The new week opens much the same as last week traded, with narrow ranges abounding in risky asset prices. From leveraged loans to junk debt, funding markets continue to run the correlations. From this “dollar” view, the lack of “buying” interest in the corporate bubble, bargain value or not, may more properly be understood as lack of “funding” interest. On that point, as noted earlier today, banks are the only aspect to really consider as both the near-term acceleration and long-term decaying structure.
From unsecured eurodollars (LIBOR) to eurodollar futures, the funding market structure remains unkind toward assuming risk again. There is an uncomfortable closeness to the worst parts around August 24 that more than suggests an almost uniform aversion; data and events since then haven’t exactly been reassuring (and notjustChina), so there is, for once, some sanity and sense here (another indication of how much the cycle has turned already).
While 12-month LIBOR has been the been the primary mover since December, it is really 3-month LIBOR that I think is perhaps the focal point or central axis of (il)liquidity. Friday’s read of 33.72 bps is the highest since October 2012 just before the first MBS trades on QE3 settled. In eurodollars, the curve inside of 2020 remains largely the same as its flatness of August 24. Given that the outer maturities have steepened that portion, it is significant that the “money part” of the curve (where about $10 trillion in open interest is traded and held) refuses to budge no matter the do’s and don’ts of this week’s FOMC melodrama.
The funding view seems quite proportional to the corporate bubble pricing regime. On the S&P/LSTA Leveraged Loan 100, the market value index remains barely above 950, not really much different than the August 26 low of 947.85. The rest of the junk bond pricing views are similarly depressed to differing degrees.
As mentioned last week, the primary problem here is time. August 24 was three weeks ago and it is increasingly clear that nothing was settled by the liquidations and disruptions. That possibility threatens to turn what might have been temporary adjustments in not just risky positions themselves but open and easily offered leverage into a more permanent and structural shift.
Obviously, that has been the case going back to last year’s “dollar” turn and even to the high point in the junk credit cycle in May 2013. But as each of these individual “events” fail to find a durable point of stability (like even a potential bottom) and the downside momentum only accelerates with each, the risk systemically becomes more about the size of the exits than whether they would actually become necessary. The fact that outward liquidity and prices seem so very linked in the aftermath suggests we may have already arrived at that point and that institutional positions remain far more than wary of it.
The real downside is where those two points intersect; funding contracts further, narrowing the exits, while the volume of those reaching for them at the same time increases exponentially into a self-reinforcing spiral. It is very much like two massive armies having already been mobilized staring directly at each other awaiting only a small spark to set “it” off.
CORPORATE PENSION DEFICITS - ~ $423B
09/17/15
THESIS
28 - Pension - Entitlement Crisis
To be sure, we’ve written quite a bit about both public and private pension plans this year. Most notably, we’ve chronicled the deplorable state of the pension system in Illinois, where a State Supreme Court ruling in May set a de facto precedent for pension reform bids across the country.
But while the focus - here and elsewhere thanks to America’s growing state and local government fiscal crisis - has been on the public sector, seven years of ZIRP has taken its toll on private sector pension plans.
We touched on this briefly in March when we noted that ECB QE could end up widening pension deficits dramatically and as FT reported last month, “UK companies are paying less towards meeting their pension shortfalls than at any point since 2009, even as aggregate pension deficits reach their highest level in five years.”
For those wondering about the extent to which falling discount rates have served to create a giant, multi-hundred billion dollar underfunded liability for S&P companies, look no further than the following graphic from Citi’s Matt King which should come with a caption that reads: “You’re welcome pensioners -- The Fed.”
The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies dropped by 2% to 81% as of August 31st, 2015, rising interest rates mitigated losses in equity markets. As of August 31st, 2015, the estimated aggregate deficit of $423 billion USD increased by $44 billion as compared to the end of July. Funded status is now up by $81 billion USD from the $504 billion USD deficit measured at the end of 2014, according to Mercer,[1] a global consulting leader in advancing health, wealth and careers.
