Sunday, February 07, 2016

Phisix 6,800: Global Central Banks Lose Control! Chart Porn of Fast and Furious PSEi Bear Market Rallies

…the turning of a financial cycle can be quite abrupt due to another feature of debt: its close link with risk-taking and the amplification of market dynamics. During boom times, when asset prices are rising and financial markets are tranquil, borrowers may be lulled into a false sense of security. We could dub this the “illusion of sustainability” whereby even large debt levels appear sustainable when credit conditions are easy and asset prices soar. The illusion of sustainability blinds both borrowers and lenders. But as the cycle turns, the combination of falling asset prices and more turbulent markets means that what was viewed previously as sustainable levels of debt begins to look much more challenging. The decline of profitability, mentioned before, is particularly relevant here. This realisation may elicit deleveraging and outflows that amplify the downward cycle. Policymakers can try to stem the decline in asset prices by loosening monetary policy to turn back the tide, but the already large stock of debt means that monetary policy becomes less effective.—Jaime Caruana General Manager, Bank for International Settlements

I recently wrote that due to my computer predicament I might not be writing this week. But current events have been so compelling for me to miss out. Nevertheless a condensed outlook
In this issue
Phisix 6,800: Global Central Banks Lose Control! Chart Porn of Fast and Furious PSEi Bear Market Rallies

-Central Banks Lose Control as Developed Economy Stocks Nosedive!
-NIRP has Failed; Why NIRP will Crash the Markets!
-Chart Porn: Fast and Furious Bear Market Rallies (1994-2016)
Phisix 6,800: Global Central Banks Lose Control! Chart Porn of Fast and Furious PSEi Bear Market Rallies
Central Banks Lose Control as Developed Economy Stocks Nosedive!
Unlike most of the establishment, at the least one of the highest official of the central bank of central banks, the Bank for International Settlements (BIS), Mr Carauana1, understands: Balance sheets matter!

This means that regardless of central bank’s sustained ramming down into the public’s throats of its credit easing policies, for entities that have been hocked to its eyeballs, you can lead the horse to the water, but you cannot make it drink. In short, credit expansion is limited by the capacity of an entity to earn and pay for such liabilities.
Yet private sector balance sheet expansion through excessive leveraging embodies a major symptom of unproductive activities or the misallocation of resources. And for as long as real savings remain enough to fund the capital consumption or the wealth transfer process, the “boom” phase will account for as the “illusion of sustainability” that masks on the progressing entropy of malinvestments or the almost wholesale blinding of borrowers and lenders. The blinding from the “illusion of stability” includes regulators, politicians and media as well.
However, if something can’t go on forever, it will stop. The laws of economics will force such uneconomic activities to surface. Real savings will be consumed. And the reversal of the “illusion of sustainability” will be evident in the character of self-reinforcing “turbulent markets”, particularly the feedback mechanism of financial losses, deleveraging or liquidations, outflows, and credit strains.
Recent attempts by central banks to subsidize stock markets through negative interest rates appear to have hit a wall
Last week I wrote2, (italics original)
My point is that these central bank policies to subsidize the stock markets via monetary policies, as shown by the experiences of Japan, China and Germany, have conspicuously been increasingly afflicted by the laws of diminishing returns.
The narrowing windows of gains only punctuate on the risk of severe or dramatic downside ‘flight’ actions overtime. Yet central banks refuse to heed reality. But they continue to focus instead on the short term. The result should be the worsening of the unintended consequences from present day ‘rescue’ actions…
While there may be residual vestiges of the BoJ NIRP’s honeymoon effect, given this week’s asymmetric responses, signs are that last two week’s central bank panacea may not last. Perhaps not even a month.
If so, in the next transition from fight to flight, then this would mean that the ensuing cascade should be sharp and fast as central banks have effectively lost control!
Just what happened to the much ballyhooed magic of central bank intervention last week?

Equity markets of nations under NIRP were in a funk! Much of the year to date losses came from last week’s amazing meltdown.

And most importantly, the deficits incurred by Japan’s Nikkei 225 emerged even prior to the announcement of the dismal US jobs report.
Recall that the Bank of Japan (BoJ) has been the latest developed economy to embrace Negative Interest Rate Policy (NIRP). It did so in response to its crashing stock markets.

