OMINOUS PORTENTS

Doug Nolan


Friday headlines from Bloomberg: “Retail Sales Rise Most in a Year, Marking U.S. Consumer Comeback” and “Consumers Turn Out to Be U.S. Growth Lifeline After All.” Ironically, U.S. retail stocks (SPDR S&P Retail ETF) were slammed 4.3% this week, trading back to almost three-month lows. Poor earnings were the culprit. Macy’s sank 15% on Wednesday’s earnings disappointment. Kohl’s missed, along with Nordstrom and JC Penney.  

It may be subtle, yet it’s turning pervasive. Support for the burst global Bubble thesis mounts by the week. With stated U.S. unemployment at 5.0% and consumer confidence at this point still in decent shape, spending has enjoyed somewhat of a tailwind. Yet the overall U.S. economy has begun to succumb to a general Credit slowdown. Despite the bounce in crude, the energy sector bust continues to gather momentum. The tech and biotech Bubbles have peaked. Cracks have quickly surfaced in fintech. There are as well indications that some overheated real estate markets across the country have cooled. Whether it is from China or Latin America or Europe, the rush of “hot money” into U.S. real estate and securities markets has slowed meaningfully.

The slowing of Credit and “hot money” flows help explain the weakness in both corporate profits and the overall stock market. And with stock prices down year-on-year, Household Net Worth has essentially stagnated. Keep in mind that Net Worth inflated from $56.5 TN at year-end 2008 to a record $86.8 TN to close 2015. Over the past six years, Net Worth increased an average $4.76 TN annually. Such extraordinary inflation in household perceived wealth supported spending – which bolstered profits and underpinned asset price inflation and more spending.  Let’s return to the irony of positive retail sales data and negative earnings. It’s easy to forget that retail had been significantly overbuilt during the mortgage finance Bubble period. The worst of the shakeout was avoided as Household Net Worth inflated from 384% (2008) to a record 484% (2015) of GDP. And while inflating perceived wealth boosted spending, zero rates and manic financing markets ensured another period of booming retail investment (bricks and mortar and Internet). There has, as well, been extraordinary growth in various services, certainly including telecommunications.


In contemporaneous analysis of the Great Depression, there was insightful debate questioning whether over-investment or mal-investment was primarily to blame. Well, there was ample blame to go around. And this gets back to the fundamental thesis: It was not insufficient “money” after the 1929 Crash that was the root cause of economic depression, but instead gross excess of “money,” Credit and speculation throughout the Roaring Twenties.  

A few weeks back I noted analysis that placed excess global energy sector investment at several Trillion. And this week from Bloomberg (Agnieszka De Sousa), “Glencore CEO Lists Mining's Mistakes After $1 Trillion Spree.” And how many Trillions of over/mal-investment were spent in recent years throughout “tech,” biotech, pharmaceuticals and retail? Tens of Trillions throughout China and Asia more generally? Downward price pressures globally on so many things should be no mystery. And by now it should be indisputable that so-called “deflationary pressures” are not the consequence of insufficient “money.”

In the name of “shortfalls in aggregate demand,” central bankers have flooded the world with “money” and Credit. Predictably, this unprecedented global monetary inflation has wreaked havoc on financial market behavior and investment patterns, while spurring self-reinforcing asset inflation and Bubbles. And aggregate demand? It is not - will never be - sufficient. As we’ve witnessed, Credit Bubbles redistribute and destroy wealth. Bubbles distort investment and spending patterns, which in the end ensure too much of a lot of stuff that the general population either cannot afford or does not desire.

Newfound retail industry worries are intriguing. Energy – and even tech and biotech – sector excess was somewhat conspicuous, but relatively narrow in focus. Retail mal-investment is much more systemic – it’s virtually everywhere. Zero rates, the yield chase and QE flooded all facets of the sector with cheap finance. “Money” flowed freely into retail-related real estate investment trusts (REITs). Retail property prices inflated as “cap rates” collapsed. The upshot was additional construction and more retail. Meanwhile, booming property values and easy finance ensured that a lot of retail that should have went bust didn’t.  

