Nervous Time
by Doug Noland
May 16, 2014
Tepper and Summers offer valuable insight.
I’ll begin with a few of this week’s notable market moves. The euro/yen declined another 82 bps, increasing its two-week decline to 1.94%, to the lowest level since February. Greek 10-year sovereign yields surged 75 bps to the highest level since March. The spread between Portugal and Germany bond yields widened 35 bps. Spreads to German bunds widened 17 bps in Spain and 24 bps in Italy. Italian stocks were hit for 3.5%. Here at home, the Bank stock index (BKX) dropped 1.7% and the Broker/Dealers (XBD) were hit for 2.2%. Let me suggest weakness at the “periphery of the periphery” – out at the “margin” that I look to for subtle market “risk on/risk off” leanings. I’ll take this week’s trading as added confirmation of the incipient risk aversion thesis.
May 14 – Bloomberg (Kelly Bit, Saijel Kishan and Joshua Fineman): “David Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, said he’s nervous about markets as the U.S. economy isn’t growing fast enough amid complacency by the Federal Reserve. ‘We have this term called coordinated complacency to describe the world’s central banks right now,’ Tepper said… ‘The market is kind of dangerous in a way.’ Tepper… said he’s more worried about deflation than inflation and that this is the time to preserve money. The money manager, who is worth $7.9 billion… said that while investors can be optimistic on markets, they should hold some cash. ‘I think its nervous time’ he said…”
Tepper (who made approximately $400,000 per hour more than me in 2013) said markets are “tough.” No disagreement here. But “coordinated complacency” from the world’s central banks? Well, the Fed funds rate is locked at near zero - and the Fed has ballooned its balance sheet an unprecedented $1.463 Trillion in 79 weeks. Not seeing a lot of complacency there. The BOJ has shown no indication of backing away from their desperate $65bn monthly “money” printing operation. The ECB has rates near zero and is about to adopt additional stimulus.
I would contend complacency is the prevailing attitude of market participants – and not central bankers. Unfortunately, central bank monetary inflation and market intervention have been the leading instigators of complacency-inducing asset price Bubbles. Tepper is fearful of “deflation” and for good reason (including $440k/hr) and would prefer that central bank “money” sustains this gilded age of speculative genius.
I’ll be the first to argue that there is heightened Bubble fragility in the global financial system and economy that will ensure interminable pressure on central bankers to keep the electronic debits and Credits coming. I also view QE3 and all the monetary stimulus as having made global markets, finance and economies only more distorted and vulnerable.
Unsustainable Credit and asset Bubbles provide the existential threat. So-called “deflation” risk is a consequence of precarious “money,” Credit, securities, asset, economic and speculative Bubbles. At this point having resorted to rank monetary inflation (and with global growth dynamics alarmingly weak), Central banks have no solution. Trying to gauge how much time is left is the pressing issue for market participants.
This week also brought further evidence of a rapidly deteriorating geopolitical backdrop. Anti-China protests erupted in Vietnam that claimed lives and shut down scores of factories and businesses. I was reminded of the horrible Indonesian riots and attacks on ethnic Chinese after the collapse of the “SE Asian Tiger” Bubbles back in 1997. China wasn’t an economic or military power back then.
Heightened social tension is not limited to Vietnam. Thailand’s military warned that they are prepared to use force if necessary if political protests again turn violent. The terrible mining accident in Turkey – and the embattled Prime Minister’s comments that “accidents happen” and its “part of the nature of the business” – sparked protests within a tense political and social backdrop. And with four weeks until the World Cup, strikes and protests returned to Brazil this week. Protests were said to have heated up in Venezuela as well.
On various fronts, it does appear a Summer of Discontent is brewing. The “Ukraine” crisis shows no sign of resolution. Things could easily spiral out of control. The Russians are winning territory – and the West seems powerless. In an interesting Bloomberg interview, Russia’s foreign secretary Sergei Lavrov made it clear that sanctions will only stiffen Russian resolve. Lavrov also warned the U.S. risks sacrificing its reputation as the holder of the “key” to “virtual money” – the “reserve currency.”
