Saturday, January 16, 2016

Weekly Commentary: Cracks at the Core of the Core

January 15 – Bloomberg (Matthew Boesler): “The U.S. economy should continue to grow faster than its potential this year, supporting further interest-rate increases by the Federal Reserve, New York Fed President William C. Dudley said. ‘In terms of the economic outlook, the situation does not appear to have changed much” since the Fed’s Dec. 15-16 meeting, Dudley said, in remarks prepared for a speech Friday… He added that he continues ‘to expect that the economy will expand at a pace slightly above its long-term trend in 2016,’ and said future rate increases would depend on incoming economic data.”

January 15 – Reuters (Ann Saphir): “The stock market's swoon does not change the economic outlook and is merely market participants trying to make sense of global developments, San Francisco Federal Reserve Bank President John Williams told reporters… ‘As the Fed is moving gradually through a process of normalization it's not surprising that we are not going to be at the peak stock prices’ of last year, Williams said. So far swings in stock market prices have not fundamentally changed his expectation for moderate economic growth, he said.”

The world has changed significantly – perhaps profoundly – over recent weeks. The Shanghai Composite has dropped 17.4% over the past month (Shenzhen down 21%). Hong Kong’s Hang Seng Index was down 8.2% over the past month, with Hang Seng Financials sinking 11.9%. WTI crude is down 26% since December 15th. Over this period, the GSCI Commodities Index sank 12.2%. The Mexican peso has declined almost 7% in a month, the Russian ruble 10% and the South African rand 12%. A Friday headline from the Financial Times: “Emerging market stocks retreat to lowest since 09.”

Trouble at the “Periphery” has definitely taken a troubling turn for the worse. Hope that things were on an uptrend has confronted the reality that things are rapidly getting much worse. This week saw the Shanghai Composite sink 9.0%. Major equities indexes were hit 8.0% in Russia and 5.0% in Brazil (Petrobras down 9%). Financial stocks and levered corporations have been under pressure round the globe. The Russian ruble sank 4.0% this week, increasing y-t-d losses versus the dollar to 7.1%. The Mexican peso declined another 1.8% this week. The Polish zloty slid 2.8% on an S&P downgrade (“Tumbles Most Since 2011”). The South African rand declined 3.0% (down 7.9% y-t-d). The yen added 0.2% this week, increasing 2016 gains to 3.0%. With the yen up almost 4% versus the dollar over the past month, so-called yen “carry trades” are turning increasingly problematic.

Importantly, the past month has seen contagion effects from the collapsing Bubble at the Periphery penetrate the Fragile Core. Japan’s Nikkei 225 index was down 7.6% over the past month. While bubbling securities markets have worked to underpin European economic recovery, now prepare for the downside. The German DAX is off 11% in the first two weeks of 2016, with stocks in Spain and Italy also sporting double-digit declines. France’s CAC 40 has fallen 9.2% y-t-d. And highlighting a key Issue 2016, European bonds have provided little offsetting protection against major equities market losses. So far in 2016, German bund yields are down only eight bps. Yields are little changed in Spain and Italy. Sovereign yields are up 20 bps in Portugal and 130 bps in Greece. European corporate debt has posted small negative returns so far in 2016.

Recent weeks point to decisive cracks at the “Core” of the U.S. financial Bubble. The S&P500 has been hit with an 8.0% two-week decline. Notably, favored stocks and sectors have performed poorly. Indicative of rapidly deteriorating economic prospects, the Dow Transports were down 10.9% to begin 2016. The banks (KBW) sank 12.9%, with the broker/dealers (XBD) down 14.1% y-t-d. The Nasdaq100 (NDX) fell 10%. The Biotechs were down 16.0% in two weeks. The small cap Russell 2000 was hit 11.3%.

Bubbles tend to be varied and complex. In their most basic form, I define a Bubble as a self-reinforcing but inevitably unsustainable inflation. This inflation can be in a wide range of price levels – securities and asset prices, incomes, spending, corporate profits, investment and speculation. Such inflations are always fueled by some type of underlying monetary expansion – typically monetary disorder. Bubbles are always and everywhere a Credit phenomenon, although the underlying source of monetary fuel often goes largely unrecognized.

I’ll posit another key Bubble Dynamic: De-risking/de-leveraging at the Periphery is problematic, with a propensity for risk aversion and associated liquidity constraints to spur contagion effects. At the Core, de-risking/de-leveraging becomes highly destabilizing. Indeed, I would strongly argue that de-leveraging at the “Core of the Core” is tantamount to financial crisis.

