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!

Has the Fed “Fallen Behind the Curve”?

In this issue:

Has the Fed “Fallen Behind the Curve”?

Have Chinese Punters Driven Up Global Inflation Expectations?

Animal Spirits versus Emergent Liquidity Strains?

Has the Fed “Fallen Behind the Curve”?

Will the US Federal Reserve raise interest rates in the coming FOMC meeting in March 14-15?

Has it been a coincidence for Fed officials to suddenly chime in to signal a March rate hike?

Last week, the big guns of the US Federal Reserve, namely presidents of St. Louis Fed James Bullard, San Francisco Fed John Williams, Richmond Fed Jeffrey Lacker, Cleveland Fed Loretta Mester, Philadelphia Fed Patrick Harker, Dallas Fed Robert Kaplan and NY Fed William Dudley, likewise Fed Governors Jerome Powell and Lael Brainhard and Fed Vice Chair Stanley Fisher has virtually expressed support for a March interest rate move.

With Fed doves L. Brainhard and W. Dudley joining the hawks, a March hike could be in the offing.

Fed fund futures as of March 3 exhibited a 79.7% chance of a March 15 rate hike.

Or has such seeming coordinated action signified a “signaling channel” intended to shape the public’s expectations?

Or has this functioned as a trial balloon to test market’s reaction?

What’s even more striking has been the speech of Fed Chair Janet Yellen who denies that the FED has been behind the curve¹

This same approach will continue to drive our policy decisions in the months and years ahead. With that in mind, our policy aims to support continued growth of the American economy in pursuit of our congressionally mandated objectives. We do that, as I have noted, with an eye always on the risks. To that end, we realize that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession. Having said that, I currently see no evidence that the Federal Reserve has fallen behind the curve, and I therefore continue to have confidence in our judgment that a gradual removal of accommodation is likely to be appropriate. However, as I have noted, unless unanticipated developments adversely affect the economic outlook, the process of scaling back accommodation likely will not be as slow as it was during the past couple of years.

Yet Ms. Yellen seems to be part of the “hawkish” crowd who may likely vote for a March rate increase.

It would be natural for any official to refuse acknowledgement of any errors attributed on them. Any lapses have almost always been blamed on external or exogenous forces.

Besides, falling behind the curve will be seen or judged in the context of the future than today.

Nevertheless, the rapid buildup in inflationary biases expressed in asset prices, which seems to have percolated into real economy prices, may have likely prompted for this abrupt change in sentiment of Fed officials.

US stocks have virtually been on fire or have been in a virtual meltup mode.

This can be seen via the fiery year to date returns by the Dow Jones Industrials (+6.29%), S&P 500 (+6.44%) and Nasdaq (+9.06%). Present returns may have already fully priced in whatever highly optimistic growth expectations that may emerge from Trump’s policies.

And a string of record breaking developments have occurred based on price actions, fund flows and valuations.

Price actions. The Dow Jones which hit 21,000 last week matched the record of the fastest 1,000 point advance which was last attained in 1999. Including the Russell 2000, all four major indices were at record highs last week. The S&P 500 has enjoyed the longest streak of gains without a 1% correction.

Fund flows. Mom and pop investors have been piling into the equity markets mostly via passively managed funds. Based on estimates by JP Morgan, retails plowed $ 86 billion into equity Exchange Traded Funds as of February.

Global investors funneled $62.9 billion into ETFs last February for a two month $124 billion record net inflows as reported by the ETF industry.

Goldman Sachs has warned of extreme complacency as global investors have discarded hedges and rushed “headlong into risk”.

Valuations. Conventional valuation metrics such as Shiller CAPE ratio, (Tobin’s) Q ratio and the Buffett indicator (market cap to GDP) reveals of severe overvaluations. The Shiller CAPE ratio and the Q ratio have reached 1929 highs! The trailing twelve months (TTM) PER of the small cap Russell 2000, based on Wall Street Journal’s Market Data Center as of March 3, was at a shocking 240.92! Whereas the Dow Jones Industrials, S&P 500 and Nasdaq TTMs were at 21.45, 24.9 and 25.78, respectively!

Quality matters too. High debt-low quality and low dividend paying stocks have mainly energized today’s record breaking streaks.