Yet part of the BoJ’s stock market rescue mission has been implicitly directed at the world’s largest pension fund, the Japan’s Government Pension Investment Fund (GPIF). As noted before, the Abe administration nudged or pressured the GPIF to makeover its portfolio by selling its JGBs or government bond holdings in order to replace them with domestic and global equities.

And because of the GPIF’s accommodation of the Abe administration, its portfolio switch has caused the pension fund to report a quarterly loss of 5.59% in the second quarter as equities underperformed. This according to the Japan Times accounts for “its worst quarterly result since at least 2008”.

Yet lower equity prices mean more losses for the pension fund to come. And more losses imperil funds for Japan’s retirees.
Moreover, the opportunity cost for such portfolio switch has been to give up on significant gains in bonds as the NIRP adaption has spurred Japanese Government Bonds (JGB) from the shortest end up to 9 years into sub-zero yields! As of last week, nearly $6 trillion of Japanese and European sovereign bonds have traded at sub-zero yields!
So as stock markets wilt, financial market participants gravitated to treasuries for safehaven. And don’t forget gold’s surge!
Additionally, by reversing its stance from an earlier denial to employ such policy, the BOJ intended to deliver a “shock and awe” to risk assets, as well as, to the USDJPY (yen).
Talk about the law of unintended consequences.
The Nikkei’s honeymoon period from the NIRP turned out to be just a three day tryst!
As of Friday, the Nikkei traded lower than when the NIRP was announced (middle window). Yet Nikkei 225 futures point to a 3% meltdown on Monday’s opening.
Yet last week’s jawboning by the BoJ last week “to expand stimulus further and is prepared to cut interest rates deeper into negative territory, signalling a readiness to act again to hit his ambitious inflation target”, as well as, by the ECB’s Mario Draghi who said anew that the ECB “will not surrender to low inflation” and vowed to ease further in March, apparently fell into deaf ears as stock markets went into a selling binge.
Financials markets have apparently grown weary of these central bank elixirs!
And as with the Nikkei, the USDJPY was dumped (upper window).

I warned that “Japan’s aging pensioners will serve as the ‘greater fool’ when stock market collapses”. And this may soon come true as sustained stock market losses will likely widen on the GPIF’s deficits.
NIRP has Failed; Why NIRP will Crash the Markets!
And here’s more. When central bank magic fails, its repercussions will spread throughout the global financial markets.
One of the unintended consequences of ZIRP-NIRP activist monetarism has been to put tremendous pressure on banking industry.

Last week, the banking index of Japan’s Topix bank, the US BKX and the Euro Stoxx 600 Bank index profusely bled! The indices shed a shocking -13.74%, -3.9% and -6.2% respectively! The three indices are now in bear markets.

Yet a furtherance of such dynamic entails further tightening in the global financial system. And yes this, in spite of the NIRP!
NIRP will not only crimp on bank margins, it massively skews on the pricing signals of the credit and risk markets, distort on the functionality of payment and settlements (such policies would encourage early payments, excess payments and deferred collection as warned by the NY FED), increase administrative cost of maintaining bank accounts as banks looks for alternative fees to make up for lost income from interest rate arbitrages (e.g. higher fees on ATM and etc…), disrupt on wholesale financing (e.g. repos, money markets) or banking system’s liquidity and compel the public to eventually hold cash. This comes even if governments impose cash controls. Last week the German goverment proposes to limit cash transaction to €5,000 (USD 5,450) while the EU also plans to expand cash controls.

Worst, NIRP attempts to destroy the essential financial concept of “time value of money” or as Investopedia defines “money available at the present time is worth more than the same amount in the future” or present discounted value.

In the context of Austrian economics, “time value of money” is equivalent to orginary interest or the “discount of future goods as against present goods” which accounts for the tradeoff between “want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future”

And this is why NIRP will fail. As the great Ludwig von Mises presciently warned3.(bold mine)
If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no consumption at all, but only saving, accumulation of capital, and investment. Not the impossible disappearance of originary interest, but the abolition of payment of interest to the owners of capital, would result in capital consumption. The capitalists would consume their capital goods and their capital precisely because there is originary interest and present want-satisfaction is preferred to later satisfaction.
Therefore there cannot be any question of abolishing interest by any institutions, laws, or devices of bank manipulation. He who wants to "abolish" interest will have to induce people to value an apple available in a hundred years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to receive interest. But such decrees would bring about capital consumption and would very soon throw mankind back into the original state of natural poverty.
Now you see the truth behind the push for ‘financial inclusion’ in emerging markets like the India or the Philippines?