There were also various news articles supporting the view of a tightening relationship between Russia and China. And with U.S and Chinese relations on a downward track, it is not lunacy to contemplate Russia and China moving decisively together in the direction of a more bipolar world of competing security, economic and, even, financial systems. Such a development would create great uncertainty – and perhaps might even help to explain the powerful bid to “safe haven” sovereign bonds of late.
May 15 – Fortune (Stephen Gandel): “Larry Summers is worried that the Federal Reserves' efforts to stimulate the economy could end up doing damage. ‘Low interest rates could become a source of instability down the road,’ said Summers… Summers was speaking to a packed auditorium of hedge fund industry professionals at SALT, the annual industry confab… Summers told the crowd that he shared concerns that low interest rates could be causing new bubbles. That’s why, Summers said, he has long favored government spending on jobs programs rather than stimulus engineered by the Fed. What’s more, Summers said that the Fed's policies are likely making the income inequality problem in the U.S. worse, by helping wealthy Americans who hold the majority of stocks, more than the rest of the country. ‘A policy that works by pumping up asset prices is not going to be egalitarian,’ said Summers.”
From my analytical perspective, Larry Summers’ comments were more notable than even Tepper’s. Summers is stating what has been dismissed for too long – but has become increasingly obvious: Misguided Fed policies have caused Bubbles and exacerbated inequality. And if Fed “money” printing is anathema to the political right and these inequitable Bubbles anathema to the political left, where will Fed doves turn to for support for future QE? Is the bullish market faith that the Fed will always be there with QE on Demand way too complacent?
May 11 – Bloomberg: “Chinese President Xi Jinping said the nation needs to adapt to a ‘new normal’ in the pace of economic growth and remain ‘cool-minded’ amid a slowdown in expansion. China’s growth fundamentals haven’t changed and the country is still in a ‘significant period of strategic opportunity,’ Xi said… At the same time, the government must prevent risks and take ‘timely countermeasures to reduce potential negative effects,’ he said.”
May 14 – MarketNews International: “Another disappointing set of Chinese data has renewed calls for the government to take action to support the economy. But official sources insist that this time really is different, and that the economic ‘new normal’ really does means slower growth with an emphasis on fundamental reform… The message that ‘this time it’s different’ has been trumpeted since President Xi Jinping said… China needs to adapt to a ‘new normal’ of slower growth. The official People's Daily said… that the West has been overly reliant on China to support the global economy, citing repeated demands at G20 meetings for Beijing to roll out stimulus measures. It's a familiar refrain -- then-Minister of Commerce Chen Deming said in 2009 that China can't play Kung-fu Panda, coming to save the world time and time again… But he was a member of the previous government, whose CNY4 trillion stimulus program enacted in November 2008 is now considered the original sin (a time of ‘crazy stimulus’, the NBS source said). The new leadership… say they are committed to cleaning up the waste created by that stimulus program and engineering a more sustainable -- and slower -- pace of economic development.”
May 11 – Reuters: “China's war chest of foreign currency reserves has become a headache as its continued rise could stoke inflation in the long term, Premier Li Keqiang said… pledging to reduce the country’s trade surplus. China’s foreign exchange reserves, the world’s largest, grew by $130 billion in the first quarter, to a record $3.95 trillion… ‘Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation,’ Phoenix New Media Ltd quoted Li as saying… ‘From China’s perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced.’ China will take steps to reduce its trade surpluses with the rest of the world…”
Are bullish markets way too complacent about China? Data confirm that apartment sales slowed sharply in April, with prices turning down across many markets (as inventories turn way up!). There is now overwhelming support for the bearish bursting China Bubble thesis. Credit has begun to slow markedly, hence China’s economic downturn is set to accelerate (outside the defense sector).