The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies dropped by 2% to 81% as of August 31st, 2015, rising interest rates mitigated losses in equity markets. As of August 31st, 2015, the estimated aggregate deficit of $423 billion USD increased by $44 billion as compared to the end of July. Funded status is now up by $81 billion USD from the $504 billion USD deficit measured at the end of 2014, according to Mercer,[1] a global consulting leader in advancing health, wealth and careers, and a wholly-owned subsidiary of Marsh & McLennan Companies (NYSE: MMC).
The S&P 500 index lost 6.3% and the MSCI EAFE index lost 7.6% in August. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased by approximately 11 basis points to 4.22 percent.
“While the decline for the month was only 2%, August was a very bumpy ride for plan sponsors,” said Matt McDaniel, a Partner in Mercer’s Retirement business. “Turmoil in equity markets stemming from concerns in China led to a decrease in funded status of more than 5% through August 24th. Fortunately, a partial recovery, combined with a rise in discount rates late in the month, allowed pension plans to recover much of the loss.”
Mercer estimates the aggregate funded status position of plans sponsored by S&P 1500 companies on a monthly basis. Figure 1 shows the estimated aggregate surplus/(deficit) position and the funded status of all plans sponsored by companies in the S&P 1500. The estimates are based on each company’s year-end statement[2] and by projections to August 31, 2015in line with financial indices. The estimates include US domestic qualified and non-qualified plans and all non-domestic plans. The estimated aggregate value of pension plan assets of the S&P 1500 companies as of July 31, 2015, was $1.84 trillion USD, as compared with estimated aggregate liabilities of $2.22 trillion USD. Allowing for changes in financial markets through August 31, 2015, changes to the S&P 1500 constituents, and newly released financial disclosures, at the end of August the estimated aggregate assets were $1.77 trillion USD, compared with the estimated aggregate liabilities of $2.20 trillion USD. Figure 2 shows the interest rates used in Mercer’s pension funding calculation.
Unless otherwise stated, the calculations are based on the Financial Accounting Standard (FAS) funding position and include analysis of the S&P 1500 companies.
Figure 1 : Estimated aggregate surplus/(deficit) position and the funded status of all plans sponsored by companies in the S&P 1500
Source: Mercer, August 2015
See Figure 2 for High Quality Corporate Bond Yield and S&P 500 data points.
One narrative we’ve built on this year is that the subpar character of the global economic recovery isn’t just a consequence of a transient downturn in demand from China whose transition from an investment-led, smokestack economy towards a model driven by consumption and services has effectively caused the engine of global growth to stall. Rather, it seems entirely possible that an epochal shift has taken place in the post-crisis world and the downturn in global trade which many had assumed was merely cyclical, may in fact be structural and endemic.
This echoes concerns we voiced in May, when BofAML was out warning that if “wobbling” global trade turned out to be structural rather than cyclical, “then EM economies should not count on meaningful demand boosts coming from above-trend growth in DM.”
Most recently, we looked at freight rates (which, incidentally, Goldman predicted earlier this year will remain subdued until 2020) noting that despite a dead cat bounce in the Baltic Dry, “freight rates on the world’s busiest shipping route have tanked this year due to overcapacity in available vessels and sluggish demand for transported goods. Rates generally deemed profitable for shipping companies on the route are at about US$800-US$1,000 per TEU. In other words, at current prices shippers are losing half a dollar on every booked contractual dollar at current rates.”
Now, WSJ is back with a fresh look at the new normal for global trade and unsurprisingly, the picture they paint based largely on WTO data and projections, is not pretty. Here’s more:
For the third year in a row, the rate of growth in global trade is set to trail the already sluggish expansion of the world economy, according to data from the World Trade Organization and projections from leading economists.
Before the recent slump, the last time trade growth underperformed the rate of an economic expansion was 1985.
“We have seen this burst of globalization, and now we’re at a point of consolidation, maybe retrenchment,” said WTO chief economist Robert Koopman. “It’s almost like the timing belt on the global growth engine is a bit off or the cylinders are not firing as they should.”
Since rebounding sharply in 2010 after the financial crisis, trade growth has averaged only about 3% a year, compared with 6% a year from 1983 to 2008, the WTO says.
Few see any signs that trade will soon regain its previous pace of growth, which was double the rate of economic expansion before 2008. In 2006, global trade volumes grew 8.5%, compared with a 4% expansion in global GDP.
