Saturday, June 20, 2015

My Weekly Commentary: Coming Home

My Mac is on a moving truck somewhere between Pittsburgh and Eugene.  Moving cross-country entails some work.  But it’s exciting to be returning home after almost 30 years.  I was a young CPA slaving away at Price Waterhouse in Portland back in 1986.  I left for the better professional opportunities available at the time in Southern California.  It's been a heck of a journey.

A lot has changed since 1986.  I grew up in Oregon, the land of Steve Prefontaine, Tom McCall and “rugged individualism.”  By the age of 11, I was making money delivering the Eugene Register-Guard, mowing lawns and working the strawberry and bean fields during the summers.  My main source of reading was every word written about my beloved University of Oregon Ducks in the sports section.  It was the age of Dick Harter, my childhood idol Ronnie Lee and the “Kamikaze Kids.”  I didn’t realize it at the time, of course, but it was a special time to be a kid in Oregon.  My upbringing prepared me well.

I had the great fortune of playing two years of high school basketball for Coach Paul (“Hoops”) Halupa (with assistant coaches Rick Havercroft and Mike Parker), who played for Harter at Oregon.  To this day, I’m still fond of using one of Coach’s favorite lines: “It will quit hurting when the pain goes away.”

After two memorable seasons at Cottage Grove, we up and moved to Newport.  In this neat little town on the beautiful Central Oregon Coast, I had the good fortune of building a relationship with another one of the toughest men I’ve ever met,  basketball coach Tom Luther.   Mr. Luther was the foreman on a salmon processing ship in Alaska, where I spent four summers working my way through university.

When times get tough, I think back to my most challenging experience in Alaska.  Hit by an early run of salmon, we once worked 165 hours in a period of just over eight days.  I can assure you that it is possible.  I still have numbness in one of my big toes, a reminder of how my legs went completely numb from the knees down.  Everyone worked hard – really hard.  And no one ever complained.  That would have been a sign of weakness.

So it feels right to come home.  It’s the right time.  We dropped off our oldest son at Ann Arbor for student orientation.  He will be a freshman this fall at the University of Michigan.  While our older son is part of the “entitlement generation,” I hope to make some changes in parenting for the benefit of our seven year-old.  The world is changing, and surely not for the better.  I want him fully immersed in hard work and nature.  Riding bikes, fishing and simple things.  We’re going to plant lots of things and we’re pondering even raising a few chickens.  It’s going to be fun.

Over the years, I’ve given significant thought to where I wanted to move my family to ride out the global storm.  I love Australia and seriously considered taking the family to the land down under.  For a while, I thought about New Zealand.  In the end, however, we’ve decided to stay in the U.S.  I expect serious issues – but I plan on being prepared.  As an optimist and analyst, I have do doubt whatsoever that it will be a fascinating time.

It’s a nice spot.  We can be to the University of Oregon campus, Matthew Knight Arena and Hayward Field in 10 minutes - and Autzen Stadium in 15.  Yet it also feels remote – the type of place one would choose for hunkering down when things turn sour.

The past few weeks I haven’t had much time to write.  But packing boxes and such has afforded the opportunity to reminisce and think.  In a way, my life has come full circle.  The global Bubble has come full circle.  Much of my professional career has been immersed in analyzing a historic financial Bubble that at this point has gone beyond what I imagined even possible.

Thinking back, 1986 was a critical year.  The U.S. “twin deficits” (fiscal and trade) were spiraling out of control.  Loose financial conditions were also stoking a dangerous stock market Bubble.  Bubble Dynamics were as well attaining powerful momentum in Japan.  At the time, the common perception was that Japan – or at least their powerful banks and manufacturers – were going to take over the world.

It was a fateful period.  Our policymakers should have more forcefully acted to rein in fiscal and Current Account deficits.  Instead, financial conditions were aggressively loosened.  Worse yet, the U.S. put intense pressure on the Japanese to loosen their policies to help rectify our trade deficits.  The upshots were parallel U.S. and Japanese Bubbles.  The U.S. stock market Bubble burst in late 1987 – with post-crash reflationary policies setting in motion Serial Boom and Bust Dynamics that have persisted/escalated now for almost 30 years.  The damage wreaked from a prolonged “Terminal Phase” of Bubble excess in Japan is a quarter century later integral to the current “global government finance Bubble” – the Granddaddy of all Bubbles.

In hindsight, one could point to 1986 as the beginning of the end of the U.S. dollar as the world’s monetary anchor.  Japan was the first major developed country to fall into the trap of unfettered “money” and Credit.  They were the forerunner of the agony wrought from dysfunctional global financial policymaking and infrastructure.

