Rising Geopolitical Risks: North Korea and France; Market Manipulation: Who’s Better China or the Philippines?

Central Banking Opioid Leads to the Insouciance to Rising Geopolitical Risks

I find it rather amusing to see how financial markets seem to have been jaded with the idea of risks.

For instance, a low probability has been imputed to geopolitical risks to have significant impacts on the markets

Hence, downside actions from the largely unexpected events such as the Brexit and the Trump victory have only been met by a series of savage upside price bidding of the world’s stock market.

And it has also been entertaining to see how central banks have attained perceived divinity, such that they are seen as having the power to shield real world risks from affecting the stock markets.

Central banks interventions work like opioids on markets

 

Bank of America’s Michael Harnett analogizes central banking interventions to JRR Tolkien’s classic “the Lord of the Rings” which he calls as the “Liquidity Supernova”.

From the Business Insider: The global markets all come down to central banks. At least that's the argument of Michael Hartnett, the chief investment strategist for Bank of America Merrill Lynch. In a note to clients on Thursday on what he called "the $1 trillion flow that conquers all," Hartnett observed that the amount offinancial assets added to central banks' balance sheets was the "one flow that matters" in the market. "$1 trillion of financial assets that central banks (European Central Banks & Bank of Japan) have bought year-to-date (= $3.6tn annualized = largest CB buying in past 10 years); ongoing Liquidity Supernova best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro," Hartnett wrote.”

This weekend, France goes into polls for the first round of presidential elections. Survey posits that this will be a very tight race. But why trust surveys especially with a huge number of undecided? Candidates of the extremes side of the political spectrum appear to be in close contention for the top spot, namely far right anti-Euro candidate Marine Le Pen and left-wing Jean-Luc Mélenchon.

Yet both candidates represents anti-EU and anti-globalization. Will the anti-establishment trends seen in the Brexit and Trump votes percolate to France? If yes then how should such impact the market?

Buy The F@#$ Dip???!!!

I wrote about the risks from North Korea last week. The war drums appear to have partly subsided. That’s because the US seem to have taken a pause. Does this signify the calm before the storm?

When the Trump administration threatened to send its armada to Korean Peninsula, the USS Carl Vinzonstrike group reportedly sailed in the opposite direction or through the Sunda Strait near Indonesia.

A US fighter jet crashed off the Philippines while attempting to land on the carrier. As the North Korean leadership continues to taunt the US government, the aircraft carrier has reached western Pacific Ocean for ajoint drill with Japanese destroyers. The rogue North Korea even went far enough to warn its patron, the Chinese government which the Yon Hap Agency reported “not to step up anti-North sanctions, warning of "catastrophic consequences" in their bilateral relations.”

If North Korean government will feel isolated and cornered, then expect even more belligerence and provocations. The likely response could be an actual shooting war. An American was reportedly detained in North Korea.

If a shooting war starts in the region, just how will the Philippine economy and markets be immune to this? Will “domestic demand” or euphemism for credit expansion function as a shield? Or will this expose the accrued imbalances?

How much opioid is required to attain indifference to a possible risk of total ruin?

Market Manipulation: Philippines Versus China

 

I am supposed to devote much space to this today. But weariness has gotten into me.

China’s stock market has landed in the international news again. The reason for this: China’s National Team has been reported to have actively contained last week’s selloffs.

The lower left chart from Bloomberg shows that the Shanghai index hasn’t fallen by more than 1% in a day during the last four months.

The Shanghai index (SSEC) dropped by 1.23% this week. As shown in the 3 day intra-session charts of the Shanghai index at the top, massive afternoon delight pumps went into action at around 1:30-2:00, or had been timed with the low of the index. 

In three sessions, the SSEC either erased all or most of the losses.

Fascinatingly, the pumping motion at the SSEC looks very similar to the two day activities at the Phisix.

But the Phisix has an ace. The latter can pump the index at a cheaper cost based on mark on close orders.

Friday’s (April 21) pump and dump should be another wonderful example.

At least it’s widely known that the Chinese national team has responsible for actively destroying the pricing system of their stock market.

But who’s the responsible here?

In the Holy Week holiday abbreviated trading session, net marking the close pumps delivered 86% of the week’s .61% return.

This week, net mark on close pumps reduced losses from 1.03% to just .67%.

