Weekly Commentary: Cracks
After posting an intra-week high of 25,800 on Tuesday, the DJIA then dropped 1,583 points (6.1%) at the week's Friday morning low (24,217) - before closing the session at 24,538 (down 3.0% for the week). The VIX traded as low as 15.29 Tuesday. It then closed Wednesday at 19.85, jumped as high as 25.30 on Thursday and then rose to 26.22 in wild Friday trading, before reversing sharply to close the week out at 19.59.
Friday's session was another wild one. The Nasdaq Composite rallied 2.6% off early-session lows to finish the day up 1.1%. The small caps were as volatile, with an almost 1% decline turning into a 1.7% gain. The Banks had a 2.8% intraday swing and the Broker/Dealers 2.4%. The Biotechs had a 3.7% swing, ending the session up 3.2%. The Semiconductors swung 3.3%, gaining 1.8% on the day.
Friday morning trading was of the ominous ilk. Stocks, Treasuries, commodities and dollar/yen were all sinking in tandem. The VIX was surging. Japan's Nikkei dropped 2.5% in Friday trading, with Germany's DAX down 2.3% and France's CAC losing 2.4%. The emerging markets (EEM) were down as much as 1.7%. For the week, the DAX sank 4.6% and the Nikkei fell 3.2%. Curiously, bank stocks outside of the U.S. came under notable pressure. European banks (STOXX) dropped 3.5%, Hong Kong's Hang Seng Financial Index 4.5% and Japan's TOPIX Bank index 3.4%.
There are cracks - cracks in the U.S. and cracks spread globally. This week's market gyrations suggest these interconnected fissures will not prove transitory. VIX traders on edge. Risk parity and the CTA community on edge. ETF complex? Everything's turned correlated. Hedges have become expensive, and the Treasury hedge isn't working. The yen has taken on a life of its own. Central bankers playing coy. How long can all of this hold together?
This was never going to end well. It's just that raging bull markets are willing to disregard so much. Fully inebriated by the bottomless libation of easy money, markets in speculative blow-off mode gleefully ignore about everything. President Trump had stated he wanted tariffs. Fed Chairman Powell was clearly no clone of Drs. Yellen and Bernanke. The Bank of Japan couldn't stick with experimental monetary inflation forever. U.S. tax cuts won't transform either a flawed financial structure or maladjusted economy.
Speculative blow-offs and "Terminal Phase Excess" are fundamental to Bubble analysis. It's important to appreciate these culminations of excess are manifestations of Monetary Disorder. Invariably, prolonged bouts of asset inflation and Bubble Dynamics were fueled by some underlying monetary disturbance. Monetary policies remained excessively loose, with rates held too low for too long, often out of fear of lurking fragilities.
Over time, markets will disregard underlying vulnerabilities - or even be willing to conceive of them bullishly. After all, structural deficiencies ensure uninterrupted easy "money" and ever higher asset prices. Speculative leverage accumulates at compounding rates.
As the cycle extends and timid central banks dilly-dally, the gap widens dramatically between bullish perceptions and mounting systemic deficiencies - between inflating expectations and deteriorating fundamental prospects. This chasm, however, is well-masked by the remarkable inflation of perceived financial wealth, along with, let us not forget, the associated boosts in "money," Credit and market liquidity.
What's more, loose financial conditions and rapidly inflating asset markets stimulate economic activity, reinforcing misperceptions as to the underlying soundness of the boom. This Wealth Illusion becomes powerfully self-reinforcing throughout both the Financial and Real Economy Spheres. It is one of the great wonders of economic history - how everyone turns so blindly optimistic right before the bottom falls out.
Tremendous structural damage can be wrought during the "Terminal Phase." Financial flows go haywire, the reign of speculation dominates, markets turn whimsical, resources are terribly misallocated and systemic risk expands exponentially. Meanwhile, over-liquefied markets see sentiment turn wildly bullish. Misperceptions are rife, as rapidly mounting risks go completely unrecognized. When the spell is inevitably broken and markets reverse sharply lower, suddenly comes the recognition that things are not as previously perceived. So much changes so abruptly, as greed swings to fear.
