Credit Bubble Bulletin : June 2016

“In this unique exploration of the role of risk in our society, Peter Bernstein argues that the notion of bringing risk under control is one of the central ideas that distinguishes modern times from the distant past. Against the Gods chronicles the remarkable intellectual adventure that liberated humanity from oracles and soothsayers by means of the powerful tools of risk management that are available to us today.”

I found myself this week thinking deeply about the now classic (1998) “Against the Gods: The Remarkable Story of Risk.” The notion that new sophisticated approaches to risk management had diminished overall system risk was integral to the 1990’s U.S. boom period. Repeated policymaker resuscitation ensured that over time this already phenomenal Bubble morphed into a global Bubble of epic proportions. And right up until the Lehman Brothers collapse the consensus view held that policymakers had things well under control. Recall that the VIX sank just weeks prior to the so-called “worst financial crisis since the Great Depression.”

It’s no coincidence that near systemic financial collapse was preceded by manic devotion to the wonders of contemporary risk management. Today, I see parallels between the Lehman failure and the UK people’s decision to leave the European Union. Until the Lehman collapse, the strong consensus view held firm that policymakers would not tolerate financial crisis or severe economic downturn. By late in the cycle, this momentous market misperception had been embedded in prices for Trillions of securities, certainly including MBS, ABS and GSE debt. Importantly, as excesses turned increasingly outrageous (i.e. 2006’s $1TN of subprime CDOs) unwavering faith in the power of policy measures ensured ongoing rapid Credit expansion.

Moreover, unabated Credit growth (and attendant economic expansion and asset inflation) coupled with confidence in policymaker control ensured that inexpensive market risk “insurance” remained readily available. Going back to initial CBBs, I took exception with the powerful interplay of securities-based finance, “activist” monetary management and booming derivatives and market risk “insurance.” The Fed’s interest-rate and liquidity backstops underpinned securities-based finance, ensuring resilient markets and economic momentum. This safeguarded the supply of cheap market risk “insurance” – protection that was fundamental to ongoing risk-taking throughout the markets and real economy.

An increasingly systemic Bubble was built on an unsound foundation of misperceptions, including confidence that policy measures were readily available to ameliorate financial and economic instability. Panic ensued when the Lehman collapse illuminated the reality that there were powerful forces operating outside of policymaker command and control.

I believed at the time that the 2008 crisis marked a momentous inflection point for “contemporary finance.” Serious flaws and misperceptions having been fully exposed, I expected a fundamental re-pricing of risk throughout the markets. I thought the days of cheap risk “insurance” were over. Going forward, if market participants desired to reduce risk they would have to liquidate holdings. And considering all the associated havoc, I expected the Federal Reserve and other regulators to adopt an aggressive oversight approach to derivatives generally.

The Bernanke Fed instead pulled out all stops to resuscitate “contemporary finance.” Zero rates and Trillions of QE were adopted with the specific objective of spurring financial market inflation. Indeed, rising securities market prices became the centerpiece of extraordinary measures to reflate the U.S. (and global) economy. Over time it became a case of “whatever it takes” to overcome bouts of market instability and sustain an increasingly unwieldy global Bubble.

Risk premiums and pricing for market “insurance” collapsed. Instead of lingering fear from the near-catastrophic 2008/2009 experience, greed reemerged emboldened more than ever. Clearly, it was assumed, policymakers learned from 2008 and would not tolerate another crisis. Especially after 2012, “Whatever it takes” on a global basis ensured policymakers retained the capacity to control developments like never before. “Risk on” finale.

Markets were obviously over-confident going to Thursday’s UK referendum. It’s all understandable. As booming securities markets over the years turned increasingly powerful and dominating, markets held sway over central bankers, politicians and electorates alike. Who’s been willing to mess with bull markets and economic recovery? Of course, the average British citizen was disgusted with so many aspects of European integration. But once in the voting booth he/she certainly wouldn’t risk a faltering currency, sinking stock market and attendant economic uncertainty. That would be nuts. Markets – including risk insurance – were priced as if it was largely business as usual: markets dictating government policies, while central bank measures dictate the markets. Yet for voters it was anything but business as usual. For the Majority, Mad as Hell…

(Inflationist) Theory held that central banks could effortlessly print “money” that would inflate both the markets and the general price level. Such a reflation would help grow out of previous debt problems, while spurring wealth creation and renewed prosperity. Yet predictable consequences include latent financial fragilities, economic maladjustment and destabilizing wealth redistributions and disparities. Responding to obvious shortcomings, central bankers were compelled to only ratchet up monetary inflation. The past few years of “whatever it takes” have been reckless, and it’s coming home to roost. It’s increasingly apparent that popular discontent has reached critical mass, and critical development are not under central bank control.