By now, one would think that loose “money” would be recognized as the chief culprit for much of the world’s ills.  The Greeks cannot be absolved from responsibility.  But lost in the discussion is that the Greeks – like Japan, like Argentina, like Iceland, like millions of U.S. subprime borrowers and so on – were buried by dysfunctional global finance.  Of course, if not for the euro Greece would never had been able to borrow hundreds of billions on the cheap.  If not for a fundamentally impaired U.S. dollar, the euro and its cadre of “subprime” sovereigns would not have luxuriated in such easy Credit Availability.  Ditto China and EM.

And this is where it gets scary.  We now have a few decades of experience of The Perils of Loose Money.  Yet, today it’s literally everywhere.  It permeates.  Somehow the loosest monetary policy imaginable – in the U.S., Europe, Japan, China and Asia is supposed to be part of the solution.   Clearly it’s the problem – a very, very serious problem.  The Chinese Bubble has inflated completely out of control.  The U.S., Europe and Japan are not that far behind.  It’s an unmitigated disaster in the making.

So I’m happy and relieved to have the family in Oregon.  I’m excited to begin pursuing the next chapter of my career.  Through the good and challenging years alike, I’ve always considered myself “a small town working class kid from Oregon” – nothing more, nothing less.  The moving truck arrives next week.  I’ll need some time to unpack the boxes – including my Mac.  And then I’ll be ready to get focused - to get my full attention back to the markets and to my analysis.  I'm thinking the timing could be just about perfect.  Thanks for reading.

Currency Watch:

June 19 – Bloomberg: “China’s central bank has kept the yuan around 6.2 to the dollar for the past three months, helping make it Asia’s hottest carry trade. The currency hasn’t deviated more than 0.4% either side of that level since March 19, giving investors the confidence to borrow in lower-yielding currencies and to take leveraged bets in a market where the benchmark sovereign yield is 3.57%. The yuan has been the most attractive destination for such trades amid an emerging-market slump, according to the Sharpe Ratio, which measures returns adjusted for price swings. Offshore Chinese bonds are rallying. BlackRock Inc. has been adding yuan debt and says exchange-rate stability in the next 18 months will make it an attractive carry trade, according to Neeraj Seth, …head of Asian credit. China is keeping the yuan steady to persuade the International Monetary Fund to grant it reserve-currency status and discourage capital outflows. ‘China’s determination in getting the yuan into the special drawing rights system has altered the bearish view on the yuan,’ said Ben Yuen, …head of fixed income at BOCHK Asset Management… ‘We expect the yuan to remain stable and we find Dim Sum corporate bonds attractive.’”

Fixed Income Bubble Watch:

June 16 – Bloomberg (Stephen Morris and Jeffrey Voegeli):  “HSBC… Chairman Douglas Flint said the clampdown on banks’ trading arms by regulators is contributing to concern by the world’s biggest investors that liquidity could vanish in a bond-market selloff. ‘We wanted banks to shrink their trading operations and they did,’ Flint said… ‘Now we’re worrying about how much more liquidity is available to long-term investors for their illiquid assets, and hence their appetite to take on such assets.’ Flint echoed the concerns of Aberdeen Asset Management Plc Chief Executive Officer Martin Gilbert, who oversees $112 billion in fixed-income assets, and BlackRock Inc., the world’s largest asset manager, which have both set aside more money to meet requests from clients to pull their funds in the event of liquidity drying up. Global bond markets have lost about $640 billion since the end of April, driven by a surge in volatility linked to the worsening Greek turmoil.”

June 16 – Financial Times (Joe Rennison and Philip Stafford): “One of the world’s biggest clearing houses has warned the industry may soon reach the limit of its ability to use the short-term financing market to park its collateral as banks are squeezed by tougher regulations.  LCH.Clearnet, the world’s largest interbank swaps clearer, said there may be limits to the amount of customer margins clearers can send to the repurchase, or repo, market as regulation constrains customers. As banks retreat from repo, Dennis McLaughlin, chief risk officer for LCH.Clearnet said it could reach a point at which it has to stop accepting new trades for clearing, as they will be unable to conduct some $150bn of client funds through the market each day. ‘Capacity reduction in the repo market is a market wide phenomenon and this has significant implications for the clearing industry,’ said Mr McLaughlin. Repo markets grease the wheels of the financial system by allowing bonds to be exchanged for cash on the proviso that they will be repurchased at a later date. It provides a vital source of short-term funding to banks and other financial entities and is often regarded as a bellwether of the financial system’s health.”

