Saturday, July 16, 2016

Weekly Commentary: Scary Time

Just another week of the “new normal”. Celebratory talk of “helicopter money,” a melt-up in stocks, another terrorist attack in France and a coup attempt in Turkey. Let’s start with Japan, with the preface that “Bubbles Go to Unimaginable Extremes – and Then Double!” and “Things Get Crazy Near the End – During ‘Terminal Phase’ Excesses.”

July 12 – Bloomberg (Emi Nobuhiro and Yoshiaki Nohara): “Japanese Prime Minister Shinzo Abe told former Federal Reserve Chairman Ben S. Bernanke at a meeting in Tokyo he wants to speed up the nation’s exit from deflation, underscoring his commitment to implementing fresh economic stimulus. ‘We are only halfway to the exit from deflation,’ Abe said at the start of the meeting… ‘We want to be steadfast in accelerating our breakaway from deflation.’ Abe’s remarks at the meeting, also attended by the Ministry of Finance’s top currency official Masatsugu Asakawa and adviser Koichi Hamada, came before he ordered Economy Minister Nobuteru Ishihara to compile stimulus measures this month.”

As global markets celebrate Japan’s reckless move to further ramp up fiscal and monetary stimulus, it’s important to place things into a little perspective. Japan has been sporadically ramping up stimulus for more than 25 years. Federal government debt to GDP was about 65% back when the Japanese Bubble burst in 1990. Massive fiscal stimulus saw debt to GDP surge to 140% by the end of the nineties. By 2009, ongoing aggressive deficit spending pushed the ratio through 200%.  It's now almost reached 250%.  Meanwhile, expanding $1.0 TN annually, the Bank of Japan’s (BOJ) balance sheet is rapidly approaching 100% of GDP. BOJ assets hovered between 30% and 40% of GDP in the ten-year period through 2012.

Prime Minister Abe must be an eternal optimist if he actually believes Japan is “halfway to the exit from deflation.” The Japanese government this week sharply lowered their fiscal 2017 CPI forecast to 0.4%. After three years of (egregious) “shock and awe” fiscal and monetary stimulus, CPI is now running below the 2013 level. And in the face of massive stimulus, the Japanese economy is forecast to expand less than 1% this year. It’s Scary Time.

Abe seeks “to be steadfast in accelerating our breakaway from deflation.” In reality, Japan is trapped in destructive runaway monetary inflation. And that’s the age old dilemma with inflation: once commenced it becomes almost impossible to rein in. Japan also highlights the problem of discretionary central banking: mistakes are invariably followed with only greater blunders. In Japan and throughout the world, there is today no turning back from the massive inflation in central bank Credit and government borrowings. It may be fallacious, ineffective and frighteningly self-destructive, but there’s no dissuading global central bankers from even more destabilizing monetary inflation and monetization.

Global markets were giddy with anticipation of additional Japanese stimulus. Ben Bernanke traveling to meetings in Japan surely signaled “helicopter money” in the offing. These days I often feel as if I’m living in a different world. I see Dr. Bernanke as the champion of deeply flawed – and failing – inflationist doctrine. It’s just hard to believe at this point that Japanese leadership doesn’t recognize that Bernanke’s experiment is failing and that they should seek guidance elsewhere. And, at this point, it’s remarkable that markets can get excited about yet another round of Japanese stimulus. Squeeze the shorts…

I guess there’s little mystery surrounding market complacency: QE liquefying securities markets indefinitely. To be sure, huge global fiscal deficits support corporate earnings and cash flow. Negative sovereign yields spur flows to risk assets, particularly corporate debt, while historically low corporate yields and ultra-loose Credit Availability stoke share repurchase financial engineering. Reduced debt service costs coupled with diminished share counts inflates earnings per share.

It’s worth nothing that first quarter U.S. stock buybacks jumped to $166.3 billion (from Factset), up 15.1% from Q1 2016. This was the second largest quarter of buybacks ever and the strongest since record Q3 2007 ($178.5bn). Forty-one S&P500 companies had repurchases exceeding $1.0 billion during the period. Stock buybacks have provided key market support in a backdrop of mutual fund outflows. That companies have a penchant for purchasing their shares when the markets come under pressure provides a critical backstop, both from liquidity and market psychology standpoints.

Returning to unfolding Asian train wrecks, Japan and China are increasingly open adversaries yet they do share a common hope for inflating out of debt problems. From financial, economic and geopolitical points of view, it’s alarming to watch both Chinese and Japanese finance in full self-destruction mode.

From Friday’s Wall Street Journal headline: “Massive Stimulus Keeps China GDP Steady in Second Quarter.” At 6.7% (beats estimates!), China’s economy appears relatively stable. Industrial production increased 6.8%. Retail sales were up 10.6% from a year ago. Government fixed asset investment rose 23.5% during the first half, largely offsetting the ongoing drop in private investment.

