Saturday, January 2, 2016

Weekly Commentary: 2015 Year in Review

The year 2015 was extraordinary. Incredibly, despite powerful confirmation of the bursting global Bubble thesis, market optimism remained deeply entrenched. All leading strategists surveyed in December by Barron’s remained bullish – some were borderline crazy optimistic.

Optimism withstood a commodity price collapse. Crude, the world’s most important commodity, crashed almost 35% to an eleven-year low, much to the peril of scores of highly leveraged companies and countries. The Bloomberg Commodities Index dropped 25%, its fifth straight year of declines. Copper fell 24%, with platinum and palladium down about 30%. In agriculture commodities, wheat fell 20%, with soybeans and corn down about 10%. Coffee sank 25%.

Bullishness persevered through deepening EM turmoil and a crisis of confidence. The Brazilian real dropped about a third (worst year since 2002), and Brazil’s sovereign debt suffered major losses. Brazil’s corporate debt market was pummeled (Petrobras, Vale, BTG, Samarco, etc.) while confidence in the nation’s major banks and government waned. Russia and Turkey showed further deterioration. Fragility surfaced in EM linchpin Mexico. Currencies suffered generally throughout EM – Latin America, Asia, the Middle East, Eastern Europe, etc. Collapsing currency peg regimes saw almost 50% devaluations for the Azerbaijani manat and Kazakh tenge. Argentina devalued the peso 30% versus the dollar. Throughout EM, dollar-denominated debt became a market concern.

Optimism survived the major financial tumult that unfolded in China. Early 2015 stimulus efforts stoked “Terminal Phase” excess in Chinese equities, a Bubble that came crashing down in a 40% summer drubbing. An August yuan devaluation destabilized markets across the globe. Aggressive (invasive) monetary, fiscal and regulatory measures somewhat stabilized equities and the yuan, at the heavy cost of extending “Terminal Phase” excess throughout the Credit system (i.e. corporate debt and “shadow banking”). The yuan posted a 4.5% 2015 decline against the dollar, the worst performance since 1994. The “offshore yuan” trading in Hong Kong dropped 5.3%.

Bullishness endured despite the August global market “flash crash.” And while the summer market dislocation provided important confirmation of mounting fragilities throughout the markets on a global basis, the bulls interpreted the event as further validating their view of unwavering central bank support and liquidity backstops. The Fed’s September flip-flop emboldened speculative excess, with U.S. equities back within striking distance of record highs by early-November.

From the perspective of my analytical framework, 2015 was momentous; not necessarily because of the year’s occurrences as much as for the far-reaching dynamics set in motion. The “Core and Periphery” analytical framework is an especially valuable tool in our efforts to decipher an easily perplexing 2015. Instability afflicting the EM “Periphery” in 2014 gravitated to the EM's “Core.” In particular, and central to the “momentous 2015” view, faltering Bubbles in commodities and China were transmitted to the “developed” world’s markets and economies (at least at the “Periphery of the Core”).

Troubled energy and commodities companies led a surge in U.S. corporate debt troubles, with the U.S. actually accounting for 60% of global defaults (from S&P). U.S. junk bonds posted negative returns for the year. Junk bond sales slowed sharply after the August “flash crash,” with 2015 issuance down about 16% from the previous year (2014 $348bn). Leveraged loan issuance was down about 20% (from S&P Capital IQ). Confidence was further shaken by a public mutual fund (Third Avenue) barring redemptions. ETF outflows became a serious market concern.

The year ended with heavy outflows from bond funds – junk as well as, notably, investment-grade. Beyond devastating consequences for highly leveraged energy and commodities players, the tightening of financial conditions was transmitted to “Core” equities market. The volume of U.S. IPO deals fell more than 40% in 2015, with money raised sinking 65% to $30 billion (from Renaissance Capital). Global IPO volumes were down 35% from 2014 to $156 billion.

In the face of a wrenching commodities collapse, a slowing global economy, heightened risk aversion and prospects for Fed rate increases, Wall Street remained undaunted. A December 28 Bloomberg headline: “Wall Street Predicts Corporate America's Bond Binge Will Go on - Wall Street’s biggest dealers are forecasting that blue chip U.S. companies will sell more than $1 trillion of bonds for a fifth straight year in 2016 as corporate America’s borrowing binge endures…” In equities, investors gravitated away from the deteriorating broader market in favor of crowding securely in “FANG” (Facebook, Amazon, Netflix and Google).

