Saturday, September 5, 2015

Weekly Commentary: The Unwind

Too often it’s as if I’m analyzing an altogether different world than conventional analysts. My strong preference is to be viewed as an adept and determined analyst, as opposed to some wacko extremist. I have always tried to distinguish my analysis from the “lunatic fringe.”

It’s my overarching thesis that the world is in the waning days of a historic multi-decade experiment in unfettered finance. As I have posited over the years, international finance has for too long been effectively operating without constraints on either the quantity or the quality of Credit issued. From the perspective of unsound finance on a globalized basis, this period has been unique. History, however, is replete with isolated episodes of booms fueled by bouts of unsound money and Credit - monetary fiascos inevitably ending in disaster. I see discomforting confirmation that the current historic global monetary fiasco’s disaster phase is now unfolding. It is within this context that readers should view recent market instability.

It’s been 25 years of analyzing U.S. finance and the great U.S. Credit Bubble. When it comes to sustaining the Credit boom, at this point we’ve seen the most extraordinary measures along with about every trick in the book. When the banking system was left severely impaired from late-eighties excess, the Greenspan Fed surreptitiously nurtured non-bank Credit expansion. There was the unprecedented GSE boom, recklessly fomented by explicit and implied Washington backing. We’ve witnessed unprecedented growth in “Wall Street finance” - securitizations and sophisticated financial instruments and vehicles. There was the explosion in hedge funds and leveraged speculation. And, of course, there’s the tangled derivatives world that ballooned to an unfathomable hundreds of Trillions. Our central bank has championed it all.

Importantly, the promotion of “market-based” finance dictated a subtle yet profound change in policymaking. A functioning New Age financial structure required that the Federal Reserve backstop the securities markets. And especially in a derivatives marketplace dominated by “dynamic hedging” (i.e. buying or selling securities to hedge market “insurance” written), the Fed was compelled to guarantee “liquid and continuous” markets. This changed just about everything.

Contemporary finance is viable only so long as players can operate in highly liquid securities markets where price adjustments remain relatively contained. This is not the natural state of how markets function. The bullish premise of readily insurable/hedgeable market risks rests upon those having written protection being able to effectively off-load risk onto markets that trade freely without large price gaps/dislocations. And, sure enough, perceptions of liquid and continuous markets do create their own reality (Soros’ reflexivity). Sudden fear of market illiquidity and dislocation leads to financial crashes.

U.S. policymaking and finance changed profoundly after the “tech” Bubble collapse. Larger market intrusions and bailouts gave way to Federal Reserve talk of “helicopter money” and the “government printing press” necessary to fight the scourge of deflation. Mortgage finance proved a powerful expedient. In hindsight, 2002 was the fateful origin of both the historic mortgage finance Bubble along with “do whatever it takes” central banking. The global policy response to the 2008 Bubble collapse unleashed Contemporary Finance’s Bubble Dynamics throughout the world - China and EM in particular.

There are myriad serious issues associated with New Age finance and policymaking going global. The bullish consensus view holds that China and EM adoption of Western finance has been integral to these economies’ natural and beneficial advancement. Having evolved to the point of active participants in “globalization,” literally several billion individuals have the opportunity to prosper from and promote global free-market Capitalism. Such superficial analysis disregards this Credit and market cycles’ momentous developments.

The analysis is exceptionally complex – and has been so for a while now. The confluence of sophisticated finance, esoteric leverage, the highly speculative nature of market activity and the prominent role of government market manipulation has created an extremely convoluted backdrop. Still, a root cause of current troubles can be boiled down to a more manageable issue: “Contemporary finance” and EM just don’t mix. Seductively, the two appeared almost wonderfully compatible - but that ended with the boom phase. For starters, the notion of “liquid and continuous” markets is pure fantasy when it comes to “developing” economies and financial systems. As always, “money” gushes in and rushes out of EM. Submerged in destabilizing finance, EM financial, economic and political systems become, as always, overwhelmed and dysfunctional. And as always is the case, the greater the boom the more destabilizing the bust.

In general, reckless “money” printing has over years produced a massive pool of destabilizing global speculative finance. Simplistically, egregious monetary inflation (along with zero return on savings) ensured that there was way too much “money” chasing too few risk assets. Every successful trade attracted too much company. Successful strategies spurred a proliferation of copycats and massive inflows. Strong markets were flooded with finance. Perceived robust economies were overrun. Popular regions were completely inundated. To be sure, the post-crisis “Global Reflation Trade” amounted to history’s greatest international flow of speculative finance. Dreadfully, now comes The Unwind.

From individual trades, to themes to strategic asset-class and regional market allocations, speculative “hot money” flows have reversed course. Global deleveraging and de-risking have commenced. The fallacy of “liquid and continuous” markets is being exposed. Faith that global central bankers have things under control has begun to wane. And for the vast majority in the markets it remains business as usual. Another buying opportunity.

Whether on the basis of an individual trade or a popular theme, boom-time success ensured that contemporary (trend-following and performance-chasing) market dynamics spurred speculative excess and associated structural impairment. They also ensured latent Crowded Trade fragilities (notably illiquid and discontinuous “risk off” markets).

