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FLOWS: Liqudity, Credit & Debt

The ECB Is Worried and It Should Be 06-09-14 Richard Duncan

The ECB Is Worried and It Should Be

The economy of the Eurozone is barely growing. The size of the economy is still 2% smaller than it was before the crisis of 2008 struck. The unemployment rate is 11.7%. Bank lending continues to contract. Now, deflation is becoming a growing threat. Prices rose just 0.5% in May compared with one year earlier. Moreover, the ongoing economic hardship in Europe is fuelling a powerful political backlash that threatens to tear the entire European integration project apart. Anti-European Union parties gained a shocking number of seats in last month’s European parliamentary elections.

On June 5th, the European Central Bank (ECB) announced an aggressive package of policy measures designed to encourage banks to lend in order to kick-start the economy and to prevent deflation from taking hold in the Eurozone area.

1. It cut its official lending rate by 10 basis points to 15 basis points (i.e. effectively 0%).

2. It announced that it would begin to charge banks 10 basis points for any excess reserves the banks held at the central bank.

3. It offered to lend up to Euro 400 billion to the banks at very low interest rates for four years if the banks agreed to relend that money to small and medium sized businesses. Importantly, it specified that loans for mortgages or to governments would not qualify for the low rates offered in this program.

4. Finally, the ECB stated that it was considering buying asset-backed securities (a form of Quantitative Easing) and that it would take even more aggressive steps if necessary (a hint that it could even begin to buy government bonds the way the Fed and the Bank of Japan are doing).

Will these measures be effective? Here are my thoughts:

Cutting the official interest rate by 10 basis points (#1) will have no impact whatsoever. Those rates were already extremely low. Consider QE (#4) is not introducing QE. Talk is cheap. The market wants to see action. If the ECB did begin QE, it would cause the Euro to fall and that would help the economy grow by boosting exports. It would also reduce the chances of deflation. “Considering it” is not the same thing as doing it.

Charging the banks 10 basis points on the deposits they hold as excess reserves with the ECB is an important step. This is the first time a major central bank has imposed “negative interest rates” on bank reserves. Let’s think about this. Banks are always eager to lend money, but only to people and companies capable of paying the money back. The reason the banks have deposited so much cash with the central bank is because there are no additional creditworthy borrowers. So, now the banks will have to decide whether they will lose more than 10 basis points by lending the money. If they would lose more than 10 basis points, they will simply pay the ECB 10 basis points. That way they will lose less. It will be very interesting to see which choice they make.

The third measure has the best chance of success. This measure will reward the banks for lending by offering them the opportunity to borrow money from the ECB at very low interest rates at a fixed rate for four years. It is a variation on the Bank of England’s Funding For Lending Scheme, which has been effective in boosting lending in the UK. The difference, however, is that under the ECB’s plan (which it calls Targeted Long Term Refinancing Operations, or TLTRO) mortgage loans do not qualify, whereas in the UK they do. This is interesting because it shows that the ECB is not willing to drive economic growth by inflating a new property bubble, whereas that is exactly how the Bank of England has orchestrated the rebound in the UK economy. It will be interesting to see whether TLTRO will be effective. The problem remains that there are just not any additional creditworthy borrowers out there.

The ECB has hoped that the announcement of these measures would cause the Euro to weaken relative to the US dollar. In the days leading up to the ECB press conference, the Euro did, in fact, weaken from 1.39 to the dollar to as low as 1.35. However, on the day of the announcement, it actually rebound to 1.36. This must have come as a disappointment for the ECB. It looks to me as though that disappointment will deepen over the weeks and months ahead, as the Euro could very possibly strengthen further from here.

ECB President Mario Draghi said he did not expect these measures to show meaningful results for three to four quarters. By that time, it is quite possible (even probable) that the Fed will have backtracked on its plans to end Quantitative Easing in the US. The market has been led to believe that US QE would end by the fourth quarter of this year. If it does not (and I believe that it won’t), then the dollar will weaken significantly from here; and that means the Euro will rise. If things play out this way, then the ECB will have to do more than just consider printing money and buying assets, it will actually have to do it.

More on Market Watch Services

BUYBACKS - $25B YTD in Japan

Record Stock Buybacks: First In The US, Now In Japan 06-23-14 Zero Hedge

It was a month ago when Zero Hedge first revealed that as QE was "tapering", a just as powerful and even more indiscriminate force had stepped in to make up for the loss of Fed buying of last resort: corporations themselves, almost exclusively on a levered basis (issuing debt whose use of proceeds are stock buybacks). Specifically, we showed that the total amount of stock bought back by corporations in Q1 was the highest since the bursting of the last credit bubble. In fact it was the highest ever.

This was promptly noticed by both the WSJ and the FT. What the two financial media outlets likely have not grasped is that based on trading desk commentary, according to which the bulk of "flow" now originates almost exclusively at C-suites ordering banks to continue the buyback activity, the Q2 stock repurchase totals will be even greater than Q1, and likely surpass $200 billion. This means that every month this quarter companies are buying back about $70 billion of their own stock: an amount which at this runrate will surpass the Fed's original QE(3) amount of $85 billion within a quarter!

But while the "mysterious, indiscriminate" buyer of US stocks has been fully unmasked now, what most likely do not know is that just this is happening at a comparable record pace nowhere else but the place which is mirroring and repeating every single Fed mistake tit for tit.

Japan.

According to Bloomberg, companies in the Topix index are acquiring their own stock at the fastest pace ever, led by NTT Docomo Inc. and Toyota Motor Corp., with $25 billion of announced purchases so far this year, data compiled by Bloomberg show. The buybacks are limiting losses in the world’s worst-performing developed equity market: Companies using the strategy have gained even as the Topix slid.

