserve governor, CNBC January 2, 2014
My market thesis from a year ago was one of bipolar outcome possibilities. Either the expanding Bubble would burst or it would likely evolve into “How crazy do things get?” I posited that a bursting EM Bubble was a likely catalyst for a period of global “risk off.” I also foresaw the possibility that overheated markets might push a Fed retreat from its $85 billion monthly QE. While U.S. equities and corporate debt markets turned conspicuously overheated, the Fed erred on the side of ongoing extreme monetary stimulus. Things did in fact turn “crazy,” which significantly raised the likelihood of perceived low probability (so-called) “black swans” in 2014. I’ll attempt to make my analytical case.
The basic analytical premise is one of extraordinarily protracted Credit and speculative cycles (unlike anything since the Twenties). These interrelated Bubbles, repeatedly bolstered by aggressive monetary stimulus, foment latent financial and economic fragilities. Financial and economic Bubbles have evolved over years to encompass the world. Unprecedented financial excess has cultivated epic global imbalances and economic maladjustment.
Historic monetary inflation again sustained global Bubbles in 2013. But this came with major associated costs: these included an increasingly unwieldy Bubble in China and powerful Bubble Dynamics taking hold in U.S. equities and corporate debt (not to mention Japan or European debt and equities). Conventional analysis holds that global central banks have largely succeeded in spurring post-crisis system recovery. From my analytical framework, they have clearly made things much worse.
After beginning 1990 at $12.80 TN, Total U.S. (Non-Financial and Financial) marketable debt ended Q3 2013 at $58.08 TN. Over this period, hedge fund industry asset jumped from about $40 billion to end 2013 in the neighborhood of $2.7 TN. The Fed’s balance sheet has inflated from $315 billion to $4.0 TN. What’s more, global Bubbles have been inflating for so long that the backdrop is accepted as normal. The Fed and global central banks have aggressively intervened to the point where a strong perception holds that they have everything well under control. It has become conventional wisdom that the 2008 crisis was indeed the “100-year flood.” These are the type of market misperceptions that lay the groundwork for serious market crises.
Total Non-Financial Debt (NFD) ended Q3 2013 at $41.348 TN. For perspective, NFD began the nineties at $10.837 TN. Annual growth in NFD averaged $715bn during the robust nineties’ expansion before debt growth succumbed to extreme excess. During the Bubble years 2002 through 2008, average annual NFD growth surged to $2.320 TN, about triple the level from the nineties.
Fundamental to my Macro Credit analysis has been the thesis that prolonged Credit Bubbles inflate myriad price and spending levels throughout the economy. In the end, this inflation is unsustainable. Efforts to inflate out of deep financial and economic structural maladjustment risk systemic collapse. Importantly, prolonged Credit inflation creates systemic dependency to large quantities of inexpensive Credit/finance. I have posited that a self-reinforcing U.S. economic recovery would require in the range of $2.0 TN of annual NFD growth. NFD grew $922 billion in 2009; $1.373 TN in 2010; $1.382 TN in 2011; and $1.864 TN in 2012. Slowdowns in both federal and state & local borrowings will see NFD growth slow to about $1.60 TN in 2013.
One could argue that my fundamental thesis has by this point been proven flawed. The year 2013 saw record stock prices, rising home prices, record Household Net Worth, lower unemployment and an improved economic backdrop – all in the face of slower system Credit growth. But how much of this was the consequence of the Fed’s $1.0 TN injection of new “money” directly into the financial markets? I’m convinced it would be a much different world without QE3. Moreover, the Fed’s extra Trillion had unappreciated deleterious effects, notably by spurring “terminal phase” excess in securities markets while deepening systemic dependency to Fed “money” printing.
Conventional analysis holds that the financial markets respond to economic fundamentals. The economy drives the process, with most seeing higher stock prices as confirmation of an economy now largely rehabilitated and operating normally. My Macro Credit and Bubble framework takes a differing approach: The “financial sphere” chiefly dictates the behavior of the “economic sphere.” Considering the Fed’s prolonged rate and QE measures - and resulting inflating asset markets (perceived wealth) - the performance of the underlying economy has been notably unimpressive. And while the bullish view sees an economy with mounting momentum, for 2014 I would suggest focusing first and foremost on latent financial fragilities (global and domestic).
From a top-down Macro Credit perspective, I see little prospect for U.S. Non-Financial Debt growth getting anywhere close to the $2.0 TN bogey in 2014. At least in the near-term, the federal deficit is not expected to expand significantly. It could also be another frugal year for state & local governments. Financial conditions in muni finance have tightened meaningfully. Taper issues will likely continue to weigh on the sector, with a potential market problem with Puerto Rican debt a festering issue.
Although Household mortgage debt turned positive in Q3 2013, I doubt the Household sector is about to commence another borrowing binge. Big stock market gains and rising home prices have bolstered consumer confidence and spending in the face of tepid income growth. At the same time, it would appear that the multi-year benefit from refinancing mortgages has run its course. While spending does enjoy some current momentum, there’s a decent case to be made that consumer expenditures are unusually vulnerable to an environment of higher market yields and weak equity markets. I would expect weak bond and equities markets, if they materialize, to bring resurgent housing inflation to a brisk conclusion in most markets. Any meaningful tightening of corporate Credit would likely impinge already weak growth in compensation.
The U.S. corporate debt market stands prominently near the top of my list of “Issues 2014.” Corporate debt growth will come in near 9% for 2013, the strongest pace since 2007. I have argued that U.S. stock and corporate debt were primary beneficiaries of QE3. Throughout 2013, corporate debt fed off of Bubbling equities, QE liquidity overabundance and powerful yield-chasing speculation. Especially after last year’s excesses, corporate securities markets could be the most vulnerable to an abrupt change in sentiment and marketplace liquidity. There has been $5.0 TN of corporate debt issuance since the ’08 crisis – and there’s a case to be made that much of this Credit is significantly mispriced in today’s marketplace.
Our experimental central bank has in only five years inflated its balance sheet from $900 billion to $4.0 TN. All along the way, I have viewed Fed measures as confirmation of my Bubble thesis, while the bulls have seen confirmation of the view that central bankers won’t tolerate a crisis.
