US Federal Reserve

Worst Q2 start for S&P 500 since 1929

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ZeroHedge reported today that the S&P had its worst percentage 2nd quarter start since 1929 overnight. Both the Dow Jones Industrial Average broke below the 200 day moving average before an at the death rally to close above. Plunge Protection Team (PPT)? The broader S&P 500 failed to hold the 200 dma. All feels ominous. Awaiting the dead cat bounce. Short dated out of the money index put options continue to look ridiculously cheap relative to other asset classes. Gold also having a good day. Bitcoin showing its true value sliding below $7.000. Best to remember in a bear market the winner is the one who loses the least.

Some interesting reading

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John Mauldin has put together a few interesting pieces over the weekend. Some of the select quotes from Thoughts from the frontline:

Money Velocity (which CM wrote about in 2016):

velocity of money, which is continuing to fall, as it has for almost 20 years…So it is somewhat disturbing to see velocity now at its lowest point since 1949, and at levels associated with the Great Depression.”

Income Disparity:

Note that it is the 95th percentile of workers that has received the bulk of the increase in wages. The bottom 50% is either down or basically flat since 1979. Even the 70th percentile didn’t do all that well.

Budget Deficits:

Over the last half-century, higher deficits have been associated with recessions. After recessions end, the deficit shrinks, and occasionally we get a surplus. That’s not happening this time. Deficits are growing even without a recession…but in the next recession tax revenues will fall, and spending will increase enough to not only swell the annual deficit but also to add north of $2 trillion to the national debt each year. We’re using up our breathing room, and that will be a problem – sooner or later.

Monetary Policy:

Ominously, you can see from Grant’s labels (In the above chart) with arrows that peak yields tended to correspond with crises. If the current breakout persists, it is probably going to get its own label, and I bet we won’t like it.

Nothing to see here?

 

35% of US households have no retirement savings plan – St Louis Fed

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According to the St Louis Fed:

Overall, 35 percent of U.S. households do not participate in any retirement savings plan.

Even among those households that do hold retirement accounts, many of them have low account balances. Figure 1 plots the sum of account balances of all IRAs, Keogh accounts and pension plans by percentile for various age groups. The median (50th percentile) household holds only $1,100 in its retirement account. Even the 70th and 80th percentiles of households have only about $40,000 and $106,000 in their retirement accounts, respectively.

This is literally before the sh1t hits the fan.

Then we wonder why Roseanne tops the ratings charts…

Just how far behind the curve is the Fed?

As the Fed raised its Fed Funds Rate to 1.5~1.75% overnight, one has to question just how far behind is it? 3M Libor rates have surged from 0.5% in 2016, c.1% at the start of 2017 to 2.27% today, the highest levels since 2008.  Normally Libor minus Overnight Index Swap (OIS) rates don’t diverge so much without causing a credit issue. The gap is effectively the market price over and above the risk free rate. At the time of the GFC, the Libor-OIS spread hit 3.5%, with 1% being the detonator level. While it is currently at 0.54% spread, it has risen consecutively for the last 32 sessions.

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As Libor drives corporate credit recycling, with corporate debt piles approaching record highs and average credit ratings the worst they’ve been in over a decade (chart below depicts Top tier as AAA and bottom tier as BBB-) we could see the Libor-OIS spread keep expanding.

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What could be causing this? If we think logically the US Treasury has to refinance $1.5 trillion over the next 12 months and $8.4 trillion over the next 4 years. Add to that a Fed looking at quantative tapering and a less eager Japan and China as buyers of US$ federal debt then the corporate will undoubtedly get crowded out. The demands for refinancing are not being met with the supply of funds.

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Of note, the St Louis Fed reports the YoY increase in inflation reported by the CPI in the US in Feb 2018 was 2.3%. The 10yr breakeven inflation rate is around 2.08%. CPI ex food items is still at 1.9%. In any event the US remains in a negative real yield environment.

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The Fed can bang on all it wants about healthy growth, full employment but the depth of problems stored up is getting worse. $9 trillion in unfunded public pension liabilities, $67 trillion in combined public, private and corporate debt…

…many are recently talking of the huge pent-up profit boost to banks which have had such compressed spreads for so long. Indeed that all makes absolute sense from a theoretical (and to date practical) reasoning but banks like those in Australia up to their gills in mortgage debt, rising spreads have far nastier implications for blowing up balance sheets than boosting P&L accounts.

In a sense it is almost futile to call central banks as being behind the curve. The failure to take the harsh medicine of almost two decades ago is gathering momentum in so far as there is not much can left to kick down the road.

Credit card delinquency in America – nothing to see here?

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Waltzing through the treasure trove of data at the St Louis Fed, this chart intrigued. It shows delinquency rates on credit cards among the smaller banks. Presumably the smaller banks have to chase less credit worthy customers because they lack the ultimate battleship marketing cannons of the bigger financial instititutions. We’re back at times worse than the highest levels seen during GFC. Among all banks, we are still away off the $40bn of delinqient credit card debts we’re back at levels higher than those before Lehman’s brought financial markets to a grinding halt.

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Add to that the step up in interest rates as well to levels we saw before the whole edifice of cards came crumbling down.

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Then why worry when the number of financial institutions looking to tighten standards on consumer lending languishes at close to zero, the types of levels we saw ahead of the market collapse? Nothing to see here?