Sure, central bankers are as committed as ever to crisis management. Global liquidity swap lines will be wide open. There will market interventions and ongoing liquidity backstops. More QE is on the horizon. But the process has turned dysfunctional and the consequences of aggressive monetary inflation extraordinarily unpredictable. Economies have fragmented. Markets have fragmented. Societies have fragmented. Political unions are fragmenting. It’s that old dilemma that central bankers can create liquidity but it’s difficult – these days impossible? - to dictate where the “money” flows in such a fragmented world.

It’s a popular argument that banks are healthier (better capitalized) these days than back in 2008. As I’ve chronicled for awhile now, global stock prices support the view that banks today confront extraordinary risks. I would add that I believe global securities market vulnerabilities greatly exceed those of 2008. A hedge fund industry and ETF complex that have each swelled to $3.0 TN are on the list of market risks that have inflated significantly since 2008. From a more real economy perspective, risks unfolding in Europe, China, Asia and EM, more generally, greatly exceed those from 2008. Actually, one has to be a real optimist to see a bright future for European, Asian or EM banking systems.

Brexit comes at a terrible time for European banks and Europe’s securities markets. To be sure, Friday trading put an exclamation mark on what was already bear market trading action. European bank stocks were down 14.5% Friday, increasing y-t-d losses to a nauseating 29%. UK banks were under intense selling pressure. Royal Bank of Scotland sank 27% in Friday’s chaotic session, while Barclays and Lloyds fell 20% and 23%. Elsewhere, Credit Suisse sank 16% during the session, with Deutsche Bank down 17% (down 35% y-t-d). Friday trading also saw Banco Santander fall 20%.

UK stocks opened Friday down about 8% but closed the session with losses of 3.2%. Spanish stocks sank 12.4% in wild trading, increasing y-t-d losses to 18.4%. Stocks in France fell 8.0%, pushing 2016 losses to 11.4%. Friday trading saw equities sink 5.7% in the Netherlands, 6.4% in Belgium, 7.0% in Portugal, 13.4% in Greece and 7.0% in Austria.

Recalling the tumultuous 2011/12 period, Italy is again becoming a market concern. Ominously, Italian bank stocks sank 22.1% Friday, a crash that pushed 2016 declines to 52%. Friday trading saw the Italian stock market (MIB) sink 14.5%, increasing y-t-d declines to 34%. And with Italian 10-year bond yields up seven bps to a four-month high 1.62%, the spread to bund yields surged 14 bps this week to a two-year high 167 bps.

European periphery spreads widened significantly Friday. Spanish 10-year bond spreads (to bunds) widened 30 bps Friday to a one-year high, with Italian spreads 29 bps wider. Portuguese spreads widened 39 bps and Greek spreads surged 91 bps.

Panic buying saw 10-year U.S. Treasury yields drop 19 bps Friday to 1.56%, the “largest single-day drop in 5½ years.” UK yields sank 29 bps to a record low 1.08%. German yields dropped another 14 bps Friday to a record low negative 0.05%. Swiss bond yields fell 13 bps to a record low negative 0.56%. After trading almost $100 higher overnight, bullion finished Friday’s session up $59 (4.7%) to a two-year high.

In Asia, the Japanese equities bear market gathered further momentum. With Friday losses of almost 8.0%, Japan’s Nikkei 225 sank another 4.2% this week to an eight-month low (increasing y-t-d losses to 21.4%). Japanese banks (TOPIX) were clobbered 8.0% during Friday’s session, boosting 2016 losses to 37%. The Shanghai Composite’s 1.1% decline increased y-t-d losses to 19.4%.

US stocks this week again outperformed most developed markets. The S&P500’s 3.6% Friday drop put the week’s decline at 1.6%. Not so bullishly, Friday trading saw the banks (BKX) drop 7.3% (down 13.1%) and the broker/dealers (XBD) sink 7.9% (down 16%).

Currency trading has turned wildly unstable. Friday trading saw the Swedish krona drop 3.7% versus the dollar. Norway and Demark currencies lost more than 2%, though these were modest declines compared to some key Eastern European EM currencies. Poland’s zloty sank 4.3% Friday, the Hungarian forint fell 3.5% and Czech koruna declined 2.4%. Friday trading saw the South African rand sink 4.6%. The Russian ruble fell 2.3% and the Turkish lira dropped 2.6%. Unsettled Friday action saw the Mexican peso trade to a record low, before ending the session down 3.8%. What’s unfolding south of the border?

