The Refined Response To Thuggery


With everything else we have to worry about we now have the thorny problem of looking out for Russian agents, or third party agents of Russia, wandering around our market towns prodding passers-by with nerve agents. The furore following the Salisbury incident which so far has resulted in Mrs May looking Prime Ministerial for really the first time while Jeremy Corbyn has reverted to type, has seen a bunch of so called diplomats booking one way tickets and an otherwise pretty measured governmental response. Meanwhile the clarion calls from the back benches, commentators in the press and the usual cabal of 'experts,' have pretty much called for the same thing, 'hit them in the pocket....... hit Putin's Oligarch friends.' 


Unfortunately, any show of resolve from these shores was somewhat undermined on Friday when 50% of the demand for a new $4bn Russian bond issues came from the UK. Total demand was around $7.5bn with UK investors dominating the $2.5bn tap of existing 2047 bonds and buyers from the US soaked up a 20% share of the notes. US investors also bought 34% of the $1.5bn of new 11 year bonds with Russians taking 35% of the issue. The deal was well engineered and offered at terms designed to mitigate failure in front of the weekend's election.


The absence of pushback from international investors, particularly in the UK and the US, is hardly laudable. The sound of the door to capital markets closing would have more resonance in Moscow than will welcoming back a few expelled spies. All that was required would have been a few discreet telephone calls, word that demand was weak would have rattled around markets and the issue would have flopped. Cue embarrassment in Moscow and perhaps a recalibration of their 'not us Guv,' responses to date. One wonders though, if anyone actually considered it as an option. Perhaps not then....

UK Rates To Move Before The US?

3 mth (Short Sterling) Interest Rate Future

I’ve previously noted, as has just about everyone else, how sanguine markets have appeared in the face of potential nae, probable post election chaos.

That may be changing.

Short stering, (which we invert, ie subtract from 100, to translate into anticipated 3 month LIBOR) above, is falling on volume.

This could be a result of concerns about a minority government, which might precipitate a rate rise to steady the pound, or anticipating the return of a Conservative government indicating continued good eco news flow which would also require a rate rise.

Barclays are suggesting the drop is because of swaps being unwound.

I think it is probably a combination of factors which is triggering the volume spike. The takeaway here is that volatility in UK related assets is increasing and will stay on that track in the coming weeks.

A Potent and Combustible Combination

First 10 minutes of Wall Street Week episode from Friday October 16, 1987 just prior to the market crash on black Monday. 

I’m not the only bear in town of course. Most market professionals quietly agree that the market has been pumped up to unsustainable levels and most expect it to self-correct in the traditional way. The only disagreement is over the timing and amplitude of correction. I’m using the cluster of unusual turn dates during this current period to identify it as a period of vulnerability for equities but with valuations and sentiment stretched to historic extremes, a catalyst could come at any time and in any form from Q1 earnings, a Grexit scenario, conflagration in the Middle East with the Saudi’s being drawn into Yemen, a cyber event and so on. 

US investors are especially low on ammunition. The NYSE available cash figure has dropped to one of its lowest levels. The last time it was near this level shares struggled for the following two months. Also, the ratio of assets in equity mutual funds to assets in safe money market funds has reached a new high. Shares have struggled to make fresh headway when the ratio has previously been close to the current extreme. 

These cash levels have been abnormally low by historic standards for a while now, perhaps reflecting what the crowd has come to believe is a “new normal.” It’s clear that managers are not looked upon favourable either by investors or their own management when not fully invested. Nobody wants to be Tony Dye. The result is a heightened state of collective market complacency.

The comfort there is the belief that “if we fall we all fall together.” We can cut and slice this with a number of other measures such as money market holdings of mutual fund investors as a % of the S&P or the percentage of cash in mutual fund investors portfolios, (2.45%) but we come to the same conclusion.  

Sentiment surveys for investors, advisors and managers are all at extreme levels. The 52 week average of the Investors Intelligence bull/bear ratio hit 3.35 last week which exceeds every reading for 35 years. These readings can of course continue to reach even greater extremes but they are telling us that markets are on borrowed time.