It is the “Core of the Core” that now concerns me the most. That is where Federal Reserve (and global central bank) policies have left their greatest mark. It is at the “Core of the Core” where momentous misperceptions and market mispricing have become deeply entrenched. It’s the “Core of the Core” that has attracted enormous amounts of “money” over recent years. It’s also here where I believe leverage has quietly been used most aggressively. Over recent years it became one massive Crowded Trade. Now the sophisticated players must contemplate beating the unsuspecting public to the exits.

I’ll return to “Core of the Core” analysis after a brief diversion to the “Core of the Periphery.” At $275 billion, Chinese Credit growth surged in December to the strongest pace since June. While growth in new bank loans slowed (15% below estimates), equity and bond issuance jumped. China’s total social financing expanded an enormous $2.2 TN in 2015, down slightly from booming 2014. Such rampant Credit growth was (barely) sufficient to sustain China’s economic expansion. At the same time, I would argue that Chinese stocks, global commodities and developing securities markets in particular have been under intense pressure due to rapidly waning confidence in the sustainability of China’s Credit Bubble.

A similar dynamic is now unfolding in U.S. and other “Core” equities markets: Sustainability in the (U.S. and global) Credit Bubble - the monetary fuel underpinning the boom - is suddenly in doubt. The bulls, Fed officials and most others see the economy as basically sound, similar to how most conventional analysts argued about the Chinese economy over the past year. Inherent fragility and unsustainability are the key issues now driving securities markets – in China, in the U.S, and globally. And, importantly, sentiment has shifted to the view that policy tools have been largely depleted.

January 15 – Reuters (Trevor Hunnicutt): “Fund investors continued to sour on U.S. stocks and corporate debt during the weekly period that ended Jan 13, Lipper data showed…, as risk appetite waned in the wake of global market turmoil. U.S.-based stock mutual funds and exchange-traded funds lost $9.0 billion to withdrawals during a week that saw U.S. stocks continue one of their worst starts to a new year… The outflows also included $5 billion pulled from one ETF alone: SPDR S&P 500 ETF… Before last week, ETF investors had been bullish on U.S. stocks, pumping money in for twelve weeks straight… Corporate bond funds suffered too. Investment-grade bond funds, widely held by retail investors, extended to eight straight weeks their streak of outflows after posting $740 million in outflows during the week. The two-month run of outflows now totals $15.4 billion, about 1.8% of the assets those funds held when the trend started…”

January 15 – Barron’s (Chris Dieterich): “Money hemorrhaged from of mutual and exchange-traded funds for the second week in a row, EPFR Global data show… Global investors pulled $12 billion out of U.S equity funds and a combined $4.5 billion from high-yield bond, bank loan and total return funds in the week ended Jan. 23. Emerging-market funds shed cash for the 11th week in a row. Over the past two weeks, some $21 billion has come out of equity funds, still shy of the $36 billion during the August 2015 selloff.”

January 15 – Bloomberg (Aleksandra Gjorgievska and Fion Li): “Exchange-traded funds that hold U.S. junk bonds dropped to their lowest levels since 2009 as the global growth fears that clobbered stock markets also raised doubts about whether companies’ would continue to generate as much cash to pay their debt obligations.”

This week saw the Bank of America Merrill Lynch High Yield Energy Bond Index trade to a record17.43% yield, surpassing the December 2008 high (from Barron’s Amey Stone). “Triple C” bond yields jumped to 18.8%, the high since 2009 (FT’s Joe Rennison). The yield on the Markit iBoxx Liquid High Yield index jumped this week to the highest level since 2012.

Returning to “Core of the Core” analysis, investment-grade corporate debt has rather abruptly joined the market turmoil. After a rocky first week of 2016, investment-grade debt spreads widened again this week to a three-year high, as investment-grade funds suffered their eighth straight week of outflows.

“Triple A” MBS occupied the mortgage finance Bubble’s “Core of the Core”. GSE securities were perceived as “money”-like (“Moneyness of Credit”), with implied backings from the Treasury and Fed seemingly guaranteeing safety and liquidity. Throughout the global government finance Bubble period, I have often invoked the concept “Moneyness of Risk Assets.” With the Federal Reserve and global central banks determined to do just about anything to uphold booming securities markets, the marketplace perceived that safety and liquidity were virtually ensured. Trillions flowed into global stock and bond mutual funds, the majority into perceived low-risk U.S. equities indexes and investment-grade corporate debt products.

