New Normal

Modern Portfolio Theory (MPT) is broken. That is how we interpret Niels Jensen's (Absolute Return Partners) latest missive as he draws a concerning line between the number of managers who rely sheep-like on the diversifying 'artifacts' of MPT in a new normal world of undiversifiable systemic risks. The shifts in intra- and inter-asset class correlations (both long- and short-term) have been incredible both in terms of direction change and magnitude - for example (as Nielsen notes) - In the 2000-03 bear market commodities were an excellent diversifier against equity market risk with the two asset classes being virtually uncorrelated (+0.05). Nowadays, the two are highly correlated (+0.69). This shift to a risk-on / risk-off world, fed by central bankers, makes the empirical Sharpe ratios of olde and track records of your favorite balanced-fund manager entirely useless for any investor seeking protection from not just volatility risk but ultimate risk - the permanent loss of capital.

If there is any demarcation with profound implications going forward, it isn't the line between the 1% and the 99% or the line dividing the Status Quo into two safely complicit ideological camps: it is the divide between those who squarely face the burden of knowing the present is unsustainable and those who flee into the comforts of denial. Those who accept the burden of knowing are part of the solution, those who cling to denial are part of the problem. Those who accept the burden of knowing do not necessarily have answers, but they are alert to alternatives and potential solutions. Those in denial can only hope that reality can be buried for a while longer.

If you are the person who sold 1,300 tons of Swiss gold in the pre-"New Normal" era, you probably would like to keep that fact to yourself. But not Michael Paprotta, or the guy who did sell 1,300 tons of gold for the Swiss National Bank from 2000 to 2005. As a reminder, the price of gold in the period was between $250 and $450, making Gordon Brown's own dump of a meager 400 tons of UK gold between 1999 and 2002 seem like amateur hour by comparison. Assuming a current price of gold of $1800 and a blended disposition price of $350/oz, this means that Switzerland effectively gave up on just under $60 billion in upside. That's ok though, the SNB's balance sheet is now full to the gills with money-good EURs. Who needs gold in a fiat regime anyway? Certainly not Michael Paprotta who gives up on tens (soon hundreds) of billions in gold upside fiat equivalents in the morning, then goes skiing in the afternoon.

For the third day in a row, there is little to write home about from the overnight action. The EURUSD has been choppy following an MNI report about comments from EU officials that suggested Germany wants to delay the Troika decision on a €31.5 billion payment to Greece until after the November 12 Eurozone finmin meeting, no doubt predicated by the already discussed willingness by Europe to not rock the boat before Obama is reelected, still leaving the question hanging: just why is an entire insolvent continent so hung up on a US presidential decision. The main FX market focus is on the European Central Bank rate decision, due at 1145GMT. The ECB is widely expected to leave rates on hold just as the BOE did moments ago (it needs to hurry up if it wants to win the race to debase) although in the New Normal one can't be sure of anything. In other news Spain auctioned off a much needed €3.99 billion in various short-term bonds, the bulk of which fell under the LTRO maturity umbrella, but which was successful nonetheless if with modestly weaker short-end results, and an overall bitter aftertaste as seen by the resumption in Spanish 10 year widening, as the entire market, not to mention Draghi, is starting to get very impatient with Rajoy, who is now even getting urged by Catalonia's Arturo Mas to finally bite the bullet and demand a bailout (and resign shortly thereafter): "A bailout is inevitable; therefore the best thing to do is to make the decision without delay,” Mas said. “Spain has the potential to overcome the situation, but it will need assistance for some time." Recall that Spain's cash needs in October surge so every single successful euro raised is more than critical.