Only $25 billion you say? Why that is less than a fifth of what their US peers are doing. Well, yes. But remember that on a relative basis, the BOJ's $75 billion or so in QE is orders of magnitude greater than the Fed's own QE when one factors in the relative sizes of the US and Japanese stock markets.

Additionally, keep in mind that the net annual bond issuance in Japan is already well below half of the amount monetized every year by the BOJ (which means if you think US bonds are illiquid, just try to buy, or sell a JGB - good luck). This means that vastly more of the BOJ's intervention ends up in the stock market: either Japan's or that of the US, courtesy of immediately fungible global fund transfers.

But back to Japanese bond buybacks, which in a far more "concentrated" and illiquid market, are having an impact on stock prices that is orders of magnitude higher than their nominal value would suggest.

Bloomberg then proceeds to give a quick lesson on logic 101: “Share buybacks have the effect of supporting the market when it’s weak,” Daiwa Securities Group Inc. quantitative analyst Masahiro Suzuki wrote in a report on June 10. “Return to shareholders is a big theme.”

Companies’ purchases of their own equity can be seen as a vote of confidence by executives that their stock has room to rise. The buybacks can also suggest a company has run out of things to spend money on, curbing its growth potential.

The problem, whether Japanese corporate executives are merely doing the same as their US peers and cashing out on their equity-linked comp plans at a furious pace thanks to their stocks hitting record highs having used corporate cash to boost the stock price while saddling the company with massive debt which will be some other CEO's concern down the line (a clear conflict of interest if there ever was one), is irrelevant. What matters is that stock buybacks have zero impact on the economy. Zilch. Nada. Because instead of investing capital in projects, either for maintenance or growth, all that happens is the shareholders get rich here and now, at the expense of economic, and certainly revenue, growth in the future (as we explained two years ago).

Even if buybacks continue, companies need to increase investments at a faster pace, according to Coutts’ Calder, a harder choice compared to improving return on equity with share repurchases in the short term. The amount of cash they hold means companies should able to afford both buybacks and capital investments, he said.

While businesses have boosted capital spending for three straight quarters, their investments in the period ended March remained 31 percent below a 2007 peak, Finance Ministry data show.

“Buybacks only result in raising ROE and share prices, so their effect on Japan’s economy is indirect,” said Masaru Hamasaki, a Tokyo-based senior strategist at Sumitomo Mitsui Asset Management Co. “Capital investment directly boosts the economy, so I think for now, they should invest more money there.”

Since the start of January, 152 companies on the Topix announced buybacks worth 2.5 trillion yen, data compiled by Bloomberg show. The previous high for an entire year was 1.5 trillion yen in 2008. Companies unveiled an average 567 billion yen in annual buybacks over the decade through 2013, the data show.

And here is where it all comes full circle, because the "economic theory" so to say seeking to reward corporations right now is that these same corporations will, out of the goodness of their heart, turn around and share their profits with their non-stock holding employees, i.e. the rank and file. Because the only way an economy can generate benign inflation is if there are real (not nominal) wage increases. Instead, Japan's only inflation to date is in import cost, in "non-core" staples such as food and energy, and of course, the stock market.

This is what is also affectionately known as trickle-down economics. It also doesn't work. Case in point - Japan's soaring stock market has resulted in exactly zero wage increases in the past 23 months, and soon: straight years of declining wages. Of course, to the Keynesians in charge it simply means that any minute now Japanese wages will increase. Alas, they won't. Because corporations realize that this emergency liquidity injection measure is merely confirmation by the central banks that the economy is failing and that companies should either be stockpiling cash for whatever comes after the Fed or BOJ withdraw, or, failing that, hand it over to shareholders who can do the same however without a corporate veil, and the money will simply reside in a personal bank account instead of a corporate one.

“The government recognizes that in order to resuscitate Japan’s economy, there needs to be a cycle where corporations profit, then return those profits to the public,” said Hisashi Kuroda, the head of Japanese equities and chief portfolio manager at Meiji Yasuda Asset Management Co. “Even if public finances are used to help companies make more money, it’ll be negative for the economy if the firms just stockpile the cash.”

Not surprisingly, with the BOJ injecting trillions into the market, some of it makes its way to corporations. Sure enough, "Non-financial firms’ holdings of cash and deposits rose to a record 232 trillion yen at the end of March, BOJ data show. Earnings by Topix companies swelled 69 percent last year as unprecedented central bank stimulus drove down the yen, boosting exporters’ profits. That added to balances built by executives to shield their companies amid more than a decade of deflation and economic malaise."

Alas, as we noted every month, none of that cash is making its way to employees. Instead, in addition to buybacks it also going for other shareholder friendly activities like dividends. "Other types of returns to shareholders are also on the rise. Estimated annual dividends per share for the Topix climbed to 24.4 yen last week, close to the highest since 2008." And while there has been a modest pick up in CapEx too, it is well below the expected, and certainly well below any level that is required to sustain a virtuous economic cycle. Because what idiot CEO would opt to invest in growth that materializes in 5 to 10 years (the typical peak IRR of CapEx) or when some other CEO is in charge, when there is an quick and easy option to cash out now if said CEO holds stock.

In the meantime, everyone in Japan, and the US, is ignoring the reality and sticking their noise in the sand.

Brokerages are touting stock-picking based on who’s next to buy back shares.

Societe Generale SA says investors should seek out cash-rich companies with low leverage and valuations. Top picks include regional lender Tottori Bank Ltd. and homebuilder Mitsui Home Co., analysts led by Vivek Misra wrote in a June 4 report.

“Many investors don’t realize that corporate Japan is changing,” said Meiji Yasuda Asset Management’s Kuroda.

It's changing all right: in less than two years Japan has adopted all the worst qualities of the US financial system. And just like in the US, when the central bank liquidity music stops, the collapse will promptly follow.