Yet the real action was with the British pound and Japanese yen. The pound traded overnight at 1.324 to the dollar, a 30-year low – before cutting Friday’s losses to 8.1% at 1.3679. And with the yen surging an alarmingly quick 5% versus the dollar, the pound was at one point down about 15% versus the yen.

Currency markets badly dislocated overnight. And discontinuous markets are a major problem for those dynamically hedging derivative exposures as well as players that are leveraged. The pound’s abrupt fall was understandable considering the amount of hedging going into the referendum. But in the yen’s discontinuity I discern important confirmation of the thesis that there remains enormous amounts of leverage in short yen “carry trades” (short/borrow in yen to finance trades in higher-yielding currencies).

The impairment of the leveraged speculating community remains an important facet of the bursting Bubble thesis. There are surely casualties from Thursday night and Friday’s trading fiasco. And as hedge fund losses mount, the potential for major redemptions appears increasingly likely. We should expect de-risking/de-leveraging to intensify. And while central banks will continue to abundantly supply a liquidity backstop, I don’t believe such measures at this point will tame problematic volatility. Market correlations have run amuck. Hedging strategies have been problematic. So risk exposures have to get smaller. Uncertainties have become too great.

June 24 – UK Daily Express (Jonathan Owen): “Five European countries may seek to follow Britain’s lead in leaving the EU in a Brexit domino effect, Germany has warned… Tensions are rising across the EU, with Denmark, France, Italy, the Netherlands, and Sweden all facing demands for referendums over Europe. In a statement, German Chancellor Angela Merkel said: ‘There is no point beating about the bush: today is a watershed for Europe, it is a watershed for the European unification process.’”

European integration is again under existential threat. And while disintegration will likely unfold over the coming years, a crisis of confidence in the markets could erupt at any point. Confidence in Europe’s banks is faltering badly. I believe faith in the ECB’s capacity to hold the banks and securities markets together is waning. How much leverage has accumulated throughout European periphery bond markets? And it is a harsh reality of Europe’s financial structure that de-risking/de-leveraging dynamics tend to see rising yields/widening spreads intensify market fears of bank impairment. Then bank worries further negatively impact sentiment in the markets and business community in a problematic vicious spiral.

The ECB could boost QE, but it recently did that. It could buy corporate debt, but it has started doing this already as well. Negative rates only worsen the banks’ predicament. And bankers facing such extraordinary uncertainties will extend Credit cautiously - in Europe, throughout EM and in securities finance. When the world worries about Europe’s financial structure and economic prospects, fears can quickly spread globally. I find myself worrying more about China. U.S. markets have remained resilient. On the one hand, our markets win by default. On the other, best I can tell there is no market in the world that remains so oblivious to a bevy of unfolding financial, market, economic and geopolitical risks. Central banks are losing control and I fear “contemporary finance” is again in the crosshairs.

For the Week:

The S&P500 declined 1.6% (down 0.3% y-t-d), and the Dow fell 1.6% (down 0.1%). The Utilities slipped 0.2% (up 16.4%). The Banks dropped 3.8% (down 13.1%), and the Broker/Dealers sank 4.0% (down 16%). The Transports were hit 3.5% (down 2.5%). The S&P 400 Midcaps declined 1.5% (up 4.2%), and the small cap Russell 2000 lost 1.5% (down 0.7%). The Nasdaq100 fell 2.0% (down 6.7%), and the Morgan Stanley High Tech index dropped 3.0% (down 4.0%). The Semiconductors declined 2.0% (up 1.8%). The Biotechs dropped 2.5% (down 32.1%). With bullion gaining $17, the HUI gold index jumped 4.7% (up 114%).

Three-month Treasury bill rates ended the week at 25 bps. Two-year government yields dropped six bps to an eight-month low 0.63% (down 42bps y-t-d). Five-year T-note yields fell four bps to 1.07% (down 68bps). Ten-year Treasury yields declined five bps to 1.56% (down 69bps). Long bond yields slipped a basis point to 2.41% (down 61bps).

Greek 10-year yields surged 37 bps to 8.31% (up 99bps y-t-d). Ten-year Portuguese yields increased a basis point to a four-month high 3.30% (up 78bps). Italian 10-year yields rose four bps to 1.55% (down 4bps). Spain's 10-year yields gained seven bps to 1.62% (down 15bps). German bund yields dropped seven to negative 0.05% (down 67bps). French yields declined four bps to 0.38% (down 61bps). The French to German 10-year bond spread widened three to 43 bps. U.K. 10-year gilt yields declined six bps to 1.08% (down 88bps).