Crowded Trade Dynamics ensure that a rush for the exits has folks getting trampled. Previous relationships break down and time-tested strategies flail. “Genius” fails. When the Crowd decides it wants out, the market turns bereft of buyers willing and able to take the other side of the trade. And the longer the previous success of a trade, theme or strategy the larger The Crowd - and the more destabilizing The Unwind. Previous performance and track records will offer little predictive value. Models (i.e. “risk parity” and VAR!) will now work to deceive and confound.

Today, a Crowd of “money” is rushing to exit EM. The Crowd seeks to vacate a faltering Chinese Bubble. “Money” wants out of Crowded global leveraged “carry trades.” In summary, the global government finance Bubble has been pierced with profound consequences. Of course there will be aggressive policy responses. I just fear we’ve reached The Unwind phase where throwing more liquidity at the problem only exacerbates instability. Sure, the ECB and BOJ could increase QE – in the process only further stoking king dollar at the expense of faltering energy, commodities, EM and China. And the Fed could restart it program of buying U.S. securities. Bolstering U.S. markets could also come at the expense of faltering Bubbles around the globe.

It has been amazing to witness the expansion of Credit default swap (CDS) markets to all crevices of international finance. To see China’s “shadow banking” assets balloon to $5 Trillion has been nothing short of astonishing. Then there is the explosion of largely unregulated Credit insurance throughout Chinese debt markets – and EM generally. I find it incredible that Brazil’s central bank would write $100 billion of currency swaps (offering buyers protection against devaluation). Throughout it all, there’s been an overriding certitude that policymakers will retain control. Unwavering faith in concerted QE infinity, as necessary. The fallacy of liquid and continuous markets persisted so much longer than I ever imagined.

I feel I have a decent understanding of how the Fed and global central bankers reflated the system after the 2008 mortgage finance Bubble collapse. The Federal Reserve collapsed interest-rates to zero, while expanding its holdings (Fed Credit) about $1 Trillion. Importantly, the Fed was able to incite a mortgage refinance boom, where hundreds of billions of suspect “private-label” mortgages were transformed into (money-like) GSE-backed securities (becoming suitable for Fed purchase). The Fed backstopped the securities broker/dealer industry, the big banks and money funds. Washington backed Fannie, Freddie and the FHLB, along with major derivative players such as AIG. The Fed injected unprecedented amounts of liquidity into securities markets, more than content to devalue the dollar. Importantly, with the benefit of international reserve currency status and debt denominated almost exclusively in dollars, U.S. currency devaluation appeared relatively painless.

These days I really struggle envisaging how global policymakers reflate after the multi-dimensional collapse of the global government finance Bubble. We’re already witness to China’s deepening struggles. Stimulus over the past year worked primarily to inflate a destabilizing stock market Bubble that has gone bust. They (again) were forced to backtrack from currency devaluation. Acute fragilities associated both with massive financial outflows and enormous amounts of foreign currency-denominated debt were too intense. Markets are skeptical of Chinese official signals that the renminbi will be held stable against the dollar. Market players instead seem to be interpreting China’s efforts to stabilize their currency as actually raising the probability for future abrupt policy measures (significant devaluation and capital controls) or perhaps a highly destabilizing uncontrolled breakdown in the peg to the U.S. dollar.

And as China this week imposed onerous conditions on some currency derivative trading/hedging, it’s now clear that Chinese officials support contemporary market-based finance only when it assists their chosen policy course. How long will Chinese officials tolerate bleeding the nation's international reserves to allow “money” to exit China at top dollar?

September 3 – Financial Times (Henny Sender and Robin Wigglesworth): “Lee Cooperman, the founder of Omega Advisors, has joined the growing chorus of investors blaming last week's stock market sell-off — and his own poor performance in August — on esoteric but increasingly influential trading strategies pioneered by hedge funds like Bridgewater. In a letter to investors…, Mr Cooperman and his partner Steven Einhorn said fundamental factors such as China's ructions and uncertainty over the US interest rate outlook ‘cannot fully explain the magnitude and velocity of the decline in equity markets last month’… ‘These technical factors can push the market away from fundamentals,’ Marko Kolanovic, a senior JPMorgan strategist, noted in a widely circulated report last week. ‘The obvious risk is if these technical flows outsize fundamental buyers. In the current environment of low liquidity, they may cause a market crash such as the one we saw on [August 24]. These investors are selling equities and will negatively impact the market over coming days and weeks.’”

I wholeheartedly agree with the statement “technical factors can push the market away from fundamentals.” Indeed, that’s been the case now for going on seven years. A confluence of unprecedented monetary inflation, interest-rate manipulation, government deficits and leveraged speculation inflated a historic divergence between securities markets Bubbles and underlying fundamentals. The global Bubble is now faltering. Risk aversion is taking hold. De-leveraging is accelerating.

The yen jumped 2.2% this week. Japanese stocks were hit for 7%. The Brazilian real sank 7.3%. The South African rand dropped 4.2%. The Turkish lira dropped another 2.9% and the Russian ruble sank 5.0%. China sovereign CDS surged, pulling Asian CDS higher throughout. The Hang Seng China H-Financials Index sank another 7.4% this week, having now declined 39% from June highs. From my vantage point, market action points to serious unfolding financial dislocation in China. It also would appear that a large swath of the leveraged speculating community is facing some real difficulty.