Our central bank’s expanding policy experiment has more recently included unemployment and inflation targets. It is commonly believed that monetary policy can readily impact employment and consumer prices. I would contend that it is certainly within the Fed’s power to manipulate interest rates lower and inject liquidity into the securities markets. Last year provided a historic example of how the Fed can indeed freely create and deploy “money.” It is, however, within the realm of (often whimsical) “animal spirits” to determine its effects upon financial markets. And, yes, this loosening of financial conditions at least in the short-run does stimulate the markets and spending. As we’ve witnessed, extreme monetary stimulus can pull the unemployment rate somewhat lower.
But how about consumer prices? I actually believe there is a major misperception when it comes to the power of contemporary central banks to dictate an aggregate price level – a misconception with potentially important implications for securities prices. In contrast to the traditional central bank printing press that distributed paper currency throughout the real economy (generally raising prices), the contemporary electronic printing press injects liquidity directly into securities markets. The paramount inflationary impact is on securities prices and issuance.
As a rough proxy for total outstanding marketable debt, I tally outstanding Treasuries, MBS, Corporate bonds and muni debt. I then add the market value of equities for a proxy of “Total U.S. Marketable Securities.” According to the Federal Reserve data (Z.1), 2007 ended with total marketable debt securities of $27.5 TN and equities of $25.6 TN, for combined Marketable Securities of $53.1 TN. As a percentage of GDP, Marketable Securities ended 2007 at a then record 378% of GDP. This compares to $6.2 TN of Marketable Securities back in 1985 at 148% of GDP; $18.8 TN of Marketable Securities at 254% of GDP in 1995; and $43.35 TN of Marketable Securities at 343% of GDP to end 2005.
I estimate that “Marketable Securities” ended 2013 at approximately $68.15 TN – fully $15 TN, or 28%, greater than the record level heading into the 2008 crisis. As a percentage of GDP, total Marketable Securities have almost reached 410% of GDP. I estimate that Marketable Securities inflated an unprecedented $6.65 TN in 2013 (waiting for Q4 data).
The average stock (Value Line Arithmetic) inflated 38.4% during 2013. The Consumer Price Index is expected to be up about 1.2%. The Fed’s Trillion dollar “money” printing operation clearly had a huge impact on equities prices, but not so much when it came to general consumer prices. There is understandable worry that the Fed is laying the groundwork for future inflation. Yet, is it possible that the Fed’s monetary operations could actually be having a perverse impact on prices outside of securities and asset markets? This could prove a major Issue 2014.
I would like to be clear on this: I am not arguing that disinflationary forces are the prevailing risk. The overarching risk remains central banks accommodating unsustainable global Credit and asset Bubbles. The Fed and global central banks’ “deflation” fight has and will continue to only exacerbate Bubble risks. And, importantly, myriad Bubbles are creating an increasingly dangerous gulf between inflated securities prices and disinflationary forces gathering momentum in real economies. This schism is a major Issue 2014.
I would contend that central banks these days have minimal control over consumer prices. Much more important is the atypical nature of contemporary economic output, with myriad services, drugs and medical procedures, digital downloads, various media and entertainment, and an incredible array of technology products creating a virtually unlimited supply of things to readily absorb purchasing power. “Globalization,” especially the (global Bubble-induced) incredible increase in manufacturing capacity throughout China and Asia, has also had a profound impact on the general pricing backdrop.
When the Fed these days injects $1.0 TN of new “money” into the markets, various forces are unleashed that actually work against its goal of higher consumer price inflation. Fed liquidity certainly worked to sustain a boom in manufacturing capacity throughout China and Asia. Prolonging the U.S. Credit Bubble also ensured a further redistribution of wealth to society’s more fortunate. The end result is that the Fed’s Trillion dramatically inflated stock prices with little of this “money” distributed generally throughout the real economy. Segments of the economy begin 2014 in a spectacular boom, while vast sections of the country and society face ongoing stagnation.
The bullish view holds that equities these days reside in this extraordinary “sweet spot” of low market yields, low inflation and expanding profits. The U.S. recovery has finally reached takeoff speed. The future is bright and such a backdrop is deserving of generous market valuations.
My analytical framework views the world from an altogether different perspective. Inflating securities markets mask that central bankers are actually losing their war. Experimental monetary policies have fomented dangerous asset Bubbles, while exacerbating financial imbalances and economic maladjustment. Disinflationary pressures globally are an increasing risk to corporate profits and Credit quality more generally. This is especially pertinent today in China, Asia and the emerging markets (EM). There, Credit continues its rapid expansion, while global overcapacity builds for too many things. Equities generally should trade at a significant discount to traditional valuations, while Credit spreads would reasonably reflect an increasingly risky financial and economic backdrop.
Last year saw cracks in EM Bubbles and the initial phase of revaluing EM securities. In a world of central bank-induced over-liquefied and highly speculative markets, trouble at the “periphery” only worked to spur excess at the “core.” U.S. (and “developed”) securities markets Bubbles, in particular, fatefully diverged from the global trend of heightened instability and mounting disinflationary forces.
The Chinese Credit system and economy are major Issues 2014. After years of runaway Credit and capital investment, the Chinese economy suffers from excess capacity across various industries. This is particularly problematic for what has become a highly leveraged economy. Corporate borrowing costs have begun to reflect this backdrop, with rising risk premiums a serious issue for highly indebted corporations. Their highly fragmented and opaque local government sector is an accident in the making. The same is true for China’s ballooning “shadow bank” and its tinderbox of Trillions of risky Credits bound with the (“moneyness”) perception that Chinese authorities will ensure safety and liquidity. Especially after again failing to confront its escalating problems 2013, I believe China will be a major global concern throughout 2014. I see all the necessary elements for a major financial crisis.
Over the past year, it appears Credit continued to grow in excess of 20% in China, Brazil, India and elsewhere throughout EM. This supports my view that the unfolding EM Credit crisis is in an early phase with the more significant economic effects yet to manifest. It’s worth noting that Asian markets have begun 2014 on the downside. Equities opened the year weak, while bond yields and CDS have moved higher. Thailand equities were hit for 5% on the first trading day of the year, while Indonesian yields jumped 53 bps (to 9.0%) this week.