Japan could have avoided this if it had merely continued it slow shallow drift into deflation: painful for debtors but sustainable for most, and most importantly, not some insane Ponzi game where the pensions of the population are being invested in overvalued, social-networking stocks. However, with its berserker rush into stimulating inflation at all costs, the next deflationary shock will be epic, and one whose only "fix" will be for the BOJ to go from mere JPY7 trillion liquidity injection per month, to literally pulling out the firehose and proceeding with creating the hyperinflation that results from a collapse in the currency which we have said since March 2009 would be the ultimate endgame of this entire failed economic and monetary experiment.

• 152 Companies in TOPIX for $25B YTD (led by NTT Docomo Inc. and Toyota Motor Corp)
• $15B in 2008 previous high
• $.6B annually over decade through 2013

• >$200B in Q2 expected

James Stafford of OilPrice.com

LNG: The Long, Strategic Play for Europe: Interview with Robert Bensh

Liquefied natural gas (LNG) to Europe isn’t a get-rich-quick scenario for the impatient investor: It’s a long, strategic play for the sophisticated investor who can handle no small amount of politics and geopolitics along the way. When it comes to Europe, Russia’s strategy to divide and conquer has worked so far, but Gazprom is a fragile giant that will eventually feel the pressure of LNG.

Robert Bensh is an LNG and energy security expert who has over 13 years of experience with leading oil and gas companies in Ukraine. He has been involved in various roles in finance, capital markets, mergers and acquisitions and government for the past 25 years. Mr. Bensh is the Managing Director and partner with Pelicourt LLC, a private equity firm focused on energy and natural resources in Ukraine.

In an exclusive interview with Oilprice.com, Bensh tells us:  

•    Why the smart LNG play is a long-term one
•    How LNG fits into the European energy picture
•    Why LNG will eventually pressure Russia in Europe
•    Why Gazprom is but a fragile giant
•    How Russia combines gas and political influence in Eastern Europe
•    How the European Union is easy to divide and conquer
•    Why the Ukraine crisis has brought attention to the South Stream pipeline
•    Why Bulgaria is the new front line
•    How Lithuania succeeded in negotiating down Gazprom
•    What Moscow’s Crimea annexation really achieved
•    Why it’s game over for Gazprom prices when Turkey steps in

James Stafford: Where does LNG fit into the overall European energy picture?

Robert Bensh: A better question might be, “When does LNG fit into the European energy picture?” When the price is right, it fits into the picture across the European Union, with new import terminals under construction, plenty of transmission lines to deliver it to land-locked countries and the prospect of deliveries from rising energy hub Turkey. And while it may not be a reality at this very moment, it is the prospect of cheaper LNG and the pace of LNG infrastructure development that has Gazprom worried about maintaining its monopoly.

James Stafford: So from an investor’s perspective, what do we need to know here?

Robert Bensh: Listen, the LNG economics are marginal. LNG is about long-term, steady supply. It’s a low-margin, long-term supply of gas to Europe. This is not a play for impatient investors who are looking to get rich quickly. This is a play for investors with longer-term vision, patience and strategic capabilities on a regional level. Those are the people who are going to make money off of this and, along the way, help reshape the balance in Europe away from Russia.

James Stafford: Who are the buyers in this scenario?

Robert Bensh: The countries that primarily take LNG are the Eastern European countries that are paying the highest gas prices and feeling the most significant strategic energy crunch from Russia. They can purchase large amounts of LNG on five 10-year contracts.

James Stafford: And what will Gazprom’s response to more LNG for Europe be? What are its options?

Robert Bensh: Gazprom will either see its supply reduced, or it will be forced to reduce prices to limit economic impact. But once we can start getting LNG through the Turkish-controlled Bosphorus Strait, it is game over for Gazprom in terms of pricing. You’ll still have LNG coming into Europe simply because demand will always exceed supply with long-term contracts in place. That’s when you’ll start to see significant amounts of Canadian and American LNG entering the European and Asian markets, which will affect gas prices in Europe.

James Stafford: Has Russia’s, or Gazprom’s, energy strategy in Europe really been as sinisterly brilliant as is often suggested?

Robert Bensh: In many ways, yes; but it has its limitations. Financially, Russian gas monopoly Gazprom is a fragile giant.

Russia’s European energy policy is to approach different EU states on an individual basis in order to discriminate with price and get the maximum price possible from each. Beyond that, Russia also attempts to lock in supply by consolidating control over strategic energy infrastructure throughout Europe, as well as Eurasia.

In 2002, for example, Russia attempted to buy major energy infrastructure holdings in the Baltic states of Lithuania and Latvia. When both countries refused to cede control, Moscow sharply cut oil deliveries to both states. The final piece of Moscow’s strategy is to maintain control of energy corridors, thus denying Europe any alternative energy routes.

Russia gets away with this because its divide-and-conquer energy strategy is made easy by the fact that the European Union is anything but unified.   

James Stafford: How does Gazprom’s controversial South Stream pipeline play into the crisis in Ukraine?

Robert Bensh: The South Stream pipeline is now coming into much clearer focus against the backdrop of the Ukraine crisis. This pipeline, which would run from the Black Sea to Austria and bypass Ukraine, is both a frightening and exciting proposition for Central and Eastern Europe. The specter of this pipeline makes the fractures in Europe highly visible.

The annexation of Crimea was significant on numerous fronts. The Ukraine crisis provided Russia with the opportunity to achieve important the economic and geopolitical goals of promoting alternative energy supplies that bypass Ukraine. And the results have been quick: Already, some EU countries have indicated that they are willing to drop their objections to the South Stream pipeline in order to increase the percentage of gas shipped directly from Russia.

James Stafford: What about Bulgaria’s recent back-and-forth over South Stream? What can we read into this?