After a rough trading session and an ominous week for global markets, I was struck by Friday evening headlines. From the Wall Street Journal: “An Investor’s Field Guild to Bottom Fishing;” “Global CEOs See Emerging Markets As Rich With Opportunity.” From CNBC: “Spike in Volatility Creates ‘Traders Paradise.” And from the Financial Times: “Wall Street Waiting for Those Buy Signals;” “Time to Buy EM Stocks, History Suggests;” “Why I’m Adding Emerging Markets Exposure Despite China Wobble;” “G20 Defies Gloom to Forecast Rise in Growth.”

There still seems little recognition of the seriousness of the unfolding global market dislocation. It’s destined to be a wrenching bear market – at best.

For the Week:

The S&P500 fell 3.4% (down 6.7% y-t-d), and the Dow lost 3.2% (down 9.7%). The Utilities sank 5.3% (down 10.7%). The Banks were hit 3.8% (down 5.7%), and the Broker/Dealers were down 3.7% (down 7.8%). The Transports declined 1.5% (down 14.7%). The S&P 400 Midcaps fell 2.8% (down 4.5%), and the small cap Russell 2000 declined 2.3% (down 5.7%). The Nasdaq100 dropped 3.3% (down 1.2%), and the Morgan Stanley High Tech index fell 2.7% (down 3.1%). The Semiconductors declined 2.7% (down 13%). The Biotechs sank 3.8% (up 9.2%). With bullion down $12, the HUI gold index sank 6.4% (down 33.8%).

Three-month Treasury bill rates ended the week at 3 bps. Two-year government yields slipped a basis point to 0.71% (up 4bps y-t-d). Five-year T-note yields fell four bps to 1.47% (down 18bps). Ten-year Treasury yields declined six bps to 2.12% (down 5bps). Long bond yields dipped three bps to 2.88% (up 13bps).

Greek 10-year yields fell five bps to 8.80% (down 94bps y-t-d). Ten-year Portuguese yields dropped 10 bps to 2.49% (down 13bps). Italian 10-yr yields declined four bps to 1.87% (down 2bps). Spain's 10-year yields added a basis point to 2.0% (up 46bps). German bund yields dropped seven bps to 0.67% (up 13bps). French yields fell eight bps to 1.01% (up 18bps). The French to German 10-year bond spread narrowed one to 34 bps. U.K. 10-year gilt yields sank 14 bps to a five-month low 1.82% (up 7bps).

Japan's Nikkei equities index was slammed for 7.0% (up 2% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.36% (up 4bps y-t-d). The German DAX equities index dropped 2.5% (up 2.4%). Spain's IBEX 35 equities index sank 5.1% (down 4.5%). Italy's FTSE MIB index slid 2.4% (up 12.9%). EM equities were under pressure. Brazil's Bovespa index declined 1.2% (down 7.0%). Mexico's Bolsa fell 1.3% (down 0.9%). South Korea's Kospi index dropped 2.7% (down 1.5%). India’s Sensex equities index sank 4.5% (down 8.4%). China’s Shanghai Exchange fell 2.2% (down 2.3%) in a holiday-shortened week. Turkey's Borsa Istanbul National 100 index dropped 2.3% (down 14.9%). Russia's MICEX equities index lost 1.2% (up 21.6%).

Junk funds this week saw outflows of $222 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose five bps to 3.89% (up 2bps y-t-d). Fifteen-year rates gained three bps to 3.09% (down 6bps). One-year ARM rates were unchanged at 2.62% (up 22bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.05% (down 23bps).

Federal Reserve Credit last week fell $9.3bn to $4.437 TN. Over the past year, Fed Credit inflated $63.9bn, or 1.5%. Fed Credit inflated $1.627 TN, or 58%, over the past 147 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $4.9bn last week to $3.347 TN. "Custody holdings" were up $53.5bn y-t-d.

M2 (narrow) "money" supply surged $33.1bn to a record $12.169 TN. "Narrow money" expanded $706bn, or 6.2%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits gained $12.8bn, and Savings Deposits jumped $19.1bn. Small Time Deposits slipped $1.6bn. Retail Money Funds were little changed.

Money market fund assets fell $16.5bn to $2.678 TN. Money Funds were down $55bn year-to-date, while gaining $92bn y-o-y (3.6%).

Total Commercial Paper sank $17.4bn to $1.032 TN. CP increased $25bn year-to-date.

Currency Watch:

September 1 – Bloomberg (Fion Li): “Hong Kong’s de facto central bank stepped in for the first time in more than four months to prevent the city’s currency from breaking out of the strong end of its pegged range against the U.S. dollar. The Hong Kong Monetary Authority said it bought $1.2 billion late Tuesday…, taking today’s injection to $2 billion. It last intervened in April, buying $9.2 billion in total during the month. The HKMA ‘will monitor the market developments closely and maintain the stability of the Hong Kong dollar,’ it said…”

The U.S. dollar index was little changed at 96.22 (up 6.6% y-t-d). For the week on the upside, the Japanese yen increased 2.2% and the Swedish krona gained 0.2%. For the week on the downside, the Brazilian real declined 7.3%, the South African rand 4.2%, the Australian dollar 3.7%, the New Zealand dollar 2.8%, the British pound 1.4%, the Mexican peso 1.1%, the Swiss franc 0.8%, the Canadian dollar 0.6%, the euro 0.3% and the Norwegian krone 0.3%.

