In A World Artificially Priced To Perfection, The Imperfections Appear

Tyler Durden's picture

From Guy Haselmann of ScotiaBank


The US economy has shown some hints of improvement, but overall it is plodding along at a pace that is neither strong nor awful. Most economists expect momentum to improve slowly to a 3% GDP growth pace in 2014, and something slightly above that in 2015. These forecasts are probably the best-case scenario. Therefore, they have asymmetrical skew to the down side. Due to crowded positions, valuations priced to perfection, and a confluence of global economic headwinds, the riskiest financial assets also have downside distribution skews of potential outcomes.

The most visible worry for investors is coming out of China, as Beijing and the PBoC attempt to tame growing imbalances and a dangerous credit boom. Recent defaults and sharp drops in many industrial commodity prices are not random events, but rather intricately connected to official plans for economic transformation. Premier Li said people should be prepared for bond and financial product defaults. In addition, PBoC announced plans for full interest rate liberalization by 2016. These changes are necessary in order for the Chinese government to pursue its ultimate goal of the Renminbi someday becoming a reserve currency.

Beijing maintains tight capital account controls. In recent months, the PBoC has expressed concerns about ‘hot money’ inflow. Total fund inflows amounted to approximately $500 billion in 2013. Officials who are trying to liberalize markets have not liked the perceived one-way bet on the Renminbi. One of the most popular (levered) trades has been to borrow in Yen and invest the proceeds in Renminbi. The trade made  sense, because the investor earned the large interest rate differential, while also benefiting from what had appeared to be the governmentally-controlled direction of each currency (Yuan stronger, Yen weaker).

One factor that may have prompted Beijing’s forceful currency move was anger at the Japanese who have driven their currency down 25% on a trade weighted basis. Their angst has likely been heightened by the fact that the US has refrained from any criticism of Japan’s policy. Recently, elevated geo-political uncertainties with Russia and EM, means that the Yen’s status as a safe haven has been putting upward pressure on the Yen. Thus, both currencies are moving the wrong way, further decimating investor yen-carry trades.

The changes being implemented to China’s economic development model are changing the behavior of State Owned Enterprises and local banks. Fewer loans are available, and loan refinancings, if available, require worse terms. Chronic overcapacity is now combining with slowing economic growth to increase debt servicing problems. Cross-guarantees risk a series of chain defaults which could then hit key supply chains.

Overcapacity is partially being blamed for plunging prices in copper, iron, cement, aluminum, solar panels and coal. Real asset collateral for trade finance arrangements ‘gone bad’ have resulted in further downward price pressures.

Lower prices and the drop in demand for key commodities products have proven to be disruptive not just for speculators, but for emerging markets in particular. The mini-contagion already appears to be leaving its mark on financial markets and the global economy.

In the past, during signs of economic weakness, the Chinese government was quick to authorize new large infrastructure projects or encourage new credit creation, but this time, those options are not desirable by officials as they are much riskier options at this point.

China, Japan and the US are the three largest economies in the world. Each country is currently in the midst of highly-significant policy maneuvers. The Fed is bringing QE to an end. China is dealing with the credit bubble issues outlined above. Japan is lifting its consumption tax from 5% to 8%. Japan’s hike in 1997 from 3% to 5% pushed the economy into a recession. In addition, Russian sanctions could magnify and potentially take a large bite out of global economic growth.

Portfolios will need to adapt to this changing environment. Just about everyone is anticipating higher Treasury yields. Most PM’s are short duration. However, the term premium is falling quickly. The technical chart looks outstanding on the long end. Macro factors are also beginning to align. I believe the next 50bps in the 30year (yield) is shaping up to be a move toward lower (not higher) yields. Portfolios are ill-prepared.

“The only thing I knew how to do was to keep on keeping on.” – Bob Dylan

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The Gooch's picture

OT: Cops shoot and kill unarmed man for "illegally camping"

knukles's picture

The whole global economy "sucks", which is a precise technical term analogous to roll over dead, shitty or yeah, right.
Now, what with that baseline, particularly within a Liquidity Trap, where the Fed can slow bond purchases, but their balance sheet continues to expand rapidly while nobody is borrowing worth mentioning....
Add onto that, EU stinks (which is another synonym for sucks) has stunk and will continue to stink, Japan is raising taxes (Yeah!!!!  Three cheers for abject stupidity!) And CHina.  Chiona, gosh....
Whadda they gonna do with all them  empty cities and rehypothicated collateral behind all those shady over engineered and just fraudulent commodity financings that'll unwind like a derivatives Nightmare on Elm Street
Damn good thing that Geo-Poilitcal Tensions are not running high and ......

........ Fucking Presto!

Rates on High Quality stuff are gonna go down.
Any port in the storm long term fixed income fund gonna be good stuff over a Long Time Horizon
Getchur income while you can, kids, while you can.
Step right up to the plate, little ones...
And yes,not just talk, but action, Uncle Knukie has been extending portfolio maturities during the most recent back-up in rates.
We'll see.

jeff montanye's picture

while both you and the poster above may be right and the next 50 basis point move in long bonds may be down, hussman notes that the prospective 10-year return on a balanced portfolio is now at the lowest level in history, at just over 2% annually. 

and that's not usually a good thing.

Al Huxley's picture

Haven't you heard?  In a police state that's not just allowed, its encouraged.  Certainly not news.

Overfed's picture

Chickenshit motherfuckers. For the life of me, I can't understand the people who worship chickenshit scum cops.

Rusty Shorts's picture

I don't know, but this is just...I don't know, just released today.

DelusionalGrandeur's picture

Weird. Looks like a group of floating lights with nothing around it. Maybe cgi, maybe not.

Rusty Shorts's picture

Yeah, I don't know either, but have been watching this guy for a while...he's into some heavy duty stuff if you poke around his channel a bit....spooky

Overfed's picture

All I know is that Stella Artois is the most flavorless beer on earth.

Iriestx's picture

Awww, come on.  Toilet water has a flavor.

Pool Shark's picture



How did you find that out?



ebworthen's picture

“The only thing I knew how to do was to keep on keeping on.” – Bob Dylan

Remember the T-Shirts "Keep on Truckin'!" ?

Robert Crumb:

the 300000000th percent's picture

The economic collapse has been underway for 6 years. People kkep wondering, when is it going to happen. Haha. It's here, it is going on right now. This is what it looks like folks. The hits will keep coming, but will largely be ignored by the "market". It will be a long slow death grind. Not as spectacular as everyone thought it would be huh?

stacking12321's picture

not yet.

but, as you may know, how did ernest hemmingway go broke?

gradually at first, then suddently.

tarsubil's picture

Are people in Detroit (along with Oakland, Baltimore, Gary and a bunch of other American cities) waiting for the collapse?

i_call_you_my_base's picture

There's no way in hell Japan is going to implement that tax.

Yen Cross's picture

   All I know, is that these maroons that are buying the aud thinking they're going to get some big stimulus from the PBoC need to lay off the "hopium pipe."

   With the stockpiles of copper and iron ore and rampant inflation in China they're likely to get their central bank addicted faces torn off in short order...

trader1's picture

stella artois?  perfection has its price?

certainly the advertisers are consuming too much of their own product...


constantine's picture

"The Fed is bringing QE to an end."

Seems like the everybody is giving the FED a pass on this lie.  So far balance sheet expansion has been accelerating rather than slowing down.  The winding down of QE has been nothing more than talk.  FED balance sheet increased by $105 billion in February and is on a similarly explosive start for March.