Japan's Nikkei equities index sank 4.2% (down 21.4% y-t-d). Japanese 10-year "JGB" yields declined two bps to a record low negative 0.18% (down 44bps y-t-d). The German DAX equities index slipped 0.8% (down 11%). Spain's IBEX 35 equities index sank 6.9% (down 18.4%). Italy's FTSE MIB index lost 7.1% (down 26.6%). EM equities were mostly under pressure. Brazil's Bovespa index added 0.4% (up 15.4%). Mexico's Bolsa declined 0.9% (up 4.4%). South Korea's Kospi index lost 1.4% (down 1.8%). India’s Sensex equities index declined 0.9% (up 1.1%). China’s Shanghai Exchange fell 1.1% (down 19.4%). Turkey's Borsa Istanbul National 100 index was little changed (up 5.1%). Russia's MICEX equities index increased 0.4% (up 7.0%).

Junk funds saw outflows of $766 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained two bps to 3.56% (down 41bps y-o-y). Fifteen-year rates rose two bps to 2.83% (down 43bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 3.71% (down 37bps).

Federal Reserve Credit last week expanded $6.6bn to $4.438 TN. Over the past year, Fed Credit contracted $2.6bn. Fed Credit inflated $1.627 TN, or 58%, over the past 189 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt was little changed last week at $3.238 TN. "Custody holdings" were down $140bn y-o-y, or 4.2%.

M2 (narrow) "money" supply last week surged $40.4bn to a record $12.798 TN. "Narrow money" expanded $834bn, or 7.0%, over the past year. For the week, Currency increased $1.2bn. Total Checkable Deposits jumped $44.4bn, while Savings Deposits slipped $2.4bn. Small Time Deposits were unchanged. Retail Money Funds declined $2.4bn.

Total money market fund assets declined $3.6bn to a two-month low $2.703 TN. Money Funds rose $102bn y-o-y (3.9%).

Total Commercial Paper declined $4.5bn to a six-month low $1.039 TN. CP expanded $87bn y-o-y, or 9.1%.

Currency Watch:

The U.S. dollar index gained 1.5% this week to 95.54 (down 3.2% y-t-d). For the week on the upside, the Japanese yen increased 1.9%, the Brazilian real 1.2%, the Australian dollar 1.1%, the New Zealand dollar 1.1% and the South African rand 0.4%. For the week on the downside, the British pound declined 4.7%, the Swedish krona 1.6%, the euro 1.4%, the Swiss franc 1.3%, the Norwegian krone 0.9%, the Canadian dollar 0.9% and the Mexican peso 0.5%. The Chinese yuan declined 0.5% versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.0% (up 16.5% y-t-d). Spot Gold jumped 1.3% to $1,316 (up 24%). Silver rose 2.2% to $17.79 (up 29%). WTI Crude slipped 34 cents to $47.64 (up 29%). Gasoline gained 1.3% (up 20%), and Natural Gas rose 1.5% (up 14%). Copper jumped 3.2% (down 1%). Wheat fell 3.4% (down 1%). Corn sank 11.1% (up 8%).

Europe Watch:

June 24 – Financial Times (Tony Barber): “Make no mistake about it. Britain’s vote to leave the EU is the most damaging blow ever inflicted on the liberal democratic international order created under US auspices after 1945. Pandora’s box is well and truly open. All Britain’s allies and friends, from Australia, Canada, India, Japan and the US to London’s 27 EU partners, had urged British voters to vote Remain. It is hard to think of anyone, beyond Britain’s borders, who will rejoice at the referendum result outside Moscow, Pyongyang and the hiding places of assorted terrorists. No state has left the EU since Belgium, France, Germany, Italy, Luxembourg and the Netherlands founded the European Economic Community with the 1957 Treaty of Rome.”

June 24 – Reuters (Ingrid Melander): “France's far right National Front party called for a French referendum on European Union membership on Friday, cheering a Brexit vote it hopes can boost its eurosceptic agenda at home. The anti-immigrant, anti-euro FN, was the only major French political party to call for Britons to vote to leave the EU. ‘Victory for freedom!’ said FN chief Marine Le Pen, who displayed the British flag on her Twitter page. ‘We now need to hold the same referendum in France and in (other) EU countries.’”

