On Economy

Well-Trained Japanese Investors are Shorting the Nikkei

We have been a bit surprised to learn that short bets on Japanese stocks have recently surged significantly. Evidently, Japanese investors are well-trained by now: they don’t expect rallies in Japan’s stock market to hold or continue. However, Japanese stocks actually remain fundamentally quite cheap, in spite of the notable surge from their 2012 interim lows.

According to Bloomberg:


“As bets pile up against Japanese stocks, investors with $293 billion in client assets see the pessimism as a signal to buy. History is on their side. Short-selling on Tokyo’s bourse jumped to the highest on record this month, as the Topix index tumbled 7.7 percent from a six-year high in September. Shares have rallied an average 9.7 percent over the three months following surges in bearish bets since 2009, according to data compiled by Bloomberg.

For Sydney-based AMP Capital Investors Ltd., that’s one reason for optimism. The outlook for company profits is another. Government-backed steps to put a floor under Japanese equities may prove dangerous for short-sellers: the central bank says it’s ready to add stimulus if the economy falters, while on Oct. 20, a Nikkei newspaper report the country’s $1.2 trillion pension fund would buy local shares roused the Topix from a three-week rout.

“Fear is hitting extreme levels and it’s time to get into the market,” Nader Naeimi, who helps manage about $125 billion as head of dynamic asset allocation at AMP, said by phone on Oct. 14. “When these sentiment indicators flash excessive pessimism, it usually suggests we’ve reached the lows.”

Bearish bets accounted for 36.6 percent of all transactions on the Tokyo Stock Exchange by value on Oct. 14, according to bourse data compiled by Bloomberg. That’s the highest since the exchange started publishing the figures in 2008. The ratio was 33.4 percent on Oct. 24.”


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Stingy Usurers at IMF Won’t Lend SDRs at Negative Rates

No negative rates for the putative Bancor … Keynes must surely be rotating in his grave. It turns out the IMF is not going to lend SDRs for less than nothing, thus breaking ranks with some well-known central banks out there (no need to name names), and even the central bank-manipulated “market” in which investors accept negative rates on certain government bonds as if that made any sense.

Instead, the IMF has decided to set a floor for its SDR interest rate to maintain its role as a profit center…it will be at what is nowadays a downright usurious height of 0.05%. So at least at the IMF, there will be no pretense that time preferences can actually turn negative.


christine-lagardeThere will be no funny money for nothing from me, busters!

(Photo credit: REUTERS / Fahad Shadeed)


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Italian Bankers are Not Amused

Italy’s banks were among the hardest hit by the ECB’s “comprehensive assessment” and the associated demands to increase their capital. The protests of Italian banks which were even echoed by the Bank of Italy (i.e., Italy’s national central bank) are widely seen as a lending the stress tests legitimacy.

For instance, the FT reports:




“Analysts and investors have taken the howls of protest from Italian central bank officials on Sunday as evidence that the European Central Bank’s health check on the continent’s banking system is sufficiently tough.

Complaints from Rome about the outcome of the ECB’s comprehensive assessment have demonstrated how Italy has emerged as the biggest loser from the process, which was designed to restore confidence in the EU’s financial system.”


“The debate over whether the European banks have lots of holes in their balance sheets is over,” said Davide Serra, founder of hedge fund Algebris. “Banks didn’t know if they had enough capital to lend until now and this will change that.”

“We now know that we can have a 5 per cent contraction in the eurozone economy and the banks will still have more than 8 per cent capital – that is very positive for the sector,” he said.


Alas, as this Bloomberg video shows, the debate is far from “over” – not least as numerous banks just sort of scraped by.

In fact, there are other reasons to doubt the toughness of the stress test. We already discussed the large amount of legacy NPLs in the European banking system yesterday, which implies that if a severe downturn were to occur in the near future, this amount would skyrocket to an even more astronomical level.

Moreover, a post stress test aggregate capital shortfall of a mere € 24 billion is just not very believable considering all the other data, especially in light of the fact that the great bulk of this shortfall is concentrated in the tiny countries of Cyprus and Greece.


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ECB’s Comprehensive Bank Assessment Finalized

A considerable level of apprehension was noticeable in the financial press in recent days, as the ECB just finished its “stress tests” and its comprehensive assessment of 130 systemically important banks in the euro are. This time, the stress tests are a bit more interesting than previous exercises of this sort were.