Chinese finance is anything but stable, with its unwieldy Credit boom running hot in June. Beating forecasts by about 60%, Total Social Financing expanded $244 billion for the month. This was up from May’s $102 billion to the strongest pace of system Credit expansion since a huge March ($370bn). A strong June put first-half Chinese Credit growth at about $1.5 TN, a sufficient sum to sustain the Bubble. Credit expanded at an almost 15% annualized rate during the first half, more than double the stated pace of economic expansion.

It’s worth noting that June’s big Credit push was primarily in bank lending. Bank loans surged $206 billion during the month, more than double May and almost equal to March’s lending bonanza. A resurgent real estate Bubble now drives bank lending. According to Bloomberg, June new home (apartment) sales were up 22% y-o-y to $150 billion. And from the WSJ: “Property sales in 2016 have jumped by up to 50% year on year in top markets.” “Terminal Phase”…

July 15 – Reuters: “Government spending in China jumped 19.9% in June from a year earlier, while revenue rose 1.7%, the Ministry of Finance said… Government spending in the first half of the year was up 15.1% from a year ago, while revenues rose 7.1%.”

Both Chinese and Japanese policymakers had intended to rein in financial excess. The Chinese government moved to (too cautiously) reign in Credit growth. The Japanese government had pronounced their plan to impose fiscal restrain in what was sold (in 2012/13) as a temporary boost in deficit spending. Both have inflated major Bubbles and both have now clearly capitulated: massive and persistent monetary inflation as far as the eye can see, and global securities markets are overjoyed.

That Abe and Kuroda essentially see no constraints on deficits and monetization hammered the Japanese currency. For the week, the yen dropped 4.3%, the “Biggest Weekly Drop Since 1999”. Stocks took flight. The Nikkei 225 index jumped 9.2%, amazing yet not even close to keeping up with the TOPIX Banks Index that surged a remarkable 17.7%.

Stimulus developments in Japan and a sinking yen provided a powerful boost to global “risk on.” A worldwide short squeeze was especially conspicuous in Europe. Italian banks jumped 10.9%, while Europe’s STOXX 600 bank index surged 6.7%. Major equities indexes rallied 4.5% in Germany, 4.3% in France and 4.2% in Spain and Italy.

Rallying global equities stoked an already powerful short squeeze in the U.S. market. The banks (BKX) surged 4.3%, the broker/dealers (XBD) 4.0% and the Transports 3.9%. The S&P500 gained 1.5% to a new record high.

The currency market remains acutely unstable. The British pound rallied 1.8% this week. Most EM currencies posted gains, except for the late Friday sell-off that left the Turkish lira down 4.3% for the week.

Watching an unfolding coup and attendant chaos live on television is a writing distraction, to say the least. Turkey, a country of 80 million and NATO ally, is at the epicenter of geopolitical dynamite. At this writing, the coup appears to have failed. Yet Friday’s developments will surely exacerbate instability that has been festering badly for some time. The Erdogan government will turn only more autocratic, and a highly polarized society will become only more fractured. Coming just a few weeks after Brexit, mayhem in Turkey is yet another troubling reminder of the rapidity and extent of geopolitical deterioration on a global basis.

Turkey is also today emblematic of the wide chasm that has developed between inflating securities markets and deflating economic prospects. Turkish stocks have been among the top performing markets globally, ending the week with 15.5% y-t-d gains. Running large current account deficits (4.5% of GDP) and having accumulated significant international debt (much denominated in U.S. dollars), Turkey has been on my list of countries at high risk of financial and economic crisis. The country is now on the downside of what was a significant Credit boom, which surely helps explain at least of some of the increasingly problematic social tension and political instability.


For the Week:

The S&P500 gained 1.5% (up 5.8% y-t-d), and the Dow rose 2.0% (up 6.3%). The Utilities declined 1.0% (up 20.5%). The Banks surged 4.3% (down 8.0%), and the Broker/Dealers jumped 4.0% (down 10.8%). The Transports rose 3.9% (up 6.3%). The S&P 400 Midcaps increased 1.5% (up 10.4%), and the small cap Russell 2000 jumped 2.4% (up 6.1%). The Nasdaq100 increased 1.4% (unchanged), and the Morgan Stanley High Tech index gained 2.0% (up 1.9%). The Semiconductors surged 3.2% (up 9.1%). The Biotechs were little changed (down 17%). With bullion declining $29, the HUI gold index was down 1.4% (up 141%).

Three-month Treasury bill rates ended the week at 30 bps. Two-year government yields increased six bps to 0.67% (down 38bps y-t-d). Five-year T-note yields jumped 15 bps to 1.10% (down 65bps). Ten-year Treasury yields surged 19 bps to 1.55% (down 70bps). Long bond yields rose 17 bps to 2.27% (down 75bps).

