New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

But financial gravity can’t be resisted indefinitely. Although the exact timing and sequence of events are unknown, it will end, as always, in a Torschlusspanik moment — a German word for last minute or literally door-shut-panic — as investors try desperately to exit when they fear that stable instability is tipping over into simple instability.  To paraphrase Trotsky, the impossible will then become inevitable—Satyajit Das, Markets are Less Stable than They Seem

In this issue

New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

-Global Stock Markets Sprints to Record Heights

-Global Mania: How We Got Here

-The Global Central Bank Dilemma: To Tighten or Not

-Phisix 8770: Big New Year Week No Guarantee of Big Annual Return

-Risks From BSP’s Winner-Take-All Policies

New Year Fireworks! Global Stocks and the Phisix Storm to Record Heights as Central Banks Tighten

Global Stock Markets Sprints to Record Heights

Wow. Stock markets around the world have virtually been rocketing! They took flight in 2016. The ascent accelerated in 2017. And stock markets have virtually gone parabolic or vertical at the onset of 2018!

 

Price momentum has become of utmost significance. And momentum, brought about by the greater fool and the fear of missing out, has only been rationalized as “fundamentals”

Led by the US, the FTSE All-World Index jumped 2.34%! US major equity benchmarks were euphoric: the Dow Jones Industrials, S&P 500, Nasdaq Composite and the Russell 2000 vaulted by an amazing 2.33%, 2.6%, 3.38% and 1.6% respectively.

Asia was equally ecstatic. The MSCI AC Pacific Index zoomed by 3.2%. Fourteen of Asia’s 17 national benchmarks were up. The average return for the region was a spectacular 1.78%!

Benchmarks of Pakistan (+4.45%), Japan (+4.17%), Hong Kong (+2.99%), Mongolia (+2.96%), Vietnam (+2.89%), the Philippines (+2.47%), Singapore (+2.54%) and China (+2.56%) were the week’s most significant gainers.

The Thailand’s SET’s January 1994 pre-Asian crisis zenith of 1,789 was finally taken out last Friday. The SET closed at 1,795.45 up by 2.38%.

Asian currencies resonated with the epic stock market mania. The JP Morgan Bloomberg Asian dollar index (ADXY) climbed .6%. The ASEAN majors - Malaysian ringgit (+1.21%), the Thai baht (+1.15%) and the Indonesian rupiah (+1.03%) – were the biggest winners.

The Philippine peso also firmed by .13% as the USD fell to Php 49.865 from Php 49.93 at the close of 2017.

Global Mania: How We Got Here

A short backdrop.

The Chinese stock market bubble peaked in July 2015 was followed by a crash.

The Chinese government responded by erecting a firewall through the Xi Jinping Put to prevent an economic contagion. The put comprised of various stock market interventions to cushion or put a floor on the collapse.  The Chinese government likewise implemented huge fiscal support measures and loosened its credit spigot.

Despite blathers of ‘deleveraging’, in 2017 the Chinese government has inundated its economy with more than USD $ 4 TRILLION in Total Social Financing and local government debt!

After the February 2016 G-20 meeting in Shanghai, several central banks announced the imposition of negative interest rates. The G-20 meeting was thus dubbed the “Shanghai Accord”.  Because the Shanghai Accord implicitly and explicitly provided support to risk assets, global stocks advanced.

Through 8 months of 2017, central banks (ex-US Federal Reserve) bought $1.96 trillion, according to Bank of America. Assets of the Swiss National Bank expanded 12% for the year as of November 2017. Part of such expansion included direct purchases of US equities ($90 billion according to Quartz).

In 2016, Brexit and the US presidential elections occurred with the unexpected or unpopular outcomes. Nevertheless, global stocks simply bid off each correction.

Paradoxically, what previously was deemed as potential sources of turbulence became fodder for a meltup. Thus, price declines narrowed in time frame and shallowed in scale. With limited incidences of declines, prices only had one direction: up, up and away!

And since markets were perceived as operating in a singular direction, the bidding wars have only intensified!

Central bank policies have become “too asset-oriented” because of economic ideology (Phillips curve and the wealth effect) and the implicit protection of the banking and financial institutions. Economic pain, as a consequence of asset declines, would not be tolerated. Naturally, central bank’s implicit support has only escalated the public’s moral hazard.

And conditioned to believe that central banks have eviscerated the business cycle, the credit cycle, and the stock market cycle, markets have become bolder and more aggressive.

