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.