For much of 2015, deterioration at the “Periphery” worked to bolster flows to “Core” markets. Investment-grade issuance jumped to a record $1.31 TN, up about 17% from 2014’s record $1.168 TN. Record low corporate yields and the Fed-induced insatiable demand for investment-grade debt sustained the historic M&A boom. For the year, global M&A reached a record $5.04 TN (from Dealogic), surpassing 2007’s record. U.S. M&A surged 56% to $2.43 TN. Despite rapidly slowing earnings growth, corporate America repurchased stock and paid dividends at record levels.

The U.S. economy likely grew about 2% in 2015, below earlier expectations and a dismal performance considering the prolonged ultra-loose monetary backdrop. Most notably, the U.S. economy turned only more unbalanced. The bust in energy and commodities gathered momentum, while Bubbles in tech and biotech inflated precariously. In general, housing markets slowed meaningfully into year-end. Yet aggregate data mask downturns in some markets and runaway booms in others. The commercial real estate Bubble inflated further. The unemployment rate dropped to 5%, yet income and wealth inequality had Americans feeling increasingly uneasy with the economic backdrop, the Fed, government and Wall Street.

Importantly, Credit growth slowed markedly in 2015, with implications for income growth, corporate profits and the asset markets more generally. Through three-quarters of 2015, Non-Financial Credit growth slowed markedly to an annualized pace of about $1.32 TN. Assuming weak Q4 growth, 2015 will see the slowest Credit expansion since 2009 ($1.204 TN). For perspective, Credit expanded $1.843 TN in 2014, $1.608 TN in 2013 and $1.923 TN in 2012. And after three-years of major stock market-induced gains in Household Assets, 2015 will see the smallest rise in Household Net Worth since 2011.

The year was notable for the increasingly problematic central bank-induced divergence between inflating securities markets and deflating real economy prospects. Bursting commodities and EM Bubbles weighed on global growth, while QE and ultra-dovish monetary policies spurred ongoing speculative excess. As the global economy deflated (in the face of aggressive monetary stimulus), over-abundant liquidity was further enticed into the inflating global financial asset Bubble. And as speculators rushed to exit faltering markets, asset classes and individual stocks, the Crowded Trade phenomenon turned only more destabilizing. The huge bets on central bank policies left markets at high risk for abrupt reversals and trade unwinds – 2015 The Year of the Erratic Crowded Trade.

The Swiss National Bank’s surprising January decision to break the swissy’s cap with the euro proved a precursor of 2015’s disorderly Crowded Trades - and the general inhospitable backdrop for leveraged speculation. Recall how the swissy moved a massive 30% as the news broke, the type of market discontinuity that blows out both leveraged trades and dynamic-trading hedging strategies. While not as dramatic, currency markets again dislocated during the August “flash crash.” Later, the euro moved an immediate 4% in early-December when Mario Draghi was unable to deliver on his vow to “do what we must to raise inflation as quickly as possible.” The year saw the risk vs. reward calculus deteriorate significantly for leveraged speculation, especially in currency trading.

January 1 – Wall Street Journal (Rob Copeland): “Hedge funds start the New Year with something to prove—again. The money managers who charge some of the highest fees on Wall Street had a chance in 2015 to outperform a flat stock market and end years of subpar performance. Instead, hedge funds lost more than 3%, on average, according to early estimates from hedge-fund-research firm HFR Inc., while the S&P 500 returned 1.4%, including dividends. Managers stumbled for myriad factors, including bad wagers on energy and currencies and an overreliance on certain stocks. ‘Everything went wrong,’ said Alexander Roepers, founder of $1.5 billion hedge-fund firm Atlantic Investment Management. ‘There were very few places to hide.’”

Hedge fund travails have been well publicized. The industry overall lost money in 2015, following several unimpressive years. Some major funds suffered their worst year since the financial crisis. Many funds closed and/or returned money to outside investors. Still, investor confidence for the most part held up. The industry overall did not suffer major outflows. Yet it wasn’t only hedge funds that struggled in 2015’s unsettled market backdrop.