The New Year begins where 2013 left off, with troubling social tensions and political uncertainties. Turkey is an important EM economy with very serious political, financial and economic issues. But my scan of the world sees a troubling backdrop conducive to ongoing social and political instability. Developments throughout the Middle East continue to appear ominous. The global Bubble has fatefully raised societal expectations in China and throughout EM. I fear escalating tensions between China and Japan, and see Japan’s yen devaluation as aggravating the situation. It may have been “enrich thy neighbor” to Bernanke in 2013, but it will be an increasingly contentious “beggar thy neighbor” in 2014.
I would include Europe as a major Issue 2014. Almost ironically, cracks in EM worked to the benefit of European markets in 2013. Speculative flows buoyed Italian, Spanish, Portuguese and Greek bonds, as "hot money" exited faltering markets in Brazil, Turkey and elsewhere. And even in 2014’s initial trading sessions, periphery eurozone bonds were global outperformers. A major question for 2014 will be how periphery European markets trade in a global “risk off” (or at least less risk-on) market dynamic. With little headway made in reducing debt throughout the region, the risk of a self-reinforcing (“debt trap”) rise in market yields remains. And if global financial conditions do tighten, the markets might begin taking a dimmer view of French fundamentals in particular.
Powered by a resurgent U.S. economy and strengthening European recoveries, the conventional view holds that the global economy is on an uptrend. I would focus instead on Chinese, Asian and EM vulnerabilities. While economic activity is today supported by generally extraordinarily loose financial conditions, this backdrop would appear vulnerable.
I believe there is today a consensus within the Federal Reserve System to wind down its balance sheet operations. But I also think they were serious when they were talking “exit strategy” with the Fed’s balance sheet about half today’s size. Federal Reserve policy is undoubtedly a major Issue 2014.
For at least the past six years, analysis of monetary policy has been fundamental to analyzing financial markets. Is the Fed’s balance sheet on its way to $10 TN? After expanding holdings to $4.0 TN, will it be possible for the Fed to now extricate itself from monetary inflation and market intervention/manipulation?
There will be major consequences if the Fed does this time follow through with its plan to taper purchases throughout 2014. Market participants have been trained to assume any bout of market weakness will have the skittish Fed quickly reversing course. I expect, however, that the Fed’s clumsy handling of its 2013 taper communications – and the frothy response in equities and corporate debt markets to Fed back-peddling – will have the Yellen Fed thinking twice before responding to the first flurry of market taper tantrums.
The return of potentially mercurial “risk on, risk off” market dynamics is an important Issue 2014. The Fed still likely has at least another $500 billion QE in the hopper, while there is as yet no indication that the Bank of Japan is pondering a QE reduction. So, for now, prospects remain for significant monetary inflation. But will it be ample?
Hedge fund industry assets are said to have reached $2.7 TN. But this is only one segment of the expansive “global leverage speculating community.” I have over the years referred to an expanding “global pool of speculative finance” as an important consequence of “activist” central banking and their monetary inflation. The conduct of this “pool” is a major Issue 2014.
When the speculators wanted to get short European debt in 2012, those markets almost buckled under selling pressure and attendant illiquidity. The Draghi backstop and global QE convinced the speculating community to be long European debt - and markets boomed. If the speculator community moves to aggressively short EM, those markets are in serious trouble. And in a world of trend-following and performance-chasing trading behavior, when the “crowd” goes long you have an unstable Bubble and when they go short it turns to painful bust.
As an analyst of Bubbles, I know that the timing of their bursting is highly unpredictable. They tend “to go to unimaginable extremes – and then double!” Yet they do inevitably burst and the longer they inflate the more problematic the bust.
The global “leveraged speculating community” is a key Issue 2014. As one of the more conspicuous beneficiaries of monetary inflation, there is today way too much “money” involved in this “crowded trade.” Global securities speculation has thrived on central bank liquidity, and winding down QE should significantly alter this game.
Going back almost 20 years to the 1994 bursting of the “bond” Bubble, leveraged speculators have enjoyed reliable market backstops. Acting as quasi-central banks, the GSE’s aggressively expanded their holdings (balance sheets) to accommodate speculative deleveraging in 1994, 1998, 2000, 2001 and 2002. Since the 2008 crisis the Fed has generously provided its balance sheet as a powerful market backstop – and risk premiums adjusted accordingly. And then a very important development occurred in 2013: Rather than backstopping the markets, the Fed’s Trillion dollar asset expansion incited risk-taking and speculative leveraging. If the Fed does indeed plan on wrapping up its balance sheet operations, what does this mean in terms of a future market backstop?
To what extent global monetary policies have incentivized risk-taking and leverage is unknown. I suspect the amount of speculative leverage in global markets is enormous. How much has been borrowed at an almost zero interest rate? How much in depreciating yen? These will at some point become crucial issues.
The Fed commencing tapering has changed the risk vs. return calculus for leveraging in fixed income. Cracks in EM Bubbles and the reversal of “hot money” flows away from EM have also fundamentally altered EM central bank demand for Treasuries, bunds and other sovereign debt securities. The backdrop would seem to ensure a much less favorable backdrop for speculative leveraging. And, potentially, a deleveraging backdrop could easily sop up much of the Fed’s tapered QE.
I don’t believe it would take all that much for worsening EM problems and some deleveraging in global fixed income to evolve into a rather serious bout of global “risk off.” And I’ll add that there’s a rather fine line between the (2013 scenario) “core” benefiting from stress at the “periphery” - and deterioration at the “periphery” spurring de-risking/de-leveraging “contagion” that begins insidiously gravitating toward the “core.”
I suspect large amounts of speculative leverage have amassed in higher-yielding corporates and MBS. I’ll assume myriad popular derivative trades incorporate leverage. I’d be shocked if the yen short and “carry trade” are not at this point enormous. There was even chatter in late-2013 of T-bill spread trades leveraged 50-100 times. From my experience, things are generally worse than I suspect. The Fed hopes its “forward guidance” puts a ceiling on market yields. However, the year 2014 could actually see supply and demand again begin to dictate the cost of finance – something that would involve one huge change in marketplace behavior.
