The Stock Market 2015-2016: Ugly Chopfest with an Equally Ugly Megaphone

There's something fishy about this "new all-time highs" rally of 2016.

It's interesting to take a longer-term view of the S&P 500 (SPX). Looking at a 10-year chart, the decline from almost 1,600 to 667 in the Global Financial Meltdown of 2007-2009 doesn't look like that big a deal, given the incredible 6-year uptrend since March 2009.

The boost phase of the rally lasted over 2 years, from 3/09 to 6/11, when the Greek debt crisis caused a temporary swoon in global markets.

Once central banks rescued markets (again), the rally resumed, but beneath the trend line.

This rally ran out of steam in early 2015. The marginal new highs in May 2015 and July-August 2016 are not even visible on this chart.

What is visible is a giant megaphone pattern that targets the old all-time high from 2007 around 1,600. A 600-point drop from 2,200 to 1,600 is of course "impossible" due to the Yellen/Kuroda/Draghi Put, i.e. central banks will buy "whatever it takes" to keep markets elevated forever.

Despite the visible "impossibility" of the SPX ever declining 600 points, that's what the pattern targets.

Even the casual observer is struck by the market's wild yo-yo'ing since early 2015--rather than trace out a definable uptrend, it's been a chopfest of dizzying declines and furious rallies.

This is not characteristic of a powerful Bull market. Rather, it is evidence of a Bull market faltering, eroding and being saved by increasingly outsized and visibly desperate central bank interventions.

$180 billion a month of additional stimulus is now required from the major central banks to keep the market afloat. Yet the returns continue to diminish.

What we have is a Red Queen's Market. The Red Queen's race refers to running fast just to stay in the same place. In a Red Queen's Market, central banks must continually increase their level of stimulus, intervention, jawboning, etc. just to keep the markets in the same place.

There's something fishy about this "new all-time highs" rally of 2016; the declines are deep but the new highs are modest. This is a tired Bull, and a spear tossed from somewhere in the restive crowd could bring it down all too easily.

The Italian Banking Crisis would complete Europe’s “Doom Loop."

 August 20, 2016

Italy's repeated attempts to stave off a full-blown financial crisis and breathe life back into its moribund banking sector can be summed up in four words: too little, too late.

In April, it set up a bad bank vehicle called Atlante that was expected to bail out the country's most troubled lenders as well as allay growing fears of a systemic crisis within the financial sector. With just €5 billion of funds to its name, it did neither.

Cue Plan B, which saw the EU in June grant permission for Italy to use "government guarantees" to create a "precautionary liquidity support program for their banks" worth €150 billion. On the surface it seemed like a lot more money, but in the end it amounted to little more than a PR stunt. The stampede out of Italian banks barely missed a beat.

Finally, at the end of July things got seriously serious with the unveiling of Plan C: a third, much larger rescue deal for Italy's chronically dependent and third largest bank, Monte dei Paschi. The deal involves a consortium of banks, led by JP Morgan, and in a secondary role, Italian investment bank Mediobanca, which will apparently help Monte dei Paschi raise €5 billion in new capital and sell €9.2 billion in bad loans at a deep discount to get them off its books.

As reported, the underwriting fees are going to be extraordinarily juicy, in particular for JP Morgan. For Monte dei Paschi, meanwhile, the impact could be somewhat more muted, especially given the immense difficulties it's likely to face offloading close to €10 billion worth of putrefying debt that nobody wants to touch, as The Economist points out:

As the Distressed-debt investors tend to buy loans in bulk, and hence prefer loans with easily recoverable, tangible collateral. The NPLs of stricken British, Irish and Spanish banks in recent years were largely mortgages: being backed by property, they could be valued from current real-estate prices. British and Irish courts are also pretty efficient at dealing with claims on collateral. Many Italian NPLs, by contrast, are uncollateralised loans to small businesses or consumers. Even when collateral has been pledged, Italian courts are much slower than those elsewhere to recover it.

This may help explain why since the announcement of its latest "rescue" on August 5, MPS' stock – reduced to a penny stock long ago – has plunged a further 8%, from €0.25 to €0.23.

If investors do not believe that even JP Morgan Chase, with the help of an all-star cast of global systemically important, precariously interconnected financial institutions, can sanitize a fraction of the bad debt putrefying on the balance sheets of the country's third biggest bank, then Italy — and by extension, the Eurozone — may have even bigger problems than previously thought. After all, Italy accounts for roughly one third of the Eurozone's estimated €1 trillion worth of non-performing loans.


But that hasn't stopped its banks from continuing to extend dirt-cheap credit to loss-making companies. Perpetual loss-makers such as fashion retailer Benetton and Feltrinelli, one of the country's largest booksellers, continue to receive ridiculously low-interest loans — all made possible, of course, by the liquidity glut conjured into existence by ECB Chairman Mario Draghi's negative interest rate policy (NIRP).

As happened in Japan at the beginning of its so-called lost decade, which to all intents and purposes continues to this day almost 30 years later, instead of biting the bullet and booking losses, large banks in Italy have kept credit lines open to borrowers even when it was clear they had no chance of honoring their obligations.