It wouldn't be the new normal markets if something freaky did not happen. WTI crude was crushed lower (back under $88) and now down almost 10% from pre-QEternity on supply build (totally ignoring the Iran and Syria-Turkey SNAFUs). HPQ stunned investors back to reality and fell 13% to nine-year lows. AAPL did it again - same 310ET time, same velocity of liftathon - which dragged indices up off what could have been a red close. Equities entirely disengaged from risk-assets soon after the US equity open this morning and never looked back as Treasury yields pushed higher into the open and slid lower all day, the USD rose quietly all day long, and gold drifted sideways to modestly higher on the day. VIX limped lower on the day but on the week stocks are up around 1%, Treasury yields down 1-2bps, USD unchanged, and gold/silver marginally higher (with WTI -4.6%). Healthcare and Financials are up around 1.75% on the week with Materials and Energy down 0.6%. Gold and Stocks are recoupled.

Quiero un iPhone para salvar el Mundo! Looks like Spain actually enjoys the sovereign-regions-banks negative loop with no wish to cut the Gordian knot.

No European data tomorrow: Mario D, the floor is all yours, after Mariano D’s bond sales.

"The Fed will, “gradually sell securities or let them mature." Rubbish!

The highlights from Bill Gross' latest monthly piece:

• Armageddon is not around the corner. I don’t believe in the imminent demise of the U.S. economy and its financial markets. But I’m afraid for them.
• Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the “Ring of Fire.”
• If the fiscal gap isn’t closed even ever so gradually over the next few years, then rating services, dollar reserve holding nations and bond managers embarrassed into being reborn as vigilantes may together force a resolution that ends in tears. The damage would likely be beyond repair.
• The U.S. and its fellow serial abusers have been inhaling debt’s methamphetamine crystals for some time now, and kicking the habit looks incredibly difficult.

Because the horse and buggy is the new normal car:

• FIAT ITALY NEW CAR SALES FALL 24% IN SEPT
• FRENCH CAR SALES FALL 18.3% IN SEPTEMBER, DOWN 13.9% THROUGH SEPTEMBER
• PORTUGUESE LIGHT VEHICLE SALES DROP 42% THROUGH SEPTEMBER

This is what happens when you don't take advantage of US, Chinese, or for that matter Global channel stuffing. It is, for now, unclear if Mario Draghi's monetization of 1-4 cylinder Fiats is forbidden by Article 123.

Chinese local governments are facing the prospect of major unemployment problems should the swathe of solar panel makers, that have been subsidized from birth to now-near-death, continue to suffer from US and European tariffs (as well as simple gross mis-allocation of capital amid massive over-capacity). However, as is the way of the mal-investing world today, no barrier to rational economic theory is too low for government status-quo maintenance as it would appear that local banks have been strong-armed into extending loans to keep them alive. As Reuters reports, debt-laden (NYSE-traded) SunTech Power Holdings  - which is close to removal from the exchange due to its dismal equity price - has just received new 'bailout' loans. First, it was a race to debase. Now, we have the race to bailout the world's most worthless companies (especially in channel-stuffed industries) as the New Normal trade wars continue.

One by one all the money-laundering loopholes in a broke world are coming to an end. First it was Swiss bank accounts, which for centuries guaranteed the depositors absolute secrecy, and as a result saw money inflows from all the wealthiest savers in the world, who felt truly safe their wealth (obtained by legal means or otherwise) would not be redistributed forcefully. In the ecosystem of finance, Switzerland was the depositor bank. Then 2008 happened, and starting with the US, shortly to be followed by every other insolvent country, demands were issued for a full list of people who had used Zurich and Geneva bank vaults to avoid the risk of asset taxation, capital controls and confiscation on their own native soil. The result was the end of the Swiss banking sector as the ultimate target of all global money laundering. In the ensuing power vacuum, others have sprung up to take its place, most notably Singapore, but its days as a tax-haven are numbered by how long it takes China to fall face first into a hard landing at which point no saving on the Pacific seaboard will be safe.

Now, it is the turn of real estate.