Concurrent with that margin debt has been contracting since Feb 2014, (a traditional warning signal), when it reached an all time high of $466bn. Margin debt peaked in front of the four greatest corrections of the past 50 years, 1973, 1987, 2000 and 2007. Note too that the level of debt in February last year expressed as a percentage of US GDP is bang in line with ratio levels at those previous peaks.

The madness abounds in bond land too. You are now guaranteed to lose money on nearly €2tr of Europe’s sovereign bonds if you buy now and hold to maturity. Bloomberg noted that the German 30 year yielded just 0.66% and if that yield rose to 1% in the next year the price of the bond would drop by 10%. Time for investors to acquaint themselves with duration and convexity perhaps. The environment is so too-good-to-be-true that a growing number of US corporations are traversing the Atlantic to issue Euro denominated corporate bonds. In fact, its been the busiest start to the year for Euro bond issuance since the currency’s introduction.

Collectively, it all creates a potent and combustible combination to trigger a bear market. In fact, it’s difficult to think of how to improve it as a bear set up.

Technically, most equity indices are in the final stages of their respective rallies. Pullbacks to date have been quick and shallow. The “buying the dip,” mantra has become so rewarding its become an automatic reflex. Overall momentum however is declining while volatility spikes are becoming more frequent. Investors at this stage of bull market maturity should be treating each decline as if it is the start of a major correction. You may be wrong once, twice, five, ten times but you only have to be right once. That’s an oft quoted mantra of would be tech millionaires but actually, I think the tables have turned.


Old market hands always have half an eye on EM bonds and currencies. It’s there that fires often start. That’s a concern when we look at the chart above.

In blue we see a basket of 20 EM currencies which has slumped to a record relative to the MSCI Emerging Markets Index. Currencies have fallen faster than equities as risk appetite for riskier assets weakens and the USD strengthens.. When the two moved out of step in October 2007 and January 2011, shares slid 66 % and 28% respectively, within a year or less.

Markets; Beware Sharks

If you invest in, work in, regulate or comment on markets you should watch the video above. If by chance you were ambling along in life thinking that those who should know better learn from their mistakes then you're not thinking.

We find ourselves again at or near the peak of a market cycle in which bubbles have been allowed to grow and mature. The end game will be every bit as ugly, if not more so, than those we've seen before.

We are about to see a series of cycle turns occur simultaneously over the next 30 trading days, which include a Fibonacci Cluster turn window with 10 observations. Within this 30 trading day period are a number of very unusual astrological events, which can affect markets. In the past, I have pointed out that major trend turns often come around the spring equinox, which this year arrives within the above Fibonacci Cluster, on March 20th, 2015.

Within this cluster turn period,  we also have a rare Total Solar eclipse (also on March 20th, 2015), the first day of the Hebrew calendar, (Nissan 1, evening also on March 20th), and a New Moon on March 20th. March 20th is also a quadruple witching hour on Wall Street.

Also within this Fibonacci cluster turn period, on April 1st, 2015 is a phi mate turn date, and on April 4th we see a Bradley model turn date, which is also Passover, and also has a Full Moon - not just any Full Moon, but a Blood Moon, the third of four in the 2014-2015 tetrad, a very rare event, that has the additional extremely rare occurrence that all four of these Blood Moons fall on the Hebrew Holy days of Passover and the Feast of Tabernacles (Genesis 1:14). Tell me none of this matters. 

For those who care, 

US economic surprises are at their lowest since 2009. On Friday the Atlanta Fed lowered its Q1 GDPNow forecast to 0.,6% from 1.2%. Investment Bank forecasts are way off the beat here.

Source; US Census Bureau; the blue mark indicates the level when Lehman happened. The uptick is not good.

Source; US Census Bureau; the blue mark indicates the level when Lehman happened. The uptick is not good.

