Credit Markets

 

[Ed. note: for a change, we are presenting a post by a stock market bull below, namely Sid Riggs, via Bonner & Partners. It is always refreshing to see a well-reasoned argument that is contrary to one’s own opinion – after all, no-one really knows the future and Sid makes a number of important points, which deserve to be given attention. Sid is actually quite correct with respect to the historical correlation between rate hikes and the stock market. The strongest counter-points we can offer are these: 1. the market is extremely overvalued, 2. long-term positioning data show that everybody is “all in” already and 3. a rate hike would not be the first act of tightening monetary policy, but in fact the third. Act one was the “taper”, act two the cessation of QE. Given the paramount importance of money supply growth to stock prices, we would argue that the decisive factor will be whether or not commercial banks decide to expand credit.]

 

A Powerful Lesson from the Recent Past

There is a lot of lip service being paid to the stock market crash that we’re supposed to expect once the Federal Reserve starts raising rates. Every time we get close to a regularly scheduled Federal Reserve statement, financial pundits pontificate about the nuances of what the Fed chair might say, not say, or imply. It’s like clockwork.

 

 

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No-One is Paying Attention – Yet

Almost exactly one year ago, we penned several articles on what we believed to be a dangerous bubble in corporate debt. The boom in both prices and bond issuance was primarily driven by the desperate “hunt for yield” of investors starved of interest-income by the inane ZIRP and NIRP policies enacted by major central banks all over the developed world.

There is no need to rehash all the arguments we made at the time – as a refresher, readers may want to revisit “A Dangerous Boom in Unsound Corporate Debt” and “Comfortable Myths About High Yield Debt” for the details. So far, the potential dangers we identified at the time haven’t become fully manifest yet, but there are now signs that this may be about to change.

 

i promiseI promise!

Image credit: Minerva Studio

 

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Venezuela: Real Wages Collapse amid Continuing Crack-Up Boom

While the crack-up boom in Venezuela continues, real wages in the country have have utterly collapsed. The bolivar is still trading close to 700 to the US dollar on the black market, and the Caracas stock index keeps making new all time highs in nominal terms almost every day. Ironically, Venezuela’s currency is called the “bolivar fuerte” (VEF), i.e. “the strong bolivar” ever since it has been “reverse split” 1 for 1,000 in January 2008.

 

brain-drainImage via designlimbo.com

 

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Poor, Forlorn, and Neglected

Neither stocks nor gold moved much on Tuesday… “Wait and see,” remains the order of the day. The Greeks, for example, have 48 hours to come to terms with their creditors. We wait to see what will happen.

We wait to see what happens in the bond market, too. Have bonds topped out? Hard to say …   For six years the Fed and other major central banks have made a bad situation worse.

By promising to keep the cost of carrying debt ultra-low, they have encouraged governments and businesses to add trillions of dollars in debt to an already debt-drenched economy.

 

abeShinzo Abe, armed with his three arrows. He has so far managed to pump up the stock market and stomp on the currency, but he the third arrow has yet to find a worthy target.

Image via The Economist

 

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The Fuse Is Lit

We’re not the only ones giving Neanderthal advice about holding on to physical cash. British newspaper the Telegraph reports:

 

The manager of one of Britain’s biggest bond funds has urged investors to keep cash under the mattress. Ian Spreadbury, who invests more than £4bn of investors’ money across a handful of bond funds for Fidelity, is concerned that a “systemic event” could rock markets, possibly similar in magnitude to the financial crisis of 2008…

The best strategy to deal with this, he said, was for investors to spread their money widely into different assets, including gold and silver, as well as cash in savings accounts. But he went further, suggesting it was wise to hold some “physical cash,” an unusual suggestion from a mainstream fund manager.

 

gold certificateA 100,000 dollar gold certificate issued in 1934 – or what the dollar once was.

 

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The Story of Our Times

Dow up 180 points on Thursday. Gold rose $16, once again breaching the $1,200-an-ounce mark. The first number measures the value of America’s business. The second measures the measure.

We watch the two, but not closely. Most often, nothing important happens. There is no information content in the numbers. Just “noise.” Then, occasionally, they say something…

Many investors and analysts spend their time trying to figure out what the numbers will say next. That is like trying to guess what will come out next from the mouth of a raving lunatic.

 

6-blind-men-hansInvestors busy figuring out where things stand …

Cartoon by Hans Moeller

 

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An Interesting Background Noise Amid Increasing Bubble Talk

As we have previously pointed out, a sharp increase in “bubble talk” is often a danger sign (see “Circular Bubble Logic” for details). There is some anecdotal, as well as some quantifiable evidence for this (such as Google search statistics). There has certainly been quite a bit of talk about certain bonds having reached unsustainable levels, but generally our impression was that there was actually a lot of complacency as well. This is especially true with regard to low or even negative yielding European government bonds, which reflected one of the most egregious central bank-directed market distortions yet (more on this further below).

 

Bond-Bubble

 

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The Tip of the Iceberg

The dollar is always losing value. To measure the decline, people turn to the Consumer Price Index (CPI), or various alternative measures such as Shadow Stats or Billion Prices Project. They measure a basket of goods, and we can see how it changes every year.

However, companies are constantly cutting costs. If we see nominal – i.e. dollar – prices rising, it’s despite this relentless increase in efficiency.

 

small-dollarPhoto credit: Hirkophoto

 

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The Madness of Negative Bond Yields

As we have frequently discussed in these pages, time preference must always be positive on a society-wide basis – it is a praxeological law that future goods and/or satisfactions are valued at a discount to identical present goods. We emphasize “identical” here because sometimes people are asserting that there are exceptions, such as in the famous example that men would prefer having ice in the summer over having it in the winter (thus, in wintertime, ice available in the future would be valued more highly). However, “summer ice” is not identical to “winter ice”, even though it has the same physical properties. The reason is that the satisfaction if provides is not the same.

 

bank

 

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An Accelerating Trend

While the euro itself has recovered a bit from its worst levels in recent sessions, euro basis swaps have fallen deeper into negative territory. In order to bring the current move into perspective, we show a long term chart below that includes the epic nosedive of 2011. We are not quite sure what the move means this time around, since there is no obvious crisis situation – not yet, anyway.

A negative FX basis usually indicates some sort of concern over the banking system’s creditworthiness and has historically been associated with euro area banks experiencing problems in obtaining dollar funding. This time, the move in basis swaps is happening “quietly”, as there are no reports in the media indicating that anything might be amiss. Still, something is apparently amiss:

 

1-euro basis swapsParty like it’s 2011: Three month, one year, three year and five year euro basis swaps – click to enlarge.

 

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