U.S. Bubble Watch:

June 19 – Bloomberg (Asjylyn Loder): “The debt that fueled the U.S. shale boom now threatens to be its undoing. Drillers are devoting more revenue than ever to interest payments. In one example, Continental Resources Inc., the company credited with making North Dakota’s Bakken Shale one of the biggest oil-producing regions in the world, spent almost as much as Exxon Mobil Corp., a company 20 times its size. The burden is becoming heavier after oil prices fell 43% in the past year. Interest payments are eating up more than 10% of revenue for 27 of the 62 drillers in the Bloomberg Intelligence North America Independent Exploration and Production Index, up from a dozen a year ago. Drillers’ debt ballooned to $235 billion at the end of the first quarter, a 16% increase in the past year, even as revenue shrank. ‘The question is, how long do they have that they can get away with this,’ said Thomas Watters, an oil and gas credit analyst at Standard & Poor’s… The companies with the lowest credit ratings ‘are in survival mode,’ he said.”

June 18 – Reuters (Edward McAllister): “Oil field work was coming in fast when GoFrac doubled its workforce and equipment fleet at the beginning of last year, just one of hundreds of small oil service companies thriving on the revival of U.S. drilling. Founded in November 2011 with a loan of around $35 million… was by 2014 making nearly that much in monthly revenues, providing the crews and machinery needed… to frack oil and gas wells from North Dakota to Texas. Executives flew to meetings across the country in a Falcon 50 private jet, and entertained customers at their suite at the Texas Rangers baseball stadium in Arlington. The firm would soon move into a 22,000-square-foot office on the 12th floor of Burnett Plaza, one of Fort Worth's most prestigious office buildings. Eighteen months on, however, without work and unable to meet monthly loan payments, GoFrac has closed its doors… The company's story… is not an isolated one. The small- and medium-sized firms that make up at least half of the nearly $100 billion a year U.S. oil services industry that provides fracking sand and specialized chemicals for fracking have been hit far harder than their large, cash-rich rivals by the downturn, experts say.”

Federal Reserve Watch:

June 19 – Bloomberg (Jeff Black): “Chair Janet Yellen has found an unusual pacifier for financial markets anxious for clues about the Federal Reserve’s intentions: a chart with 68 blue dots. The dots represent Fed officials’ forecasts for their main interest rate over the next three years. At her press conference this week, Yellen deployed them to emphasize her message that policy will remain easy for ‘quite some time’ after the Fed raises rates above zero. Investors took note. Stocks rallied after the so-called ‘dot plot’ showed more Fed officials projecting just one rate rise this year, instead of two or more, and slower increases thereafter. Some observers, including Jan Hatzius at Goldman Sachs Group Inc., assume that Yellen herself is among those who see just one move in 2015…”

Global Bubble Watch:

June 19 – Bloomberg (Corina Ruhe): “Eurogroup President Jeroen Dijsselbloem said that ‘the way as it goes now we’re going into that direction’ of a Greek exit from the euro area. Dijsselbloem spoke… after euro-area finance ministers on Thursday failed to reach a financial deal to keep Greece afloat. ‘Only if the Greeks come up with a new and serious proposal, this could lead to a new agreement, but for now we’re far away from that,’ said Dijsselbloem…”

June 18 – Bloomberg (Karl Stagno Navarra, Stephanie Bodoni and Rebecca Christie): “International Monetary Fund chief Christine Lagarde said Greece won’t be given a grace period if it fails to make a payment at the end of the month as Chancellor Angela Merkel said there’s still time to reach a deal on aid. Lagarde, whose policies were labeled ‘criminal’ last week by Prime Minister Alexis Tsipras, said that Greece will immediately be considered in default unless it pays about 1.5 billion euros ($1.7bn) due to the fund on June 30. ‘It will be in default -- it will be in arrears vis-a-vis the IMF, yes, on July 1,’ Lagarde said…”

June 19 – Bloomberg (Chris Anstey, Matthew Brockett and Tracy Withers): “A Greek default and exit from the euro probably would test the global financial system in ways different to the Lehman Brothers crisis of 2008, according to New Zealand’s finance minister. Liquidity backstops such as international swap lines have strengthened since the 2008 cataclysm, and banks have scaled back their balance sheets, making them more resilient, Bill English said… New Zealand could become ground zero for the first market response to a Greek crisis should it come over a weekend, as it hosts the start of the global trading day. ‘In some respects it’s better prepared, in other respects it’s untested as to how it would absorb a significant shock -- because a lot of the risk has been regulated out of the banking system,’ English said, referring to the global financial system. ‘We don’t know what that means if there’s another shock,’ said English…”