It is worth recalling that my tally of Total U.S. Securities (Treasuries, Agencies, Corp Bonds, Munis and Equities) ended Q2 2015 at a record $76.924 TN, or 429% of GDP. This was up $30.90 TN (77%) from 2008’s $46.034 TN (313% of GDP) – and greatly exceeded 2007’s $53.279 TN (368% of GDP).

As securities market inflation inflated Household Net Worth, spending increases bolstered corporate profits and income growth. Booming markets, especially ultra-easy financial conditions throughout the corporate Credit market, spurred stock buybacks and incited record M&A activity. As noted above, Bubbles are self-reinforcing but inevitably unsustainable. Especially with faltering Bubbles at the “Core of the Core,” wealth effects will now operate in reverse. Spending (household and corporate) will slow, with domestic issues joining international to pummel corporate profits. Significant tightening in corporate Credit will weigh heavily on both stock repurchases and M&A. And as economic prospects darken at home and abroad, there will be reinforcing downward pressure on U.S. equities and investment-grade corporate debt.

Back in 2000, Dallas Fed president Robert McTeer suggested that our economy’s ills would be rectified “if everyone would hold hands and buy an SUV.” And for the next 15 years Fed policies did the unimaginable in the name of (indiscriminately) stimulating growth of any kind possible. And if epic mortgage finance Bubble financial and economic maladjustment was not enough, the past seven years have seen the type of financial folly and egregious wealth redistribution that tear societies apart.

The bottom line is that Bubbles destroy and redistribute wealth, though the true effects are masked for a while by inflated securities and asset markets – along with resulting unsustainable spending patterns and economic activity. Regrettably, years of policy mismanagement, gross financial excess, deep structural maladjustment and the most imbalanced economy in our nation’s history will now come home to roost. At this point, I cannot confidently forecast how quickly the bust will unfold. I do, however, believe this process has begun as Bubbles falter at the “Core of the Core.”

For the Week:

The S&P500 (down 8.0% y-t-d) and the Dow (down 8.2%) both fell 2.2%. The Utilities increased 0.6% (up 0.6%). The Banks dropped 4.2% (down 12.9%), and the Broker/Dealers sank 5.1% (down 14.1%). The Transports lost 3.7% (down 10.9%). The S&P 400 Midcaps declined 3.0% (down 9.2%), and the small cap Russell 2000 fell 3.7% (down 11.3%). The Nasdaq100 lost 3.0% (down 9.8%), and the Morgan Stanley High Tech index fell 2.6% (down 9.9%). The Semiconductors were hit 4.4% (down 13.4%). The Biotechs were clobbered 6.8% (down 16%). With bullion down $15, the HUI gold index sank 10.0% (up 4%).

Three-month Treasury bill rates ended the week at 23 bps. Two-year government yields fell nine bps to 0.84% (down 21bps y-t-d). Five-year T-note yields dropped 10 bps to 1.46% (down 29bps). Ten-year Treasury yields declined nine bps to a three-month low 2.03% (down 22bps). Long bond yields fell 12 bps to 2.81% (down 21bps).

Greek 10-year yields jumped 19 bps to 8.62% (up 130 bps y-t-d). Ten-year Portuguese yields rose 13 bps to 2.72% (up 20bps). Italian 10-year yields increased three bps to 1.56% (down 3bps). Spain's 10-year yields gained five bps to 1.75% (down 2bps). German bund yields rose three bps to 0.54% (down 8bps). French yields slipped a basis point at 0.87% (down 12bps). The French to German 10-year bond spread declined four to 33 bps. U.K. 10-year gilt yields sank 11 bps to 1.66% (down 30bps).

Japan's Nikkei equities index sank 3.1% (down 9.9% y-t-d). Japanese 10-year "JGB" yields were unchanged at a record low 0.21% (down 5bps y-t-d). The German DAX equities index dropped 3.1% (down 11.1%). Spain's IBEX 35 equities index sank 4.1% (down 10.5%). Italy's FTSE MIB index fell 2.9% (down 10.4%). EM equities were mostly under pressure. Brazil's Bovespa index was hit 5.0% (down 11%). Mexico's Bolsa rallied 1.4% (down 5.0%). South Korea's Kospi index declined 2.0% (down 4.2%). India’s Sensex equities index fell 1.9% (down 6.4%). China’s Shanghai Exchange sank 9.0% (down 18.0%). Turkey's Borsa Istanbul National 100 index recovered 0.6% (down 0.9%). Russia's MICEX equities index was clobbered 8.0% (down 8.7%).

Junk funds saw outflows jump to $2.1bn (from Lipper). Notably, investment-grade bond funds saw their eighth consecutive week of outflows ($740 million).

