Archive - Jan 22, 2014 - Story

As we first reported one week ago, the first shadow default in Chinese history, the "Credit Equals Gold #1 Collective Trust Product" issued by China Credit Trust Co. Ltd. (CCT) due to mature Jan 31st with $492 million outstanding, appears ready to go down in the record books. In turn, virtually every sellside desk has issued notes and papers advising what this event would mean ("don't panic, here's a towel", and "all shall be well"), and is holding conference calls with clients to put their mind at ease in the increasingly likely scenario that there is indeed a historic "first" default for a country in which such events have previously been prohibited. So with under 10 days to go, for anyone who is still confused about the role of trusts in China's financial system, a default's significance, the underlying causes, the implications for the broad economy, and what the possible outcomes of the CCT product default are, here is Goldman's Q&A on a potential Chinese trust default.

Supporters of warfare, welfare, and Wonder Woman cheered last week as Congress passed a one trillion dollar “omnibus” appropriation bill. This legislation funds the operations of government for the remainder of the fiscal year. Wonder Woman fans can cheer that buried in the bill was a $10,000 grant for a theater program to explore the comic book heroine. That is just one of the many outrageous projects buried in this 1,582-page bill. Fortunately, in recent years more Americans have recognized that a constant defense of liberty requires opposing both war and welfare. The question facing Americans is not whether Congress will ever cut spending. The question is will the spending be reduced in an orderly manner that avoids inflecting massive harm on those depending on government programs, or will spending be slashed in response to an economic crisis caused by ever-increasing levels of deficit spending. Because politicians are followers rather than leaders, it is ultimately up to the people what course we will take. This is why it is vital that those of us who understand the dangerous path we are currently on do all we can to expand the movement for liberty, peace, and prosperity.

What are you afraid of, exactly? ConvergEx's Nick Colas notes we all have our phobias and fears, some logical and anchored in reality and others irrational but still powerful; but for the capital markets currently it seems there is no fear. The CBOE VIX Index started the year at 14.2 and has fallen to a close of 12.9 today. That move, Colas adds, has dragged the IVs of everything from U.S. large cap energy stocks to gold to corporate bonds lower in its wake.  Even expectations for Emerging Markets equity volatility are in retreat as we start 2014. But, when near term historical or implied volatility becomes this complacent, it seems appropriate to spend a little more time pondering what might go wrong.  Markets, after all, have the entire “What should go right” side of the trade well understood and reflected in current prices. In that spirit, here is the "Top 10" list of what might take us off the rails of complacency in 2014.

As we previously noted, the 85 richest people in the world have about as much wealth as the poorest 50% of the entire global population does.  In other words, 85 extremely wealthy individuals have about as much wealth as the poorest 3,500,000,000 do.  There is certainly nothing wrong with making money.  In fact, the founders of the United States intended for this nation to be a place where free markets thrived and where everyone could pursue their dreams.  Unfortunately, this country (along with the rest of the world) has moved very much in the opposite direction.  Today, we have a debt-based global financial system which is dominated by gigantic predator corporations and big banks.  Working together with national governments, these corporations and banks have constructed a system in which the percentage of all global wealth that is being funneled to the very top of the pyramid steadily grows over time. The Founding Fathers were very correct to be very suspicious of large concentrations of power.  In the early days of the United States, the federal government was very small and the size and scope of corporations was greatly limited.  Our nation thrived and a huge middle class blossomed. Sadly, over the past several decades the pendulum has completely swung in the other direction.

When facing a corrupt system, provide for yourself and your community those necessities that the system cannot or will not. Become independent from establishment-controlled paradigms. If you and your community do this, the system will have one of two choices: 1)  Admit that you do not need them anymore and fade into the fog of history, Or... 2)  Reveal its tyrannical nature in full and attempt to force you back into dependence. In either case, the citizenry gains the upper hand. We are hard-pressed to think of a better recent example of the non-participation principle in action than the rise of Mexican citizen militias in the Western state of Michoacan.

With every component of HSBC's China Manufacturing PMI either dropping or showong slower growth, it is hardly a surprise that the much-watched survey of economic strength dipped into contractionary territory. At 49.6 this is the lowest since July 2013 and dropped month-over-month by the most since May 2013. HSBC argues this is "domestic demand cooling" but new export orders tumbled at an accelerating pace as did employment. Of course, the silver lining is that because the prices components did not show acceleration then the PBOC has room to 'stimulate' to avoid repeating growth deceleration but that appears - despite today's further CNY 120 billion reverse repo - to not be the plan for the PBOC for now (given the 20-plus percent YoY gains in house prices). S&P futures fell 6 points on the news, AUDJPY is turmoiling, and Treasuries rallied 1bps.

It's not all ponies and unicorns in Davos today. Paul Singer's dismal views on financial fragility were followed up by a panel, as The Telegraph's Ambrose Evans-Pritchard reports, that poured cold water on the claims that the European crisis is over. Harvard professor Kenneth Rogoff said the launch of the euro had been a "giant historic mistake, done to soon" but EMU leaders are still refusing to take the necessary steps, and is squandering the "scarce resource" of its youth, badly needed to fortify an aging society as the demographic crunch sets in. But it is ex-Buba head Axel Weber that unleashed the ugly truth: "Markets are currently disregarding risks, particularly in the periphery...Europe is under threat. I am still really concerned."