On the other hand, rising markets have only entrenched central bank dependence to accommodate these. Or, central banks have becomehostaged to the markets.

Even when expectations from economic ideology haven’t materialized, the US Federal Reserve has started to tighten. It has upped the tempo of its interest rate hike (3x in 2017). More importantly, it announced a progressive rollback of its assets. It will first desist from reinvesting the maturing assets.

Then it would commence on the tapering lift-off. From Investopedia.com: (bold mine)

At the Federal Reserve June meeting, committee members stated that once tapering begins they will start by letting $6 billion a month in maturing Treasuries run off, which will slowly increase to $30 billion over the coming months. With regards to its agency debt and Mortgage-Backed Securities (MBS), the Fed laid out a similar plan where it will begin tapering $4 billion a month until it reaches $20 billion.  Additionally, the Fed said the long-run plan is to keep the balance sheet "appreciably below that seen in recent years but larger than before the financial crisis."

And finally, confirmation. On September 20, 2017, the Fed officially announced lift-off. The unwinding of the balance sheet was underway.The $50 billion per month taper would begin in October, and at this rate, the balance sheet would drop below $3 trillion in 2020 at which point the next discussion will be how big should the Fed's balance sheet remain once tapering is over.

The Fed must be taking this stand to build upon ammunition once a downturn reappears. [Updated to add: Reuters Fed official says rates are last resort against financial risks January 6]. They are doing this in spite of unfulfilled expectations from the implanted policies. Outgoing Fed chairwoman Janet Yellen recently admitted that the Fed’s view on inflation and employment could be a mistake. Yet, the acknowledgment has been perceived by the marketplace as an assurance of the perpetuation of the easy money regime.

Baby steps tightening have only cemented the public’s perception that the central bank put will remain in place.

That said, aggressive punts and speculative excesses have been spreading to other spheres such as cryptocurrencies and commodities. Gold posted its eight best runs since 1968.

Mainstream perception of the recent global synchronized recovery represents the ramifications of central bank actions in early 2017.

 

The backpedaling on stimulus has been more than just the FED. The ECB has likewise commenced on halving of its asset purchasing program.  Despite the Bank of Japan’s pronouncement of maintaining its ultra-easy monetary policy, the BOJ has embarked on stealth quantitative tightening (QT).

Interestingly, China’s interbank loan SHIBOR rates suddenly plunged across the curve last week which has most likely been from unannounced liquidity injections by the PBOC. Such interest rate “magic” fueled a rally in the yuan (+.28%) and in Chinese stocks (Shanghai Composite up 2.56%). And the rebound Chinese assets reinforced the levitation of global stocks.

So 2018 should be very interesting.

The Global Central Bank Dilemma: To Tighten or Not

It is my view that central banks have been boxed into a corner. Maintain the current environment, economic maladjustments will be magnified by the escalation of the blowoff phase. Tighten beyond the market’s expectations, the market crashes.

Though central banks are unlikely to extricate themselves from spoon feeding global markets, the current and projected phase of incremental tightening/normalizing would most likely take the wind away from the current parabolic momentum.

Bear in mind, once volatility remerges, it is no guarantee that central banks can control them. If central banks cannot control the upside, then downside actions could hold a similar sway.

Proof?

The CNBC on the FOMC December minutes: “In light of elevated asset valuations and low financial market volatility, a couple of participants expressed concern that the persistence of highly accommodative financial conditions could, over time, pose risks to financial stability," the minutes said.”

Remember that the central bank put has been programmed or hardwired into the market’s psychology such that cumulative marginal changes in expectations can morph into an accident. Greed can transmogrify into fear.

Additionally, markets have become totally anesthetized to any form of risk.

Even more, I see an escalation of geopolitical risks in 2018.

Here are some clues:

“Speaking in front of thousands of troops and over 300 perfectly organised military vehicles, Xi – the Communist Party's General Secretary – ordered his forces to prepare for the event of war.” (Daily Star, Chinese President Xi Jinping orders army to prepare for WAR in chilling footage, January 4,2018)

“The Centers for Disease Control and Prevention (CDC) has scheduled a briefing for later this month to outline how the public can prepare for nuclear war."While a nuclear detonation is unlikely, it would have devastating results and there would be limited time to take critical protection steps. Despite the fear surrounding such an event, planning and preparation can lessen deaths and illness," the notice about the Jan. 16briefing says on the CDC's website, which features a photo of a mushroom cloud.” The notice went on to say that most people don't know that sheltering in place for at least 24 hours is "crucial to saving lives and reducing exposure to radiation." (CBS CDC to hold briefing on how public can prepare for nuclear war January 5, 2018)