Greek 10-year yields declined 12 bps to 7.64% (up 32bps y-t-d). Ten-year Portuguese yields rose five bps to 3.10% (up 58bps). Italian 10-year yields gained six bps to 1.25% (down 34bps). Spain's 10-year yields gained eight bps to 1.22% (down 55bps). German bund yields jumped 19 bps to 0.00% (down 62bps). French yields rose 13 bps to 0.23% (down 76bps). The French to German 10-year bond spread narrowed six bps to 23 bps. U.K. 10-year gilt yields increased 10 bps to 0.83% (down 113bps). U.K.'s FTSE equities index gained 1.2% (up 6.8%).

Japan's Nikkei equities index surged 9.2% (down 13.3% y-t-d). Japanese 10-year "JGB" yields rose five bps to 0.24% (down 50bps y-t-d). The German DAX equities index surged 4.5% (down 6.3%). Spain's IBEX 35 equities index rose 4.2% (down 10.6%). Italy's FTSE MIB index jumped 4.2% (down 21.8%). EM equities were higher. Brazil's Bovespa index surged 4.6% (up 28.2%). Mexico's Bolsa gained 2.1% (up 8.7%). South Korea's Kospi index jumped 2.8% (up 2.9%). India’s Sensex equities index advanced 2.6% (up 6.6%). China’s Shanghai Exchange gained 2.2% (down 13.7%). Turkey's Borsa Istanbul National 100 index surged 6.2% (up 15.5%). Russia's MICEX equities gained 2.5% (up 10.2%).

Junk bond mutual funds saw inflows of $1.8 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates added a basis point to 3.42% (down 67bps y-o-y). Fifteen-year rates declined two bps to 2.72% (down 54bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 3.67% (down 50bps).

Federal Reserve Credit last week expanded $1.8bn to $4.432 TN. Over the past year, Fed Credit declined $17.5bn. Fed Credit inflated $1.621 TN, or 58%, over the past 192 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $7.1bn last week to $3.222 TN. "Custody holdings" were down $122bn y-o-y, or 3.7%.

M2 (narrow) "money" supply last week dropped $27bn to $12.822 TN. "Narrow money" expanded $800bn, or 6.7%, over the past year. For the week, Currency was little changed. Total Checkable Deposits jumped $23.2bn, while Savings Deposits dropped $51bn. Small Time Deposits gained $1.7bn. Retail Money Funds slipped $0.9bn.

Total money market fund assets rose $19.5bn to $2.720 TN. Money Funds rose $88bn y-o-y (3.3%).

Total Commercial Paper gained $8.1bn to $1.048 TN. CP expanded $19.4bn y-o-y, or 1.9%.

Currency Watch:

The U.S. dollar index gained 0.4% to 96.68 (down 2.0% y-t-d). For the week on the upside, the British pound increased 1.8%, the Brazilian real 0.6%, the Canadian dollar 0.5%, the Norwegian krone 0.5%, the Swiss franc 0.1% and the Australian dollar 0.1%. For the week on the downside, the Japanese yen declined 4.3%, the New Zealand dollar 2.6%, the Mexican peso 0.5%, the South African rand 0.2%, the euro 0.2% and the Swedish krona 0.1%. The Chinese yuan traded unchanged versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index increased 0.9% (up 15.9% y-t-d). Spot Gold declined 2.1% to $1,337 (up 26%). Silver slipped 0.2% to $20.30 (up 47%). WTI Crude increased 54 cents to $45.95 (up 24%). Gasoline jumped 3.7% (up 12%), while Natural Gas fell 2.1% (up 18%). Copper rallied 5.4% (up 5%). Wheat declined 2.4% (down 10%). Corn slipped 0.8% (down 2%).

Europe Watch:

July 12 – Wall Street Journal (Paul J. Davies): “Brussels is caught in a game of chicken with the Italian banking system and both sides are wrestling with highly unpredictable outcomes. Italy wants to use public money to shore up its weakest banks and help them all to keep lending. But since the financial crisis, regulators have fought to ensure banks are no longer too big to fail and have made it all but impossible to use taxpayers’ money. In the middle of this standoff is Banca Monte dei Paschi di Siena, Italy’s third-biggest bank by assets, which has the highest ratio of bad loans to total loans and the lowest valued shares. This has come to a head because stress tests at the end of July are likely to further expose Italian capital needs. And right now, no private investors seem willing to invest.”