Overconfidence. Last week, a photo app developer, Snap had a sparkling debut—a 44% jump in its share prices. The company has been burning cash, has no profits and has barely significant sales and was last valued at a whopping 78x earnings!

And it’s not just stocks.

Junk bonds have become the “best performing bonds this year” as investors stampeded into them. Yields of junk bonds as exemplified by BofA Merrill Lynch US High Yield CCC or BofA Merrill Lynch US High Yield Effective Yield have plumbed to 2014 lows.

Real estate prices have almost recaptured the 2007 glory. The S&P Dow Jones reported that last December, the S&P CoreLogic Case-Shiller U.S. National Home Price NSA index posted a 5.8% yoy gains, the 10-City composite 4.9% and the 20 city composite 5.6%. The S&P/Case-Shiller 20-City Composite Home Price Index can be seen just a stone throw distance from the 2007 highs.

To add, prices of Commercial Real Estate (CRE) are at record highs. Just last February, the FED had a special mention of heightened risks in the sector: “Commercial real estate (CRE) valuations, which have been an area of growing concern over the past year, rose further, with property prices continuing to climb and capitalization rates decreasing to historically low levels”.

And again it’s more than just asset prices; it’s about inflation expectations too.

Three major inflation gauges the 10-Year Treasury Inflation-Indexed Security, Constant Maturity, the 5-Year, 5-Year Forward Inflation Expectation Rate and the 10-Year Breakeven Inflation Rate have been scaling upwards since June 2016 albeit at an accelerated rate. January’s ISM manufacturing prices (prices paid) have doubled from a year ago!

US CPI which increased to 2.5% last January has climbed for the sixth consecutive month to reach its highest level since 2012.

And it’s not just the US. Risks appetite has been whetted essentially everywhere.

Global stocks are at record highs.

In Asia, major equity bellwethers of Bangladesh, Pakistan or Vietnam continues to carve fresh zeniths. Meanwhile, stock market benchmarks of Australia, New Zealand Taiwan, and Indonesia have been testing record heights. Also, major indices of Japan, Hong Kong, Korea, Singapore and Thailand have reached 52 week peaks.

Aside from stocks, the current risk ON climate has been manifested in bonds.

Asia’s corporate debt continues to swell. The premium between emerging market sovereign debt and US corporate bonds has been in a compressing trend. And with lowered rates, such has spurred a race to sell bonds in the corporate world of emerging markets.

Moreover, sizzling global property prices have scaled upwards to near 2007 apogee. That’s based on the IMF’s global real house price index.

And again, it’s not just asset prices; but real economy prices too.

In both emerging and developed Asia, rising government CPI or CPI at elevated levels can be seen in Taiwan, South Korea, China, Sri Lanka, Myanmar, Vietnam, Indonesia and the Philippines.

On the other hand, CPI recently jumped in Japan, Singapore, New Zealand, Malaysia, Thailand and Mongolia.

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.

Have Chinese Punters Driven Up Global Inflation Expectations?

Yet mounting inflationary biases have originated mostly from the massive expansion of central bank balance sheets.

Assets of major central banks have rocketed 271% to $17.6 trillion (January 2017) from about $6.5 billion in 2008 (Yardeni.com).

The ongoing QE programs by Bank of Japan, Bank of England and ECB accrue to around $2 trillion a year.

On top of the QEs by the trio have been China’s social financing. Total Social Financing (TSF) data has spiked to a cumulative $2.7 trillion in 12 months last January, of which bank loans at US $1.8 trillion has accounted for 67% of the lending by financial institutions, but also by Chinese households and non-financial entities.

Add to the above, outside the formal sector financing has been the US $ 3.8 trillion off-balance sheet assets, which is otherwise known as the “shadow banking system”.

Since issued money has to go somewhere, the tsunami of liquidity has only bolstered shifting episodes of frenzied speculations by the average Chinese on stocks (2015) to bonds to real estate and to commodities.

Aggregate trading volume of commodity futures roared to a record 177.4 trillion yuan ($25.5 trillion) or up 30% yoy in 2016, according to Bloomberg.

This entails that perhaps much of the price inflation seen in the commodity spectrum have been from the Chinese speculators. And this could have been interpreted as “reflation” by most of the world.