First, bring the majority into the formal banking system. Next, impose ZIRP and NIRP. Then Ban cash. Also, impose all forms of capital controls.

The end result (or the ultimate goal) is the (full) CONTROL by the establishment of private sector’s savings! Authorities and their establishment agencies can charge myriad fees at will, monitor every movement of funds of the account holder, eventually they will direct monetary flows (control transactions or everyone’s business), they will garnish accounts which they see as acting against their mandates or rules, and or simply confiscate or tax private sector’s resources during times of distress.

Events at the developing world have been showing the way!

Yet the basic laws of economics ensure that financial totalitarianism will be met by mountains of obstacles.
Proof? The global banking system’s dilemma in the face of ZIRP-NIRP has been spotlighted by this news report from the Financial Times4. (bold mine)
Share prices of major banks have plunged this week, with Credit Suisse hitting a 24-year low and Deutsche falling to 2009 prices. Santander, BBVA and UniCredit also traded at levels last seen during the eurozone crisis.
Bank weakness is truly global. US banks were downbeat on fourth-quarter earnings and the S&P financials are down more than 12 per cent in 2016. Indices for European and Japanese banks have lost nearly a quarter of their value this year.

Ultra-loose monetary policy, including the adoption of negative rate policy in Japan and expectations of further easing in Europe, has heightened fears for global economic growth. Lower long-term interest rates also reduce the earning power of banks. US financials have been hit hard by a lower net interest margin outlook while investors worry that the commodity plunge will intensify credit losses for the sector.
“This is totally linked to the rates environment,” said Lloyd Harris, a credit analyst at Old Mutual Global Investors. “At the end of last year, you were positioned for a rising rate environment. The equity market this year reflects that those expectations around higher rates have diminished.”
Bradley Golding, managing director at Christofferson, Robb & Co, highlighted that bank profitability is reduced as leverage and capital constraints leave lenders competing for the same business opportunities.
“The yield curve used to steepen in a recession and spreads used to widen, so even if you lost money on your existing book, new loans were done at a profitable level. Quantitative easing really hasn’t allowed that to happen,” said Mr Golding.
In mid-January, Italy provided an early indicator of the trauma ahead for bank investors, with Monte dei Paschi hitting a record low on the back of concerns about non-performing loans.
Weakness in equity prices has extended to the riskiest bank bonds. The €95bn market for so-called additional tier 1 bonds, which convert to equity or are written down when a bank’s capital falls, has endured dramatic losses this year.
Policies from panicking central banks have now caused disorder, distress and a tizzy at the financial markets. Curiously, these policies have been designed to protect them. Now it appears to have backfired.
And stock market anxiety has now spread. In the US, the once crowd or momentum favorites or the index drivers, the FANG (Facebook, Amazon, Apple, Netflix and Google) has likewise fallen to the strains from recent wave of selling. Linkedin crashed an astounding 44% last Friday! [there is more to discuss but I’m short of time]
And interestingly, all these have been occurring even as the USD has weakened. The USD sank by a hefty 2.6% this week.

Of course, the USD has signified today’s most crowded trade. And any reversal from a crowded trade will imply extended and amplified volatility.


And with massive shorts against EM currencies, the unwinding of the crowded trade positions (short EM) translated to big rallies. Asian currencies rallied strongly. And part of the rallying Asian currencies got reflected on stocks. Indonesian JKSE soared 3.98%, Philippine Phisix jumped 1.16% and the Thai Set added .41%. Meanwhile the Malaysian KLSE lost -.32% this week.
The Indonesian rupiah gained 1.12%, the Philippine peso .14% and the Thai baht +.29%. On the other hand the Malaysian ringgit slid .13%.
Aside from the intense pushbacks by financial markets on NIRP and on assurances by central banks of Japan and the EU, the much tempered expectations that the FED will further raise rates, the massive short covering on EM currencies, the Chinese government made sure that they celebrate this week’s New Year Spring Festival by stinging offshore yuan (CNH) shorts.

