martes, 19 de mayo de 2015

martes, mayo 19, 2015
"The End is Near!"

Bill Gross penned another interesting commentary, “A Sense of an Ending.” The title comes from a Julian Barnes novel, of which Gross pulls the following quote: “There is accumulation; there is responsibility, there is unrest – great unrest.”

Mr. Gross and I share similar analytical frameworks. He focuses on debt, while discussing a market cycle that commenced back in 1981 with Treasury bonds yielding 14.5%. Gross believes that the great Credit Cycle has about run its course.

It’s worth pulling some data from 1981. Emblematic of this historic boom, I’m fond of tallying Treasuries, Agency Securities, Corporate Bonds and Muni debt (from the Fed’s Z.1) as a proxy for “Total Debt Securities (TDS).” Total Equities are added to come to a value for “Total Securities.”

Back in 1981 Treasuries totaled $816bn, Agency Securities $324bn, Corporate Bonds $550bn and Muni debt $444bn. TDS ended 1981 at $2.134 TN, or 66% of GDP. At $1.382 TN, Total Equities amounted to 43% of GDP. This put “Total Securities” at $3.516 TN, or 109% of GDP.

Fast-forward to the end of 2014: Treasury Securities had inflated to $12.996 TN; Agency Securities to $7.934 TN; Corporate Bonds to $11.569 TN; and Municipal debt to $3.652 TN. Total Debt Securities grew to $36.152 TN, or 208% of GDP. Total Equities inflated to $36.457 TN, or 209% of GDP. Having inflated almost 2,000% since 1981, Total Securities ended 2014 at $72.608 TN, or an unprecedented 417% of GDP.

I really don’t prefer to come off as some whacko extremist, which perhaps helps explain why I highlight the thoughts of market gurus such as Bill Gross and Stanley Druckenmiller. From my analytical perspective, we’re in the “Terminal Phase” of a historic global experiment in electronic “money” and Credit, in “activist” monetary management and in economic structure. 

Getting somewhat closer to Bill Gross’s parlance, we’re in the endgame of a historic experiment in market-based finance. And in a 35-year Super-Bubble, it's only fitting that the endgame has things turning extraordinarily chaotic: Policy measures turn progressively desperate, throwing gas on increasingly manic and unhinged markets.

Back to the data: On the back of 209% growth of GSE Securities (to $3.916 TN) and 176% expansion of Corporate Bonds (to $4.480 TN), Total Debt Securities inflated 116% during the nineties to $13.506 TN. Total Equities inflated an incredible 416% during the decade to $19.401 TN. After beginning at 178%, Total Securities ended the nineties at 341% of GDP.

There were key developments during the nineties that remain fundamental to understanding today’s complex Bubble predicament. So I’ll keep pounding away. The move to “activist” monetary management under the prolonged reign of chairman Greenspan was paramount. The aggressive “asymmetrical” rate slashing provided a powerful backstop for risk-taking, certainly including leveraged securities speculation. Less obvious, the Fed’s early-nineties yield curve manipulation – covert bank recapitalization – provided extraordinary opportunities to profit from securities leveraging.

There’s another momentous development overlooked over the years. After “decade of greed” eighties excess, the post-Bubble backdrop was one of a highly impaired banking system. The savings & loan industry had collapsed. The Texas banks were wiped out. Even some major banking institutions (Citibank!) were in trouble, especially after the collapse of the coastal real estate Bubbles (East and West, commercial and residential). Greenspan took extraordinary measures, adopting “activist” policymaking that the Fed believed was justified because of mounting risks of economic depression and deflation. They’ve been fighting this bogeyman on and off now for 25 years.

There’s great irony in the free-market proponent Alan Greenspan morphing into the father of centrally planned “activist” monetary management. To be sure, this transformation changed history. Central to Greenspan’s thinking was the view that it was imperative to both recapitalize the banking system and spur market-based Credit expansion. It was the Fed’s role to ensure system reflation - a task left primarily to the GSEs, fledgling securities and derivatives markets and rapidly expanding broker/dealer and hedge fund industries (“Wall Street finance”).

