Credit Suisse: "Our Risk Appetite Index Is Near Panic"

Sure, it's been a bad year for investors, with the S&P posting the smallest of gains in the first half (all of which thanks to tech stocks) after several hair-raising, monthly incidents including February's vol-spike, April's real yield scare, May's Emerging Market massacre and June's trade war fears as shown in the following Citi chart...

... but it's hardly been apocalyptic: in fact, most of the shocks that took place were well telegraphed to those who paid attention. And yet, according to Credit Suisse, after the first six months of the year investors are in a state of near shock.

According to Credit Suisse economist James Sweeney, "our Global Risk Appetite Index is near panic" and adds that "our equity-only (relative performance across EM and DM countries) and credit-only (relative performance of US IG sector/rating/maturity buckets) versions are already there."

What is causing paralysis? According to the second largest Swiss bank, the investor "panic" can be attributed to:

Trade disputes, the Italian budget, Fed tightening, and emerging market turbulence are contending to be the main driver of this risk appetite slump. However, growth concerns have featured too, as European data in particular have disappointed. Meanwhile, many investors claim that widening credit spreads and a flattening yield curve portend the cycle's end.

To Sweeney, who focuses mostly on economic developments, "there is a significant chance that our global risk appetite index falls below -3 in the coming months, which we define as "panic".

Panics have historically coincided with periods of weak IP momentum. Since 1990, there are only two examples of global IP momentum growing faster than its current rate when risk appetite entered panic: July 2002 and August 2011. In 2002, IP momentum weakened almost immediately. In 2011, an IP slump did not occur until 12  months later, when risk appetite had recovered."

Indeed, as the chart below shows, IP is nowhere near "panic" territory, suggesting that there is something well beyond economic sentiment to spook investors and traders.

And yet, one specific region poses significant risk to the future global economy: Europe. According to Sweeney, "at the end of last year European business surveys hit multidecade highs and IP momentum reached 7%. Such growth was unsustainable but the abruptness of the slowdown has been extreme."

That's putting it mildly, because after Europe's cliff-like divergence in Q1 when the Citi eco surprise index plunged to near record low, "broad signs of a Q2 rebound did not emerge, contrary to our expectations. Whether we should "give up" on European growth is a central question now, which we try to answer by addressing what went wrong in the first place."

Sweeney's take: "for global growth to stay strong in the second half of 2018, European growth must improve."

Which in a time of escalating protectionism and trade war for the export heavy continent, could be a major problem. However, there is a silver lining: if and when investors panic, and the projected IP rebound fails to materialize, central banks will have no choice but to respond, effectively voiding any ECB plans to not only end QE but to hike rates, whether in the summer of 2019 or the last months of the year.

In short: global investors panicking is the best possible thing that could happen to, well, global investors as it means another bailout from central banks.

Unless of course, central banks refuse to get involved this time, and leave markets to their own devices. Which could be a problem: with 40% of today's traders never living through a real market crisis where central banks did not step in, the next time price discovery takes place without a central bank backstop, investors may just learn what panic really means.

Commodities about to rally off 16-year support?

Commodities have spent the majority of the past 16-years inside of rising channel (1). Despite this long-term uptrend that remains in play, they have been declining since they hit the top of this channel back in 2011.

The decline over the past 7-years has the TR Equal weight commodity index testing rising channel support at (2), where it could be creating a bullish ascending triangle pattern (flat tops and rising bottoms).

A very important support test is in play currently. Commodity bulls do not want to see this long-term support channel broken to the downside.

If commodities can rally and breakout at (3), the "Measured Move" suggests they could rally at least 10%.

This index is in a tight jam between rising support and horizontal resistance. Something has to give soon. If its an upside breakout, it would suggest a nice rally for this sector that has struggled for years and investors would want to be on board if it happens.

Looming Dollar Shortage Getting Worse As Emerging Markets Implode

One of the most important macro-situations that's developing right now is the looming U.S. dollar shortage. 

I don't mean in the sense that banks don't have enough dollars to lend out – I'm talking about the foreign sovereign markets.

Here are some of the things that's causing liquidity to dry up. . .

