BofA: "In Every Market Shock Since 2013 Central Banks Have Stepped In To Protect Markets"

There is a reason why those calling for a crash, or even a market correction in the past decade, have been carted out feet first: central banks, and noweher was this more obvious than the shocking aftermath of Brexit. The UK's Brexit vote (Jun-16) marked the point when the buy-the-dip trade became a self-fulfilling put, according to a new analysis by Bank of America.

However the buying did not develop on its own: "From the taper tantrum in 2013 through the Aug-15 China devaluation shock when Yellen decided not to raise rates due to "weak equities" (which were only down just over 10% from life-highs) the Fed consistently (even if only verbally) supported markets during stress."

At that point the "buy the dip" Pavolovian reflex was so strong, central banks could dit back and watch: sure enough, when in early 2016 Yellen suggested the Fed may need to move more "cautiously" because of the risk of Brexit, once Brexit happened, the market rebounded so quickly (3 days) it did not need to step in. From that point forward, dips have only become shallower as investors compete for "dip alpha".

Or as BofA summarizes, "In every major market shock since the 2013 Taper Tantrum, central banks have stepped in (even if verbally) to protect markets. Following the Brexit vote, markets no longer needed to hear from CBs as they rebounded so quickly that CBs didn't need to respond. Buy-the-dip has a become a self-fulfilling put"

This brings up two interesting observations: i) the Fed put is falling with rising rates, and ii) paradoxically the market needs a shock to discover what the new "strike price" is, yet this is impossible due to BTDers stepping in assuming the Fed backstop. BofA explains:

The Fed put strike is falling with rising rates even if markets don't realize it. As our Head of Global Economics, Ethan Harris, has pointed out, sitting at the lower bound in rates put the Fed in risk-management mode, meaning they had to be ultrasensitive to the risk of making a policy mistake as they had no traditional ammunition to fight a potential downturn. But as the Fed gradually increases rates, and with markets seemingly unconcerned, they will inherently become less sensitive to risk. In other words, the Fed put strike is falling both because the Fed is rebuilding ammunition, and because it recognizes that markets can better stand on their own. Of course surprise inflation remains the real killer as it would effectively handcuff the Fed from providing a high strike put, and will require much higher stress before they can step in.

However, we still need to see a shock to know where the Fed put strike is. Just because the Fed put strike is falling with rising rates doesn't mean markets will recognize it until there is a shock of sufficient magnitude to test it. And while Powell is believed to have a largely similar policy stance as Yellen, until we see how he (and his new committee) react to financial stress, it's hard to know exactly where the Fed put strike sits. This fact, along with the uncertainty of when we see a sufficient shock to test the Fed, makes calling an end to this environment difficult. For example, in 2017 the strong buy-the-dip mentality, and arguably solid fundamentals, prevented the Fed from being tested.

Meanwhile, in a world without market shocks, vol continues to decline, forcing even more vol-selling in a self-reinforcing feedback loop as Citi showed yesterday.

 

 Bank of America has a slightly different representation of the various low-vol feedback loops currently active in the market:

So does this mean that the status quo continues? BofA believes the answer is yes, and "there is a clear risk that the 2017 low vol environment carries on through 2018, which is more likely if inflation were to fail to rise, prolonging the current goldilocks period. The Fed could continue to slowly plod along with hikes, and absent a sufficient exogenous shock, the market may maintain full faith that they could pause (or cut) if needed. In this case equities would again generate exceptional Sharpe ratios, beating almost any other asset, as we saw this year. As US equities recorded nearly their highest Sharpe in history this year (the Dow Jones Industrials recorded a Sharpe of 4, 99th %-ile since 1935), the chance of this repeating yet again may be lower than some expect."

Aside from inflation, however, there is one other risk to breaking the goldilocks regime: other central banks, and the extensively discussed inflection point in mid-late 2018/early 2019 when liquidity injections by all central banks fade out, and eventually become a drain of liquidity.

While the Fed is closest to normalizing policy and has been among the largest contributors to the moral hazard injected into markets, the ECB and BOJ still matter. We project G4 balance sheets will finally peak and begin to decline in Q1 '18 (Chart 8), another key inflection point in the global QE story. However, the more important question is whether QE remains effective at suppressing volatility. While it's a slow moving risk, we have noted that since 2016 more QE in Japan and Europe have not dampened vol as they had previously but in some cases (e.g. when Kuroda went to negative rates in Jan-16) actually resulted in higher volatility. This is a key reason we continue to like owning Japanese vol, as you can own QE failure risk with positive carry.

