Monday, August 29, 2016

Spending like there’s no tomorrow

America The Debt Pig: We Are A ‘Buy Now, Pay Later’ Society – And ‘Pay Later’ Is Rapidly Approaching

By Michael Snyder, on August 28th, 2016

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America The Pig - Public DomainIf you really wanted to live like a millionaire, you could start doing it right now.  All you have to do is to apply for as many credit cards as possible and then begin running up credit card balances like there is no tomorrow.  At this point, I know what most of you are probably thinking.  You are probably thinking that such a lifestyle would not last for long and that a day of reckoning would eventually come, and you would be exactly right.  In fact, anyone that has ever had a tremendous amount of credit card debt knows how painful that day of reckoning can be.  To mindlessly run up credit card debt is exceedingly reckless, but unfortunately that is precisely what we have been doing as a nation as a whole.  We are a “buy now, pay later” society, and our national day of reckoning is approaching very, very quickly.

Often we like to focus on our exploding national debt, but household debt is out of control too.  In fact, the total amount of household debt in the United States is now up to a whopping 12.3 trillion dolllars

In the second quarter, total household debt increased by $35 billion to $12.3 trillion, according to the New York Fed’s latest quarterly report on household debt. That increase was driven by two categories: auto loans and credit cards.

We throw around words like “trillion” so often these days that they often start to lose their meaning.  But the truth is that 12.3 trillion dollars is an astounding amount of money.  It breaks down to about $38,557 for every man, woman and child in the entire country.  So if you have a family of four, your share comes to a grand total of $154,231, and that doesn’t even include corporate debt, local government debt, state government debt or the gigantic debt of the federal government.  That number is only for household debt, and there aren’t too many Americans that could cough up their share right at this moment.

Do you remember when I wrote about how credit card companies are specifically targeting less educated and less sophisticated consumers?  Well, that is where much of the credit card debt growth has come lately.  Just check out these numbers

Now, credit cards are returning among individuals with low credit or subprime credit scores below 660. Among people with credit scores between 620 and 660, the share that had a credit card rose to 58.8% in 2015 from a low of 54.3% in 2013. Among those with scores below 620, the number of people with a credit card increased to 50% from a low of 45.6% two years ago. Both figures for 2015 are the highest since 2008.

In America today, we are enjoying a standard of living that we do not deserve.

We consume far more wealth than we produce.  The only way we are able to do that is by going into debt.

Debt takes future consumption and brings it into the present.  In other words, we are damaging the future in order to make the present a little bit better.  On an individual level, we may enjoy the big screen television we buy with a credit card today, but we are taking away our ability to spend money later.  And on a national level, what our unprecedented debt binge is doing to future generations of Americans is beyond criminal.

Earlier this month I explained these things to a live studio audience down at Morningside, and you can view a video of that right here

In this article I haven’t even talked about corporate debt yet.  Instead of learning their lessons from the last financial crisis, big corporations have gone on the biggest debt spree of all time.  If you can believe it, corporate debt has approximately doubledsince the last financial crisis.  In other words, since the last recession we have essentially matched the total amount of corporate debt that we accumulated from the beginning of the country up to 2009.

Unfortunately, a lot of that debt is now going bad.

In previous articles I have documented that corporate debt delinquencies are now the highest that they have been since the last financial crisis, and corporate debt defaults are also the highest that they have been since the last financial crisis.

At this point, even the mainstream media is acknowledging that we have a corporate debt “crisis”.  The following comes from an article that was just put out by the Denver Post

The number of companies that have defaulted so far this year has already passed the total for all of last year, which itself had the most since the financial crisis. Even among companies considered high-quality, or investment grade, credit-rating agencies say a record number are so stretched financially that they’re one bad quarter or so from being downgraded to “junk” status.

Companies whose debt is already deemed “junk” are in the worst shape in years. To pay back all they owe, they would have to set aside every dollar of their operating earnings over the next eight and a half years, more than twice as long as it would have taken during the 2008 crisis, according to Bank of America Merrill Lynch.

Are you starting to get the picture?

And I haven’t even started talking about our national debt yet.  When Barack Obama entered the White House, we were 10.6 trillion dollars in debt.  Today, we are 19.4 trillion dollars in debt.  That means that we have added 8.8 trillion dollars to the national debt under Obama, which breaks down to an average of 1.1 trillion dollars of additional debt a year.

We have been taking more than 100 million dollars of future consumption and bringing it into the present every single hour of every single day during the Obama administration.  That is why I am constantly referring to our “debt-fueled standard of living”.  We do not deserve to live the way that we do, but since we are able to steal from our children and our grandchildren we are able to enjoy a standard of living that most people in the world can only dream about.

Of course we are literally destroying the future of America in the process, but very few people seem to care about that these days.

Without all of this debt, we would be in a very deep economic depression right now.

But even with all of this “stimulus”, we are still mired in the worst economic “recovery”since 1949.  In fact, Barack Obama is actually on track to be the very first presidentin all of American history to not have one single year when U.S. GDP grew by 3 percent or better, and he has had two terms in which to try to get that accomplished.  The percentage of working age Americans that actually have a job is way down from where it was just prior to the last recession, and in this video I explain why the employment numbers put out by the government are not nearly as good as the administration would have us believe…

If the American people would have been willing to sacrifice and make some very hard choices a long time ago, maybe we could have gotten a handle on all of this debt.

But instead we continue to rack up debt as if there is no tomorrow, and in the process we are literally destroying tomorrow.

Every dollar of debt that we accumulate now makes life worse for our children and our grandchildren.

Unfortunately, we are a bunch of debt pigs, and we just can’t help ourselves.  We have come to believe that it is “normal” to go into so much debt, and as a society we continue to race toward economic oblivion.