Retail sales, wholesale sales and rail traffic are all at multiyear recessionary lows while the wholesale inventories to sales ratio is at levels which usually spark an equity correction. In fact, we haven’t seen some of this data sink to these levels since Lehman. Earnings estimates point to a 4.9% decline in Q1 which is the largest drop since 2009, yet the market then anticipates a dramatic recovery. Insider selling meanwhile has leapt to warning levels. With this backdrop the Fed’s response will of course be closely watched with many fingers on hair triggers. If they play safe and delay rate rises to start later than expected a period of market turmoil will follow.

The reason the dollar is so strong is quite simply because the US is in better shape than is either Europe, China or Japan and that’s not saying very much. Japan has become one big old peoples home and is currently, in financial terms, eating itself with the only JGB bid coming from the BoJ and public debt at 240% of GDP. Just to orientate you, 40% of tax recepits go on interest on public debt with the 10 year yield at 0.4%. Interest rates at normal levels would absorb all tax receipts and lead to a brutal tax burden on the remaining workforce that hasn’t yet retired. There are words to describe Japans situation, professional courtesy precludes their use here. Europe is mired in centralist socialism and China has just gone through an epic and badly handled credit boom.

The madness in Europe speaks for itself. The ECB is now literally destroying the Euro in a disastrous quest to restart economic growth by monetising $1.2 trillion of mostly European government debt. But Europe’s stagnation is not due to  insufficient private sector borrowing or interest rates that discourage it. The problem is a state sector that has reached nearly 50% of GDP and is thereby smothering entrepreneurs and investment everywhere on the continent. It also  means a public debt burden so high that prohibitive levels of taxation are unavoidable. Stated differently, Europe’s economic growth problem is structural and was the result of statist policies over many decades.  The only thing Draghi will accomplish with his massive bond buying campaign is to drive the Euro to par and below; and enable Europe’s government, all of which can now borrow long-term money at 1% or less, to kick the can down the road, thereby insuring that Europe’s eventual day of fiscal reckoning will be oh so cataclysmic.

 All of these will experience financial disorder and turmoil at some point but for now, let’s take a quick look at just one of those, China. I’m a long time China bear in that I’ve never bought into the “China will save the world,” view that some have promulgated over recent years. Yes, China has kept pricing low and created demand for exports but actually, it takes a very long time to transform an economy and China now is running straight into problems resulting from its credit boom.

While analysts have been lowering Chinese growth estimates those estimates are coming down from a very high level. Current estimates of 7% growth are still too optimistic. Is China turning into Japan? That’s the new topic. Chinese debt stands at $30 Trillion, up $9 trillion since 2008 and debt is 200-300% of GDP counting Shadow Banks.  If the average interest rate is 7% (banks 6% shadow banks 10%), the economy would need to grow 21% in real terms to service the debt and that’s not happening.

Since that cannot happen, banks cannot make loans without injections from PBOC. A fundamental problem is 100% of new credit goes to rollovers. This creates a Zombie economy effect with no credit demand. Steel demand is down, electricity is down, cement demand is down and growth is likely to be sub-zero this quarter. The economy is not growing.

 Moreover, there is massive overcapacity in petrochemicals, construction machinery, steel, cement, aluminium, and housing. The housing excess is extreme with 70 million units of new housing in the pipeline. It will take years of growth to fill capacity.

Aluminium official said privately debt Is $1 trillion, profit 20 billion. Local governments force mills to open because smelters cannot make payments, banks have NPLs. Smelters are capital, not labour intensive.

 The  consumer sector is tracking close to 0% growth as well, average days of clothing inventory is 174 days, electronics 123 days. Consumer companies on the China exchange decline in gross revenue is 2% for the year, 6% third quarter.

 QE3 created a flow of speculative money into China. That tap is shut off and capital flight is accelerating and is a growing problem. Policy now is not about jobs but about keeping money flowing and all capital is used to avoid defaults. We may therefore happily anticipate more defaults, a substantial devaluation, more anti-corruption raids, (especially in financial services), and a clamping down of foreign influence. The consequent demand shock will continue to ripple out. Be prepared not to be surprised by China and if you have money in there I’d mostly be getting it out.