Last December, “VLADIMIR Putin has hit out at the “aggressive”new US national security strategy and warned Moscow will react. The Russian president said the US missile defence sites in Romania containing interceptor missiles could also house ground-to-ground intermediate-range cruise missiles, which would be in violation of the 1987 Intermediate-range Nuclear Forces (INF) Treaty. He told the military officials that both the US and NATO have been "accelerating build-up of infrastructure in Europe" and emphasised that the deployment of NATO forces near Russia's borders had threatened its security. (Express.co.uk, Russia's Putin blasts 'AGGRESSIVE' US national security strategy as relations PLUMMET December 22, 2017)

Last November, “Vladimir Putin has warned Russian businesses they should be ready to switch to military production in preparation for war. The Russian President told defence ministry officials on Wednesday that the arms production industry - both private and state owned - needed to be prepared to step up manufacturing at a moment's notice.” (Sky News Vladimir Putin tells Russian arms firms to be ready for war, November 23, 2017)

I do hope that Putin’s war preparation is about puppies, “THE Russian military has unveiled its latest puppy recruits, showing off Vladimir Putin’s forces softer side in its New Year’s message.” Express.co.uk Dogs of war! Putin’s military unveils latest puppy recruits in adorable New Year's video January 3, 2018

Though the good news, “President Donald Trump told reporters Saturday at Camp David that he's open to talking with North Korean leader Kim Jong Un. "Sure, I always believe in talking," he said. "But we have a very firm stance. Look, our stance, you know what it is. We're very firm. But I would be, absolutely I would do that. I don't have a problem with that at all." (CNN Trump on North Korea: 'I always believe in talking' January 6, 2018)

Besides, there are many potential geopolitical risk channels, like protectionism, Middle East war, escalation of cyber war, accidents and more…

Lastly, economic downturns will likely increase incumbent frictions and bring to the surface hidden ones.

Phisix 8770: Big New Year Week No Guarantee of Big Annual Return

Essentially, domestic events have resonated with global developments.

The Phisix surged 2.47% in the first week of 2018. Though it would be facile to point out that such a feat would account for the fifth biggest return since 2017, returns don’t appear out of the vacuum.

The Phisix seemed to have been ‘forced up’ especially on Friday January 5th. However, some forces looked as if they have resisted closing the week with a huge advance similar to 2017. So aside from engineered pumps, there was a pump and dump.

 

Returns have been a function of index levels too.

The huge 5.98% New Year week return of 2009 was an offspring to the 2008’s annual (-48.29%) collapse.

In contrast, 2017’s big move 5.96% came after successive two years of marginal declines: -3.85% in 2015, and -1.6% in 2016. Or, the Phisix closed below 7,000 for two years and was materially down from the April 2015 record of 8,127.48.

The Phisix started 2018 at record 8,558.

That’s not all. With the entrenched gaming of the system, returns have been foisted upon the pseudo-market. In fact, 2017’s magnificent New Year week 5.96% advance was preceded by 2016's end of the year trading week’s awesome gains of 4.22%! That is to say, in two holiday abbreviated trading weeks, the Phisix soared by a stunning 10.18%! These essentially pillared 2017’s 25.11% returns.

Fast forward today.

The Phisix would have closed above 8,820 to 8,850 had some cabal of shysters not dumped a boatload of SM shares last Friday. SM plunged a shocking -4.23% in a flash! SM, which was up by 1.37% before the market intervention phase, found itself suddenly down by -2.86% at the closing bell. Nevertheless, end session pumps on Ayala Corp +.95% and JG Summit 1.2% alleviated the last minute retracement of gains in the headline index from SM.

New Year week’s gain of 2.47% plus end December 2017 advance of 1.5% adds up to 3.97%, still a considerable markup.

As one can see from the above, such has not been evidence of a healthy functioning market.  

Also, New Year week performance does not guarantee a robust annual return for 2018 (lowest pane)

 

The meat of this week’s phenomenal gains accrued from the performance of the second quintile group

Risks From BSP’s Winner-Take-All Policies

While major central banks have been gradually pulling back on the liquidity stimulus, mostly to build upon policies as insurance against financial risk and to reduce financial instability manifested in the euphoric marketplace, the BSP remains wedded to a winner-take-all policy.