Freddie Mac 30-year fixed mortgage rates fell five bps to 3.92% (up 26bps y-o-y). Fifteen-year rates dropped seven bps to 3.19% (up 21bps). One-year ARM rates were unchanged at 2.68% (up 31bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates sinking 15 bps to 3.93% (down 39bps).

Federal Reserve Credit last week expanded $3.8bn to $4.451 TN. Over the past year, Fed Credit declined $11.3bn, or 0.3%. Fed Credit inflated $1.640 TN, or 58%, over the past 166 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week dropped a notable $34.7bn to a nine-month low $3.277 TN. "Custody holdings" were down $23bn y-o-y, or 0.7%.

M2 (narrow) "money" supply declined $16.7bn to $12.330 TN. "Narrow money" expanded $702bn, or 6.0%, over the past year. For the week, Currency increased $3.9bn. Total Checkable Deposits surged $135bn, while Savings Deposits dropped $160bn. Small Time Deposits were unchanged. Retail Money Funds gained $4.0bn.

Total money market fund assets rose $7.9bn to $2.743 TN. Money Funds rose $37bn y-o-y (1.4%).

Total Commercial Paper sank $35.5bn to $1.046 TN. CP expanded $16.2bn y-o-y, or 1.6%.

Currency Watch:

January 13 – Wall Street Journal (Aaron Back): “Chinese savers are scrambling to swap their yuan for dollars. But shouldn’t capital controls stem the tide? Individuals in China are only allowed to convert up to $50,000 a year. In fact, even this narrow channel could open up a major leak. Do the math and the numbers get large rather quickly. China’s urban population in 2014 came to 737 million, according to World Bank estimates. Assume that the wealthiest 1%, who easily have enough savings, convert the maximum allowed amount into dollars this year. That would amount to nearly $370 billion of outflows. If the top 2% of urban individuals do so, it would mean $740 billion of outflows. That is to say nothing of the many other ways to get money out of the country, legal or otherwise.”

January 12 – Wall Street Journal (Anjani Trivedi and Fiona Law): “Beijing escalated the battle for control of its currency, effectively shutting down the offshore market where traders had been betting on a decline in the yuan. Traders said a surge of yuan buying by state-owned banks on Friday and Monday in Hong Kong sent the cost of borrowing yuan overnight soaring past 66% by Tuesday, making it prohibitively expensive for investors to finance bets against the currency, known as a short sale. The move has boosted the currency’s value by as much as 1.8% since Friday against the U.S. dollar. Beijing typically enlists state-owned financial firms to do its bidding and has intervened in the offshore market in the past.”

January 12 – Bloomberg (Kyoungwha Kim and Enda Curran): “An unprecedented surge in the cost of borrowing in yuan in Hong Kong adds to questions about the outlook for the city’s role as the biggest offshore hub for the Chinese currency. The overnight yuan Hong Kong Interbank Offered Rate climbed 53 percentage points to 66.82% on Tuesday -- a side-effect of a campaign by the People’s Bank of China to curb arbitrage between the offshore and onshore rates for the currency. ‘A 66% rate is murderous for others being swept up in this who are not speculating,”said Michael Every, head of financial markets research at Rabobank Group. Central banks ‘usually win a round like this, but lose in the end,’ he added.”

January 14 – Bloomberg: “The Hong Kong dollar sank by the most in more than a decade and speculation mounted in the options market that the city’s 32-year-old currency peg will end as investors lose confidence in Chinese assets. The local dollar dropped as much as 0.28% -- its biggest intra-day loss since October 2003 -- to a four-year low of HK$7.781 versus the U.S. dollar. Options prices indicate there’s a 27% chance the currency will weaken beyond its permitted trading range of HK$7.75-HK$7.85 by the end of this year, up from 9.5% on Dec. 31…”

January 13 – Bloomberg (Candice Zachariahs and Y-Sing Liau): “The South African rand plummeted by the most in more than seven years on Monday and bonds tumbled as market turmoil in China and a drop in U.S. stocks deterred risk-taking. The rand plunged as much as 9%, the most since October 2008, to 17.9169 per dollar, before paring losses.”

The U.S. dollar index added 0.6% this week to 98.95 (up 0.3% y-t-d). For the week on the upside, the Norwegian krone increased 0.5% and the yen 0.2%. For the week on the downside, the South African rand declined 3.0%, the Canadian dollar 2.6%, the Mexican peso 1.8%, the British pound 1.8%, Australia dollar 1.3%, the New Zealand dollar 1.3%, the Swedish krona 1.0%, the Brazilian real 0.6%, the Swiss franc 0.6% and the euro 0.1%. The Chinese yuan increased 0.2% versus the dollar.