July 13 – Reuters (Francesco Canepa): “Stressed euro zone governments swayed domestic banks to buy their bonds when the debt crisis was at its height, using ‘moral suasion’ to counter surging borrowing costs, a research paper published by the ECB showed… Domestic banks have traditionally been buyers of a significant proportion of the debt issued by governments in the currency bloc. But the study of the purchasing patterns of 60 banks in Greece, Ireland, Italy, Portugal and Spain between 2010-12 showed that, in months when their governments needed to issue or roll over a large amount of paper, they were even more likely than usual to buy than their foreign peers. ‘Our estimates thus strongly and consistently suggest that collusion between banks and sovereigns (or 'moral suasion') took place during the sovereign debt crisis,’ authors Steven Ongena, Alexander Popov and Neeltje Van Horen wrote…”

Brexit Watch:

July 14 – Bloomberg (Jill Ward, Scott Hamilton and Lucy Meakin): “Mark Carney looks poised to repeat a strategy that served him well during the global financial crisis. As the Bank of England governor seeks to stave off any turmoil after Britain’s decision to quit the European Union, he has cited his experience at Canada’s central bank in 2008 as a guide. Acting early to prevent a deeper downturn became the hallmark of his approach in the prelude to the international slump… ‘One thing Carney is very good at doing is jumping ahead of the curve,’ said James Rossiter, an economist at TD Securities in London and a former official at the both the British and Canadian central banks. ‘As governor of the Bank of Canada, he was cutting rates dramatically before Lehman went bust. To have that sort of foresight, to know this was going to be a bigger issue than perhaps the markets were appreciating, and to go forth on a clear easing strategy, is something that we could see him repeating.’”

July 13 – Reuters (Freya Berry and Pamela Barbaglia): “Britain's vote to leave the European Union has put private equity firms on the back foot, forcing them to stall some planned deals, reconsider fundraising strategies and possibly move staff to centers that will remain in the bloc. The referendum result… is making institutional investors have second thoughts about committing to new funds for private equity (PE) deals in Britain... Many deals which have been in the works for months are now hanging in the balance. ‘We've had all the stages of grief. People wasted entire days just talking about it (Brexit),’ said one London-based private equity banker. ‘Now we're basically ignoring any UK deals because no one wants to invest in the UK.’”

July 12 – Financial Times (Judith Evans and Attracta Mooney): “Henderson Global Investors plans to sell 440 Strand, the headquarters of the private bank Coutts, by the end of 2016 as suspended property funds begin offloading prime assets to provide liquidity to investors. The property, bought for £175m in 2014, was valued at £220m before the Brexit vote and will be formally brought on to the market in the autumn by the suspended Henderson UK Property fund… The sale of 440 Strand is one of a number of disposals expected to follow the suspensions of seven property funds last week after investors rushed for the exit following the UK’s vote to leave the EU.”

July 14 – Bloomberg (Scott Hamilton): “A measure of London home-price changes fell to its weakest since the financial crisis as the U.K.’s vote to leave the European Union sent shock waves across the nation. The index by the Royal Institution of Chartered Surveyors dropped to minus 46 in June from minus 35 the previous month, showing that more real-estate agents are recording lower prices in the capital than higher ones. The reading was the weakest since early 2009… A separate report from Acadata Ltd. and LSL Property Services Plc showed home values in the capital were already being hurt ahead of the vote…”

Italy Watch:

July 12 – Reuters (Gavin Jones): “Italy's economy will grow by less than 1% this year and only marginally faster in 2017, the International Monetary Fund said…, cutting its previous forecast... The outcome of last month's referendum in Britain has heightened volatility on financial markets and increased downside risks for Italy, the Fund said in a report following its annual Article IV meetings with the Italian authorities. The euro zone's third-largest economy is now seen growing at ‘just under 1% in 2016 and at about 1% in 2017’… Only in around 2025 will Italian output return to its 2008 peak before the global financial crisis, it said… ‘The authorities thus face a monumental challenge. The recovery needs to be strengthened to reduce high unemployment faster and buffers need to be built, including by repairing strained bank balance sheets and decisively lowering the very high public debt,’ the report said.”

July 11 – Financial Times (Jim Brunsden, James Politi and Dan McCrum): “Italy has been warned it must abide by ‘strict’ EU rules for rescuing teetering lenders, limiting Rome’s ability to pump public money into the country’s financial sector. Jeroen Dijsselbloem, head of the eurozone’s committee of 19 finance ministers, said… that any Italian plan would have to respect EU rules that force losses on creditors before they can be bailed out with taxpayer funds. The EU rules are ‘very clear’ on when creditors should face compulsory losses, known as bail-ins, Mr Dijsselbloem said… ‘The only thing that to me is very important is that we respect what we have agreed between us, because otherwise everything will be questioned in Europe,’ said Mr Dijsselbloem, the Dutch finance minister.”

July 13 – Bloomberg (Katie Linsell and Tom Beardsworth): “Credit traders are buying more protection on Banca Monte dei Paschi di Siena SpA debt amid concern that a potential rescue plan for Italian lenders will lead to losses for bondholders. Credit-default swaps covering a gross $95 million of Monte Paschi debt changed hands in the week ended July 8, more than seven times the average in the previous four weeks… Prices on Wednesday signal a 56% probability of default on junior bonds in five years…”

Central Bank Watch:

July 14 – Bloomberg (Mark Gilbert): “The bond market is telling us that Milton Friedman's 1969 thought experiment -- freshly-created money appearing in people's bank accounts, known as helicopter money -- may be closer than we think. Almost $10 trillion of the world's bonds now yields less than zero, of which more than $6 trillion is Japanese debt. According to the Sankei newspaper on Tuesday, Japanese Prime Minister Shinzo Abe was recently told by adviser Etsuro Honda that ‘now is the time to introduce helicopter money,’ while special adviser Koichi Hamada said it should be restricted to a one-time event. ‘Wo ist der Hubschrauber?’ the economist Russell Napier asked recently, alluding to whether the… European Central Bank would soon resort to helicopter money.”

