Headline of the Day: Media's Change of Tune: Cheap Oil Now a Bane to the Economy!

Interesting headline from today's Nikkei Asia (economy section)

Haven’t we (the average citizens) been inundated by media that cheap oil was supposed to be a boon for the economy? In particular, consumers should have engaged in a spending binge that would have boosted GDP or G-R-O-W-T-H?

So why the seeming (or reluctant) change of tune? Because things have been falling apart now? That denial through rationalizations by spin doctors or so-called 'experts' haven’t delivered what they were supposed to?

Or has it also been that previous denials were meant or designed to camouflage that the fundamental problem of tanking oil prices has been due to mainly government interventions? That easy money policies have enabled a massive debt financed buildup of oil supply? Also that easy money policies have hardly led to consumer income growth but instead to asset bubbles, part of which financed the energy sector’s supply side boom?

Or has it been that the pressures from the entitlement society of the welfare state along with hubris by the governments of oil producing nations prompted the said authorities to think that they were above the laws of economics for them to keep pumping regardless of prices (in the name of 'market share')?

Ideas have consequences. And it appears that we will distressingly pay a heavy price for applying the wrong ideas.

As Oil Prices Collapse Anew, Tremors Hit Global Stock Markets

Financial market crashes have become real time.

Well, last night oil prices plummeted again. The European Brent crashed 5.87% to 53.11 per bbl while the US counterpart the WTIC dived 5.42% to close BELOW $50 or $49.95 a bbl.

The chart above from chartrus.com reveals that the present levels of US WTIC have reached 2009 post Lehman crisis levels.

Then, oil prices responded to deteriorating economic and financial conditions. Today, oil prices seem to lead the way.

Collapsing oil prices hit key stock markets of major oil producers, such as the Gulf Cooperation Council, quite hard.

The recent sharp bounce that partly negated losses from the harrowing crash that began last September seem to have been truncated as Dubai Financial, Saudi’s Tadawul, and Qatar’s DSM suffered 3.35%, 2.99% and 1.91% respectively (charts from Asmainfo.com) last night.

In short, bear market forces seem as reinforcing its presence in these stock markets.

Yesterday’s oil price meltdown affected least Oman’s Muscat and Bahrain Bourse. Nonetheless, again bear markets have become a dominant feature for GCC bourses.

A prolonged below cost of production oil prices will translate to heavy economic losses for Arab oil producing states. Such will also entail political repercussions as welfare programs of these nations depend on elevated oil prices as discussed here.  This will also have geopolitical ramifications.

Incidentally, as I previously pointed these nations play host to a majority of Philippine OFWs. 

More than half or about 56% of OFWs according to the Philippine Overseas Employment Administration (POEA) have been deployed to this region. Will OFWs (and their employers) be immune from an economic or financial crisis? This isn’t 2008 where the epicenter of the crisis was in the US, hence remittances had been spared from retrenchment. For this crisis, there will be multiple hotbeds.

So a financial-economic collapse (possibly compounded by political mayhem) in GCC nations may impede any remittance growth that could compound on the travails of the Philippine bubble economy.

It’s not just in emerging markets, though, last night Europe’s stock markets likewise convulsed.

Part of the concerns had not only been about oil but about a GREXIT or Greek default from tumultuous Greek politics based on the failure to muster majority support for a presidential candidate.

Incredibly German’s DAX was slammed 3% (table above from Bloomberg).

Crashing Greek stocks lost another 5.63% yesterday.

Apparently broad based selling also buffetted near record US stock markets.

The XLE Energy Sector endured another tailspin down by 4.19%. Yesterday’s clobbering only fortified the bear market forces affecting the US energy sector which has diverged from her peers.

I propounded that the slumping energy sector will eventually impact the rest of the markets. Divergence will become convergence; periphery to the core.

Remember, the reemergence of heightened financial volatility comes in the face of October’s stock market bailout via stimulus implemented by ECB, BoJ-GPIF, and the PBOC.

This implies that the soothing or opiate effects, which had a 3 month window, has been losing traction. 

Will Ms. Yellen come to the rescue???

As Oil Prices Collapse Anew, Stocks of US Energy and Oil Exploration Firms Crash!

So the US stock markets isn’t invulnerable to market crashes after all.

As I have been saying, since October, market crashes have become real time. Most importantly, incidences of global market crashes has been spreading.

Prices of both US and Europe’s oil benchmarks continues to plummet, falling by over 3% last night. OPEC projects that demand for oil will be the weakest in 12 years. But this hasn't just been about oil. Commodity prices in general has been sluggish as seen by the CRB index or even in Industrial metal stocks (GYX)

Meanwhile, crashing oil prices has also prompted the S&P Oil and Gas exploration (XOP) benchmark to a 4.79% meltdown last night!