Global market cap is about to hit $100 trillion and Goldman Sachs thinks the only way is down

Global market cap is about to hit $100 trillion.

A bull run of this length — nearly nine years — was last seen before the Great Depression.

Goldman Sachs believes the "bull market in everything" is about to come to an end.

In the medium term, we face either "slow pain" or "fast pain" in the equities markets, Goldman says.

This is a chart of the value of all stocks in all companies in all countries, globally. It is, technically, the market cap of Planet Earth, and everyone who sees it does a double take. In just the last few months, total market cap has rocketed upward to nearly $100 trillion worldwide:

Business Insider / Bloomberg data

I saw the chart in a note from CLSA analyst Damian Kestel: "I almost fell off my chair when I saw this and went to check that Bloomberg hadn't reclassified some data … but no. I included this chart of total equity market cap in [a previous note to clients] in early June this year. At that point total world market cap was US$74 trillion, it's now US$93 trillion," he wrote. (The chart excludes ETFs and the like, so there is no double-counting of single stocks in different indexes.)

What is worrying about the chart is that final, fast peak in 2017. Until then, world market cap looked like any other stock index: A series of incremental gains building on each other over time, with a pronounced dip around the Great Financial Crisis in 2008, followed by a healthy recovery.

This year, the chart just looks insane.

In the medium term there will be either "slow pain" or "fast pain"

Goldman Sachs international analyst Christian Mueller-Glissmann and his colleagues think the "bull market in everything" is about to come to an end. "the average valuation percentile across equities, bonds and credit is the highest since 1900," they write, and it will produce two likely medium-term scenarios: "Slow pain" or "fast pain" as a correction creates a bear market.

Their analysis starts from the perspective of a "60/40" portfolio, meaning an investment that is 60% in the S&P 500 Index and 40% in US government bonds — a typical blend you'd see in any private pension mutual fund or 401(k) plan. It's exactly the type of investment you are likely to be relying on to retire, in other words. Bonds are usually used as a hedge against stocks because they often hold their value when shares tumble.

"The current valuation percentile is most comparable to the late 20s, which ended in the 'Great Depression'"

But that extended runup since 2009 — nearly nine years with a correction — has created a scenario last seen right before the Great Depression in the early 20th Century, the Goldman team says:

"The favourable macro backdrop has boosted returns across assets, driving a 'bull market in everything', despite and because there has been little inflation in the real economy. But as a result, valuations across assets are expensive vs. history, which reduces the potential for returns and diversification ... And elevated valuations increase the risk of drawdowns for the simple reason that there is less buffer to absorb shocks. The average valuation percentile across equity, bonds and credit in the US is 90%, an all-time high. While equities and credit were more expensive in the Tech Bubble, bonds were comparably attractive at the time. The current valuation percentile is most comparable to the late 20s, which ended in the 'Great Depression.'"

Here is the historical perspective:

G

Good luck!

Bubble Watch: US Margin Debt Now Equal the Economy of Taiwan

When Central Banks attempted to corner the sovereign bond market via ZIRP and QE, they forced ALL risk in the financial system to adjust lower.

Remember, in a fiat-based monetary system such as the one used by the world today, sovereign bonds NOT gold are the ultimate backstop for the financial system.

And for the US, which controls the reserve currency of the world, sovereign bonds, also called Treasuries, represent the "risk-free" rate of return for the entire world.

So when the Fed moved to corner this market, forcing the yields on these bonds to drop to all-time lows, it was effectively forcing ALL risk in the US financial system to adjust to an abnormal risk-profile.

Put simply, the Fed created a bubble in bonds, which in turn fueled a bubble in everything.

Yes, everything… corporate bonds, municipal bonds, stocks, even consumer credit. Indeed, nine years into this insanity things have reach such egregious levels of excess that even tertiary debt instruments such as margin debt have reached levels greater than ever before.

What is margin debt?

Margin debt is money that stock investors borrow in order to buy stocks. It is direct leverage. And it just hit a new record… or $561 billion.

To put this number into perspective, it is:

Equal to the entire economy of Asian powerhouse Taiwan.

Nearly greater than the amount of margin debt borrowed at the peak of the last bubble in 2007 50%.

DOUBLE the amount of margin debt borrowed at the peak of the Tech Bubble.

Now, no one in their right mind would argue that late 2000 or late 2007 were periods of fiscal restraint.

Well, today investors are borrowing hundreds of billions or dollars MORE to invest in the stock market than they were at those times.