Contrary to the white-wash attempts that characterized the laughable stress tests performed during the euro area’s sovereign debt crisis by the EBA (European Banking Authority), the ECB is forced to walk a slightly finer line. The reason is that it will become the regulator of these 130 large banks and will therefore be held responsible if anything goes wrong. On the other hand, the ECB is also eager to avoid a panicky market reaction to the results, and will therefore presumably try not to be too harsh in its assessments. In fact, looking at press reports, it certainly appears as though the criteria have been watered down quite a bit. Some observers argue that the ECB is far too beholden to political and market expectations to make its assessment credible (see also further below).

To this it should be noted that no fractionally reserved bank can be regarded as truly solvent, for the simple reason that such banks cannot actually fulfill their payment obligations to holders of overnight deposits. It works only as long as only a small percentage of depositors attempt to withdraw the money that they have been promised to receive “on demand”. Under normal conditions, this doesn’t pose a big problem, as banks continually receive new deposits and most deposit money tends to stay inside the system. Up to a point, a bank threatened by a run on its deposits can also rely on the lender of last resort (i.e., the central bank) to supply it with liquidity by discounting its securities.

Since money is nowadays a mere token signifying nothing, there is also no limit on its production. The ECB seems quite confident with regard to this aspect of the banking system, as its minimum reserve requirement for demand deposits stands at a mere 1%. In theory, the European banking system could multiply every deposit a hundred-fold by creating additional fiduciary media on the back its existing deposit base. In practice, this is highly unlikely to happen, but it shows that it is nowadays not seen as necessary anymore to even pretend that deposits are sufficiently “backed” with standard money (in the fiat money system, standard money = currency and bank reserves with the central bank).

The banks themselves have already received the results of the ECB’s assessment yesterday, but they will only be made public on Sunday – apparently the intention is to avoid roiling the markets. European bank stocks have recently tested an important short term technical support level and rebounded from there over the past few days:


1-Euro-Stoxx Banks, STEuro-stoxx Bank Index, daily – click to enlarge.


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Nothing to Lose …

Europe’s all-too-predictable relapse into recession is gathering force, threatening not only the pipe dream of economic and political unity, but eroding grandiose illusions that have helped prop up the world’s financial house of cards. The unwillingness of France in particular to play by the EU’s — i.e.,  Germany’s — rules appears to have doomed the EU dream.

The idea of a border-less Europe bound by a common currency and a shared desire to forever banish war from the Continent was a lofty one, but it was mired from the start in deeply rooted political animosities, grass-roots skepticism and bureaucratic overreach. Now these problems, along with a great many others, have turned the EU project into a Tower of Babel. A million pages of meticulously codified EU rules might as well have been written in cuneiform, so inscrutable and arcane have they become.

And useless as well. France’s prolonged economic death rattle has been made possible by running annual deficits larger by half than the 3% “allowed” by Brussels. And now, channeling  de Gaulle for what could turn out to be France’s last hurrah, the French have flouted Merckel’s authority, and common sense itself, by proposing to remedy the problem by hiring more government workers and expanding tax breaks.

Portugal, Greece, Spain and the other deadbeat rabble have been cheering them on, and why not? They think they have nothing to lose — that Germany is the only country with any skin in the game. Their folly is about to be laid bare, however, unless Germany gives in and allows Europe’s Central Bank to monetize the collective debts of Europe Fed-style.


france-government-debt-to-gdpFrance’s public debt to GDP ratio. Flaunting Maastricht since forever and a day – click to enlarge..


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Turning Japanese


You’ve got me turning up and turning down

and turning in and turning ’round

I’m turning Japanese

I think I’m turning Japanese


– The Vapors


Are we all turning Japanese? For longtime Diary sufferers it’s a familiar question…

We’ve been asking for almost 15 years – ever since we saw the US following in those Japanese footsteps, running from a big boom… to a big bust.

It all started for us when we were driving out to the country one evening many years ago. To keep the children occupied – there were five of them with us at the time – we asked them what they wanted to be when they grew up. Imagine our surprise. Among the fighter pilots and TV stars was one little boy who replied, “I want to be Japanese.”

Manga cartoons were popular at the time. So were Japanese video games. Japanese stocks, on the other hand, were not. After hitting 38,000 points in 1989, Japan’s Nikkei stock market index (the equivalent of the Dow) fell to 7,000 in April of 2000.

Meanwhile, every smokestack in Nippon seemed to take a breather, every working man got 10 years older and every financial journalist wondered what was wrong with a people who had been so dynamic just a few years before.

We foresaw the same for US stocks and the US economy. Maybe we were just 14 years – and counting – too early. Maybe we were just wrong.


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A Fount of Originality and Contrarian Thinking …

Just pulling your leg, dear reader. The Barron’s big money poll contains about as much originality and contrarian thinking as you can find on CNBC … slightly less, actually.