The carnage in the energy sector (XLE) led last night’s selling pressure.

Even the bullish Bespoke Invest admits: "The S&P 500 Energy sector has now fallen 25% from its peak nearly six months ago, while the S&P 500 Oil Exploration and Production group has fallen even more at -45%.  If you want to label it a crash, be our guest." 

The energy sector's meltdown spread to the general market.

Will the energy sector, particularly the shale industry, serve as the causa proxima to a financial crisis?

Remember these crashes comes in the face of ECB-BoJ-PBoC easing which seems to indicate that the ecstatic phase of the stimulus seems to have already faded.

And those who buy into the “immunity”, “decoupling” and G-R-O-W-T-H thesis will soon be surprised when crashes becomes THE general market condition.

History tells us that the obverse side of EVERY mania is a CRASH, central Bank Put notwithstanding!

Causa Proxima: Will US Shale Oil Debt function as the Modern Day Equivalent of Housing Subprime Mortgages?

Every crisis requires a trigger, a causa proxima or events or “incidences which saps the confidence in the system” as historian Charles Kindleberger wrote in his classic book; Manias, panics and Crashes.

Could high yield debt from US Shale industry be the modern day equivalent of the US housing subprime mortgages of 2007-8?

I explored on this last weekend: Yet it’s a wonder how the oil and energy industry (also the material industry) will respond to still collapsing prices or how they will affect economic activities. So far, new oil and energy permits have plummeted 40% (!), and so with Shale permits down 15% for across all major oil formations last month. Shale oil at the Bakken oil field at North Dakota has seen prices even plunge to $49.69 last November 28 (!), according to a Bloomberg report. That’s way (24%) below the $65.63 WTIC oil quoted last Friday. Yet from 2007-2012, about 16% of job growth came from the oil gas industry which outperformed the other sectors, according to the EIA. If the oil industry retrenches this will impact jobs as well as other sectors attached to them.

Analyst David Stockman splendidly expounds on this (excerpted from Mr. Stockman’s Contra Corner)

The US housing mania… [bold original, italics mine]

At bottom, the leading edge of the housing mania was the implicit price of land. That’s what always get bid up to irrational heights when the central bank fiddles with free market pricing of capital and debt.

Even as land prices were being driven to irrational heights you didn’t need to spend night and day in arcane data dumps to document it. All you had to do was look at the stock price of the homebuilders.

As I documented in The Great Deformation, the combined market cap of the big six national homebuilders including DH Horton, Lennar, Hovnanian, Pulte, Toll Brothers and KBH Homes soared from $6.5 billion in 2000 to $65 billion by the 2005-2006 peak. Yet you only needed peruse the financial statements and disclosures of any of these high-flyers and one thing was screamingly evident. They weren’t homebuilders at all; they were land banks that did not own a single hammer or saw or employ a single carpenter or electrician.

Stated differently, the homebuilders’ soaring profits were nothing more than speculative gain on their land banks—gains driven by the cheap mortgage mania that had been unleashed by Greenspan when he slashed the so-called policy rate from 6% to 1% in hardly 30 months of foot-to-the-floor monetary acceleration between 2001 and 2004.

Indeed, that cluelessness amounted to willful negligence. DH Horton was the monster of the homebuilder midway—–a giant bucket shop that never built a single home, but did accumulate land and sell finished turnkey units by the tens of thousands each period. Did it not therefore occur to the monetary politburo that DH Horton had possibly not really generated a 11X gain in sustainable economic profits in hardly 5 years?

The Shale oil mania…

So now we come to the current screaming evidence of bubble finance—–the fact that upwards of $500 billion of junk bonds ($200B) and leveraged loans ($300 B) have surged into the US energy sector over the past decades—–and much of it into the shale oil and gas patch.

Folks, you don’t have to know whether the breakeven for wells drilled in the Eagleville Condy portion of the great Eagle Ford shale play is $80.28 per barrel, as one recent analysis documents, or $55 if you don’t count all the so-called “sunk costs” such as acreage leases and oilfield infrastructure. The point is, an honest free market would have never delivered up even $50 billion of leveraged capital—let alone $500 billion— at less than 400bps over risk-free treasuries to wildly speculative ventures like shale oil extraction. 

The fact is, few North American shale oil fields make money below $55/barrel WTI on a full cycle basis (lease cost, taxes, overhead, transport, lifting cost etc.). As shown below, that actually amounts to up to $10 less on a netback to the wellhead basis—–the calculation that drives return on drillings costs.