This year the WTO is expected to cut its 2015 trade forecast a second time after a sudden contraction in the first half of the year—the first such decline since 2009.
“It’s fairly obvious that we reached peak trade in 2007,” said Scott Miller, trade expert at the Center for Strategic and International Studies, a Washington, D.C., think tank.
And this, bear in mind, is the environment into which the Fed intends to hike, even as the emerging economies which have been hit the hardest by the slowdown in trade (which has served to depress commodities and wreak havoc on commodity currencies) would likely suffer from accelerated capital outflows in the wake of an FOMC liftoff.
What's also notable here is that this comes as central banks have engaged in round after round of easing in a desperate, multi-trillion quest to boost global growth, suggesting that competitive devaluations are a zero sum game and to the extent that individual countries can boost exports in the short term by devaluing, that gain comes at someone else's expense, meaning, in The Journal's words, "foreign-exchange moves have little chance of raising trade overall" and even if they did, the backdrop of depressed demand means that what many EMs are producing, no one now wants, irrespective of how cheap it may be.
Make no mistake, the most worrying part of the new normal for trade is what it portends for emerging markets. We've already seen Brazil's investment grade rating cut by S&P as the country careens headlong into fiscal, political, and economic crises. As Morgan Stanley put it in August, Brazil is the epicenter and one can reasonably expect that other EMs will follow in its footsteps should the WTO's projections about the sturctural nature of depressed global demand and trade prove accurate. What comes next is the descent of the emerging world into frontier status, and as we've put it on several occasions, after that it will be time to break out the humanitarian aid packages.
Of course, as we mentioned late last month, there is one more possibility: central banks could learn how to print trade.
Day after day investors are treated to 5-Star Morningstar managers, so-called "strategists", economissseds with entire religions on the line, and circus barkers who proclaim that: a) The US is decoupled from the rest of the world; and/or b) The US is the cleanest dirty shirt; an/or c) There are no indications that the US economy is near a recession. Here are four simple charts - from, just today's data - that destroy this glass half full and rose-colored ignorance of reality...
1) Business Inventories-to-Sales are at recesssion-inducing levels...
1a) Sidenote 1 - Wholesale Inventories relative to sales have NEVER been higher...
1b) Sidenote 2 - here is why that is a problem...
2) Industrial Production is - as would expeted given the inventories - rolling over into recession territory...
2a) Sidenote - as Empire Fed confirmed this morning for August - inventories are collapsing (and along with that Q3 GDP)...
3) Retail Sales is not supportive of anything but a looming recession...
And finally,
4) The last 6 times Auto Assemblies collapsed at this rate, the US was in recession...
So - still think The US is "safe" - because stocks are certainly not priced for anything other than a hockey-stick of hope in earnings rebounds, let alone a collapse into recession.
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Market
TECHNICALS & MARKET
COMMODITY CORNER - AGRI-COMPLEX
PORTFOLIO
SECURITY-SURVEILANCE COMPLEX
PORTFOLIO
THESIS - Mondays Posts on Financial Repression & Posts on Thursday as Key Updates Occur
Bianco research started in 1998 and is affiliated with Arbor research and training. It is an independent research company with James Bianco as its president. Bianco research specializes in macro, fixed income and equity research.
James views financial repression in light of what Ben Bernake said in his November 12 op-ed in the Washington post:
”the purpose of QE2 is the fed buys bonds, force down interest rates, that would make them relatively unattractive for most bond investors, seeking alternatives they would move further out the risk curve and they would not buy .They would push up those assets prices, create a wealth effect expecting a cycle in which the wealth effect creates economic growth to justify those higher prices”.
The forced down interest rate will not bode well for individuals who need certain rates of return to guarantee things like pension and retirement. You end up taking more risk by buying riskier assets which pushes up its price causing you to feel wealthier. He explains that when a government body in this case the CBN steps in and sets price at levels where they would not ordinarily go by themselves, they are repressing the price of interest rate, inflating the price of risk assets. They argue it is a greater good because of the wealth effect that comes from that.