June 24 – Reuters (Giada Zampano): “Italy's anti-immigrant and euroskeptic Northern League will start a petition calling for a law that allows a referendum on whether the country wants to exit the European Union, its leader said on Friday. In a news conference following the announcement of the U.K.'s decision to leave the EU, Northern League's head Matteo Salvini said that it was time to give Italians a vote on their EU membership, as the citizens of Britain have just done.”

Brexit Watch:

June 24 – Reuters (Guy Faulconbridge and Kate Holton): “Britain has voted to leave the European Union, forcing the resignation of Prime Minister David Cameron and dealing the biggest blow since World War Two to the European project of forging greater unity. Global stock markets plunged on Friday, and the British pound saw its biggest one day drop in history, as results from a referendum defied bookmakers' odds to show a 52-48% victory for the campaign to leave the bloc Britain joined more than 40 years ago. The United Kingdom itself could now break apart, with the leader of Scotland, where nearly two-thirds of voters wanted to stay in the EU, saying a new referendum on independence from the rest of Britain was ‘highly likely’.”

June 21 – Financial Times (Anne-Sylvaine Chassany): “Marine Le Pen has seized on the referendum on Britain’s EU membership to request a similar vote in France, as she threw her weight behind the Leave camp in the final stretch of the campaign. The leader of the French far-right National Front party said that the UK referendum taking place on Thursday was proof that the EU was “decaying”, as she pressed her case for France to leave the bloc. ‘I would vote for Brexit, even if I think that France has a thousand more reasons to leave than the UK,’ Ms Le Pen said… ‘Because we have the euro and Schengen,’ she added, referring to the single currency and the passport-free zone she staunchly opposes. ‘Whatever the result, it shows the EU is decaying, that there are cracks everywhere,’ she said.”

June 22 – Wall Street Journal (Eric Sylvers): “Fresh from its victory over the weekend in the Rome mayoral race, Italy’s antiestablishment 5 Star Movement has called for a national referendum on whether the country should do leave the euro. ‘The euro as it exists today doesn’t work and we need to consider other alternatives such as a euro 2 or alternative currencies,’ Luigi Di Maio, a party leader in the lower house of parliament, said Tuesday night…”

Fixed-Income Bubble Watch:

June 24 – Wall Street Journal (Aty Burne and Jenny Strasburg): “Rates on overnight loans between banks spiked Friday, a sign lenders were husbanding their cash as the U.K. vote to leave the EU roiled markets. Banks were paying an average of 0.8% around noon Friday to borrow money from other lenders against high-quality government bonds… That ‘repo’ rate was up from 0.75% at the open of Friday’s session and from 0.69% Thursday, as votes on the U.K.’s continued membership in the EU trickled in. On Wednesday, the rate was 0.57%... The moves were unusually large for a $3 trillion market in which rates typically change by only one or two hundredths of a percentage point a day. ‘The volatility and flight to quality in the overall U.S. Treasury market caused a panic this morning in the repo market,’ said Scott Skyrm, a repo and securities financing expert at Wedbush Securities…”

June 21 – Financial Times (Alexandra Scaggs): “Even people who don’t normally find money markets interesting (we’ve heard such baffling types exist) might pause to consider a number like this: $160 trillion. That’s the notional outstanding value of US dollar financial products currently indexed to the London Interbank Offering Rate, or Libor — you remember, that rate survey that was awkwardly riggable. So we should all pay attention Tuesday afternoon when a committee of global interest-rate dealers discusses alternatives to Libor for US interest-rate swaps. That market has a notional outstanding value of around $100 trillion, as shown below.”

Global Bubble Watch:

June 21 – Reuters (John Geddie): “Euro zone governments have eased up on efforts to overhaul their struggling economies because the ECB's ultra-easy monetary policy has pushed their borrowing costs to record lows, …Standard & Poor's said… Speaking in London, S&P's top EMEA analyst Moritz Kraemer said there was a strong relationship between government bond yields… and their willingness to undertake structural reforms… ‘All of these (reform) efforts from the governments have really fallen by the wayside under the palliative that the ECB is providing,’ Kraemer told the Euromoney Global Borrowers & Bond Investors Forum… ECB policymakers have been urging governments to take advantage of easy financing conditions to implement reforms and make sure the bloc's slow recovery becomes more sustainable. But ‘the moment the pressure goes away, the action goes away as well’, said Kraemer.”