The bubble in bonds is what finances this entire mess. By creating a bubble in bonds, the US Federal Reserve has created a bubble in EVERYTHING because borrowing costs are at absurdly low levels.

This is why the term The Everything Bubble is used since 2014. It's also why many things has been written on this issue as well as what's coming down the pike: because when this bubble bursts (as all bubbles do) the policies Central Banks employ will make those from 2008-2015 look like a cakewalk.

The ECB Comes Clean On Rising Rates and the Coming Systemic Reset

Remember how the Fed, ECB and others all claimed ZIRP and QE were about generating economic growth, making mortgages more affordable, and helping consumers?

Well, that was a gigantic lie. The truth is that every major policy employed by Central Banks since 2008 have been about one thing…

Maintaining the bond bubble.

Governments around the world have used the bubble in bonds to finance their bloated budgets. If interest rates were anywhere NEAR normal levels, most countries would lurch towards default in a matter of weeks.

If you think this is conspiracy theory, consider that the European Central Bank openly admitted this in its semi-annual Financial Stability Review this week:

Even so, [the ECB] said that "higher interest rates may trigger concerns about sovereigns' debt-servicing capacity," and noted that "distrust in mainstream political parties continues to rise, leading to fragmentation of the political landscape away from the established consensus."

Source: Bloomberg.

In plain speak, the ECB is admitting here that if rates were to rise, the financial world would quickly realize that most countries couldn't finance their debt payments. Indeed, the five largest economies in the world are all near or above Debt to GDP levels of 100%

The bubble in bonds is what finances this entire mess. It's what lets the political class continue to spend money the government doesn't have. And it's why the entire financial system is now in a bubble.

Remember, sovereign bonds are the bedrock for the current fiat-based financial system, so when they go into a bubble, EVERYTHING goes into a bubble, as all risk assets adjust to ridiculously cheap interest rates.

This is why the term The Everything Bubble is used since 2014. It's also why many things has been written about this issue as well as what's coming down the pike: because when this bubble bursts (as all bubbles do) the policies Central Banks employ will make those from 2008-2015 look like a cakewalk.

2018 Will Be When Central Bank Policy Crashes Into the Wall

The bubble in sovereign bonds is looking dangerously close to popping.

And ironically, what could burst it is the very thing Central Banks have been pursuing aggressively for the last 9 years: inflation.

As known, Treasury yields adjust to account for inflation. The relationship is not perfect as bonds are also priced based on economic activity. However, the fact remains, if the rate of inflation spikes, Treasury yields rise as well to account for this.

You can see this in the chart below:

Put simply, if inflation rises, so do Treasury yields.

This in turn means Treasury prices will fall (bond prices fall as yields rise).

And that is a HUGE problem for the Federal Reserve.

The entire reflationary move in the financial system since 2008 was based on the Fed creating a bubble in US Treasuries or sovereign bonds. The Fed did this by cutting rates to zero, pulling down the short end of the bond market. It then targeted the long end of the market with QE programs.

Put simply, the Fed tried to corner the Treasury market, thereby creating a bubble in the most senior asset class in the US financial system. But in order for the Fed to create this bubble, it had to print a massive amount of money ($3.5 trillion or so).

Between this, and the Fed maintaining Zero Interest Rate Policy (ZIRP) for seven years, the Fed unleashed inflation. It's taken longer than one would expect, but it's finally here.

As I write this, the Fed's official inflation metric, the CPI, is already clocking in above the Fed's target rate of 2%.

Similarly, the Fed's "Sticky CPI" which measures price movements in assets that are slow to adjust to inflation, is clocking in over 2%.

The ISM Prices Paid Index (a survey for managers in the corporate sphere) also shows a spike in both manufacturing AND services prices.

This is critical as it shows that not only is inflation translating into higher prices on manufactured goods, but it also shows that even the services side of the economy is recognizing the threat. Put simply, the cost of everything is rising.

Indeed, this is finally translating into higher wages in the corporate arena (hourly wages are now clocking in at nearly 3%). This is particularly critical because once workers are demanding higher wages due to higher costs of living (inflation) it means that inflation is now firmly entrenched in the economy.

U.S. government debt yields jumped Friday after metrics in the latest Labor Department jobs report showed budding signs of inflation. The closely watched average hourly wages figure rose by an annualized 2.9 percent, a faster pace than the Federal Reserve's 2 percent target for inflation.

Source: CNBC

Put simply, inflationary pressures are on the rise. And they are going to implode the bond market unless Central Banks step back from the endless money printing.