Fixed-Income Bubble Watch:

July 12 – Bloomberg (John Gittelsohn): “Investors who rushed into bonds last week will face a hard time making money as the market finds a bottom and rates begin to rebound, according to Jeffrey Gundlach, chief executive officer of DoubleLine Capital. ‘There’s something of a mass psychosis going on related to the so-called starvation for yield,’ Gundlach… said… ‘Call me old-fashioned, but I don’t like investments where if you’re right you don’t make any money.’”

July 12 – CNBC (Jeff Cox): “The reason anyone would buy negative-yielding debt is actually pretty simple: Because they have to. They are central bankers looking to help promote economic growth. They are insurance companies, pension funds and money managers who have to match liabilities with assets… Together, those buyers have helped build a nearly $12 trillion funnel of negative-yielding sovereign debt — unprecedented in world history. Ostensibly, the global race to the bottom was supposed to stimulate growth, and it may just well keep pushing risk assets higher. But what awaits on the other side is adding to the worries of investing professionals. ‘Ultimately, there will be a day of reckoning,’ said Erik Weisman, chief economist at MFS Investment Management. ‘When that will be remains very much to be seen.’”

July 12 – Wall Street Journal (Kevin Kingsbury and Matt Jarzemsky): “U.S. stocks might be setting record highs, but all isn’t well with the health of American companies. The trailing 12-month junk-bond default rate hit a 6-year high in June at 4.9%, says Fitch Ratings, highlighting the ongoing pain from the oil patch. Energy companies defaulted on $28.8 billion of debt the first half of this year, Fitch calculates, putting the sector’s default rate at 15%. For exploration and production, the rate is 29%.”

Global Bubble Watch:

July 14 – Bloomberg (Sridhar Natarajan and Sabrina Willmer): “The big rally in stocks and bonds has some of the world’s top money managers putting up warning signs. Laurence D. Fink and Howard Marks joined the likes of Bill Gross and Jeffrey Gundlach cautioning that buyers may be ignoring sluggish economic growth and Britain’s departure from the European Union as they look to put their money somewhere, anywhere, amid low interest rates… A run-up in global stocks has added more than $4 trillion to the value of equities worldwide since June 27 on speculation central banks in major economies will boost stimulus. It’s been a swift turnaround from the doom-and-gloom surrounding global equities on June 24, the day after the British vote, when stocks lost $2.5 trillion in market value.”

July 8 – Wall Street Journal (Anooja Debnath): “A seventh straight week of gains in German bunds has pushed yields on securities of all maturities to unprecedented lows -- leaving about $801 billion of debt out of the reach of the European Central Bank. The surge in sovereign debt since Britain’s vote to exit the European Union last month has pushed yields on about 70% of the securities in the $1.1-trillion Bloomberg Germany Sovereign Bond Index below the ECB’s minus 0.4% deposit rate, making them ineligible for the institution’s quantitative-easing program. For the euro area as a whole, the total rises to almost $2 trillion.”

July 10 – Wall Street Journal (Christopher Whittall and Sam Goldfarb): “The free fall in yields on developed-world government debt is dragging down rates on global bonds broadly, from sovereign debt in Taiwan and Lithuania to corporate bonds in the U.S., as investors fan out further in search of income. The ever-widening rush for yield could create problems if interest rates snap back, which would cause losses on investors’ low-yielding portfolios, or if credit quality falls. And the global yield grab is raising questions about whether rates can prove reliable economic indicators… ‘What we are seeing is a mechanical yield grab taking place in global bonds,’ said Jack Kelly, an investment director at Standard Life Investments. ‘The pace of that yield grab accelerates as more bond markets move into negative yields and investors search for a smaller pool of substitutes.’”

July 15 – Financial Times (Rochelle Toplensky): “Yield-hungry investors buoyed by the prospects of further monetary easing have invested $124bn in bond exchange traded funds globally this year… ‘EPFR Global-tracked Bond Funds took in over $9bn for the second week running as investors responded to predictions of a rate hike-free remainder of 2016 in the US and fresh monetary tailwinds for emerging markets,’ said EPFR.”

