As Fundamentals Corrode, US Stocks Soar to Fresh Record Highs!

In face of progressing self contradictions, US stocks has broken through new highs.

What contradictions?

1) G-20 Ministers predicted a 10-15% drop in cross border investments. From Bloomberg: The ministers projected a 10 percent to 15 percent drop in cross-border investment this year, Gao said. Britain’s referendum in favor of leaving the European Union will crimp global trade in the short term, and a G-20 workshop will study the potential impact, China’s Vice Commerce Minister Wang Shouwen said at the briefing. In February, finance chiefs and central bankers from the group agreed to consult closely on foreign-exchange markets and reiterated pledges to refrain from competitive devaluations. Since then, currency markets have been roiled by Brexit, which caused the pound to plunge and helped drag down China’s yuan.

10% decline is not a drop but a collapse. If global investment flows fall or crash, then where will growth in output, trade, jobs, incomes, earnings come from? This would lead to a global recession.

2) Surging defaults at the US high yield bond spectrum

From Fitch: The trailing 12-month (TTM) U.S. high yield bond default rate finished 1H16 at 4.9%, the highest level since May 2010, says Fitch Ratings. The $50.2 billion of defaults during 1H16 alone is greater than the $48.3 billion seen in full year 2015. Fitch believes defaults are on track to tally as much as $90 billion by year-end.  Energy companies continue to account for a sizable portion ($28.8 billion) of defaults in 1H16, bringing the energy sector default rate to 15%, while the E&P sub-sector rate is at 29%. Despite the run up in prices since the February trough, there will be additional sector defaults, with Halcon Resources expected to file imminently. 

From Bloomberg: U.S. high-yield bonds in default reached the highest levels in at least six years as more energy companies buckled under pressure from stagnant oil prices. Speculative-grade U.S. defaults spiked to 5.1 percent of the total outstanding in the second quarter from 4.4 percent in the first, according to a July 12 report from Moody’s Investors Service. The global high-yield default rate could finish the year at 4.9 percent, with the U.S. as much as 6.4 percent, Moody’s said.

3) Defaults of Global Corporate Bonds Hit 2009 Highs.

From the CNBC: Corporate bond defaults have just crossed an ominous milestone. Fully 100 companies have defaulted on debt, 50 percent more than for the same period in 2015 and the highest level since 2009, according to S&P Global Ratings. Low oil and commodity prices, along with financial market volatility in the United States and abroad, have been the primary problems for the bond market this year. While the actual ratio of distressed issues is on the decline, the level of defaults has climbed. While the defaults have been weighted heavily to the energy sector, analysts at S&P said there's no guarantee things will stay that way. "Over the past year, we have seen a strong increase in both the number and percentage of defaults in the energy and natural resources sector," the agency said in a note. "So far, there has been little spillover effect into other sectors, but we are not ruling this out in the coming quarters."

4) US commercial bankruptcies surge in 1H 2016

From the American Bankruptcy Institute (chart from Alhambra Partners): Total commercial filings during the first six months of the year (Jan. 1-June 30) increased 29 percent to 19,470 over the 15,071 total commercial filings during the same period in 2015, according to data provided by Epiq Systems, Inc. Commercial chapter 11 filings also climbed during the first half of 2016 as the 3,220 filings represented a 25 percent increase over the 2,575 commercial chapter 11 filings during the first six months of 2015. Total bankruptcy filings, however, fell to 398,495 during the first six months of 2016, representing a 6 percent decrease from the 422,914 total filings during the same period a year ago. The 379,025 total noncommercial filings for the first half of 2016 represented a 7 percent drop from the noncommercial filing total of 407,843 for the first half of 2015. “As economic challenges continue to weigh on the balance sheets of struggling companies, especially those in energy and retail, more businesses are seeking the financial fresh start of bankruptcy,” said ABI Executive Director Samuel J. Gerdano. “Commercial bankruptcy filings for 2016 will likely total close to 40,000.” Total commercial filings for the month of June 2016 were 3,294, representing a 35 percent increase from the 2,442 filings in June 2015. Commercial chapter 11 filings registered a 36 percent increase, as the 366 commercial chapter 11 filings in June 2015 climbed to 499 in June 2016. Total bankruptcy filings, however, decreased to 66,284 for the month of June, a 5 percent decline from the 69,772 filings in June 2015. The 62,990 total noncommercial filings for June represented a 7 percent drop from the June 2015 noncommercial filing total of 67,330.

5) A buildup of stress in other credit spectrum can also be seen via surging delinquencies and delinquency rates. 

6) Even the US government has sounded the alarm bells on the auto lending sector…

From the Wall Street Journal: A U.S. banking regulator warned about growing credit risk in the auto-lending sector, raising the prospect of fresh regulatory pressure in the area. The Office of the Comptroller of the Currency, which supervises large national banks including many of the largest banking firms in the U.S., highlighted the risks in its twice-annual report Monday. The OCC said auto-lending risk is increasing “because of notable and unprecedented growth” across all types of lenders. “As banks have competed for market share, some banks have responded with less stringent underwriting standards,” the report said.