Importantly, top policy officials have made it clear that they remain focused on necessary readjustment rather than major stimulus. Chinese central bankers and bank regulators appear to be hastily preparing for the onset of financial crisis. Increasingly, they’ve pointed blame at the Fed and U.S. and Japanese policies for their predicament. Foreign exchange reserves a “burden?” The world is really changing.
Think of it this way: Going all the way back to the nineties, the Fed has promoted and accommodated a New Age Credit system increasingly dominated by marketable-based Credit (as opposed to traditional bank loans). This new system ensured ever-increasing market risk (growing quantities of securities with market, duration and Credit risk) and a resulting booming derivatives (“insurance”) marketplace. To ensure viability for this ballooning system of securitizations and derivatives, the Federal Reserve pegged short-term rates and essentially guaranteed that securities markets would remain “liquid and continuous.” Basically, the Fed had to promise that Credit would remain in a perpetual “bull market.” And this assurance of financial nirvana nurtured a historic cycle of speculative excess – speculation that I believe is late in the “Terminal Phase.”
Not surprisingly, there have been (going all the way back to the 1994 bond bust) market problems all along the way. To be sure, this system – both domestically and on an international basis – has proven itself highly unstable – a propagator of serial booms and busts. The Fed and global central bankers have had to resort to increasingly radical measures to resuscitate faltering or burst Bubbles. The system came close to meltdown back in 2008/09. Eurozone finance came close to meltdown again in 2011/2012. And since autumn 2012 global central bankers have instigated the greatest monetary inflation in history. Global securities markets have inflated to record highs, as exuberant investors now look back at the “Lehman crisis” as the proverbial “100-year flood.”
From my analytical perspective, this global Bubble in New Age Credit has finally arrived at a critical crossroads. Rates have been held at zero for years. And for years, Fed and global central bank balance sheets have inflated like never before. This “money” printing culminated with the Fed and BOJ combining for $150bn a month. Fledgling asset and securities Bubbles were pushed to dangerous excess everywhere – bigger and more dangerous than ever. Global securities markets speculative excess now dwarfs even 2007.
Yet even extreme financial excess equates with only feeble (and highly unbalanced) economic growth. Moreover, the world has seemingly now been fully inundated by Fed Credit and U.S. debt. And, importantly, the Chinese no longer see it in their best interest to do another round of big stimulus and accumulate only more U.S. IOUs and global debt securities. Russia and others see a global system controlled by the West that is working against their interests.
But when it comes to the Summer of Discontent thesis, let me throw this unappetizing morsel out as food for thought: bear market. Bull markets are all about optimism and self-reinforcing speculation and liquidity excess. Bear markets are the creatures of unmet expectations, disappointment and waning liquidity. I have made the case that desperate monetary stimulus from the world’s central bankers has created a dangerous divergence: inflated and highly speculative securities market Bubbles (and the associated distorted “Truman World” view of reality) versus very real deteriorating fundamental prospects and heightened global risk. I’ve tried to make the case that with Fed balance sheet expansion winding down, the markets have become extraordinarily vulnerable to a bout of “risk off” de-risking and de-leveraging.
But let me get a little more specific. With the Fed promising not to raise rates for some time to come, the marketplace is really complacent with regard to the end of QE3. Rates are staying at zero – and the Fed is surely willing to respond to market instability with more “money” printing, so the thinking goes. So the bullish view that financial conditions stay loose indefinitely has solidified. Is this a major misconception that holds potential for a big downside surprise?
I worry that the big negative lurking out there is the reality that the Fed no longer controls “financial conditions.” Especially with the recklessness of QE3, precariously loose finance became the domain of hedge funds leveraging high-yielding instruments and performance-chasing finance flooding into high-yield ETF products. Now, with monetary inflation having levitated price levels all over the place – bonds, stocks, homes, household incomes, spending, corporate earnings and cash flows, global finance, etc. – the system is today extraordinarily susceptible to speculative de-leveraging and the reversal of flows out of the ETF complex. And this week we have confirmation that David Tepper, king of sophisticated market operators, is sensing “Nervous Time.”
