Historic Crossroad: As US Stock Markets Etch Superfecta Record Highs, Global Short Term Funding Strains Intensify!

Sure, US stocks continue to not only hit NEW records but carve such milestone with a violent (BW-SSO strain) MELTUPs!

And because four of such indices set a landmark last week, fresh records have been adulated like a horse race “superfecta” win! (USA Today November 22).  

Yet the last time these four indices accomplished the same milestone was in December 1999 (“Wall St.’s record century”, CNN Money December 31, 1999). Three months from then, meltUP morphed into meltDOWN or the dotcom crash.

Of course, each chapter of history ipso facto is unique. Hence, history definitely won’t repeat, instead, it will most likely rhyme. That’s because even if general conditions are different today from the past, the conditions that undergird every bubble remains the same: malinvestments financed by credit inflation!

Yet it’s a curiosity to see the acclaimed glory from the “superfecta” moment accompanied by growing divergence of powerful economic and financial forces from within and without.

For instance, while developed market equity benchmarks have been on a tear, market breadth has reportedly been materially deteriorating.

Noted Eric Bush from the splendid Gavekal Blog, (November 21): “More than one out of five developed market stocks and more than two out of five emerging market stocks are in a bear market (down over 20% from a high) in the past 200 days. In the developed market, the percentage of stocks in a bear market has doubled from just 11% in late September to 22% as of Friday’s close. EM stocks have fared worse as just 18% of EM stocks were in a bear market in late September and now 44% are in bear market.”

I have pointed out that it’s not just US stocks, but likewise the US dollar that has been racking up sharp gains.

The pulsating surge by Japan’s stock markets has been fueled by a 3 week winning streak by the US dollar against the Japanese yen which according to Bloomberg (November 25), accounted for the “biggest three-week gain versus the yen since 1995”. See another record of sorts!

Over the past three weeks or since the culmination of US elections, the Nikkei 225 racked up a scintillating 11.4% return while the Topix 8.7%!

The violence in the movements of currency and equity markets has only crescendoed!

This week’s continuing US dollar strength has driven the Chinese yuan to a new 8 year low!

From the ShanghaiDaily.com (November 26): “THE yuan continued to depreciate yesterday against the US dollar to hit its weakest point since June 2008. The central parity rate of the yuan weakened for the third straight trading day by falling 83 basis points to 6.9168 against the US dollar yesterday, according to the China Foreign Exchange Trading System. In the past 15 trading days, the yuan ended down 14 days and rose only once against the greenback. On Thursday, the yuan dropped below 6.9 against the greenback”.

And it’s not just the yuan, emerging market currencies (and bonds) the Turkish lira and the Indian rupee have hit historic lows (Reuters, November 24).

Meanwhile, the Malaysian ringgit seem as rapidly approaching the Asian crisis low (Financial Times, November 24)

It has not just been currencies, emerging market bonds had recently been dumped as shown by the JP Morgan’s Emerging Market Bond Index (EMB) chart above. EMB’s crash has been accompanied by a spike—record volume (orange rectangle).

EMB’s top 10 issues shown (below window)

Last week, I showed how the Chinese financial system had been experiencing strains as the yuan wobbled. It turned out that China’s central bank, the PBoC pumped 990 billion yuan (145.6 billion U.S. dollars) back then, according to China.org.cn (November 21), yet interbank rates still soared. In short, PBoC’s liquidity easing measures have hardly alleviated pressures building within its financial system.

And for this week, along with the falling yuan, rates almost across the Shibor curve (as of November 25) continue to soar!

Meanwhile, volatility tantrums persist to plague Hong Kong’s offshore yuan HIBOR rates!

The 1 and 3 month rates have scaled back up to near January 2016 highs! Even the Overnight rate has experienced the largest string of volatilities in two years! (chart from Analystz.hk)

Such mounting interbank tremors can also be seen in Europe and in the US.