Robert Bensh: For the South Stream pipeline, which is largely a macrocosm of the Ukraine crisis, the front line is Bulgaria, where Russian influence is now at its strongest, and where there is already talk of the country becoming the next Ukraine. The wider EU is trying to block the South Stream project, while Central and Eastern Europe are very torn. Bulgaria is where this pipeline will enter the EU, and accusations persist that Gazprom has had a hand in framing Bulgarian legislation that would circumvent EU competition directives. All of Europe wants this pipeline, but Brussels doesn’t want it to be majority-Russian owned — they want to enable other suppliers to bring gas through it.

The Bulgarian story is getting very interesting. Last week, the Bulgarian government said it was suspending working on South Stream, under pressure from the EU over the project and U.S. sanctions against Russian firms working on the project. Bulgaria is caught in a very bad place here—between Russia and the EU. On the one hand it is suspending work—for now, as it consults with the EU. On the other hand, it is making sure everyone knows it still intends to go ahead with South Stream.  

James Stafford: How much of a threat to Russia is the European Commission’s pending investigation into Gazprom’s monopolistic activities?

Robert Bensh: Europe has argued that Gazprom manipulates prices for political gain and the European Commission is set to release the results of a two-year investigation this month, which is expected to demonstrate substantial evidence that Gazprom is breaking European laws. After that report is released, the EC could take action relatively quickly with up to10 billion euros in fines, which Gazprom cannot afford. Again, the Bulgaria question will figure prominently in his debate.

James Stafford: How does Russia take advantage of the divisions within the EU?

Robert Bensh: The problem within the EU is that Western European countries have more supply opportunities, while Central and Eastern Europe are stuck with Russia. There is no common policy among the EU countries, so there can be no unified front to take on Russia in the energy sphere. Russia takes full advantage of this bifurcation. While talking of interdependence and dialogue, Russia has insisted on providing demand guarantees for the producers and sharing responsibilities and risks among energy supplier’s consumers and transit states. Russia’s actions have not backed up its visions for a new global energy security due to the state policy of not budging from monopolizing gas production or oil and gas pipeline transportation. Europeans are wholly energy dependent on Russia.   

Russia conducts geo-economic warfare on Europe. Russia’s vast oil and gas resources and strategic geographic positioning has translated into increased influence in global energy markets and political clout in its relations with the numerous states that remain more or less dependent on Russian energy. Lawsuits and rulings from the European Commission will prove to be well intended, yet ultimately failed efforts to control Russia’s policy aims driven by control of energy supply and transportation. Here is where efforts to reduce dependence by one client state will have a concomitant benefit for other client state consumers. The European Union lacks a coherent, unified energy strategy and policy towards Russia. Russia thus wisely triangulates client states and the EU to achieve their policy goals either through cheaper supply or infrastructural development.   

James Stafford: Will other countries in the region follow the example of Lithuania and Poland—both of which are aggressively pursuing alternatives to Russian piped gas?

Robert Bensh: Some, yes, out of necessity. The wisest ones, of course, will develop what they can internally of their own resources in an effort to reduce or possibly even remove the need for Russian oil and gas.

James Stafford: Where in Europe is there the potential to actually develop domestic resources to reduce Russian dependence?

Robert Bensh: Ukraine has the potential to do so. Poland, potentially, as well. Other countries, the Baltics in particular, will have a much harder time reducing dependence through internal resource development. For this reason, the development of LNG and additional transportation routes to the region are vital strategically to reduce the dependence on Russian energy.

James Stafford: How should we perceive Lithuania’s recent success in negotiating down gas prices with Gazprom?

Robert Bensh: The country has very earnestly pursued LNG and is close to signing a supply deal with Norway’s Statoil. This, in turn, has forced Russia into price concessions for fear of losing market share. But for now, it’s a luxury that the poorer members of the EU in Central and Eastern Europe cannot afford, economically or politically.  

Unfortunately, most countries will not play ball. Either they have enough of an internally generated resource base to help reduce dependence on Russian energy, or they have multi-integrated economic ties to Russia. Or both.  

The crisis in Ukraine has taught us a devastating lesson: The failure to reduce dependence on Russia, in combination with a multi-integrated economic union with Russia, exposes a client state to geo-economic warfare. In Ukraine, this situation eventually led to President Viktor Yanukovych refusing to sign an Association Agreement with the European Union, which in ignited the Maidan protests that led to the president’s overthrow and Russia’s annexation of Crimea.   

James Stafford: Where will politics and geopolitics head this off? What is Russia’s weak point, it’s Achilles’ heel?

Robert Bensh: Russia has done a good job of tactically focusing on each client state, recognizing their weaknesses and exacerbating them to suit their needs. The only countries that can head this off are those with independent economies and diversified energy supplies. Russia can only provide oil and gas supplies and energy infrastructure development. It cannot provide expertise in oil and gas drilling or service, which really comes from the United States.

And Gazprom’s Achilles’ heel—that which makes it a fragile giant—is the prospect of losing the European market to LNG. And it eventually will, at least in part, though it won’t be tomorrow.

James Stafford: What does the LNG pricing look like right now?

Robert Bensh: LNG is always about $1 less than Gazprom. The U.S. wants to sell their LNG, period. Asian prices are higher, anywhere from $3-$4 higher. But long, steady supply will always get sold. Unless Gazprom comes down in its prices, to make LNG uneconomic, there will always be an LNG marketplace in Europe. There will always be enough supply to meet demand in Europe. All Gazprom has to do is drop its prices down $1 and LNG will be uneconomic. But you have some countries in Europe who are willing to pay a premium to reduce their dependence on Russian gas. LNG supply and the development of internal resources is a strategic decision being made by each country.  