Commodities Watch:

January 15 – Reuters: “Top global miner BHP Billiton said on Friday it would book a $7.2 billion writedown on the value of its U.S. shale assets, reflecting a slump in oil and gas prices and a bleak near-term outlook. The hefty impairment is the third spawned by BHP's badly timed push into U.S. shale in 2011, when it spent $20.6 billion, including assumed debt, on two acquisitions at a time when oil and gas prices were much higher than they are now.”

The Goldman Sachs Commodities Index sank 5.5% (down 10.4% y-t-d). Spot Gold gave back 1.4% to $1,089 (up 2.6%). March Silver was little changed at $13.91 (up 0.8%). February WTI Crude was hammered $3.49 to $29.67 (down 20%). February Gasoline sank 8.0% (down 19%), and February Natural Gas lost 15.3% (down 10%). March Copper dropped 3.8% (down 9%). March Wheat declined 1.0% (up 1%). March Corn gained 1.8% (up 1%).

Fixed-Income Bubble Watch:

January 13 – Bloomberg (Fion Li): “The cost to protect against defaults by North American investment-grade companies soared to a three-year high as concern lingered over falling commodity prices and financial-market turmoil triggered by China… The risk premium on the Markit CDX North America Investment Grade Index, which is tied to 125 equally weighted companies, rose five bps to 103.3…”

January 15 – Wall Street Journal (Richard Barley): “Equity markets have been center-stage in 2016, posting steep declines that have rattled investors. Credit markets have seen less spectacular moves—but are still sending signals that aren’t reassuring. Compared with the 9.5% decline for the Stoxx Europe 600 or the 6% drop in the S&P500, corporate-bond returns over the year-to-date look unremarkable. But they are still moving in the wrong direction: U.S. high-yield bonds are down 1.7%..., while their European peers are down 1.5%. U.S. investment-grade bonds have even eked out a small gain—up 0.5%—but that is down to the rally in Treasurys. Investment-grade spreads in both the U.S. and Europe have widened by 0.1 percentage point… Meanwhile, credit ratings are deteriorating at their fastest pace since the 2008-2009 financial crisis, and investment-grade companies have been engaged in financial engineering such as acquisitions and stock buybacks.”

Global Bubble Watch:

January 15 – Financial Times (Gabriel Wildau and Tom Mitchell): “Communist China has one of the world’s highest levels of income inequality, with the richest 1% of households owning a third of the country’s wealth, a report from Peking University has found. The poorest 25% of Chinese households own just 1% of the country’s total wealth, the study found. China’s Gini coefficient for income, a widely used measure of inequality, was 0.49 in 2012, according to the report. The World Bank considers a coefficient above 0.40 to represent severe income inequality. Among the world’s 25 largest countries by population for which the World Bank tracks Gini data, only South Africa and Brazil are higher at 0.63 and 0.53… The figure for the US is 0.41, while Germany is 0.3.”

January 12 – Financial Times (Robin Wigglesworth and Joe Rennison): “Yields on safer government bonds are climbing despite investors dumping equities again, indicating a renewed bout of reserve liquidation by foreign central banks seeking to prop up their currencies. The 10-year yields of US Treasuries, German Bunds and UK Gilts — all popular havens in times of market turmoil — rose on Monday in spite of a wave of risk aversion… ‘It is surprising everyone,’ said Bob Michele, chief investment officer at JPMorgan Asset Management. ‘You would have expected to see Treasury yields much lower in the flight to quality bid … It all leads to the same thing. There is reserve manager selling of Treasuries.’ …Traders and analysts attribute the unexpected market movements to foreign central banks, led by China, selling some of their holdings of safer government bonds and counteracting buying by money managers seeking a refuge from the turbulence, pushing yields higher and prices, which move inversely to yields, lower.”

January 12 – Bloomberg (Katie Linsell): “The outlook for corporate borrowers worldwide is the worst since the global financial crisis, according to Standard & Poor’s. Potential downgrades at the ratings company exceed possible upgrades by the most since 2009… The difference widened the most since the financial crisis in the past six months, S&P said. The corporate-debt outlook has darkened, particularly in Latin America, because of slower growth in China and a commodity rout that’s cut prices to the lowest since at least 1991. Company defaults have already risen to the highest since 2009 and investors are demanding the biggest yield in four years to hold junk bonds. There may be ‘significantly’ more ratings downgrades than upgrades in 2016, S&P analysts led by… Terry Chan wrote… S&P is considering cutting ratings at 17% of the companies it covers, as of December, the report said. That compares with possible upgrades for 6% of issuers. The 11 percentage-point gap is more than double the difference in June 2014, the report said.”