Where Italy differs from Japan is that it is already well into its second lost decade and the sheer scale of its problems are only just beginning to emerge, having been masterfully masked by an epic expansion of bad debt, which jumped from 5% of banking assets in 2008 (5% being the threshold for sound banking) to almost 20% today.

Yet despite — or perhaps because of — the unconditional generosity of Italian banks to Italian firms, the country's economy continues to stutter. It is smaller today than it was in 2008 and not much larger than in 2000. And according to Enrico Colombatto, a professor of economics at Turin University, the future holds even grimmer prospects:

Growth continues to disappoint and the estimates for 2017 have recently been cut, unemployment is relatively high, investment is stagnant and companies keep going belly up. Furthermore, Italian treasury bonds would be worth much less than their present price if the markets did not believe that, should the need arise, the European Central Bank would step in and bail out the Italian government.

That is precisely what the ECB and the European Commission will end up doing. The alternative is beyond unthinkable: Not only would it mean allowing bank bondholders — including very large foreign banks and hundreds of thousands of Italy small savers — to take a massive hit, potentially sparking a run on bank deposits; it would also trigger the final dreaded phase of Europe's so-called doom loop.

If Italian banks began falling like flies, it would only be a matter of time before investors began selling (or shorting) Italian bonds en masse, by which point the Doom Loop would be in full flow. The more the bond prices fell, the more impaired the banks' balance sheets would become since they hold a big chunk of these bonds. And it would speed up the stampede out of Italian bonds and banking shares. Rinse and repeat, until all that's left is a smoldering husk of a banking system.

The contagion effect would quickly spread beyond Italian shores. The total exposure of French banks to Italian debt exceeds €250 billion. That's triple the amount of exposure of the second most exposed European nation, Germany, whose banks hold €83.2 billion worth of Italian bonds. Deutsche bank alone has over €11.76 billion worth of Italian bonds on its books. The other banking sectors most at risk of contagion are Spain (€44.6 billion), the U.S. (€42.3 billion), the UK (€29.8 billion) and Japan (€27.6 billion).

Which is why, despite principled opposition from certain quarters, the monetary equivalent of the kitchen sink will end up being thrown at Italy's banking crisis. In all likelihood, it too will be too little, too late.

These big banks have every reason to try keeping Italian banks afloat.

50% Near Term Correction in Stocks

Volatility is the name of the game. Stocks are acting up, but standing strong. Oil is propelling higher and the US dollar is falling. Turmoil around the world has never been higher and an ominous shadow is lurking in the background, ready to strike.

The situation that we now face is ultimately going to end in a collapse of epic proportion. The financial world is now a ticking bomb that is just waiting to explode - I know this, you know this and even if the masses don't, they can feel it in their bones.

The only ones that don't seem to be aware of this dangerous situation are the elites who are currently profiting off of this heightened turmoil and their mainstream media mouthpieces who couldn't be more happy to assist in the destruction of the Western financial world. After all, it would make for a good story, right?

Unfortunately, I am not alone in this assessment of the current global situation. Marc Faber, a prominent voice in the financial community and the editor of the Gloom, Boom and Doom report has taken an ultra bearish view of the current economy.

A recent CNBC article, highlights a recent interview they had with Marc Faber this past week, and states the following:

The notoriously bearish Marc Faber is doubling down on his dire market view. 

The editor and publisher of the Gloom, Boom & Doom Report said Monday on CNBC’s “Trading Nation” that stocks are likely to endure a gut-wrenching drop that would rival the greatest crashes in stock market history.

“I think we can easily give back five years of capital gains, which would take the market down to around 1,100,” Faber said, referring to a level 50 percent below Monday’s closing on the S&P 500.

The S&P 500 is sitting at 2,184.29 at the time of writing! This would be a truly stunning collapse of the markets. One that would send the financial world plummeting out of control. Contagion would spread and the credit markets would utterly and completely seize up. 

What is equally as shocking as this claim of monumental collapse is the fact that Marc Faber believes this will happen in the near term future! This isn't some far fetched 5-10 year prediction that no one will remember he made down the road. No, this is a bold statement from a man who accurately predicted the 2008 crisis and many of the drastic events that have unfolded in modern times. 

Marc Faber is just one more expert that is ringing the alarm bells. Sadly, the mainstream media continue to dismiss the experts who are trying to warn the masses, stating that we are conspiracy theorist and nothing more. Even though we have been proven right in our predictions time and time again, causing the trash can to nearly overflow with tin foil hats.

I don't know if the collapse is in the near term such as Marc Faber believes, but I know that it could occur at anytime. Whether it be a week, a month, or years from now, wouldn't you rather be prepared? The risk is simply too great to not be.

Secret Fed Minutes "Revealed"

Aug 20, 2016 8:56 AM

This week, The Federal Reserve released the minutes from its July meeting a few weeks ago in which they decided to NOT raise interest rates.
These minutes are the official archive of the meeting, providing details about the presentations, debates, and discussions that took place.
They contain very formal sounding language, referring to their near-zero interest rates as "accommodation" in the same way that my high school health teacher preferred to use the more clinical term "copulation" instead of "sex".
As an example, the most recent Fed minutes state:

"members agreed to indicate that they would continue to closely monitor global economic and financial developments."

What in the world does that even mean?