Over the years, CBB analysis has focused on three epic and interrelated experiments: 1) Unfettered market-based finance. 2) A de-industrialized financial/services/consumption-based U.S. economic structure. 3) Activist central bank monetary inflation and market manipulation.
These runaway experiments have combined to inundate the world with "money" (dollar balances), inflating historic asset Bubbles at home and abroad. Unhinged U.S. finance cultivated unhinged finance globally. A Friday headline from ZeroHedge: "Pat Buchanan Blasts 'The Fatal Delusions of Western Man - We fed the Tiger, and Created a Monster...'" China is unequalled in terms of feeding off unfettered dollar-based finance while championing economic power, national wealth, military might and global ambitions. And not until Bubbles burst will we have a clearer understanding as to how much wealth has been redistributed and how much has been pilfered and destroyed - and to what regrettably great consequence.
Myriad global Bubbles have been fundamental to unprecedented wealth redistribution, inequalities and economic stagnation - potent fuel for populism and anti-globalization movements (Italian election Sunday). The backdrop has nurtured the rise of the strongman politician, dictator and despot. In a deeply divided world, seemingly the only common understanding is that central bankers and policymakers won't tolerate market dislocation, recession or crisis.
March 2 - Bloomberg (Joe Deaux, Andrew Mayeda, Toluse Olorunnipa, and Jeff Black): "President Donald Trump pushed back against a wave of criticism against steel tariffs, telling the world that not only are trade wars good, they are easy to win. Trump is facing anger from manufacturers and trade partners in China and Europe after announcing tariffs of 25% on imported steel and 10% on aluminum for 'a long period of time.' The formal order is expected to be signed next week. 'When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win,' Trump said in an early morning tweet on Friday."
March 2 - Axios (Mike Allen and Jonathan Swan): "President Trump has long mused about doing what he wants, when he wants, how he wants. He wanted tariffs on steel and aluminum - big ones - now. He wanted to negotiate with Congress - in public, on his court, surprise and shock, all for the cameras. He wanted to ditch any P.C. pretenses and consider Singapore-style death for all drug dealers. He wanted to play by his rules alone. Why it matters: His staff at times managed to talk him off the ledge. No more. Tired of the restraints, tired of his staff, Trump is reveling in ticking off just about every person who serves him."
Trump's Tariffs should come as little surprise. Perhaps markets are finally beginning to come to terms with the disequilibrium and turmoil of the Trump presidency. Rumors have it that Wall Street darling Gary Cohen, having lost on tariffs, could be on his way out. It's alarming to see the spectacle of the President referring to the Attorney General as "DISGRACEFUL," and Mr. Sessions pushing back with "I will continue to discharge my duties with integrity and honor…"
Top aid and close confidante Hope Hicks abruptly resigned this week, with National Security advisor H.R. McMaster's job said to be in jeopardy. Trump family members are under intense scrutiny, while chief of staff John Kelly has been under attack. After assailing the NRA and contemplating gun control, what might our President do next? Turn on the stock market? But hasn't he used surging equities to define the incredible merits of his leadership? Commentators Friday on Bloomberg TV used "unleashed" and "rogue." Not so easy to disregard the Washington spectacle when the markets are unsettled.
Fed Chairman Powell's testimony should have provided little surprise. He impressed as a traditional central banker. It's been awhile, and it sure was refreshing. Powell highlighted recent economic momentum and, as a disciplined central banker should at this point, demonstrated a resolve to move toward normalizing monetary policy. Our top central banker wasn't going to belabor the nuances of academic discussions on employment demographics or r-star. No talk of the economy's higher "speed limit" or of a "global savings glut."
The new Chairman is not in awe and, at least to commence his term, seems disinclined to pander to the markets. With greed waning, the change in tone was difficult for an uncomfortable Wall Street to ignore. Markets have grown too accustomed to central bank chiefs with an academic view of "efficient" markets - scholars wedded to doctrine that it's the role of central banks to bolster and backstop securities markets. Powell knows better. As the old saying goes, "he knows where the bodies are buried." Wall Street fancies the naïve. FT: "'Powell Put' Assumption Challenged as Fed Chief Shows Hand."