I’ll begin with a few of this week’s notable market moves. The euro/yen declined another 82 bps, increasing its two-week decline to 1.94%, to the lowest level since February. Greek 10-year sovereign yields surged 75 bps to the highest level since March. The spread between Portugal and Germany bond yields widened 35 bps. Spreads to German bunds widened 17 bps in Spain and 24 bps in Italy. Italian stocks were hit for 3.5%. Here at home, the Bank stock index (BKX) dropped 1.7% and the Broker/Dealers (XBD) were hit for 2.2%. Let me suggest weakness at the “periphery of the periphery” – out at the “margin” that I look to for subtle market “risk on/risk off” leanings. I’ll take this week’s trading as added confirmation of the incipient risk aversion thesis.
May 14 – Bloomberg (Kelly Bit, Saijel Kishan and Joshua Fineman): “David Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, said he’s nervous about markets as the U.S. economy isn’t growing fast enough amid complacency by the Federal Reserve. ‘We have this term called coordinated complacency to describe the world’s central banks right now,’ Tepper said… ‘The market is kind of dangerous in a way.’ Tepper… said he’s more worried about deflation than inflation and that this is the time to preserve money. The money manager, who is worth $7.9 billion… said that while investors can be optimistic on markets, they should hold some cash. ‘I think its nervous time’ he said…”
Tepper (who made approximately $400,000 per hour more than me in 2013) said markets are “tough.” No disagreement here. But “coordinated complacency” from the world’s central banks? Well, the Fed funds rate is locked at near zero - and the Fed has ballooned its balance sheet an unprecedented $1.463 Trillion in 79 weeks. Not seeing a lot of complacency there. The BOJ has shown no indication of backing away from their desperate $65bn monthly “money” printing operation. The ECB has rates near zero and is about to adopt additional stimulus.
I would contend complacency is the prevailing attitude of market participants – and not central bankers. Unfortunately, central bank monetary inflation and market intervention have been the leading instigators of complacency-inducing asset price Bubbles. Tepper is fearful of “deflation” and for good reason (including $440k/hr) and would prefer that central bank “money” sustains this gilded age of speculative genius.
I’ll be the first to argue that there is heightened Bubble fragility in the global financial system and economy that will ensure interminable pressure on central bankers to keep the electronic debits and Credits coming. I also view QE3 and all the monetary stimulus as having made global markets, finance and economies only more distorted and vulnerable.
Unsustainable Credit and asset Bubbles provide the existential threat. So-called “deflation” risk is a consequence of precarious “money,” Credit, securities, asset, economic and speculative Bubbles. At this point having resorted to rank monetary inflation (and with global growth dynamics alarmingly weak), Central banks have no solution. Trying to gauge how much time is left is the pressing issue for market participants.
This week also brought further evidence of a rapidly deteriorating geopolitical backdrop. Anti-China protests erupted in Vietnam that claimed lives and shut down scores of factories and businesses. I was reminded of the horrible Indonesian riots and attacks on ethnic Chinese after the collapse of the “SE Asian Tiger” Bubbles back in 1997. China wasn’t an economic or military power back then.
Heightened social tension is not limited to Vietnam. Thailand’s military warned that they are prepared to use force if necessary if political protests again turn violent. The terrible mining accident in Turkey – and the embattled Prime Minister’s comments that “accidents happen” and its “part of the nature of the business” – sparked protests within a tense political and social backdrop. And with four weeks until the World Cup, strikes and protests returned to Brazil this week. Protests were said to have heated up in Venezuela as well.
On various fronts, it does appear a Summer of Discontent is brewing. The “Ukraine” crisis shows no sign of resolution. Things could easily spiral out of control. The Russians are winning territory – and the West seems powerless. In an interesting Bloomberg interview, Russia’s foreign secretary Sergei Lavrov made it clear that sanctions will only stiffen Russian resolve. Lavrov also warned the U.S. risks sacrificing its reputation as the holder of the “key” to “virtual money” – the “reserve currency.”
