Book Value

Bottom line for financials is that 2014 is looking to be a tough year, even if the Sell Side wants to believe that growing earnings is still possible on flat revenue

It has been a while since we heard from the rational folks over at GMO. Which is why we are happy that as every possible form of bubble in the capital markets rages, Jeremy Grantham lieutenant Ben Inkster was kind enough to put the raging Fed-induced euphoria in its proper context. To wit "the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confi rm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market.... On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued."

Following the past two days of reports in which we noted that both the broader Chinese housing market was overheating and reflating at an unprecedented pace as 69 of 70 cities posted Y/Y home price gains, while a separate report showed a blistering 12% price increase in Shanghai new homes in one week, it was only a matter of time before the PBOC resumed its tighter policy posturing, which infamously sent short-term repo rates to 25% briefly in June and nearly led to a collapse of the already fragile local banking system, in an attempt to pretend it is still in control of what is now the world's fastest growing credit bubble and of course, Chinese inflation which is now impacted not only by record domestic credit production but by hot money flows from both the Fed and the BOJ.  Predictably enough, as reported overnight by the Global Times, the PBOC suspended its open market operations Tuesday without injecting money as usual, a move that analysts said was in response to a surge in foreign capital inflows in September. And just like the last time the PBOC proceeded to "surprise" the market with its own tapering intentions, overnight funding rates soared, with the one-day repo rate surged 67 bps, most since June 20, to 3.7561%; while the seven-day repo rate rose 42 bps, most since July 29, to 4.0000%. This, however, brings us to the far more important story, one reported by Bloomberg overnight, and one which we predicted is inevitable over a year ago: namely that the Chinese banks, filled tothe gills with bad and non-performing debt, are finally preparing for the inevitable default onslaught and as a result have suddenly tripled their debt write offs in what can be best described as preparing for an avalanche of defaults.

To summarize Goldman:

• All upside is multiple expansion-driven, i.e. relentless Fed pumping of risks as the final bubble grows to unprecedented proportions,
• A market which even tenured economists say is a disaster waiting to happen.
• But hey, the music is still playing so everyone must dance all the way until Goldman's 2100 target... in 2015.

All of this has come and gone before, but since this time will be different, one can just ignore the recurring past.

Hong Kong's richest are busy offloading local assets which institutions are happy to buy. It's exhibit A why institutional money often represents dumb money. 

So are you going to be among the few, the proud, the surprised Sell Side analysts?

Over the weekend, we humbly suggested that the dream of ongoing US equity market multiple expansion may be over. It would appear SocGen not only agrees but finds current valuations very stretched. On the basis of Price-to-Book (valuation) and return-on-equity (profitability), the US equity market is extremely 'expensive'; and "hoping" for further expansion on the RoE to save the day is whimsical given the limits to leverage. Still, despite Obama's sell signal, it appears from today's open that the BTFATH crowd remains alive and well.

The Euro area is no longer the centre of all the stress... EM countries are! Despite their significant correction in recent months, SocGen notes that valuations remain far more extreme (or cheap) and outflows are dominating (despite a 24% discount on a price-to-book basis across EM stocks, they reain rich historically). Significant structural issues like balance of payments, deficit or inflation may lead to further turmoil in emerging markets, potentially destabilising the underlying economies. Simply put, SocGen warns, valuations have further to fall; do not catch the falling knife (yet).

The first phase of the boom has already taken place, the pullback seems to have run its course and Phase II is set to deliver fortunes.

Amid the cozy world of X-Factor, American Idol, and Dance Moms, we can often be lulled into the belief that all is well in the world. But once the cocoon of mind-numbing media is shrugged off, the realities of the world are all too 'Matrix-like' exposed. Simon Black's travels have exposed these three things...

• Pentagon Plans for the Worst in Syria (WSJ)
• Russia and US agree to Syria conference after Moscow talks (FT)
• Hedge Funds Rush Into Debt Trading With $108 Billion (BBG)
• Detroit is the new "deep value" - Hedge funds in search of distress take a look at Detroit (Reuters)
• Commodities hedge funds suffer weak first quarter (FT)
• But... but... Abenomics - Toshiba posts 62% decline in Q1 net profit (WSJ)
• Americans Are Borrowing Again but Still Less Than Before Freeze (WSJ)
• Man Utd announce Alex Ferguson to retire (FT)
• Asmussen Says ECB Discussed ABS Purchases to Spur SME Lending (BBG)
• Benghazi Attack Set for New Review (WSJ)
• Belgium Says 31 People Arrested Over $50 Million Diamond Theft (BBG)
• Brazilian diplomat Roberto Azevêdo wins WTO leadership battle (FT)
• Bangladesh Garment Factory Building Collapse Toll Reaches 782 (BBG)

Using cheap debt to buy assets makes a lot of sense right now, but only if it's done right. That wasn't the case with the world's largest retail M&A deal this year.

A bank losing billions of dollars in a recessionary environment, REDUCES regulatory capital, failing to report liabilities - in order to pay special investors a special dividend! Sounds about right doesn't it? Unless your a common shareholder!

• The Inland Empire bubble is back: BMW to Amazon Space Demand Spurs Rush to Inland Empire (BBG)
• Tamerlan Tsarnaev was on classified government watch lists (Reuters)
• Brothers in Boston Bombing Case Said Drawn to Radicalism (BBG)
• Germany Spurns Calls to Loosen Austerity Stance (WSJ)
• Spain poised to ease austerity push (FT)
• What ever happened to France's voice in Europe? (Reuters)
• U.S., South Korea Reach Nuclear Deal (WSJ)
• U.S. Sees No Hard Evidence of Syrian Chemical Weapons Use (BBG)
• RBA Set to Invest Foreign Currency Reserves in China, Lowe Says (BBG)
• FedEx Wins $10.5 Billion Postal Contract as UPS Shut Out (BBG)

Shareholders Join Bankers, Economists, Financial Experts, Regulators and the American People In Calling for a Break Up of the Giant Banks