I really get so tired of their forked-tongue garbage.
Interest rates are at 5,000 year lows. There are now 500 MILLION people around the world, in fact, living under NEGATIVE interest rates.
Remember that money is essentially nothing more than a measurement of economic value, in the same way that a meter or a mile is a measure of distance.
Just imagine the chaos if there were some unelected committee of bureaucrats who got together from time to time to change the value of the mile.
Or imagine if, tomorrow morning, they decided that the mile would be shortened by 20%.
Some people would benefit from that arrangement (taxi drivers). Others would be worse off (taxi passengers). There are always winners and losers.
Similarly, there are always winners and losers with monetary policy.

And these unelected central bankers have made a series of very deliberate decisions to forsake one segment of the population (anyone trying to save money) for the benefit of another (those who are heavily in debt, like, ummmm, governments).
They try to wrap their decisions up with fancy sounding language about "accommodation" and 14 pages of fluff like:

". . . the Committee should wait to take another step in removing accommodation until the data on economic activity provided a greater level of confidence that economic growth was strong enough to withstand a possible downward shock to demand."
But if there were some secret minutes detailing the Fed's inner conscience that were leaked to the public, here's what they would really be saying:


"Nothing terribly catastrophic has happened yet, so we have decided to continue screwing responsible savers with interest rates that are at 5,000 year lows so that this dangerous asset bubble can persist, the federal government can continue indebting future generations, and the commercial banks can keep making tons of money, because we are shit scared that even the tiniest 0.25% increase in interest rates will completely derail this totally fragile economy, and that would be really bad for Barack Obama and Hillary Clinton."

Are Central Banks Secretly Preparing For Another Crisis?

August 19, 2016

A major crisis warning signal just hit.
It concerns "behind the scenes" liquidity for Central banks.
Here's how it works.
When "all is well" in the financial system, foreign Central Banks like to park money at the Fed overnight. The reason they do this is because the Fed offers a special program that yields more interest than money markets.
So when things are calm in the financial system, foreign Central Banks don't need emergency access to capital and so park significant amounts of money with the Fed overnight.
But when things are bad and foreign Central Banks NEED access to capital, this number falls.
As Worth Way notes, this number is falling… in a big way. In fact, any time it's fallen by this much (5.6% year over year) a crisis hits soon after.

Shocking Government Report Finds $6.5 Trillion In Taxpayer Funds "Unaccounted For"

Aug 19, 2016 4:42 PM
Last week, we first touched on a topic which, in any non-banana republic, would be a far greater scandal than what Ryan Lochte may or may not have been doing in a Rio bathroom: namely, government corruption, falsification and potential fraud and embezzlement, which has resulted in the Pentagon being unable to account for up to $8.5 trillion in taxpayer funding.
Today, Reuters follows up on this disturbing issue, and reveals that the Army's finances are so jumbled it had to make trillions of dollars of improper accounting adjustments to create an illusion that its books are balanced. The Defense Department's Inspector General, in a June report, said the Army made $2.8 trillion in wrongful adjustments to accounting entries in one quarter alone in 2015, and $6.5 trillion for the year. Yet the Army lacked receipts and invoices to support those numbers or simply made them up.
As a result, the Army's financial statements for 2015 were "materially misstated," the report concluded. The "forced" adjustments rendered the statements useless because "DoD and Army managers could not rely on the data in their accounting systems when making management and resource decisions."


For those wondering, this is what $1 trillion in $100 bills looks like.


Now multiply by 6.
This is not the first time the DoD has fudged its books: disclosure of the Army's manipulation of numbers is the latest example of the severe accounting problems plaguing the Defense Department for decades. The report affirms a 2013 Reuters series revealing how the Defense Department falsified accounting on a large scale as it scrambled to close its books. As a result, there has been no way to know how the Defense Department – far and away the biggest chunk of Congress' annual budget – spends the public's money.... The Army lost or didn't keep required data, and much of the data it had was inaccurate, the IG said.
In other words, it is effectively impossible to account how the US government has spent trillions in taxpayer funds over the years. It also means that since the money can not be accounted for, a substantial part of it may have been embezzled.

"Where is the money going? Nobody knows," said Franklin Spinney, a retired military analyst for the Pentagon and critic of Defense Department planning, cited by Reuters.
The significance of the accounting problem goes beyond mere concern for balancing books, Spinney said. Both presidential candidates have called for increasing defense spending amid current global tension; the only issue is that more spending may not be necessary - all that is needed is less government corruption and theft.
An accurate accounting could reveal deeper problems in how the Defense Department spends its money. Its 2016 budget is $573 billion, more than half of the annual budget appropriated by Congress. The Army account's errors will likely carry consequences for the entire Defense Department. Congress set a September 30, 2017 deadline for the department to be prepared to undergo an audit.
What's worse is that the "fudging" of the numbers is well known to everyone in the government apparatus. For years, the Inspector General – the Defense Department's official auditor – has inserted a disclaimer on all military annual reports. The accounting is so unreliable that "the basic financial statements may have undetected misstatements that are both material and pervasive."
Not surprisingly, trying to figure out where the adjustments are has proven to be impossible.

Jack Armstrong, a former Defense Inspector General official in charge of auditing the Army General Fund, said the same type of unjustified changes to Army financial statements already were being made when he retired in 2010.