 

1. Soaring U.S. deficits – the United States' need for constant funding is requiring huge amounts of capital

2. A strengthening U.S. Dollar – which is weakening the rest of the worlds currencies

3. Rising U.S. short-term rates and LIBOR rates – courtesy of the Federal Reserve's tightening 

4. The Fed's quantitative tightening program – unwinding their balance sheet by selling bonds

 

These four things are making global markets extremely fragile. . .

I've written about this dollar shortage before – but things are getting much worse. 

As a recap of why this all matters – when the U.S. buys goods from abroad, they are taking in goods and sending out dollars. Otherwise said, they are selling dollars out of the country in return for goods.

Those countries that sold to America now have dollars in return. But since countries don't have a mattress to store their money under – they must find liquid and 'safe' places to put it.

With the dollar as the world's reserve currency – and U.S. treasury market being the most liquid – countries usually take the dollars and funnel them back into the U.S. via buying bonds.

Since the U.S. is a net-debtor – inflows of new money is constantly required to pay out outstanding bills. So there's always fresh debt that foreigners can buy.

And if you haven't checked lately, the national debt is over $21 trillion – and growing faster. The latest Congressional Budget Office (CBO) report stated that at the current rate – U.S. debt-to-GDP will be over 100% by 2028 (if not sooner).

So how does this tie into a dollar shortage?

Let me break it down. . .

The always-rapidly-growing U.S. deficit requires constant funding from foreigners. But with the Federal Reserve raising rates and unwinding their balance sheet through Quantitative Tightening (QT) – meaning they're sucking money out of the banking system.

These two situations are creating the shortage abroad. The U.S. Treasury's soaking up more dollars at a time when the Fed is sucking capital out of the economy. 

Not too mention the strengthening dollar and higher short-term yields are making it more difficult for foreigners to borrow in dollars. Especially at a time when Emerging Market's are imploding. 

And as we know – while the dollar gets more expensive – other currencies are getting weaker.

Here's some of the largest Asian economies and how much their currencies have weakened against the dollar. . .

Unfortunately – foreign Central Banks have only limited options of what they can do to protect their currencies. . .

One – they can raise rates to defend their local currency. The idea is that if they offer higher interest rates, investors will park money in the country.

But raising rates will slow their growth down and hurt the nations debtors. And with Trump's trade policies causing concerns for export heavy economies – mainly the Emerging Markets – making borrowers pay more interest isn't a good thing.

Two – they can sell their dollar reserves instead. The Central Bank can sell their reserves at a discount on the Foreign Exchange market. And buy their local currency in return – pushing the USD down against their own currency.

The problem with this option is that it's very costly and risky. . .

All the years of surpluses it took for them to build up those dollar reserves can disappear in a blink of an eye. And what do they get in return for all that cost? Temporary stability of their currency until they run out of dollars to sell. This is what happened in the 1998 'Asian Contagion' crisis that decimated Asian economies.

And it appears things are already approaching 'critical mass' as foreign Central Banks grow concerned with the Fed's tightening. Here are a couple of examples. . .

The Vietnamese Central Bank recently announced that they're willing to intervene in the foreign exchange market to protect the stability of their local currency – the Vietnamese Dong (VND) – which just hit a record low.

This means they're using 'Option Two' – selling their dollar reserves (pushing the USD Forex down) and buying the Dong on the open market (pushing the VND up). 

This will 'stabilize' their currency's value – that is, until they run out of dollars. . .

Another example – the Reserve Bank of India (RBI) governor – Urjit Patel – penned a piece in the Financial Times urging the Fed to slow down their tightening to prevent further chaos in the emerging markets. 

Indonesia's new central bank chief shared the RBI's feelings – calling on the Fed to be "more mindful of the global repercussions of policy tightening."

With the U.S. Treasury requiring significant funding from abroad. And the Fed raising rates while pulling dollars out of the economy via Quantitative Tightening – this is the foundation of a dollar shortage.

The soaring U.S. dollar, Emerging Market chaos, and depreciating Asian currencies are all effects from this.