June 21 – Bloomberg (Darren Boey): “Asia-Pacific banks face ‘a powerful storm’ which will probably hurt profit growth in an industry that earned half a trillion dollars last year, according to McKinsey & Co. A triple threat of slowing economic growth, technology disruption and weaker balance sheets could come together to ‘cripple’ returns on equity by 2018, the… consultancy said… Profit growth may slow to below 4% annually between 2016-2021, down from about 10% in 2011-2014, said Joydeep Sengupta, one of the report’s authors. The region’s slowdown has led to weaker lending growth and surging loan defaults, sending stressed assets in China, India, Indonesia and Japan to almost $400 billion last year, according to McKinsey… The consultancy’s analysis indicates banks in Asia need to raise $400 billion to $600 billion in additional capital by 2020 to cover losses from nonperforming loans…”

Federal Reserve Watch:

June 21 – New York Times (Nelson D. Schwartz): “Weak economic growth in the United States could force the Federal Reserve to hold off on any imminent interest rate increases, the Federal Reserve chairwoman, Janet L. Yellen, told Congress… While Ms. Yellen said that the American economy’s long-term prospects remain favorable, she signaled that headwinds, including slower employment gains in recent months, weak productivity growth and the persistence of a sluggish pace of inflation have prompted the Fed to adopt a more cautious stance. ‘The latest readings on the labor market and the weak pace of investment illustrate one downside — that domestic demand might falter,’ Ms. Yellen said… ‘Proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace,’ she said.”

June 22 – Reuters (Rodrigo Campos): “The Federal Reserve on Tuesday delivered its starkest warning yet under Chair Janet Yellen that by its assessment U.S. stocks are pricey. ‘Forward price-to-earnings ratios for equities have increased to a level well above their median of the past three decades,’ the Fed's twice-annual Monetary Policy Report, the U.S. central bank concluded.”

U.S. Bubble Watch:

June 22 – Wall Street Journal (Aaron Kuriloff): “Companies in the S&P 500 spent $161.4 billion buying back shares in the first quarter of 2016, the second-largest amount on record… Buybacks in the first quarter increased 12%, compared with the $144.1 billion spent in the first quarter of 2015, according to… S&P Dow Jones Indices. For the 12 months ending in March 2016, S&P 500 companies spent a record $589.4 billion, beating the $589.1 billion spent in 12 months through December 2007. The increase in buybacks comes as cash reserves for companies in the S&P 500 Industrials set a record of $1.347 trillion as of the first quarter, up 1.1% from the prior record of $1.333 trillion set at the end of 2014, said Howard Silverblatt, senior index analyst.”

June 22 – Bloomberg (Eric Balchunas): “The low volatility exchange-traded fund (ETF) craze has little to do with investors seeking less volatility. Instead, the billions of dollars flowing into ETFs that track stocks exhibiting the least amount of volatility is a classic case of performance-chasing. Like little kids playing soccer, many investors follow the outperformance ball… It happens with stocks, bonds, active mutual funds, hedge funds, and increasingly with ETFs. Right now, the soccer ball is in the low-volatility part of the field, where nearly all low-vol ETFs are outperforming their respective markets—be they large-caps, small-caps, or international equities.”

June 22 – Bloomberg (Prashant Gopal): “U.S. home prices rose 5.9% in April from a year earlier as job growth spurred competition for a limited number of listings… Values have increased steadily as buyers, bolstered by an improving labor market and easing mortgage standards, battle for a tight supply of homes on the market. Inventory at the end of April was down 3.6% from a year earlier…”

June 22 – Bloomberg (Patrick Clark): “A popular narrative of the U.S. housing market has been that big city prices are locking out young buyers, feeding a cycle in which a growing number of people are forced to rent at ever higher rates as demand overwhelms supply. Throw in the fact that wages haven’t kept pace, and you have a world where a wide swath of Americans can't save enough to ever buy that first home. The reality may be a bit more complicated. It's true that, when combined with a lack of government support for affordable housing, this situation has pushed the number of cash-poor renters to a new high. Some 26% of U.S. renters paid at least half their income to landlords in 2014, up from 20% in 2001…”

June 21 – Reuters (Lisa Lambert): “Hedge funds, banks and insurance companies have recently jumped into ‘marketplace lending,’ drawing the attention of U.S. regulators, who said on Tuesday they are concerned that borrowing by consumers and small businesses through online platforms may pose risks to U.S. financial stability. In its annual review of the U.S. financial system released on Tuesday, the Financial Stability Oversight Council (FSOC) consisting of all the country's financial regulatory chiefs, also said it is watching events overseas, including this week's ‘Brexit’ vote and the turmoil in Venezuela. It also noted that China ‘is in the midst of long-term transitions in its economy,’ which could have global implications.”