The Army issues two types of reports – a budget report and a financial one. The budget one was completed first. Armstrong said he believes fudged numbers were inserted into the financial report to make the numbers match.

"They don't know what the heck the balances should be," Armstrong said.
Meanwhile, for government employees, such as those at the Defense Finance and Accounting Services (DFAS), which handles a wide range of Defense Department accounting services, the whole issue is one big joke, and they refer to preparation of the Army's year-end statements as "the grand plug," Armstrong said. "Plug", of course, being another name for made-up numbers.
Finally, how on earth can one possibly "not account" for trillions? As Reuters adds, at first glance adjustments totaling trillions may seem impossible. The amounts dwarf the Defense Department's entire budget. However, when making changes to one account also require making changes to multiple levels of sub-accounts. That creates a domino effect where falsifications kept falling down the line. In many instances this daisy-chain was repeated multiple times for the same accounting item.


The IG report also blamed DFAS, saying it too made unjustified changes to numbers. For example, two DFAS computer systems showed different values of supplies for missiles and ammunition, the report noted – but rather than solving the disparity, DFAS personnel inserted a false "correction" to make the numbers match.

DFAS also could not make accurate year-end Army financial statements because more than 16,000 financial data files had vanished from its computer system. Faulty computer programming and employees' inability to detect the flaw were at fault, the IG said.
DFAS is studying the report "and has no comment at this time," a spokesman said. We doubt anyone else will inquire into where potentially trillions in taxpayer funds have disappeared to; meanwhile the two presidential candidates battle it out on the topic of tax rates when the real problem facing America is not how much money it draws in - after all the Fed can and will simply monetize the deficit - but how it spends it. Sadly, we may never know.

The good news is there is a way to avoid failure and stagnation: avoid the mainstream like the plague.

The mainstream became mainstream because it worked: the mainstream advice to "go to college and you'll get a good job" worked, the mainstream financial plan of buying a house to build equity to pass on to your children worked, the mainstream of government regulation worked to the public's advantage at modest cost to taxpayers and the mainstream media, despite being cozy with government agencies such as the C.I.A. and operating as a profit machine for the families that owned the newspapers, radio stations, etc., functioned as a basically honest broker of information and reporting.
Now, the mainstream has failed. Mainstream career advice now leads to crushing debts and career stagnation, mainstream financial planning generates high risks, mainstream government regulations are costly and burdensome, and the mainstream media is little more than a corporate-owned mouthpiece of propaganda and distributor of infotainment that is sold as "news."
Does anyone actually believe the mainstream political process isn't broken? Those who claim it isn't broken are either well-paid shills just doing their job or they're delusional.
The mainstream American diet now leads to chronic disease and early death. Supersized portions, large amounts of sugar and/or salt in virtually every packaged food item, heavy doses of low-quality fats in almost all mainstream fast foods--these have become mainstream at a very high cost in diminished health and reduced years of life free of chronic disease and pain.
The mainstream level of fitness contributes to chronic disease and early death. The mainstream lifestyle is one in which people passively watch a few daredevils pursue extreme sports on a variety of digital screens, passively "consume" music rather than learning to play music themselves, passively consume "news" rather than being engaged in community activities that make news, and so on.
The mainstream healthcare system is structured so it is incapable of promoting health. As my longtime friend GFB recently asked, "Who is happy with the current healthcare system?" Certainly not the doctors and nurses or the patients. Perhaps Big Pharma is happy as a result of their enormous profits (more of which is spent on marketing the latest marginally useful and often dangerous drug than on R&D), but even Big Pharma has legitimate complaints about the cost and time required to get a potentially life-changing drug (such as immunotherapy drugs) through the pipeline.
But the real problem is the soaring costs of the system will eventually collapse the entire economy. The same can be said of the soaring costs of increasingly marginal higher education, the soaring costs of increasingly marginal weapons systems, and so on.

Stunning Admission From Deutsche Bank Why A Shock Is Needed To Collapse The Market, And Force A Real Panic

Aug 13, 2016 9:59 PM

In what may be some of the best, and most lucid, writing on everyone's favorite topic, namely "what happens next" in the evolution of the financial system, Deutsche Bank's Dominic Konstam, takes a look at the current dead-end monetary situation, and concludes that in order for the system to transition from the current state of financial repression, which has made a mockery of all asset values due to central bank intervention, to a semi-credible system driven by fiscal stimulus, there will have to be a crash, one which jolts policymakers out of their stupor that all is well simply because stocks are at all time highs. 

And since a legitimate fiscal stimulus is what is needed to re-ignite the economy, US and global GDP will continue declining, even as stocks keep rising to new all time highs, not on fundamentals (which are all pointing in the opposite direction), but due to even more central bank intervention and financial repression, thus a Catch 22, which ultimately - according to DB - ends in the only possible way: with a major crash.  

As Konstam puts it, "the status quo could continue for several years yet – if nothing "breaks" in the system" but "without an external economic shock it is hard to see policymakers being prepared to take dramatic, fiscal action to jumpstart the global economy and bounce it out of a financial repression defined by low and falling real yields to one that at least initially is defined by rising nominal yields through higher inflation expectations."

