and inverting the term structure...
For the first time since April...
This surge is coming right after Large Specs have rebuilt the largest net short vol position since the Feb XIV collapse.
Is the next short-vol-squeeze coming?
Morgan Stanley is not the only bank to urge clients to turn more skeptical, if not outright bearish.
As Bank of America Chief Investment Officer Michael Hartnett writes in his latest Thundering Word report titled suggestively enough "Charts of Darkness fo Apocalypse Dow"...
... "relative to consensus we remain bearish on financial assets" and notes the following:
we believe peak asset Prices in 2018 are consistent with peak investor Positioning, peak corporate Profit expectations, and peak Policy stimulus. We believe the peaking of the 3Ps is occurring in a late-cycle macro & market backdrop (in 42 trading days the S&P500 bull market becomes the longest of all time). We forecast low & volatile single digit gains for stocks, low single-digit losses for bonds, and relatively strong 2018 for cash, commodities and the US dollar.
And whereas Morgan Stanley's Sheet laid out a qualitative explanation for his skepticism, Hartnett takes us through a visual landscape of his "charts of darkness", which lay out the primary reasons for his bearishness, including:
These are the "five profit and policy reasons" he remains bearish.
Presenting, Bank of America's Charts of Darkness
1. Quantitative Tightening: YTD G3 central bank asset purchases of $125bn well below $1.5tn run rate of 2017; we estimate liquidity growth turns negative in 6-8 months; Fed tightening always triggers an event (Chart 2).
2. Trade War: new US tariffs set to boost US protectionism to highest level since mid- 1970s; further action on China ($200bn), autos ($350bn), NAFTA ($690bn) would raise tariff revenue as % total imports to levels not seen since 1946 (Chart 3); our own view is 2018 "trade war" really just 1st stage of new arms race between US & China to reach national superiority in technology, and protectionism inevitably on rise to address inequality.
3. Peak Profits: 2018 global EPS forecast robust (15.5%) but 2019 slipping (9.4% down from 10.4% in April); lead indicators continue to weaken (e.g. soft June South Korea exports, Chart 4).
4. German fiscal stimulus: we believe ECB tightening is doomed to fail as has been case in Japan past 30 years (implying 8bp ECB policy rate in 2030 - Chart 5); until Italy, migration, trade wars force Germany to capitulate on fiscal austerity (note German current account surplus staggering 8% of GDP while sharing a border with Italy - youth unemployment rates >33% - Chart 6) a case cannot be made for European banks.
5. Yield Curve: flattest US Treasury yield curve since Sept'07, just 36bps from 1st inversion since 2007; curve inversions have preceded 7/7 prior recessions since 1970 by 4 to 5 quarters (Chart 7).
* * *
So with all that in mind, one would assume that the BofA CIO would recommend bearish traders. Yes... and no.
The reason for Hartnett's ambivalence is that much of the potential downside appears to already be priced in, and as a result, investor positioning close to triggering contrarian "buy signals" for risk assets in coming months.
And, in light of the approaching "extreme bear" sentiment print, Hartnett reminds his readers that "as always the best asset to buy is "humiliation", which occurs when extreme bearishness combines with a financial event and/or recession risk, e.g. Feb'16 when BofAML Bull & Bear Indicator @ 0.0 coincided with China hard landing, US recession fears, HY credit events as oil dropped below <$30bbl."
We've argued for an SPX 2550 to 2850 range this year; a move to the bottom of this range could elicit a buy signal and nice trading rally for distressed markets (e.g. EU equities, EM debt).
Just like earlier in the year, ahead of the February VIXtermination and during the market blow-off top phase when he urged client to buy stocks if the S&P slides to 2,550, which turned out to be the precise market floor so far, Hartnett writes that a "big, exciting entry point at levels below 2550 first requires extreme bearishness to coincide with 2019 recession fears (weak US labor market data) and further credit contagion (global debt = 3.5X GDP or $240tn) causing Fed to pause hiking cycle in H2."