China Bubble Watch:

June 22 – Bloomberg: “China is stepping up stimulus by stealth in its efforts to ensure hitting the leadership’s growth target this year, with moves that will enhance the role of the state even as policy makers say they want a bigger role for the market. The fiscal deficit when taking off-budget spending into account will exceed 10% of gross domestic product this year -- more than triple the government’s stated ratio of 3%, according to economists at UBS… and JPMorgan…”

June 21 – Bloomberg: “Time is running out for Chinese companies addicted to short-term debt. About 47% of the 4.3 trillion yuan ($654bn) of local-currency bonds sold by Chinese non-banking companies in 2016 mature in one year or less… Ten out of the 17 onshore notes that defaulted this year have such short maturities… As banks try to keep zombie companies alive, short-term liabilities including loans account for 86% of the total versus 40% globally, a Natixis analysis of the 3,000 biggest listed companies in China shows. ‘The frequent deadlines of short-term bonds are giving investors a big headache,’ said Qiu Xinhong… manager at First State Cinda Fund Management Co…. ‘There are so many troubled companies relying on new short-term borrowings to roll over debt or even to repay interest.’ Chinese companies repaying existing obligations by issuing new securities has never been such a big threat to the world’s second-biggest economy as a record 1.1 trillion yuan of notes of one year or less mature from July to September…”

June 22 – Financial Times (Gabriel Wildau): “Chinese bankruptcies have surged this year as the government uses the legal system to deal with ‘zombie’ companies and reduce industrial overcapacity as part of a broader effort to restructure the economy. Courts in China accepted 1,028 bankruptcy cases in the first quarter of 2016, up 52.5% from a year earlier… Just under 20,000 cases were accepted in total between 2008 and 2015. China’s legislature approved a modern bankruptcy law in 2007 but for years it was little used, with debt disputes often handled through backroom negotiations involving local governments.”

Brazil Watch:

June 21 – Bloomberg (Filipe Pacheco, Fabiola Moura and Cristiane Lucchesi): “The bankruptcy filing of Oi SA, the largest in Brazil’s history, is reverberating through the nation’s strained financial industry… Even as Egyptian billionaire Naguib Sawiris said he’s prepared to invest in the wireless carrier, Monday’s bankruptcy filing is likely to leave Banco do Brasil SA, Itau Unibanco Holding SA and others with steep losses on their holdings of Oi debt and trigger payments on $14 billion of derivatives contracts that are designed to pay out in an event of a default. Shares of Banco do Brasil slumped 4.5%. The unrelenting two-year recession is wreaking havoc on Brazilian corporations… Bankruptcy filings doubled in May to 184 after rising 55% last year, according to… Serasa Experian.”

Japan Watch:

June 22 – Reuters (Leika Kihara): “Dissenting Bank of Japan board member Takahide Kiuchi said the central bank should review its negative interest rate policy, give itself more time to hit its 2% inflation target, and warned that the demerits of its massive monetary stimulus were outweighing the benefits. A prolonged period of ultra-low interest rates, brought about by the BOJ's huge asset purchases, and the adoption of negative rates had destabilised the bond market and damaged the central bank's credibility, Kiuchi said… ‘The additional (positive) effects of quantitative and qualitative easing (QQE) have been diminishing,’ Kiuchi told business leaders…’On the other hand, numerous side effects of QQE seem to be increasing steadily,’ he said.”

June 19 – Bloomberg (Keiko Ujikane Yoshiaki Nohara): “Japan’s exports fell for an eighth consecutive month in May as shipments to China, the U.S. and Europe slumped, undermining Prime Minister Shinzo Abe’s efforts to revive the economy. Overseas shipments declined 11.3% in May from a year earlier… Imports fell 13.8%, leaving a trade deficit of 40.7 billion yen ($389 million).”

June 23 – Reuters (Stanley White): “Japanese manufacturing activity contracted in June at roughly the same pace as the previous month…, but concerns remain due to supply chain disruptions from an earthquake in April and falling exports. The Markit/Nikkei Japan Flash Manufacturing Purchasing Managers Index (PMI) was a seasonally adjusted 47.8 in June…”

Europe Watch:

June 22 – CNBC (Fred Imbert): “The European Union will have to address some key questions regardless of whether the U.K. votes to leave, Hans Olsen, global head of investment strategy at Stifel, said… ‘These questions will persist because the core problems in Europe have not been fixed. You still have a sclerotic, super-national government in Brussels that just continues,’ he told CNBC's ‘Squawk Box.’ ‘If they're listening to their market, which in this case is Britain, they'll undertake a reform effort to get better decision-making a more robust response to their problems. But I think in the short term, you get a big market dislocation. The question is, what really changes after that?’ he said.’”