There won’t really be U.S. LNG hitting Europe until 2017-2018. There isn’t enough LNG coming from the U.S. to supply both Asia and Europe. Until there are more export terminals built in the U.S., there will always be significantly more demand than supply, from a U.S. standpoint. For now, U.S. LNG does not impact Europe—we’re not transporting enough in the next five years.  

James Stafford: Last month, amid the crisis in Ukraine, Russia and China inked what is viewed as a highly significant gas deal. What are the implications of this deal for Europe?

Robert Bensh: Let's put this into perspective a bit: This Russia-China deal might not be squeezing out potential supply to Europe, but making up for the likely disappearance of the market for gas from Ukraine. A decade ago, Ukraine was buying 52 billion cubic meters of gas annually from Russia, and last year, this was down to 28bcm. The take-or-pay agreement signed in 2009 was for 42 bcm, which is more than the annual supply as per the China deal. It is not unreasonable to think of Ukraine being totally self-sufficient in gas over the next decade as rational energy pricing reduces very inefficient consumption, while Ukraine has lot of opportunities to hike production -- assuming it remains unified.

This is part one of a three-part series of interviews examining the prospects for Black Sea LNG.

"There is no FREEDOM without NOISE -

and no STABILITY without VOLATILITY."

Norway Sovereign Wealth Fund Unveils "New Strategy" - Buy 5% Of Every European Stock 06-24-14

Having learned last week that the world's central banks are their sovereign wealth proxies have secretly pumped over $29 trillion into markets in the last few years, it is not entirely surprising to hear from one of the largest - Norway $888 billion oil fund - that it is buying stocks with bond hands and feet. As The Financial Times reports, Yngve Slyngstad, chief executive of Norway's sovereign wealth fund, is hiring aggressively to manage its real estate portfolio andwhile the oil fund already owns 2.5% of every listed European company on average, it plans to go above 5%. Phew, bagholder found...

As The FT reports,

Yngve Slyngstad, chief executive of Norway's $888bn oil fund, emphasised that it was "continuation of the strategy" but with numerous small changes.

All are in the same direction: we are incorporating as distinguishing characteristics firstly that we are very long-term investors…and secondly the very large scale and size of the fund.

The fund expects the number of companies it owns more than 5 per cent in to rise from 45 to 100 by 2016 and Mr Slyngstad said "the majority of those will be in European companies".

The oil fund already owns 2.5 per cent of every listed European company on average but going above 5 per cent will see it step up its responsible investor role by talking to chairmen and boards more.

"Why 5 per cent? We have put up explicitly higher demands on us in an ownership role," Mr Slyngstad explained. But he argued this would not lead to the fund becoming an activist but rather merely a "responsible investor".

But it's real estate where they are growing...

Another change will be a "very rapid growth in the number of employees", as Mr Slyngstad terms it, going from 370 at the end of last year to 600 by 2016.

However, 200 of those will be in its property arm and given only 38 currently are Mr Slyngstad said the build-up in the rest of the fund is not too speedy.

All those people are needed in property as the fund is struggling to reach its target of having 5 per cent of its assets in real estate; it currently has 1.2 per cent.

"The growth we are foreseeing in the real estate portfolio is such that we will have to manage some of these properties ourselves."

So there it is - the marginal buyer of property and stocks around the world (most especially Europe) is none other than the high-price-of-oil beneficiary Norway sovereign wealth fund.

"There is no FREEDOM without NOISE -

and no STABILITY without VOLATILITY."

These Fake Rallies Will End In Tears: "If People Stop Believing In Central Banks, All Hell Will Break Loose" 06-24-14 Detlev Schlichter via Zero Hedge

Investors and speculators face some profound challenges today: How to deal with politicized markets, continuously “guided” by central bankers and regulators? To what extent do prices reflect support from policy, in particular super-easy monetary policy, and to what extent other, ‘fundamental’ factors? And how is all this market manipulation going to play out in the long run?

It is obvious that most markets would not be trading where they are trading today were it not for the longstanding combination of ultra-low policy rates and various programs of ‘quantitative easing’ around the world, some presently diminishing (US), others potentially increasing (Japan, eurozone). As major US equity indices closed last week at another record high and overall market volatility remains low, some observers may say that the central banks have won. Their interventions have now established a nirvana in which asset markets seem to rise almost continuously but calmly, with carefully contained volatility and with their downside apparently fully insured by central bankers who are ready to ease again at any moment. Those who believe in Schumpeter’s model of “bureaucratic socialism”, a system that he expected ultimately to replace capitalism altogether, may rejoice: Increasingly the capitalist “jungle” gets replaced with a well-ordered, centrally managed system guided by the enlightened bureaucracy. Reading the minds of Yellen, Kuroda, Draghi and Carney is now the number one game in town. Investors, traders and economists seem to care about little else.

“The problem is that we’re not there [in a low volatility environment] because markets have decided this, but because central banks have told us…” Sir Michael Hintze, founder of hedge fund CQS, observed in conversation with the Financial Times (FT, June 14/15 2014). “The beauty of capital markets is that they are voting systems, people vote every day with their wallets. Now voting is finished. We’re being told what to do by central bankers – and you lose money if you don’t follow their lead.”

That has certainly been the winning strategy in recent years. Just go with whatever the manipulators ordain and enjoy rising asset values and growing investment profits. Draghi wants lower yields on Spanish and Italian bonds? – He surely gets them. The US Fed wants higher equity prices and lower yields on corporate debt? – Just a moment, ladies and gentlemen, if you say so, I am sure we can arrange it. Who would ever dare to bet against the folks who are entrusted with the legal monopoly of unlimited money creation? “Never fight the Fed” has, of course, been an old adage in the investment community. But it gets a whole new meaning when central banks busy themselves with managing all sorts of financial variables directly, from the shape of the yield curve, the spreads on mortgages, to the proceedings in the reverse repo market.

Is this the “new normal”/”new neutral”? The End of History and the arrival of the Last Man, all over again?