As for the conclusion, or why a financial shock is long overdue, KOnstam says that "ironically the shock that is needed would require a collapse in risk assets for policymakers to then really panic and attempt dramatic fiscal stimulus. "

This is critical - and inevitable - as only a shock can lead to an "unwind of the falling yield/rising equity market where all financial assets trade badly."

the end of financial repression will see price levels fall so that yields once again look attractive, or said otherwise, there will be a demand for Treasuries, even without the perpetual implicit backstop of central bank purchases. 

For such a move to be sustainable itself requires the economic fundamentals to shift – inflation needs to be more secure against an underlying backdrop of robust real growth. Most people now understand that this is not a job for monetary policy alone. Yet the current reach for yield simply prolongs the status quo for policy disappointment.

Which brings us full circle: recall that over the past few months virtually every prominent investment bank, from JPMorgan to Goldman Sachs have warned clients that a selloff is coming. Now, Deutsche Bank has taken it to a whole new level, explaining why a financial crash has to happen to purge the system from the toxic aftereffects of 7 years of financial repression, and to kickstart a fiscal stimulus that will not happen unless markets tumble in the first place. 

And while Konstam's line of reasoning is absolutely correct, we doubt just how his employer would look upon a market plunge that wipes out 30%, 40%, or even 50% of global equity values: would Deutsche Bank even survive such a crash? As such we doubt that the strategist's analysis and forecast, correct as it may be, will be endorsed by his employer, even if by now it is clear to all that only a major crash, i.e. a global reset, can kick start the world out of its zombie-like, centrally-planned existence, into the long overdue phase of whatever it is that comes next.

the end of financial repression will see price levels fall so that yields once again look attractive, or said otherwise, there will be a demand for Treasuries, even without the perpetual implicit backstop of central bank purchases. 

For such a move to be sustainable itself requires the economic fundamentals to shift – inflation needs to be more secure against an underlying backdrop of robust real growth. Most people now understand that this is not a job for monetary policy alone. Yet the current reach for yield simply prolongs the status quo for policy disappointment.

Which brings us full circle: recall that over the past few months virtually every prominent investment bank, from JPMorgan to Goldman Sachs have warned clients that a selloff is coming. Now, Deutsche Bank has taken it to a whole new level, explaining why a financial crash has to happen to purge the system from the toxic aftereffects of 7 years of financial repression, and to kickstart a fiscal stimulus that will not happen unless markets tumble in the first place. 

And while Konstam's line of reasoning is absolutely correct, we doubt just how his employer would look upon a market plunge that wipes out 30%, 40%, or even 50% of global equity values: would Deutsche Bank even survive such a crash? As such we doubt that the strategist's analysis and forecast, correct as it may be, will be endorsed by his employer, even if by now it is clear to all that only a major crash, i.e. a global reset, can kick start the world out of its zombie-like, centrally-planned existence, into the long overdue phase of whatever it is that comes next.

* * * 

Below is Konstam's full must read analysis:

Stocks must fall for yields to rise – but unlikely to happen anytime soon

It is pretty much understood that we are in full on financial repression mode, as witnessed by super benign core yields lead by lower real yields with more recently the further downward drift in euro peripheral yields, including the UK. The new high in equities is consistent with our view of financial repression that necessarily has yield returns on all assets being incrementally replaced by price returns – stretched relative valuations follow already increasingly stretched absolute valuations. The last round of economic data does little to suggest any change in this dynamic. As we highlighted last week the conundrum for the US is how an overly strong labor market without meaningful wage inflation resolves itself against markedly weak productivity data with a GDP cake that if anything seems to be stagnating.

With the current status quo, it is clear to us that US yields if anything are still too high – we think they are near the upper bound of a range that pivots closer to 1.25 percent with real yields in particular too high. This probably still reflects a reluctance of investors to get meaningfully long the market although much of the short base has been covered and this in turn reflects a still fairly strong consensus on the economics front that the labor market strength can still resolve itself through higher wages and a virtuous circle of rising demand and productivity – a scenario we would not rule out but not our central view.

More importantly however are what prospects there may be to jolt us out of this financial repression and to what extent regardless of proactive policy, is there a natural end to financial repression – at some point does something have to break in the system. On the former the most likely candidate is obviously some form of global fiscal stimulus. Despite optimism around this in early July we have not exactly had the green light on either helicopter money in Japan or Italian bank bailout. It is still too early to call the US election and stimulus prospects here but the general sense is that it is still difficult to sense the urgency when equities make new highs. Policymakers aren't used to dealing with financial repression and that unfortunately is one of the defining characteristics of stagnation.

We suspect the fall will be defined by markets looking for dramatic policy news that somehow "responds" to super low bond yields and underwrites rising risk asset prices but only to be disappointed precisely because policymakers don't bide the urgency. The result is that yields can fall still further even with risk assets still trading well – hanging onto their relative valuation rationale.