There were also various news articles supporting the view of a tightening relationship between Russia and China. And with U.S and Chinese relations on a downward track, it is not lunacy to contemplate Russia and China moving decisively together in the direction of a more bipolar world of competing security, economic and, even, financial systems. Such a development would create great uncertainty – and perhaps might even help to explain the powerful bid to “safe haven” sovereign bonds of late.
May 15 – Fortune (Stephen Gandel): “Larry Summers is worried that the Federal Reserves' efforts to stimulate the economy could end up doing damage. ‘Low interest rates could become a source of instability down the road,’ said Summers… Summers was speaking to a packed auditorium of hedge fund industry professionals at SALT, the annual industry confab… Summers told the crowd that he shared concerns that low interest rates could be causing new bubbles. That’s why, Summers said, he has long favored government spending on jobs programs rather than stimulus engineered by the Fed. What’s more, Summers said that the Fed's policies are likely making the income inequality problem in the U.S. worse, by helping wealthy Americans who hold the majority of stocks, more than the rest of the country. ‘A policy that works by pumping up asset prices is not going to be egalitarian,’ said Summers.”
From my analytical perspective, Larry Summers’ comments were more notable than even Tepper’s. Summers is stating what has been dismissed for too long – but has become increasingly obvious: Misguided Fed policies have caused Bubbles and exacerbated inequality. And if Fed “money” printing is anathema to the political right and these inequitable Bubbles anathema to the political left, where will Fed doves turn to for support for future QE? Is the bullish market faith that the Fed will always be there with QE on Demand way too complacent?
May 11 – Bloomberg: “Chinese President Xi Jinping said the nation needs to adapt to a ‘new normal’ in the pace of economic growth and remain ‘cool-minded’ amid a slowdown in expansion. China’s growth fundamentals haven’t changed and the country is still in a ‘significant period of strategic opportunity,’ Xi said… At the same time, the government must prevent risks and take ‘timely countermeasures to reduce potential negative effects,’ he said.”
May 14 – MarketNews International: “Another disappointing set of Chinese data has renewed calls for the government to take action to support the economy. But official sources insist that this time really is different, and that the economic ‘new normal’ really does means slower growth with an emphasis on fundamental reform… The message that ‘this time it’s different’ has been trumpeted since President Xi Jinping said… China needs to adapt to a ‘new normal’ of slower growth. The official People's Daily said… that the West has been overly reliant on China to support the global economy, citing repeated demands at G20 meetings for Beijing to roll out stimulus measures. It's a familiar refrain -- then-Minister of Commerce Chen Deming said in 2009 that China can't play Kung-fu Panda, coming to save the world time and time again… But he was a member of the previous government, whose CNY4 trillion stimulus program enacted in November 2008 is now considered the original sin (a time of ‘crazy stimulus’, the NBS source said). The new leadership… say they are committed to cleaning up the waste created by that stimulus program and engineering a more sustainable -- and slower -- pace of economic development.”
May 11 – Reuters: “China's war chest of foreign currency reserves has become a headache as its continued rise could stoke inflation in the long term, Premier Li Keqiang said… pledging to reduce the country’s trade surplus. China’s foreign exchange reserves, the world’s largest, grew by $130 billion in the first quarter, to a record $3.95 trillion… ‘Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation,’ Phoenix New Media Ltd quoted Li as saying… ‘From China’s perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced.’ China will take steps to reduce its trade surpluses with the rest of the world…”
Are bullish markets way too complacent about China? Data confirm that apartment sales slowed sharply in April, with prices turning down across many markets (as inventories turn way up!). There is now overwhelming support for the bearish bursting China Bubble thesis. Credit has begun to slow markedly, hence China’s economic downturn is set to accelerate (outside the defense sector).