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.2% (down 12.7% y-t-d). Spot Gold fell 1.0% to $1,122 (down 5.3%). September Silver was unchanged at $14.55 (down 7%). September Crude gained 83 cents to $46.05 (down 14%). September Gasoline sank 6.8% (down 4%), and September Natural Gas fell 2.2% (down 8%). September Copper declined 1.4% (down 18%). September Wheat sank 3.3% (down 21%). September Corn fell 3.2% (down 9%).

Global Bubble Watch:

September 4 – Bloomberg (Alessandro Speciale, James Mayger and Rainer Buergin): “China sought to ease concerns that its slowing economy could drag down global growth and signaled it won’t get dragged into tit-for-tat currency devaluations. Yi Gang, deputy governor of the Chinese central bank, said Friday that his country’s economy is solid despite the stock market selloff and the yuan will be stable. He spoke in an interview in Ankara where finance ministers and central bankers from the Group of 20 nations are meeting. ‘The Chinese economy’s fundamentals are fine,’ Yi said. ‘No one can predict exactly on the market volatility, but I’m confident that the renminbi exchange rate will be more or less stable around the equilibrium level.’”

September 2 – Reuters (Mike Dolan): “China's summer shock may mark the end of an era of globalization that helped define world markets for more than a decade. Investor anxiety about the consequences is well-founded. Beijing's integration into the global economy since 2002 reshaped the financial as well as economic landscape - mainly by the way China itself and the economies it supercharged with outsize demand for raw materials banked the hard cash windfalls they earned over the following 12 years. According to the International Monetary Fund, the dollar value of foreign currency reserves held by all developing nations ballooned by almost $7 trillion in just one decade to a peak of some $8.05 trillion by the middle of last year. While China was the main driver, accounting for about half of that increase, its economic boom created a commodity supercycle that flooded the coffers of resource-rich nations from across Asia to Russia, Brazil and the Gulf. As the vast bulk of this hard cash was banked in U.S. Treasury and other low risk, rich-country bonds, they were at least one critical factor in the halving of U.S. Treasury and other Group of Seven government borrowing costs over the same period… Emerging market forex reserves fell by about half a trillion dollars between mid-2014 and the end of the first quarter of 2015, IMF data shows, and this is likely far from the end.”

September 2 – Financial Times (Robin Wigglesworth): “It has been a cruel summer for one of the trendiest, most innovative investment strategies of the asset management industry. ‘Risk parity’ funds seek to give investors equity-like returns with bond-like stability at low cost. They use financial engineering, judicious leverage and passive but clever allocations to stocks, bonds and commodities, with each contributing equally to the risk of the overall portfolio. The industry grew to between $400bn and $600bn of assets under management, spearheaded by the hedge fund managers Bridgewater and AQR, but also spreading to many relatively conservative insurance companies and pension funds. But business has sagged badly during the summer months. JPMorgan’s index of 17 risk parity funds that report daily has lost 8.2% since the beginning of May.”

September 3 – Financial Times (Henny Sender and Robin Wigglesworth): “Lee Cooperman, the founder of Omega Advisors, has joined the growing chorus of investors blaming last week’s stock market sell-off — and his own poor performance in August — on esoteric but increasingly influential trading strategies pioneered by hedge funds like Bridgewater. In a letter to investors on September 1, Mr Cooperman and his partner Steven Einhorn said fundamental factors such as China’s ructions and uncertainty over the US interest rate outlook ‘cannot fully explain the magnitude and velocity of the decline in equity markets last month’. Omega’s equity-focused investment funds dropped by between 9% and 11% in August… The ‘systemic/technical investors’ blamed by Mr Cooperman include so-called risk parity funds and momentum investors known as CTAs. Initially commodity-focused, these commodity trading advisers’ funds now invest across futures markets and are typically computer driven. These investors, along with ‘smart beta’ passive equity strategies that have become increasingly popular, adjust their exposures according to algorithms in response to market moves, and spikes in volatility can trigger a rash of automated selling.”

September 3 – Wall Street Journal (John Carney): “The poet Hilaire Belloc once described August as ‘the soldier month’ that looted the earth with a ‘fiery temper.’ That sentiment is no doubt shared by many investors as long-dormant volatility beset the stock market the past few weeks. Despite the recent financial gyrations—or perhaps because of them—it has been a surprisingly quiet, even sleepy summer for investment bankers… The business of underwriting high-grade bonds issued by U.S. corporations has ground to a halt, with no new issuance at all since the third week of August, according to Thomson Reuters. Globally, investment-grade corporate-bond issuance, excluding financial institutions, declined by nearly 26% from August 2014… Equity underwriting is also slumbering. The volume of initial public offerings in the third quarter is on track to decline by 66%...”