The failure of a policy response allows for more financial repression. We are anyway already beyond the point of preemptive policy since preemption is supposed to recognize and avoid looming problems beforehand. It is clear that the nature of those problems are already material including squeezed interest margins for banks, insurance solvency issues etc. But to be fair, the lack of a fiscal response itself bears witness to the perceived fiscal stress during the 2008 crisis and the need to insulate taxpayers. Additional fiscal burdens can be thought of as a variant of financial repression where future inflation and negative real rates do the redistribution as opposed to the structure of the fiscal regime. Helicopter money fuses financial repression from the money side with the fiscal response in a potentially dramatic way whereby the would be spenders get to spend a lot more directly at the expense of the ongoing savers. And while it may have its own political hurdles that ultimately are insurmountable, it offers a perfectly reasonable alternative equilibrium option where the goal is to raise the price level as well as improve the real growth outlook by overcoming excess savings. The fusion of fiscal with monetary policy can also be appreciated in the context of the fiscal theory of price where monetary policy can offer infinite paths for money growth and potential nominal growth but fiscal policy effectively selects which path is realized based on an equilibrium condition that the NPV of all future budget deficits needs to sum to zero.

The status quo could continue for several years yet – if nothing "breaks" in the system. There are ways of course for either avoiding breaks or at least patching them – mitigating the impact of negative rates on banks is now in vogue with subsidized bank loans for on lending. And we may yet see soft forms of bank bailout still being allowed. This is similar to the use of alternative yield curves for discounting insurance liabilities.

The conclusion is that without an external economic shock it is hard to see policymakers being prepared to take dramatic, fiscal action to jumpstart the global economy and bounce it out of a financial repression defined by low and falling real yields to one that at least initially is defined by rising nominal yields through higher inflation expectations. Ironically the shock that is needed would require a collapse in risk assets for policymakers to then really panic and attempt dramatic fiscal stimulus. 

The logic would also fit with the same correlation structure for financial assets - an unwind of the falling yield/rising equity market where all financial assets trade badly. In other words the end of financial repression will see price levels fall so that yields once again look attractive. For such a move to be sustainable itself requires the economic fundamentals to shift – inflation needs to be more secure against an underlying backdrop of robust real growth. Most people now understand that this is not a job for monetary policy alone. Yet the current reach for yield simply prolongs the status quo for policy disappointment.

"The Final Melt Up", "A Blow Off Top": Money Floods In As Investors Turn Euphoric At Triple Record High"

Aug 12, 2016 8:02
In a historic trifecta, yesterday for the first time since December 31, 1999 all three US indexes posted concurrent record highs for the first time.

At the same time, as the WSJ points out, the ratio of stocks that trade on the New York Stock Exchange and the Nasdaq hitting 52-week highs versus 52-week lows recently surged to its highest level in years. "The last time we've seen levels like this consistently was in 2013, which went on to be one of the best years for stocks," said Frank Cappelleri, executive director of institutional equities at Instinet LLC. In 2013, the S&P 500 rose 30%.

Ironically, the ongoing meltup continues even as major sellside banks from JPM to Goldman Sachs, have been warning about an imminent downturn. Less than two weeks ago, we reported that Goldman had turned outright bearish, urging clients to "sell" stocks over the next three months, reiterating a bearish call it has made for the past quarter. Framing our skepticism, we asked whether "Goldman will again be wrong? It's distinctly possible, in which case we expect the firm to capitulate some time in September, when the S&P is around 2,300 and urging what clients it has left to buy stocks at all time highs."
So far, the S&P appears to be distinctly headed toward that price target. Others believe that the market has indeed entered a blow-off top phase.
As the WSJ writes, for some traders, the trends suggest stocks could enjoy a sudden surge. The bump could happen once investors return from summer vacations and begin taking some cash off the sidelines, they say. U.S. stock-trading volumes have been below the 2016 average in recent weeks.

The consensus one-year target for the Dow Jones Industrial Average is now more than 20000 as of Tuesday, up from around 18860 in February just before stocks hit a 2016 low, according to S&P Dow Jones Indices. On Thursday, the Dow rose 0.6% to 18613.52. The S&P 500 gained 0.5%
and the Nasdaq Composite added 0.5% to 5228.40.
Others say while they believe stocks will continue to creep up in coming months, they don't foresee a "melt-up."
The bulls like to point out the rally in stocks in the late-1990s which is often viewed as a case study for how stocks can shoot up even after reaching new highs. Between when the Nasdaq Composite hit a record high in November 1998 and the index's peak in March 2000, the index more than doubled.

John Linehan, portfolio manager of the T. Rowe Price Equity Income Fund, says typical melt-ups come when exiting a recession, when a significant stock-market overhang has been eliminated or when investors are fundamentally rethinking how to value stocks.

In the case of the late-1990s, the U.S. market was shaking off the emerging-market crisis and the collapse of hedge-fund firm Long-Term Capital Management and its reverberations across financial markets, and focusing instead on a batch of new, disruptive technology companies. Furthermore, investors were increasingly ignoring long-held beliefs about measuring a company's value based on its earnings in favor of metrics such as price-to-eyeballs, or how many page views a dot-com company received in a given month.