I believe Powell recognizes the perils associated with backstopping a speculative marketplace. That doesn't mean he won't be compelled to do it. At some point, he'll have little choice. But it likely means he will not act in haste. The Powell Fed will be much more cautious in delivering market assurances. He was skeptical of QE in the past, and I'll assume he knows he was right. He will resort to additional QE slowly and cautiously. Importantly, I believe the new Chairman will want to pull the Fed back to traditional central banking. His preference would be to conclude the monetary experiment - end the follies of "whatever it takes."
February 27 - Bloomberg (Jeanna Smialek): "Call them the star wars. Debate is heating up over whether the Federal Reserve's neutral interest rate -- commonly called r-star -- is about to head higher, and America's monetary policy outlook hinges on who has it right. In one corner, San Francisco Fed President John Williams and his co-authors think long-term factors are holding down the interest rate that neither stokes nor slows growth, so the Fed will have to stop lifting rates this cycle at a historically low endpoint. In the other, Goldman Sachs chief economist Jan Hatzius thinks the recent decline owes to cyclical factors and could reverse meaningfully, allowing the Fed to lift rates higher next year. The intellectual showdown is relevant as Jerome Powell heads to Capitol Hill Tuesday for his first testimony as Fed Chair, and as central bank-watchers look eagerly for hints about how the new chief expects r-star to evolve."
An incredible amount of intellectual effort is expended on "r-star," the Philipps Curve, NAIRU (non-accelerating inflation rate of unemployment), and the like. "R-star" - the neutral rate - is a myth. There is no single aggregate price level - there is no equilibrium interest rate. Importantly, the three epic experiments completely altered price dynamics throughout finance and real economies. Inflation is no longer too much money chasing too few goods. Too much "money" - in this age of momentous technological advancement, globalization and changes in the nature of economic output - no longer manifests primarily in problematic consumer price inflation.
There are instead powerful inflationary biases in securities and asset markets. Too much "money" - and activist central bank support - chasing limited quantities of securities (and upscale homes, commercial real estate, art, collectibles, etc.) The academics need to discard "r-star." Determining monetary policy based on some convoluted notion of aggregate consumer price indices (or economic equilibrium) in the current backdrop will ensure destabilizing loose finance for securities and asset markets.
In Powell's testimony, there was mention of the long-accepted view that central banks should not be in the business of Credit allocation. Yet contemporary central bankers have gone so far as to conspicuously favor the securities markets. This is fundamental as to why financial stability risks now reign supreme. Central bankers should take a broad view of monetary stability and begin extricating themselves from the business of incentivizing financial flows and speculation into the markets. I know others disagree, but I believe the majority of central bankers would prefer to return back to traditional monetary management. After almost a decade, they've grown weary - of the experiment; rationalizing the experiment; justifying the experiment.
March 2 - Bloomberg (Toru Fujioka): "The Bank of Japan will start thinking about how to exit its massive monetary stimulus program around the fiscal year starting in April 2019, Governor Haruhiko Kuroda said Friday, marking the first time he's provided any clear guidance on timing for normalizing policy. The yen surged, gaining as much as 0.5% to 105.71 per dollar, while yields on Japanese sovereign debt climbed across the curve. The Nikkei 225 Index closed 2.5% lower and the Topix Index fell 1.8%."
For the Week:
The S&P500 fell 2.0% (up 0.7% y-t-d), and the Dow dropped 3.0% (up down 0.7%). The Utilities sank 2.9% (down 7.8%). The Banks declined 2.0% (up 4.9%), while the Broker/Dealers were little changed (up 6.5%). The Transports fell 2.3% (down 2.6%). The S&P 400 Midcaps declined 1.3% (down 1.3%), and the small cap Russell 2000 dipped 1.0% (down 0.2%). The Nasdaq100 fell 1.2% (up 6.5%). The Semiconductors added 0.9% (up 8.8%). The Biotechs slipped 0.8% (up 10.3%). With bullion down $6, the HUI gold index declined 2.1% (down 10.0%).
Three-month Treasury bill rates ended the week at 1.61%. Two-year government yields were unchanged at 2.24% (up 36bps y-t-d). Five-year T-note yields added a basis point to 2.63% (up 42bps). Ten-year Treasury yields were little changed at 2.87% (up 46bps). Long bond yields declined two bps to 3.14% (up 40bps).