China Bubble Watch:

August 30 – Financial Times (Jamil Anderlini): “China’s government has decided to abandon attempts to boost the stock market through large-scale share purchases, and will instead intensify efforts to find and punish those suspected of ‘destabilising the market’, according to senior officials. For two months, a ‘national team’ of state-owned investment funds and institutions has collectively spent about $200bn trying to prop up a market that is still down 37% since its mid-June peak. China’s leaders feel they mishandled the stock market rescue efforts by allowing too much information to become public, according to senior regulatory officials speaking at a meeting late on Thursday — an account of which has been seen by the Financial Times.”

August 30 – Wall Street Journal (Jeremy Page and Lingling Wei): “Shortly before President Xi Jinping boarded a plane last month to attend a summit in Russia, his office issued an executive order: China’s stock markets must go back up. The massive state-backed share-buying that ensued propped up the markets briefly in mid-July, allowing Mr. Xi to showcase China’s economic might at the summit with emerging-market leaders. In recent weeks, though, share prices have plunged again, taking global markets with them and triggering an international crisis of confidence in Mr. Xi’s stewardship of the world’s second-largest economy. Mr. Xi will project an image of strength when he presides over a World War II Victory Day parade on Thursday featuring fighter jets, ballistic missiles and 12,000 troops—an event China hasn’t marked in such a high-profile way before. Three weeks later, he heads to Washington for a state visit meant to convey China’s parity with the U.S. Yet just as he stages these displays of power, political insiders and analysts say Mr. Xi—while still publicly popular in China—is looking more vulnerable than at any time since taking office in 2012.”

September 1 – Wall Street Journal (Lingling Wei and Anjani Trivedi): “China is imposing fresh controls to prevent too much money from leaving its shores, escalating its battle against a deepening slump in the world’s No. 2 economy. The country’s central bank said Tuesday that it will make it more expensive for investors to pressure the yuan to weaken against the U.S. dollar. A weaker currency generally prompts investors to look elsewhere to put their cash and would complicate the government’s efforts to generate spending and bolster economic growth. Some of the country’s largest lenders, including Bank of China Ltd. and China Citic Bank Corp., are beefing up their internal checks on large foreign-exchange conversions by corporate clients… Chinese companies can exchange yuan for foreign currencies only for approved business purposes, such as paying for imports or approved foreign investments. Meanwhile, financial regulators, together with the country’s security forces, are stepping up efforts to rein in illegal money-transfer agents who make a living by helping people move money out of China.”

August 31 – Financial Times (Sun Yu and Jeremy Grant): “China’s wobbly response to the bursting of its stock market bubble, the sudden devaluation of the renminbi and the mystery over the true health of the country’s economy continue to spook investors, large and small. But China’s wealthiest people know exactly what to do in these bewildering times: get some of their money out. More than 60% of wealthy Chinese people surveyed in July by FT Confidential… said they planned to increase their overseas holdings in the coming two years. Residential property was the most popular future investment, followed by fixed-income securities, commercial property, trust products and life insurance policies.”

September 2 – Financial Times (Patti Waldmeir, Josh Noble and Stephen Foley): “China’s efforts to apportion blame for its stock market rout have injected fear into the country’s financial sector and spooked many of the foreign investors Beijing has spent years trying to court. Recent moves by the authorities to tackle malpractice, manipulation and ‘rumour-mongering’ have sent a chill through the market, with analysts and investors increasingly fearful of provoking Beijing’s ire. ‘I can feel the government supervision is strengthening. We are required to use more gentle wording in reports and our opinion should not be too strong,’ said an analyst at a Chinese brokerage. The nervous mood has been fuelled by uncertainty over the whereabouts of a prominent hedge fund boss, Li Yifei, who was this week summoned for meetings with financial market authorities in Beijing in connection with their probe into stock market volatility… Chinese shares have slumped more than 40% from their mid-June peak, wiping about $5tn off the value of listed companies and sending shockwaves through global equity markets. The Chinese government responded to the share price slide by spending about $200bn to prop up markets. It also banned short sellers, halted initial public offerings, encouraged margin trading and prohibited share sales by all big investors… ‘China is such an important market that, historically, investors have put up with some uncertainty. But the current combination of volatility and uncertainty is a bit too much to deal with,’ said one investment banker in Hong Kong. ‘I think we’ll look back on this in three years' time and say it was unbelievable.’”

August 30 – Financial Times (Ben Bland): “China’s banks are facing an ever tighter squeeze as profits stagnate and bad loans jump while the economy continues to slow and heavily indebted companies struggle to survive. The country’s big four state-controlled banks — Agricultural Bank of China, ICBC, Bank of China and China Construction Bank — reported only marginal gains in net profit for the first half of the year, while official measures of non-performing loans surged… Moody’s analysts argue that the PBoC’s August 11 decision to engineer a sharp fall in the renminbi, as part of a move to a more flexible exchange rate regime, has increased the risks of capital outflows, making funding and liquidity conditions for Chinese banks even tougher.”