In Europe, due to increasing shortages of collateral, the European Central Bank reportedly plans to lend out its inventory to the marketplace. From Reuters.com (November 23): “The European Central Bank is looking for ways to lend out more of its huge pile of government debt to avert a freeze in the 5.5 trillion-euro short-term funding market that underpins the financial system, central bank sources told Reuters. The ECB has bought more than a trillion euros ($1.06 trillion) of euro zone government bonds in a bid to shore up economic growth and inflation in the euro zone. For the most part the bank is holding these bonds. By doing so, it has taken away the key ingredient for repurchase agreements, or repos, whereby financial firms lend to each other against collateral, typically high-rated government bonds such as Germany's…Germany, the only large euro zone country with a top-notch credit rating, is where the problem is at its most severe. With the ECB now owning more than a quarter of all outstanding German bonds, funds pay up to 1.5 percent to borrow a 10-year Bund, up from some 0.40 percent a year ago, according to Icap data. This is putting a strain on investors as they face increasingly frequent demands to put up cash or liquid collateral against their derivative positions due to new regulation.”

Soaring equity markets as credit markets experience increasing symptoms of gridlock, astonishing divergences, right?

Ironically, the ECB came up with their updated financial stability review. Here they identified the four biggest risks to financial stability over the next TWO years.

The ECB’s four biggest risks, as noted by the Business Insider UK (November 24): 1)Financial contagion stemming from political uncertainty — "Global risk repricing leading to financial contagion, triggered by heightened political uncertainty in advanced economies and continued fragilities in emerging markets." 2) A vicious circle between banks not making much money and not being able to grow — "Adverse feedback loop between weak bank profitability and low nominal growth, amid challenges in addressing high levels of non-performing loans in some countries," says the ECB. 3) Debt sustainability — The ECB said that "re-emerging sovereign and non-financial private sector debt sustainability concerns in a low nominal growth environment, if political uncertainty leads to stalling reforms at the national and European levels." 4) Investment funds — These funds, which are a supply of capital belonging to a group of investors that are used to buy securities such as stocks, are seen as risk factor. "Prospective stress in the investment fund sector amplifying liquidity risks and spillovers to the broader financial system," says the ECB.

So much risks being discounted by markets that apparently has become jaded to risks.

Yet US short term money markets have also been revealing of deepening signs of strains.

US Libor rates have not only been climbing, but the recent ascension appears to be accelerating. USD Libor curve or 1, 3, 6 and even the 12 month can be seen above ramping up (12 month not included).  

Much of the rise in LIBOR rates had earlier been blamed on 2a7 or the Money Market Reform. But the 2a7 reform took effect last October 14. And instead of declining USD Libor rates even accelerated upwards!

The TED Spread, an indicator of credit risk, is measured by the price difference between short term US (3 month) bills and 3 month Eurodollar futures. TED spread has begun ascending in 2H 2015 and has spiked in September. Though the measure of credit risk has eased, the TED spread remains substantially elevated, and importantly, still has been in an uptrend.

In short, the above indicators, which appear in consonance with China’s financial conditions, emerging market rout, put into spotlight signs of decaying global liquidity conditions that have only amplified the US dollar “shorts”.

And US inflation expectations as shown by the 5-year breakeven inflation (lowest window) continue to streak upwards.

If inflation expectations continue to mount, then the US Federal Reserve may be incited to increase rates at a faster pace than what the market expects.

And this would only aggravate signs of tightening monetary conditions. But of course, I have deep reservations on such course of action.

Add to signs of tightening conditions, global bond yields have been climbing for the past three months (see left, chart from Forbes) as central banks appear to be reconsidering further employment of QEs.

The alleged Trump deficit spending and increased inflationary outlook have only aggravated increases in bond yields

The selloffs in US Treasury and other fixed-income instruments had only induced rotation towards US stocks (Reuters November 25). Yet such entails of a critical narrowing breadth of risk assets headed higher.

And with the limited number of upside trend chasing activities, the rotation dynamic has only provoked a violent MELTUP in developed economy stocks.

And yet sustained higher rates are likely to serve as the proverbial pin that would burst the credit-fueled “superfecta”, as evidenced by S&P 500’s record debt to EBITDA (right chart from Zerohedge), or Trump’s Big Fat Ugly Bubble.

Current developments which are not only marked by magnified volatility through violent market actions but by its extremeness have been indicative of a historic crossroad in progress.

To paraphrase what has been said as a Chinese curse: We are truly living in the most interesting times!

Developing Self-Contradiction: Near Record US Stocks as Record Negative Yielding Bonds Transform into a Crowded Trade!

Current unfolding developments in the global financial markets have truly been striking. To borrow the revolting phrase, this time does seem different!

The “difference” lies in the interrelationship and the feedback mechanism between market participants and political policies channeled through central banks. Or how present markets playout the boom bust cycle predicated mostly on political actions.