As Germany goes, so goes . . .

German economy left SHATTERED after Brexit vote, shock new figures reveal

Posted by aurelius77 on August 29, 2016

CONFIDENCE in Germany’s economy has plunged in the wake of Britain’s vote to leave the European Union, dramatic new figures have revealed.

Business morale in Europe’s biggest economy tumbled in August at its fastest rate since the height of the eurozone debt crisis in 2012, showed the closely-followed economic institute Ifo survey.

The monthly 106.2 reading – from 108.3 in July – is now sitting at its lowest level since February.

Experts said the impact of Brexit is now starting to bite in Germany.

Ifo head Clemens Fuest said: “Business confidence in Germany has clearly worsened.

At the same time, another index measuring corporate expectations in the country fell to it the lowest since October 2014, as Britain’s vote to leave the EU starts to take its toll.

He said business expectations had been hardest in the sectors with strong ties to the British market, such as chemicals and automobiles.

A sector breakdown showed the weaker headline figure was driven by deteriorated sentiment in manufacturing, wholesaling and retailing.

It comes after predictions last month that Brexit could wipe 0.4 per cent from Germany’s growth over the next eight months, according to the German Institute for Economic Research.

Full article: German economy left SHATTERED after Brexit vote, shock new figures reveal (Express)

Thursday, August 25, 2016

Financial Exposive Device = FED

Bubbles In Bond Land—-A Central Bank Made Mania, Part 3

by David Stockman • August 24, 2016

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The Giant Volcano Of Uncollectible Capital Gains In Global Bond Markets

…….In short, the global bond market has become a giant volcano of uncollectible capital gains. For example, long-term German bunds issued four years ago are now trading at 200% of par.

Yet even if the financial system of the world somehow survives the current mayhem, the German government will never pay back more than 100 cents on the dollar.

What that means is there will eventually be a multi-trillion dollar bond implosion as speculators and bond fund managers alike scramble to cash-in their capital gains at the first sign that the global bond markets are breaking and heading back to par or below. And it is not just the “winners” who will be stampeding for the exists.

There will also be an even larger and sorrier band of “losers” in an even greater state of panicked flight. We refer here to all the Johnny-come-lately bond managers on the planet who are today buying trillions of bonds at a premium to par. For example, the premium price of the 4% coupon Italian bonds that have traded up to a 1.2% yield owing to Mario Draghi’s $90 billion per month buying spree will get absolutely monkey-hammered when the ECB’s Big Fat Bid finally ends.

To be sure, these befuddled money manages claim to have no choice or that these premium bonds still have a slightly better yield than subzero. Yet what they are actually doing is strapping on a financial suicide vest. These premiums absolutely must disappear before maturity, and most probably suddenly, violently and all at once when the great global bond bubble finally implodes.

Likewise, there is nearly $3 trillion of junk bonds and loans outstanding in the US alone, and that is double the level extant on the eve of the great financial crisis. But double the money embodies far more than double the risk.

That’s partially because the drastic, central bank induced compression of benchmark bond yields has been transmitted into ultra-low absolute levels of junk bond yields via spread pricing. Compared to all of modern history, current junk bond yields in the 5-6% range are just plain ridiculous.

After all, long-term junk bond losses have been in the 3-4% range, inflation is still running close to 2% on a trend basis and taxes have not yet been abolished. So the sheer math of it is that the average single B junk bond today has negative value——and that’s before the next default cycle really kicks into gear..

And junk bond defaults like never before in history are coming with a vengeance. That’s because a very substantial portion of current junk credit outstandings went into speculations that even LBO shops wouldn’t have entertained 15 years ago.

To wit, it was used to fund radical commodity price speculations in the shale patch, mining and other commodity plays, subprime auto lending schemes and financing for stock buybacks and dividend recaps by highly leveraged companies. Accordingly, the embedded business and credit risk in the $3 trillion of outstanding US junk bonds and loans is off the charts.

BofA Merrill Euro High Yield Index 2016

Already by mid-year 2016, defaults in the shale patch had taken down 40% of outstandings. Even cautious rating agencies like Fitch now project high yield bond defaults will hit nearly $100 billion in 2016 or double last year’s already elevated levels.

But as usual the rating agencies are far behind the curve. Standard and Poor’s, for example, projects that by June 2017 today’s rapidly rising defaults will only hit the 4-7% range. But they are smoking the same thing they were in 1989, 1999, and 2007!

In fact, the junk bond sector will soon be hit by a double whammy that will push loss rates to unprecedented levels. That’s because there is already a deeply embedded loss due to the distortions of ZIRP/NIRP on benchmark bond pricing. When the central banks of the world are eventually forced to shut down their printing presses and permit rates to normalize, these losses will be transmitted across the entire credit spectrum.

On top of that, the massive global deflation/ recession currently unfolding means defaults will easily soar far above the prior 11-12% peaks. And the next peak default cycle will last far longer than the historic results shown in the chart because this time the central banks will not be in a position to reflate the bond and other financial markets.

The prior default peaks shown below are part of the two-decade long super-cycle of global credit and investment growth. Each junk bond market break was quickly reversed by successive rounds of central bank money printing.

But the world economy is now stranded at Peak Debt and the central banks are out of dry powder. The latter have reached the limits of subzero rates, the credibility of QE is fading fast and Bernanke’s fleet of helicopter money drops will never get off the ground in the US or Germany, and that’s mainly what matters.

So this time recessionary conditions will persist and the implied revenue growth in most junk bond deals will never happen. The resulting cumulative build-up of cash flow shortfalls, therefore, will be immense. This means that a far larger share of issuers will eventually default—-especially given the elevated credit risk already embedded among commodity oriented issuers.