July 12 – Financial Times (Jamie Chisholm): “It’s been called the most hated bull market in history but it hasn’t stopped Wall Street this week hitting a new record. Many investors can’t reconcile above historical average equity valuations with the sour message about economic health sent by record low bond yields. Hedge funds in particular have struggled to enjoy the rally. Why? Adam Parker, chief US equity strategist at Morgan Stanley, cites a number of excuses… It is supposedly harder to make money when the market is overcrowded and Mr Parker notes there are now about 3,400 equity-focused hedge funds… Second, ‘low interest rates have removed the rebate that hedge funds received, a non-trivial driver of historical returns when rates were materially higher’. Greater regulatory oversight is making hedgies more wary of using information they have come across… The sector is also suffering from too much ‘groupthink’…”

July 12 – Bloomberg (Andrea Tan): “MSCI Inc. isn’t usually a name that springs to mind when one thinks of the most powerful players in the global equity market… Yet thanks to the surging popularity of passive investing, MSCI and a handful of its rivals -- including FTSE Russell and S&P Dow Jones Indices -- are quietly replacing the giants of money management as the most important arbiters of where the world’s stock investments flow. The average proportion of equity funds in the U.S., Europe and Asia that mimic index providers’ security and country allocation decisions has doubled over the past eight years to about 33%, according to Morningstar…”

July 10 – Bloomberg: “Global cross-border investment may decline by as much as 15% this year as trade remains sluggish, China’s commerce minister said after a Group of 20 trade ministers meeting Sunday. The G-20 representatives pledged to increase their efforts to facilitate trade and urged other World Trade Organization member nations to do likewise to enable global commerce, Gao Hucheng said at Sunday’s briefing. The ministers had met in China’s financial capital for two days of talks on how to boost investment cooperation before heads of state convene for a Sept. 4-5 leaders summit in the eastern city of Hangzhou.”

U.S. Bubble Watch:

July 12 – Wall Street Journal (Corrie Driebusch and Ben Eisen): “Records reached this week by major U.S. stock indexes underscore the power of a popular but controversial tool: the corporate share buyback… Among the most prominent drivers of the 2016 stock rally has been companies’ willingness to buy back shares. The strategy has been embraced by firms and outside investors alike, because it drives up share prices and improves per-share earnings by reducing the number of shares outstanding. Some investors decry buybacks as financial engineering. Shares outstanding in the S&P 500 have fallen this year from year-earlier levels, on track for the first yearly decline since 2011, according to S&P Dow Jones Indices. Companies in the S&P 500 bought back $161.39 billion of shares during the first three months of the year, the second-biggest quarter for repurchases ever.”

July 12 – Bloomberg (Oliver Renick and Bailey Lipschultz): “The rally that just thrust the S&P 500 Index above a record that stood for 13 months is being fueled by companies Wall Street likes least. Utilities, consumer-staples shares and phone stocks are surging as much as four times faster in 2016 than the S&P 500 as a whole. With valuations approaching records, the groups rank among the most-hated stocks with analysts… It’s another example of the circuitous route stocks have taken to scale the wall of worry and power to their first all-time high since 2015. The rush into equities whose prospects are least-tied to the economic cycle has swollen valuations in industries that are normally sought out for safety. While fueling an 18% rebound in American shares since February, it’s an anomaly that some worry will leave investors with few options should markets turn.”

July 13 – CNBC (Jeff Cox): “So much for 2016 being the year of the stock picker. In fact, this has been the year investors wanted to do anything but try to pick stocks. Active fund managers had their worst first half ever, with fewer than one in five beating a basic market benchmark, according to… Bank of America Merrill Lynch that go back to 2003. Stock pickers were done in by two major factors: following the crowd and an uneven pattern of correlations among stocks. The 10 most-crowded stocks lagged the 10 least-owned by a whopping 18 percentage points, which BofAML called ‘an atypically high spread.’ …The active fund industry has been fighting to stave off a market trend where dollars have been flowing heavily into passive funds that track indexes rather than rely on individual stock picks. The $3 trillion global exchange-traded fund space took in $24.5 billion in June alone, part of a pattern that has seen $117.9 billion in inflows for 2016… That is behind trend compared with 2015, though ahead of the $13.2 trillion mutual fund industry, which saw outflows of $46.9 trillion in the first five months of the year… Overall, just 18% of large-cap fund managers have beaten the Russell 1000 benchmark for 2016… The best year for active was 2007, in which 61% outperformed; the total was 41.3% in 2015.”

July 12 – Bloomberg (Emma Orr): “U.S. high-yield bonds in default reached the highest levels in at least six years as more energy companies buckled under pressure from stagnant oil prices. Speculative-grade U.S. defaults spiked to 5.1% of the total outstanding in the second quarter from 4.4% in the first, according to a July 12 report from Moody’s... The global high-yield default rate could finish the year at 4.9%, with the U.S. as much as 6.4%, Moody’s said. Missed payments on high-yield or speculative bonds are already near levels that prevailed in 2009 and 2010, according to analysts at Moody’s and Fitch…, who are forecasting defaults will get worse before they get better next year. At $50.2 billion, U.S. high-yield defaults have already surpassed the $48.3 billion total for all of 2015, and they’re on course to reach as much as $90 billion by year-end…”