That means global economies and stock markets will grow far more fragile – until the Fed inevitably reverses their tightening to re-liquidize global markets. 

As usual – expect things to get worse before they get better. 

The New Oil Cartel Threatening OPEC

When reports emerged that India and China are in talks about forming an oil buyers' club,OPEC was probably too busy with its upcoming June 22 meeting to concern itself with that dangerous alliance. Now, it may be time for it to start worrying.

"The timing is right. The boom in U.S. oil and gas production gives us greater leverage against OPEC," the Times of India quoted an Indian official as saying last month after the formal start of said talks. The two countries, after all, account for a combined 17 percent of global oil consumption and they are the ones that would be the hardest hit if prices rise as a result of OPEC's actions.

What's more, they might not be alone in this attempt to curb OPEC's clout on the global oil market. According to Bloomberg's Carl Pope, Europe and Japan, previously reluctant to take part in any anti-OPEC projects, may now join in. The reason they are likely to join in is that unlike in previous oil price cycles, now there are alternatives to fossil fuels. Electrification is where OPEC may have to face off with a future oil buyers' cartel.

India, China, and Europe are all very big on EV adoption. Japan is a leader in battery manufacturing.

If they set their minds to it, these four players could upend the oil market and effectively cripple OPEC. Of course, this is a best-case scenario of the kind that rarely unfolds in reality.

Let's take India, for example. A recent survey suggested that as many as 90 percent of Indian drivers were willing to switch to EVs if the government built the necessary charging infrastructure, reduced road taxes, and increased subsidies. Another survey identified price and range as additional roadblocks towards the mass adoption of EVs in India. Because of these challenges, New Delhi recently amended its ambitious goal of having an all-EV fleet on the roads of the country by 2030 to having 30 percent of the fleet electric.

China, for its part, is the undisputed leader in global EV adoption: the country accounted for more than 50 percent of global EV sales last year in case you were thinking, "Wait, wasn't that Norway?" However, this was in large part made possible by generous government subsidies for EV manufacturing. These subsidies are due to be wound downto 0 by 2020, and carmakers are already beginning to brace for a future without the support of the state. It's safe to say it remains uncertain if the EV boom will continue after 2020.

This precarious situation with EVs is reason enough for China and India to seek more clout on international oil markets dominated by OPEC and would justify the formation of a "buyers' club."

Europe, for its part, is, as a whole, a top performer in EV adoption and it is also very big on environmentalism. At the same time, it still imports crude and quite a lot of it, so it cares about oil prices as a large buyer.

China and India are facing challenges in EV adoption. Europe could help and benefit from it. After all, taken together, Europe, China, India, and Japan account for the manufacturing of as much as 65 percent of the world's cars, and a lot of these are manufactured in Europe. These four also consume 35 percent of the world's crude oil and would like to reduce this number.

According to Pope, if they get together, they would be able to negotiate either a more gradual or a faster shift to EVs. It would all depend on whether OPEC would agree to maintain lower prices or not.

A more skeptical view would note the challenges in EV adoption such as subsidies and infrastructure. These would take time to be overcome even if everyone played together. Yet long-term, an oil buyers' alliance could be a force to be reckoned with by the oil producers, and the latter need to start paying attention now.

A Hard Rain's a-Gonna Fall

Après moi, le déluge

~ King Louis XV of France

A hard rain's a-gonna fall

~ Bob Dylan (the first)

As the Federal Reserve kicked off its second round of quantitative easing in the aftermath of the Great Financial Crisis, hedge fund manager David Tepper predicted that nearly all assets would rise tremendously in response. 

"The Fed just announced: We want economic growth, and we don't care if there's inflation... have they ever said that before?"

He then famously uttered the line "You gotta love a put", referring to the Fed's declared willingness to print $trillions to backstop the economy and financial makets.

Nine years later we see that Tepper was right, likely even more so than he realized at the time.

The other world central banks followed the Fed's lead. Mario Draghi of the ECB declared a similar "whatever it takes" policy and has printed nearly $3.5 trillion in just the past three years alone. The Bank of Japan has intervened so much that it now owns over 40% of its country's entire bond market. And no central bank has printed more than the People's Bank of China.