Moreover, as the junk bond default rate continues to rise, the “extend and pretend” market, which has forestalled defaults in the last few cycles, will also dry-up.   Consequently, hidden defaults will finally come to the surface and issuers will resolve their inability to pay in the bankruptcy courts, not in the junk refinancing markets.

Financial Explosive Devices (FEDs) And The Coming Financial Carnage

Yet the junk bond sector is only a small section of the coming bond market carnage. The scramble for yield generated by central bank financial repression, in fact, has systematically impregnated the global markets with FEDs (financial explosive devices).

Even as approximately 200 principal central bankers and senior staff have spent the last seven years pushing interest rates toward the zero bound or below, there have been millions of financial operators and capital users scouring the earth for ways to escape it.

Recently, one of these zero bound escape routes blew sky high when the 9.5% contingent convertible bond of 2049 issued by an obscure German bank, Bremer Landesbank (BLB), plunged by 40% from 120 to 73 in just minutes—–a move which has, in turn, spooked broader global markets.

It turns out that Bremen LB is a $29 billion German state-owned bank heavily invested in shipping loans that is now facing massive write downs and the need to raise capital from its principal owners—-German Landesbank NordLB, the city of Bremen, and the savings banks association in Northrhine Westphalia.

Here’s the thing. All the parties involved had stumbled into risk that extended way over the end of their financial skis. Indeed, the cliff diving bonds shown below were at the very end of a long chain of mispricings emanating from today’s central banking regime.

It originated awhile back when central banks made cheap debt available to households in the US and Europe. That caused a consumption boom there, and an oversized export boom in China and the far east.

Next, more cheap capital enabled by the Asian central banks funded an artificially large investment boom in China and among its EM supply chain, which, in turn, caused demand for bulk, crude oil and container ship capacity to surge.

Needless to say, still more cheap capital generated a massive excess of highly leveraged ship-building capacity that needs cash flow to service its debt. So the huge state enabled ship-building industries of China and South Korea built new ships like there was no tomorrow and, to move the iron, priced them near marginal cost.

Then, even more yield hungry capital hooked-up with the growing surplus of these “new builds”, funding on high leverage what is ultimately a day rate commodity (i.e. shipping capacity).

Even then, the daisy chain was not done. The bank arrangers and other intermediaries who bought and financed the surplus ships that the central bankers indirectly built needed to enhance their own returns. So they funded their newly acquired “assets” with yield-bait like the Bremen LB contingent bonds which blew sky high on a moments notice.

The one thing that is absolutely true in a $300 trillion global financial market is that Bremen LB is not a one-off. After a $20 trillion central bank printing spree and 90 months on the zero bound these kind of FEDs exist in their tens of thousands.

Soon we will know their names.

After all, creating this kind of fiery demise is what central banks ultimately do……

DB and “Fatal Consequences”

Deutsche Bank CEO Warns Of “Fatal Consequences” For Savers

Posted by aurelius77 on August 25, 2016

Deutsche Bank’s war of words with the ECB is not new: it was first unveiled in February when, as we wrote at the time “A Wounded Deutsche Bank Lashed Out At Central Bankers: Stop Easing, You Are Crushing Us.” Europe’s largest bank, with the massive derivatives book, then upped the ante several months later in June, when its chief economist Folkerts-Landau launched a shocking anti-ECB rant in which it warned of social unrest and another Great Depression.

Ironically, these infamous diatribes hurt more than helped: telegraphing to the market just how hurt DB was as a result of the ECB’s monetary policy, the market punished its stock, which has been recently trading within spitting distance of all time lows, in effect making Deutsche Bank’s life even harder as it now has to contend not only with its own internal profitability problems, but also has to maintain a market-facing facade that all is well. So far, it has not worked out very well, prompting numerous comparisons to another infamous bank.

So, in what may have been DB’s loudest cry for help against the ECB’s unwavering commitment to rock-bottom interest rates, the bank’s CEO, John Cryan, warned in a guest commentary ahead of the Handelsblatt Banking Summit titled, appropriately enough “Banks in Upheaval”, to be held in Frankfurt on August 31 and September 1, that “monetary policy is now running counter to the aims of strengthening the economy and making the European banking system safer.

However, his most striking warning was not aimed at Mario Draghi, but at Germany itself – and ostensibly his own clients – implicitly suggesting that if Deutsche Bank goes down it is taking everyone down with it, when, as cited by Bloomberg, he warned of “fatal consequences” for savers and pension plans while “companies refrain from investments due to ongoing uncertainty and demand less loans.”

The details are known to those who have followed the paradox of central bank failure – if only for the economy and ordinary people –  summarized earlier today by Citi’s Matt King.

Quoted by Handelsblatt, Cryan warned that “the ECB’s policy is squeezing the margins of Europe’s struggling banks, making it harder for insurers to find profitable investments and dangerously distorting financial market prices.” Meanwhile, he added, the hoped-for benefits haven’t materialized. “Given the continued uncertainty, companies are holding back on investments and are hardly seeking any credit anymore,” he wrote.

While Cryan admits that the ECB’s intervention did avoid an all out collapse in Europe it has done so at extreme costs, like negative rates on most German debt. Which is why, Cryan writes it is high time for a change in direction at the ECB. He would say that: his bank is in the midst of a painful restructuring and battling to keep the confidence of investors, so the side effects of the ECB’s policy are causing it particular pain. That’s one reason why Mr. Cryan is particularly critical of the negative interest rate on bank deposits at the ECB. He said net interest income, traditionally the most important pillar of bank earnings in the euro zone,had fallen by 7 percent since 2009.