But there will be no difference in the eventual outcome.

Under today’s condition, one might observe that the worst the outlook, the greater the risks, the bigger the uncertainty, yet the fiercer the rallies in the risk markets.

Unlike the Philippines were risk asset rallies have been mostly about embedded misplaced emotional convictions about economic and financial progress, the incentives that shapes the global markets seem to be about what central bankers have done, and what they have been expected to do.

Based on labor data, US stocks soared last Friday. The S&P is about a hair away from attaining an all time high!

Yet along with US stocks, global stocks soared too. Importantly, even as global stocks melted up, global bonds had a bigger record breaking performance!

Curiously even media sees a developing self-contradiction in US stocks and bonds

The Marketwatch provides a mainstream view of current developments: “Investors typically don’t buy bonds and stocks at the same time. Bonds are considered a haven, while stocks are favored when risk appetite is higher. Bond prices move in the opposite direction of yields, so appetite for the perceived safety of bonds is driving yields lower even as investors scooped up equities at a rapid clip Friday. According to Dow Jones data, the S&P 500 has closed at a record high and the 10-year has closed below 2% only once in the last 40 years. That was back in 2013, as the U.S. economy was still emerging from the financial crisis, aided by a dollop of quantitative easing from the Federal Reserve. Colin Cieszynski, chief market strategist at CMC Markets told MarketWatch that yields diving lower can be explained by appetite from foreign investors, who are eager to gobble up Treasurys in a world where nearly $12 trillion in debt offers negative yields. Worries about embattled Italian banks and lingering concerns about sluggish growth in China, the world’s second-largest economy, are among investors’ biggest concerns. “Buying today on nonfarm payrolls has been pretty relentless. I think bond yields are being driven down by offshore uncertainty (Brexit, China, Italy/EU) rather than domestic issues,” Cieszynski said. He believes that expectations that the Fed will remain reluctant to raise interest rates due to these global growth worries creates an optimal environment for stocks to prosper. “It is like we’re heading into another Goldilocks environment of a strong economy without the fear of the Fed raining on the easy money parade by boosting rates,” he said. Another way to think about this market dynamic is a popular acronym that Wall Street has adopted lately: TINA, or there is no alternative. In other words, in a world rattled by the prospect of anemic global growth, both U.S. stocks and bonds are benefiting because they are the only game in town.”

The huge stock market rally comes even as earnings outlook for US firms are expected to remain gloomy.

From the Financial Times (bold mine): US companies face another bleak earnings season with analysts forecasting the longest profit recession since the financial crisis. Energy groups are expected to weigh heavily on S&P 500 results while a number of other sectors such as financials are struggling to increase profitability. Earnings of the major groups that comprise the S&P 500 index are seen falling 5 per cent in the second quarter from the same three-month period in 2015. That forecast is slightly lower than the 6.8 per cent decline seen during the first quarter, but will mark the fourth-straight quarterly decline, according to data from S&P Global Market Intelligence. Excluding the energy sector, S&P 500 earnings are set for a decline of 0.4 per cent. The tepid profit expectation comes as the Wall Street benchmark closed the second half of 2016 less than 1.5 per cent below its all-time high, prompting some strategists to question whether stock prices have risen ahead of fundamentals. The S&P 500 closed out the first half priced at 19.5 times trailing 12-month earnings, one of the highest multiples since 2004, according to Bloomberg data. The price/earnings ratio based on forecast profits over the next 12 months was 17.3 times, compared with a 15-year average of 16, S&P Global Market Intelligence data show.

US yield curve has been intensively tightening (upper window) as yields plunge to record lows (bottom). Meanwhile the S&P streaks to record highs!

Deutsche bank recently noted that the based on their model the yield curve points to a 60% odds of recession in the next 12 months!

Wow, furious rallies in the face of higher risks of recession! This is like playing the Russian Roulette.

Additionally, another significant development in the risk spectrum has been in the UK: Seven property funds worth “more than half of the £25 billion ($32 billion)” notes the CNN, has closed their doors to investor redemptions last week!

Reason? Increasing uncertainty and risks over property markets have virtually exposed on the maturity mismatches inherent in these funds. So the first symptom: emergent liquidity strains. Again from the CNN, “the funds are heavily exposed to offices and other prime commercial property in the U.K. that can't be unloaded quickly enough when nervous investors want their money back.”