After five years of aggressive Federal Reserve and government intervention in our monetary and financial systems, it's time to ask: Where are we? The "plan," such as it has been, is to let future growth sweep everything under the rug. To print some money, close their eyes, cross their fingers, and hope for the best. On that, we give them an "A" for wishful thinking – and an "F" for actual results. If we take a closer look at the projections, the idea that we're going to grow – even remotely – into a gigantic future that will consume all entitlement shortfalls within its cornucopian maw becomes all but laughable. Of course, the purpose of this exercise is not to make fun of anyone, nor to mock any particular beliefs, but to create an actionable understanding of the true nature of where we really are and what you should be doing about it.

Effective April 1st, Target announced to day that it would no longer offer healthcare coverage to its part-time employees. As The Hill reports, Target's HR executives 'spun' the decision as good for the employees..."by offering them insurance, we could actually disqualify many of them from being eligible for newly available subsidies that could reduce their overall health insurance expense." The company will provide a $500 cash payment to "minimize disruption," and specifically calls out Obamacare as "providing new options... that we believe our part-time members may prefer."Of course, just for good measure, Target is cutting 475 jobs and chooing not to fill a further 700 open positions - again, we presume, to minimize disruption (to their bottom line).

There was a time in the financial industry when the many wouldn't suffer for the sins of the few (although taxpayers were certainly excluded from this maxim). Well, for the "many" who work at JPMorgan, that is no longer the case because as Reuters reports, JPM employees can forget getting a pay raise in 2013 (although with sub-2% annual inflation as calculated by the BLS one wonders just why anyone should be getting a raise: just hand out an edible iPad or two and the COLA is fixed). The reason for the lack of a raise: "the bank's massive legal bills" - bills which incidentally were incurred when a select few JPM employees cheated and defrauded the system - illegally - in order to procure massive year end bonuses, most if not all of which were not clawed back, and subsequently were caught (one can only imagine how many of the "few" are still at the bank, doing manipulation and defrauding as usual. And now it is everyone else's turn to pay because the bank lacked the most elementary supervision of its criminal employees (long since fired) and raked up roughly $20 billion in litigation and legal settlement charges.

Citi's credit group is bullish; but, as they admit, for all the wrong reasons. Bullish, because they still believe that the extraordinary liquidity environment which has dominated the last four years will remain in place this year (despite tapering) and for the wrong reasons because aside from their doubts about the foundations of much of the economic recovery itself, nearly all the factors that they would normally base their view on the markets on seem to be pulling in the opposite direction. In their own words, "everything is expensive; and the market is driven purely by a variant of the Greater Fool's Theory."

Dedicated readers of The Wall Street Journal have recently been offered many dire warnings about a clear and present danger that is stalking the global economy. They are not referring to a possible looming stock or real estate bubble. Nor are they talking about other usual suspects such as global warming, peak oil, the Arab Spring, sovereign defaults, the breakup of the euro, Miley Cyrus, a nuclear Iran, or Obamacare. Instead they are warning about the horror that could result from falling prices, otherwise known as deflation. Get the kids into the basement Mom... they just marked down Cheerios!

NFLX is soaring after hours to fresh all time highs, not so much due to some blockbuster numbers, but because the company reported results that beat Wall Street's lowballed estimates once again. These were as follows:

• Revenue of $1.175 billion; EPS of $0.79, or $48.4 million, beating expectations of $0.66; Domestic net adds were 2.33 million, vs estimate 2.05 million, leaving a total of 33.4 million subs at the end of the quarter, and 31.7 million paid subs.

In terms of the company's business model, the things are as they were: NFLX is using the cash generated from its doomed, runoff legacy DVD rental business, which in Q4 generated $110MM of the total profit, or half of total, and is using that to fund its international expansion. So far, NFLX has 10.9 million total international streaming subs, which resulted in losses of $57.2 million. It remains unclear what the breakeven on this international growth strategy is in terms of subs, although NFLX has so far burned $663 million on foreign expansion in the past two years, offset by $991 million in profits at its domestic streaming operations. Does this justify a 300x P/E? For now the market's answer is a resounding yes, having sent the stock higher by $55 in the after hours, up 17%!

The Dow Transports has outperformed the Industrials by over 3% year-to-date (+1.9% vs -1.1%) as both the Trannies and Russell pressed new record highs today (as the Dow and S&P lagged on bigger-cap earnings disappointments). Treasuries lost ground with the front-end worst (5Y +6bps) but 30Y was unch leading to a significant further flattening in the curve to its 2nd flattest close in 17 months. The USD ended the day (and week so far) unchanged as a big drop in CAD was offset by a rally in AUD and GBP. Gold & silver dribbled lower all day and were smacked into the close; with copper flat to slightly lower on the day as WTI surged towards $97 (narrowing the spread to Brent to 1-month lows). It was recent business-as-usual in VIX as it leaked higher testing 13% once again and credit markets remain divergent from stocks (though the relative safety of investment grade credit was bid this afternoon). For those keeping track, today's market was brought to you by the letters USDJPY and the number 17.62.

The reason why today's move is largely meaningless and purely optical, is because there is still an 85% differential between the official rate, and what one can get for a dollar on the black market. Which as the chart below shows is substantially higher, and at last check was 78.38 Bolivars per dollar. Said otherwise, the brand new official exchange rate, which will soon be implemented for everyone, is still 590% higher than the real clearing price of the currency on the black market. Curious why the currency is crashing so fast? Perhaps ask the 50% (and rising) annual inflation in the socialist paradise.