Importantly, top policy officials have made it clear that they remain focused on necessary readjustment rather than major stimulus. Chinese central bankers and bank regulators appear to be hastily preparing for the onset of financial crisis. Increasingly, they’ve pointed blame at the Fed and U.S. and Japanese policies for their predicament. Foreign exchange reserves a “burden?” The world is really changing.
Think of it this way: Going all the way back to the nineties, the Fed has promoted and accommodated a New Age Credit system increasingly dominated by marketable-based Credit (as opposed to traditional bank loans). This new system ensured ever-increasing market risk (growing quantities of securities with market, duration and Credit risk) and a resulting booming derivatives (“insurance”) marketplace. To ensure viability for this ballooning system of securitizations and derivatives, the Federal Reserve pegged short-term rates and essentially guaranteed that securities markets would remain “liquid and continuous.” Basically, the Fed had to promise that Credit would remain in a perpetual “bull market.” And this assurance of financial nirvana nurtured a historic cycle of speculative excess – speculation that I believe is late in the “Terminal Phase.”
Not surprisingly, there have been (going all the way back to the 1994 bond bust) market problems all along the way. To be sure, this system – both domestically and on an international basis – has proven itself highly unstable – a propagator of serial booms and busts. The Fed and global central bankers have had to resort to increasingly radical measures to resuscitate faltering or burst Bubbles. The system came close to meltdown back in 2008/09. Eurozone finance came close to meltdown again in 2011/2012. And since autumn 2012 global central bankers have instigated the greatest monetary inflation in history. Global securities markets have inflated to record highs, as exuberant investors now look back at the “Lehman crisis” as the proverbial “100-year flood.”
From my analytical perspective, this global Bubble in New Age Credit has finally arrived at a critical crossroads. Rates have been held at zero for years. And for years, Fed and global central bank balance sheets have inflated like never before. This “money” printing culminated with the Fed and BOJ combining for $150bn a month. Fledgling asset and securities Bubbles were pushed to dangerous excess everywhere – bigger and more dangerous than ever. Global securities markets speculative excess now dwarfs even 2007.
Yet even extreme financial excess equates with only feeble (and highly unbalanced) economic growth. Moreover, the world has seemingly now been fully inundated by Fed Credit and U.S. debt. And, importantly, the Chinese no longer see it in their best interest to do another round of big stimulus and accumulate only more U.S. IOUs and global debt securities. Russia and others see a global system controlled by the West that is working against their interests.
But when it comes to the Summer of Discontent thesis, let me throw this unappetizing morsel out as food for thought: bear market. Bull markets are all about optimism and self-reinforcing speculation and liquidity excess. Bear markets are the creatures of unmet expectations, disappointment and waning liquidity. I have made the case that desperate monetary stimulus from the world’s central bankers has created a dangerous divergence: inflated and highly speculative securities market Bubbles (and the associated distorted “Truman World” view of reality) versus very real deteriorating fundamental prospects and heightened global risk. I’ve tried to make the case that with Fed balance sheet expansion winding down, the markets have become extraordinarily vulnerable to a bout of “risk off” de-risking and de-leveraging.
But let me get a little more specific. With the Fed promising not to raise rates for some time to come, the marketplace is really complacent with regard to the end of QE3. Rates are staying at zero – and the Fed is surely willing to respond to market instability with more “money” printing, so the thinking goes. So the bullish view that financial conditions stay loose indefinitely has solidified. Is this a major misconception that holds potential for a big downside surprise?
I worry that the big negative lurking out there is the reality that the Fed no longer controls “financial conditions.” Especially with the recklessness of QE3, precariously loose finance became the domain of hedge funds leveraging high-yielding instruments and performance-chasing finance flooding into high-yield ETF products. Now, with monetary inflation having levitated price levels all over the place – bonds, stocks, homes, household incomes, spending, corporate earnings and cash flows, global finance, etc. – the system is today extraordinarily susceptible to speculative de-leveraging and the reversal of flows out of the ETF complex. And this week we have confirmation that David Tepper, king of sophisticated market operators, is sensing “Nervous Time.”
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