Meanwhile, the beneficiaries of the ECB’s asset reflation policy are few: only around nine million Germans own stocks, just over 10 percent of the population. The risk is now that savings will lie dormant in bank accounts without earning interest. Germany’s central bank, the Bundesbank, has calculated that Germany had a savings ratio of 9.7 percent for 2015, the highest level since 2010, and it’s likely to rise further in 2016. In the first quarter it was up 0.2 percentage points above the year-earlier level.

Worse may come if Cryan’s fatalistic warning comes true: after all, few CEOs ever talk of “fatal consequences”, especially since the context of these words has become so very clear.

The warnings for savers could not be any clearer.

Full article: Deutsche Bank CEO Warns Of “Fatal Consequences” For Savers (Zero Hedge)

Wednesday, August 24, 2016

Bubbles Part 2

Bubbles In Bond Land—-A Central Bank Made Mania, Part 2

by David Stockman • August 23, 2016

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I am in the throes of finishing a book on the upheaval represented by the Trump candidacy and movement. It is an exploration of how 30 years of Bubble Finance policies at the Fed, feckless interventions abroad and mushrooming Big government and debt at home have brought America to its current ruinous condition.

It also delves into the good and bad of the Trump campaign and platform and outlines a more consistent way forward based on free markets, fiscal rectitude, sound money, constitutional liberty, non-intervention abroad, minimalist government at home and decentralized political rule.

In order to complete the manuscript on a timely basis, I will not be doing daily posts for the next week or two. Instead, I will post excerpts from the book that crystalize its key themes and which also relate to the on-going gong show in the presidential campaigns and in the financial and economic arenas. Another of these is included below.

I am also working with my partners at Agora Financial on a new version of Contra Corner. More information on that will be coming later this month.

Trumped Final

Why The Eurozone Is A Financial Powder Keg

……….In short, Europe is a financial and political powder keg. The ECB is bluffing a $40 trillion debt market (including bank loans) and the Brussels apparatchiks are bluffing 340 million citizens.

The only problem is that the true facts of life are so blindingly obvious that it’s only a matter of time before these bluffs are called. And then the furies will break loose.

In the first place, the EU-19 is marching toward the fiscal wall and even Germany’s surpluses cannot hide the obvious. During the last six years, the collective debt-to-GDP ratio among the Eurozone nations has gone from 66% to 91% of GDP. The sheer drift of current policy momentum will take the ratio over the 100% mark long before the end of the decade.

Euro Area Government Debt to GDP

Secondly, notwithstanding the ebb and flow of short-term indicators, there is no evidence whatsoever that Europe is escaping its no growth rut. Indeed, euro area industrial output has continued to flat-line, and remains 10% below the pre-crisis peak, and even below the level achieved way back in 2002.

You can’t grow your way out of debt on the basis of a profile like that shown in the graph below. Even then, the underlying truth is more daunting because the picture is flattered by Germany’s exports to China and the EM that are fast coming to a halt.

Thirdly, the state sector in Europe has gotten so big that politics are paralyzed. Accordingly, it is virtually impossible that the true barrier to growth—crushing taxes and interventionist dirigisme—-can be eliminated.

Check out recent pro-market policy actions in Italy, France or Spain. There have been none that amount to anything—–unless you consider the newly conferred right of French shopkeepers to be open 12 Sundays per year rather than 5 to be anything other than symbolism.

In fact, since the financial crisis the state sector in the Eurozone has continued to envelop more and more of the GDP, rising from 45% of output in the EU-19 in 2007 to nearly 50% today.

So with no growth and rising debt, how long can the Brussels bureaucrats continue to bluff? The tables below—–which includes a breakdown of the EUR 331 billion that each of the Eurozone nations owe on Greece alone—suggests not for long.

Importantly, this table includes each country’s so-called Target 2 liabilities at the ECB, which has actually loaned EUR 110 billion to Greece against “collateral” provided by the Greek central bank. That collateral, of course, is the massive unpayable debt of the Greek government!

Is it possible that France could absorb its $70 billion share and see its 10-year bond remain at today’s 20 bps? Is it likely that Italy’s paralyzed government would last even a day if its $60 billion of Greek guarantees were called or that its 10-year bond would trade for even a nanosecond longer at today’s 1.20%?

Would not the bombastic crooks that run the Spanish government send a few legions of crusaders into Greece before they made good on the $42 billion they are on the hook for?  Would the bond speculators basking in the Riviera not hit the sell button at the sound of the Spanish hoofs?

So, yes, the euro and the Eurozone do not have a prayer of surviving. It is only a question of when the bluff of the German leadership and a handful of bureaucrats in Brussels and Frankfurt is called.

They have fed their electorates the delusion that Greece is fixed, financial markets have been stabilized and the rest of the Eurozone has benefited from the survival of the single currency.

In fact, worldwide bond managers and speculators are tickled pink because nearly all of Greece’s $350 billion of unpayable Greek debt—-on which they would have suffered grievous losses—— has been transferred to the taxpayers of the EU-18. Whatever the precise scenario and timing , therefore, this Big Lie will be exposed when the Greek economy and democracy finally buckles under the weight of the absurd obligations that have been imposed upon them by Merkel and the Brussels apparatchiks.

In a word, Greece is finished, the bailout commitments will be called, and all hell will break loose in a $20 trillion bond market that is in thrall to a raging central bank induced mania.

Barclays: Official exposure to Greece in EMU by country and type

Source: @FGoria The Lunatic Chase For Yield Is Global

The destruction of honest pricing in the European bond market is only the tip of the iceberg. Our lunatic central bankers have unleashed a worldwide pincer movement among market participants that is flat-out suicidal. To wit, the leveraged fast money gamblers everywhere on the planet are chasing prices ever higher as the sovereign bonds of “open to buy” central banks become increasingly scarce.

At the same time, desperate bond fund managers, who will lose their jobs for just sitting on cash, are chasing yields rapidly lower on any bond issued anywhere that still has a positive current return.

