What is the prudent response when hefty profits beg to be booked and assets purchased with leverage/debt start declining? Sell, sell, sell. A financial sell-off doesn't even need a real crisis to spread like wildfire; it simply needs nosebleed asset valuations, excessive leverage/credit and risk priced at "the bull market is guaranteed to last essentially forever" levels. Prudence alone will ignite the conflagration.
Confused how to trade the second coming of the dot com bubble and a world in which irrational exuberance has hit irrationally exuberant levels? You are not alone. Here is some insight from none other than David Einhorn originating in his latest letter to investors.
Gone are the days where people looked towards next year when building their portfolios, or five years down the road as they approach retirement. Now from a combination of apprehensiveness and shear paranoia in our unstable markets, investors are looking only as far as they can throw for their personal investment decisions. In more than 30 years of money management, Lance Roberts has never seen such a rapid change in the way people make financial plans. Instead of saving for the future, many are opting for fast gains - yet at the same time they want low risk. Others are playing it completely safe. In fact, in a quarterly poll, 83% of respondents said they were holding on to their cash versus investing in the stock market.
In the upcoming week, the key event is the US FOMC, though we and the consensus do not expect any key decisions to be taken. Though a strengthening of forward guidance is still possible, virtually nobody expects anything of import to be announced until the Dec meeting. In the upcoming week we also have five more central bank meetings in addition to the FOMC: Japan, New Zealand, India, Hungary and Israel. In Hungary we, in line with consensus, expect a 20bps cut to 3.40% in the policy rate. In India consensus expects a 25bps hike in the repo rate to 7.75%. On the data front, US IP, retail sales and pending home sales are worth a look, but the key release will be the ISM survey at the end of the week, together with manufacturing PMIs around the world. US consumer confidence is worth a look, given the potential impact from the recent fiscal tensions.
The reason why the Chinese Shanghai Composite again can't catch a bid (and why the Baltic Dry is sliding and will continue sliding from recent highs) is the same as the main event yesterday: the concerns that while the Fed punchbowl is and will continue to be filled beyond the point of overflowing, China - where inflation has once again taken a turn for the worse as it did this summer when after much repo pain the PBOC killed it early on in order to not repeat the scary episode of 2011 - may be actively engaging in monetary tightening. And like yesterday, when the PBOC refrained from adding liquidity via reverse repos, so today for a third straight auction the Chinese Central Bank refused to inject short-term funding into the system. The immediate result: China’s one-month Shibor rose 59 bps, most since June 25, to 5.4000%; three-month Shibor rose to 4.6876% from 4.6843% yesterday, while the key 7-Day Repo Rises 63 Bps to 4.68% hitting 5% prior, which was the biggest jump since July.
What politicians want from their regulatory efforts is a world of pure beta and zero alpha. This is the ultimate “level playing field”, where no one knows anything that everyone else doesn’t also know. The presumption within regulatory bodies today is that you must be cheating if you are generating alpha. How’s that? Alpha generation requires private information. Private information, however acquired, is defined as insider information. Insider information is cheating. Thus, alpha generation is cheating. QED. Why would politicians want an alpha-free market? Because a “fair” market with a “level playing field” is an enormously popular Narrative for every US Attorney who wants to be Attorney General, every Attorney General who wants to be Governor, and every Governor who wants to be President … which is to say all US Attorneys and all Attorneys General and all Governors. Because criminalizing private information in public markets ensures a steady stream of rich criminals for show trials in the future. Because the political stability of the American regime depends on a widely dispersed, non-zero-sum price appreciation of all financial assets – beta – not the concentrated, zero-sum price appreciation of idiosyncratic securities. Because public confidence in the government’s control of public institutions like the market must be restored at all costs, even if that confidence is misplaced and even if the side-effects of that restoration are immense.
Even as JPMorgan seems set to put its London Whale troubles behind it with a nearly $1 billion imminent settlement, while at the same time throwing two mid-level traders at NY prosecutors and washing its hands of the whole tempest in a teapot affair, a curious snag has appeared. The CFTC, which in the past has never had a problem with promptly settling any market manipulation abuse with any bank in exchange for a small cash-greased slap on the hand, is suddenly a sticking point in JPM's ability to just walk away from the biggest prop trading Snafu in history. As WSJ reports, "the CFTC is focusing on the bank's increasingly aggressive trades made over several months early last year, when it added tens of billions of dollars to its derivatives positions—contracts tied to investment-grade corporate bonds, these people say. The CFTC is likely to use new powers granted by the Dodd-Frank law that allow it to charge firms for recklessly manipulating markets, say people familiar with the agency's thinking."
It is somewhat ironic that none other than CNBC is reporting the news (which was suggested here months ago in "Will JPMorgan's "Enron" Be The End Of Blythe Masters?") that as part of its divestment of its physical commodities unit announced previously, JPMorgan may also seek to cover up any trace of market manipulation in the division recently embroiled in the aluminum cartel scandal (which we reported on in June 2011 and which story recently rose to prominence as a result of follow up reporting by the NYT) by getting rid of none other than Blythe Masters.