June 21 – New York Times (Eduardo Porter): “Is ‘Europe’ finished? The latest polls and political prediction markets this week suggest that Britons will vote on Thursday to stay in the European Union. The Leave campaign, led by Boris Johnson, the former mayor of London who tried to whip up a surge of resentment against immigrants into a vote for Britain to leave the bloc, looks set to fail. But even if the pro-European Remain cause pulls out a victory, the popular hostility against the decades-long process of European integration — evident not only in Britain but across the Continent — underscores a defining weakness. Europe itself lacks a firm democratic foundation. Europe’s leaders face a clear-cut choice: For their integration agenda to succeed — preserving the free movement of people within the bloc, forging ahead with the euro and the single market, keeping doors open to outsiders — the E.U. must figure out how to overcome the narrow national interests and mistrust that tie it up in knots every time a collective response is needed.”

June 22 – Reuters (Sarah White): “The parched olive groves and tranquil towns of Spain's southern Cordoba province are an unlikely backdrop for a political upset that could reverberate across Europe. Yet some locals like 57-year-old Lorenzo Molina, an unemployed librarian, hope they can help deliver just that in a fresh nationwide election on June 26 following an inconclusive December ballot. Gains for an anti-austerity alliance led by the young Podemos party in tightly-contested provinces like this could tip the balance in its bid to lead the next government, and this could turn Spain into the European Union's next headache… A surge into second place for Unidos Podemos (‘Together We Can’) ahead of Spain's Socialists would make the far-left front a serious contender to form a coalition government, cementing the decline of Spain's once-mighty center-left in the process.”

Geopolitical Watch:

June 22 – Reuters (David Brunnstrom and Matt Spetalnick): “The United States warned China on Wednesday against taking ‘additional provocative actions’ following an impending international court ruling on the South China Sea that is expected to largely reject Beijing's broad territorial claims. A senior State Department official voiced skepticism at China's claim that dozens of countries backed its position in a case the Philippines has brought against Beijing and vowed that Washington would uphold U.S. defense commitments.”

June 22 – Reuters (Megha Rajagopalan): “China's top newspaper strongly criticized the United States… after it deployed two aircraft carriers on a training mission in East Asia where military tensions have risen amid China's growing assertiveness. The U.S. carriers John C. Stennis and Ronald Reagan began joint operations in seas east of the Philippines at the weekend in a show of strength ahead of an international court ruling expected soon on China's expansive territorial claims in the contested South China Sea. ‘The U.S. picked the wrong target in playing this trick on China,’ the People's Daily, the official newspaper of the ruling Communist Party, said…”

June 21 – Financial Times (Robin Harding): “At about 9.50pm on the evening of June 8, a Russian destroyer and its support vessels sailed north into the 24-nautical mile contiguous zone around the disputed island chain that Japan calls the Senkaku and China the Diaoyu. So began an international incident that touches half of the world, from Beijing to Moscow, Delhi to Washington. Warships are free to navigate the contiguous zones of other nations and Russian ships had passed this way before. But at about 12.50am on the morning of the June 9 a Chinese frigate for the first time ever entered the contiguous zone sailing south. A tremor went up the Japanese chain of command until China’s ambassador to Tokyo was summoned from his bed. At one point the Chinese vessel sailed directly towards an island, prompting fears in Tokyo of a landing. But then it curved round to intercept and match the Russian vessel’s course, with the ships departing to the north-east at 3.10am.”

June 22 – Reuters (Denis Pinchuk and Dmitry Solovyov): “Russia must boost its combat readiness in response to NATO's ‘aggressive actions’ near Russia's borders, President Vladimir Putin said… Addressing parliament on the 75th anniversary of Nazi Germany's attack on the Soviet Union, Putin berated the West for being unwilling to build ‘a modern, non-bloc collective security system’ with Russia. ‘Russia is open to discuss this crucial issue and has more than once shown its readiness for dialogue… But, just as it happened on the eve of World War Two, we do not see a positive reaction in response.’”

June 19 – Dow Jones (Anton Troianovski): “Germany's foreign minister warned the country's allies against ‘saber-rattling and war cries’ directed toward Russia, hinting at a widening split in Europe over how to deal with the perceived threat of aggression by Moscow against former members of the Communist bloc. ‘Anyone who believes that symbolic tank parades on the Alliance's eastern border will increase security is wrong,’ Foreign Minister Frank-Walter Steinmeier said, referring to recent Western military exercises… ‘We would be well advised not to deliver up any excuses for a new, old confrontation,’ he said.”

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