Greek 10-year yields declined three bps to 4.33% (up 25bps y-t-d). Ten-year Portuguese yields fell five bps to 1.99% (up 4bps). Italian 10-year yields sank 10 bps to 1.97% (down 5bps). Spain's 10-year yields fell five bps to 1.55% (down 2bps). German bund yields were unchanged at 0.65% (up 22bps). French yields dipped a basis point to 0.92% (up 14bps). The French to German 10-year bond spread narrowed one to 27 bps. U.K. 10-year gilt yields dropped five bps to 1.47% (up 28bps). U.K.'s FTSE equities index dropped 2.4% (down 8.0%).
Japan's Nikkei 225 equities index sank 3.2% (down 7.0% y-t-d). Japanese 10-year "JGB" yields gained two bps to 0.07% (up 2bps). France's CAC40 dropped 3.4% (down 3.3%). The German DAX equities index sank 4.6% (down 7.8%). Spain's IBEX 35 equities index lost 3.0% (down 5.1%). Italy's FTSE MIB index dropped 3.4% (up 0.3%). EM markets were lower. Brazil's Bovespa index declined 1.8% (up 12.3%), and Mexico's Bolsa dropped 2.3% (down 3.7%). South Korea's Kospi index fell 2.0% (down 2.6%). India's Sensex equities index slipped 0.3% (unchanged). China's Shanghai Exchange declined 1.0% (down 1.6%). Turkey's Borsa Istanbul National 100 index dipped 0.6% (up 1.3%). Russia's MICEX equities index fell 2.1% (up 8.5%).
Junk bond mutual funds saw outflows of $703 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates gained three bps to 4.43%, the high since January 2014 (up 33bps y-o-y). Fifteen-year rates jumped five bps to 3.90% (up 58bps). Five-year hybrid ARM rates declined three bps to 3.62% (up 48bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down five bps to 4.61% (up 31bps).
Federal Reserve Credit last week declined $3.1bn to $4.366 TN. Over the past year, Fed Credit contracted $60.6bn, or 1.4%. Fed Credit inflated $1.555 TN, or 55%, over the past 278 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $5.9bn last week to $3.418 TN. "Custody holdings" were up $243bn y-o-y, or 7.6%.
M2 (narrow) "money" supply declined $5.1bn last week to $13.843 TN. "Narrow money" expanded $553bn, or 4.2%, over the past year. For the week, Currency dipped $1.2bn. Total Checkable Deposits fell $9.3bn, while savings Deposits were little changed. Small Time Deposits added $1.5bn. Retail Money Funds gained $3.2bn.
Total money market fund assets declined $2.0bn to $2.842 TN. Money Funds gained $164bn y-o-y, or 6.1%.
Total Commercial Paper slipped $2.7bn to $1.092 TN. CP gained $121bn y-o-y, or 12.4%.
Currency Watch:
The U.S. dollar index added 0.1% to 89.935 (down 2.4% y-o-y). For the week on the upside, the Japanese yen increased 1.1%, the Norwegian krone 0.8%, and the euro 0.2%. For the week on the downside, the South African rand declined 3.1%, the Canadian dollar 1.9%, the Mexican peso 1.4%, the British pound 1.2%, the Australian dollar 1.1%, the New Zealand dollar 0.9%, the Swedish krona 0.9%, the Brazilian real 0.5%, the Swiss franc 0.1%, the South Korean won 0.1% and the Singapore dollar 0.1%. The Chinese renminbi declined 0.13% versus the dollar this week (up 2.54% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index dropped 2.2% (down 0.2% y-t-d). Spot Gold slipped 0.5% to $1,323 (up 1.5%). Silver declined 0.5% to $16.466 (down 4.0%). Crude sank $2.30 to $61.25 (up 1%). Gasoline jumped 5.0% (up 6%), and Natural Gas gained 2.7% (down 9%). Copper sank 3.4% (down 5%). Wheat surged 7.7% (up 17%). Corn jumped 2.9% (up 9.8%).
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