So what are the big money’s big ideas this time around? They continue exhibit a huge bearish consensus on bonds, which we have in the past flagged as a big contrary indicator (you will notice that we also pointed out their bearish consensus on the Nikkei in this past article – the Nikkei promptly had an explosive rally right after the survey was published). Otherwise they are still “investing by ruler” – in other words, they are simply extrapolating what has happened in the recent past into the future, which is precisely what most Wall Street strategists and most mainstream economists do as well. Not one of these groups will ever identify a turning point in a timely manner.

The biggest bullish consensus is on US large cap stocks with 84% bulls, the biggest bearish consensus (certain to be wrong for the umpteenth year in a row) is on US treasury bonds with 91% bears (!).

Gold aficionados will be pleased to learn that there is a 76% bearish consensus on gold, which provides a nice contrast to the 69% bullish consensus that pertained in October of 2012, just as gold was getting ready to tank big.


1-big money poll, BarronsA good road map of what to do and what not to do – avoid the areas with the biggest bullish consensus, instead buy whatever they hate with a passion – click to enlarge.


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An Age of Wonders

That we live in an age of man-made wonders is beyond dispute. Painless root canals. Tinder. Central bank price controls.

We were traveling hard over the last couple weeks. Somewhere along the way we picked up a cold, which dogged us from Vermont to Maryland’s Eastern Shore. But the security X-ray at Nashville International Airport seemed to finally knock it out.

Global stocks have lost more than $3 trillion of their value so far this month. But the authorities rushed to the rescue like a surgeon taking out a ruptured gallbladder. As St. Louis Fed president James Bullard told Bloomberg TV (reprinted from yesterday’s Diary):


“I also think that inflation expectations are dropping in the US. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target.

And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So … continue with QE at a very low level as we have it right now. And then assess our options going forward.”


Perhaps some future generation of philosophers will understand it better. To us, it resides among the great mysteries… along with the virgin birth and Hillary’s front-runner status.


Hillary ClintonThe Lord only knows what they see in this war-mongering harpy …

(Photo via troll.me)

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False Assumptions and Wrong Predictions

An interesting article on MarketWatch today caught my attention. The subhead is the money quote, “Back in April every economist in a survey thought yields would rise. Guess what they did next.”

Every? The article refers to 67 economists polled by Bloomberg, all of whom would seem to believe in the quantity theory of money. This means they believe a rising money supply causes rising prices. That means they think the bond market expects inflation. Which means they expect the interest rate to rise, because investors will somehow demand more.

It didn’t happen because every assumption in that chain is false.

Many people also expect interest rates to rise after the Fed’s bond buying program—quantitative easing—ends. Let’s take a look at the yield on the 10-year US Treasury bond from 1981 through today. This graph is courtesy of Yahoo Finance, though I have labeled it as carefully as I could for the three rounds of QE so far.


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Creating Enemies Everywhere

Over the weekend, we were down in Nashville at the Stansberry Conference Series event, along with Ron Paul, Porter Stansberry, Jim Rickards and others. The question on the table: What’s ahead for the US?

Ron Paul took up the question from a geopolitical angle. He told the crowd that the military-security industry had Congress in its pocket.

As a result, we can expect more borrowing, more spending and more pointless and futile wars. They may be bad for the country and its citizens, says Paul, but they are good for the people who make fighter jets and combat fatigues.

“We’ve been at war in the Middle East for decades,” he said. “We supported Osama bin Laden against the Soviets in Afghanistan… and the result of that was the creation of al-Qaeda.

“Then we supported Saddam Hussein against Iran. Saddam and bin Laden hated each other. But after 9/11 we attacked Saddam, using a bunch of lies to justify it. We sent over military equipment worth hundreds of billions of dollars. This equipment is now in the hands of ISIS – another enemy we created… and a far more dangerous one.”


isis-hummerISIS fighters proudly parading their new Hummer courtesy of US tax cows …

(Photo credit: REUTERS/Stringer)


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Dear Investors, the Time to Leave your Brains at the Door has Come …

This is really too funny. The latest investment fad – which strikes us as a typical “late bubble” idea, we might add – is letting machines do your “investing” for you. And statistically speaking, it actually seems to be a good idea. Of course, it presumably only works as long as no grueling long term bear market intervenes, such as has happened in Japan. Or even worse, something like the 68 year long bear market in Europe following the peak of the South Seas and Mississippi bubbles in Britain and France.


“Investment advisers concerned about competition from cut-rate digital investment firms known as “robo-advisers” received an olive branch on Wednesday from Betterment LLC, one of the largest of the new competitors.

The New York-based firm, which uses questionnaires and algorithms to create portfolios of inexpensive exchange-traded funds for individual investors, said it is now offering the program to advisers who tout financial planning and investment skills to generally wealthy individuals.