To emphasize, the above central banks infused humongous amounts of liquidity to the tune of nearly $ 5 trillion last year! And they are likely to continue with such infusions in 2017. And this excludes other emerging market central banks that have mimicked their developed market peers.

Yet if my suspicion holds true that the perceived “reflation” had largely been a transmission mechanism from the Chinese punters indirectly financed by the PBoC, just what would happen to the “reflation” trade once there could be a pullback in liquidity?

WTIC and Brent prices appear to be manifesting a topping formation. Gasoline and gold prices cratered last week, perhaps in response to the Fed’s hawkishness.

For instance, given that energy and transportation have largely influenced the recent spike in US CPI, then what happens if oil and gasoline prices fumble anew?

Would the FED reverse course and reintroduce QE?

Animal Spirits versus Emergent Liquidity Strains?

Curiously, despite the huge ballooning of credit creation, which can be seen in the sizeable expansion of assets of China’s central bank, the People’s Bank of China (PBoC), its foreign exchange holdings continues to fall (see above).

And this appears to have been reflected in the decline of the offshore (CNH) and of the onshore (CNY) yuan. The falling yuan has popularly been attributed to capital flight or “capital outflows”

And despite the repeated injections by the PBoC, Shibor rates across the curve remains elevated and unstable since the 2H of 2016. Perhaps part of these may have been from the 54% surge in bankruptcy cases in 2016. But the liquidity pressures can be seen, not just in Shibor, but in CNH Hibor (Hong Kong) rates too.

All these looks like signs of US dollar liquidity shortage amidst a flood of liquidity in the yuan. This demonstrates that domestic liquidity has a much different dynamic than the US dollar liquidity. Maybe the PBoC has been substituting US dollar illiquidity with yuan liquidity in the hope to contain tensions from the mismatch.

Yet once domestic liquidity recedes in China, out of political design from authorities or by sheer weight of market forces, it is likely to reverse present signs of “reflation”. Even more, this could amplify the US dollar illiquidity strains.

And US dollar illiquidity may not be confined to China but likewise to the $9.7 trillion US dollar borrowers outside the US whereby emerging markets account for a third. Slower economic growth would likely induce greater demand for the US dollar.

And should the Fed persist to increase interest rates, China’s US dollar liquidity dilemma may be amplified.

And even worst, should a trade war be opened, present liquidity flows will most likely experience dislocations, hence, liquidity conditions can be expected to deteriorate

It’s not just in China. Even amidst the ongoing euphoria in the US markets, signs of liquidity strains have been present.

LIBOR rates have been rising across the curve since 2015: overnight, 1-month, 3-month, 6 month, 12 month. Goldman Sachs estimated that $28 trillion of loans have been tied to Libor. While LIBOR rates are way off the highs 2007, the fact they are rising could be a sign of emergent hidden stress.

The same rising dynamic applies to the liquidity indicator the TED spread.

Much of these had been blamed on the 2a7 reform, but today they seem as mostly imputed to prospective interest rate actions by the FED.

And yet, despite higher inflation expectations, yield spreads have been flattening. An example would be the 10-2 year spread.

Perhaps such has affected the rate of growth (% from a year ago) of commercial industrial loans, which at 6.7% in January, has tumbled to 2013 lows.

In addition, hard data seem to have departed from the ebullience exhibited by survey based “soft” data and the financial markets.

For instance, US 4Q GDP slowed to 1.9%. In addition, Atlanta Fed’s GDPNOW marked down 1Q 2017 to 1.8%.

In Europe, the ECB’s payment and settlement system TARGET2 has now been running a record.

In January, Germany posted its highest ever inflow. On the obverse side have been record outflows from Italy and Spain. Spain appears to be fast catching up with Italy.

It is not clear whether this is about populist politics or about Europe’s fragile banking system. It can even be both. France, Germany and Netherlands are slated to hold national elections this year.

At the end of the day, current market activities have been reflecting on mostly “animal spirits” or the herding effect that has been lubricated by domestic liquidity and rationalized on hope.

Yet ultimately, liquidity conditions will likely determine its sustainability.

1 Chairman Janet Yellen “From Adding Accommodation to Scaling It Back” At The Executives' Club of Chicago, Chicago, Illinois March 3, 2017