September 1 – Reuters (Sam Shen, Michelle Price and Lawrence Delvingne): “Investigations by Chinese authorities into wild stock market swings are spreading fear among China-based investors, with some unsure if they are simply helping with inquiries or actually under suspicion, executives in the financial community said. Chinese fund managers say they have come under increasing pressure from Beijing as authorities' attempts to revive the country's stock markets hit headwinds, with some investors now being called in to explain trading strategies to regulators every two weeks. One manager at a major fund - part of the ‘national team’ of investors and brokerages charged with buying stocks to revive prices – said a friend, also an executive at a large fund, was recently summoned for a meeting with regulators, along with all other mutual funds that had engaged in short-selling activity. ‘If I don't come back, look after my wife,’ his friend told him, handing the manager his home telephone number.”

August 31 – Bloomberg: “China’s brokerages tumbled after four Citic Securities Co. executives were detained and people familiar with the matter said the industry was told to contribute another 100 billion yuan ($15.7bn) to a stock market rescue fund. Citic executives… admitted alleged insider trading, the state-run Xinhua News Agency said. The nation’s largest brokerage fell as much as the maximum 10% in Shanghai and slid to the lowest since May 2014 in Hong Kong… The China Securities Regulatory Commission ordered the rescue-fund contributions at a meeting with 50 brokerages on Saturday that was attended by CSRC Chairman Xiao Gang, said the people, who asked not to be identified… The regulator encouraged listed brokerages to buy back shares worth as much as 10% of their total market value, the people said.”

Fixed Income Bubble Watch:

September 4 – Bloomberg (Michelle Kaske): “Puerto Rico’s Public Finance Corp., which in August became the commonwealth’s first debt issuer to default on its obligations, failed to pay bondholders an additional $4 million of interest due Sept. 1. The missed payment was noted Friday in an electronic filing to the Municipal Securities Rulemaking Board’s website, called EMMA. The agency, which owes about $1 billion of debt repaid through legislative appropriation, owed investors $4 million of interest this month…”

U.S. Bubble Watch:

September 1 – Financial Times (Kadhim Shubber): “US bond markets have suffered the longest barren spell for at least 20 years as stock market volatility has deterred even the bravest investment-grade companies from issuing debt. It is 10 business days and counting since a company last issued US investment-grade bonds, the longest stretch of inactivity excluding Christmases in the records of Dealogic…The last US-marketed IG bonds, excluding financial institutions, were $600m-worth of debt issued by Hershey’s on August 18… Investment-grade issuance has run at record levels this year as companies have tried to take advantage of low interest rates to refinance, and to fund share buybacks and takeovers. US-marketed IG bond issuance is $567bn this year, according to Dealogic… The difference between yields on US corporate debt and government Treasuries has climbed by almost a third to 1.55% this year, though these spreads have moderated slightly since their August peak of 1.6%.”

August 31 – Reuters (Sarah McBride and Heather Somerville): “The waves of cash surfed relentlessly by some of Silicon Valley's largest venture-backed businesses are showing signs of receding amid concern the companies may already be worth more than their likely valuations once they finally go public. Investors have created 132 privately held companies valued at $1 billion or more each, according… CB Insights… After a turbulent week for equities, prompted by worries about the faltering Chinese economy, it may take longer for companies aiming to join their ranks to raise multimillion-dollar funding rounds, and they may not get the investment terms they want. ‘Many companies in the market for funding right now are struggling to meet their valuation expectations and are going to have to reassess,’ said Jon Sakoda of venture firm NEA. In the last couple of years, the biggest VC-backed firms, dubbed ‘unicorns’ in 2013 by venture capitalist Aileen Lee of Cowboy Ventures, raised increasing amounts of money at a rapid pace. Airbnb, for instance, raised three nine-figure funding rounds starting in 2011. In June it sealed a $1.5 billion deal that propelled its valuation to $25.5 billion, the third-largest among venture capital-backed companies worldwide.”

August 28 – Wall Street Journal (Michael Wursthorn and Annamaria Andriotis): “While the stock market has surged from its low on Tuesday, the recent sharp downdraft highlighted the risks that individual investors and financial institutions face from loans backed by investment portfolios. Brokerages, including those owned by banks, encouraged their financial advisers to sell so-called securities-based loans to clients in recent years as many portfolios were ballooning during the market’s upswing. At Morgan Stanley, for instance, balances in these loans rose 37% in the year through June 30. But the six-day rout that erased more than $2 trillion in market capitalization from U.S. stocks was a jolt for some of those borrowers, who were forced to choose between putting up more collateral and having to sell some of the investments securing the debt. ‘These loans are a really great option for [obtaining] extra capital if the market is producing returns,’ said Susan Axelrod, head of regulatory affairs for the Financial Industry Regulatory Authority… ‘But customers have to be aware that a market downswing…would make these products less attractive.’”

September 1 – Bloomberg (Sho Chandra): “Manufacturing in the U.S. expanded in August at the slowest pace since May 2013 as anemic demand from emerging markets such as China translated into leaner factory order books. The Institute for Supply Management’s index fell to 51.1, lower than the Bloomberg survey median, from 52.7 in July… A measure of exports matched the weakest reading since April 2009.”

