Really BIG
Doug Nolan
Notable developments for two key facets of the global government finance Bubble this week.
November 21 – Financial Times (George Steer):
“Hedge funds betting on a decline in US and European stock markets have suffered an estimated $43bn of losses in a sharp rally over recent days.
Short sellers, many of whom had built up bets against companies exposed to higher borrowing costs over the past year or so, have been caught out by a ‘painful’ rebound in ‘low quality’ stocks this month, said Barclays’ head of European equity strategy Emmanuel Cau.
That has come as the market has grown more confident that the US Federal Reserve’s cycle of rate rises is finally over.”
It's definitely been The Year of the Squeeze.
The Goldman Sachs most short index began the year with a 34% rally into early February.
And after a spring retreat, the index surged 32% in the June/July period.
While painful, the recent equities squeeze has been relatively modest.
Yet stocks are only part of the story.
Powerful squeezes have engulfed bonds, currencies, and the Credit default swap (CDS) marketplace.
Under the headline, “Crushed Bond Shorts See Quants Rush to Exit Wrong-Way Fed Bets,” a Tuesday Bloomberg article by Edward Bolingbroke:
“The front-end of the Treasuries curve is expected to be propped up in the near-term by further waves of covering from commodity trading advisers, or CTAs, fresh from a washout of short positions triggered by last week’s US inflation data.”
The above FT article ran under the headline, “Hedge Fund Short Sellers Suffer $43bn of Losses in Market Rally.”
To be sure, traditional short sellers account for only a small fraction of outstanding short positions.
In last week’s WSJ article reporting on renowned short seller Jim Chanos’ decision to shutter his funds after almost four decades, it was noted that the short-only hedge fund sector has shriveled down to a mere (market inconsequential) $5 billion.
November 21 – Financial Times (George Steer):
“The US stock market’s “Magnificent Seven” have been a headache for mutual fund managers, who have mostly eschewed them and are paying the performance price.
Hedge funds have taken a different tack — in short, they yelled ‘YOLO’ and jumped in with both feet.
From Goldman Sachs…: ‘The combination of elevated hedge fund concentration and the strong performance of popular stocks has supported returns this year but lifted our crowding index to a record high.
Our Hedge Fund VIP list of the most popular long positions has returned +31% YTD, and most of the ‘Magnificent 7’ mega-cap tech stocks remain at the top of the list.
Mirroring the increasing concentration in the equity market, concentration in hedge fund portfolios has risen; the typical hedge fund holds 70% of its long portfolio in its top 10 positions.
These dynamics have also lifted hedge fund exposure to the Momentum factor to a near record.
'Hedge fund crowding is now the most extreme it has been in the 22 years that Goldman has tracked hedge fund positioning…”
The FT article references “Goldman’s quarterly Hedge Fund Trend Monitor, which analyses over 700 hedge funds with $2.4tn of gross stock positions.”
“Hedge fund exposure to momentum has rarely been as extreme as this, and the swing since 2022 has been astonishing.”
A Bloomberg article stated the Goldman hedge fund universe holds $1.6 TN of longs versus $797 billion of shorts.
Today, most shorting is associated with long/short and derivatives strategies.
The Goldman hedge fund universe captures only a slice of the vast “global leveraged speculating community.”
Within my analytical framework, the global levered speculators operate as the marginal source of marketplace liquidity.
“Risk on” leveraging creates liquidity, while de-risking/deleveraging destroys it.
Shorting stocks is likely only a small part of overall short exposure.
I assume there’s a huge short position in Treasuries that finances holdings of higher yielding corporate debt. Shorting of Japanese government debt and other yen instruments could be one of the largest short positions ever.
While there have been close calls, it’s been a rewarding year for levered speculation.
Yet fragility lies just below the surface.
Performance dispersion has been exceptional.
Some funds have performed quite well, while many have struggled.
This has promoted extreme crowding in the high-flying big momentum technology stocks (i.e., “magnificent seven” and AI).
The highly levered Treasury “basis trade” is surely crowded, along with myriad “carry trades” (corporate bonds, MBS, EM, European periphery).
Most importantly, I view leveraged speculation as one Really BIG Crowded Trade.
Way too much “money” playing popular trading strategies ensures volatility and unstable markets.
In particular, the proliferation of hedging and options strategies promotes instability.
The potential is there for hedging and derivatives strategies to precipitate a market crash.
But so far, this market structure has fueled repeated upside dislocations.
