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).
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.