July 12 – Wall Street Journal (Nick Timiraos): “The Congressional Budget Office’s annual snapshot of long-term federal spending and revenue shows the national debt remains on a firmly upward trajectory, but its rate of acceleration remains increasingly uncertain owing to lower interest rates and slower economic growth. Tuesday’s report shows the federal debt, which has doubled since 2008 to about 75% of gross domestic product, will rise to 122% in 2040, up from an estimate of 107% last year, eclipsing the historical peak set after World War II…”

July 11 – Financial Times (Alistair Gray): “A top US regulator has sounded a new alert over banks’ commercial real estate lending, adding to concerns that bubbles may be forming in parts of the country’s property market. Thomas Curry, comptroller of the currency, used the watchdog’s twice-yearly report on financial risks… to warn about looser underwriting standards and concentrations in banks’ CRE portfolios. The remarks come after his office, together with regulators at the Federal Reserve and the Federal Deposit Insurance Corporation, said last year they would ‘pay special attention’ to banks’ commercial property lending. Yet banks have continued to expand in the area, helping to fund development of shopping centres, apartment blocks and other commercial projects. CRE loans originated by banks in the first quarter leapt by 44% from the same period in 2015… Banks’ share of CRE originations has risen from just over a third in 2014 to more than half in the first quarter of 2016 — a record.”

July 12 – Wall Street Journal (Andrew Ackerman): “A U.S. banking regulator warned about growing credit risk in the auto-lending sector, raising the prospect of fresh regulatory pressure in the area. The Office of the Comptroller of the Currency, which supervises large national banks including many of the largest banking firms in the U.S., highlighted the risks in its twice-annual report Monday. The OCC said auto-lending risk is increasing ‘because of notable and unprecedented growth’ across all types of lenders. ‘As banks have competed for market share, some banks have responded with less stringent underwriting standards,’ the report said.”

July 12 – New York Times (Michelle Higgens): “New York City’s ultraluxury real estate frenzy — with its sky-piercing condominium towers and $100 million price tags — has finally come to an end. Even with every conceivable amenity, the eight- and nine-digit prices attached to trophy homes with helicopter views and high-end finishes never bore much relation to actual value. Rather, a class of superrich investors primarily drove the market, choosing high-priced real estate as their asset of choice, because it was less volatile than other investments and they could use shell companies to hide their identities. But today a four-year construction boom aimed at buyers willing to spend $10 million or more has flooded the top of the market just as global market turmoil has caused wealthy investors to pull back and the federal government has moved to scrutinize some all-cash transactions.”

July 14 – Bloomberg (Michelle Jamrisko): “Almost nine years after the housing-market bust helped trigger the most recent recession, RealtyTrac senior vice president Daren Blomquist sees the industry waving a red flag. The same fervent speculation that abetted the housing bubble is showing up in the bloated share of foreclosures snapped up by third-party investors at auction — a record 31% in June, according to RealtyTrac… Many of those third-party buyers are ‘mom and pop’ investors with less experience, said Blomquist. At the same time, institutional investors, a subset of the third-party investors who purchase at least 10 properties a year, are ducking out of the market.”

China Bubble Watch:

July 12 – Wall Street Journal (Paul J. Davies): “When China let Dongbei Special Steel Group default on a bond payment this spring, it was supposed to mark a new determination to allow long-coddled state industries to suffer the consequences of their bad decisions. Three months later, the result has been…nothing. The ailing steel mill has missed five more payments on its $6 billion in debt, but has yet to formally file for the equivalent of bankruptcy protection, close unproductive units or start a restructuring of its operations. In more-mature economies, defaults usually usher in wrenching change, including boardroom purges and asset sales. But China’s nascent efficiency drive already has been forced to take a back seat to short-term concerns about growth and employment. As a result, China’s twin problems of overcapacity and souring debts at state-run companies are likely to drag on for years, holding back growth and keeping the country awash in unwanted goods.”

July 13 – Bloomberg (Enda Curran): “China releases trade figures…, and a steep rise in… imports from Hong Kong has raised concerns that trade invoices are being manipulated to get capital out of the country amid fears the yuan will continue to weaken. May’s imports from Hong Kong surged a record 243% from a year ago, while overall imports have been falling.”

Japan Watch:

July 13 – Bloomberg (Enda Curran): “Ben S. Bernanke earned the nickname ‘Helicopter Ben’ for once suggesting a central bank could overcome deflation by cranking up the money presses to finance tax cuts. He’s always made clear such efforts would be a last resort… So when the former Federal Reserve chairman arrived in Tokyo for talks with Japan’s top policy makers this week, bond traders, stock investors and economists had reason to wonder. Was Shinzo Abe’s economic team ready to break the glass, pull the emergency lever and entertain such a radical shift in policy as direct fiscal financing by the central bank. While officials… played down the most extreme scenario, two of Abe’s top advisers did call for a double-barreled blitz of coordinated fiscal stimulus and money printing. The prospect of a new chapter in Japan’s stimulus history is all the more likely after the thumping political win Abe’s Liberal Democratic Party pulled off in the just-held upper house election. Abe enjoys wide majorities in both chambers of the Diet and unrivaled power in Japanese politics, at least for the moment.”