It was believed that the upshot of safeguarding the banking system’s capital base would be a sounder financial system and stable economy. This view was closely related to the (Friedman/Bernanke) view that much of the Great Depression could have been avoided had the Fed recapitalized the banking system after the crash. Moreover, Greenspan saw a financial system where various risks (i.e. Credit, duration and liquidity) were dispersed throughout the “marketplace” as more robust than the traditional model of risk accumulating at highly leveraged banks. Central to this doctrine is that markets behave efficiently and rationally - i.e. self-adjustment around an equilibrium level, as opposed to unstable markets prone to self-reinforcing excess and Bubbles. This specious premise had New Age central bankers happy to intervene to backstop tottering markets without having to fret upside dislocations and Bubbles.

From a policy standpoint, market-based Credit proved phenomenally seductive. For one, the Fed then controlled history’s most powerful monetary transfer mechanism: system Credit, risk-taking and wealth could all be spurred along simply by contemplating a 25 bps reduction in the funds rate. At the same time, one could rest on a New Paradigm notion that markets were uniquely capable of properly pricing and allocating finance (along with real resources). 

Moreover, it was easy during the nineties to overlook the booming market in GSE securities, corporate bonds, ABS and an array of derivative products when traditional measures of boom-time banking excess were largely absent. Market-based Credit turned out to be unbelievably enticing - for market participants, bankers and central bankers.

History is unambiguous: Credit is inherently unstable. And for years I have argued that market-based Credit is highly unstable. And especially after recent years, I will add more generally that a market-based financial system is dangerously unstable. There is, however, a powerful counter-argument that is essentially the bedrock of today's bullish view on securities markets: Astute policymakers have come to garner the insight and employ the necessary tools to bolster and stabilize markets and, accordingly, economies. For better or worse, market-based finance and the attendant “activist” monetary management regime overpowered the world.

The evolution of policy saw aggressive rate cuts in response to systemic risk, active communication of policy intensions to the markets and even the orchestration of bailouts – later morphing into something more dangerous. “Activist” policymaking transformed into massive monetization and explicit market manipulation – whatever it takes to sustain the great securities bull market. Amazingly, the centrally planned inflation of risk markets became the prevailing monetary policy tool. After all, with securities markets having inflated to multiples of underlying real economies, ensuring strong (“bull”) markets became the central banks' chief “monetary transmission mechanism.” Moreover, with vulnerable economic structures, nothing would be tolerated that might risk pushing economies back into recession. The mighty bull market had to continue – for the good of all humanity.

Importantly, systemic risk rises exponentially during the “Terminal Phase.” The clearest example was the explosion of mispriced mortgage Credit during 2006/07 – surging quantities of high-risk loans/securities that depended on ever increasing quantities of high-risk lending, higher home prices and a thriving securities marketplace.

Today’s (not as discernable) “Terminal Phase” is dependent upon an unending stream of willing buyers of inflated securities in the face of mounting market and economic risks. It depends on corporate America’s insatiable appetite for its own stock. It depends on the leveraged speculating community staying in the game and remaining bullish. It absolutely relies on the system continuing to expand Credit – at home and abroad. And all of this is dependent upon “activist” policy measures that have pretty much run their course (over almost 30 years).

As an analyst of Bubbles, there’s always a fundamental question: What is the source of the Credit fueling the boom and how stable is it? If the boom is fueled by market-based finance, then there is an inherent stability issue. Years of policy measures to intervene and manipulate markets essentially foster a massive financial scheme – a confidence game. The question then becomes the relative stability or fragility of this scheme. At this point, what are the prospects for an expansion of Credit sufficient to sustain a historic Bubble in market-based finance?

And this gets right to the heart of the matter: Asset-based Credit rests on the ongoing inflation of asset prices. It is, after all, a real challenge to leverage an asset declining in value. As was experienced in 2009, faltering asset markets incite a self-reinforcing contraction of Credit and asset values. More generally, a system comprised largely of market-based finance rests upon ever-rising security market prices.

So how vulnerable is this edifice of market-based finance? Well, how much speculative leverage has accumulated? What is the scope and degree of market mispricing that creates vulnerability to a change in market perceptions? How much has “activist” central bank monetary management distorted market perceptions, prices and financial flows?

“Moneyness of Credit” was fundamental to the mortgage finance Bubble. I have argued that the “Moneyness of Risk Assets” has been integral to something much bigger - the global government finance Bubble. So all Bubble analysis now has an international component. 