Generally, leverage would be a focal point of attempts to assess systemic fragility. But I’ll return to my rough estimate of $68 Trillion of U.S. “Marketable Securities.” I believe misguided Fed (and fellow global central bank) monetary inflation has inflated financial asset prices generally. Indeed, the key Issue 2014 may be the almost across-the-board mispricing of U.S. securities markets. And we saw a glimpse back in May/June of how destabilizing flows can quickly unfold when market participants suddenly realize their perceived low-risk funds and strategies are at risk of significant losses.
Market Bubbles turn unwieldy near their conclusions. I fully expect unwieldy global markets throughout 2014: Bubbles inflating, deflating and vacillating. Greed and Fear and speculation run wild. Policy confusion and acute market uncertainty. At this point, conventional analysis seems particularly oblivious, which increases the risk of the proverbial “black swan.” And when it comes to Bubbles and “black swans,” I tend to see bursting Bubbles (i.e. “black swans”) as high probability outcomes. What tends to make them so-called low probability events is only the uncertainty of their timing.
For the Week:
The S&P500 slipped 0.5% (down 0.9% y-t-d), while the Dow was little changed (down 0.6%). The S&P 400 Midcaps declined 0.2% (down 0.7%), and the small cap Russell 2000 fell 0.4% (down 0.7%). The Utilities dropped 1.4% (down 1.9%). The Banks increased 0.6% (up 0.3%), and the Broker/Dealers rose 1.3% (up 0.2%). The Morgan Stanley Cyclicals were little changed (down 0.7%), while the Transports slipped 0.3% (down 1.0%). The Nasdaq100 declined 1.0% (down 1.5%), and the Morgan Stanley High Tech index dipped 0.7% (down 1.3%). The Semiconductors fell 0.6% (down 1.6%). The Biotechs declined 0.6% (unchanged). With bullion recovering $24, the HUI gold index rallied 2.7% (up 2.9%).
One-month Treasury bill rates ended the week at one basis point, and three-month rates closed at 7 bps. Two-year government yields added a basis point to 0.40%. Five-year T-note yields were unchanged at 1.73%. Ten-year yields were little changed at 3.00%. Long bond yields declined one basis point to 3.93%. Benchmark Fannie MBS yields were unchanged at 3.61%. The spread between benchmark MBS and 10-year Treasury yields was little changed at 61 bps. The implied yield on December 2014 eurodollar futures increased 2 bps to 0.445%. The two-year dollar swap spread gained one to 11 bps, and the 10-year swap spread rose one to 7 bps. Corporate bond spreads were mixed. An index of investment grade bond risk was about unchanged at 63 bps (low since October '07). An index of junk bond risk declined one to 311 bps (low since June '07). An index of emerging market (EM) debt risk increased one to 308 bps.
Debt issuance remained halted for the holidays. I saw no investment grade, junk, convertible debt or international dollar debt issues this week.
Ten-year Portuguese yields sank 37 bps to 5.65% (down 52bps y-o-y). Italian 10-yr yields fell 30 bps to 3.92% (down 21bps). Spain's 10-year yields dropped 35 bps to 3.87% (down 114bps). German bund yields slipped a basis point to 1.94% (up 41bps). French yields declined 3 bps to 2.55% (up 42bps). The French to German 10-year bond spread widened 2 to 61 bps. Greek 10-year note yields were down 27 bps to 8.18% (down 273bps). U.K. 10-year gilt yields fell 5 bps to 3.02% (up 91bps).
Japan's Nikkei equities index gained 0.7% to a more than six-year high (up 56.7% y-o-y). Japanese 10-year "JGB" yields jumped 4 bps to a three-month high 0.74% (down 7bps). The German DAX equities index dropped 1.6% (down 1.2% y-t-d). Spain's IBEX 35 equities index fell 1.0% (down 1.2%). Italy's FTSE MIB index gained 0.8% (up 0.8%). Emerging markets were under pressure. Brazil's Bovespa index slipped 0.6% (down 1.0%), and Mexico's Bolsa fell 1.6% (down 1.6%). South Korea's Kospi index sank 2.8% (down 3.2%). India’s Sensex equities index declined 1.6% (down 1.5%). China’s Shanghai Exchange fell 0.9% (down 1.6%). Turkey's Borsa Istanbul National 100 index rallied 3.7% (down 2.3%)
Freddie Mac 30-year fixed mortgage rates rose 5 bps to a new three-month high 4.53% (up 119bps y-o-y). Fifteen-year fixed rates gained 3 bps to 3.55% (up 91bps). One-year ARM rates were unchanged at 2.56% (down a basis point). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 6 bps to 4.69% (up 63bps).
Federal Reserve Credit declined $4.1bn to $3.982 TN. Over the past year, Fed Credit was up $1.085 TN, or 37.5%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $697bn y-o-y, or 6.4%, to a record $11.546 TN. Over two years, reserves were $1.328 TN higher for 13% growth.
M2 (narrow) "money" supply jumped $23.5bn to a record $11.001 TN. "Narrow money" expanded 5.4% ($569bn) over the past year. For the week, Currency increased $0.5bn. Total Checkable Deposits added $4.9bn, and Savings Deposits gained $18.0bn. Small Time Deposits slipped $1.3bn. Retail Money Funds increased $1.3bn.
Money market fund assets jumped $24.0bn to $2.719 TN. Money Fund assets were up $14bn from a year ago, or 0.5%.
Total Commercial Paper sank $55.1bn to $1.046 TN. CP was down $36 bn over the past year, or 3.3%.
The U.S. dollar index gained 0.5% to 80.791 (up 0.9% y-t-d). For the week on the upside, the New Zealand dollar increased 1.5%, the Australian dollar 0.9%, the Canadian dollar 0.7%, the Japanese yen 0.3% and the Singapore dollar 0.2%. For the week on the downside, the South African rand declined 2.1%, the Brazilian real 1.6%, the Swiss franc 1.5%, the euro 1.2%, the Danish krone 1.2%, the British pound 0.4%, the Mexican peso 0.4% the Norwegian krone 0.2%, the Swedish krona 0.2% and the South Korean won 0.1%.
December 31 – Bloomberg (Phoebe Sedgman and Debarati Roy): “Gold futures, which reached a six- month low today, posted the biggest annual slump in three decades as an improving economy cut demand for wealth protection. Silver touched the lowest since July. Bullion… prices fell 28% this year… Silver dropped 36% in 2013 to $19.37 an ounce, the biggest annual drop since 1981.”
