US Federal Reserve

Time to “put” some eggs in this basket!

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In the everything bubble it is hard to find exposure to ‘relatively’ cheap things. Just a quick glance at the S&P500 index derivatives market one can see that ‘Put’ options (i.e. buying a put option gives the owner the right to sell at a particular strike price) prices are scraping the bottom of the barrel. While the above 2450 strike price (expires on 19 Jan 2018) seems a stretch for an S&P 500 Index showing 2662 (8.7% higher than the above put option) listening to outgoing Fed Chair Janet Yellen in the December FOMC press conference tells us that group think is alive and kicking. At least she admitted that,

The stock market has gone up a great deal this year…asset valuations are elevated….We see ratios in the high end of historical ranges…but Economists are not great at knowing what the right valuations are…we don’t have a terrific track record

Whatever the ultimate timing is of the impending pullback in asset bubbles, the downside will be extra ugly, especially now with so much market behaviour driven by robots with algorithms that have not been thoroughly tested in bear markets.  Time to own some longer dated put options me thinks. #MPGA (Make puts great again)

This can’t wait

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John Mauldin has written an informative piece entitled “this can’t wait” which sums up a lot of pieces I’ve written on the sickening state of public pension unfunded liabilities and the debt super cycle that is facing us. While Mauldin is trying to sell his investment services on the back of this, I wasn’t when I wrote mine. Public service announcement? Maybe but the stats of the black holes we face in pensions and central bank QE which has failed to boost money velocity will bite. Hard. There will be no “I told you so” glory because almost everyone will lose big.

Even if people want to criticize me for being a perma-bear there is no harm in being aware of what is likely coming.

Bitcoin now on prime time Japanese variety TV

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The picture above is of Tetsuro Degawa, a Japanese comedian who does his best to show himself to have little intelligence. On prime time TV tonite he was talking about Bitcoin. The sign to the right partially says “can you understand Bitcoin in 5 minutes?” 

Japanese TV audiences generally gasp at new information so Bitcoin was a subject of great interest. Still one wonders if Degawa is presenting on the crypto currency that we’re one stage away from the taxi driver giving tips.

Today, Bitcoin is trading over $15,000 up another 13% today alone. Apparently Warren Buffett has disclosed Berkshire Hathaway has bought some too.

In 20 years in financial markets I cannot work out how something backed by nothing other than greed in a market that is not regulated and highly vulnerable to cyber terrorism continues to sucker more people in.

Tulip mania may be removed as the bubble yardstick before long. As one of my experienced private wealth managers likes to say, “I have difficulty fathoming the “no euphoria this time” view.”

Houston we have a housing problem

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Yes, Australian banks are the most levered to the Home mortgage market. Over 61%. Daylight comes second followed by Norway and Canada. US banks are half the Aussies. Of course any snapshot will tell us that prices are supported by immigration and a robust economy. However when Aussie banks are c.40% exposed to wholesale markets for credit (Japanese banks are around 95% funded by domestic depositors) any turn around in global interest rates means Aussie banks will pay more and eventually be forced to pass it on to tapped out borrowers. The Reserve Bank of Australia kept interest rates flat while tacitly admitting its stuck

A study back in March showed that in Western Australia almost 50% of people with a home loan would be in stress/severe stress if rates jumped 3%. Victoria 42% and bubbly NSW at 38%. I can’t remember bubble Japan property (as dizzy as it got) experienced such stress. A recent ME Bank survey in Australia found only 46 per cent of households were able to save each month. Just 32 per cent could raise $3000 in an emergency and 50 per cent aren’t confident of meeting their obligations if unemployed for three months.

The Weekend AFR reported that according to Digital Finance Analytics, “ there are around 650,000 households in Australia experiencing some form of mortgage stress. If rates were to rise 150 basis points the number of Australians in mortgage stress would rise to approximately 930,000 and if rates rose 300 basis points the number would rise to 1.1 million – or more than a third of all mortgages. A 300 basis point rise would take the cash rate to 4.5 per cent, still lower than the 4.75 per cent for most of 2011.”

The problem for Aussie banks is having so many mortgage loans on their books backed against lofty housing prices means that we could face a situation of zombie lending. The risk is that once the banks mark-to-market the real value of one house that is foreclosed upon the rest of the portfolio then starts to look shady and all of a sudden the loss ratios blow out to unsustainable levels. So for all the negative news flow the banks cop for laying off staff while making billions, note net interest margins continue to fall and when confidence falls out of the housing market, the wholesale finance market will require sizable jumps in risk premiums to compensate. Indulge yourself with the chart pack from the RBA on pages 29 & 30 where net margins are 50% lower than they were in 2000, profitability under pressure, non performing loans starting to rise back toward post GFC levels…call me pessimistic but housing prices to income is at 13x now vs only 7x when GFC bit, how is that safety net working for you?

Some may mock, but there is every chance we see a semi or total nationalization of the Aussie banks at some point in the future. Nobody will love the smell of napalm in the morning but then again when the Vic government is handing out interest free loans to the value of 25% of the house price for first home buyers you know you’re at the wrong point in the cycle. Maybe TARP is just short for tarpaulin.