July 14 – Bloomberg (Toru Fujioka and Keiko Ujikane): “Ben S. Bernanke, who met Japanese leaders in Tokyo this week, had floated the idea of perpetual bonds during earlier discussions in Washington with one of Prime Minister Shinzo Abe’s key advisers. Etsuro Honda, who has emerged as a matchmaker for Abe in corralling foreign economic experts to offer policy guidance, said that during an hour-long discussion with Bernanke in April the former Federal Reserve chief warned there was a risk Japan at any time could return to deflation. He noted that helicopter money -- in which the government issues non-marketable perpetual bonds with no maturity date and the Bank of Japan directly buys them -- could work as the strongest tool to overcome deflation, according to Honda. Bernanke noted it was an option, he said.”

July 14 – Bloomberg (Andy Sharp): “The Japanese population of Japan, the world’s fastest-aging major nation, fell the most on record as the number of deaths outweighed those born in the country. The number of Japanese living in the country fell for a seventh straight year, down by 271,834 to 125.9 million people as of Jan 1…"

EM Watch:

July 14 – Reuters (Sujata Rao): “Emerging economies will see net capital outflows of around $350 billion this year, half of 2015 levels, the Institute of International Finance said…, cutting its early-2016 forecast of a $448 billion exodus. The IIF, one of the most authoritative trackers of capital flows to and from the developing world, noted emerging markets had been pummelled in early-2016 but have since seen a sustained recovery in portfolio investment. ‘The turnaround has been driven by a renewed search for yield in the face of the sharp decline in rates in mature markets fed by expectations of ever more dovish central banks,’ the IIF said.”

Leveraged Speculator Watch:

July 12 – Bloomberg (Hema Parmar): “Running an underperforming hedge fund? Your clients are noticing. Eighty-four percent of investors in hedge funds pulled money in the first half of the year, and 61% said they will probably make withdrawals later this year, according to a Credit Suisse Group AG study… The main driver among those who redeemed: their fund underperformed. The survey, which polled more than 200 allocators with almost $700 billion invested in hedge funds, found that most were redirecting their money to other managers, rather than exiting the asset class altogether. Only 9% said they weren’t planning to reinvest the money they pulled in other hedge funds.”

Geopolitical Watch:

July 12 – CNBC (Huileng Tan): “Having already wound the populace up to fever pitch with a barrage of nationalist propaganda, China was expected to pull out the rhetorical big guns when it reacted to The Hague's decision on rights to the South China Sea. And it didn't disappoint. Barely 50 minutes after a tribunal at the Permanent Court of Arbitration (PCA) in the Netherlands ruled that China had no claim to the valuable region, the People's Daily had published an editorial headlined: S. China Sea Arbitration: A U.S.-led conspiracy behind the farce. The editorial criticized the U.S. for four major ‘wrong-doings’: colluding with its allies to ‘rubbish China,’ showing off its military force and putting pressure on China, playing China and Association of South East Asian Nations countries against one other, and manipulating the international arbitration tribunal… ‘We do not claim an inch of land that does not belong to us, but we won't give up anything that is ours,’ Wu Chengliang, an editor at Communist Party-run newspaper, added.”

July 12 – Wall Street Journal (Ben Blanchard and Martin Petty): “China vowed to take all necessary measures to protect its sovereignty over the South China Sea and said it had the right to set up an air defense zone, after rejecting an international tribunal's ruling denying its claims to the energy-rich waters. Chinese state media called the Permanent Court of Arbitration in the Hague a ‘puppet’ of external forces… Beijing has repeatedly blamed the United States for stirring up trouble in the South China Sea, where its territorial claims overlap in parts with Vietnam, the Philippines, Malaysia, Brunei and Taiwan. ‘China will take all necessary measures to protect its territorial sovereignty and maritime rights and interests,’ the ruling Communist Party's official People's Daily said in a front page commentary…”

July 14 – Wall Street Journal (Rebecca Smith): “An early morning passerby phoned in a report of two people with flashlights prowling inside the fence of an electrical substation in Bakersfield, Calif. Utility workers from Pacific Gas & Electric Co. later found cut transformer wires. The following night, someone slashed wires to alarms and critical equipment at the substation, which serves 16,700 customers…. Police never learned the identities or motive of the burglars. The Bakersfield attacks last year were among dozens of break-ins examined by The Wall Street Journal that show how, despite federal orders to secure the power grid, tens of thousands of substations are still vulnerable to saboteurs. The U.S. electric system is in danger of widespread blackouts lasting days, weeks or longer through the destruction of sensitive, hard-to-replace equipment. Yet records are so spotty that no government agency can offer an accurate tally of substation attacks, whether for vandalism, theft or more nefarious purposes.”