It appears that in the past few weeks, the number 25% is strange attractor of bad luck for Greece. First, a month ago we learned that Greek unemployment has for the first time ever reached 25%. Now we get to see the income statement and balance sheet manifestation of a society in socioeconomic collapse - Kathimerini reports that Greek bad loans, or those which haven't seen a payment made in over 3 months, have hit a record €57 billion, or 25% of all bank debt. "With one in every four loans not being repaid for more than three months, the bank system is feeling the pressure, leading to additional capital requirements that are expected to aggravate the state debt further." That was Kathimerini's spin. The reality is that just like in Spain, where between bad loans and deposit outflows, the country has become a protectorate of the ECB, which is now fully in control of its banking system, so too in Greece Mario Draghi's tentacles are now in every bank office. Should Greece repeat the festivities of this summer and threaten to pull out of the Eurozone, the ECB will merely in turn threaten to push the red button and cut off all cash to terminally insolvent Greek banks, which of course would also mean a total halt of all deposit outflow activity. So instead what will happen is the ongoing rise in unemployment, and the increase in bad loans as percent of total, until one day the economy, even with all the money in the world pumped into it from Frankfurt, will no longer move. That day is getting very close.

Traditionally, when it comes to reading behind the manipulated media's tea leaf rhetoric and timing major inflection points in the economy, the most accurate predictor are financial firms, whose sense of true economic upside (or downside) while never infallible, is still better than most. Yet unlike employment, which is usually a lagging, or at best concurrent indicator, one aspect that has always been a tried and true leading indicator, has been real estate demand, in this case rental contracts. Due to the long-term lock up nature of commercial real estate contracts, firms are far less eager to engage in rental transactions (and bidding wars) when they expect a worsening macroeconomic environment. Which is why news that office vacancy in Manhattan's Plaza district, the area between Sixth Avenue and the East River from 47th to 65th streets, anchored by the landmark Plaza Hotel at Fifth Avenue and Central Park South which is home to some of the nation’s most expensive and prestigious office towers, and where America's largest hedge funds and PE firms have their headquarters, has just risen to 12.3%, or a two year high, is probably the most troubling news for the economy and a real indicator of what to expect of the immediate future.

The financial crisis of 2008 shook politicians, bankers, regulators, commentators and ordinary citizens out of the complacency created by the 25-year "great moderation". Yet, for all the rhetoric around a new financial order, and all the improvements made, many of the old risks remain (and some are far larger). The following 'story' suggests a scenario based on an 'avoidable history' and while future crises are not avoidable, being a victim of the next one is.

"John Banks was woken by his phone at 3am on Sunday 26th April 2015. John worked for Garland Brothers, a formerly British bank that had relocated its headquarters to Singapore in late 2011 as a result of..."

In a fiery article written today, Telegraph's Ambrose Evans-Pritchard unleashes a scathing critique of Europe's AAA club for daring to demand that Spain actually follow through with what they have been pretending to be doing, namely cutting spending and promoting improved government tax collections. We now know that Spain did neither, with spending increasing while tax revenues dropped from last year (and as we will not tire of pointing out, if the government has lost sight of the ball, and the economy is collapsing, it is not due to a cut in spending but due to its own inability to govern - something the people in a democratic regime usually are quite capable of fixing on their own). But complying with agreements in a broke Europe is not part of the New Normal. His summation, phrase briefly is as follows: "We discover – yet again, you might say – that Germany, Holland, and Finland will not stand behind their solemn pledge of solidarity when push comes to shove. Spain’s premier Mariano Rajoy has been betrayed. Nobody should be entirely surprised if he and the Spanish arch-nationalists in his circle offer a condign riposte, and bring down the entire temple on the heads of the creditor powers." Of course, none of that is true, and what Germany, Holland and Finland are doing is doing their best to get dragged into the money pit that the rest of their insolvent socialist neighbors can so efficiently dug in the last several years.  What the article really is, is simply Ambrose's contrition for misreading the balance of power in Europe. Like so many others, he was all too eager to swallow the misdirection narrative that as a result of Mario Monti's stubborn gambit at the June 27th Euro-summit, the balance of power had finally shifted from the exporting, rich and quite solvent nations, to their liquidity and bailout addicted neighbors, something we claimed all along was a major mistake.