December 31 – Wall Street Journal (Sarah Krouse): “It is getting a lot harder to sell hedge-fund-style investing to the masses. More ‘liquid alternative’ mutual funds closed in 2015 than in any year on record, according to… Morningstar Inc., as inflows dwindled and performance weakened. The results show that enthusiasm is fading for what had emerged in recent years as one of the hottest products in asset management—funds that combine hedge-fund strategies like shorting stock with the daily liquidity of mutual funds. In all, 31 liquid-alternative funds have been closed this year, up from 22 a year earlier… ‘You had so many funds that were launched in the last couple of years and hadn’t really been tested by market volatility and you’re starting to see the cracks in them,’ said Jason Kephart, an analyst at Morningstar… Fund companies aggressively pitched liquid-alternative products, saying they could help protect investors from volatility and offer better returns. Assets in liquid-alternative funds grew to $310.33 billion at the end of 2014 from $124.44 billion at the end of 2010.”

It was certainly not the year of the “non-correlated” fund or asset class. Overall, most funds and strategies that were expected to perform well in the event of market instability failed to live up to expectations. Symptomatic of the general backdrop, too much “money” has flooded into various “liquid alternative,” “risk parity,” and sophisticated hedging strategies. Instead of providing investor protection, the proliferation of variations of model-directed, trend-following strategies only exacerbated market instability.

An overarching theme from 2015 was that the market turned increasingly unstable, while the vast majority of strategies used for market risk mitigation performed disappointingly. This is closely related to another critical market development illuminated in 2015: rapidly waning benefits to diversification. The halcyon post-crisis backdrop of holding (leveraging?) a portfolio of U.S. equities, fixed-income and global stocks & bonds – all generating positive returns – ended with a vengeance. Commodities were a disaster and EM was a minefield. Moreover, bonds were no longer providing a reliable hedge against “risk off” market turbulence. Perhaps not obviously, but the game turned much more difficult in 2015. Bloomberg: “The Year Nothing Worked: Stocks, Bonds, Cash Go Nowhere”

I didn’t adopt the terminology, but “quantitative tightening” was used (initially by Deutsche Bank) starting in August to describe the dynamic whereby EM outflows forced EM central bankers to liquidate Treasuries and “developed” sovereign debt securities. A key “virtuous cycle” dynamic from the global government finance Bubble period had been the large flow of finance into EM that was then easily/predictably recycled back into “developed” markets through the purchase of sovereign debt.

2015 marked a key inflection point for EM international reserved holdings, with important implications for EM and global market stability. The potential for big EM central bank liquidations became a significant market uncertainty. Moreover, the prevailing dynamic where “risk off” instability led predictably (great for hedging!) to aggressive buying of Treasuries (and “developed” sovereigns) was supplanted by fear that global tumult would spur EM outflows, Treasury sales and a destabilizing pop in global yields. Importantly, Treasuries lost the attribute of providing a cheap and reliable hedge against faltering global risk markets. This greatly compromised popular diversification and hedging strategies.

China’s international reserve position ended November at $3.4 TN, declining from the 2014 high of $4.0 TN. Reserves were down $405bn through November. Estimates had outflows from China surging to $200 billion monthly during the summer, and perhaps remaining near $100 billion per month through year-end  China imposed onerous measures throughout the summer and fall that amounted to capital controls. These, along with the late-summer market crackdown on selling, short-selling and derivatives trading, ensured an international investor crisis of confidence in the course of Chinese policymaking. Crackdowns on the securities firms and what has evolved into "wildcat banking" significantly complicates the already fragile Chinese Credit backdrop.

Fundamental to “momentous 2015” is the thesis that the year marks a pivotal year in confidence in global policymaking generally. Clearly, the unfolding bust saw a dramatic change in perceptions with respect to the aptitude of Chinese officials. In general, confidence in the effectiveness of QE waned throughout the year. A global commodities collapse in the face of ongoing QE was unnerving.

As the year progressed, it seemed only central bankers remained confident that QE could reverse the downward trajectory of global CPI. Within individual central banks, skepticism mounted as to both the effectiveness of QE and the associated risks to financial stability. The Bank of Japan hesitated to increase QE, while market darling Draghi couldn’t deliver on what the market had believed was promised more aggressive QE. Market perceptions shifted from “whatever it takes” QE on demand to fears that current QE, while not all that effective, could be as good as it gets.