And this involves only end session pumps.

The above shows why the Philippine equity markets have even been worse than China in the context of market manipulation.

 

It’s almost a new normal. It’s another week where the moderate decline of the key bellwether concealed on the incredible degree of volatility simmering underneath it.

9 of 30 issues or 30% has gains or losses of 2%.

Such outsized volatility has just been symptoms of grotesque price deformity.

And it wouldn’t be appropriate to call the violent price actions as panic buying or selling. Vertical prices in both directions are hardly from retail investors.

Instead, Philippines stocks have largely been about domestic banks and nonbank financial institutions versus foreign money.

 

And yet foreign money can now even showcase local money.

Except for the taper tantrum (2013) days where locals sold as foreigners bought, much of the events since 2014 to 2016 reveal that foreign money leads the direction of the Phisix.

When foreigners bought, the Phisix moved higher. However, when foreign money sold, the same bellwether either went down or went into a consolidation mode.

It’s only in 2017 where the Phisix rose even as foreigners sold.

This shows of the intense desperation of local institutions in trying to prop the overvalued stock markets. They would do “whatever it takes” just to meet this goal.

Damn the real world consequences!

Fitch downgrades France: how credit rating changes impacts the markets

France will celebrate Bastille day with a bad news, Fitch Ratings joined S&P and Moody’s in stripping France of its AAA credit rating.

From Bangkok Post:

Ratings agency Fitch downgraded France from the top AAA credit rating on Friday, citing a heavier government debt load and poor prospects for growth.

In slashing France's rating to 'AA +', Fitch became the last of the big three credit raters to knock France off the top perch. Last year Standard & Poor's and Moody's already downgraded France from the AAA club.

Fitch, which is part French owned, had warned in its previous appraisal that France had reached the very limit of being able to hold on to its top grade grail.

But with Fitch now expecting public debt to peak next year at 96 percent of gross domestic product, the agency said it had no choice but to lower the mark, though with a stable outlook.

I think that France deserves more, or that the present downgrades may just be the start of the string of downgrades that France will be faced with.

But the actions of the credit rating agencies gives some very important insights, particularly on the effects of re-ratings on the marketplace.

Contra to the mainstream intuition that downside re-ratings of debt should translate to higher interest rates as default risk premium should rise, the S&P and Moody’s actions in 2012, particularly in January and November, respectively, came in backdrop of the opposite direction:a colossal rally 10 year bonds expressed via sharply lower yields. 

So the French government can easily issue a rejoinder to these credit rating agencies saying “you fools, the market says you are wrong!”

But of course, this has not been simple. 

Part of that rally has been due to the series of credit easing policies by the ECB since the financial crisis of 2007, and, more importantly, the  ECB’s implicit backstop. ECB’s Mario Draghi unveiled the details of the bond buying scheme via outright monetary transactions, or OMTs last September.

The US Federal Reserve has also reportedly injected over $1 trillion in cash to European banks with US operations. Such funds may have also been used to buy government European debt too.

Other factors as such as changes in reserve requirement could have also contributed to bond boom. Fund manager Charles Gave of Gavekal Research recently wrote: (bold original)

Knowing this, why then are French rates so low? The usual explanations (purchases by the Swiss National Bank and Mrs. Watanabe buying) have some merit, but other factors may also be at play. France has a large financial sector, with huge international positions. Some entities may be selling international holdings which demand large reserve requirements. The proceeds are then brought back in France to buy French government bonds—against which there are no reserve requirements.

The economic impact of such a trend would indeed be benign for interest rates. But ultimately, it raises the risk on the French financial balance sheet: less diversity, and more vulnerability to a problem with the local sovereign.

In short, there has been a lot of moving parts, mostly political interventions, that has led to the bond rally.

The popular wisdom is that upgrades and downgrades impact the equity markets where upgrades lifts the markets while downgrades should do the opposite.

Well in the French case, this simply has not been true.

And as I previously pointed out, French markets and the economy has gone in antipodal directions and thus a parallel universe. Sporadic recessions through 2012 hasn’t stopped the French equity benchmark the CAC 40 from booming.

France has seen booming bond markets and stock markets amidst intermittent recession and credit rating downgrades—all contradictory to mainstream wisdom.

Of course, all these have operated on the backdrop of an easy money landscape which is about to change.  The developing “head and shoulders” formation in the CAC 40 could serve as clue.