The same FT article quoted Salman Ahmed, global bond strategist at Lombard Odier Investment Managers as follows: “Low volatility is the most important topic in markets right now. On the one side you have those who think this is the ‘new normal’, on the other are people like me who think it cannot last. This is a very divisive subject.”

PIMCO’s Bill Gross seems to be in the “new normal” camp. At the Barron’s mid-year roundtable 2014 (Barron’s, June 16, 2021) he said: “We don’t expect the party to end with a bang – the popping of a bubble. […] We have been talking about what we call the New Neutral – sluggish but stable global growth and continued low rates.”

In this debate I come down on the side of Mr. Ahmed (and I assume Sir Michael). This cannot last, in my view. It will end and end badly. Policy has greatly distorted markets, and financial risk seems to be mis-priced in many places. Market interventions by central banks, governments and various regulators will not lead to a stable economy but to renewed crises. Prepare for volatility!

Bill Gross’ expectation of a new neutral seems to be partly based on the notion that persistently high indebtedness contains both growth and inflation and makes a return to historic levels of policy rates near impossible. Gross: “…a highly levered economy can’t withstand historic rates of interest. […] We see rates rising to 2% in 2017, but the market expects 3% or 4%. […] If it is close to 2%, the markets will be supported, which means today’s prices and price/earnings are OK.”

Of course I can see the logic in this argument but I also believe that high debt levels and slow growth are tantamount to high degrees of risk and should be accompanied with considerable risk premiums. Additionally, slow growth and substantial leverage mean political pressure for ongoing central bank activism. This is incompatible with low volatility and tight risk premiums. Accidents are not only bound to happen, they are inevitable in a system of monetary central planning and artificial asset pricing.

Low inflation, low rates, and contained market volatility are what we should expect in a system of hard and apolitical money, such as a gold standard. But they are not to be expected – at least not systematically and consistently but only intermittently – in elastic money systems. I explain this in detail in my book Paper Money Collapse – The Folly of Elastic Money. Elastic money systems like our present global fiat money system with central banks that strive for constant (if purportedly moderate) inflation must lead to persistent distortions in market prices (in particular interest rates) and therefore capital misallocations. This leads to chronic instability and recurring crises. The notion that we might now have backed into a gold-standard-like system of monetary tranquility by chance and without really trying seems unrealistic to me, and the idea is even more of a stretch for the assumption that it should be excessive debt – one of elastic money’s most damaging consequences – that could, inadvertently and perversely, help ensure such stability. I suspect that this view is laden with wishful thinking. In the same Barron’s interview, Mr. Gross makes the statement that “stocks and bonds are artificially priced,” (of course they are, hardly anyone could deny it) but also that “today’s prices and price/earnings are OK.” This seems a contradiction to me. Here is why I believe the expectation of the new neutral is probably wrong, and why so many “mainstream” observers still sympathize with it.

1. Imbalances have accumulated over time. Not all were eradicated in the recent crisis. We are not starting from a clean base. Central banks are now all powerful and their massive interventions are tolerated and even welcome by many because they get “credited” with having averted an even worse crisis. But to the extent that that this is indeed the case and that their rate cuts, liquidity injections and ‘quantitative easing’ did indeed come just in time to arrest the market’s liquidation process, chances are these interventions have sustained many imbalances that should also have been unwound. These imbalances are probably as unsustainable in the long run as the ones that did get unwound, and even those were often unwound only partially. We simply do not know what these dislocations are or how big they might be. However, I suspect that a dangerous pattern has been established: Since the 1980s, money and credit expansion have mainly fed asset rallies, and central banks have increasingly adopted the role of an essential backstop for financial markets. Recently observers have called this phenomenon cynically the “Greenspan put” or the “Bernanke put” after whoever happens to lead the US central bank at the time but the pattern has a long tradition by now: the 1987 stock market crash, the 1994 peso crisis, the 1998 LTCM-crisis, the 2002 Worldcom and Enron crisis, and the 2007/2008 subprime and subsequent banking crisis. I think it is not unfair to suggest that almost each of these crises was bigger and seemed more dangerous than the preceding one, and each required more forceful and extended policy intervention. One of the reasons for this is that while some dislocations get liquidated in each crisis (otherwise we would not speak of a crisis), policy interventions – not least those of the monetary kind – always saved some of the then accumulated imbalances from a similar fate. Thus, imbalances accumulate over time, the system gets more leveraged, more debt is accumulated, and bad habits are being further entrenched. I have no reason to believe that this has changed after 2008.

2. Six years of super-low rates and ‘quantitative easing’ have planted new imbalances and the seeds of another crisis. Where are these imbalances? How big are they? – I don’t know. But I do know one thing: You do not manipulate capital markets for years on end with impunity. It is simply a fact that capital allocation has been distorted for political reasons for years. Many assets look mispriced to me, from European peripheral bond markets to US corporate and “high yield” debt, to many stocks. There is tremendous scope for a painful shake-out, and my prime candidate would again be credit markets, although it may still be too early.