The urgent unwind of hedges, short positions, and bearish CDS trades combine with FOMO for melt-up dynamics.
The bottom line is that this aberrant structure impedes normal market function.
Under the Friday Bloomberg headline, “Wall Street Goes All-In on Cross-Market Meltup as Bears Retreat” (Isabelle Lee and Denitsa Tsekova):
“It’s the major casualty of November’s sizzling stock rally: Investor caution.
Thanks to what’s shaping up to be one of the biggest market meltups over the last 100 years, demand for protective strategies has all but evaporated.
Professional and retail traders are battling to keep pace with an S&P 500 that has advanced almost 9% this month alone.
Erstwhile defensive refuges — everything from inflation-protected bonds to cash ETFs and bearish options — are being jettisoned.
In their place: Surging appetite for junk bonds and small-cap equities.”
On the other side of the world, Chinese Bubble deflation has gained important momentum, provoking only more extreme measures from an increasingly desperate Beijing.
As reality begins to penetrate analysis, numbers quickly turn Really BIG.
November 22 – Bloomberg:
“Chinese leaders are making their most forceful push yet to end the nation’s property crisis, ramping up pressure on banks to plug an estimated $446 billion shortfall in funding needed to stabilize the industry and deliver millions of unfinished apartments.
Policymakers are finalizing a draft list of 50 developers eligible for financial support that includes Country Garden Holdings Co. and Sino-Ocean Group, indicating a pivot by Beijing to help some of the most distressed builders.
Meanwhile, the country’s top lawmaking body said banks should increase funding for developers to reduce the risk of additional defaults and make certain that housing projects get completed.”
November 19 – Wall Street Journal (Rebecca Feng and Cao Li):
“China’s housing market has a big problem: millions of unfinished homes that were sold but not delivered.
Solving that is crucial for a recovery, but the problem keeps getting bigger.
More property developers are defaulting on their debt and adding to the logjam of construction delays and stalled residential developments across the country.
Potential home buyers have lost confidence in the housing market because they fear developers won’t be able to complete their projects.
That sentiment has created a vicious circle as falling new home sales imperil even more companies.
Households that have been waiting for years for the apartments they paid for have also become increasingly desperate for a resolution…
Nomura’s chief China economist, Ting Lu, reckons that there are around 20 million units of uncompleted and delayed presold homes across China.
He estimated that more than $440 billion would be needed to finish those homes and predicts that Beijing will eventually have to fill that funding gap.”
What are the options when purchasers have provided down-payments and already taken out mortgages on 20 million apartment units - and now developers don’t have the money to complete construction?
With years’ worth of inventory in many markets, China could live without millions of additional units.
Beijing could simply write reimbursement checks to the 20 million buyers.
But that would leave millions of construction jobs in jeopardy, along with a legacy of scores of eyesore uncompleted projects.
November 23 – Bloomberg:
“China may allow banks to offer unsecured short-term loans to qualified developers for the first time, people familiar with the matter said, a major push to ease the property crisis that’s dragging down growth in the world’s second-largest economy…
If the support measures are approved, they would represent China’s most forceful attempt yet to plug an estimated $446 billion shortfall in funding needed to stabilize the industry and deliver millions of uncompleted homes.”
Cajoling an already stretched and vulnerable banking system into unsecured developer lending reeks of desperation.
November 24 – Wall Street Journal (John Cheng):
“Any step by China to allow banks to provide unsecured loans to qualified developers ‘would be a risky move’ for the lenders, according to JPMorgan...
Such a measure ‘would be negative for banks as it would raise concerns about national service risk and credit risk in the medium term,’ analysts including Katherine Lei and Karl Chan wrote...
What’s more, implementation ‘would be challenging, as banks could circumvent such guidance due to credit risk concerns.’”
Bloomberg Economics offered their take, with a report titled, “Unsecured Property Loans?
Good Idea, Won’t Work.”
“China’s policymakers appear to be racing to fill a liquidity gap facing developers, which we estimate at 15% of GDP.”
“The commercial incentive for banks to lend to developers in current market conditions is questionable — even loans to the top firms in the sector are risky.
Consider the loan officer who’s on the hook if a loan goes sour — their career could be on the line.
With that thought, we conclude that the policy effort to right the teetering property sector is far from over.”