James doesn’t think that the wealth effect occurs as a result of that. According to him, Milton Friedman in 1915 developed the permanent income hypothesis which states that if an asset goes up in price for example a house, you treat it as another form of permanent income. One the other hand, if your stock portfolio goes up, you perceive as temporary due to what you read in the paper.
“That’s why we obsess over the fed because we think all this stuff is temporary and we want to find out how temporary it is, because when the fed raises rates… I guess to mix my metaphors a little bit with the old warren buffets’ old line that we find out that we are swimming naked when the tide goes out”.
That’s why a rate hike is such a big deal in the financial markets. What will the Feds do?
“There are two things to keep in mind concerning what the feds will do. There’s the economic data and the market pricing of it”.
He says that based on the economic data, the fed has set up some parameters for itself and from a data dependent point of view, they have everything they need, but James believes that what will hold back the feds will be market instability. Currently, there is a great deal of volatility and uncertainty in the Chinese and emerging markets. He believes the instability in these markets will cause the feds will to maintain interest rates because they are hoping that things would calm down enough by Dec. He mentions that part of the reason for the unstable markets is due to the Feds insistence on raising rates.
EU
On his view of the EU, James Bianco has this to say:
“The history of the Europe is for the last thousand years is every generation they try to kill each other and the last one was in World War 2”.
Then they decided to get closer in order to prevent more wars. This led them to create the euro. According to him, the problem with the euro, is that you have 17 different countries in different cycles using the same currencies. He says that Draghi’s plan is to get interest rates to below zero and continue trying to stimulate the economy. He goes further to explain that the current refugee crisis that the EU is facing will have a huge negative impact on their economy. He doesn’t think Draghi’s plan will work because people think it’s temporal and as long as they think that, the permanent income hypothesis will take effect.
Check out his interview with Gordon T Long which covers this and much more.
Written by Richard Duncan | Tuesday, September 15, 2015
For many years, two growth engines, the United States and China, powered the global economy. Both of those engines have now failed. Consequently, the global economy is rapidly losing altitude. Return to your seats and buckle your seat belts. A global economic nosedive may be in your immediate future.
For decades, the US economy was driven by rapid credit growth. The ratio of total credit to GDP rose from 150% in 1980 to 370% in 2007. So long as credit expanded, the Americans had more money to spend even though their wages had long since stagnated. The more they spent, the more the US imported. Surging imports - and an out of control trade deficit that earlier generations could not even have imagined – set off a global economic boom that transformed the world.
If only the Americans could have kept borrowing more every year forever, all the age-old problems of mankind would have dissolved away. Unfortunately, debt has to be repaid – even in America. When that became impossible in 2008, credit began to contract, banks began to fail, major institutions were nationalized, spending fell, and imports contracted. Trillions of dollars of fiscal and monetary stimulus prevented a total economic breakdown, but US imports no longer grew rapidly enough to drive the global economy. One of the engines of global economic growth had seized up.
That left China. China’s economic miracle was export-led and investment-driven. When the US crisis began, China’s exports fell. To prevent an economic collapse, Chinese policymakers ramped up investment. Industrial capacity was expanded. New cities were built. New highways and train tracks crisscrossed the country. This investment was funded with debt. Chinese bank loans tripled between 2009 and now. In that way, China’s economy continued to grow and to pull in imports from the rest of the world.
China’s leaders had hoped that the US economy would soon recover and that China could resume exporting its way to ever-greater prosperity. That didn’t happen. Once US fiscal and monetary stimulus faded, US imports began to contract again. During the first seven months of 2015, US imports were down by an average of 2.2% a month relative to the same period last year.
Meanwhile, China’s credit-fuelled investment boom had produced excess industrial capacity on a scale the world had never seen before. The supply glut across all industries caused product prices to plunge. Reduced corporate revenues became insufficient to pay even the interest on the debt that had funded the investments. Growing non-performing loans are once again threatening the solvency of China’s banking system. Additional investment would only make matters worse.
