"Today’s markets have a vulnerability that has not existed through most of history. Today’s valuations only make sense in light of low expected cash rates. Remove that expectation, and pretty much every asset across the board is vulnerable to a fall in price, as the rising real discount rate plays no favorites. There is no asset class you can hold that would be expected to do well if the real discount rate rises from here. Under normal circumstances, a rising real discount rate would probably come on the back of rising inflation or stronger than expected growth, which are diversifiable risks in a portfolio. But May’s shock to the real discount rate came not because inflation was unexpectedly high or because growth will be so strong as to lift earnings expectations for equities and other owners of real assets, but because the Fed signaled that there was likely to be an end to financial repression in the next few years. And because financial repression has pushed up the prices of assets across the board and around the world, there is unlikely to be a safe harbor from the fallout, other than cash itself." - GMO
Don't look now but futures are up as usual, driven higher by both good and bad news. The biggest event of the weekend, if largely priced in, was the victory by Abe's coalition in the upper-house leading to the following seat breakdown. Of course, judging by the Yen and market reaction, which barely managed to eek out a gain: its first in four trading days, the event was largely of the "sell the news" type despite such bold proclamations: "Abe’s victory in the upper house is bullish for Japanese equities and the Japanese economy as a whole, as the removal of political headwinds bolsters the government’s ability to press forward with all ‘three arrows’ of its growth strategy," John Vail, Tokyo-based chief global strategist at Nikko Asset Management Co., which manages $162 billion, wrote in an e-mail. Elsewhere in Europe, Portugal bond yields have plunged by roughly 60 bps on news that the Portuguese President Silva has backed the centre-right coalition government, consequently ruling out snap polls. Well, what else is he going to do? This also comes on the heels of a Goldman report that said a second bailout for the country will be necessary and will likely be discussed in the fall. That too is bullish. What also was bullish in Europe apparently is that government debt hit a new record high of 92.2% of GDP. Remember: debt is wealth so just buy more futures. Looking forward to the US, the market will focus on the latest existing home sales data, the Chicago Fed activity index, as well as earnings report releases from McDonalds, Texas Instruments and Halliburton and a bunch of other companies that will beat EPS and miss revenues.
Sunday's 'golidlocks' data dump from China was enough for many to herald the turn is in and it's all plain-sailing from here, but the reality is a little different (as always). As Bloomberg's Michael McDonough notes, there is little upside for the yuan given China's slowing economy and a strengthening US Dollar. The gloomier outlook may also weigh on domestic equity markets. The Shanghai Composite Index has underperformed global peers in the past year. The pace of expansion may fall below the government’s goal of 7.5 percent and that may prompt a rate cut and/or an accelerated pace of infrastructure project approvals. Policy makers need to prove they remain in control, meaning GDP growth must finish the year at or above the target (even if it means inflation and social unrest), but for now, the following four charts suggest all is not well with the 'soft-landing'...
The global crisis is a financial crisis driven primarily by global trade and capital imbalances; and Hinde Capital believes the crisis is in full swing again and asset prices are in danger of falling globally. Money is less effective at catching the falling knife. Investors and policymakers do not believe this is the beginning of a major EM contagion crisis. They are lulling themselves into a false sense of security. They see the EM market tremors, and do not fear a re-run of the EM crises of old. They are right. This is not (just) going to be an EM crisis. The disproportionate reaction of central bankers and policymakers alike has merely succeeded in compounding and exacerbating the error of this highly imbalanced monetary system. Recent events in emerging countries are a manifestation of the continuing unravelling of our monetary order.
Risk assets are not quite (yet) back to the ‘melt-up' of May but equity markets are trading in a confident mood after Bernanke caused sentiment to flip from glass ‘half empty' to ‘half full'. China Q2 GDP data did not derail price action as equity futures anticipate a positive start of the week. The semi-annual testimony of the Fed Chairman is typically a seminal event on the market calendar but do we dare say that the one coming up this week is a non-event following last week's message on policy accommodation? The VIX index dropped 7 points over the last three weeks of which 2 points alone came last Thursday and Friday as stocks roared to new highs and shrugged off the candid observation on the Chinese economy by finance minister Lou Jiwei. If a 6.5% growth rate is tolerable in the future, there is little doubt that commodities and the AUD have further to fall. Chinese GDP slowed from 7.7% to 7.5% according to data released overnight and prospects for the second half don't look much brighter after evidence of slowing credit growth. Data on Friday showed declines of narrow money from 11.3% yoy to 9.1% in May, with broad money growth slowing to 14% yoy. Non-bank credit and new foreign currency bank lending also weakened.
Even with duelling Fed members today (Bullard vs Plosser) the message from 'the man' led markets on a one-way street all week. Even though Boeing impacted the Dow (and Trannies):
- S&P managed its best week in 6 months (+2.6%);
- Gold's best week in almost 8 months (+5.1% or $62);
- Treasuries' best week in 13 months (10Y -14.5bps);
- High Yield bonds best week in 20 months (+3%); and the
- USD's equal worst week in 21 months (-1.8%).
VIX remains modestly bid and IG credit spreads are underperforming. Market breadth today was weak as S&P volume was very low and the intraday range the lowest in 5 months. The 330ET Ramp was 10 minutes late but just as effective in its goal of running stops to a green Dow as Bullard's words seemed magical.