It has been an unprecedented forcefeeding of stimulus into the global system. And, contrary to what most people realize, it hasn't diminished over the years since the Great Recession. In fact, the most recent wave from 2015-2018 has seen the highest amount of injected 'thin-air' money ever:

In response, equities have long since rocketed past their pre-crisis highs, bonds continued rising as interest rates stayed at historic lows, and many real estate markets are now back in bubble territory. As Tepper predicted, financial and other risk assets have shot the moon.

And everyone learned to love the 'Fed put' and stop worrying.

But as King Louis XV and Bob Dylan both warned us, what's coming next will change everything.

The Deluge Approaches

This halcyon era of ever-higher prices and consequence-free backstopping by the central banks is ending.

The central banks, desperate to give themselves some slack (any slack!) to maneuver when the next recession arrives, have publicly committed to 'tightening monetary policy' and 'unwinding their balance sheets', which is wonk-speak for 'reversing what they've done' over the past decade.

Most general investors today just don't appreciate how gargantuanly significant this is. For the past 9 years, we've become accustomed to a volatily-free one-way trip higher in asset prices. It's been all-glory with no risk while the 'Fed put' has had our backs (along with the 'EBC put', the 'BOJ' put, the 'PBoC put', etc). Anybody going long, buying the (few, minor) dips along the way, has felt like a genius.

That's all over.

Based on current guidance from the central banks, "global QE" is expected to drop precipitously from here:

With just the relatively tiny amount of QE tapering so far, 2018 has already seen more market price volatility than any year since 2009. But we've seen nothing so far compared to the volatility that's coming later this year when QE starts declining in earnest.

In parallel with this tightening, global interest rates are rising after years of flatlining at all-time lows. And it's important to note that our recent 0% (or negative) yields came at the end of a 35-year secular cycle of declining interest rates that began in the early 1980s.

Are we seeing a secular cycle turn now that rates are creeping back up? Will rising interest rates be the norm for the foreseable future?

If so, the world is woefully unprepared for it.

Countries and companies are carrying unprecendented levels of debt, as are many households. Rising interest rates increases the cost of servicing that debt, leaving less behind to invest or to meet basic operating needs.

Simon Black reminds us that, mathematically, rising interest rates result in lower valuations for stocks, bonds and housing. But so far, Wall Street hasn't gotten the message (chart courtesy of Charles Hugh Smith):

(Source)

So we're presented with a simple question: What happens when the QE that's grossly-inflating markets stops at the same time that interest rates rise?

The answer is simple, too: Prices fall.

They fall commensurate with the distortion within the system. Which is unprecendented at this stage.

But Wait, There's More!

So the situation is dire. But it gets worse.

Our debt that's getting more expensive to service? Well, not only are we (in the US) adding to it at a faster rate with our newly-declared horizon of $1+ trillion annual deficits, but we're increasingly antagonizing the largest buyers of our debt.

This is most notable with China (the #1 Treasury buyer), whom we've dragged into a trade war and just announced $50 billion in tariffs against. But Japan (the #2 buyer) is also materially reducing its Treasury purchases. And not to be outdone, Russia recenty dumped half of its Treasury holdings, $47 billion worth, in a single fell swoop.

Should this trend lead, understandably, to lower demand for US Treasurys in the future, that only will put further pressure on interest rates to move higher.

And this is all happening at a time when the stability of the rest of the world is fast deteriorating.

Developing (EM) countries are getting destroyed as central bank liquidity flows slow and reverse -- as higher interest rates strengthen the USD against their home currencies, their debts (mostly denominated in USD) become more costly while their revenues (denominated in local currency) lose purchasing power.

Fault lines are fracturing across Europe as protectionist, populist candidates are threatening the long-standing EU power structure. Italy's economy is struggling to remain afloat and could take the entire European banking system down with it. The new tit-for-tat tariffs with the US aren't helping matters.

And China, trade war aside, is seeing its fabled economic momentum slow to multi-decade lows.

All pieces on the chessboard are weakening. 