"Traditional risk controls and safeguards - that relied on human judgment and speeds - must be reevaluated in light of new markrt structures," are the initial findings from the CFTC regarding the prevalance of high-frequency trading in futures markets. As USA Today reports, efforts to reduce trading order-processing times could "lead to a competitive race to the bottom" where positions outpace risk systems and potentially lead to systemic threats. All the signals are that the top US financial regulator may impose new restrictions to halt breakdowns and to avoid high-speed trading which "could provide opportunities for information advantage." Of course, we've heard this before and with trading volumes at 15-year lows, we suspect the 'industry' will be lobbying hard; but this is a positive step (only 3 years after the CFTC started to look at HFT).
Just as natural selection selects for traits that improve the odds of success/survival in the natural world, Economic Darwinism advances people and policies that boost profits and power within the dominant environment. If there was one phrase that summarized the current malaise, it would be "The Federal Reserve's 20-year policy of easy money created an environment virtually assured to select bankers, bureaucrats, educators, and elected officials who least understood the consequences of a credit crisis." In other words, a hyper-financialized environment of near-zero interest and abundant credit rewarded those people and policies that succeed in that environment.
From the historical perspective, concentrating virtually all systemic risk into the state is a Grand Experiment. Cheap, abundant oil, expanding working-age populations and rapidly increasing productivity conjured the illusion that the state was large enough and powerful enough to absorb infinite risk with no real consequence. The problem is the state's ability to tax/print/borrow money to cover payouts and losses is not infinite. Having transferred virtually all systemic risks to the state, we presume the state is so large and powerful that a virtually limitless amount of risk can be piled onto the state with no consequences. Offloading risk onto the state does not make the risk vanish; it simply concentrates the risk of collapse into the state itself.
The rapid pace of China credit expansion since the Global Financial Crisis, increasingly sourced from the inherently more risky and less transparent "shadow banking" sector, has become a critical concern for the global markets. From the end of 2008 until the end of 2013, Chinese banking sector assets will have increased about $14 trillion. As Fitch notes, that's the size of the entire US commercial banking sector. So in a span of five years China will have replicated the whole US banking system. What we're seeing in China is one of the largest monetary stimuli on record. People are focused on QE in the US, but given the scale of credit growth in China Fitch believes that any cutback could be just as significant as US tapering, if not more. Goldman adds that China stands to lose up to a stunning RMB 18.6trn/$US 3trn. should this bubble pop. That seems like a big enough number to warrant digging deeper...
Greed; corporate arrogance; lobbying influence; excessive leverage; accounting tricks to hide debt; lack of transparency; off balance sheet obligations; mark to market accounting; short-term focus on profit to drive compensation; failure of corporate governance; as well as auditors, analysts, rating agencies and regulators who were either lax, ignorant or complicit. This laundry list of causes has often been used to describe what went wrong in the credit crunch crisis of 2008-2010. Actually these terms were equally used to describe what went wrong with Enron more than twenty years ago. Both crises resulted in what at the time was the biggest bankruptcy in U.S. history — Enron in December 2001 and Lehman Brothers in September 2008. Naturally, this leads to the question that despite all the righteous indignation in the wake of Enron's failure did we really learn or change anything?
After weeks of emptying of their Gold vaults and making headlines in recent days over their oligolopolization of commodity warehousing, it seems the threat of a probe has excited Blythe and her colleagues to dump while the dumping is good:
- JP. MORGAN TO EXPLORE STRATEGIC ALTERNATIVES FOR ITS PHYSICAL COMMODITIES BUSINESS
Options include sale, spin-off, or strategic partnership as they re-confirm that they are "fully committed to traditional banking activities," as they look to drop the holdings of commodities assets and the physical trading business. We can only assume that "physical commodities" include the company's extensive inventories of tungsten (as well as the vault housing it), and not so extensive stores of gold and silver. That said, we are confident that the collapse in represented (but not warranted) JPM Comex gold vault holdings to a record low, and this news is completely unrelated.
As we warned here most recently, the shadow-banking system remains the most crisis-catalyzing part of the markets currently as collateral shortages (and capital inadequacy) continue to grow as concerns. In recent weeks, between The Fed, Basel III, and the FDIC, regulators have signalled the possible intent to change risk, netting, and capital rules that could have dramatic implications on the repo markets and now, it seems, the SEC has begun to recognize just how big a concern that could be. As Reuters reports, the SEC urged funds and advisers last week to review master repurchase agreement documentation to see if there are any procedures to handle defaults, and if necessary, prepare draft templates in advance. A retrenchment in repo markets is unwelcome news for the liquidity of the underlying securities and the impact on the derivative portfolios should not be underestimated.