2015 developments also support the view that the bursting of the global Bubble portends serious geopolitical risk and instability. Geopolitical tensions were on the rise virtually everywhere. Strongman Putin took his show to the Middle East, a region increasingly a volatile cauldron of mayhem. Strongman Erdogan’s Turkey shot down a Russian fighter jet. Millions of refugees to Europe, further destabilizing the political backdrop. Multiple terrorist attacks. ISIS. The U.S. challenged China in the South China Sea. Strongman Xi Jinping took further measures to centralize authority and solidify power. Japan’s Shinzo Abe pushed forcefully ahead with reform and militarization. 2015 was the year of the authoritative leader – on a seemingly global basis. With pundits and traditional analysts in disbelief, Bernie Sander catches fire with an anti-capitalism and anti-Wall Street message, while the Donald Trump phenomenon takes the Republican primary season by storm. And few see the association to Credit Bubbles, unsound “money” and Credit, inflationism and resulting central bank-induced monetary disorder.

Important pillars of the bull case evaporated throughout 2015. Global price pressures weakened, the global Credit backdrop deteriorated and the global economy decelerated. Indeed, a global bear market commenced yet most remain bullish. Serious and objective analysts would view this ominously.


For the Week:

The S&P500 declined 0.8% (down 0.8% in 2015), and the Dow fell 0.7% (down 2.2%). The Utilities slipped 0.5% (down 9.8%). The Banks dropped 1.4% (down 1.6%), and the Broker/Dealers fell 0.9% (down 3.5%). The Transports dropped 1.5% (down 17.8%). The S&P 400 Midcaps fell 1.2% (down 3.7%), and the small cap Russell 2000 lost 1.6% (down 5.7%). The Nasdaq100 slipped 0.6% (up 8.4%), and the Morgan Stanley High Tech index declined 0.3% (up 6.8%). The Semiconductors dropped 1.6% (down 3.4%). The Biotechs slipped 0.2% (up 10.9%). With bullion down $15, the HUI gold index sank 4.8% (down 32.2%).

Three-month Treasury bill rates ended the week at 16 bps. Two-year government yields rose four bps to 1.05% (up 38bps in 2015). Five-year T-note yields increased two bps to 1.75% (up 10bps). Ten-year Treasury yields added a basis point to 2.25% (up 8bps). Long bond yields gained five bps to 3.02% (up 27bps).

Greek 10-year yields dropped 66 bps to 7.32% (down 243bps in 2015). Ten-year Portuguese yields added a basis point to 2.52% (down 11bps). Italian 10-year yields dropped six bps to 1.59% (down 30bps). Spain's 10-year yields declined four bps to 1.77% (down 16bps). German bund yields slipped a basis point to 0.62% (up 8bps). French yields were unchanged at 0.99% (up 16bps). The French to German 10-year bond spread widened a basis point to a 10-week high 37 bps. U.K. 10-year gilt yields rose four bps to 1.96% (up 21bps).

Japan's Nikkei equities index gained 1.4% (up 9.1% y-t-d). Japanese 10-year "JGB" yields declined a basis point to 0.26% (down 6bps in 2015). The German DAX equities index added 0.1% (up 9.6%). Spain's IBEX 35 equities index fell 1.5% (down 7.2%). Italy's FTSE MIB index slipped 0.2% (up 12.7%). EM equities were mostly lower. Brazil's Bovespa index fell 1.5% (down 13.3%). Mexico's Bolsa lost 1.3% (down 0.4%). South Korea's Kospi index fell 1.3% (up 2.4%). India’s Sensex equities index gained 1.1% (down 5.0%). China’s Shanghai Exchange sank 2.5% (up 9.4%). Turkey's Borsa Istanbul National 100 index sank 3.4% (down 16.3%). Russia's MICEX equities index gained 1.5% (up 26.1%).

Junk funds saw inflows of $144 million (from Lipper), ending three weeks of big outflows.

Freddie Mac 30-year fixed mortgage rates rose five bps to a six-month high 4.01% (up 14bps y-t-d). Fifteen-year rates added two bps to 3.24% (up 9bps). One-year ARM rates were unchanged at 2.68% (up 28bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up seven bps to 4.10% (down 18bps).

Federal Reserve Credit last week declined $6.1bn to $4.455 TN. Over the past year, Fed Credit declined $5.0bn, or 0.1%. Fed Credit inflated $1.644 TN, or 58%, over the past 164 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week rose $14.2bn to $3.324 TN. "Custody holdings" were up $48bn y-o-y, or 4.8%.