Let’s squeeze in a few Bloomberg Intelligence (Kristy Hung) highlights:
“Tier-3 cities’ new-home inventory – at 33 months of average sales in September, the highest since the series started in 2010…”
“The backlog in tier-2 cities at 24 months of sales was the second highest in 11 years.”
“A surge in secondhand home listings is set to add further supply-side pressure on residential prices, as more homeowners seek to offload their second, third, or fourth properties…”
A couple of the week’s FT headlines:
“China Property: Running Out of Options as Fallout Spreads to Shadow Banking.”
“China Struggles to Spend its Way Out of Economic Crisis.”
Bloomberg estimates that total developer debt exceeds $12 TN.
Beijing faces a multi-trillion dollar black hole – one that expands greatly when China’s banking system eventually succumbs.
And there’s more than $12 TN of local government debt, along with a $3 TN trust industry.
Lots of Really BIG numbers.
November 23 – Financial Times (Hudson Lockett and Sun Yu):
“Zhongzhi, one of the biggest groups in China’s vast shadow financing market, faces a shortfall of as much as $36.4bn and has warned that it is ‘severely insolvent’ in a letter to investors.
The worsening situation at Zhongzhi has put the spotlight on liquidity issues in China’s nearly $3tn shadow financing market and its exposure to the country’s property sector crisis.
Zhongzhi, a sprawling financial conglomerate, wrote… that its total assets amounted to just Rmb200bn ($28bn) against obligations of up to Rmb460bn.
The company blamed the shortfall on the departure of ‘multiple senior executives and key personnel’ and the 2021 death of founder Xie Zhikun…
The company said ‘internal management ran wild’ as a result of these departures.
‘The group’s investment products have defaulted one after the other, and we deeply apologise to investors,’ it said.”
These BIG numbers can be challenging to comprehend.
My brain gets stuck on the combined half Trillion dollars of Evergrande and Country Garden liabilities.
And now a single investment company, Zhongzhi, fesses up to a $36 billion hole in its balance sheet.
In a company comment I fear is applicable to too many Chinese institutions and companies, “internal management ran wild.”
It’s worth noting that Chinese stocks have basically ignored global “risk on,” the Xi Jinping charm offensive, and a loudening drumbeat of stimulus measures.
Developer stocks popped on the latest news, but financial stocks have been notably subdued.
The Hang Seng China Financials Index declined 1.3% in Friday trading, reducing week’s gain to only 1.2%.
China’s CSI300 Index declined 0.8% this week, closing barely above four-year lows.
A good segue to China’s October Credit data.
Aggregate Financing increased a weaker-than-expected $260 billion, with October (first month of the quarter) typically a slower lending month.
This was down from September’s strong $577 billion, but up from October 2022’s $128 billion.
Three-month growth of $1.273 billion was 30% above comparable year ago growth.
At $4.360 TN, y-t-d growth in Aggregate Financing is running 8.6% ahead of last year.
It’s worth noting that 2023 Credit growth is tracking just ahead of 2020’s all-time record.
Total Loan growth slowed to a stronger-than-expected $103 billion, down from September’s $323 billion, but up from the year ago $86 billion.
Y-t-d growth of $3.350 TN is running 14% ahead of 2022, with one-year growth of 11.3%.
Corporate Loans dropped to $72 billion from September’s $234 billion, but were up from last year’s $65 billion.
Y-t-d growth of $2.264 TN is running 9% ahead of 2022, with one-year growth of 13.5%.
Consumer Loans (chiefly mortgages) contracted $5 billion, down from September’s $121 billion increase.
Y-t-d growth of $650 billion is 37% ahead of comparable 2022, but 32% below 2021.
One year growth of 6.8% remains near multi-decade lows.
Government Bond growth of $220 billion was second only to June 2022’s $227 billion.
Three-month growth of $522 billion was up 150% from comparable 2022 ($208bn).
At $1.052 TN, y-t-d growth was 21% ahead of 2022.
Government bonds expanded 14.3% over one year, 32.6% over two and 51% over three years.
When I ponder China’s current predicament, I often return to Ben Bernanke’s thesis on the Great Depression: if only the Fed had printed money and recapitalized the U.S. banking system, collapse would have been avoided.
This is flawed analysis.
China could today spend Trillions plugging holes in developer, local government, and corporate balance sheets, while recapitalizing their bloated banking system.
Yet it would still require upwards of $4.5 TN of new Credit each year to hold collapse at bay.
Beijing will spend Really BIG amounts, but it’s fighting a losing battle against Bubble Dynamics.
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