"Clearly we're not coming out of a recession, and it feels like there's still many unknowns out there," Mr. Linehan said, referring to the present. Coming risks include the pace of economic growth, geopolitics and the U.S. presidential election, he said.
That said, there has been a change, as market multiples have now repriced to levels not seen since prior market bubbles: as the WSJ adds, what does point to a melt-up situation, some analysts say, is a shift in how investors are valuing stocks. Stock prices compared with their past 12-month earnings are at elevated levels compared with their 10-year averages. But many investors are justifying buying more stocks because valuations based on bond yields, which remain near unprecedented lows, suggest multiples could climb even higher and stocks still are relatively attractive.
In other words, if yields drop further, use the Fed model to justify buying; if yields go up, the recovery is finally kicking in and it's time to buy even more. Meanwhile, the real reason for the meltup is simple: $200 billion in monthly fungible QE by central banks.
And, as always, at some point the punch bowl is always taken away.

Even the strong gains in the late 1990s gave way to steep declines. In the year following its peak, the Nasdaq Composite lost more than half its value, and it took 15 years to return to its pre-tech boom highs. Some analysts now say they worry most of the gains from this rally could be in the past—that the melt-up has essentially happened.
One persistent investor type is the BTFDer, such as Stuart Hoffman, chief economist for PNC Financial Services Group, who said that "I think the next 5% is more likely to be down than up." Which for him is good news: "That's probably an opportunity to buy." '
Considering that activist central banks now step in at even a modest, low single digit dip in the market, it's probably not a bad idea.

Finally, for all the talk about this being the most hated rally, in a note titled "the Final Melt-Up"...

... BofA' Michael Hartnett points out that funds are now flooding virtually every asset class (except the dreaded money markets which have been spooked by upcoming regulation). To wit:
* Equities: $6.5bn inflows (first inflows in 4 weeks) (note divergence between $10.0bn ETF inflows & $3.5bn mutual fund outflows)
* Bonds: $9.8bn inflows (inflows in 17 of past 19 weeks)
* Precious metals: $0.9bn inflows (inflows in 10 of past 11 weeks)
* Money-markets: $3.6bn outflows (largest in 7 weeks)
Equity flows:
* EM: 6 straight weeks of inflows ($1.3bn)
* Europe: $2.7bn outflows (27 straight weeks of outflows)
* US: $4.9bn inflows (first inflows in 4 weeks)
What else BofA sees:
Risk-on weekly flows: equity inflows ($6.5bn), credit inflows ($7.0bn), gold inflows ($0.9bn) & money-market outflows ($3.6bn)
Bulls on the rise: BofAML Bull & Bear Indicator rises to 4.3 from "buy signal" low of 1.6 (June 28th) (Chart 2); sentiment getting more bullish but not yet at an extreme; stay long risk until B&B approaches "complacent" territory of 8.0
Cyclicality on the rise: largest inflows to Japan equities in 7 months ($1.6bn); largest 4-week inflows to financials in 8 months ($1.2bn); largest inflows to tech in 4 months ($0.5bn); investors still love credit but are now rotating to economic-sensitivity in stock markets
Private clients turn cyclical: BofAML GWIM client ETF flows show profit-taking in defensive leaders of staples/telcos/utilities, rotation to cyclical laggards of Europe/Japan/EM, industrials/materials/financials (Chart 3)...likelihood of melt up in risk assets into Jackson Hole growing...likely followed by jump in yields.
EM melt up: big inflection point in EM debt flows (largest 6-week inflows on record of $18bn or 6% of AUM) now mutating into EM equity flow inflection point (Chart 1):

VIX And Junk Bond Spreads Are Out Of Whack

Aug 12, 2016 2:27 PM
The relationship between the VIX and the spread between high yield bonds over 10-year treasuries is highly correlated (87% over the past 15 years).

"The Final Melt Up", "A Blow Off Top": Money Floods In As Investors Turn Euphoric At Triple Record High

Aug 12, 2016 8:02 am
In a historic trifecta, yesterday for the first time since December 31, 1999 all three US indexes posted concurrent record highs for the first time.

Big European Banks Try to Block Contagion from Italian Banking Crisis (Before it Sinks them)

August 5, 2016
These big banks have every reason to try keeping Italian banks afloat.
Europe has plenty of reasons to be worried these days, but none more so than the seemingly terminal decline of the old continent's banking system. So fragile are Europe's banks that they can't even get through an ECB stress test — whose primary purpose is to restore confidence in Europe's banking system, by ignoring two of the most insolvent national banking sectors (Greece and Portugal) as well as the main source of stress (negative interest rates) — without sparking a panicked sell-off.
Before the test, UK-based Barclays predicted that any bank found to have a core capital ratio of less than 7.5% would come under pressure. There was no shortage of candidates, including, ironically, Barclays itself, which made it through the stress scenario with a core capital ratio of just 7.3%. The bank's shares have fallen by about 5% since Monday.
Barclays is no small-time institution; it is the UK's second largest bank by assets and a member of the select club of global systemically important financial institutions: it's too big to fail. So, too, is Deutsche Bank, which in the test was the 10th riskiest out of 51 on core capital and whose shares have tumbled 60% since May. Credit Suisse, another systemically important institution, has lost close to two-thirds of its market value in the last year while Italy's Unicredit, another too-big-to-failer, has shed roughly the same amount since the start of 2016.
The market capitalization of Deutsche and Credit Suisse has shrunk so much that they just suffered the ignominy of being ejected from the Euro Stoxx 50, a stock index designed by Deutsche Börse Group that comprises Europe's 50 largest and most liquid stocks.
Meanwhile, things have gotten so bad at Italy's third biggest bank, Monte dei Paschi, that it was just removed from the Euro Stoxx 600 after getting top honors in the ECB's stress test. Under a stress scenario its Common Equity Tier 1 (CET1) slumps to negative 2.44%. In other words, the world's oldest bank is not just insolvent in an adverse scenario; it's insolvent right now.
This realization prompted yet another stampede out of Italy's banking equities. On Thursday, Italy's government responded by issuing blanket denials in an almost slapstick attempt at damage control.
Italy's banks are "not in crisis" and pose "no systemic threat", the country's EconMin, Pier Carlo Padoan, breezily informed the country's parliament.
In an interview with Politico, Bank of Italy Governor Ignazio Visco asserted that most of Italy's largest financial institutions are "robust" and able to withstand economic shocks:
"Overall, the results (of the stress test) provide a fair picture of the current state of affairs of Italian banks: many institutions with robust fundamentals, and a few, well identified cases of serious but manageable weakness, which must be tackled and solved, as required by bank supervisors."
Today, Visco told the Italian media that it is "wise to be prepared" to use taxpayers (state aid, as it's called) to bail out Italian banks, "regardless of Monte dei Paschi," for which state aid is already in the works, "though it does not mean it will be necessary." So state aid for other Italian banks too, not just Monte dei Paschi?