3. “Macro-prudential” policies create an illusion of safety but will destabilize the system further. – Macro-prudential policies are the new craze, and the fact that nobody laughs out loud at the suggestion of such nonsense is a further indication of the rise in statist convictions. These policies are meant to work like this: One arm of the state (the central bank) pumps lots of new money into the system to “stimulate” the economy, and another arm of the state (although often the same arm, namely the central bank in its role as regulator and overseer) makes sure that the public does not do anything stupid with it. The money will thus be “directed” to where it can do no harm. Simple. Example: The Swiss National Bank floods the market with money but stops the banks from giving too many mortgage loans, and this avoids a real estate bubble. “Macro-prudential” is of course a euphemism for state-controlled capital markets, and you have to be a thorough statist with an iron belief in central planning and the boundless wisdom of officers of the state to think that this will make for a safer economy. (But then again, a general belief in all-round state-planning is certainly on the rise.) The whole concept is, of course, quite ridiculous. We just had a crisis courtesy of state-directed capital flows. For decades almost every arm of the US state was involved in directing capital into the US housing market, whether via preferential tax treatment, government-sponsored mortgage insurers, or endless easy money from the Fed. We know how that turned out. And now we are to believe that the state will direct capital more sensibly? — New macro-“prudential” policies will not mean the end of bubbles but only different bubbles. For example, eurozone banks shy away from giving loans to businesses, partly because those are costly under new bank capital requirements. But under those same regulations sovereign bonds are deemed risk-free and thus impose no cost on capital. Zero-cost liquidity from the ECB and Draghi’s promise to “do whatever it takes” to keep the eurozone together, do the rest. The resulting rally in Spanish and Italian bonds to new record low yields may be seen by some as an indication of a healing Europe and a decline in systemic risk but it may equally be another bubble, another policy-induced distortion and another ticking time bomb on the balance sheets of Europe’s banks.

4. Inflation is not dead. Many market participants seem to believe that inflation will never come back. Regardless of how easy monetary policy gets and regardless for how long, the only inflation we will ever see is asset price inflation. Land prices may rise to the moon but the goods that are produced on the land never get more expensive. – I do not believe that is possible. We will see spill-over effects, and to the extent that monetary policy gets traction, i.e. leads to the expansion of broader monetary aggregates, we will see prices rise more broadly. Also, please remember that central bankers now want inflation. I find it somewhat strange to see markets obediently play to the tune of the central bankers when it comes to risk premiums and equity prices but at the same time see economists and strategists cynically disregard central bankers’ wish for higher inflation. Does that mean the power of money printing applies to asset markets but will stop at consumer goods markets? I don’t think so. – Once prices rise more broadly, this will change the dynamic in markets. Many investors will discount points 1 to 3 above with the assertion that any trouble in the new investment paradise will simply be stomped out quickly by renewed policy easing. However, higher and rising inflation (and potentially rising inflation expectations) makes that a less straightforward bet. Inflation that is tolerated by the central banks must also lead to a re-pricing of bonds and once that gets under way, many other assets will be affected. I believe that markets now grossly underestimate the risk of inflation.

Some potential dislocations

Money and credit expansion are usually an excellent source of trouble. Just give it some time and imbalances will have formed. Since March 2011, the year-over-year growth in commercial and industrial loans in the US has been not only positive but on average clocked in at an impressive 9.2 percent. Monetary aggregate M1 has been growing at double digit or close to double-digit rates for some time. It presently stands at slightly above 10 percent year over year. M2 is growing at around 6 percent.

U.S. Commercial & Industrial Loans (St. Louis Fed – Research)

None of this must mean trouble right away but none of these numbers indicate economic correction or even deflation but point instead to re-leveraging in parts of the US economy. Yields on below-investment grade securities are at record lows and so are default rates. The latter is maybe no surprise. With rates super-low and liquidity ample, nobody goes bust. But not everybody considers this to be the ‘new normal’: “We are surprised at how ebullient credit markets have been in 2014,” said William Conway, co-founder and co-chief executive of Carlyle Group LP, the US alternative asset manager (as quoted in the Wall Street Journal Europe, May 2-4 2014, page 20). “The world continues to be awash in liquidity, and investors are chasing yield seemingly regardless of credit quality and risk.”

“We continually ask ourselves if the fundamentals of the global credit business are healthy and sustainable. Frankly, we don’t think so.”

1 trillion is a nice round number

Since 2009 investors appear to have allocated an additional $1trn to bond funds. In 2013, the Fed created a bit more than $1trn in new base money, and issuance in the investment grade corporate bond market was also around $1trn in 2013, give and take a few billion. A considerable chunk of new corporate borrowing seems to find its way into share buybacks and thus pumps up the equity market. Andrew Smithers in the Financial Times of June 13 2014 estimates that buybacks in the US continue at about $400bn per year. He also observes that non-financial corporate debt (i.e. debt of companies outside the finance sector) “expanded by 9.2 per cent over the past 12 months. US non-financial companies’ leverage is now at a record high relative to output.”

Takeaways

Most investors try to buy cheap assets but the better strategy is often to sell expensive ones. Such a moment in time may be soon approaching. Timing is everything, and it may still be too early. “The trend is my friend” is another longstanding adage on Wall Street. The present bull market may be artificial and already getting long in the tooth but maybe the central planners will have their way a bit longer, and this new “long-only” investment nirvana will continue. I have often been surprised at how far and for how long policy makers can push markets out of kilter. But there will be opportunities for patient, clever and nimble speculators at some stage, when markets inevitably snap back. This is not a ‘new normal’ in my view. It is just a prelude to another crisis. In fact, all this talk of a “new normal” of low volatility and stable markets as far as the eye can see is probably already a bearish indicator and a precursor of pending doom. (Anyone remember the “death of business cycles” in the 1990s, or the “Great Moderation” of the 2000s?)

Investors are susceptible to the shenanigans of the manipulators. They constantly strive for income, and as the central banks suppress the returns on many mainstream asset classes ever further, they feel compelled to go out into riskier markets and buy ever more risk at lower yields. From government bonds they move to corporate debt, from corporate debt to “high yield bonds”, from “high yield” to emerging markets – until another credit disaster awaits them. Investors thus happily do the bidding for the interventionists for as long as the party lasts. That includes many professional asset managers who naturally charge their clients ongoing management fees and thus feel obliged to join the hunt for steady income, often apparently regardless of what the ultimate odds are. In this environment of systematically manipulated markets, the paramount risk is to get sucked into expensive and illiquid assets at precisely the wrong time.