He concludes: "we're not there yet."
RTE says Greece Crisis Declared 'Over' as Eurozone Agrees on Debt Relief
The BBC says Greece Hails 'Historic' Debt Relief Deal
The Financial Times says EU Commissioner Calls End to Greek Crisis
This was another can-kicking announcement according to Eurointelligence.
Here it is. Finally, a deal on debt relief for Greece. It is a fudge of sorts, but a deal that ends the eight-year-long Greek debt crisis - for now. These are the main components of the deal:
A €15bn loan disbursement at the end of the programme, of which €3.3bn can be used to buy back IMF loans;
A 10-year extension of the EFSF loans, and a ten-year deferral of interest payments and amortization starting from 2033; and
A return of profits from Greek bonds (SMP and ANFA) held by Eurozone central banks, a total of €4bn, with semi-annual payments and subject to reform targets.
There is no growth clause, no interest-rate cuts, no major buyback programme. This is not debt relief in the way the IMF defines it, but debt relief of the kicking-the-can-the-road variety.
It also leaves Greece with a significant exposure to IMF loans. Even if Greece were to use the €3.3bn to buy back IMF loans, that still leaves €7.1bn to be repaid by 2024.
The IMF abstained almost entirely from the debate as it is now officially leaving the programme and will only participate in the post-memorandum oversight, writes Kathimerini. Christine Lagarde refused to make any statements about Greece. What this means for the IMF role after the programme ends is yet to be seen.
So this is it, after eight years, three bailout programmes and endless eurogroup meetings. And with debt nearly at 180% of GDP, there is still the potential for things to turn wrong. But for now, everyone seems happy.
Reader Lars, from Norway, offered his assessment of the situation this morning:
Hello,
It's hard to keep a straight face these days. Greece is now out of the crisis according to the EU. And the MSM seems to go with that narrative.
Loan servicing has been kicked down the road som Greece will stay a debt slave for many, many years. Most focus on debt as a percentage of GDP. That's not the correct place to start. Compared to the productive share of the Greek economy, it's game over. Greece will never raise under this debt burden. New debt is required to create growth, but who will lend to a nation loaded with debt. So investments will have to be 100% equity.
Nobody looks at the dynamic picture. What will things look like in 10 years time? Same as in 2010.
It's sad that this type of propaganda is spread.
With everything included, Greece has a public debt of close to €500 billion (contingent liabilities included) for a private sector of €80-90 billion. The banks are filled sky high with Non-Performing-Loans. Youth employment is over 30%. What kind of future is that?
Regards
Lars
E. responded: "Greece is now totally enslaved by Brussels. The only way for the Greeks to get out of slavery is to revolt by reneging on all EU/ECB debt and launching a new Drachma. It will come."
No one has bothered to ask what happens to Greece, Italy, or the Eurozone in general, in the next recession. Whatever the recession possibilities are in the US, they are far greater in the EU.
Trump's tactics are such that an EU recession can happen at any time.
I envision a destructive breakup of the Eurozone, but the trigger will be pulled by Italy, not Greece.
The move is expected to unlock 700 billion yuan ($108 billion) in liquidity amid growing trade war tensions, a sharp slowdown in the Chinese economy, a tumbling stock market, rising forced margin call, and a spike in corporate defaults.
According to the central bank, the aim of the cut is" to support small and micro enterprises, and to further promote the debt-to-equity swap program." The cut will apply to major state-run commercial banks, joint-stock commercial lenders, postal banks, city commercial lenders, rural banks and foreign banks, in other words: virtually everyone.
"The size of the liquidity being unleashed has beat expectations and it's larger than the previous two cuts this year", said Citic fixed income research head Ming Ming. "It's almost a universal cut as it covers almost all lenders."
The RRR cut was also widely expected following the publication of a central bank working paper on Tuesday calling for such a cut.
According to Bloomberg, the cut is designed to achieve two things:
... amid a plunge in China credit creation and a record drop in Chinese off-balance sheet financing, and is meant to provide an economic spark to offset the risk of further economic contraction.