This is the reason, for example, that they are chasing yield out the duration curve to 30-year and even 50-year paper. Accordingly, the 30-year US treasury bond has produced a 22% return during the last six months. To say the least, that’s not shabby at all considering that its current yield is just2.25%.

All the rest, of course, is capital gains—–meaning that the whole scenario is nuts. A recent Wall Street Journal piece entitled, “35-Year-Old Bond Bull On Its Last Legs”,  quotes a European fund manager that explains why everything is going haywire:

Neil Dwayne, global strategist at Allianz Global Investors, is still buying. “Every piece of analysis we do on the bond market tells us they are structurally overvalued,” he said. But he is buying US Treasurys anyway. “That’s what you have to do when you have the ludicrous valuations in Europe and Japan.”

Exactly. The poor man is buying a bond he hates because Draghi and Kuroda have driven him out of what amounts to a $15 trillion corner of the sovereign debt market.

So in addition to front-runners on repo, we now have institutional fund managers from all over the world piling into the US bond market in a frantic chase after the last positive yield standing. Thus, when the 10-year US treasury note hit a low yield of 1.34% in July, it literally made history. There has never been a lower yield since 1790.

Needless to say, this planetary scramble for yield puts Janet Yellen right in the financial dunce chair where she belongs.

She and the rest of her posse keep insisting that 90 months of ZIRP and $3.5 trillion of bond-buying (QE) have so far produced no serious signs of over-valuation or bubbles. But, pray tell, what does she think is happening in the US Treasury market at this very moment?

Over the last seven years, the Fed has done it level best to drive US treasury yields into the sub-basement of economic plausibility. Now the other major central banks are helping it to finish the job.

Needless to say, with the other major 10-year government bonds actually in sub-zero land, this can’t go on much longer. The weighted average yield in the entire development world government bond market had skidded to just40 bps in early July. At the current rate of decline, the entire global market could be in the subzero zone by the end of the year.

You could call this central bank driven yield stripping. And the latter would be bad enough if its effects were limited to just the vast moral hazard it poses to governments and politicians all over the world.

After all, we are now entering the zone in which government debt is tantamount to free money. In fact, Germany issued new ten-year bunds recently which actually bear a negative coupon.

But as we suggested above, it is not just politicians who are being lulled into the delusion of free money. The central bank driven stampede for yield has spilled over into every nook and cranny of the fixed income and equity markets around the world.

Anything which prices on a spread basis against sovereign debt, or which is impacted by the endless destructive arbitrages that falsification of bond prices inherently generate, has been drastically over-valued.

The Destructive Frenzy In the US Corporate Bond Market

It now appears that US corporate bond issuance will hit a record $1.7 trillionthis year—-or 55% more than the last blow-off in 2007. And that is due to one reason alone——bond managers are desperate for yield and are moving out the risk spectrum exactly as our monetary central planners have ordained.

And that’s not the half of it. The other side of the coin is that the massive proceeds from this orgy of bond issuance are not going into productive investments in plant, equipment, technology and other forms of business efficiency and capacity enhancement. As we demonstrated in earlier chapters, real net business investment in the US is still 20% below its turn of the century level.

Instead, this corporate fund-raising spree is being cycled right back into the stock market in the form of share buybacks, M&A deals and other financial engineering maneuvers. Since the financial crisis, in fact, upwards of $7 trillion has gone into stock buy backs and M&A deals.

This massive purchasing power, in turn, has driven the stock market to the perilous heights described in Chapter 12. It has effectively turned America’s C-suites into stock trading rooms . Our stock option crazed CEOs and boards are doing nothing less than de-equitizing their balance sheets and eating their seed-corn.

Someday the due bill will arrive. But in the interim corporate finances are being ransacked owing to the scramble for yield set in motion by central banks and the $13 trillion of subzero sovereign debt that has been generated during the last two years.

But this monumental deformation is so recent that there is very little negative coupon debt that has yet been issued in the marketplace. Subzero land is overwhelmingly a phenomena of the secondary market, meaning $13 trillion of bonds are trading at significant premiums to par—-and, in some Japanese and German issues, massively so…..

Tuesday, August 23, 2016

Is the Big Short Here?

“Mother of all Shorts” when Stocks Cave to Reality?

by Wolf Richter • August 22, 2016

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“Everything feels distorted and unnatural”: Citigroup

On Monday, the S&P 500 index edged down 1.2 points. Over the last three trading days, the &P 500 has moved in a 12-point range, from 2175 to 2187. The index is now down a practically invisible 0.34% from its record close on August 15. Over the past 30 trading days, it had only five daily moves, up or down, of more than 0.5%, according to The Wall Street Journal, “equaling the lowest since October 1995.”

And trading volume has fallen asleep – much more so than during the normal summer lull. Even the algos appear to have been turned off for maintenance. Jared Woodard, a strategist at BofA Merrill Lynch, summarized it this way:

“Last week and the week before, you had to make sure your machine was actually on because it was flashing so infrequently.”

And no one is worried about anything.

The Chicago Board Options Exchange SPX Volatility Index (VIX) – the vaunted “fear index” – spent much of the past two weeks below 12, only a smidgen above the record low of July 2014.

In other words, nothing moves. But something has been moving: Earnings. The wrong way.

All-out financial engineering, record share buybacks, questionable accounting methods, such as those used by Valeant, and other tricks and devices [“The bezzle shrinks”: LendingClub, Theranos, Breitling Energy], have just one purpose: Drive up earnings, or at least “adjusted” ex-bad-items earnings per share that Wall Street likes to proffer, and that investors gobble up, eyes tightly closed, in a form of Consensual Hallucination.