While on the subject of busts, Lending Club dropped 50% this week. Count me skeptical of the incredible virtues of “marketplace lending,” “peer to peer” and “fintech” more generally. How much valuable innovation is available after decades of radical experimentation – not to mention thousands of years of lending? Yet every boom cycle greets financial innovation with boundless enthusiasm.

I do appreciate that few businesses enjoy the capacity to grow accounting profits as rapidly as lending to those with difficulty borrowing from traditional sources/channels. Lenders can charge high rates, ensuring a profits bonanza so long as rapid loan book growth is maintained. Minimal provisions for future loan losses can be justified, with the percentage of seasoned loans turning sour remaining small in comparison to (rapidly expanding) total loans. But ballooning growth in loan books requires that the lender retains ready access to funding markets. Telecom debt in the nineties and subprime in the 2000s come to mind. It’s amazing how long ridiculous lending crazes can endure – and it’s equally amazing how abruptly the “money” spigot can be shut off.  

After last week’s drubbing, global financial stocks saw little relief this week. U.S. bank stocks were down 1.6% Friday, more than erasing the modest gain from earlier in the week. Bank stocks are now down 9.7% year-to-date, with the broker/dealers losing 12.7%.

Globally, Italian banks sank another 2.9% this week, increasing 2016 losses to 36.9%. European bank stocks were volatile but ended the week little changed (down 22.1% y-t-d). The Hang Seng Financials sank 2.5% this week, increasing 2016 losses to 17.8%. It’s worth noting that the Shanghai Composite dropped 3.0% this week, increasing its y-t-d decline to 20%. China’s ChiNext (“innovative and fast-growing enterprises”) Index was clobbered 4.9%. 

May 9 – Reuters (Samuel Shen, Pete Sweeney and Kevin Yao): “China may suffer from a financial crisis and economic recession if the government relies too much on debt-fueled stimulus, the official People's Daily quoted an ‘authoritative person’ on Monday as saying. The People's Daily, official paper of the ruling Communist party, in a question and answer interview quoted the person as saying excessive credit growth could heighten risks and trigger a financial crisis if not controlled properly. ‘Trees cannot grow to the sky. High leverage will inevitably bring about high risks, which could lead to a systemic financial crisis, negative economic growth and even wipe out ordinary people's savings,’ the person… said in response to a question on whether stimulus should be used in future economic policy. ‘We should completely abandon the illusion of reducing leverage by loosing monetary conditions to help accelerate economic growth.’”

China’s “authoritative person” sounds like he really knows what he’s talking about. Chinese officials face a quite serious dilemma. They’ve inflated history’s greatest Bubble and they apparently have come to appreciate that the current policy course is unsustainable. Housing Bubble to stock market Bubble to commodities Bubble to runaway Credit Bubble. At this point, it seems completely reasonable to me that Chinese officials recognize that there really is no alternative than reining in destabilizing Credit excess. I doubt they appreciate the complexities, myriad challenges and extraordinary risks that await them.

May 13 – Bloomberg: “China’s broadest measure of new credit rose less than expected last month, suggesting that the central bank is starting to temper a flood of borrowing amid warnings from officials about potential side effects of the debt binge. Aggregate financing was 751 billion yuan ($115bn) in April…, below all 26 analyst forecasts… New yuan loans were 555.6 billion yuan, compared with the median estimate for 800 billion yuan… ‘Policy makers have started to think again and are holding back after injecting too much liquidity in the first quarter,’ said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd… ‘I expected a switch in policy, but didn’t expect it to come so soon.’”

After a spectacular – and historic - $1.0 TN of Q1 Credit growth - total “social financing” fell to $115 billion in April. Was this abrupt slow-down policy-induced? What can be expected from Credit growth going forward? These are incredibly important issues with global ramifications. Confusion abounds. Do policymakers have a cohesive plan – or are we witness to epic floundering? Is Beijing unified or is dissension building? The week saw more air released from China’s commodities Bubble.