In a separate statement, the PBOC said that the move will "help push forward the steady progress of structural deleveraging, and strengthen support to the weak links of small-and-micro businesses. It is a targeted and precise fine-tuning. The PBOC will keep implementing prudent and neutral monetary policy, and create a favorable monetary and financial environment for high-quality development and supply-side reform."
However, countering speculation that the RRR cut may indicate a shift in China's deleveraging posture, Wen Bin, a researcher at China Minsheng Banking Corp. told Bloomberg that "the RRR cut this time doesn't change the PBOC's prudent policy stance. The decision fits the current economic and liquidity situation. It is also an innovative move and addresses structural problems, as the central bank ordered the lenders to use the money unleashed to push forward debt-to-equity swaps and support small-and-micro-sized businesses. This can help relieve financial burdens for some companies while reducing leverage."
In other words, China is spinning the RRR as a move meant to fund mass deleveraging through debt for equity swaps, not as the start of an easing cycle which would send the Yuan sliding and could potentially be perceived as a stealth devaluation by the US, resulting in even more aggressive trade retaliation.
The move will ease liquidity shortages currently seen in the implementation of debt-to-equity programs, and it shows that policy makers still don't want to send a signal of across-the-board easing, Ming said. "The central bank may have predicted rising debt risks in the near future, so it decided to set up such an arrangement," he said.
That said, the PBOC explicitly said that the funds unlocked from the reserve ratio cut shouldn't be used to support so-called zombie companies, of which China has many as even the IMF noted in December. It remains to be seen if this is just a smokescreen, considering that the companies most in need of deleveraging are precisely China's "walking dead" companies.
Finally, there is the market, which many have suggested is the real reason for the much anticipated cut. As a reminder, the Shanghai Composite recently slumped below 3,000 for the first time since the summer of 2016.
The risk here, however, is not just to China's wealth effect, but to a wave of margin calls resulting in forced selling of stocks pledged as collateral for loans. About $1 trillion worth of stocks listed in Shanghai or Shenzhen, China's two main market, are being pledged as collateral for loans, according to data from the China Securities Depository and Clearing Corp., or ChinaClear. The staggering number is equivalent to about 12% of the market.
Plenty of Chinese stocks are also used as collateral in margin financing, whereby investors borrow to plow more money into stocks. In all, some 23% of all market positions were leveraged in some way by the end of last year in China, according to Bank of America Merrill Lynch.
As the WSJ explained recently, the pledging of shares as loan collateral is particularly prevalent among smaller private companies. Unlike in the U.S., where institutional shareholders are a big market presence, private Chinese firms are often controlled by a major shareholders, who often own more than half of company. These big stakes are the most convenient tool for such big shareholders to raise their own funds.
Here the risk for other shareholders is that when major investors take out such share-backed loans is that stocks can plunge sharply when the borrowers run into trouble. Hong Kong-listed China Huishan Dairy fell 85% in one day in March 2017: It is unclear what triggered the selloff in the first place, but the fact that Huishan's chairman had pledged almost all of his majority shareholding in the company to creditors likely made the crash worse.
And, as a result of the recent market rout, last week UBS said that it sees a growing risk in China's stock pledges; the bank calculated that the market cap of pledged stocks that have fallen below levels triggering liquidation amounts to 440 billion yuan with some 500 billion yuan below warning line, which translates to ~1% and 1.1% of China's entire market value of $6.8 trillion. A separate analysis by TF Securities, as of Jun 19th, stock prices of 619 companies were close to levels where margin calls will be triggered.
It is unclear whether the relatively modest $100BN in released liquidity will be able to hit all of China's desired targets of assisting corporate deleveraging, slowing the mass default wave, preventing the economic slowdown and arresting the stock market rout and surging margin calls. It is, however, unlikely especially if Trump persists in imposing further tariffs on Chinese goods, suggesting that as much as the PBOC denies it, today's RRR cut is just the start of China's easing process.