December 31 – Bloomberg (Whitney McFerron and Phoebe Sedgman): “Corn headed for the biggest annual drop since at least 1960 and wheat tumbled the most in five years as grain production climbs to records worldwide and outpaces demand for food, livestock feed and use in biofuels. Corn plunged 39% in 2013… Farmers worldwide are producing record amounts of everything from soybeans to wheat, leaving food prices tracked by the United Nations 13% below an all-time high in 2011 and spurring banks including Goldman Sachs Group Inc. to predict further declines in crop prices in 2014.”
December 31 – Bloomberg (Luzi Ann Javier): “Coffee futures fell, capping the longest run of annual declines since 1993, on concern that a global glut will increase as crop conditions improve in Brazil, the world’s biggest producer and exporter of arabica beans… Global production is set to exceed demand for the fourth straight season, pushing inventories to a five-year high…”
The CRB index sank 2.7% this week (down 1.3% y-t-d). The Goldman Sachs Commodities Index was hit for 4.1% (down 2.8%). Spot Gold rallied 1.9% to $1,237 (up 2.6%). March Silver gained 0.8% to $20.21 (up 4.3%). February Crude dropped $6.36 to $93.96 (down 4.5%). January Gasoline fell 5.7% (down 4.9%), and February Natural Gas declined 1.5% (up 1.7%). March Copper dropped 0.9% (down 1.5%). March Wheat slipped 0.5% (up 0.1%), and March Corn declined 0.9% (up 0.4%).
U.S. Fixed Income Bubble Watch:
December 31 – Bloomberg (Margaret Collins and Charles Stein): “Bond mutual funds in the U.S. posted record investor withdrawals of $80 billion this year as investors fled fixed income in anticipation that interest rates will rise further. The redemptions… represented 2.3% of bond-fund assets, Brian Reid, chief economist at… Investment Company Institute, said… The previous annual record for redemptions from bond funds was in 1994, when investors pulled about $62 billion in the full year, or 10% of assets…”
December 31 – Dow Jones (Michael Aneiro): “Two sweet spots for bond investors this year - junk bonds and short-duration bonds - have converged to sharply drive up prices of short-dated junk bonds… Companies have issued $361 billion of low-rated bonds in the U.S. this year, a record in Dealogic data going back to 1995. The share of junk debt maturing in eight or more years represented 59% of issuance, the lowest since 2009.”
December 31 – Dow Jones: “Junk bonds are the rare shiny spot in a world of hurt for US fixed income markets. Bonds sold by low-rated US companies handed investors a total return of 7.4% this year through Monday, the only US fixed income segment that posted positive returns, according to Barclays. The biggest loser is TIPS with a loss of 8.5%, the biggest annual loss since the US government started selling the bonds in 1997. Nominal Treasury bonds have posted a loss of 2.6% through Monday, investment-grade corporate bonds were down 1.4%, MBS were down 1.4% while municipal bonds were down 2.6%.”
January 3 – Bloomberg (Sridhar Natarajan): “Sales of collateralized loan obligations surged 49% in 2013 amid demand for debt that protects against rising interest rates, ending the year just shy of the record set six years ago. Money managers from Blackstone Group LP to Carlyle Group LP raised $82 billion of CLOs last year in the U.S…., Issuance fell short of the $92.8 billion peak in 2007 as the total amount of funds expanded to about $280 billion.”
January 2 – Wall Street Journal (Al Yoon and Mike Cherney): “Puerto Rico is struggling to convince investors and credit-rating firms that it is on the path to financial health amid rising borrowing costs and fears over a potential downgrade of its debt. Yields on Puerto Rico's $70 billion worth of debt… ended 2013 at record highs, raising questions over the commonwealth's ability to tap credit markets to bolster its finances. The average yield on Puerto Rico's 10-year bonds hit 9.87% on Friday… Yields… more than doubled in 2013. The coming months are shaping up to be a test for Puerto Rico. The island's beleaguered economy makes it more difficult for Puerto Rico to juggle its budget deficit as well as its debt load, which weighs in at nearly 70% of GDP…”
January 2 – Bloomberg (Charles Mead): “General Electric Co. is leading U.S. corporate issuers that have about $427 billion of bonds and loans maturing this year, down 5% from 2013, as borrowing costs ascend from record lows. GE, the largest maker of jet engines, has $35.2 billion of debt due in 2014, mostly at its finance unit, followed by banks including JPMorgan Chase & Co. and its $28.2 billion, and Bank of America Corp.’s $26.9 billion…”
Federal Reserve Watch:
January 3 – Bloomberg (Joshua Zumbrun and Steve Matthews): “Ben S. Bernanke said the headwinds that have held back the U.S. economy may be abating, leaving the country poised for faster growth as his tenure as Federal Reserve chairman comes to an end. ‘The combination of financial healing, greater balance in the housing market, less fiscal restraint, and, of course, continued monetary policy accommodation bodes well for U.S. economic growth in coming quarters,’ Bernanke said… ‘Of course, if the experience of the past few years teaches us anything, it is that we should be cautious in our forecasts.’”
January 3 – Bloomberg (Joshua Zumbrun): “Federal Reserve Bank of Philadelphia President Charles Plosser, an opponent of bond purchases by the Fed, said the central bank will need sufficient willpower to unwind its $4 trillion balance sheet and curb inflation. ‘Technically we certainly can do that,’ Plosser said today of the Fed’s plans to eventually tighten the reins on bank reserves that have grown because of its bond buying. ‘It’s going to be more a question of will than technical capabilities.’ …‘We like to believe that everything is going to be gradual, everything is going to be smooth, and everything is going to be hunky-dory,’ Plosser said… ‘History does suggest that the Fed, as an institution, is oftentimes late when it comes to tightening.’”
December 31 – Reuters: “Dallas Federal Reserve Bank President Richard Fisher said his votes on the central bank's policy panel in 2014 will reflect his concern that the Fed’s bond-buying risks stoking inflation and exposing the institution politically. …Fisher called the excess reserves piling up in the U.S. banking system potential ‘tinder’ for inflation, and he said the central bank's plans to eventually unwind its extraordinary policies relied on an untested ‘theoretical exit strategy.’ ‘I expect that my own voting behavior will reflect this concern I've just stated,’ Fisher said… ‘I worry about the fact that we’ve already painted ourselves into a corner that's going to be very hard to get out of.’”