China had no choice but to begin to invest less. Reduced investment means less demand for the rest of the world’s commodities. As the Chinese slowdown gathered pace in 2014, Chinese imports began to weaken. They then began to contract. During the first eight months of 2015, Chinese imports were down by an average of 14% each month relative to the first eight months of 2014. As a result, global commodity prices have collapsed, falling to levels last seen in the twentieth century. The second engine of global growth has clearly broken down.
Falling demand from China and plunging prices sent the economies of the commodity producing countries into a tailspin. Russia, Brazil and Canada have fallen into recession. The currencies of numerous Emerging Market economies have fallen sharply. The earnings of the metals, mining and energy companies are being hard hit. New investment will inevitably decline, while unemployment will rise. Now, the global selloff in stocks is producing a negative wealth effect that will soon take a toll on consumption.
All of these negative conditions are likely to become worse before they get better. Credit growth in the United States is not going to reaccelerate enough to drive the global economy. The slowdown in Chinese investment has only just begun. The global economy has descended to a recessionary altitude. Turbulence is worsening. Visibility is poor. The flight plan is lost. Confidence in the pilots is low. Hang on. We are flying into trouble. A hard landing may be the best-case scenario.
I discussed this engine failure during an interview on CNBC Squawk Box Asia on September 14th. If you would like to watch the interview, here’s the link:
The risk that oil could fall as low as $20 a barrel is rising, with a persistent surplus requiring prices to remain lower for longer to rebalance the market, Goldman Sachs said, cutting its forecasts again.
"While we are increasingly convinced that the market needs to see lower oil prices for longer to achieve a production cut, the source of this production decline and its forcing mechanism is growing more uncertain, raising the possibility that we may ultimately clear at a sharply lower price with cash costs around $20 a barrel Brent prices," Goldman said in a note Friday.
The sources of stress: an abundance of oil coupled with a scarcity of storage space. The bank estimates the industry added around 240 million barrels of petroleum to storage tanks from January to August. It projects available identified storage capacity outside China at around 375 million barrels and expects an around 240 million barrel inventory build outside China between September of this year and the end of 2016.
"If you don't bring U.S. or global production down low enough underneath demand to create that rebalancing then you're likely to slam into storage capacity constraints and that would put that downward pressure," said Jeffrey Currie, head of commodities research at Goldman, in a CNBC "Power Lunch" interview Friday.
But it noted $20 a barrel isn't its base case, even though risks that oil will fall that low continue to rise, especially as the bank expects only moderate production declines through the end of the year. There is a less than 50 percent chance it would reach $20 a barrel, Currie noted.
Cuts to production are not "significant enough," as low-cost output continues to surprise to the upside, Currie added. Risk that neither producers with strong balance sheets nor weak balance sheets would want to trim production "reinforces this idea of lower for longer," he noted.
Goldman cut its one-month, three-month, six-month and 12-month WTI oil price forecasts to $38, $42, $40 and $45 a barrel, respectively. That's down from $45, $49, $54 and $60 previously.
It cut its average price forecast for 2016 to $45 a barrel from $57.
Brent for October delivery settled down 75 cents at $48.14 a barrel on Friday, while U.S. crude fell to $44.63 a barrel, down $1.29. That follows a wild ride for oil prices, with crude rallying from a low of $37.75 touched Aug. 24, with daily swings of more than 5 percent in either direction.
"The oil market is even more oversupplied than we had expected," Goldman said. "We now forecast this surplus to persist in 2016 on further OPEC production growth, resilient non-OPEC supply and slowing demand growth, with risks skewed to even weaker demand given China's slowdown and its negative emerging market feedback loop."
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.
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The Media is not a solicitation to trade or invest, and any analysis is the opinion of the author and is not to be used or relied upon as investment advice. Trading and investing can involve substantial risk of loss. Past performance is no guarantee of future returns/results. Commentary is only the opinions of the authors and should not to be used for investment decisions. You must carefully examine the risks associated with investing of any sort and whether investment programs are suitable for you. You should never invest or consider investments without a complete set of disclosure documents, and should consider the risks prior to investing. The Media is not in any way a substitution for disclosure. Suitability of investing decisions rests solely with the investor. Your acknowledgement of this Disclosure and Terms of Use Statement is a condition of access to it. Furthermore, any investments you may make are your sole responsibility.
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