The Timing Is Becoming Clear

Yes, the financial markets are currently still near all-time highs (or at the high, in the case of the Nasdaq). And yes, expected Q2 US GDP has jumped to a blistering 4.8%.

But the writing is increasingly on the wall that these rosy heights won't last for much longer.

These next three charts from Palisade Research, combined with the above forecast of the drop-off in global QE, paint a stark picture for the rest of 2018 and beyond.

The first shows that as the G-3 central banks have started their initial (and still small) efforts to withdraw QE, the Global Financial Stress Indicator is spiking worrisomely:

Next, one of the best predictors of global corporate earnings now forecasts an imminent collapse. As go earnings, so go stock prices:

And looking at trade flows -- which track the movement of 'real stuff' like air and shipping freights -- we see clear signs that the global economy is slowing down (a trend that will be exacerbated if oil prices rise as geologist Art Berman predicts): 

The end of QE, higher interest rates, trade wars at a time of slowing global trade, China/Europe weakening, EM carnage -- it's like both legs of the ladder you're standing on being sawed off, as well all of the rungs underneath you. 

Conclusion: a major decline in the financial markets is due for the second half of 2018/first half of 2019.

Actions To Take

Gathering clouds deliver a valuable message: Seek shelter before the storm.

Specifically, it's time to:

• Get liquid. When the rug gets pulled out from under today's asset prices, 'flat' will be the new 'up'. Simply not losing money will make you wealthier on a relative basis -- it's the easiest, least-risky strategy for most investors to prepare for what's coming. "Cash is king" in the aftermath of a deflationary downdraft, when your dry power can be then used to purchase high-quality income-producing assets at excellent value -- fractions of their current prices. And in the interim, the returns on cash are getting better for investors who know where to look. We've recently explained how you can now get 2%+ interest on cash stored in short-term T-bills (that's 30x more than most banks will pay on cash savings). If you're sitting on cash and haven't looked seriously yet at that program, you really should review our report. With more Fed tightening expected in the future, T-bill rates are likely headed even higher.
• Get your plan for the correction into place now. In addition to your cash, how is the rest of your portfolio positioned? Do you have suitable hedges in place to mitigate your risk? Does your financial advisor even acknowledge the risks detailed in the above article? The last thing you want to do in a market downdraft is make panicked decisions. So if you haven't already put together a contingency plan for a 20-40%+ market drop, consider scheduling a consultation with the firm we endorse (it's completely free).
• Nibble into commodities. The commodities/equities price ratio is the lowest it has been in 47 years. That ratio has to correct some point soon. Much of that correction will be due to stocks dropping; but the rest will be by commodities holding their own or appreciating. While it's true that commodities could indeed fall as well during a general deflationary rout, that's not a guarantee -- especially given that many commodities are now selling at prices close to -- or in some cases, below -- their marginal cost of production. The easiest commodities to own yourself, the precious metals, are 'dirt cheap' right now (especially silver), as explained in our recent podcast with Ronald Stoeferle. And with today's bloodbath, they just got even cheaper. 
• Assess and address your biggest vulnerabilities before the next crisis hits. Are you worried about the security of your current job when the next recession hits? Are rising interest rates causing you to struggle in deciding whether to buy or sell a home? Are you trying to come up with a plan for a resilient retirement? Are you assessing the pros and cons of relocating? Do you have homesteading questions? Are you trying to create new streams of income? Chris offers private consultations on these common questions, as well as many others. If you're wrestling with big life decisions like these, scheduling a consultation with him can prove valuable in helping you make the best choice.

We're lurching through the final steps of familiar territory as the status quo we've known for the past near-decade is ending.

The mind-bogglingly massive central bank stimulus supporting asset prices are disappearing. Interest rates are rising. It's hard to overemphasize how seismic these changes will be to world markets and the global economy.

The coming months are going to be completely different than what society is conditioned for. Time is running short to get prepared.

The currency and bond markets of five major countries are now in the danger zone, as many more teeter on the edge.

Because when today's Everything Bubble bursts, the effect will be nothing short of catastrophic as 50 years of excessive debt accumulation suddenly deflates.

A hard rain indeed is gonna fall.