In this environment it may ultimately pay to be a speculator rather than an investor. Speculators wait for opportunities to make money on price moves. They do not look for “income” or “yield” but for changes in prices, and some of the more interesting price swings may soon potentially come on the downside, I believe. As they are not beholden to the need for steady income, speculators should also find it easier to be patient. They should know that their capital cannot be employed profitably at all times. They are happy (or should be happy) to sit on cash for a long while, and maybe let even some of the suckers’ rally pass them by. But when the right opportunities come along they hope to be nimble and astute enough to capture them. This is what macro hedge funds, prop traders and commodity trading advisers traditionally try to do. Their moment may come again.

As Sir Michael at CQS said: “Maybe they [the central bankers] can keep control, but if people stop believing in them, all hell will break loose.”

I couldn’t agree more.

"There is no FREEDOM without NOISE -

and no STABILITY without VOLATILITY."

The Fed's "Too Large & Too Illiquid" Bond Trap 06-23-14 Peter Schiff of Euro Pacific Capital via ZH

The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. Last week, while the Wall Street Journal pondered how the Fed may set interest rates three to four years in the future (an exercise that David Stockman rightly compared to debating how many angels could dance on the head of a pin), the media almost completely ignored one of the most chilling pieces of financial news that I have ever seen. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an "exit fee" to liquidate their positions.Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.

Recently Federal Reserve Governor Jeremy Stein commented on what has become obvious to many investors: the bond market has become too large and too illiquid, exposing the market to crisis and seizure if a large portion of investors decide to sell at the same time. Such an event occurred back in 2008 when the money market funds briefly fell below par and "broke the buck." To prevent such a possibility in the larger bond market, the Fed wants to slow any potential panic selling by constructing a barrier to exit. Since it would be outrageous and unconstitutional to pass a law banning sales (although in this day and age anything may be possible) an exit fee could provide the brakes the Fed is looking for. Fortunately, the rules governing securities transactions are not imposed by the Fed, but are the prerogative of the SEC. (But if you are like me, that fact offers little in the way of relief.) How did it come to this?

For the past six years it has been the policy of the Federal Reserve to push down interest rates to record low levels. In has done so effectively on the "short end of the curve" by setting the Fed Funds rate at zero since 2008. The resulting lack of yield in short term debt has encouraged more investors to buy riskier long-term debt. This has created a bull market in long bonds. The Fed's QE purchases have extended the run beyond what even most bond bulls had anticipated, making "risk-free" long-term debt far too attractive for far too long. As a result, mutual fund holdings of long term government and corporate debt have swelled to more $7 trillion as of the end of 2013, a whopping 109% increase from 2008 levels.  

Compounding the problem is that many of these funds are leveraged, meaning they have borrowed on the short-end to buy on the long end. This has artificially goosed yields in an otherwise low-rate environment. But that means when liquidations occur, leveraged funds will have to sell even more long-term bonds to raise cash than the dollar amount of the liquidations being requested.

But now that Fed policies have herded investors out on the long end of the curve, they want to take steps to make sure they don't come scurrying back to safety. They hope to construct the bond equivalent of a roach motel, where investors check in but they don't check out. How high the exit fee would need to be is open to speculation. But clearly, it would have to be high enough to be effective, and would have to increase with the desire of the owners to sell. If everyone panicked at once, it's possible that the fee would have to be utterly prohibitive.

As we reach the point where the Fed is supposed to wind down its monthly bond purchases and begin trimming the size of its balance sheet, the talk of an exit fee is an admission that the market could turn very ugly if the Fed were to no longer provide limitless liquidity. (See my prior commentaries on this, including may 2014's Too Big To Pop)

Irrespective of the rule's callous disregard for property rights and contracts (investors did not agree to an exit fee when they bought the bond funds), the implementation of the rule would illustrate how bad government regulation can build on itself to create a pile of counterproductive incentives leading to possible market chaos.

In this case, the problems started back in the 1930s when the Roosevelt Administration created the FDIC to provide federal insurance to bank deposits. Prior to this,consumers had to pay attention to a bank's reputation, and decide for themselves if an institution was worthy of their money. The free market system worked surprisingly well in banking, and could even work better today based on the power of the internet to spread information. But the FDIC insurance has transferred the risk of bank deposits from bank customers to taxpayers. The vast majority of bank depositors now have little regard for what banks actually do with their money. This moral hazard partially set the stage for the financial catastrophe of 2008 and led to the current era of "too big to fail."

In an attempt to reduce the risks that the banking system imposed on taxpayers, the Dodd/Frank legislation passed in the aftermath of the crisis made it much more difficult for banks and other large institutions to trade bonds actively for their own accounts. This is a big reason why the bond market is much less liquid now than it had been in the past. But the lack of liquidity exposes the swollen market to seizure and failure when things get rough. This has led to calls for a third level of regulation (exit fees) to correct the distortions created by the first two. The cycle is likely to continue.

The most disappointing thing is not that the Fed would be in favor of such an exit fee, but that the financial media and the investing public would be so sanguine about it. If the authorities consider an exit fee on bond funds, why not equity funds, or even individual equities? Once that Rubicon is crossed, there is really no turning back. I believe it to be very revealing that when asked about the exit fees at her press conference last week, Janet Yellen offered no comment other than a professed unawareness that the policy had been discussed at the Fed, and that such matters were the purview of the SEC. The answer seemed to be too canned to offer much comfort. A forceful rejection would have been appreciated. 

But the Fed's policy appears to be to pump up asset prices and to keep them high no matter what. This does little for the actual economy but it makes their co-conspirators on Wall Street very happy. After all, what motel owner would oppose rules that prevent guests from leaving? The sad fact is that if investors hold bond long enough to be exposed to a potential exit fee, then the fee may prove to be the least of their problems.