Tesla – 30 reasons it will likely end up a bug on a windshield

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Contrarian Marketplace ー Tesla – 30 Reasons it will likely be a bug on a windshield

Contrarian Marketplace Research (CMR) provides 30 valid reasons to show Tesla (TSLA) is richly valued. Institutional investors have heard many of the financial arguments of its debt position, subsidies, cash burn and other conventional metrics. What CMR does is give Tesla all the benefits of the doubt. Even when extended every courtesy based on Tesla’s own 2020 production target of 1,000,000 vehicles and ascribing the margins of luxury makers BMW Group (BMW GR) & Daimler (DAI GR) the shares are worth 42% less than they are today. When stacked up against the lower margin volume manufacturers, the shares are worth 83% less. There is no fuzzy math involved. It is merely looking through a different lens. We do not deny Tesla’s projected growth rates are superior to BMW or DAI but the risks appear to be amplifying in a way that exposes the weak flank of the cult that defines the EV maker- ‘production hell’.

Follow social media feeds and Tesla’s fans bathe in the cognitive dissonance of ownership and their charismatic visionary, CEO Elon Musk. No-one can fault Musk’s entrepreneurial sales skills yet his business is at the pointy end of playing in the major leagues of mass production, which he himself admitted 18 months ago was a ‘new’ challenge. Let us not kid ourselves. This is a skill that even Toyota, the undisputed king of manufacturing, a company that has coined pretty much every industrial efficiency jargon (JIT, Kanban, Kaizen) has taken 70 years to hone. It might have escaped most investors’ attention but Lockheed Martin called on Toyota to help refine the manufacturing processes of the over budget F-35 Joint Strike Fighter. If that is not a testament to the Japanese manufacturer’s brilliance Tesla is effectively Conor McGregor taking on Aichi’s version of Floyd Mayweather.

Yet Tesla’s stock has all the hallmarks of the pattern we have seen so many times – the hype and promise of disruptors like Ballard Power, GoPro and Blackberry which sadly ended up in the dustbin of history as reality dawned. Can investors honestly convince themselves that Tesla is worth 25x more than Fiat Chrysler (a company transformed) on a price to sales ratio? 10x Mercedes, which is in the sweet spot of its model cycle?

Conventional wisdom tells us this time is different for Tesla. Investors have been blinded by virtue signalling governments who are making bold claims about hard targets for EVs even though those making the promises are highly unlikely to even be in office by 2040. What has not dawned on many governments is that 4-5% of the tax revenue in most major economies comes from fuel excise. Fiscal budgets around the world make for far from pleasant viewing. Are they about to burn (no pun intended) such a constant tax source? Do investors forget how overly eager governments made such recklessly uncosted subsidies causing the private sector to over invest in renewable energy sending countless companies to the wall?

Let us not forget the subsidies directed at EVs. The irony of Tesla is that it is the EV of the well-heeled. So the taxes of the lawnmower man with a pick-up truck are going to pay for the Tesla owned by the client who pays his wages to cut the lawn. Then we need look no further than the hard evidence of virtue signalling owners who run the other way when the subsidies disappear.

To prove the theory of the recent thought bubbles made by policy makers, they are already getting urgent emails from energy suppliers on how the projections of EV sales will require huge investment in the grid. The UK electricity network is currently connected to systems in France, the Netherlands and Ireland through cables called interconnectors. The UK uses these to import or export electricity when it is most economical. Will this source be curtailed as nations are forced into self-imposed energy security?

So haphazard is the drive for EV legislation there are over 200 cities in Europe with different regulations. In the rush for cities to outdo one another this problem will only get worse. Getting two city councils to compromise is one thing but 200 or more across country lines? Without consistent regulations, it is hard to build EVs that can accommodate all the variance without boosting production costs. On top of that charging infrastructure is an issue. Japan is a good example. Its EV growth will be limited by elevator parking and in some suburban areas, where car lots are little more than a patch of dirt where owners are unlikely to install charging points. Charging and battery technology will keep improving but infrastructure harmonisation and ultimately who pays for the cost is far from decided. With governments making emotional rather than rational decisions, the only conclusion to be drawn is unchecked virtuous bingo which will end up having to be heavily compromised from the initial promises as always.

Then there are the auto makers. While they are all making politically correct statements about their commitments to go full EV, they do recognise that ultimately customers will decide their fate. A universal truth is that car makers do their best to promote their drivetrains as a performance differentiator to rivals. Moving to full EV removes that unique selling property. Volkswagen went out of its way to cheat the system which not only expressed their true feelings about man-made climate change but hidden within the $80bn investment is the 3 million EVs in 2042 would only be c.30% of VW’s total output today. Even Toyota said it would phase out internal combustion in the 2040s. Dec 31st, 2049 perhaps?

Speaking to the engineers of the auto suppliers at the 2017 Tokyo Motor Show, they do not share the fervour of policy makers either. It is not merely the roll out of infrastructure, sourcing battery materials from countries that have appalling human rights records (blood-cobalt?) but they know they must bet on the future. Signs are that the roll out will be way under baked.