The lesson here is that the credit rating upgrades or downgrades have little relationship with market actions. And for those in the mainstream who tout these to justify a bias, they are most likely to be misguided and wrong.

Parallel Universe: Booming German and French Stocks as Economies Stagnate

In a the world where central bankers have become demigods, the disconnection between the financial markets and the real economy have increasingly become evident.

From the Bloomberg:

The German economy expanded less than forecast in the first quarter and France’s slipped into recession, increasing pressure on the European Central Bank to do more to stimulate growth.

German gross domestic product rose 0.1 percent from the fourth quarter, when it fell a downwardly revised 0.7 percent, the Federal Statistics Office in Wiesbaden said today. Economists forecast a 0.3 percent gain, according to the median of 41 estimates in a Bloomberg News survey. The French economy contracted 0.2 percent in the three months through March after shrinking the same amount in the final quarter of last year.

The above data revealed in the charts below. [Charts courtesy of tradingeconomics.com and stockcharts.com]

 

The German equity market bellwether, the DAX, has been on an uptrend (upper pane) since October 2011 even when statistical economic growth peaked during the first semester of 2010 and continues to worsen (lower pane). Thus, the two year divergence can hardly be interpreted as anomaly.

Year to date, the DAX, as of yesterday’s close, has been up 9.55% even as statistical economic growth is at the borderline with the negative.

The French phenomenon seems even more elaborate.

The French equity market as measured by its bellwether, the CAC, has been on an uptrend along with the German DAX where both began to reverse near simultaneously higher during the last quarter of 2011.

Ironically, the French economy has been zigzagging mostly in the recessionary territory (lower window) even as the stock market continues to boom through 2012 (upper window).

Once again, the French economy has been reported above as enduring a statistical recession, but the CAC has been up 10.38% year to date as of yesterday's close.

The above has been exhibiting the unintended consequences of central bank policies.

The micro or the real economy continues to suffer from real economic obstacles (high taxes, more mandates, relative price distortions, regulations and etc….) which deters investments, but adds to the incentives generated by easy money policies in diverting capital towards yield chasing activities in the financial markets, where the latter have also been buttressed by central bank guarantees.

Such parallel universe is a sign of an unsustainable bubble in progress. 

For now we see a boom. Eventually we would either see a grand bursting of these bubbles that would likely lead to cascading wave of debt defaults or a currency crisis.

Imploding Welfare States: France Faces Downgrade After U.S. Cut

One by one the Bismarckian welfare states appear to be collapsing from their own weight.

From Bloomberg,

The decision by Standard & Poor’s to downgrade the U.S. credit rating leaves France as the AAA country most likely to lose its top grade, some investors and economists say.

France is more expensive to insure against default than lower-rated governments including Malaysia, Thailand, Japan, Mexico, Czech Republic, the state of Texas and the U.S.

“France is not, in my view, a AAA country,” said Paul Donovan, London-based deputy head of global economics at UBS AG. “France can’t print its own money, a critical distinction from the U.S. It is not treated as AAA by the markets.”

While all three major credit-rating companies have confirmed France’s top level in recent months, market measures indicate increasing investor skittishness over the country’s vulnerability to the European debt crisis. Euro-region central bank governors signalled after emergency talks yesterday that they would buy bonds from Spain and Italy to counter investor concerns and limit fallout from the U.S. cut…

While France’s debt of 84.7 percent of gross domestic product is less than Italy’s 120.3 percent, as a percentage of economic output it has risen twice as fast as Italy’s since 2007. French government debt totaled 1.59 trillion euros ($2.3 trillion) at the end of 2010, according to the European Union; Italy’s was about 1.8 trillion euros. France has had a larger budget deficit than Italy every year since 2006. S&P rates Italy A+, four levels below France.

Chart from the Economist

It has been turning out to be a great vindication and equally a monumental triumph for the Classical Liberals whom have warned all these years about the artificiality of this system.

As the great Ludwig von Mises once wrote,

An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.

This process of liquidating the Santa Claus principle has been happening as Risk Free are being exposed as Risk Loaded.

Although governments should be expected to keep up the struggle and resort to even more desperate measures in order to preserve this unsustainable system (via inflationism).

At the end of the day, economic reality will overwhelm them.