Unstable
Doug Nolan
Markets are certainly Unstable.
After trading at a record high of 42,427 on July 11th, Japan’s Nikkei 225 Index was 26.6% lower at August 5th lows.
The Nikkei sank 19.5% in just three sessions, only to recover 20.0% in eight sessions.
The Nikkei surged 9.3% this week.
From the July 10th closing high to August 5th intraday lows, the Semiconductor (SOX) Index sank 25% - before rallying almost 21% in nine sessions.
The SOX was up 9.8% this week.
Over this period, Nvidia slumped 33% - only to rally 35%.
Nvidia was up 18.9% this week.
From the July 10th high to August 5th lows, the Nasdaq100 (NDX) dropped 15.7% before rallying 12.2%.
The NDX was up 5.4% this week, with the S&P500 3.9% higher.
The yen rallied 14% versus the dollar in 18 sessions – and has retreated 5% over nine sessions.
Over this period, the Mexican peso sank 22% against the Japanese yen (at August 5th lows) and has since rallied about 13%.
At August 5th highs, EM CDS had spiked 29 in three sessions to a nine-month high 197 bps – and has since retreated 29 bps.
The “core” has matched “periphery” instability.
Ten-year Treasury yields traded at 4.29% on July 24th, and then were down 62 bps to 3.69% at August 5th lows.
Ten-year yields were back above 4% on August 8th, only to sink back to 3.80% on the 14th – before closing this week at 3.88%.
Two-year Treasury yields were at 4.54% on July 22nd, before sinking 89 bps to 3.65% on August 5th lows.
The two-year yield ended the week unchanged at 4.05%.
At August 5th lows, the market was pricing 148 bps of Fed rate cuts by year-end.
The market ended this week expecting 96 bps of cuts.
In the Monday, August 5th panic, the market priced as much as 70 bps of rate reduction by next month’s meeting.
The market ended the week expecting 33 bps.
It’s been notably wild at the periphery of the “core.”
High yield CDs traded at 330 bps on August 1st, only to surge 73 to trade to 403 bps in early Monday, August 5th trading.
High yield CDS sank 32 this week to 330 bps.
High yield spreads to Treasuries spiked 73 bps – then retreated 62 bps.
High yield spreads narrowed 20 this week to 319 bps.
I appreciate the Friday evening Bloomberg headline, “Wall Street Whiplash Schools Traders on Fragile Modern Markets.”
August 16 – Bloomberg (Denitsa Tsekova and Isabelle Lee):
“Greed has overcome fear on Wall Street — and the market cataclysm that shook up the world in recent weeks may well prove a mere blip on long-term price charts.
Yet the summer rout will also go down as a particularly extreme example of a trend that’s shaped modern finance for years now: Increasingly frequent shocks blowing up with little warning.
As fast as volatility erupted, it has calmed, with the S&P 500 posting its biggest weekly gain since November, junk bonds scoring a week of gains and Treasury yields stabilizing…
The VIX Index, Wall Street’s ‘fear gauge,’ has just broken two records: the fastest-ever spike of 25 points or more, and the fastest comeback from the spike…
The reversals are a nightmare for anyone trying to attach sensible explanations to the motion of markets.”
I don’t know about sensible, but I’ll have a go at an explanation.
Years of Bubble excess have forged epic market distortions and associated acute fragility.
The proliferation of levered strategies and speculation generally ensures instability is ready to erupt at any point.
And to have an intense bout of de-risking just ahead of monthly options expiration makes for some interesting dynamics.
Moreover, two key readings on inflation hit during expiration week.
Many would have specifically hedged around these potentially market-moving data points.
I believe the unwind of yen “carry trade” leverage is a harbinger of things to come – the first serious crack in the global speculative Bubble.
But I also appreciate that a bout of intense “risk off” hedging/shorting/bearish speculation creates dry tinder for the unwinding of hedges and brutal squeezes – and that these disorderly squeeze rallies have tended to take on lives of their own.
This is a Bubble unlike anything experienced in our lifetimes.
It seems utterly determined to suck in every last person.
There will be no easy profits betting on the timing of its demise.
And it’s just refusing to cooperate with all these strategies – sophisticated and otherwise – aiming to hedge various market risks.
Market dynamics will make it extremely difficult to be out of harm’s way when things finally unravel.