 As China comes closer to a crash landing, the China-dependent EM economies are rapidly faltering. Brazil will suffer sequential years of GDP decline for the first time since 1930-1931.  In fact the China-led global commodities and industrial production boom is cooling so fast that global CapEx in mining and energy, materials processing, manufacturing and shipping is on the verge of a huge downward correction. That will also hit the high end machinery and engineering exporters like Germany and the US, creating a further negative loop in the gathering deflationary crisis.

These ricocheting impacts from the China implosion will drive the dollar still higher. That’s because Chinese companies have borrowed something like $1.5 trillion in external dollar markets, and the EM economies which boomed from the China trade also borrowed trillions in dollar markets, owing to the cheap dollar interest rates manufactured by the Fed, and the global scramble for “yield”  by dollar based money managers.

The flood of cheap dollar based capital which flowed into China and the EM appeared to fuel economic miracles in countries like Indonesia, Brazil and Turkey. Unfortunately, the financial boomerang is flying back at them at devastating speed.  As China and the EM struggle against global deflation, their economies are faltering and exchange rates are sinking. Accordingly, they are desperately trying to hedge their immense dollar exposures, a process which drives the USD steadily higher.

There is a message here in it’s the most important I can see. That is, a soaring dollar is not good on any level and it is certainly not reflecting stability. Rather, because other regions are in a bigger mess than is the US the rising dollar is a red flag which is screaming that instability is hurtling down the track toward us.


That's It Then

I note Jim Cramer rang the bell to open the New York Stock Exchange today to mark 10 years of his Mad Money segment on CNBC. 

I strongly suspect he may be ringing the bell on the market top too. I would find some symmetry there.

After all, it was partly his teenage histrionics that added pressure on the "something must be done camp," that has driven the market to these absurd QE driven heights. "My people have played this game for 25 years...... they are losing their jobs" OK Jim...... your friends got bailed out. Where has that left the rest of the voters in your country and the lead that its given to other central banks intent on mortgaging future generations so your friends can upgrade their yachts? In fact Jim, real household income in the US remains 4% lower than it was pre crisis yet debt is higher, all $8tr of it in fact in the US, investment in infrastructure, R&D and business are lower yet a towering house of cards dependant on issuing cheap debt to buy back equity is alone sustaining US equity markets and we can trace its origins all the way back to those who were screaming like little girls with their fingers trapped in car doors who thought their toys were being taken away...

Then Something Bad Happened

Morale was blown up across trading desks this morning as many YTD P/L's go negative after the deal break on Shire Pharma. The maths are ugly; Paulson -$550m, Magnetar -$350m, Elliot -$200m. When these deal breaks happen spreads in other deals tend to widen inflicting more carnage on P/L's. Still, when merger arb guys get killed we're often close to a short term bottom.


Guy Debelle Says It As He Sees It

If we didn't know who RBA assistant governer Guy Debelle was before this morning we certainly do now. His comments that that markets are likely heading for a "violent sell-off" have caught the eye. It's unusual for a centrral banker to be open, frank and transparent so we ought to welcome his observations. Worth a read to get the context here and his comments about market makers here

"But there are probably a sizeable number of investors who are presuming they can exit their positions ahead of any sell-off. History tells us that this is generally not a successful strategy. The exits tend to get jammed unexpectedly and rapidly."

Could have written it myself!

“Sell everything and run for your lives”

Headline of the week comes from who else but Albert Edwards at SocGen in his Global Strategy Weekly with his "‘Basket trade’ suggests “Sell everything and run for your lives”........... taken from a letter last weekend to the FT from a Mr Matt long who writes,

Sir: The next financial apocalypse is imminent. I know this to be true because the (FT Weekend) House and Home section is now assuming the epic proportions last seen before the great crash. Twenty four pages chock full of adverts for mansions and wicker tea trays for $1,000. You’re all mad.
Sell everything and run for your lives.
Matt Long, Seilh, France.

I rather like Mr Long's approach but fear that he is more accurate in his assessment than perhaps he knows and certainly than most of my colleagues in the City either appreciate or will admit to.