While mean reversion is an obvious trade, the reality is that for all the auto makers kneeling at the altar of the EV gods, they are still atheists at heart. The best plays on the long side are those companies that happily play in either pond – EV or ICE. The best positioned makers are those who focus on cost effective weight reduction – the expansion of plastics replacing metal has already started and as autonomous vehicles take hold, the enhanced safety from that should drive its usage further. Daikyo Nishikawa (4246) and Toyoda Gosei (7282) are two plastics makers that should be best positioned to exploit those forking billions to outdo each other on tech widgets by providing low cost, effective solutions for OEMs. Amazing that for all of the high tech hits investors pray to discover, the dumb, analogue solution ends up being the true diamond in the rough!

Ultra High Net Worth Individuals (by country)

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In an ever growing world of haves vs have nots, Elliman has released an interesting update on the statues of global wealth and where it is likely to head over the next decade. It suggests North America has 73,100 UNHWIs at an average of $100mn each or $7.31 trillion. To put that in perspective 73,100 North Americans have as much wealth as Japan & France’s annual output combined. Over the next decade they expect 22,700 to join the ranks.

Europe has 49,650 UHNWI also at the magical $100mn mark (presumably the cut off for UHNWI or the equivalent of Japan.

Asia is growing like mad with $4.84 trillion split up by 46,000 or $105mn average. In a decade there are forecast to be 88,000 UHNWIs in Asia.

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I am not sure what the World Bank was smoking when coming up with the coming forecasts I’ve rthe next decade but the figures smel fishy.  Then it all comes down to this chart.

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1) Political uncertainty? Everywhere you look – Trump, Brexit, Catalonia, Australia, France, Germany, Austria, Czech Republic, The Netherlands, Hungary, Poland etc etc

2) Potential fall in asset values – looks a very high chance of that. Current asset bubbles are almost everywhere – bonds, equities, real estate etc

3) Rising taxes – maybe not the US or Canada (if you follow the scrutiny over Finance Minister Morneau), but elsewhere taxes and or costs of living for the masses are rising

4) Capital controls – China, India etc

5) Rising interest rates – well the US tax cuts should by rights send interest rates creeping higher. A recent report showed 57% of Aussies couldn’t afford an extra $100/month in mortgage – a given if banks are forced to raise lending rates due to higher funding costs (40% is wholesale finance – the mere fact the US is raising rates will only knock on to Aus and other markets).

Surely asset prices at record levels and all of the other risk factors seemingly bumping into one another…

So while UHNWIs probably weather almost any storm, perhaps it is worth reminding ourselves that the $100mn threshold might get lowered to $50m. It reminds me of a global mega cap PM who just before GFC had resplendent on his header “nothing under $50bn market cap”. Post GFC that became $25bn then eventually $14bn…at which point I suggested he change the header entirely.

I had an amusing discourse on LinkedIn about crypto currencies. The opposing view was that this is a new paradigm (just like before GFC) and it would continue to rise ( I assume he owns bit coins). He suggested it was like a promissory note in an electronic form so has a long history dating back millennia. I suggested that gold needs to be dug out of the ground – there is no other way. Crypto has huge risk factors because it is ultimately mined in cyber space. State actors or hackers can ruin a crypto overnight. There have already been hacking incidents that undermine the safety factor. It does’t take a conspiracy theory to conjure that up. To which he then argued if it all goes pear shaped, bitcoin was a more flexible currency. Even food would be better than gold. To which I suggested that a border guard who is offering passage is probably already being fed and given food is a perishable item that gold would probably buy a ticket to freedom more readily as human nature can adapt hunger far more easily in the fight for survival. I haven’t heard his response yet.

In closing isn’t it ironic that Bitcoin is now split into two. The oxymornically named Bitcoin Gold is set to be mined by more people with less powerful machines, therefore decentralizing the network further and opening it up to a wider user base. Presumably less powerful machines means fewer safeguards too although it will be sold as impervious to outsiders. Of course the idea is to widen the adoption rate to broaden appeal. Everyone I know who owns Bitcoin can never admit to its short comings. Whenever anything feels to be good to be true, it generally is. Crypto has all the hallmarks of a fiat currency if I am not mistaken? While central banks can print furiously, they will never compete with a hacker who can digitally create units out of thin air. Fool’s Gold perhaps? I’ll stick to the real stuff. I’ll take 5,000 years of history over 10 years any day of the week.

When the “best” of today is far worse than the worst of the worst in 70 years

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The St Louis Fed records that in the last 70 years, the average time one is in a state of unemployment (i.e. duration) in America is now 25 weeks (6 months). Assuming that we are in the sweet spot of a tight labour market we can see clearly that this  post-GFC ‘recovery’ at its best is 25% worse than the worst we have seen over seven decades of post recession recoveries which has barely nudged over 20 weeks. Looking at CEO Bullard’s remarks in a presentation back in April 2016, titled ‘Slow normalization or no normalization?’ that these are extraordinary times.