There is today way too much speculative finance, while there’s also way too much hedging activity.
This ensures extremely potent “risk on” and “risk off” – with each bout of de-risking innately boosting the likelihood of a precarious “risk on” reverberation.
Fragility mounts.
Things get interesting here if “risk on” gathers momentum.
All the talk of an economy falling into recession and of emergency Fed rate cuts seems even sillier after this week’s data.
Weekly Unemployment Claims declining to a five-week low of 227,000 is not indicative of a labor market falling off a cliff.
And consumption, while not booming as before, has certainly not succumbed to a downward spiral.
At 1.0%, growth in July Retail Sales was stronger-than-expected (0.4%).
Sales excluding automobiles and gas increased 0.4%.
Retail Sales were up 4.0% y-o-y, with sales excluding auto and gas up 4.6% y-o-y.
University of Michigan Consumer Expectations jumped 3.3 points to a stronger-than-expected 72.1 – a four-month high.
August 15 – Bloomberg (Jaewon Kang):
“Walmart Inc. raised its sales guidance for the full year, buoyed by consumers buying necessities and seeking deals even as they curtail spending elsewhere.
The… company said it now expects net sales to rise as much as 4.75% for the year, versus previous guidance for a gain of as much as 4%.
It also raised its targets for operating income and profits.
‘We are seeing that the consumer continues to be discerning, choiceful, value-seeking’ and focusing on essentials, Chief Financial Officer John David Rainey said...
‘We are not seeing any incremental fraying of our customers’ financial health.’”
NFIB Small Business Optimism rose 2.2 points to a stronger-than-expected 93.7 – the high all the way back to February 2022.
The “Expect Better Economy” component jumped to the strongest reading (-7) since November 2020.
“Plan to Hire” was unchanged at the high (15) since December.
And while Housing Starts and Building Permits were both weak, this data doesn’t really dovetail with the Wall Street bullish narrative.
Our nation is short of housing stock, and this shortage is a key factor (along with inflating compensation) in ongoing rent and housing inflation.
Housing affordability is a serious issue.
It’s worth noting that the CPI component “shelter costs” rose a stronger-than-expected 0.4% during July.
The U.S. economy is neither weak nor robust.
It is, as Bubble Economy’s invariably become, maladjusted and highly unbalanced.
Not coincidently, the global Bubble Economy is similarly maladjusted and unbalanced.
China’s historic Bubble is deflating. Despite myriad stimulus measures and ongoing elevated Credit growth, the Chinese economy has yet to achieve a self-sustaining recovery.
Recent data and developments indicate mounting downside risks.
August 13 – Bloomberg:
“China’s bank loans to the real economy contracted for the first time in 19 years, a grim milestone that underscores why weak domestic demand has emerged as a major hurdle to the economy’s growth and recovery.
Yuan-denominated bank loans that exclude those extended to financial institutions shrank by 77 billion yuan ($10.7bn) at the end of July from a month ago…
That marked the first drop since July 2005, as more debt was repaid than taken out.
Chinese households and businesses are rushing to repay debt as investment returns dwindle and real borrowing costs — adjusted for falling prices across the economy — remain elevated.”
China’s July Credit data suggest economic stagnation, though July is typically a seasonally slow month (following the usual strong end to Q2).
Total Aggregate Financing expanded $108 billion (to $55.3 TN), down huge from June’s $461 billion - but ahead of July 2023’s $75 billion.
At $2.635 TN, y-t-d growth in Aggregate Financing is 14.6% below comparable 2023.
Aggregate Financing expanded $4.521 TN, or 8.2%, over the past year.
Total Loans increased only $37 billion (to $35.1 TN), down from June’s $297 billion and below July ‘23’s $48 billion.
At $1.889 TN, y-t-d Loan growth is 20% below comparable 2023.
One must go back to 2017 for weaker lending.
Years of double-digit year-over-year Consumer Loan growth ended in 2022.
Growth contracted ($30 billion) in July for the third contraction in six months.
Year-to-date loan growth of $176 billion is only a third of comparable 2023 and a quarter of comparable 2021.
Consumer Loans expanded only 3.8% over the past year, a far cry from the heady 15% level in 2021 and the 25% back in 2017.
With China’s great apartment Bubble now deflating, weak consumer borrowing is no surprise.