JPM Beats Thanks To $1.4 Billion Reserve Release; Net Interest Margin Drops To Record Low; Mortgage Production SlidesSubmitted by Tyler Durden on 07/12/2013 07:37 -0400
Cutting through the noise of JPM's earnings, here are the salient facts: the company beat the bottom line expectation of $1.45 with an $1.60 ex-DVA print. However, this number included the now traditional "puffery" benefit from loan loss reserve releases, specifically $950MM pretax ($0.15 EPS) from mortgage loan loss reserves and $550MM pretax ($0.09) from credit cards. Additionally, the company reserved a whopping $600 million for litigation, or about $0.09, and according to the firm this should be backed out from the bottom line. Of course, that assumes the litigation against JPM will not be an ongoing, non-onetime event. In other words, ex-releases, JPM misses, however it was right in line if one assumes the litigation reserve was indeed one-time. In summary, the firm had a total of $19.4 billion in loan loss reserves and the release of $1.4 billion was the biggest since Q3 2012. What is worse going forward was the slide in Mortgage Production pretax income which was $582mm, down a whopping $349mm YoY, "reflecting lower margins and higher expense, partially offset by higher volumes and lower repurchase losses." For those curious how the rate spike has impacted JPM, here it is: mortgage originations down 7% Q/Q, and firmwide it dropped to $52 billion. But perhaps the worst news is that despite the dramatic spike up in yields at the end of the quarter, JPM reported a Net Interest Margin that in Q2 was the lowest ever, dropping to just 1.05% on a market-based basis, the firm's defined NIM slid to 2.20%.
Nothing says 'wealth' like a luxury Swiss watch (or two), and despite the equity markets of developed 'wealthy' nations resurgent in their inflated-asset-based selves, it seems the demand for luxury watches remains subdued at best. While Asia appears to be a big drag (as we noted here), Europe and the US are also plunging; but have no fear as African sales are up 25% (there's the real wealth effect?). The 'wealth effect' plan appeared to be working until the beginning of 2013 when, in spite of the almost unprecedented and inexorable rise in equities, Swiss watch exports collapsed to their worst levels since the great recession. Transitory blip? Doesn't seem that way as the most recent YoY change is the worst in six months.
The only story this morning remains Bernanke's after hours speech, which solidly trumped the FOMC minutes in market impact, and which, in addition to ramping US equity futures to just about new all time highs, sent the EURUSD soaring by almost the same amount (+300 pips) as the actual QE1 announcement on March 18, 2009. Such is the power of verbal currency warfare, when Bernanke hasn't acutally done anything and merely hinted the Fed is as confused as ever about what to do. Of course, as Commerzbank notes this morning, the U.S. economy would have to lose a lot of momentum for the Fed to cancel tapering, and the central bank would only expand the purchase program if the economy collapses, but none of that matters to the "wealth effect" for the 1% where economic destruction simply means more wealth.
Bernanke's comments give market cause to re-think its outlook for tapering and eventaul rate hike. Here's why and what it means.
Commenting on the divergence between the bond market's Taper-On reaction and the equity markets Taper-off reaction amid the total lack of clarity from the FOMC, CNBC's Rick Santelli asks the (rhetorical) question that everyone should ask: "[What the Fed minutes said] is, listen, we have to wait for bigger confirmation that the economy is doing better; and for that, we're going to look at the employment side. [At the same time] we have the fewest people working that can work in 30 years, and all-time-record-high profits for corporations. Now, does that strategy sound rational to you?" It seems, now that Bernanke has seemingly promised that it will really never end, that Santelli's question will become increasingly critical in this country.
It’s summer. Markets are supposed to be in the doldrums. But, that characterization hardly fits thus far this summer. What is different this year? We are nearing a possible inflection point in terms of Fed actions. The mere suggestion from the Fed that something is going to change is enough to supercharge markets, either up or down. If anyone was not convinced of market dependence on liquidity (and not fundamentals), the last thirty or so days should have clued them in. The Fed’s charter never included keeping markets levitating beyond where they should be. Now, at least de facto, it does. The Fed surrendered whatever independence it supposedly had. It is now just another tool of the political class. Stay tuned, this story has hardly begun.
Equity futures markets (US and Asian) and AUD are sliding off overnight highs amid the worst YoY exports performance in China since October 2009. The 3.1% drop (compared to expectations of a 3.7% gain) is the biggest miss in a year and the first negative print since January 2012 - making the second big miss in a row as the 'fake' trade data driven by the shadow-banking-arbitrage is unwound out of historical data.
- China, the single biggest contributor to global growth over the past decade, slowing markedly.
- World trade now flirting with recession.
- OECD industrial production in negative territory YoY.
- Southern Europe showing renewed signs of political tensions as unemployment continues its relentless march higher and tax receipts continue to collapse.
- Short-term interest rates almost everywhere around the world that are unable to go any lower, even as real rates start to creep higher.
- Valuations on most equity markets that are nowhere near distressed (except perhaps for the BRICS?).
- A World MSCI that has now just dipped below its six month moving average.
- A diffusion index of global equity markets that is flashing dark amber.
- Margins in the US at record highs and likely to come under pressure, if only because of the rising dollar.
The trick so far has been to create massive inflation, export the effects of it to other trading partners, and end up with a lot more money here in the USA, or the illusion of more money. Well, loans, for houses, cars, and college tuitions. In a word: debt. Let’s call it “Rainman Economics,” because it begins to resemble the behavior of a severely autistic human being who performs a small range of obsessive actions over and over and over, often centered on numbers. Rainman Economics is the policy of the Federal Reserve and, indirectly, the government under Mr. Obama. This is the eeriest summer. The coordinated effort to devalue gold - so as to maintain the sagging reputation of the world’s re$erve currency - has had the effect mainly of funneling it out of weak hands in the west to strong hands in the east, to countries that at one time or another we regarded as adversaries. In these games of currency war, there are too many moving parts for comfort. Something’s in the air this hot, soggy summer and it smells like the loss of faith.