May 13 – Wall Street Journal (Biman Mukherji): “China’s steel and iron-ore futures prices tumbled again as renewed worries about excess supplies sent traders rushing for the exits. Iron ore ended Friday down 5.2% at 363 yuan ($55.68) a metric ton, steel rebar down 4.6% at 2,030 yuan a metric ton and hot-rolled coil down 4% at 2,195 yuan a metric ton. For the week, iron-ore futures and steel-rebar futures… both dropped 13% and hot-rolled coil fell 12%, bringing the losses since the April 21 peak to the neighborhood of 25%.”

The week saw little respite for faltering EM. South Africa’s rand sank 3.5% this week to a six-week low. The Mexican peso dropped another 1.7%, the Chilean peso sank 3.9% and the Colombian peso declined 1.2%. Rising instability had the Turkish lira falling another 1.5%, with Turkey’s stocks down 0.7%, “longest rout since December…” With Brazilian President Dilma Rousseff suspended while awaiting impeachment proceedings, Brazil’s currency declined 0.9%.  

Returning to the U.S. and the burst Bubble thesis, it’s worth nothing that the Transports sank 3.0% this week to two-month lows, having now given back all 2016 gains. Copper prices dropped 3.5%, trading to two-month lows. Ten-year Treasury yields sank eight bps to 1.70%, the low yield since January’s market tumult period.

The bond market is just not buying into Fed talk of multiple rate rises this year.

Instead, bond yields lend strong support for the view of latent U.S. and global fragilities. For me, the backdrop is reminiscent of previous early-stage deflating Bubbles. A Friday Reuters article certainly brought back memories – Ominous Portents.  

May 13 – Reuters (Sharon Bernstein): “California Governor Jerry Brown… is expected to amend his proposed $170.7 billion spending plan for the next fiscal year in the wake of unexpectedly low tax revenues. In January, Brown proposed a new state budget that increased public spending on education, healthcare and infrastructure in an indication of the state's continued rebound from years of economic doldrums. But earlier this week, state officials said that tax revenues for the first four months of the year were $869 million below projections, due in large part to unexpectedly low income tax revenues in April, which were more than $1 billion below expectations.”


Friday headlines from Bloomberg: “Retail Sales Rise Most in a Year, Marking U.S. Consumer Comeback” and “Consumers Turn Out to Be U.S. Growth Lifeline After All.” Ironically, U.S. retail stocks (SPDR S&P Retail ETF) were slammed 4.3% this week, trading back to almost three-month lows. Poor earnings were the culprit. Macy’s sank 15% on Wednesday’s earnings disappointment. Kohl’s missed, along with Nordstrom and JC Penney.  

It may be subtle, yet it’s turning pervasive. Support for the burst global Bubble thesis mounts by the week. With stated U.S. unemployment at 5.0% and consumer confidence at this point still in decent shape, spending has enjoyed somewhat of a tailwind. Yet the overall U.S. economy has begun to succumb to a general Credit slowdown. Despite the bounce in crude, the energy sector bust continues to gather momentum. The tech and biotech Bubbles have peaked. Cracks have quickly surfaced in fintech. There are as well indications that some overheated real estate markets across the country have cooled. Whether it is from China or Latin America or Europe, the rush of “hot money” into U.S. real estate and securities markets has slowed meaningfully.

The slowing of Credit and “hot money” flows help explain the weakness in both corporate profits and the overall stock market. And with stock prices down year-on-year, Household Net Worth has essentially stagnated. Keep in mind that Net Worth inflated from $56.5 TN at year-end 2008 to a record $86.8 TN to close 2015. Over the past six years, Net Worth increased an average $4.76 TN annually. Such extraordinary inflation in household perceived wealth supported spending – which bolstered profits and underpinned asset price inflation and more spending.  

Let’s return to the irony of positive retail sales data and negative earnings. It’s easy to forget that retail had been significantly overbuilt during the mortgage finance Bubble period. The worst of the shakeout was avoided as Household Net Worth inflated from 384% (2008) to a record 484% (2015) of GDP. And while inflating perceived wealth boosted spending, zero rates and manic financing markets ensured another period of booming retail investment (bricks and mortar and Internet). There has, as well, been extraordinary growth in various services, certainly including telecommunications.