But even those expertly doctored “adjusted” earnings per share of the S&P 500 companies have declined (on a trailing 12 months basis), according to FactSet, since their peak in November 2014 – for nearly two years, even as stocks have chased after new highs (red marks and text added):


Note the open-jaws syndrome between falling doctored “adjusted” earnings per share and rising stock prices. These two normally correlate. But no longer. They’ve been going into opposite directions for two years.

And earnings aren’t about to turn around. According to FactSet, “adjusted” earnings per share for the S&P 500 declined 3.2% in the second quarter. For the third quarter, the consensus forecast – so the optimistic case – is a decline of another 2%.

Analysts adjust their forecasts down as the quarter progresses so that companies have a chance to exceed these lowered expectations. A month from now, analysts will likely forecast an even larger decline in earnings. And they’re already forecasting an earnings decline for the entire year.

John Lonski, Chief Economist at Moody’s Capital Markets Research, when he mused that “overvalued equities threaten credit outlook,” put it this way:

Of late, the market value of US common stock is setting new record highs, notwithstanding the likelihood of a second straight annual decline by 2016’s broadest measure of pretax operating profits. As derived from the Blue Chip consensus forecast of early August 2016, profits will not at least match 2014’s apex until 2018 on a calendar-year basis.

So the Blue Chip optimist soothsayers think that earnings might not go back to the level of two years ago until 2018. And even as they’re saying this, earnings are still heading south.

Yet stocks are hovering at all-time highs, on very thin volume, and no one sees any risks to speak of, and earnings – even those beautifully doctored and “adjusted” earnings – for sure don’t matter anymore.

What underlies this paradisiacal faux reality?

Lousy economic data in an economy ruined by free money and hobbled by asset price inflation out the wazoo, where companies no longer have to show profits or profit growth or revenue growth, or anything at all, other than share buybacks interspersed with some delicious mergers & acquisitions and a good dose of layoffs….

Matt King, head of credit strategy at Citigroup, explains is this way to The Journal:

“Everything feels distorted and unnatural, you know the source of that is the central banks but equally there’s nothing to stop them carrying on.”

Some fearless central-bank non-believers, with one eye on the above chart, might call it “the mother of all shorts.” And many have gone done in flames.

For Wall Street and for investors listening to Wall Street, it has now been firmly established that central banks will always bail them out. No matter what. And no matter what the cost to the real economy. At first there was the “Greenspan put” (a put option is a form of protection against dropping prices). The Greenspan put led to the Financial Crisis, when stocks crashed in a dizzying manner.

This gave rise to the ferocious scorched-earth Bernanke put that included QE and zero-interest-rate policies. Since then, every time stocks or bonds more than squiggled, central banks – and not just the Fed – stepped in to rectify the situation with policies that have become ever crazier. This has taught investors a lesson:

Nothing matters anymore, nothing but central banks.

Now there’s the Yellen put. So far, she hasn’t disappointed. Occasionally, she mumbles something about valuations being “stretched” and warns about the “reach for yield,” but these words are just decoration around the edges of her put.

And now markets are more precarious than ever, with silly valuations and a historic debt overhang, the very result of all these central bank puts. Liquidity is thin. And markets tend to go haywire and apply maximum pain when investors, perhaps lulled to sleep by all these puts, least expect it. And here’s the thing: stocks crashed twice since 2000, despite the Fed’s puts. Why? Because reality suddenly got on top of them


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Bubbles Forever

Bubbles In Bond Land——A Central Bank Made Mania, Part 1

by David Stockman • August 22, 2016

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…..Sometimes an apt juxtaposition is worth a thousand words, and here’s one that surely fits the bill.

Last year Japan lost another 272,000 of its population as it marched resolutely toward its destiny as the world’s first bankrupt old age colony. At the same time, the return on Japan’s 40-year bond during the first six months of 2016 has been an astonishing 48%.

That’s right!

We aren’t talking Tesla, the biotech index or Facebook. To the contrary, like the rest of the Japanese yield curve, this bond has no yield and no prospect of repayment.

But that doesn’t matter because it’s not really a sovereign bond anymore.These Japanese government’s bonds (JGBs) have actually morphed into risk free gambling chips.

Front-running speculators are scooping up whatever odds and sots of JGB’s that remain on the market and are selling them to the Bank of Japan (BOJ) at higher and higher and higher prices.

At the same time, these punters face virtually no risk. The BOJ already owns 426 trillion yen of JGB’s, which is nearly half of the outstandings. And that’s saying something, given that Japan has more than one quadrillion yen of government debt which amounts to 230% of GDP.

Moreover, it is scarfing up the rest at a rate of 80 trillion yen per year under current policy, while giving every indication of sharply stepping-up its purchase rate as it segues to outright helicopter money.

It can therefore be well and truly said that the BOJ is the ultimate roach motel. At length, virtually every scrap of Japan’s gargantuan public debt will go marching into its vaults never to return, and at “whatever it takes” in terms of bond prices to meet the BOJ’s lunatic quotas.

The Big Fat Bid Of The World’s Central Banks

Surely, BOJ Governor Kuroda will go down in history as the most foolish central banker of all-time. But in the interim the man is contributing—-along with Draghi, Yellen and the rest of the central bankers’ guild—-to absolute mayhem in the global fixed income market.

The effect of their massive bond purchases or so-called QE policies has been to radically inflate sovereign bond prices. The Big Fat Bid of central bankers in the benchmark government securities sector, in turn, has caused drastic mispricing to migrate into the balance of the fixed income spectrum via spread pricing off the benchmarks, and from there into markets for converts, equities and everything else.

Above all else, the QE driven falsification of bond prices means that central banks have supplanted real money savers as the marginal source of demand in the government bond markets. But by their very ideology and function, central bankers are rigidly and even fiercely price inelastic.