Satyajit Das Slams Policymaker Ignorance: "QE-Forever Cycle" Means Catastrophe Is Inevitable

Aug 1, 2016 9:48 AM
"Policymakers have chosen to ignore the central issue of debt as they try to resuscitate activity," warns Satyajit Das in a shocking Op-Ed in today's FT, and with global central banks now printing $180 billion a month (and growing), "the global economy may now be trapped in a QE-forever cycle," confirming von Mises prescription that "there is no means of avoiding the final collapse..."
The European Central Bank and Bank of Japan are buying around $180 billion of assets a month, according to Deutsche Bank, a larger global total than at any point since 2009, even when the Federal Reserve's QE programme was in full flow.

And if market consensus proves accurate, that total is about to rise by billions more

But as Das details, a combination of QE and the prospect of fresh fiscal stimulus won't generate a recovery.
Since 2008, total public and private debt in major economies has increased by over $60tn to more than $200tn, about 300 per cent of global gross domestic product ("GDP"), an increase of more than 20 percentage points.
Over the past eight years, total debt growth has slowed but remains well above the corresponding rate of economic growth.Higher public borrowing to support demand and the financial system has offset modest debt reductions by businesses and households.
If the average interest rate is 2 per cent, then a 300 per cent debt-to-GDP ratio means that the economy needs to grow at a nominal rate of 6 per cent to cover interest.
Financial markets are now haunted by high debt levels which constrain demand, as heavily indebted borrowers and nations are limited in their ability to increase spending. Debt service payments transfer income to investors with a lower marginal propensity to consume. Low interest rates are required to prevent defaults, lowering income of savers, forcing additional savings to meet future needs and affecting the solvency of pension funds and insurance companies.
Policy normalisation is difficult because higher interest rates would create problems for over-extended borrowers and inflict losses on bond holders. Debt also decreases flexibility and resilience, making economies vulnerable to shocks.

Attempts to increase growth and inflation to manage borrowing levels have had limited success. The recovery has been muted.
Sluggish demand, slowing global trade and capital flows, demographics, lower productivity gains and political uncertainty are all affecting activity. Low commodity, especially energy, prices, overcapacity in many industries, lack of pricing power and currency devaluations have kept inflation low.
In the absence of growth and inflation, the only real alternative is debt forgiveness or default. Savings designed to finance future needs, such as retirement, are lost.

Additional claims on the state to cover the shortfall or reduced future expenditure affect economic activity. Losses to savers trigger a sharp contraction of economic activity. Significant writedowns create crises for banks and pension funds. Governments need to step in to inject capital into banks to maintain the payment and financial system's integrity.
Unable to grow, inflate, default or restructure their way out of debt, policymakers are trying to reduce borrowings by stealth. Official rates are below the true inflation rate to allow over-indebted borrowers to maintain unsustainably high levels of debt. In Europe and Japan, disinflation requires implementation of negative interest rate policy, entailing an explicit reduction in the nominal face value of debt.
Debt monetisation and artificially suppressed or negative interest rates are a de facto tax on holders of money and sovereign debt. It redistributes wealth over time from savers to borrowers and to the issuer of the currency, feeding social and political discontent as the Great Depression highlights.

The global economy may now be trapped in a QE-forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.


If the economy responds, then increased economic activity and the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.

If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control. All the while, debt levels continue to increase, making the position ever more intractable as the Japanese experience illustrates.
Economist Ludwig von Mises was pessimistic on the denouement. "There is no means of avoiding the final collapse of a boom brought about by credit expansion," he wrote. "The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved"

The global economy may now be trapped in a QE-forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.


If the economy responds, then increased economic activity and the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.

If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control. All the while, debt levels continue to increase, making the position ever more intractable as the Japanese experience illustrates.
Economist Ludwig von Mises was pessimistic on the denouement. "There is no means of avoiding the final collapse of a boom brought about by credit expansion," he wrote. "The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system.


Fabrizio