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Meanwhile American household savings languish at 3%. Similar levels as just before GFC  melt down. Not much in the rainy day funds. So when Trump’s new economic policy advisor Larry Kudlow starts telling us to back a strong dollar and weak gold, you know exactly what to do.

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Moral hazard was supposed to be contained at the private sector level. Looks as though this time around the government is joining the party.

Fasten your seatbelts!

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The “Fasten your seatbelts” edition (March 6, 2018) of the High-Tech Strategist by Fred Hickey is best read with antidepressants or a stiff drink. To be honest I hadn’t seen a copy of this research for at least 5 years. Today I’ve read it three times hoping I haven’t missed or misread anything. It is well reasoned and well argued. I would even admit to there being confirmation bias on my side but it is compelling. Usually confirmation bias is a worrying sign although prevailing sentiment or group think, it isn’t!

Perhaps the scariest claim in his report is a survey that showed 75% of asset managers have not experienced the tech bubble collapse in 2000. So their only reference point is one where central banks manipulated the outcome in 2007/8. S&P fell around 56% peak to trough. I often like to say that an optimist is a pessimist with experience. A lot of experienced punters have quit the industry post Lehman’s collapse, hollowing out a lot of talent. That is not to disparage many of the modern day punters but it does experience is a hard teacher because one gets the test first and the lesson afterwards.

Hickey cites an interview with Paul Tudor Jones who said that the new Fed Chairman Powell has a situation not unlike “General George Custer before the battle of the Little Bighorn” (aka Custer’s Last Stand). He spoke of $1.5 trillion in US Treasuries requiring refinancing this year. CM wrote that $8.4 trillion required refinancing in 4 years. In any event, with the Fed tapering (i.e. selling their bonds) couple with China and Japan feeling less willing to step up to the plate he conservatively sees 10yr rates hit 3.75% (now 2.8%) and 30 years rise above 4.5%. Now if we tally the $65 trillion public, private and corporate (worst average credit ratings in a decade) debt load in America and overlay that with a rising interest rate market things will get nasty. Not to mention the $9 trillion shortfall in public pensions.

Perhaps the best statistic was the surge in the number of articles which contained ‘buy-the-dip’ to an all time record. Such lexicon is often used to explain away bad news. It is almost as useless as saying there were more sellers than buyers to explain away a market sell off. In any event closing one’s eyes is a strategy.

Hickey runs through the steps leading up to and during the bear market that followed the tech bubble collapse. It was utter carnage. Bell wether blue chips like Cisco fell 88% from the peak. Oracle -83%. Intel -82%. Sun Microsystems fell 96%.

To cut a long story short, assets (bonds, equities and property) are overvalued. The Bitcoin bubble and consequent collapse have stark warnings that he saw in 2000. He recommends Gold, Gold stocks (which he claims are selling at deeper discounts than the bear market bottom) Silver, index and stock put options (Apple, Tesla, NVidia & Amazon) and cash. Can’t say CM’s portfolio is too dissimilar.

As Hickey says, “fasten your seatbelts

$8.4 trillion of the $21 trillion in US debt matures in 4 years. What could possibly go wrong?

E0F20948-4A5A-48F1-B8AF-06FA92EBAC7AWith a US Fed openly stating it is looking to prune its bloated balance sheet by around $2 trillion, it seems that $8.4 trillion of that debt held by the public matures within the next 4 years according to the US Treasury. To that end, debt maturing in the next 10 years totals $12.233 trillion. It needs to be ‘rolled over’. The national debt pile has jumped $1 trillion in the last 6 months. After the GFC and an overly accommodative central bank, the Treasury took advantage of this free money. Under President Obama, the debt doubled. That’s right, debt in his 8 years equaled that of the previous 43 administrations combined. Most of it was short term meaning the mop up operation starts earlier.

While there is little doubt this $8.4 trillion will be recycled, the question is at what price. With rising rates and a Fed back-pedaling one would expect the interest bill can only lift. At the moment the US federal government pays around $457 billion p.a. in interest alone. Average interest rates rose for the first time since 2006. Were average rates to climb back to 2007 levels then the interest bill alone would surpass $1 trillion.

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This global aversion to tightening belts continues. Many US corporations have taken the same approach to their balance sheets as the government as pointed out in the previous example on GE. Lever up and be damned with the credit rating as the spreads have been almost irrelevant to higher rated paper. It has been a financially credible decision to lower WACC and increase ROE provided one didn’t lose control and overdose on free money. However the relatively short duration on corporate debt is facing a similar refinancing cliff as the US government.

All this cumulative debt needing refinancing while credit ratings are on average the worst they’ve ever been in a rising interest rate environment coupled with a bubble in bonds while a growing number of these levered consumer and industrial stocks have negative equity. What could possibly go wrong?

Do we see the Fed reverse its decision and embark on more QE? Indeed to do such a thing would tank the dollar and send the yen back towards the 70s to the US$. Interesting times ahead. Throw on the $7 trillion shortfall in state public pension liabilities and watch the fire from the other side of the river. Finally some university think tank has come out saying that wiping out the $1.5 trillion in student debt would be ‘stimulatory’ to the economy adding 1.5 million jobs. What a world we live in when we get to walk away from responsibility and accountability.