In contemporaneous analysis of the Great Depression, there was insightful debate questioning whether over-investment or mal-investment was primarily to blame. Well, there was ample blame to go around. And this gets back to the fundamental thesis: It was not insufficient “money” after the 1929 Crash that was the root cause of economic depression, but instead gross excess of “money,” Credit and speculation throughout the Roaring Twenties.  

A few weeks back I noted analysis that placed excess global energy sector investment at several Trillion. And this week from Bloomberg (Agnieszka De Sousa), “Glencore CEO Lists Mining's Mistakes After $1 Trillion Spree.” And how many Trillions of over/mal-investment were spent in recent years throughout “tech,” biotech, pharmaceuticals and retail? Tens of Trillions throughout China and Asia more generally? Downward price pressures globally on so many things should be no mystery. And by now it should be indisputable that so-called “deflationary pressures” are not the consequence of insufficient “money.”

In the name of “shortfalls in aggregate demand,” central bankers have flooded the world with “money” and Credit. Predictably, this unprecedented global monetary inflation has wreaked havoc on financial market behavior and investment patterns, while spurring self-reinforcing asset inflation and Bubbles. And aggregate demand? It is not - will never be - sufficient. As we’ve witnessed, Credit Bubbles redistribute and destroy wealth. Bubbles distort investment and spending patterns, which in the end ensure too much of a lot of stuff that the general population either cannot afford or does not desire.

Newfound retail industry worries are intriguing. Energy – and even tech and biotech – sector excess was somewhat conspicuous, but relatively narrow in focus. Retail mal-investment is much more systemic – it’s virtually everywhere. Zero rates, the yield chase and QE flooded all facets of the sector with cheap finance. “Money” flowed freely into retail-related real estate investment trusts (REITs). Retail property prices inflated as “cap rates” collapsed. The upshot was additional construction and more retail. Meanwhile, booming property values and easy finance ensured that a lot of retail that should have went bust didn’t.  

While on the subject of busts, Lending Club dropped 50% this week. Count me skeptical of the incredible virtues of “marketplace lending,” “peer to peer” and “fintech” more generally. How much valuable innovation is available after decades of radical experimentation – not to mention thousands of years of lending? Yet every boom cycle greets financial innovation with boundless enthusiasm.

I do appreciate that few businesses enjoy the capacity to grow accounting profits as rapidly as lending to those with difficulty borrowing from traditional sources/channels. Lenders can charge high rates, ensuring a profits bonanza so long as rapid loan book growth is maintained. Minimal provisions for future loan losses can be justified, with the percentage of seasoned loans turning sour remaining small in comparison to (rapidly expanding) total loans. But ballooning growth in loan books requires that the lender retains ready access to funding markets. Telecom debt in the nineties and subprime in the 2000s come to mind. It’s amazing how long ridiculous lending crazes can endure – and it’s equally amazing how abruptly the “money” spigot can be shut off.  

After last week’s drubbing, global financial stocks saw little relief this week. U.S. bank stocks were down 1.6% Friday, more than erasing the modest gain from earlier in the week. Bank stocks are now down 9.7% year-to-date, with the broker/dealers losing 12.7%.

Globally, Italian banks sank another 2.9% this week, increasing 2016 losses to 36.9%. European bank stocks were volatile but ended the week little changed (down 22.1% y-t-d). The Hang Seng Financials sank 2.5% this week, increasing 2016 losses to 17.8%. It’s worth noting that the Shanghai Composite dropped 3.0% this week, increasing its y-t-d decline to 20%. China’s ChiNext (“innovative and fast-growing enterprises”) Index was clobbered 4.9%. 