Fidelity Investments, which provides brokerage services to clients of 3,000 independent advisers and has custody of their assets, is referring Registered Investment Advisers (RIAs) who want to test digital investing to Betterment. The mutual fund giant will receive a one-time asset-based fee for RIA clients or prospects referred to Betterment.

Advisers who have tested the program said it will allow them to accept younger, less wealthy people who they had previously ignored and perhaps appeal to traditional clients. Betterment says that it produces returns 4.30 percent higher than those achieved by the average do-it-yourself investor.”


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A Rebound Attempt

Here is a brief update on the action in the stock and bond markets. In Wednesday’s trading, the stock market initially declined sharply and the action was accompanied by a frenzy of short-covering in treasury notes across the maturity curve (see Tuesday’s comment on the outsized speculative net short position in 10 year notes. Similarly large speculative short positions are also extant in shorter maturities).

The “trigger events” were many – an overnight plunge in crude oil prices cemented the idea that a global economic slowdown is underway (which seems indeed to be the case) and this idea received further ammunition when a few US economic data were released. Producer prices fell and the Empire State manufacturing survey plunged by 21 points, way below expectations. Significantly, new orders declined sharply (for more details on the survey see Mish’s write-up).

Of course, we don’t believe that the stock market is weakening because punters have suddenly found out that there is economic weakness. As so often, the fundamental news follow the market and don’t lead it – what’s more, the very same news would likely have been ignored only a few weeks earlier, or even have been met with bullish spin. The real reason for stock market’s weakness is the declining growth momentum of the money supply and the impending end of “QE3”. This has already created a great many negative effects in “risk assets”, which were merely masked by the previous strength in popular cap-weighted indexes. Readers may also want to check the comments by Variant Perceptions on the recent decline in stock buybacks and the market’s reliance on multiple expansion. Both seem relevant data points, which we have previously discussed here as well.


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The Market’s Knockout Punch Is Still to Come

The Fed’s EZ money policies will either succeed or fail. Either way, it will be a disaster. If they succeed, interest rates will rise … and America’s debt-addicted economy will get the shakes.

If they fail, the Fed will double down with further acts of reckless improvisation – including bigger doses of credit – until the whole thing blows up.

But let’s give credit where it is due. The recent employment numbers speak a kind of success. In spite of the Fed’s policies, the US economy is not only still alive … but also it’s getting back on its feet.

If this is so, it is good news for the people who have finally found meaningful employment. As for the future of the US economy, it is a disaster.




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Getting Worried

New England is stunning this time of year. Just what you’d expect. The leaves turn brown, yellow and red, putting on their best outfits and strutting their stuff in the cool autumn air.

Autumn, especially in New England, is the loveliest time of the year. The sun barely clears the tops of the trees, even at noon. The light, filtered through the colored leaves, gives the earth the rich and heavy air of a funeral parlor.

Perhaps that is why there are market crashes in the fall. Investors feel the approach of death. The stock market fell hard on Thursday … and then kept falling on Friday. Before the week was over, investors were worried.

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Derivatives “Stays” – The Next Step in Corralling Investor Funds

We previously discussed the debate over the introduction of new rules that would allow money market funds to stop withdrawals – see “Redemption Gates for Money Market Funds” for details. This debate followed on the heels of similar proposals being made for bond funds. These regulations aim to “forestall panics” by preventing investors from withdrawing their funds from wobbly looking entities in the event of another financial crisis.

We personally believe that there can hardly be a better argument for holding physical gold outside of the system, but apart from that such rules are obviously weakening property rights.


Now another set of similar regulation is about to be introduced, in this case concerning derivatives:


“The $700 trillion financial derivatives industry has agreed to a fundamental rule change from January to help regulators to wind down failed banks without destabilizing markets. The International Swaps and Derivatives Association (ISDA) and 18 major banks that dominate the market will now allow financial watchdogs to apply temporary stays to prevent a rush to close derivatives contracts if a bank runs into trouble, the ISDA said on Saturday.

A delay would give regulators time to ensure that critical parts of a bank, such as customer accounts, continue smoothly while the rest is wound down or sold off in an orderly way.

That would help to avoid the type of market chaos sparked by the collapse of Lehman Brothers in 2008 and also end the problem of banks being considered too big to fail.

The Financial Stability Board (FSB), a regulatory task force for the Group of 20 economies (G20), had asked the ISDA to make the changes with the aim of ending the too-big-to-fail scenario in which banks are propped up with taxpayer money to avoid market disruption.

Under the new contract terms, default clauses in derivatives contracts such as interest rate or credit default swaps would be suspended for a maximum of 48 hours.”


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