January 3 – Bloomberg (Jeanna Smialek): “Federal Reserve policy makers will continue to weigh reductions to a bond-buying program aimed at stimulating growth because improvements in the job market are meeting the central bank’s objectives, Richmond Fed President Jeffrey Lacker said. ‘We’ve seen a substantial improvement in a variety of indicators of labor market conditions, including the unemployment rate and the level of employment,’ Lacker said… ‘So it made sense to initiate the process of bringing the program to a close. I expect further reductions in the pace of purchases to be under consideration at upcoming meetings.’”
Central Bank Watch:
December 28 – Bloomberg (Cornelius Rahn): “European Central Bank President Mario Draghi sees no need for further cuts to the institution’s benchmark rate amid ‘encouraging signs’ that the euro crisis may be resolved, Der Spiegel reported… ‘At the moment we see no immediate need to act’ on the main refinancing rate, the magazine cited Draghi as saying. ‘The crisis isn’t over, but there are many encouraging signs.’”
U.S. Bubble Economy Watch:
December 30 – Bloomberg (Lu Wang and Whitney Kisling): “Five years after the equity bull market started, U.S. investors returned to stocks in 2013, just in time for the best relative returns versus bonds on record. Exchange-traded and mutual funds investing in shares took in about $162 billion, the most since 2000… At the same time, the Standard & Poor’s 500 Index climbed 29%, beating government debt by 32% percentage points, the widest spread since at least 1978… Companies in the S&P 500 are worth $3.7 trillion more today than they were 12 months ago following a year when Federal Reserve Chairman Ben S. Bernanke signaled the curtailment of economic stimulus. The bull market, born at the depths of the credit crisis, enters its sixth year fueled by zero-percent interest rates and conviction among investors that it’s finally safe to own stock again.”
December 30 – Bloomberg (Rich Miller and Michelle Jamrisko): “Rising income inequality is starting to hit home for many American households as they run short of places to reach for a few extra bucks. As the gap between the rich and poor widened over the last three decades, families at the bottom found ways to deal with the squeeze on earnings. Housewives joined the workforce. Husbands took second jobs and labored longer hours. Homeowners tapped into the rising value of their properties to borrow money to spend. Those strategies finally may have run their course as women’s participation in the labor force has peaked and the bursting of the house-price bubble has left many Americans underwater on their mortgages. ‘We’ve exhausted our coping mechanisms,’ said Alan Krueger, an economics professor at Princeton University… ‘They weren’t sustainable.’”
December 31 – Bloomberg (Michelle Jamrisko): “Home prices in 20 U.S. cities rose in October from a year ago by the most in more than seven years… The S&P/Case-Shiller index of property prices in 20 cities climbed 13.6% from October 2012, the biggest 12-month gain since February 2006, after a 13.3% increase in the year ended in September…”
January 3 – Bloomberg (Oshrat Carmiel): “Manhattan apartment sales surged in the fourth quarter, setting a record for year-end transactions… Sales of condominiums and co-ops jumped 27% from a year earlier to 3,297, the highest fourth-quarter total in 25 years of record-keeping, according to… Miller Samuel Inc. and… Douglas Elliman Real Estate… The inventory of homes for sale at the end of December fell 12% from a year earlier to 4,164, the lowest since Miller Samuel began tracking that data 14 years ago.”
December 31 – Chicago Tribune (Mary Ellen Podmolik): “Chicago-area home prices rose 10.9% in October from a year ago, the best showing for the local market since December 1988, according to a widely watched housing price index released Tuesday.”
December 31 – Bloomberg (Nadja Brandt): “…An influx of young families in search of alternatives to the most-expensive U.S. coastal markets is fueling a real estate boom in Denver, where commercial-property spending and home prices have jumped to records… Spending on construction of new commercial buildings this year is estimated at about $2.55 billion, up 26% from 2012 and the most in at least two decades, according to the city Community Planning & Development Department.”
December 30 – Bloomberg (Andy Fixmer): “Tony Stark did more than save the world in ‘Iron Man 3.’ He helped deliver a record summer in theaters and carry Hollywood to a new high for all of 2013. With two days left, U.S. and Canadian cinemas are certain to pass last year’s record $10.8 billion in ticket sales by about 1%, researcher Rentrak Corp. said…”
Global Bubble Watch:
December 31 – Bloomberg (Mary Childs): “Bond investors worldwide who were stung by their first annual losses since 1999 are bracing for more declines as the Federal Reserve pulls back on stimulus that’s supported fixed-income markets for five years. Debt globally fell 0.4% in 2013 as losses of 3.4% in U.S. Treasuries offset the 1.2% gain in corporate debt that was led by a 7% return in high yield, according to Bank of America Merrill Lynch index data. Europe’s recovery from a sovereign debt crisis led to a 57% rally in Greek bonds and a 12% surge for those of Ireland.”
January 2 – Bloomberg (Matthew G. Miller and Peter Newcomb): “The richest people on the planet got even richer in 2013, adding $524 billion to their collective net worth, according to the Bloomberg Billionaires Index… The aggregate net worth of the world’s top billionaires stood at $3.7 trillion at the market close on Dec. 31… The biggest gains came in the technology industry, which soared 28% during the year.”
December 31 – Wall Street Journal (Ryan Dezember): “Private-equity firms are set to return a record amount of cash to their investors for 2013, after taking advantage of buoyant markets to sell hundreds of billions of dollars of investments. From initial public offerings to company debt deals that pay private-equity investors hefty dividends—this year will be remembered for the gains earned by firms that specialize in buying and selling companies, and by the pension funds, university endowments and wealthy individuals that invest in them. Investors in private-equity funds are expected to receive more than $120 billion for 2013, topping last year’s record of $115 billion, according to estimates by Cambridge Associates… In the first half of 2013, private-equity firms returned $60.8 billion to investors.”
January 3 – Bloomberg (Scott Hamilton): “U.K. house prices rose and mortgage lending surged more than forecast as the property market’s momentum continued to build at the end of 2013. Nationwide Building Society said home values increased 1.4% in December, taking their gain last year to 8.4%, the biggest annual increase since 2006.”