January 12 – Bloomberg (Bradley Olson and Erin Ailworth): “Crude-oil prices plunged more than 5% on Monday to trade near $30 a barrel, making the specter of bankruptcy ever more likely for a significant chunk of the U.S. oil industry. Three major investment banks— Morgan Stanley, Goldman Sachs Group Inc. and Citigroup Inc.—now expect the price of oil to crash through the $30 threshold and into $20 territory in short order… As many as a third of American oil-and-gas producers could tip toward bankruptcy and restructuring by mid-2017, according to Wolfe Research… More than 30 small companies that collectively owe in excess of $13 billion have already filed for bankruptcy protection so far during this downturn, according to law firm Haynes & Boone… Together, North American oil-and-gas producers are losing nearly $2 billion every week at current prices, according to a forthcoming report from AlixPartners, a consulting firm…”

January 14 – Bloomberg (Selcuk Gokoluk): “The number of junk-rated companies that defaulted on debt repayments almost doubled in 2015 and the picture may worsen further this year, according to Moody’s… There were 108 speculative-grade defaults worldwide last year, up from 55 the previous year, Moody’s said... The default rate climbed to 3.4% of issuers for the 12 months ended December, it said.”

January 10 – Financial Times (Jonathan Wheatley): “Policymakers in emerging markets should brace themselves for another round of growth challenges, analysts have warned… ‘The year has started with Chinese volatility and with more doubts about Chinese policy in general, and that puts even more pressure on emerging markets,’ says Maarten-Jan Bakkum, senior emerging market strategist at NN Investment Partners… Many EM companies filled up on cheap foreign currency debt during years of the US’s ultra-loose monetary policies, which have now gone into reverse. Foreign currency debt at EM companies rose from $900bn to $4.4tn in the decade to mid-2015…”

January 14 – Bloomberg (Stephen Stapczynski): “Oil’s collapse has delayed $380 billion worth of investment on 68 major upstream projects, according to industry consultant Wood Mackenzie Ltd. The developments account for about 27 billion barrels of oil equivalent and about 2.9 million barrels a day of production is being deferred to early next decade… Deepwater projects will be hit the hardest and account for more than half of new project deferrals, it said.”

U.S. Bubble Watch:

January 15 – CNBC (Elizabeth MacBride): “As volatility in the stock market grows, a handful of experts are raising an alarm about the rise of index ETFs and mutual funds, which has never accounted for this much of the market before. They warn that the unprecedented amount of index ETFs trading in the market… could magnify, or even cause, flash crashes. In turn, that may put individual investors, who are increasingly invested in index funds, more at risk... From 2007 through 2014, index domestic equity mutual funds and ETFs received $1 trillion in net new cash and reinvested dividends, according to the… Investment Company Institute. In contrast, actively managed domestic equity mutual funds experienced a net outflow of $659 billion… from 2007 to 2014.”

January 14 – Bloomberg (Tracy Alloway): “A handful of dominant stocks were responsible for rescuing the U.S. equities market last year. The ability of Facebook Inc., Inc., Netflix Inc., and Google Inc. (now Alphabet Inc.)—known as ‘FANG’—to continue carrying America’s equities on their collective shoulders has come under intense scrutiny in recent weeks… A similar trend can be seen in the corporate bond market where companies sell their debt, with the average size of new investment-grade bonds reaching $793 million in 2015, up 12% from the prior year and the highest level since at least 2006… The growing weight of larger bond sales (and the expanding hefty of the big investors who snap them up) has some analysts concerned about the market's resiliency in the face of rising defaults.”

January 12 – Bloomberg (Tracy Alloway): “Commercial and industrial lending, the engine of banks' loan book growth in recent years, is showing signs of cracking, thanks to the dramatic fall in the price of oil and weakness in non-consumer-related things. On Tuesday, Deutsche Bank analysts cautioned that losses on C&I portfolios could end up as high as 90 bps in 2016, more than the 20bps loss-rate currently expected by the Wall Street bank, and far more than the 15bps loss rate reported for last year. ‘Credit concerns are rising given continued pressure on oil prices (and commodities more broadly) as well as mixed U.S. economic data. If credit does weaken more than expected, many think it will show up in C&I given strong growth (+57% at large banks since 2010 vs. total loans +30%), loosening of underwriting standards and the risk liquidity declines for certain borrowers,’ Deutsche Bank analysts led by Matt O'Connor said…”

