Goldman Reveals "Top Trade" Reco #5 For 2014: Sell Protection On 7-Year CDX IG21 Junior Mezzanine TrancheSubmitted by Tyler Durden on 12/03/2013 08:22 -0400
If the London Whale trade was JPM selling CDS in tranches and in whole on IG9 and then more, and then even more in an attempt to corner the entire illiquid IG9 market and then crashing and burning spectacularly due to virtually unlimited downside, Goldman's top trade #5 for 2014 is somewhat the opposite (if only for Goldman): the firm is inviting clients to sell CDS on the junior Mezz tranche (3%-7%) of IG21 at 464 bps currently, where Goldman "would apply an initial spread target and stop loss of 395bp and 585bp, respectively. Assuming a one-year investment horizon, the breakeven spread on this trade is roughly 554bp (that is, 90bp wider than where it currently trades)." In other words, Goldman is going long said tranche which in an environment of record credit bubble conditions and all time tights across credit land is once again, the right trade. Do what Goldman does and all that...
Overnight repo rates are spiking once again in early trading as the typically smaller banks that are more desperate bid aggressively for whetever liquidity they can find. 5Y Chinese swap rates have also reached a record high as the Yuan reaches its highest since Feb 2005. Chinese authorities are clearly stepping up the rhetoric:
- *CHINA SHADOW-FINANCE RISKS WILL SPREAD TO BANKS, FANG SAYS
- *VERY BIG CHANCE ONE OR TWO SMALL CHINA BANKS WILL FAIL: FANG
- *SOME CHINA TRUST INVESTMENT FIRMS MAY FAIL, SELL ASSETS: FANG
- *CHINA MUST PLAN FOR BANK-FAIL SCENARIOS TO MANAGE RISKS: FANG
- *CHINA NEEDS TO PAY MORE ATTENTION TO CORPORATE LEVERAGE: HU
The gambit between the PBOC's liqudity provision and the growing dependence on their "spice" is clear - the question is, of course, will banks send a message (via the markets) to the PBOC or will they self-select (on first-mover's advantage) eradicating the weakest.
"We're Stuck In An Escher Economy Until The Existing Structure Collapses And Is Rebuilt On Stronger Principles"Submitted by Tyler Durden on 11/09/2013 13:26 -0400
1. Even if the economy returns to full employment under existing policies, it won’t remain there after (and if) interest rates normalize.
2. Based on today’s debt and valuation levels (charts 8-9, for example), rising interest rates will have an even harsher effect than suggested by the 60 year history
3. Contrary to the establishment’s “sustainable recovery” narrative, the most plausible outcomes are: 1) interest rates normalize but this triggers another bust, or 2) interest rates remain abnormally low until we eventually experience the mother of all debt/currency crises.
We’re stuck in an Escher economy (see below), thanks to the impossibility of the establishment economic view, and this will remain the case until the existing structure collapses and is rebuilt on stronger policy principles.
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.
If the Fed was worried about 'froth' in the markets earlier in the year, then this chart should have them panicking. Of course, as Jim Bullard noted Friday, there is no bubble because everyone knows there is no bubble but judging by the massive surge in covenant-lite loan issuance, there is a bubble in forced demand for leveraged loans. At $188.7 billion, the 2013 issuance of these highly unsafe loans (which have seen huge inflows since the Fed started talking taper back in May) is almost double that of the peak of the last credit bubble in 2007 and is five times the size of 2012 YTD issuance at this time. As Reuters notes, Covenant-lite loans used to be reserved for stronger companies and credits, but are now so common in the U.S. leveraged loan market that investors are becoming wary of some credits with a full covenant package. With corporate leverage at all-time highs, what could go wrong?
In what is unbelievable hypocrisy and re-writing of history based on 20/20 hindsight, Bullard, in responding to a question of asset bubbles, explained that while all Fed members are "concerned about asset bubbles," they do not see one now. His reasoning is so cognitively dissonant as to be almost comedic:
- *BULLARD SAYS TECH BUBBLE, HOUSING BUBBLE WERE BOTH `NO SECRET'
- "Bubbles Of The Past Were Gigantic And Obvious... Not Now"
So there it is - because the St. Louis Monday-Morning-Quarterbacker can now so clearly see the previous epic bubbles (which the Fed did not see and merely pumped even higher) were obvious and one is not obvious now (unless you actually take a minute or two to consider forward earnings growth and margin expectations in light of lower deficits, unemployment, and global growth; high-yield credit spreads; primary issuance levels; and the fact that corporate leverage is at record highs).