Many high profile hedge funds have announced short positions on the yuan. Billionaire crony George Soros have engaged China’s president Xi Jinping in a public debate as the former declared a short position against the Chinese currency at the year’s start.
The PBoC reported a massive decline to its foreign currency hoard to the tune of $118 billion last January. This brings the Chinese government’s forex reserves to just $3.2 trillion from a pinnacle of nearly $4 trillion in early 2014.
So the likelihood that last week’s state intervention on the CNH market would redound to even lower reserves in February as the Chinese government desperately puts on a façade on her financial assets, stocks, bonds, and the currency.
Chinese financial markets will be closed for the week in celebration of the Chinese New Year, so they will hardly be a factor.
Yet despite her absence, with central banks appears to effectively been losing control! This only means that the selling pressures on risk asset will likely crescendo!
To repeat my warning last week,
If so, in the next transition from fight to flight, then this would mean that the ensuing cascade should be sharp and fast as central banks have effectively lost control!
Decoupling anyone?
Chart Porn: Fast and Furious Bear Market Rallies (1994-2016)
Below is the table that highlights all the bear market rallies from 1994-2016.
The oversold bounce of the previous two weeks has signified as one of the most intense bear market rallies since 1994. In 11 days, the average daily % gains totaled 1.02%!

Yet the most powerful and the swiftest bear market rallies, aside from the most incidences which had the two traits, occurred in 2007-2008.
Since no two bear markets are the same, it would be futile to report on statistical correlation.
What matters are the causal linkages that led to them.
There had been 3 bear market strikes in 1994-95.

The 3 bear markets were a natural response to the blistering 179% skyrocketing of the PSEi in 1993! The bear markets wanted to profit take, yet the easy money environment prevented this from happening. So from the deferment of the market clearing process, imbalances mounted.
During the 3 bear market strikes, bulls feverishly and violently pushed the PSEi back up 24.46%, 24.5% and 31.57%, respectively, in very short periods of time. Thus the W shaped activities.
It was in the fourth attempt that bulls managed to prevail…for a limited period: 1 year and 2 months. However, the 1996 rally marked the last before the expiration of the 1986-1997 11 year secular bull market cycle.

The 1997-8 Asian crisis bear market saw two massive bull market rebellions or fierce countercyclical rallies during its first wave down, 18.64% and 52.2% correspondingly.

Yet those bear market rallies accounted for as false positives in terms of the return of the bull market.

The bear market cycle that started in 1997 had four major cyclical rallies on the path to its culmination. Aside from the above, the spurned rallies of 1998-1999, 2000-2001 and 2001-2002. Rallies during these cycles declined in scale and duration.

The GFC inspired 5 fast and furious countercyclical rallies that all went down the drain.

All 5 eventually surrendered to the bears.

However, the 2009 return of the bulls, mainly due to BSP easy money policies led to the bull market which was rattled by 2013 taper tantrum chapter.

The rally from taper tantrum bear market resonated with 1994-1995 cycle. But unlike 1994-95 which responded to a fantastic one year 179% spurt, the 2013 episode came in response to the 320% return in 3 years and 2 months.
Nonetheless the rate cut by the BSP in October 2012, which combusted a 10 month 30%+++ money supply growth from massive credit expansion, salvaged the PSEi taper tantrum away from bear market and back into the fold of the bulls.


Most events do not happen out of random, as they represent consequences of previous actions.
And this is why we have a 2016 bear market.
And the 2016 bear market will unmask “the illusions of stability”. 

As history shows, the most recent vicious rally only reinforces the denial phase that foreshadows the demise of the 2003-2015 bullmarket.

____
1 Jaime Caruana General Manager Bank for International Settlements, Credit, commodities and currencies Lecture at the London School of Economics and Political Science February 5, 2016
3 Ludwig von Mises Originary Interest, Part Four: Catallactics or Economics of the Market Society, Chapter XIX. The Rate of Interest, Human Action Mises Institute

4 Financial Times Global financial stocks slide to new lows February 5, 2016


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