M2 (narrow) "money" supply surged $53.1bn to a record $12.359 TN. "Narrow money" expanded $718bn, or 6.2%, over the past year. For the week, Currency slipped $0.7bn. Total Checkable Deposits rose $19.5bn, and Savings Deposits added $1.5bn. Small Time Deposits declined $0.9bn. Retail Money Funds jumped $33.7bn.

Total money market fund assets rose $16bn to $2.759 TN. Money Funds rose $26bn y-o-y (1.0%).

Total Commercial Paper surged $33.8bn to $1.056 TN. CP expanded $48bn in 2015, or 4.8%.

Currency Watch:

The U.S. dollar index gained 0.8% this week to 98.69 (up 9.3% y-t-d). For the week on the upside, the New Zealand dollar increased 0.6% and the Australian dollar 0.3%. For the week on the downside, the Norwegian krone declined 2.3%, South African rand 2.2%, British pound 1.1%, the euro 0.9%, Swedish krona 0.8%, Brazilian real 0.4%, Swiss franc 0.3%, Japanese yen 0.2%, Canadian dollar 0.2% and Mexican peso 0.1%.

Commodities Watch:

December 31 – Reuters (Barani Krishnan and Ahmad Ghaddar): “Oil prices rose on Thursday but fell as much as 35% for the year after a race to pump by Middle East crude producers and U.S. shale oil drillers created an unprecedented global glut that may take through 2016 to clear. But for 2015, both benchmarks fell double-digits for a second straight year as Saudi Arabia and other members of the once-powerful Organization of the Petroleum Exporting Countries (OPEC) again failed to boost oil prices. The U.S. shale industry, meanwhile, surprised the world again with its ability to survive rock-bottom crude prices, churning out more supply than expected, even as the sell-off in oil slashed by two-thirds the number of drilling rigs in the country from a year ago.”

The Goldman Sachs Commodities Index slipped 0.8% to end 2015 down 25.5%. Spot Gold fell 1.4% to $1,061 (down 10%). March Silver sank 4.0% to $13.80 (down 12%). February WTI Crude declined $1.06 to $37.04 (down 31%). February Gasoline increased 0.5% (down 14%), and February Natural Gas gained 0.8% (down 19%). March Copper increased 0.5% (down 25%). March Wheat recovered 0.5% (down 20%). March Corn declined 1.6% (down 10%).

Global Bubble Watch:

December 28 – Bloomberg (Lu Wang): “The idea behind asset allocation is simple: when one market struggles, it’s OK because an investor can jump into another that is thriving. Not so in 2015. In fact, if you judge the past year by which U.S. investment class generated the largest return, a case can be made it was the worst for asset-allocating bulls in almost 80 years, according to… Bianco Research LLC and Bloomberg. With three days left in 2015, the Standard & Poor’s 500 Index gained 2.2% with dividends, cash is up less, while bonds and commodities show losses. After embracing everything from Treasuries to high-yield bonds and technology shares amid seven years of zero-percent interest rates, investors found themselves with nowhere to run at a time when the Federal Reserve’s campaign of stimulus drew to an end. Normally it isn’t like this. Since 1995, practically every year has seen some asset deliver returns exceeding 10%.”

December 28 – Financial Times (Ed Crooks): “As a miserable year for the oil industry draws to a close, any relief executives might feel will be tempered by the knowledge that 2016 is shaping up to be even worse. The collapse in oil and gas prices that began in the summer of last year has already cost hundreds of thousands of jobs, and caused projects worth hundreds of billions of dollars to be cancelled or delayed. Today, the external environment is more challenging than it was a year ago, and the energy companies’ ability to cope with tough conditions is diminished. For oil and gas producers, 2016 will be a year of cost-cutting, restructuring, refinancing when it is possible, and in some cases bankruptcy when it is not… Companies that are exclusively focused on production and have weak balance sheets will have done well if they can make it through the year. The outlook was already dire a year ago. Since then, Brent crude has fallen a further 39%... close to an 11-year low.”

December 30 – Associated Press: “Companies around the world spent a record $5.04 trillion on acquisitions in 2015, according to Dealogic, as slow worldwide economic growth and low interest rates pushed companies to combine forces. …The value of global deals soared 37% in 2015… Low interest rates since the Great Recession have made it cheaper for companies to borrow money to pay for acquisitions, and because the global economy grew only slowly this year, companies decided it made more sense to buy their competitors instead of trying to boost their sales on their own.”