January 13 – Bloomberg (Tracy Alloway): “So far, 2016 has not been a good year for peer-to-peer, or marketplace, lenders. Shares of LendingTree, an online market for mortgages and other loans, were wilting on Wednesday, falling as much as 27.8%... Just yesterday, the company announced it would exceed its previous guidance for the fourth quarter and full year of 2015, with revenue forecast to inch up to $253.5 million, compared with a previous forecast of $252.5 million. LendingTree may be the starkest example of investors taking the air out of the lending industry's collective tires…, but other companies have also fared poorly. On Deck Capital, which specializes in business loans, fell as much as 10.8% on Wednesday. Meanwhile, LendingClub, the country's biggest marketplace lender, declined 5.5%. In fact, specialty finance companies in general have been falling, with the Dow Jones Specialty Finance Index down 2.5% on Wednesday.”

January 11 – CNBC (Tom DiChristopher): “Half of U.S. shale oil producers could go bankrupt before the crude market reaches equilibrium, Fadel Gheit, said… The senior oil and gas analyst at Oppenheimer & Co. said the ‘new normal oil price’ could be 50 to 100% above current levels… Fracking is significantly more expensive than extracting oil from conventional wells. ‘Half of the current producers have no legitimate right to be in a business where the price forecast even in a recovery is going to be between, say, $50, $60. They need $70 oil to survive,’ he told CNBC’s ‘Power Lunch.’”

January 12 – Wall Street Journal (Laura Kusisto): “After six years of rising apartment rents in U.S. cities, investors from all corners of the real-estate industry are piling into new projects in a bet that the boom still has a long way to run. Over the next three years, developers are expected to build almost one million apartments in the U.S., more than the nearly 900,000 constructed over the previous three, according to researcher Axiometrics Inc. In 2014, multifamily rental construction reached 328,000 units, its highest in nearly 30 years, according to… Jed Kolko, a senior fellow at the Terner Center for Housing Innovation at the University of California, Berkeley. The main lure for investors: rising rents. Average rents nationwide rose 4.6% in 2015, the biggest gain since before the recession, according to real-estate researcher Reis Inc. Rents have increased by more than 20% since the beginning of 2010.”

China Bubble Watch:

January 11 – Bloomberg (Luke Kawa): “China has seen nearly $1 trillion in capital leave the nation since the second quarter of 2014, and according to analysts at JPMorgan Chase, the sky's the limit for outflows going forward. The causes of these massive capital outflows, which have prompted the People's Bank of China to tap the country's war chest of reserves to support the currency, have grown more numerous in the second half of 2015, argues a team led by managing director Nikolaos Panigirtzoglou. Amid the broadening of sources of downward pressure on the yuan, however, a major factor that may have restrained the central bank from devaluing the currency in a big way has vanished. ‘The Chinese capital outflow picture appears to have entered a new phase in [the third quarter], broadening to include foreign direct investment and portfolio instruments, something that could make future capital outflows practically boundless,’ writes the JPM team.”

January 11 – Financial Times (Patrick Jenkins): “If the US or Europe had experienced the kind of equity market slump that China has suffered of late, its financial institutions would be quaking and leading the list of biggest fallers in Shanghai and Hong Kong trading… Traditionally China’s large financial institutions are not big stock market players — retail investors make up the bulk of the market. In reality, the banks are the most exposed to China’s ills. They are directly bound up in the stock market turmoil and the government’s efforts to shore up sentiment against the flood of selling. Figures relating to the past week or so are not yet available. But during a similar rout in early July last year, 17 banks… lent more than $200bn to facilitate broker purchases of shares and funds… Like banks in the west before the financial crisis, China’s lenders — with government encouragement — have inflated a vast credit bubble, funding the country’s ambitious companies and fast-expanding property market. Chinese banking assets now amount to more than $30tn. Over the past decade, credit growth has consistently topped 10% a year. (It peaked at close to 35% in 2009.) Even this year, it is expected to be double the 6-7% forecast rate of GDP growth.”

January 11 – Reuters (Li Zheng): “China's banking regulator and the main bond clearinghouse have asked commercial banks to reduce yields offered on their wealth management products, five sources with direct knowledge of the matter told Reuters… Bank wealth management products, which are marketed by banks but often backed by risky third party assets including high interest loans or bonds, continue to offer yields of up to 10% or higher, even though domestic benchmark interest rates and bond yields have fallen sharply over the past year.”