June 18 – Bloomberg (Martin Ritchie): “From Brazil to Canada and Mexico to Turkey, steelmakers are unhappy with China. The producer of half the world’s steel is destabilizing the market with ‘massive and increasing overcapacity in an era of slowing growth,’ according to a joint statement by industry associations from around the world… All regions are suffering from a ‘dramatic increase in unfair imports,’ it said. China exported more of the alloy in April than any other country produced, according to the World Steel Association. Prices have slumped worldwide as China ships excess output overseas amid slowing domestic demand… ‘Whenever there is trade friction you will hear these complaints,’ said Helen Lau of Argonaut Securities (Asia)… ‘The bottom line though is that China’s steel industry is in decline. China is exporting more because domestic demand is not very strong, but at the same time there is export demand.’”

June 15 – Bloomberg (Grant Smith):  “The world is on the brink of the longest-lasting oil glut in at least three decades and OPEC’s quest for market share makes it almost unavoidable. Oil supply has exceeded demand globally for the past five quarters, already the most enduring glut since the 1997 Asian economic crisis… If the Organization of Petroleum Exporting Countries were to keep pumping at current rates it would become the longest surplus since at least 1985 by the third quarter… There are few signs the 12-nation group will cut back. Saudi Arabia, OPEC’s biggest member, will probably increase production to intensify pressure on U.S. shale drillers, Goldman Sachs Group Inc. predicts. OPEC’s supplies may be swollen further this year if Iran reaches a deal with world powers to ease sanctions on its exports, Commerzbank AG says.”

Europe Watch:

June 19 – Financial Times (Ferdinando Giugliano): “Until this week, the big suspense surrounding Greece was whether Athens would be able to meet a €1.6bn debt repayment to the International Monetary Fund due at the end of June or go bankrupt. But the fear of default is rapidly being overtaken by a separate — and possibly more dangerous — ticking time bomb: the solvency of Greece’s banks. As anxious savers withdraw deposits, economists warn that Greece’s precarious lenders could collapse. During a meeting of eurogroup finance ministers on Thursday, Benoît Cœuré, a member of the European Central Bank’s board, speculated that Greek banks might not be able to open for business on Monday.”

June 18 – Bloomberg (Yalman Onaran): “Greek banks, which received two capital infusions in the past two years, may need a third one as a recession drives up losses from bad loans. The four biggest lenders, accounting for 91% of the country’s banking assets, could see their 12 billion euros ($14bn) of tangible core capital wiped out by mounting provisions as overdue and restructured loans default. Even if Greece reaches an agreement with European creditors to free up additional money, its next bailout will need to include a new round of funding for the ailing banks… With the recovery stalled, the four banks -- National Bank of Greece SA, Piraeus Bank SA, Alpha Bank AE and Eurobank Ergasias SA -- could require 16 billion euros in additional provisions to cover losses if half of the 59 billion euros of overdue and restructured loans on their books sour.”

China Bubble Watch:

June 17 – Wall Street Journal (Lingling Wei):  “Chinese companies are turning to an unlikely source for profits in the soft economy: the country’s red-hot stock markets. Take Dong Jun, who earlier this year shut down his factory making lighting equipment and electrical wiring and let go some 100 workers. The 50-year-old comes to the plant in the eastern city of Yancheng almost daily, but spends his time trading stocks on behalf of his company, Yanwu Keda Electric Co. ‘Manufacturing is a very hard business these days,’ said Mr. Dong, chairman of the company. ‘I want to make some money from the stock market and use the profits to restart my manufacturing business later, when the economy turns for the better.’ Chinese companies are finding stock investing an attractive option as the wider economy struggles with tepid demand, excess industrial capacity, persistently high borrowing costs and other troubles.”

June 15 – Financial Times (Gabriel Wildau):  “More than 4,000 new Chinese hedge and private equity funds have launched in the last three months, fuelling a mass exodus from traditional investment houses, as ambitious fund managers seek to profit from the country's booming stock market. The number of private investment funds — including securities, private equity, and venture capital — totalled 12,285 by the end of May, up from 7,989 three months earlier, figures from China's securities regulator show. Assets under management increased by $75bn to $433bn… Last February, the government switched to a streamlined registration procedure for private equity and hedge funds… Employees at hedge and private equity funds have risen by over 60,000 in three months, topping 199,000 by the end of May. ‘More than half of our research team has left over the past year to join hedge funds,’ said a vice-president for institutional business at a large Chinese securities brokerage in Shanghai. ‘It's the same with our [mutual fund] clients. Now all the fund managers are 'post-80s',’ she said, referring to those born after 1980.”