The froth is back. As we noted yesterday, corporate leverage has never been higher - higher now than when the Fed warned of froth, and as the BIS (following their "party's over" rant 3 months ago) former chief economist now warns, "this looks like to me like 2007 all over again, but even worse." The share of "leveraged loans" or extreme forms of credit risk, used by the poorest corporate borrowers, has soared to an all-time high of 45% - 10 percentage points higher than at the peak of the crisis in 2007. As The Telegraph reports, ex-BIS Chief Economist William White exclaims, "All the previous imbalances are still there. Total public and private debt levels are 30pc higher as a share of GDP in the advanced economies than they were then, and we have added a whole new problem with bubbles in emerging markets that are ending in a boom-bust cycle." Crucially, the BIS warns, nobody knows how far global borrowing costs will rise as the Fed tightens or “how disorderly the process might be... the challenge is to be prepared." This means, in their view, "avoiding the tempatation to believe the market will remain liquid under stress - the illusion of liquidity."
If Fed governor Jeremy Stein had concerns about a resurgent credit bubble in February when he wrote his warning about "Overheating in Credit Markets: Origins, Measurement, and Policy Responses" then he should certainly not look at the bubbly ferocity that is taking place in the bond world just half a year after his letter failed to make any dent in the yield-chasing animal spirits.
A steady rise in leverage in recent years means Corporate Asia now has the most leveraged balance sheets globally. As Morgan Stanley's Viktor Hjort notes, with Fed liquidity anticipated to slow, now the cycle turns more adverse. Asian corporate balance sheets face a combination of slower growth and higher funding costs. Slower economic growth is putting downward pressure on earnings growth and rising real rates is putting upward pressures on funding costs turning bad macro into even tougher micro. Asian banks are tightening lending standards in their procyclical way but Asian credit markets are facing a fundamental environment that for many corporate borrowers will feel like a recession.
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...
Curious how Abenomics is progressing six months after its announcement? These charts courtesy of Diapason should provide a convenient status update.
For the first time, a mainland Chinese company has defaulted on its bonds. SunTech Power Holdings has been clinging on by its teeth but after failing to repay $541mm of notes due on March 15th - and following four consecutive quarters of losses through the first quarter of 2012 and since then having failed to report quarterly earnings - owed to Chinese domestic lenders, the firm is restructuring. As Bloomberg reports, Chinese solar companies are struggling after taking on debt to expand supply, leading to a glut that forced down prices and squeezed profits - and most notably were unable to renegotiate its liabilities and obtain “additional flexibility” from creditors. This is highly unusual and perhaps is the beginning of a trend for Chinese firms. We already know the little discussed but gargantuan size of China's corporate bond market (which dwarves the US relative to GDP) as the mis-allocated credit tsunami of the last few years begins to hit its lending limit - just as Chinese corporate leverage is surging. If Suntech, the world’s largest solar-panel maker as recently as 2011, could not renegotiate its loans, we humbly suggest there are more problem firms out there about to find their friendly local banker a little less enthusiastic - just as Marc Faber warned recently.
In one sentence, during 2013, we expect imbalances to grow. These imbalances are the US fiscal and trade deficits, the fiscal deficits of the members of the European Monetary Union (EMU) and the unemployment rate of the EMU thanks to a stronger Euro. By now, it should be clear that the rally in equities is not the reflection of upcoming economic growth. Paraphrasing Shakespeare, economic growth "should be made of sterner stuff". Many analysts rightly focus on the political fragility of the framework. The uncertainty over the US debt ceiling negotiations and the fact that prices today do not reflect anything else but the probability of a bid or lack thereof by a central bank makes politics relevant. Should the European Central Bank finally engage in Open Monetary Transactions, the importance of politics would be fully visible. However, unemployment is 'the' fundamental underlying factor in this story and we do not think it will fall. In the long term, financial repression, including zero-interest rate policies, simply hurts investment demand and productivity.
The Chinese economy has been enjoying a cyclical rebound since the beginning of Q4 2012. SocGen's central scenario is that this recovery will last until early Q2 2013 and then gradually lose momentum. In the medium term, they still anticipate a bumpy path of secular deceleration, leading to an average growth rate of 6-7% over the next five to seven years, down from 10% per annum over the last three decades. This piece focuses on what is probably the most popular “what-if” question about the Chinese economy – what if China hard lands (with real GDP growth rate plummets to below 6%)? As China undergoes demographic ageing and growth of the working-age population slows, this minimum stable growth level will decline further. However, if progress in rebalancing and structural reform remains slow, the probability of a hard landing will rise over the medium term. In the tail risk scenario set out below, 2013 will see several quarters with just 3% growth and full year growth would stand at just 4.2%, but what are th triggers, how would it evolve, how would the government respond, and how bad could things get?
The question whether China will suffer a "hard" or "soft" landing is, in the long-term, largely irrelevant and misleading. A far more critical question is whether the period of 10%, or even 7% annual growth, for the world's biggest marginal growth dynamo of the past decade, is now over. Read on for the answer.