Globally, there’s a prevailing market view that policymakers will backstop markets and economies. Stocks and bonds (and derivatives!) around the world are viewed as being superior liquid stores of value (money-like). This epic misperception comes compliments of the Fed, BOJ, ECB, SNB, BOE (global central banks generally) and Chinese officials.

When focusing on unfolding global fragilities, China will play a prominent role. Some twenty years after Greenspan, the Chinese fell into a similar trap: a push to “de-regulate” and safeguard their banking system led to a runaway expansion of risky non-bank and market-based finance. In the process they lost control of their financial and economic Bubbles. This week saw additional weak data out of China – and, of course, louder chatter of imminent major Chinese stimulus. In perhaps a sign of friction to come, China’s trade minister this week called out other countries’ currency devaluations as responsible for the waning competitiveness of Chinese manufacturers.

That China, a country of almost 1.4 billion, jumped aboard the global Credit Bubble is a key reason why I’m convinced in “Terminal Phase” analysis. That two of the world’s most powerful central banks - the Bank of Japan and European Central Bank – desperately resorted to rank currency devaluation is also central to my “End is Near!” thesis.

On the one hand, the unprecedented expansion of Chinese manufacturing capacity ensures an enduring supply overhang (and downside cost pressures) for scores of goods and commodities. 

As such, the irrepressible Chinese Bubble put the final dagger in the notion that respective central banks around the world control their domestic price levels. Meanwhile, BOJ and ECB devaluations incited massive speculative leveraging (“carry trades”), while providing a temporary new lease on life for leveraged macro “investing.” Market-based finance depends on rising securities prices. Denominated in yen and euros, global securities markets inflated tremendously over the past year.

As I focused on last week, the end result has been unprecedented market distortions and “Crowded Trade” problems. At this point, normalization is impossible. The Bubble must inflate or it falters. And last week I posed the question: “What more can policy measures do to promote additional speculative leveraging?” While these big “macro” speculative bets may continue to play out for now, the risk vs. reward calculus for being short the euro and yen is much less compelling today than six months ago.

European bond markets continued to unravel this week, with securities market pressures building globally. Friday’s payroll data (on the heels of the UK election) provided a decent risk-market jolt. At 5.3%, the April unemployment rate would seem to support the bullish view. 

Curiously, “king dollar” was unable to muster much of a Friday rally. Tuesday’s $51.4bn March trade deficit (“worst in six years”) followed by Wednesday’s dismal 1.9% decline in Q1 productivity supported the emerging view of unsound U.S. economic fundamentals.

From my analytical perspective, the dynamic underpinning U.S. Credit is unsound. First of all, traditional sources of Credit growth have been insufficient to sustain inflated securities markets and an unbalanced economic boom. It is my strongly held view that an array of speculative leverage is underpinning the U.S. Bubble. I suspect there is enormous leverage throughout the U.S. debt market - from T-bills, longer-term Treasuries to MBS to corporates. I would be surprised if there was not enormous leverage embedded in myriad derivative trading strategies. 

There is likely as well leveraging involved in about every source of yield – from dividend stocks, to perceived low-risk corporate bonds, to REITs, to commercial real estate and residential rentals.

There is also anecdotal support for my view that enormous amounts of global “hot money” have been flooding into U.S. asset markets – notably from China, Japan, Europe and Latin America. This helps to explain booming U.S. real estate markets in the face of paltry mortgage Credit growth. And how much leveraged speculative finance has been arriving via borrowing/shorting in (devaluing) yen and euros for easy profits in the bubbling market for king dollar securities?

In total, I believe domestic and foreign-sourced “hot money” would be measured in the Trillions. And I believe this Bubble Finance likely amounts to a substantial proportion of overall system finance, the “money” that feeds its way into spending, incomes, corporate cash-flows and government receipts. This is the finance that fuels the markets, makes the fiscal situation appear manageable and, importantly, spurs record stock buybacks. And it is this “money” the fuels asset markets higher, in the process ensuring loose corporate Credit conditions that drive an ongoing M&A boom. While most see a great bull market, I see a deeply systemic Bubble with dire consequences.

A period of wild volatility would be perfectly reasonable if indeed “The End is Near!” It appears global markets have entered just such a period.

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