7) …as well as the commercial real estate

From Reuters: Credit risks have risen in U.S. commercial real estate as lenders compete more fiercely in a low rate environment, a federal banking regulator said on Monday, adding that it was stepping up its scrutiny of the sector. The Office of the Comptroller of the Currency (OCC) said in its semiannual risk report that while the financial performance of lenders improved in 2015 compared to a year earlier, credit risks were higher across the industry. The U.S. Federal Reserve has kept interest rates low for more than seven years to help the U.S. economy recover from the 2008 financial crisis. But that policy is also weighing on bank profits and pushing lenders to compete more fiercely for worthy borrowers. That competitive pressure is increasing risk, the OCC said. "It's at this stage of the cycle that we also see strong loan growth combined with easing underwriting to result in increased credit risk," Comptroller of the Currency Thomas Curry said in prepared remarks.

8) Investment gurus continue to see heightening risks in the face of higher stock prices

From Bloomberg: The big rally in stocks and bonds has some of the world’s top money managers putting up warning signs. Laurence D. Fink and Howard Marks joined the likes of Bill Gross and Jeffrey Gundlach cautioning that buyers may be ignoring sluggish economic growth and Britain’s departure from the European Union as they look to put their money somewhere, anywhere, amid low interest rates. “If we don’t see better than anticipated corporate earnings I think the rally will be short-lived,” Fink, 63, said in an interview Thursday. A run-up in global stocks has added more than $4 trillion to the value of equities worldwide since June 27 on speculation central banks in major economies will boost stimulus. It’s been a swift turnaround from the doom-and-gloom surrounding global equities on June 24, the day after the British vote, when stocks lost $2.5 trillion in market value.

Jeffrey Gundlach calls the market environment as suffering from mass psychosis. From Marketwatch: This market is dealing with a “mass psychosis.” That’s the latest perspective on the state of Wall Street from Jeff Gundlach, the star money manager who founded DoubleLine Capital. Late Tuesday, during his regular webcasts to discuss markets, Gundlach sounded perplexed that investors’ demand for the perceived safety of government bonds has driven 10-year Treasury notes  to record lows, even as the Dow Jones Industrial Average and the S&P 500 index scored fresh record highs Wednesday. “There’s something of a mass psychosis going on related to the so-called starvation for yield,” said Gundlach, whose fund manages about $100 billion. “Call me old-fashioned, but I don’t like investments where if you’re right you don’t make any money,” he said.

So as I understand it, the increasing signs of degeneration the in the global economy, poor earnings growth prospects, rising credit risks in the US and the world, increasing concerns by the US government on loan quality conditions of suspected bubble areas of CRE and autos, frenzied buying of global bonds which has brought about record low yields or $13 trillion negative yielding bonds, and panicking central banks equals RECORD high US stocks!

So that’s it, the greater the wall of worry, the more aggressive one should be!

The moral of the story: don’t fight central banks. Blind faith in central bankers are key to obtaining portfolio positive returns!

It’s why “active fund managers had their worst first half ever, with fewer than one in five beating a basic market benchmark, according to data from Bank of America Merrill Lynch that go back to 2003”. (CNBC)

And it has been why funds of hedge funds suffered from redemptions due to underperformance. From Bloomberg: Funds of hedge funds lost more than $100 billion in 12 months because of outflows and poor performance, according to a new report. Clients pulled $50.3 billion over the four quarters through March, while managers posted $51.5 billion in investments losses, research firm eVestment said Friday after analyzing data from more than 2,500 funds. Assets in the sector shrank 11 percent to $841.6 billion, the lowest since June 2009.

And worst, the penalty of losing faith on central banks will mean more client withdrawals.

From Bloomberg: Eighty-four percent of investors in hedge funds pulled money in the first half of the year, and 61 percent said they will probably make withdrawals later this year, according to a Credit Suisse Group AG study released Tuesday. The main driver among those who redeemed: their fund underperformed.

And which entity has been responsible for recently pushing US stocks to record highs? Well the answer to this according to Citi’s Matt King (via Zero Hedge) has been “a surge in net global central bank asset purchases to their highest since 2013”

Additionally, Mr King adds, “The underlying drivers are an acceleration in the pace of ECB and BoJ purchases, coupled with a reversal in the previous decline of EMFX reserves. Other indicators also point to the potential for a further squeeze in global risk assets: a broadening out of mutual fund inflows from IG to HY, EM and equities; the second lowest level of positions in our credit survey (after February) since 2008; and prospects of further stimulus from the BoE and perhaps the BoJ.

So just hope too that central banks will also able to fix the worsening geopolitical conditions such as the recent terror strike at Nice France and the botched coup attempt on the Turkey’s Erdogan regime which the Turkish government hinted that the US was behind the event.