Brazil Watch:

January 15 – Bloomberg (Anna Edgerton, Carla Simoes and Sabrina Valle): “Brazilian President Dilma Rousseff said her administration would be willing to evaluate government assistance to support state oil company Petroleo Brasileiro SA if conditions in the energy market deteriorate. ‘We won’t rule out that it could be necessary to evaluate,’ Rousseff said… ‘It’s not just the Brazilian government that won’t rule it out; no government would rule it out.’ But at a separate event in Rio de Janeiro hours later, Petrobras Chief Financial Officer Ivan Monteiro told reporters that the company isn’t weighing a share sale, nor is it considering asking for any kind of government rescue.”

EM Bubble Watch:

January 13 – Bloomberg (Elena Popina): “Investors pulled more money from emerging markets in the three months through December than ever before as investors dumped riskier assets in China amid concern the country’s currency will weaken further, according to Capital Economics Ltd. Capital outflows from developing nations reached $270 billion last quarter, exceeding withdrawals during the financial crisis of 2008, led by an exodus from China as investors pulled a record $159 billion from the country just in December, Capital Economics’ economist William Jackson said in a report… Outflows from emerging markets rose to a record $113 billion in December, Capital Economics said. Over 2015, investors pulled $770 billion from developing nations, compared with $230 billion a year earlier.”

Leveraged Speculation Watch:

January 13 – Bloomberg (Simone Foxman): “Pershing Square Holdings Ltd., the publicly traded security of Bill Ackman’s activist hedge fund, lost 11.4% this year through Jan. 12… The performance carried Ackman’s losing streak into the new year amid market weakness. The vehicle, which makes wagers on and against stocks, fell 20.5% in 2015…”

Europe Watch:

January 15 – Bloomberg (Rainer Buergin): “The European Union’s Schengen free-movement area might end if the bloc doesn’t increase spending to help stem the inflow of refugees, German Finance Minister Wolfgang Schaeuble said. Schengen is ‘close’ to failing and the EU would face a ‘tremendous, enormous’ threat if Germany was forced to copy measures taken in Sweden to limit the migration of people fleeing war and poverty and reintroduce border controls, Schaeuble told reporters… ‘We can only avoid such a development if we solve the problems quicker, through better and more effective protection of the external borders and through more and more intensive support and cooperation with the regions and the countries in the neighborhood, the region of origin and neighboring regions, so that the flow to Europe clearly declines,’ Schaeuble said. ‘And for that we will need a lot more money.’”

January 14 – Reuters (Balazs Koranyi): “The European Central Bank sees scope for further cuts to its deposit rate after the one announced last month as inflation risks missing the ECB's already lowered forecasts, minutes of the bank's December meeting showed… The euro zone economy is at risk from weakening emerging market growth, sagging demand for its exports and increased geopolitical risks, the ECB said in the minutes of a meeting at which it eased policy less than markets expected.”

Japan Watch:

January 14 – Reuters (Tetsushi Kajimoto): “Japan’s core machinery orders tumbled the most in 18 months in November after solid gains in prior months… The 14.4% fall in core orders, a highly volatile data series regarded as a leading indicator of capital spending in the coming six to nine months, compared with economists' median estimate for a 7.9% month-on-month decline…”

Geopolitical Watch:

January 11 – Wall Street Journal (Andrew Browne): “As Chinese financial markets went berserk last week, Beijing activated a jumbo-sized airstrip it has built among the shipping lanes of the South China Sea by piling sand on top of coral. Whether by accident or design, the arrival of three chartered airliners on Fiery Cross Reef—ahead of the jet fighters that Western security analysts believe China will soon dispatch to the disputed area—was well-timed. For a moment, at least, it deflected attention from the source of the market concern: China’s worsening economy. Photographs of the aircraft stopovers went viral on the Internet. China’s online population lost itself in the patriotic mission to extend China’s strategic reach, which government propagandists managed to dress up as a tropical escapade… Expect more nationalist distractions as China’s economy enters what many experts now believe will be a slow and painful decline. Not all are likely to be so charmingly disguised—or end as uneventfully.”

January 15 – Wall Street Journal (Josh Chin): “Chinese authorities signaled a return to an earlier, more strident era of social control this week by formalizing the arrests of several long-detained human-rights lawyers and activists on suspicion of subversion. The use of subversion, a political crime that carries a possible life sentence, marks a dramatic escalation in the Chinese government’s campaign to choke off sources of potential dissent, activists say. It comes as slowing economic growth threatens to exacerbate social tensions in the world’s most-populous country. Police delivered formal arrest notices to the families of at least 11 lawyers, legal assistants and activists who had been in custody since being rounded up in a nationwide sweep in early July…”