The next issue will be solvency.

Importantly, the actions of 7 UK property funds have a signified a real time revelation of the boom bust psychology. From the same article: “It's a remarkable shift in sentiment for a market that once appeared unstoppable. In the wake of the global financial crisis, ultra-low interest rates and a flood of foreign money pushed prices through the roof, particularly in London.”

Easy money has not only failed to ensure liquidity, it has created the bubble. And like all bubbles, greed suddenly mutates into fear!

And record low yields in US treasuries have reverberated around the world. Record negative yielding bonds may have already reached $13 trillion!

According to the Times of India (bold mine(: For the first time ever, nearly $13 trillion worth of government bonds worldwide — representing more than a third of all government debt — have negative interest rates. Returns or yields on bonds drop as their prices rise following an increase in demand. Demand for bonds and gold has soared as central banks kept interest rates down and investors rushed to safe haven investments following Brexit, or UK's vote to leave the European Union.

Last week, Netherlands have joined the elite group where borrowers are being paid to borrow as expressed by negative bond yields.

As global bonds hit new records, while US stocks likewise soar to near record highs, the Chinese yuan (expressed via the offshore CNH, the same applies to the onshore CNY) fell to its lowest level in 5 years! (see lower chart)

Said differently, US dollar relative to the yuan has soared to a 5 year high! Another risk milestone for the week!

Italian and European banks have been under sustained strains as seen by crashing stocks and soaring CDS. Europe’s banking strains has resonated with Japanese banks and partly the underperformance of US bank stocks.

This week sustained pressures on Italian bank stocks has only impelled Italy’s Prime Minister Matteo Renzi to extract concessions from the EU by using derivatives as negotiating leverage to counter Italy’s Non Performing Loans. From Reuters (bold mine): Speaking at a joint news conference with Swedish Prime Minister Stefan Lofven, Renzi said other European banks had much bigger headaches than their Italian counterparts. "If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This is the ratio: one to one hundred," Renzi said. He did not directly name Deutsche Bank, but he has singled it out for criticism in the past, including last December, when he said he would not swap Italian banks for their German peers.

Interest rate swap derivative contracts accounted for 78% of the notional outstanding US $493 trillion worth of global OTC derivatives as of the 2H of 2015 according to the Bank for International Settlements data!

Desperate for yields, it would appear that in anticipation of expanded central banks actions plus incumbent QE programs has only set in motion an astounding frantic escalation in the “front running” dynamic that has led to the explosive growth in negative yielding bond.

And that while the selloffs in Italian and European banks have only masked the resounding buildup of risks particularly in the derivatives frontier, such has only magnified the incentives to chase yields to further push bonds deeper into negative territory.

Central bank policies have been forcing markets into a stampede towards negative yielding bonds. And that negative yielding bonds have been transformed into a one way or crowded trade!

And that spillover in the bond chasing phenomenon has partly spread to stocks.

Nevertheless, the crowded trade from a deep seated assumption that central banks “will do whatever it takes” to subsidize and provide cushion to the markets from a crash represents as a clear and present danger

As the ever sagacious Credit Bubble Bulletin analyst Doug Noland trenchantly pointed out (bold mine)

World markets are in the midst of something on a frighteningly grander scale than 2007-2008. Tens of Trillions of sovereign debt have become trapped in speculative melt-up dynamics, as central bankers, derivative traders, speculators and safe haven buyers all battle to procure precious bonds. And I don’t believe it’s coincidence that the world’s largest derivative players are seeing their stock prices suffer under intense selling pressure. Meanwhile, sinking bank shares heighten market fears, which only feeds the dislocation and reinforces the dynamic imperiling the big derivative operators. 

Markets have become entirely deformed where prices have been dramatically falsified and driven far far far away from reality. All these due to sustained and deepening interventions by central banks.

And yet as markets push in a one way direction, cracks on the real economy have become conspicuous

Again Mr Noland:

The Fed and global central bankers have nurtured the illusion that risk markets are safe and liquid (money-like). They have spurred “contemporary finance” and the transformation of increasingly risky assets into perceived safe and liquid securities. Ironically, as the liquidity myth is illuminated in UK real estate funds, a sovereign debt market dislocation ensures “money” floods into potential liquidity traps in risk markets around the world.

Truly spectacular “this time seems different” developments!

We are living in interesting times!