The Raw Deal
We stepped out on our front stoop Wednesday morning and paused to take it all in. The sky was at its darkest hour just before dawn. The air was crisp. There was a soft coastal fog. The faint light of several stars that likely burned out millennia ago danced just above the glow of the street lights.
And this is what they saw watching the sky from Mt. Wilson that night…
If one searches for news on LIBOR (=London Interbank Offered Rate, i.e., the rate at which banks lend dollars to each other in the euro-dollar market), they are currently dominated by Deutsche Bank getting slapped with a total fine of $775 million for the part it played in manipulating the benchmark rate in collusion with other banks (fine for one count of wire fraud: US$150 m.; additional shakedown by US Justice Department: US$625 m., the price tag for a deferred prosecution agreement).
Blow-Off Pattern Recognition
As noted in Part 1, historically, blow-patterns in stock markets share many characteristics. One of them is a shifting monetary backdrop, which becomes more hostile just as prices begin to rise at an accelerated pace, the other is the psychological backdrop to the move, which entails growing pressure on the remaining skeptics and helps investors to rationalize their exposure to overvalued markets. In addition to this, the chart patterns of stock indexes before and after blow-off moves are displaying noteworthy similarities as well.
“On Margin” – a late 1929 cartoon illustrating the widespread obsession with the stock market at the time. There was just a 10% margin requirement, i.e., investors could leverage their capital at a ratio of 10:1. The demand for margin credit was so strong, that it pushed call money lending rates in New York up quite noticeably. This in turn made it increasingly difficult to maintain extremely leveraged positions.
Why is the stock market seemingly so utterly oblivious to the potential dangers and in some respects quite obvious fundamental problems the global economy faces? Why in particular does this happen at a time when valuations are already extremely stretched? Questions along these lines are raised increasingly often by our correspondents lately. One could be smug about it and say “it’s all technical”, but there is more to it than that. It may not be rocket science, but there are a few issues that are probably not getting the attention they deserve.
The stock market has blown widespread expectations out of the water by embarking on a seemingly unstoppable rally since Donald Trump was elected POTUS.
Cartoon by Frank Hanley
As you can see below, we have marked “Brexit day” on the chart as well, which was another noteworthy juncture. Not only was the success of the “Leave” campaign just as big a surprise as Trump’s election victory, but it was yet another occasion on which the market ended up fooling most observers by dramatically reversing course after a mere two days of relatively mild panic selling.
Looming Currency and Liquidity Problems
The quarterly meeting of the Incrementum Advisory Board was held on January 11, approximately one month ago. A download link to a PDF document containing the full transcript including charts an be found at the end of this post. As always, a broad range of topics was discussed; although some time has passed since the meeting, all these issues remain relevant. Our comments below are taking developments that have taken place since then into account.
USD-CNY, the onshore exchange rate of the yuan vs. the USD. After years of relentless appreciation, the yuan topped in early 2014 and has weakened just as relentlessly ever since. The yuan’s top coincided with the beginning of the “tapering” of the Fed’s QE3 debt monetization program and the peak in China’s foreign exchange reserves at just below $4 trillion. There was practically no lead time involved, which is rare. Although the yuan is not convertible and therefore by definition a “manipulated currency” (is there a fiat currency that isn’t manipulated?), the assertion that China’s authorities are deliberately weakening the yuan is erroneous. The opposite is true: they are trying to keep it from falling or are at least trying to slow down its descent with every trick in the book (every intermittent phase of yuan strength since the beginning of the decline was triggered by intervention). Understandably so: due to the close correlation between the level of forex reserves and credit and money supply growth in China, a rapid depletion of reserves is likely to impact the country’s giant credit bubble. One of the moving parts in this equation are bank reserve requirements, which the PBoC essentially uses to control the extent of credit growth triggered by the accumulation of reserves (a.k.a. “sterilization”). These peaked at 21.5% in June 2011 and were since then lowered to 17% to keep domestic credit expansion going – click to enlarge.
A Shift in Expectations
When discussing the outlook for so-called “risk assets”, i.e., mainly stocks and corporate bonds (particularly low-grade bonds) and their counterparts on the “safe haven” end of the spectrum (such as gold and government bonds with strong ratings), one has to consider different time frames and the indicators applicable to these time frames. Since Donald Trump’s election victory, there have been sizable moves in stocks, gold and treasury bonds, as the election result has strongly boosted certain market expectations.
A Quick Chart Overview
Below is an overview of charts we picked to illustrate the current market situation. The selection is a bit random, but not entirely so. The first set of charts concerns positioning and sentiment. As one would expect, these look fairly stretched at the moment, but there are always ways in which they could become even more stretched. First a look at the NAAIM exposure index:
A Very Odd Growth Spurt in the True Money Supply
The growth rates of various “Austrian” measures of the US money supply (such as TMS-2 and money AMS) have accelerated significantly in recent months. That is quite surprising, as the Fed hasn’t been engaged in QE for quite some time and year-on-year growth in commercial bank credit has actually slowed down rather than accelerating of late. The only exception to this is mortgage lending growth – at least until recently. Growth in mortgage loans is still very slow though, especially compared to historical growth rates. It cannot really account for the recent surge in money supply growth either.
Year-on-year growth rates of TMS-2 (11.19%, black line) and total loans and leases at commercial banks (7.7%, red line) as of October. In absolute terms money TMS-2 has soared by a staggering $840 billion since the beginning of the year – click to enlarge.
Most read in the last 20 days:
- Gold – An Overview of Macroeconomic Price Drivers
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- Doomsday Device
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- India – Is Kashmir Gone?
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- Pulling Levers to Steer the Machine
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- Credit Contraction Episodes
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- Cracks in Ponzi-Finance Land
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- Mea Culpa – Precious Metals Supply and Demand
Input Data Errors Dear Readers, I owe you an apology. I made a mistake. I am writing this letter in the first person, because I made the mistake. Let me explain what happened. The wrong stuff went into the funnel in the upper left-hand corner... I wrote software to calculate the gold basis and co-basis (and of course silver too). The app does not just calculate the near contract. It calculates the basis for many contracts out in the distance, so I can see the...
- French Election – Bad Dream Intrusion
The “Nightmare Option” The French presidential election was temporarily relegated to the back-pages following the US strike on Syria, but a few days ago, the Economist Magazine returned to the topic, noting that a potential “nightmare option” has suddenly come into view. In recent months certainty had increased that once the election moved into its second round, it would be plain sailing for whichever establishment candidate Ms. Le Pen was going to face. That certainty has been...
- The Cost of a Trump Presidency
Opportunity Cost Rears its Head Last Thursday’s wanton attack on a Syrian air field by the US and its bellicose actions toward North Korea have brought the real cost of candidate Trump’s landslide victory last November to the forefront. It didn't take long for Donald Trump to drop his non-interventionist mask. The decision was likely driven by Machiavellian considerations with respect to domestic conditions, but that doesn't make it any better. Unlike...
- Heavily Armed Swamp Critters
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- Hell To Pay
Behind the Curve Economic nonsense comes a dime a dozen. For example, Federal Reserve Chair Janet Yellen “think(s) we have a healthy economy now.” She even told the University of Michigan’s Ford School of Public Policy so earlier this week. Does she know what she’s talking about? Somehow, this cartoon never gets old... If you go by a partial subset of the ‘official’ government statistics, perhaps, it appears she does. The unemployment...
- Trump Is An Insider Now
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