For example, the madman Draghi will pay any price—-absolutely any price—–to acquire his $90 billion per month QE quota. He sets the price on the margin, and at present that happens to be a yield no lower than negative 0.4% for a Eurozone government security of any maturity. Presumably that would include a 500-year bond if the Portuguese were alert enough to issue one.

Needless to say, no rational saver anywhere on the planet would “invest” in the German 10-year bund at its recent negative 20 bps of yield. The operational word here is “saver” as distinguished from the hordes of leveraged speculators (on repo) who are more than happy to buy radically over-priced German bunds today.

After all, they know the madmen at the ECB stand ready to buy them back at an even higher price tomorrow.

Yet when you replace savers with central bankers at the very heart of the financial price discovery process in the benchmark bond markets, the system eventually goes tilt. You go upside down.

The Fiscal Equivalent Of A Unicorn—–“Scarcity” In Sovereign Debt Markets

That condition was aptly described in a recent Wall Street Journal piece about a new development in sovereign debt markets which absolutely defies human nature and the fundamental dynamics of modern welfare state democracies.

To wit, modern governments can seemingly never issue enough debt. This is due to the cost of their massive entitlement constituencies, special interest racketeers of every stripe and the prevalence of Keynesian-style rationalizations for not extracting from taxpayers the full measure of what politicians are inclined to spend.

Notwithstanding that endemic condition, however, there is now a rapidly growing “scarcity” of government debt—-the equivalent of a fiscal unicorn. As the WSJ noted:

A buying spree by central banks is reducing the availability of government debt for other buyers and intensifying the bidding wars that break out when investors get jittery, driving prices higher and yields lower. The yield on the benchmark 10-year Treasury note hit a record low Wednesday.

“The scarcity factor is there but it really becomes palpable during periods of stress when yields immediately collapse,’’ he said. ”You may be shut out of the bond market just when you need it the most.’’

Owing to this utterly insensible “scarcity”, central banks and speculators together have driven the yield on nearly $13 trillion of government debt—or nearly 30% of total outstandings on the planet—into the subzero zone. This includes more than $1 trillion each of German and French government debt and nearly $8 trillion of Japanese government debt.

Nor is that the extent of the subzero lunacy. The Swiss yield curve is negative all the way out to 48 years, where recently the bond actually traded at -0.0082%.

So we do mean that the systematic falsification of financial prices is the sum and substance of what contemporary central banks do.

Forty years from now, for example, Japan’s retirement colony will be bigger than its labor force, and its fiscal and monetary system will have crashed long before. Yet the 10-year JCB traded at negative 27 bps recently while the 40-year bond yielded a scant 6 basis points!

When it comes to government debt, therefore, it can be well and truly said that “price discovery” is dead and gone. Japan is only the leading edge, but the trend is absolutely clear. The price of  sovereign debt is where central banks peg it, not even remotely where real money savers and investors would buy it.

The world is even poorer ... In yield terms...after Brexit

Still, that’s only half the story, and not even the most destructive part. The truth of the matter is that the overwhelming share of government debt is no longer owned by real money savers at all. It is owned by central banks, sovereign wealth funds and leveraged speculators.

As to the latter, do not mistake the repo-style funding deployed by speculators with genuine savings. To the contrary, their purchasing power comes purely from credit (repo) extracted from the value of bond collateral, which, in turn, is being driven ever higher by the Big Fat Bid of central banks.

What this means is that real money savings—– which must have a positive nominal yield—-are being driven to the far end of the sovereign yield curve in search of returns, but most especially ever deeper into the corporate credit risk zone in quest of the same.

The Pure Lunacy Of Mario Draghi

Nowhere is the irrational stampede for yield more evident than in the European bond markets. After $90 billion per month of QE purchases by the ECB, European bond markets have been reduced to a heap of raging  financial market lunacy.

It seems that Ireland has now broken into the negative interest rate club, investment grade multinationals are flocking to issue 1% debt on the euro-bond markets and, if yield is your thing, you can get all of 3.50% on the Merrill Lynch euro junk bond index.

That’s right. You can stick your head into a veritable financial meat grinder and what you get for the hazard is essentially pocket change after inflation and taxes.

Remember, the average maturity for junk bonds is in the range of 7-8 years. During the last ten years Europe’s CPI averaged 2.0% and even during the last three deflationary years the CPI ex-energy averaged 1.2%.

So unless you think oil prices are going down forever or that the money printers of the world have abolished inflation once and for all, the real after-tax return on euro junk has now been reduced to something less than a whole number. It might be wondered, therefore, whether the reckless stretch for “yield” has come down to return free risk?

Well, no it hasn’t. Yield is apparently for desperate bond managers and other suckers.

In fact, among the speculators who wear big boy pants the bond markets are all about capital gains and playing momo games. It’s why euro junk debt—-along with every other kind of sovereign and investment grade debt—-is soaring. In a word, bond prices are going up because bond prices are going up. It’s an utterly irrational speculative mania that would do the Dutch tulip bulb punters proud.

In the days shortly before Draghi issued his “whatever it takes” ukase, for instance, the Merrill Lynch euro high yield index was trading at 11.5%. So speculators who bought the index then have made a cool 230% gain if they were old-fashioned enough to actually buy the bonds with cash.

And they are laughing all the way to their estates in the South of France if their friendly prime broker had arranged to hock them in the repo market even before payment was due. In that case, they’re in the 1000% club and just plain giddy.

BofA Merrill Euro High Yield Index 2016

Does Mario Draghi have a clue that he is destroying price discovery completely? Do the purported adults who run the ECB not see that the entire $20 trillion European bond market is flying blind without any heed to honest price signals and risk considerations at all?