June 14 – Reuters (Samuel Shen and Pete Sweeney):  “Senior executives of listed firms in China have stepped up the pace at which they are selling shares in their own companies, suggesting they may have doubts about whether their stock prices can go much higher. In May company insiders… sold a combined 1.68 billion shares, a tripling from April…”

June 17 – Bloomberg:  “China saw net foreign capital inflows in the first five months of the year, suggesting stabilization in a leakage of funds which had been among reasons behind the central bank’s efforts to boost liquidity. A net $20 billion in capital flowed into China in the first five months of the year… China’s government has kept the currency from depreciating sharply against the U.S. dollar this year to stem outflows and support its bid for the yuan to enter the International Monetary Fund’s Special Drawing Rights basket. The central bank twice cut the amount of cash banks need to set aside as reserves, moves interpreted as compensating for earlier leakages.”

June 18 –Time (Hannah Beech): “Jubilation among Hong Kong’s democratic forces didn’t last long. Less than five hours after local lawmakers rejected Beijing’s plan for how the territory’s next leader will be chosen, China’s official Xinhua News Agency possibly declared the Hong Kong parliamentarians’ veto immaterial. The one-sentence bulletin from Xinhua announced: ‘BEIJING, June 18 (Xinhua) — Chinese top legislature on Thursday said its decision on Hong Kong’s electoral reforms last August will remain in force in the future, despite Hong Kong Legislative Council’s veto of the universal suffrage motion.’”

EM Bubble Watch:

June 18 – Bloomberg (Martin Ritchie): “Few expected India’s science minister to cut the monsoon outlook as he unveiled a weather forecasting system on June 2. The surprise contributed to a 1.5-trillion-rupee ($23bn) two-day slump in the nation’s equities. The rupee also slid as Harsh Vardhan’s prediction of weaker rainfall stoked concern that reduced farm output may hurt the economy. The episode is the latest example of growing water risks for investors and companies in India. About half of the country’s 1.26 billion people face potential surface-water supply disruptions, setting the stage for clashes with thirsty industries just as Prime Minister Narendra Modi seeks to make his nation a manufacturing power. And India isn’t alone: From Africa to the Americas, surging demand is exacerbating a global water deficit as groundwater diminishes.”

Geopolitical Watch:

June 17 – Reuters (Maria Tsvetkova): “President Vladimir Putin said… that Russia was concerned about an anti-missile defense system near its borders, after announcing that Russia would add more than 40 intercontinental ballistic missiles (ICBM) to its nuclear arsenal this year. ‘We will be forced to aim our armed forces ... at those territories from where the threat comes,’ Putin said. Putin made his comments a day after Russian officials denounced a U.S. plan to station tanks and heavy weapons in NATO member states on Russia's border. Putin said it was the most aggressive act by Washington since the Cold War a generation ago.”

June 17 – Associated Press (Kim Tong-Hyung): “North Korea says it has been hit by its worst drought in a century, resulting in extensive damage to agriculture. The official Korean Central News Agency said the drought has caused about 30% of its rice paddies to dry up. Rice plants normally need to be partially submerged in water during the early summer. ‘Water level of reservoirs stands at the lowest, while rivers and streams (are) getting dry,’ it said in a report…”

Japan Watch:

June 19 – Bloomberg (Leika Kirhara and Stanley White): “The Bank of Japan maintained its massive stimulus programme and its upbeat assessment of the economy on Friday, signalling its conviction that growth will strengthen enough to accelerate inflation to its 2% target without more monetary easing. With business sentiment improving and capital expenditure picking up, the BOJ maintained its rosy assessment that the economy continues to recover. As widely expected, the central bank also kept intact its pledge to increase base money at an annual pace of 80 trillion yen (£410bn) through aggressive asset purchases.”

June 16 – Nikkei Asia Review (Ryo Saeki):  “Rifts are growing within the Bank of Japan's policy board over whether to continue pursuing the additional monetary easing measures unveiled in October last year. On Oct. 31 last year, the board decided to expand the monetary base by 80 trillion yen ($648bn) annually through government bond and other asset purchases. While BOJ Gov. Haruhiko Kuroda is determined to continue the current financial stimulus measures, Takehiro Sato and other policy board members are cooling toward the idea. If the chasm widens, the board members might become more vocal about their differences with Kuroda… In a June 10 speech, Sato said there is a lack of persuasive evidence of a further rise in inflation expectations. Hoping to break the country out of deflation, the BOJ has set an inflation target of 2%. Sato openly questioned the effectiveness of the bank's current monetary easing measures.”