December 30 – Bloomberg (Lucy Meakin): “Greek bonds returned almost four times as much as any other government securities this year as the nation that sparked Europe’s sovereign debt crisis moved toward economic recovery after six years of contraction. Greece’s 47% year-to-date return was the best of 34 sovereign debt markets tracked by Bloomberg World Bond Indexes. The second-best performer was Ireland, which exited its international bailout program on Dec. 15, with a 12% gain.”
EM Bubble Watch:
January 3 – Bloomberg (Ian Sayson and Lyubov Pronina): “Emerging-market stocks fell to a four-month low as China’s service industry data fueled concern the economy is slowing. Turkey’s lira weakened to a 10-year low while the nation’s shares dropped for a third day. Industrial & Commercial Bank of China Ltd. led a 2.6% slump in the Hang Seng China Enterprises Index in Hong Kong. The lira headed toward a record low as a corruption scandal pushed the currency to its most oversold level in a decade, while Thailand’s stocks extended a rout on persistent political uncertainty.”
January 2 – Financial Times (Pan Yuk): “Global bond sales from emerging markets have defied all odds to hit a record high in 2013. Despite the market turmoil caused last summer by concerns over the US Federal Reserve’s plans to scale back its monetary stimulus programme, EM bond issuance jumped to $506bn last year, surpassing 2012’s record $488bn, according to Dealogic… EM companies led the charge, issuing $345bn in global bonds while sovereigns managed to raise $100bn.”
January 2 – Bloomberg (Taylan Bilgic): “The selloff that sent Turkish local-currency debt plunging five times more than emerging-market peers last year is showing few signs of easing, amid a standoff between Prime Minister Recep Tayyip Erdogan and the judiciary. Turkey’s lira-denominated debt lost 20% in 2013, the most after Indonesia and compared with a drop of 4% in a Bloomberg portfolio of bond returns for 31 developing nations. Two-year yields jumped 98 bps in December and the lira fell the most since September 2011 as a corruption probe embroiled Erdogan’s cabinet and led three ministers to quit.”
December 30 – Bloomberg (Ye Xie and Katia Porzecanski): “The mounting power struggle between Turkish Prime Minister Recep Tayyip Erdogan and the judiciary is turning the stock market into the world’s worst performer and driving the currency to unprecedented lows. The Borsa Istanbul 100 Index has slumped 21% in dollar terms this month, extending this year’s slide to 32%...”
December 30 – Bloomberg (Benjamin Harvey and Selcan Hacaoglu): “Turkey’s Prime Minister Recep Tayyip Erdogan entered the last week of 2013 reeling from a corruption probe that has splintered his party and highlighted economic vulnerabilities as investors unload the nation’s risk. Erdogan took the defense of his administration to the road over the weekend, addressing supporters at six election rallies and lashing out at prosecutors heading the graft investigation, which his Finance Minister Mehmet Simsek called a ‘soft coup.’ …While Erdogan led Turkey… to triple its nominal gross domestic product over the past 11 years, an explosion in private debt over that period pushed the current-account deficit to records, increasing susceptibility to capital outflows when risk perception rises. ‘The Turkish economy is vulnerable due to its dependency on borrowed money from abroad and the size of the current- account deficit,’ Anthony Skinner, head of analysis at Maplecroft, a global risk and strategic forecasting consultancy… ‘There is little to suggest that this crisis will be resolved quickly,’ and ‘investors will continue to seek to sell the Turkish lira.’”
China Bubble Watch:
December 30 – New York Times (Neil Gough): “The total debt of local governments in China has soared to nearly $3 trillion as the country’s addiction to credit-fueled growth has deepened in recent years, according to… a long-awaited report… by the central auditing agency. In the report, which is likely to further raise concerns about China’s debt problem, the National Audit Office found that local governments across the country had accumulated 17.89 trillion renminbi, or $2.95 trillion, worth of debt obligations as of the end of June. That was an increase of 12.7% from December 2012… The June figure also represented a dramatic increase of 67% from the end of 2010… In the five years since the onset of the global financial crisis, local governments at the provincial, municipal, county and township levels across China have gone on a spending spree, loading up on debt to fund a surge in investment in infrastructure, real estate and other projects… With a few exceptions for pilot programs, local governments in China are prohibited from directly taking on loans or issuing bonds. Instead, they have set up thousands of special-purpose financing vehicles that borrow on the government’s behalf to fund a given project. Such financing vehicles had confirmed, probable and potential debt obligations totaling 6.96 trillion renminbi as of June…, accounting for nearly 40% of all local government debt. As part of an investigation that began in July, the agency said, it deployed 54,000 auditors across the country, who combed through the books of more than 62,000 government departments and institutions and examined 3.4 million debt instruments related to more than 700,000 projects. Including financial obligations on the national level, the audit office report found that China’s total government debt stood at 30.27 trillion renminbi at the end of June, up from 27.77 trillion renminbi in December 2012.”
January 2 – Financial Times (Simon Rabinovitch): “Faced with a mountain of maturing loans this year, China has given local governments the go-ahead to issue bonds as a way of rolling over their debt to avoid defaults. The announcement by the National Development and Reform Commission… is the most explicit official endorsement of a massive debt refinancing operation that has become unavoidable and is already under way, analysts said. The need for the rollover highlights the tricky balance that Beijing must strike as it tries to rein in debt without triggering a sharp downturn in growth. Local government debt levels have soared 70% to almost $3tn in less than three years… Nearly 40% of that overall amount will mature before the end of this year, placing huge pressure on local governments to come up with the cash to make repayments. With many of the original loans used for infrastructure projects that have yet to generate revenue, rollovers have long been seen as one of the few viable options for preventing defaults… In practice it is evident that rollovers have already occurred in China on a massive scale. This week’s audit noted that 60% of debt was to mature before the end of 2015. However, according to a 2010 audit, more than 50% of debt was to mature before the end of 2013. The implication is that the vast majority was not paid back but simply refinanced… As the amount of debt in the Chinese financial system has steadily increased, the cost of issuing new bonds has risen. The yield on top-rated AAA corporate bonds has soared about 200 bps to more than 6% over the past half year.”