If the Philippine economy has been as robust as popularly depicted, why has it been that the BSP’s emergency measures (historically low-interest rates and expanded BSP balance sheets from subsidies to the National Government) remain in place?

Why has the BSP adamantly been resisting normalization of financial conditions? How are emergency measures consistent with a healthy entity?

Most of all, with an “ALL-IN” policy, what ammunition or insurance toolkit does the BSP hold in reserve once financial risk emerges?  Realization of financial risks may be triggered exogenously or endogenously.

If the answer is little or none, what would happen to the Philippine economy under such circumstances? Or has the Philippine economy attained a status where it has become totally immune to risks?

Convincing me is very easy once the above questions are satisfactorily answered or addressed

Yet, let me offer two reasons for the BSP’s recalcitrance.

One. Massive Fiscal Deficits. The huge debt-financed government spending would drain the system’s liquidity. The BSP hopes that through the banking system’s continued credit expansion would offset the liquidity “crowding out” dilemma. The BSP and the DoF have forgotten about prices (interest rates and inflation).

Two. Tax reform. A miscalculation by the DoF on the implementation of the tax reform program would not only be reflected in fiscal balance but also on the affected sectors of the economy. And part of the likely contingent required to address dislocations would entail easy access to money. Therefore, easy money conditions must prevail…

...except that the reason the economy is called as such is that it operates under the premise of “scarcity”. 

And ROP yields of the 10, 20 and 25-year maturities exhibit scarcities in motion! The entire curve has been rising.

So they can pump PSEi at will. But as history has shown, vertical (SSO-BW) prices eventually return to their roots.

Yellen’s Most Dovish Rate Hike

The US Fed hiked interest rates for the second time in three months last week

But instead of a perceived tightening, the perception of a dovish rate hike prompted for a decline of the USD which combusted global risk assets.

Alhambra’s Joseph Calhoun handily wins the quote of the week: The market was starting to price in four (today’s plus two more) and that had to come out of the market after the meeting. This was the most dovish rate hike in the history of rate hikes. Greenspan’s old conundrum was that long term rates weren’t rising as the Fed hiked. The conundrum today is that even short term rates aren’t rising as the Fed hikes. Two year note yields are right back to where they were after the December rate hike. 

Ms. Yellen actually poured oil into the fire when she said: “Even after this increase, monetary policy remains accommodative, thus supporting some further strengthening in the job market and a sustained return to two percent inflation”

She also introduced the word “symmetric” in the FOMC statement which meant flexibility in their inflation targeting: “And it's a reminder, 2 percent is not a ceiling on inflation. It's a target. It's where we always want inflation to be heading. And there will be some times when inflation is above 2 percent, just like it's been below 2 percent. We're not shooting for inflation above 2 percent. But it's a reminder that there will be deviations above -- above and below when we're achieving our objective.”

I have recently opined that the likely reason for the rate hikes may hardly be due to the reading of statistical tea leaves like output gaps but rather that the Fed behind the curve. [Has the Fed “Fallen Behind the Curve”?(March 11, 2017)]

From the perspective above, it’s easy to see the likely factors or influences that may have altered the perspective of the majority officials of the US Federal Reserve.

If the FED has indeed been behind the curve, timid rate hikes will only further bolster the underlying risk appetites.

And Ms. Yellen’s observation that this may “potentially require us to raise rates rapidly sometime down the road” may become self-fulling prophecy.

This is what I meant by falling behind the curve.

Instead of impeding further ramps in asset prices, half-hearted rate increases serve only to accelerate a feedback loop.  In 2004-2006, the Fed raised rates by 17 times! Yet prices of property and the S&P escalated further. US housing prices topped a few months before the Fed’s last rate hike.

In sales, this would be equivalent to “selling a price increase”. In anticipation of a price increase, buyers would buy more quantity of items than they would under normal circumstances. By the same token, timid rate hikes, instead, whet the people’s appetite to load up on debt which they use to chase after asset bubbles. That’s what happened during the last credit cycle which ended with the Lehman bankruptcy.

Yet in the previous cycle, the FED raised rates about four years after (or in 2004) it began cutting rates in 2001 in response to the dotcom bust.

In the current cycle, the Fed hiked rates in late 2015, seven years after it began to slash rates in 2007 in response to the Great Recession.

Seen from the context of the S&P, the first time the Fed increased rates the bull market was only 1 and a half years old or at its first leg.