But weakened corporate lending – in the face of myriad economic stimulus measures – should be cause for concern.
Corporate Loans expanded only $18 billion in July, down from June’s $227 billion to the weakest reading back to 2019.
At $1.552 TN, y-t-d Corporate Loan growth is running 15% below comparable 2023 – with the weakest expansion back to 2021.
One-year growth remains elevated at 10.6% - but has decelerated sharply from the heady 14% y-o-y rate from last July.
But one category of Credit continues its rapid expansion.
Government Bonds gained $96 billion during the month (to $10.3 TN), up from July 2023’s $57 billion.
At $563 billion, y-t-d growth is 6% ahead of the year ago level.
A favorite Bubble maxim: When major Bubbles burst, things invariably turn out worse than even the most bearish analysts had expected.
I have closely monitored China’s Bubble for years.
I’ve referred to their apartment Bubble as the history’s greatest speculative Bubble – an unmitigated disaster.
I’m seeing evidence that things are worse than I thought.
August 14 – Bloomberg:
“At least 48 million homes in China have been sold before construction has been completed, suggesting the country’s property crisis won’t be resolved anytime soon, according to a report from Bloomberg Intelligence.
The figure, based on pre-sales data from 2015 through the first half of this year, is bigger than Germany’s total housing stock in 2021.
It presents a direct threat to developers’ revenue because people could start avoiding pre-sales of new developments and instead buy completed or second-hand housing, analysts Kristy Hung and Monica Si wrote.”
Estimates have as many as 100 million unoccupied apartment units throughout China.
Add to that another 48 million apartments sold but not yet delivered.
With scores of developers lacking the resources to complete construction, millions of Chinese families fear their apartments will never be built and they will sacrifice their significant down payments.
And with confidence shaken, along with an enormous inventory of previously sold units, buyers are avoiding the developers.
The death spiral continues for developers, apartment prices, and consumer confidence.
August 10 – Financial Times:
“Multinational groups from Volkswagen to AB InBev and L'Oréal have sounded the alarm about demand in China, with the effects of a slowing economy exacerbated by shrinking appetite for foreign brands and intensifying domestic competition.
In results this week WPP, the… advertising giant, cited a near one-quarter drop in Chinese sales in the past three months…
‘People expected China to turn a sharper corner after Covid than it has,’ said WPP chief executive Mark Read.
Weak demand in China has been a feature of half-year earnings across much of the global consumer goods sector.”
August 14 – Bloomberg:
“The world’s biggest steel producer sounded the alarm about an industry crisis in China that carries the potential to ripple around the globe and plunge the sector into a deeper downturn.
Conditions in China’s steel sector are like a ‘harsh winter’ that will be ‘longer, colder and more difficult to endure than we expected,’ China Baowu Steel Group Corp. chairman Hu Wangming told staff at the company’s half-year meeting, warning of a worse challenge than major traumas in 2008 and 2015.”
Comments out of Beijing this week suggest additional stimulus will be forthcoming.
Perhaps this helps explain this week’s pop in industrial metals prices.
Whether Chinese officials realize it yet or not, holding financial and economic collapse at bay will require massive inflation of government debt and PBOC holdings.
Other countries share a similar fate.
Little wonder Gold closed Friday trading at a record $2,508.
I noted at the top the recent roundtrip moves in equities, CDS prices and many risk indicators.
Bond yields are the glaring exception (the yen’s pullback is somewhat less glaring).
Ten-year Treasury yields traded at 4.46% in early July and were at 4.29% on July 24th.
Yields closed panic-day August 5th at 3.79%.
They ended this week down six bps to 3.88%.
I think I understand why Treasury yields are so low – and why the market is still pricing almost 100 bps of cuts by the December 18th FOMC meeting – three cuts (one 50bps) in four months, all around a historic election.
And it’s not because of imminent recession.
These markets are a big problem.
Market structure is a critical issue.
In short, speculative markets lack the capacity to adjust and correct.
This only increases the risk of dislocations and crashes – as we saw inklings of on August 5th.
If “risk on” has legs, I ponder the stimulative impact of loose conditions, lower market yields, and rising equities prices on the U.S. Bubble Economy.
I can imagine Chair Powell rewriting a few paragraphs for his Jackson Hole speech.
Does he really want to throw fuel on this rally?
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