December 27 – CNBC (Leslie Shaffer): “Deal-makers across Asia-Pacific were hustling in 2015, racking up more than $1 trillion in mergers and acquisitions, topping 2014's record by 37%, Dealogic said. That accounted for a record 24% share of announced global deals… Domestic M&A volume in Asia-Pacific also hit a record high of $947.9 billion, accounting for 81% of the region's $1.16 trillion total, Dealogic said. Intra-Asia deals -- or deals where an Asian acquirer targets Asian assets -- also surged around 34% in value to $72.3 billion in 2015…”

U.S. Bubble Watch:

December 31 – Associated Press (Ken Sweet): “The volatile trading that defined 2015 led to a very choppy market for companies wanting to go public. The number of U.S. companies that successfully made an initial public offering of stock in 2015 dropped by more than 40% compared with 2014, according to a report by IPO research firm Renaissance Capital. The amount raised was considerably less as well, falling to $30 billion in 2015 from $85.3 billion… The August downturn and a U.S. market correction in September convinced a lot of companies to put their plans to go public on hold, Renaissance Capital said. ‘For the first eight months of the year, the IPO market was on target to reach over 200 IPOs with solid returns, but went into a tailspin in August and September that wiped out positive performance, drove abnormally high IPO discounts and brought issuance to a near halt by year-end,’ the firm said… IPO activity stalled not only in the U.S., but around the world. The amount of money raised in IPOs globally was $156.2 billion, down 35% from a year earlier.”

December 28 – Bloomberg (Darrell Preston): “In Kern County, California, one of the nation’s biggest oil producers, tumbling energy prices have wiped more than $8 billion from its property-tax base, forcing officials to tap into reserves and cut every department’s budget. It’s only getting worse… As the price of crude falls for a second year, marking the steepest decline since the recession, the impact is cascading through the finances of states, cities and counties, in ways big and small… Alaska, Louisiana and Oklahoma have seen tax collections diminished by the rout, which has put pressure on credit ratings and led investors to demand higher yields… In Texas, the largest producer, the state’s sales-tax revenue dropped 3% in November from a year earlier… Further west, Colorado’s legislative forecasters on Dec. 21 estimated that the state’s current year budget will have a shortfall of $208 million… In North Dakota, tax collections have trailed forecasts by 9% so far for the 2015-2017 budget.”

December 28 – Bloomberg (Dan Murtaugh): “In 2015, the fracking outfits that dot America’s oil-rich plains threw everything they had at $50-a-barrel crude. To cope with the 50% price plunge, they laid off thousands of roughnecks, focused their rigs on the biggest gushers only and used cutting-edge technology to squeeze all the oil they could out of every well. Those efforts, to the surprise of many observers, largely succeeded. As of this month, U.S. oil output remained within 4% of a 43-year high. The problem? Oil’s no longer at $50. It now trades near $35. For an industry that already was pushing its cost-cutting efforts to the limits, the new declines are a devastating blow. These drillers are ‘not set up to survive oil in the $30s,’ said R.T. Dukes, a senior upstream analyst for Wood Mackenzie…”

December 28 – Associated Press (Alex Veiga): “There's a dark side to those delightfully low gas prices: Housing markets are slumping in communities that were recently flush from the U.S. shale oil fracking boom. Home sales are down sharply this year in North Dakota and the West Texas cities of Midland and Odessa. Home sales have also slowed in El Paso, and, more recently, in Houston. The drilling boom… brought tens of thousands of workers to oil fields in several states to run drilling rigs and supply the equipment and services needed to produce crude. Then the price of oil tanked, plummeting by half in late 2014 and reaching levels this year not seen since the financial crisis. Oil companies abandoned drilling projects and began laying off workers.”

December 30 – Bloomberg (Sarah Mulholland): “For commercial real estate investors, the good times may be over. The Federal Reserve’s first interest-rate increase in nine years has removed a crutch that’s helped sustain 33 consecutive months of price growth of at least 10% and padded returns for buildings from office towers to luxury hotels. While values won’t necessarily fall, they aren’t likely to climb much higher next year, according to Tad Philipp, a commercial-property debt analyst at Moody’s… ‘A lot of the smart money is saying it’s a better time to sell than to buy,’ Philipp said… ‘The warning light is on that the rate of appreciation is poised to decelerate.’ It’s a tenuous moment for landlords. Fallout from a protracted slump in oil prices and slowing growth in China are looming as borrowing costs slowly start to climb, threatening to crimp returns.”