May 9 – Reuters (Samuel Shen, Pete Sweeney and Kevin Yao): “China may suffer from a financial crisis and economic recession if the government relies too much on debt-fueled stimulus, the official People's Daily quoted an ‘authoritative person’ on Monday as saying. The People's Daily, official paper of the ruling Communist party, in a question and answer interview quoted the person as saying excessive credit growth could heighten risks and trigger a financial crisis if not controlled properly. ‘Trees cannot grow to the sky. High leverage will inevitably bring about high risks, which could lead to a systemic financial crisis, negative economic growth and even wipe out ordinary people's savings,’ the person… said in response to a question on whether stimulus should be used in future economic policy. ‘We should completely abandon the illusion of reducing leverage by loosing monetary conditions to help accelerate economic growth.’”

China’s “authoritative person” sounds like he really knows what he’s talking about. Chinese officials face a quite serious dilemma. They’ve inflated history’s greatest Bubble and they apparently have come to appreciate that the current policy course is unsustainable. Housing Bubble to stock market Bubble to commodities Bubble to runaway Credit Bubble. At this point, it seems completely reasonable to me that Chinese officials recognize that there really is no alternative than reining in destabilizing Credit excess. I doubt they appreciate the complexities, myriad challenges and extraordinary risks that await them.

May 13 – Bloomberg: “China’s broadest measure of new credit rose less than expected last month, suggesting that the central bank is starting to temper a flood of borrowing amid warnings from officials about potential side effects of the debt binge. Aggregate financing was 751 billion yuan ($115bn) in April…, below all 26 analyst forecasts… New yuan loans were 555.6 billion yuan, compared with the median estimate for 800 billion yuan… ‘Policy makers have started to think again and are holding back after injecting too much liquidity in the first quarter,’ said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd… ‘I expected a switch in policy, but didn’t expect it to come so soon.’”

After a spectacular – and historic - $1.0 TN of Q1 Credit growth - total “social financing” fell to $115 billion in April. Was this abrupt slow-down policy-induced? What can be expected from Credit growth going forward? These are incredibly important issues with global ramifications. Confusion abounds. Do policymakers have a cohesive plan – or are we witness to epic floundering? Is Beijing unified or is dissension building? The week saw more air released from China’s commodities Bubble.

May 13 – Wall Street Journal (Biman Mukherji): “China’s steel and iron-ore futures prices tumbled again as renewed worries about excess supplies sent traders rushing for the exits. Iron ore ended Friday down 5.2% at 363 yuan ($55.68) a metric ton, steel rebar down 4.6% at 2,030 yuan a metric ton and hot-rolled coil down 4% at 2,195 yuan a metric ton. For the week, iron-ore futures and steel-rebar futures… both dropped 13% and hot-rolled coil fell 12%, bringing the losses since the April 21 peak to the neighborhood of 25%.”

The week saw little respite for faltering EM. South Africa’s rand sank 3.5% this week to a six-week low. The Mexican peso dropped another 1.7%, the Chilean peso sank 3.9% and the Colombian peso declined 1.2%. Rising instability had the Turkish lira falling another 1.5%, with Turkey’s stocks down 0.7%, “longest rout since December…” With Brazilian President Dilma Rousseff suspended while awaiting impeachment proceedings, Brazil’s currency declined 0.9%.  

Returning to the U.S. and the burst Bubble thesis, it’s worth nothing that the Transports sank 3.0% this week to two-month lows, having now given back all 2016 gains. Copper prices dropped 3.5%, trading to two-month lows. Ten-year Treasury yields sank eight bps to 1.70%, the low yield since January’s market tumult period. The bond market is just not buying into Fed talk of multiple rate rises this year. Instead, bond yields lend strong support for the view of latent U.S. and global fragilities. For me, the backdrop is reminiscent of previous early-stage deflating Bubbles. A Friday Reuters article certainly brought back memories – Ominous Portents.  

May 13 – Reuters (Sharon Bernstein): “California Governor Jerry Brown… is expected to amend his proposed $170.7 billion spending plan for the next fiscal year in the wake of unexpectedly low tax revenues. In January, Brown proposed a new state budget that increased public spending on education, healthcare and infrastructure in an indication of the state's continued rebound from years of economic doldrums. But earlier this week, state officials said that tax revenues for the first four months of the year were $869 million below projections, due in large part to unexpectedly low income tax revenues in April, which were more than $1 billion below expectations.”

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