December 31 – Bloomberg: “China’s new home prices in December jumped by the most this year even as the country’s biggest cities tightened property controls to moderate price gains. The average price rose 12% from a year earlier to 10,833 yuan ($1,789) per square meter (10.76 square feet), SouFun Holdings Ltd., the nation’s biggest real estate website owner, said… New home prices in Shenzhen posted the biggest gain in almost three years in November, rising 21% from a year earlier alongside Guangzhou… Beijing and Guangzhou posted the largest year-on-year gains among the 10 biggest cities SouFun surveyed, both rising about 28%.”
December 30 – Bloomberg: “China’s benchmark money-market rate will probably stay near a record in the coming quarter as policy makers seek to cut overall debt that a state-run researcher estimates has topped $18 trillion… China needs to deleverage because total liabilities in the world’s second-largest economy reached 111.6 trillion yuan ($18.4 trillion) in 2012 and accounted for 215% of gross domestic product, Li Yang, vice president of the Chinese Academy of Social Sciences government think tank, wrote… President Xi Jinping last month said the performance of regional officials will be measured on how effectively they control debt. The People’s Bank of China allowed the repo rate to surge this month even as the benchmark Shanghai stock index tumbled 5.3 percent. ‘The PBOC is determined to deleverage the economy, and it doesn’t think the financial system is really short of cash,’ said Yang Feng, Beijing-based fixed-income analyst at Citic Securities Co., the nation’s biggest brokerage. “The government no longer appreciates the model of letting cheap money fuel investment, as debt levels are already high. Investors now need to pay more attention to the impact of rising financing costs.’”
December 31 – Bloomberg (Tomoko Yamazaki and Komaki Ito): “China’s benchmark interest-rate swap rose the most on record this year on speculation policy steps to free up borrowing costs will drive money-market rates higher. The one-year swap rate, the fixed payment to receive the floating seven-day repo rate, jumped 187 bps in 2013 to 5.22%..., after touching all all-time high at 5.24% earlier. It surged 125 bps… this quarter and increased 18 bps today.”
December 31 – Bloomberg: “More than 2% of China’s arable land, or an area the size of Belgium, is too polluted to grow crops, the government said, offering new evidence of the environmental cost associated with 30 years of breakneck growth. About 50 million mu (3.3 million hectares) of farmland is too spoiled for planting, Vice Minister of Land and Resources Wang Shiyuan said… Concerns that toxic soil is spoiling crops and making people sick join those about China’s polluted skies and water as issues that have highlighted the cost of economic expansion, which has averaged about 10% annually over three decades.”
Japan Bubble Watch:
December 30 – Bloomberg: “China ruled out talking to Japanese Prime Minister Shinzo Abe, saying he ‘closed the door’ to any meetings with Chinese leaders after visiting a site that memorializes fallen Japanese soldiers including war criminals. ‘Chinese people don’t welcome him,’ Foreign Ministry spokesman Qin Gang said… ‘What Abe needs to do now is confess his mistakes to the Chinese government and the Chinese people.’ Qin’s remarks reflect China’s anger over Abe’s Dec. 26 visit to the Yasukuni shrine and signal that tensions strained by a territorial dispute in the East China Sea won’t improve soon.”
December 30 – Bloomberg (Anna Kitanaka): “Japanese shares rose, with the Nikkei 225 Stock Average capping its biggest yearly gain in four decades, as the yen retreated past 105 per dollar to its weakest in more than five years… The Nikkei 225 added 0.7% to 16,291.31 at the close of trading in Tokyo, closing the year 57% higher, the largest such increase since a 92% surge in 1972.”
December 27 – Bloomberg (Tomoko Yamazaki and Komaki Ito): “Japanese hedge funds are heading for record returns this year as investors bet that Prime Minister Shinzo Abe’s policies will succeed in reviving the world’s third-largest economy… The Eurekahedge Japan Hedge Fund Index, which tracks about 80 funds, returned 24% in the 11 months through November, heading for the best year since the… researcher began compiling data in 2000.”
January 3 – Bloomberg (Kartik Goyal): “Indian interest rates will remain elevated as long as surging inflation imperils economic growth, a deputy governor of the country’s central bank said. ‘If you are having continuously high inflation, it will kill your growth,’ the Reserve Bank of India’s K.C. Chakrabarty told Bloomberg TV… ‘If interest rates are high, that’s because inflation is high, and unless inflation is brought down, interest rates will not come down.’”
January 2 – Wall Street Journal (Todd Buell): “Lending to the private sector in the euro zone plunged in November at the sharpest annual rate since records began over 20 years ago… , suggesting that the region will struggle to get its anticipated economic recovery in full gear. Private sector lending in the euro zone declined by 2.3% on the year, after a 2.2% decline in October… The deepening decline increases pressure on the central bank to embark on further measures to stimulate lending, analysts said.”
December 30 – UK Telegraph (Denise Roland): “ECB head says German worries over eurozone are misplaced Mario Draghi has spoken out against the ‘perverse angst’ displayed by Germans over the European Central Bank's policies. The… central bank cut rates to a new record low of 0.25% in November, despite resistance from German policymakers, who are fearful that low interest rates could fuel housing bubbles in its major cities. In April, German Chancellor Angela Merkel said the country's economy, which has consistently outperformed its eurozone peers since the financial crisis, was ready for a rate rise even though the rest of the single currency bloc needed looser monetary policy. However, Mr Draghi, and Italian, said German anxiety was misplaced. In an interview with German daily Der Spigel, he said: ‘Each time it was said, for goodness' sake, this Italian is ruining Germany. There was this perverse angst that things were turning bad, but the opposite has happened: inflation is low and uncertainty reduced.’”
December 30 – Dow Jones: “Central banks around the world will eventually have to change their low interest-rate policy which is posing a problem for long-term investments, German Finance Minister Wolfgang Schaeuble said… ‘Of course, this can't carry on forever,’ Mr. Schaeuble was quoted as saying… He said there are early signs that money supply is declining slowly in financial markets, while interest rates for German government bonds have risen slightly. Germans have been particularly outspoken about the low interest-rate policy pursued by the European Central Bank. Many fear the policy is benefiting crisis-hit euro-zone countries at the expense of German savers.”