China Bubble Watch:

December 31 – Reuters (Engen Tham and Denny Thomas): “Chinese authorities are starting to police the nation's foreign exchange market in a way currency traders have rarely seen before, levying penalty payments for aggressive trading and prompting some banks to turn down business. Reuters reported on Wednesday that China's central bank had suspended at least three foreign banks from conducting some of their foreign exchange business until the end of March. China's past willingness to tolerate some capital flight has paved the way for locals to take billions from the country for funnelling into assets such as French vineyards and luxury properties in the world's leading cities. But with the country's growth at its weakest in 25 years and the currency heading for a record fall this year, China is aiming to stem the capital outflows…”

December 28 – Bloomberg: “China’s banking regulator laid out planned restrictions on thousands of online peer-to-peer lenders, pledging to ‘cleanse the market’ as failed platforms and suspected frauds highlight risks within a booming industry. Online platforms shouldn’t take deposits from the public, pool investors’ money, or guarantee returns, the China Banking Regulatory Commission said…, publishing a draft rule that will be its first for the industry. The thrust of the CBRC’s approach is that the platforms are intermediaries -- matchmakers between borrowers and lenders -- that shouldn’t themselves raise or lend money. It rules out P2P sites distributing wealth-management products, a tactic that some hoped would diversify their revenue sources. ‘The rule is quite strict,’ Shanghai-based Maizi Financial Services, which operates a P2P site and other investment platforms, said in a statement. ‘The industry’s hope of upgrading itself with wealth management products and adopting a diversified business model is completely dashed.’”

December 29 – Washington Post (Simon Denyer): “Careless talk could cost you your job. Especially if you bad-mouth the boss. Chinese President Xi Jinping has carried out the most far-reaching anti-corruption campaign in Communist Party history — and, at the same time, the harshest crackdown on free speech in decades. Now he is tightening the screws further, outlawing internal dissent within the party through new disciplinary rules that have led to the firings of an academic, a newspaper editor and a senior police officer for ‘improper discussion’ of government policy. The purge is an attempt to silence rising dissent within the party, experts say, and is a reflection of Xi’s obsession with control, as well as the dramatic centralization of power he has engineered in the past two years.”

December 28 – Bloomberg: “Chinese corporate defaults will likely spread next year as borrowing costs climb, financial companies surveyed by Bloomberg said. All 22 bond traders, analysts and others surveyed forecast China’s corporate default rate will rise in 2016, while over 70% expect the extra yield on corporate notes to increase. The premium on five-year AA rated company securities over government notes has risen to 175.9 bps after plunging to an eight-year low of 169.2 bps last month. More firms in China are struggling to repay debt amid the worst economic slowdown in a quarter century. The number of listed companies with more debt than equity has jumped to 913 from 705 in 2007… ‘There have been quite a number of bond defaults recently and defaults will become normal in the near future,’ according to a Dec. 24 research note from Hua Chuang Securities Co. written by analysts led by Qu Qing. ‘Investors need to watch out for companies exposed to industries in which the government is trying to cut excess capacity.”

Brazil Watch:

December 31 – Wall Street Journal (John Lyons): “After a year in which the currency crashed, the economy shrank and Congress started impeaching President Dilma Rousseff, many Brazilians are asking: How much worse can it get? ‘It will get worse before it gets worse,’ read a recent newspaper headline. ‘Darkness at the end of the tunnel,” read another. Latin America’s biggest economy is forecast to shrink 2.8% in 2016, after having contracted an estimated 3.7% in 2015. Inflation and joblessness are on the rise.”