In the current setting, the Fed increased rates in December 2015 when the bullmarket was about 7 years old!

The point here is that modern day central banks are afraid to take the proverbial punch bowl away because of they are in mortal dread of debt deflation. Debt signifies a monster which they have created, which ironically, they have been afraid to confront.

Yet the question is if the aging US bullmarket would still have the stamina to carry through amidst the tremendous amount of malinvestments that have been acquired or accumulated through the years.

As I have been pointing out here, near vertical record US stocks has been founded from increasing questionable quality. It has been practically been pillared on hope backed by rationalizations and by the herding effect predicated on the fear of missing out.

In the 4Q US flow of funds, US stocks were driven secondarily by corporate buybacks and primarily by retail investors who chased after passive funds.

Here’s Mr. Ed Yardeni with the details:  (bold mine)

(1) Supply-side totals. Net issuance of equities last year totaled minus $229.7 billion, with nonfinancial corporate (NFC) issues at -$565.7 billion and financial issues at $269.7 billion. The increase in financials was led by a $283.9 billion increase in equity ETFs, the biggest annual increase on record. The decline in NFC issues reflected the impact of stock buybacks and M&A activity more than offsetting IPOs and secondary issues. 

(2) Demand-side total. To get a closer view of the demand for equities, let’s focus now on the quarterly data at an annual rate rather than at the four-quarter sum. This shows that equity mutual funds have been net sellers for the past five quarters, reducing their holdings by $151.3 billion over this period. Over the same period, equity ETFs purchased $266.4 billion, with their Q4-2016 purchases a record $485.4 billion, at a seasonally adjusted annual rate. Other institutional investors have been selling equities for the past 24 consecutive quarters, i.e., during most of the bull market! Foreign investors have also been net sellers over this same period. 

So smart money sold while retail investors piled in.

The normally bullish Mr. Yardeni concluded: “The bottom line is that the current bull market has been driven largely by corporations buying back their shares, as I have been observing for many years. More recently, we have been seeing individual investors increasingly moving out of equity mutual funds and into equity ETFs.Both kinds of buyers tend to be much less concerned about historically high valuation multiples than more traditional buyers are. We may be witnessing the beginning of an ETF-led melt-up, which may simply reflect individual investors pouring money into passive stock index funds. Lots of them seem to bemore interested in seeking out low-cost funds rather than cheap stocks. In this case, valuation multiples would lead the melt-up, until something happens to scare investors out of those passive funds, which could trigger either a correction or a nasty meltdown. It is obviously a bit late in the game to start only now to be a long-term investor given that stocks aren’t cheap no matter how valuation is sliced and diced.”

And there’s one thing I forgot to mention last week.

The US treasury injected hundreds of billions of funds into the system in anticipation of the expiration of the US debt ceiling last March 15 from the start of the year. Since this has almost been similar to a credit easing, this may have driven the record-breaking “Trump bump trade”. Unfortunately, this is a liquidity illusion. The first reason: the Fed’s hiking cycle would mean trimming of excess reserves in the system. The next reason is that when the debt ceiling will be lifted, the US treasury will likely sell huge amounts of debt into the system which means it would entail draining a lot of liquidity in the system.

 

And just how will a drain in liquidity impact the already pressured US retail industry led by the restaurant and the department stores? Retail sales grew at the weakest pace in 6 months last February.

Even worst, credit instruments to shopping malls seem as Wall Street’s next biggest shorts!

From Bloomberg (March 13, 2017):

Wall Street speculators are zeroing in on the next U.S. credit crisis: the mall.

It's no secret many mall complexes have been struggling for years as Americans do more of their shopping online. Now they're catching the eye of hedge-fund types who think some may soon buckle under their debts, much as many homeowners did nearly a decade ago.

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy's and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.

Wow, if US shopping malls become the epicenter of a crisis, this will likely spread across the globe the world! Guess what would happen to Philippine malls???

As a final thought, it wasn’t just the FED that hiked rates. Countries which had their currencies pegged to the USD like Hong Kong, UAE and Kuwait raised interest rates. China’s PBOC raised rates on repos (open market operations) and medium lending facility 10 hours after the FED hiked. While the BOJ kept policy unchanged, rumors floated of a “stealth tapering” where the BoJ would miss hitting its annual LSAP targets.

With global stocks on a tear as liquidity is being withdrawn, just how sustainable can this environment be?

As a final note, the Geert Wilders, the far-right contender lost the Netherland’s national elections last week.