Worse still, do they have an inkling that the soaring price of debt securities has absolutely nothing to do with their macroeconomic mumbo jumbo about “deflation” and “low-flation”?  Or that they are in the midst of a financial mania, not a ” weak rate environment” due to the allegedly “slack” demand for credit in the business and household sectors?

In fact, European financial markets are being stampeded by a herd of front runners who listen to Draghi reassure them on a regular basis that come hell or high water, the ECB will buy every qualifying bond in sight at a rate of $90 billion per month until March 2017. Full stop.

Never before has an agency of the state so baldy promised speculators literally trillions in windfall gains by the simple act of buying today what Draghi promises he will be buying tomorrow.

And that will be some tomorrow. As more and more sovereign debt sinks into the netherworld of negative yield and falls below the ECB’s floor (-0.4%), there will be less supply eligible for purchase from among the outstanding debt of each nation in the ECB’s capital key.

This is price fixing with a vengeance. It is no wonder that repo rates recently have plunged into negative territory.

But here’s the thing. The geniuses at the ECB are not cornering the market; they are being cornered by the speculators who are recklessly front-running the central bank with their trigger finger on the sell button.

Everything in the European fixed income market—sovereign and corporate—– is now so wildly over-priced and disconnected from reality that the clueless fools in Frankfurt dare not stop. They dare not even evince a nuance of a doubt.

So this is a house of cards like no other. Greece remains a hair from the ejection seat, yet everything is priced as if there is no “redenomination” risk.

Likewise, with the European economies still dead in the water, and notwithstanding some short-term data squiggles in the sub-basement of historic trends, the debt of Europe’s mostly bankrupt states is priced as if there is no credit risk anywhere on the continent outside of Greece.

Well then,  just consider three fundamentals that scream out danger ahead. Namely, public debt ratios continue to rise, GDP continues to flat-line, and the Eurozone superstate in Brussels continues to kick the can and bury its member states in bailout commitments that would instantly result in political insurrection in Germany, France and every other major European polity were they ever to be called……

Monday, August 22, 2016


What Does A Widening VSTOXX/VIX Spread Mean To The Underlying Equity Markets?

Aug. 22, 2016 11:57 AM ET

Mark Shore

Mark Shore

Shore Capital Research LLC


Over the past week the VSTOXX / VIX spread narrowed and then widened as the EURO STOXX 50 Index declined.

A one and two standard deviation move would price the spread between 8.8 and 12.5.

As a sentiment indicator could an overbought VSTOXX / VIX spread imply at least short-term support in the EURO STOXX 50 Index & the S&P 500?

My recent article " VSTOXX / VIX Spread May Imply An Equity Correction" discussed some of the basics of the spread and potential signals it may offer about the underlying EURO STOXX 50 index and the S&P 500 index. I received a lot of positive feedback and demand for this analysis, so I will be updating the spread data and analysis on a regular basis. Think of the spread as a sentiment indicator to be used in conjunction with other analytical tools.

Previously I discussed how the VSTOXX / VIX ($VIX) spread was wide and overbought at around 8.9, based on end of day data. Generally speaking it is difficult for the spread to continuously sustain a price above 8 to 10. As discussed previously, a break in the spread was probably going to occur. Since then the spread did decline to 6.34 by August 12th and rallied to 9.79 by August 19th.

During the past week most of the spread price change was due to the movement of VSTOXX spot as it rallied from 17.8981 on August 12th to 21.1313 on August 19th. Over the last five days the EURO STOXX 50 Index declined -2.52% and currently -9.16% for the year to date. This recent decline would explain why the VSTOXX index began to move higher this past week. Keep in mind the EURO STOXX 50 Index has yet to recover to the highs of 2007 or the highs of 2000 (see Chart 3).

During this past week the VIX spot price remained relatively stable bouncing in a range of the 12s to the 11s and closing on August 19th at 11.34.

Chart 1: Historical Daily Data of VSTOXX Spot, VIX Spot and VSTOXX/ VIX Spread

Source: Bloomberg data

Chart 1 shows the historical daily spot prices for VSTOXX, $VIX and the VSTOXX/ $VIX spread. As the chart notes, it is difficult for the spread to sustain spreads above 8 for an extended period of time. If you focus only on the positive spread pricing which is about 91% of the time; a one standard deviation move from the average price would price the spread at about 8.8. A two standard deviation move will price the spread at 12.5. Because most of the spread prices are positive, by adding in the negative prices, a one and two standard deviation move to the upside doesn't have a material impact on where it would be priced.

If the spread can't maintain a wide price and if VSTOXX spot should remain in the 20s or higher than the $VIX would have to move higher to narrow the range. Chart 1 also illustrates the spread often widens when both volatility indexes rally. But that wide price is often short-lived. There is a growing probability the $VIX will start to move off of its lows to narrow the spread price. This was discussed in detail with regard to the $VIX forward curve in my recent article " Is The VIX Forward Curve Giving Clues Of An Overbought Equity Market?"

Chart 2: Daily VSTOXX Spot / $VIX Spot Spread 6/1/1999 to 8/19/2016

Source: Bloomberg data

Chart 3: Daily Close EURO STOXX 50 Index 6/1/1999 to 8/19/2016

Source: Quandl

In summary, as of August 19th, the $SPX is only up 0.47% for the month even though it has made new highs recently. The market may be consolidating in the current range before it takes the next leg higher or perhaps it is showing signs of exhaustion before it begins to correct.

The EURO STOXX 50 Index declined this past week and will traders become cautious of further declines in the near future? This could be the catalyst for the VSTOXX / $VIX Spread to quickly widen and then narrow after the spread becomes overbought.

As a sentiment indicator keep an eye to see if the underlying equity markets seek at least a short-term bottom if the spread spikes into overbought territory.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.