September 1 – Bloomberg (Matthew Malinowski and Dominic Carey): “Gone are the days of Brazilians flooding Miami to spend millions on fast cars and bling. An era of austerity has dawned in Latin America's largest economy as the country charts a course in fiscal tightening. ‘The good times are over,’ Jankiel Santos, chief economist at BESI Brazil, said… ‘Brazil is in a difficult situation, and needs to correct the excesses of the past.”

September 2 – Wall Street Journal (Timothy W. Martin): “The nation’s second-largest pension fund is considering a significant shift away from some stocks and bonds, one of the most aggressive moves yet by a major retirement system to protect itself against another downturn. Top investment officers of the California State Teachers’ Retirement System have discussed moving as much as 12% of the fund’s portfolio—or more than $20 billion—into U.S. Treasurys, hedge funds and other complex investments that they hope will perform well if markets tumble… Its holdings of U.S. stocks and other bonds would likely decline to make room for the new investments.”

Europe Watch:

September 4 – Reuters (Paul Carrel, Caroline Copley, Rene Wagner and Michelle Martin): “German industrial orders fell more than expected in July on lower foreign demand, pointing to some weakness in the export engine that supported growth in Europe's largest economy in the first half of this year. Contracts for goods fell by 1.4% on the month, the Economy Ministry said on Friday, undershooting the Reuters consensus forecast for a 0.6% drop. Factories received 5.2% fewer bookings from abroad, while domestic orders rose by 4.1%.”

September 4 – Wall Street Journal (Marcus Walker, Matthew Dalton and Valentina Pop): “Germany and France pressed the rest of Europe to end squabbling over its exploding migration crisis that is sowing new political divisions across the Continent. German Chancellor Angela Merkel and French President François Hollande called for a burden-sharing system to distribute across the European Union the swelling numbers of people arriving from violent regions in the Middle East, Africa and South Asia.”

EM Bubble Watch:

September 1 – Bloomberg (Cecile Gutscher and Zahra Hankir): “The August meltdown that wiped more value off emerging-market stocks than at any time since the collapse of Lehman Brothers Holdings Inc. has gotten investors more fixated than ever on China’s economic fortunes. As the shock Chinese yuan devaluation sent at least half of the main developing countries into bear-market territory last month, the capitalization of the 31 largest emerging equity markets slid by $2 trillion… The decline in market capitalization in August was the steepest since $2.5 trillion was wiped out in October 2008, a month before the Federal Reserve started an unprecedented stimulus program that bolstered appetite for riskier assets for years.”

August 31 – Bloomberg (Christopher Langner and David Yong): “Southeast Asia’s biggest companies have increased debt sixfold since the regional financial crisis, stoking concern over default risks as investors draw parallels with the 1998 meltdown. The region’s 100 largest listed companies by assets… had accumulated $392 billion by June 30… That’s up six times from December 1998. Debt loads as a proportion of assets are climbing back near levels from the crisis at 31.7%, up from 29.5% in 2010… S&P said foreign-currency debts grew two to three times more rapidly than local debt for Malaysian, Philippine and Indonesian companies between 2010 and 2014, based on its own sample of the top 100 companies. The borrowings made up 30 to 50% of total debt there, it said.”

September 3 – Financial Times (Dan McCrum): “What happens when industrial companies act like hedge funds? The companies in question are manufacturers, transport groups, utilities and other large businesses in emerging markets that have sold dollar bonds to international investors. Work published by the Bank for International Settlements suggests that these groups… have used that funding to invest at home, profiting from differences in interest rates for dollar and local-currency borrowers. They have become part of the so-called shadow banking system, funnelling dollars around the world unnoticed by bank regulators. The trade, enabled in part by the rise of China, is another sign of the way the financial system continues to evolve and, with the world’s second-largest economy having slowed, highlights uncertain links and effects that may be exposed. Ten years ago the finance director of a Brazilian conglomerate or an Indian tractor maker would have struggled to raise debt denominated in a hard currency such as the dollar. Doing so was called the ‘original sin’ of borrowers, and left them at risk of default if the value of the local currency collapsed. But then the financial world noticed the burgeoning Bric economies — Brazil, Russia, India and China — and began to fund the commodity boom created by their rapid growth. Capital became even more plentiful after the 2008 financial crisis. Low returns for debt in mature markets pushed investment tourists abroad. The total for emerging market dollar bonds outstanding is about $1.7tn, larger than the long-established US high-yield debt market.”

September 2 – Bloomberg (Moonyoung Tae): “South Korea’s foreign-exchange reserves dropped for a second month in August, a sign the central bank likely intervened to stem a slide in the won. The reserves fell $2.88 billion to $367.94 billion, after a July drop of $3.93 billion that marked the biggest decline in three years… The won sank last month to its weakest level since October 2011 as China’s surprise devaluation of the yuan dimmed the outlook for exports, weakening emerging-market currencies across Asia, and a military standoff between North and South Korea heightened tensions on the peninsula.”

September 1 – Bloomberg (Jiyeun Lee): “South Korea -- the world’s biggest exporter to China -- is getting squeezed as weaker demand from its larger neighbor helped send its shipments tumbling the most since 2009. The nation’s exports plunged 14.7% in August from a year earlier, an eighth straight monthly decline, as shipments to all its major markets fell… Economists had forecast a 5.9% drop.”