EM Bubble Watch:

December 28 – Bloomberg (Mahmoud Habboush): “Saudi Arabia released a more tightfisted budget for 2016, reflecting scaled-back revenue expectations and lower spending on subsidies because of sinking oil prices and its involvement in the war in neighboring Yemen. Here are some key points in the first spending plan under King Salman… The government forecasts the deficit will narrow to 326.2 billion riyals ($87 billion) in 2016, from 367 billion riyals this year. The 2015 deficit is about 16% of gross domestic product, according to Alp Eke, senior economist at National Bank of Abu Dhabi. The median estimate of 10 economists forecast a shortfall of 20% of GDP this year…”

Fixed Income Bubble Watch:

December 28 – Bloomberg (Cordell Eddings): “Wall Street’s biggest dealers are forecasting that blue chip U.S. companies will sell more than $1 trillion of bonds for a fifth straight year in 2016 as corporate America’s borrowing binge endures beyond the end of the Federal Reserve’s zero-rate monetary policy. Bank of America Corp. is predicting $1.22 trillion in issuance. The forecast from Morgan Stanley is $1.05 trillion, Wells Fargo… foresees $1.24 trillion and Barclays Plc anticipates $1.34 trillion. Bond sales by investment-grade companies reached a record $1.31 trillion this year, thanks to an unprecedented $469.8 billion in acquisition-related financing… With $627 billion in mergers expected to close in 2016, analysts like Bank of America’s Hans Mikkelsen expect more issuance is on the way. ‘The pipeline of announced deals with a likely high-grade funding component remains large,’ Mikkelsen, who heads U.S. investment-grade credit strategy at Bank of America, wrote…”

December 28 – Bloomberg (Michelle Davis): “More U.S. companies have defaulted on their debt this year than issuers from any other country or region, S&P analysts led by Diane Vazza wrote… As of last week, 111 companies worldwide had defaulted on their obligations, the highest tally since 2009 when the figure hit 242 for the same period. About 60% of this year’s global defaults have come from U.S. borrowers, Vazza wrote, up from 55% a year ago, when 33 of 60 defaulters were American. After the U.S., companies from emerging markets were the second-largest defaulters, accounting for 23% of the pool… Plummeting oil prices and speculation about how the Federal Reserve’s plan to tighten monetary policy would affect corporate borrowing costs has made companies more vulnerable, Vazza wrote. ‘The current crop of U.S. speculative-grade issuers appears fragile, and particularly susceptible to any sudden, or unanticipated shock,’ she wrote.”

December 30 – Bloomberg (Michelle Kaske and Romy Varghese): “Puerto Rico will default on about $37 million in bond payments due Jan. 1 and divert revenue to make others, escalating a conflict with investors as Governor Alejandro Garcia Padilla seeks to restructure a $70 billion debt burden. The amount is a fraction of the almost $1 billion in interest due at the start of the year. The island will miss payments on $35.9 million of non-commonwealth guaranteed Puerto Rico Infrastructure Financing Authority debt and $1.4 million of Public Finance Corp. bonds. The money is being used to help pay investors who are owned $328.7 million of interest on general-obligation debt.”

Leveraged Speculation Watch:

December 30 – Bloomberg (Filipe Pacheco): “Investors who bet on Brazil’s local bonds this year were saddled with the biggest losses among major economies. The outlook for 2016 isn’t much better. Borrowing dollars at the end of 2014 and buying reais, a practice known as the carry trade, left investors with losses of 22% as Brazil’s currency posted the second-biggest slump in emerging markets amid political turmoil, the country’s worst recession in 25 years and two credit-rating cuts to junk. The loss was almost twice that for traders who bought Mexico’s peso and four times that of the Korean won.”

January 1 – Financial Times (Miles Johnson): “Brevan Howard’s $20bn flagship fund is down for a second year in a row in a further blemish to the trading record of one of the largest hedge funds in Europe. While Brevan Howard’s 0.8% loss for 2015 is small compared with some of its rivals, it inflicts a symbolic wound to a hedge fund that until 2014 had proudly defended its history of having never lost money in a calendar year for its clients. The loss comes as some of the world’s highest profile hedge fund managers have suffered brutal losses over the past 12 months and several large funds have chosen to close down altogether.”

Europe Watch:

December 31 – UK Daily Mail (Gerri Peev): “The influx of more than a million refugees should be welcomed as an 'opportunity', Angela Merkel told Germans last night. The country's leader used her New Year address to urge citizens not to have 'coldness in their hearts' but to embrace the 1.1million newcomers. Mrs Merkel has been blamed for fuelling the European migrant crisis by promising to welcome those who make it to Germany. She was initially praised by Germans for her decision to allow many of those escaping war and poverty to stay. But with the numbers of migrants from the Middle East and Africa reaching more than a million, doubts have grown and her popularity has suffered.”