August 31 – Bloomberg (Onur Ant): “Turkish exports fell to their lowest July figure since 2010 as shipments to Russia slumped by half from a year earlier. Sales abroad fell more than 16% to $11.2 billion last month, widening Turkey’s trade deficit to $7.03 billion… Exports declined on an annual basis for the seventh month in a row as demand for Turkish goods in main markets fell. Shipments to Russia, Turkey’s second largest trade partner in 2014, dropped by 48% from July last year while exports to the European Union declined 14%.”

Brazil Watch:

August 31 – Bloomberg (Paula Sambo Denyse Godoy): “The real sank to a 12-year low and the Ibovespa sank on speculation that Latin America’s largest economy is struggling to put its finances in order and avoid a credit-rating cut to junk. Brazil’s bond risk traded near the highest level since 2009. The equity gauge extended the worst monthly slide in 2015, led by banks, after President Dilma Rousseff was said to have abandoned the idea of reviving a tax on financial transactions to boost revenue. Brazil’s government cut its estimate for budget savings for the second time this year, forecasting a deficit for 2016 as Congress steps up its opposition to tax increases and spending reductions.”

Geopolitical Watch:

August 30 – Bloomberg (David Tweed): “As Xi Jinping presides over thousands of goose-stepping troops marching down Beijing’s Changan Avenue -- or ‘Eternal Peace Street’ -- on Thursday, the Chinese president will also proclaim his commitment to the world’s peaceful development. It’s a message China’s neighbors may find hard to swallow as it flexes its military muscle from the East China Sea to the Indian Ocean. The parade marking the 70th anniversary of World War II’s end -- or ‘Victory of the Chinese People’s Resistance Against Japanese Aggression and the World Anti-Fascist War’ -- will put on display much of what has frayed nerves throughout the region. The first-of-its-kind victory celebration will show the world the military might Xi has put at the center of his Chinese Dream for national rejuvenation. The pageant will feature 12,000 soldiers, almost 200 of China’s latest aircraft and mobile ballistic missile launchers capable of delivering nuclear warheads to the continental U.S. ‘There is a fairly crude signal to the international community that China is a modern power not to be trifled with,’ said Rory Medcalf, head of the National Security College at the Australian National University… ‘But this doesn’t sit well with the anxiety that already exists in the region.’”

September 3 – CNBC (Matthew J. Belvedere and Steve Liesman): “Treasury Secretary Jack Lew… diplomatically but firmly criticized China's handling of its currency devaluation. He also said the recent trading turmoil isn't a major concern at this point, but ‘I keep my eye on the market.’ Regarding China, whose devaluation last month helped set off the plunge in world markets, Lew said: ‘They have to understand, and I make this point to them quite clearly, that there's an economic and a political reality to things like exchange rates.’ His comments follow those of other officials who have been critical of the way China went about devaluing its currency. ‘They need to understand that they signal their intentions by the actions they take and the way they announce them. And they have to be very clear that they're continuing to move in a positive direction. And we're going to hold them accountable,’ said Lew…”

September 1 – Reuters (Arshad Mohammed, Matt Spetalnick and Mark Hosenball): “The United States is considering sanctions against both Russian and Chinese individuals and companies for cyber attacks against U.S. commercial targets, several U.S. officials said… The officials, who spoke on condition of anonymity, said no final decision had been made on imposing sanctions, which could strain relations with Russia further and, if they came soon, cast a pall over a state visit by Chinese President Xi Jinping in September. The Washington Post first reported the Obama administration was considering sanctioning Chinese targets, possibly within the next few weeks, and said that individuals and firms from other nations could also be targeted.”

August 31 – Sydney Morning Herald (John Garnaut): “China has won the first round of its contest for control in the South China Sea by completing construction of an archipelago of artificial islands, say senior Australian sources. And there is little that will stop China from winning the next round, too, as an indecisive US Administration and allies including Australia struggle to follow through on earlier promises to challenge unlawful Chinese claims with ‘freedom of navigation’ exercises, the sources say. By 2017, military analysts expect China will have equipped its new sand islands with ports, barracks, battlements, artillery, air strips and long-range radar systems that will enable it to project military and paramilitary power into the furthest and most hotly-contested reaches of the South China Sea.”

Japan Watch:

September 4 – Bloomberg (Yuji Nakamura, Toshiro Hasegawa and Anna Kitanaka): “Global investors are pulling money out of Japan’s equity market at the fastest pace since at least 2004, according to Mizuho Securities Co. Foreigners last week sold a net 1.85 trillion yen ($15.4bn) of Japanese stocks and equity index futures, the biggest combined outflow since Mizuho began tracking the data more than a decade ago, said Yutaka Miura, a Tokyo-based senior technical analyst at the brokerage. Investors are fleeing amid concern about China’s economic outlook and the prospect of higher interest rates in the U.S., he said. ‘This is a result of investors dumping global risk assets,’ said Miura. ‘Japanese stocks have performed well since the start of the year, so similar to what’s happening in Europe, we’re seeing people take profits.’”