In short, as the oil market price takes its next leg down into the $50s/bbl. bracket, much of the  fracking patch will become a losing proposition. Moreover, given the faltering state of the global economy and the huge overhang of excess supply, it is likely that the current crude oil crash will be more like 1986, which was long-lasting, than 2008-09, which was artificially resuscitated by the raging money printers at the world’s central banks.

So why is there a shale patch depression in store? Because there is literally a no more toxic combination than the high fixed costs of fracked oil wells, which produce 90% of their lifetime output in less than two years, and the massive range of short-run uncertainty that applies to the selling price of the world’s most important commodity.

Surely, it doesn’t need restating, but here is the price path for crude oil over the past 100 months. That is to say, it went from $40 per barrel to $150, back to $40, up to $115 and now back to barely $60 in what is an exceedingly short time horizon.

Obviously, what we have here is another massive deformation of capital markets and the related flow of economic activity. The so-called “shale miracle” was not made in Houston with some technology help from Silicon Valley. The technology of horizontal drilling and well fracking with chemicals has been around for decades. What changed were the economics, and those  were made in the Eccles Building with some help from Wall Street.

As to the latter, was it not made clear by Wall Street’s mortgage CDO meth labs last time that when the central bank engages in deep and sustained financial repression that it produces a stampede for “yield” which is not warranted by any sensible relationship between risk and return? It should not have been even possible to sell a shale junk bond or CLO that was based on assets with an effective two year life, a revenue stream subject to wild commodity price swings and one thing even more unaccountable. Namely, that the enterprise viability of virtually every shale junk issuer has always been dependent upon an endless rise in the junk bond issuance cycle.

Stated differently, oil and gas shale E&P operators are drastic capital consumption machines. Due to the lightening fast decline rates of shale wells, firms must access more and more capital just to run in place. If they don’t flush money down the well bore, they die along with all the “sunk” capital that was previously put in place.

In the case of shale oil, for example, it is estimated that were drilling to stop for just one month, production in the Eagle Ford, Bakken and one or two other major provinces would drop by 250,000 barrels per day. After four months, the drop would be 1 million bbl./day and after a one-year, nearly half the current four million barrels of shale oil production would disappear.

That’s why all of a sudden there is so much strum and drang about “breakeven” pricing. Obviously, new drilling is not going to go to zero under any imaginable price scenario, but for all practical purposes the shale revolution could shut down just as fast as did the housing boom in 2006-2007. In effect, the shale financing boom presumed that both the junk bond cycle and the oil price cycle had been eliminated.

Needless to say, they have not. So the impending “correction” may well be as swift and violent as was the housing bust.

The coming shale oil bust…

Indeed, in the short-run the shale crash could be worse. The fantastic, debt-fueled drilling spree of the past 5-years is now sunk and will produce rising levels of production for a few quarters until rig activity is sharply curtailed and some of the better capitalized operators stop drilling in order to avoid lease expiration writeoffs.

So as the WTI market price is driven toward $50/ barrel, recall that the netback to the producer is significantly less. In the case of the biggest shale oil province, the Bakken, the netback to the well-head is upwards of $11 below WTI.  Accordingly, cash flow will plunge and that source of drilling funds will evaporate with it.

But the big down-leg is coming in the junk market. This time around, Wall Street has been even more reckless in its underwriting than it was with toxic securitized mortgages. Barely six months ago it sold $900 million of junk bonds for CCC rated Rice Energy.  The latter operates in the Marcellus gas shale trend but that makes the story even more preposterous.

These bonds were sold at barely 400 bp over the 10-years treasury, and the issue was 4X oversubscribed. That is, there was upwards of $4 billion of demand for the bottom of the barrel securities of a shale speculator that had generated the following results during its 15 quarters as a public filer with the SEC. To wit, it had produced $100 million of cumulative operating cash flow versus $1.2 billion of CapEx. In short, if the junk bond market dies, Rice Energy is a goner soon thereafter.

The transmission mechanism: From debt to the economy…

As the global boom cools, oil demand withers, the junk market craters, and the shale patch tumbles into depression, someone might actually note the chart below.

Its been another central bank parlor trick. The job count in the 45 non-shale states last Friday was 400,000 lower than it was at the end of 2007. That’s right, not one new job—even part-time or in the HES complex—- for the last seven years.

All the new jobs have been in the 5 shale states. That is, they were manufactured by the Fed’s tidal wave of cheap capital and the central bank fueled global recovery which created the illusion that $100 oil was here to stay.

But it isn’t and neither is the shale boom, the shale jobs or the shale investment spike, which counts for a good share of overall CapEx growth since the crisis.

Yes, indeed. The monetary politburo did it again.

Phisix: Tremors Rock Philippine Casino Stocks, Malaysian Financial Markets

How could they? How could policymakers have allowed so much debt to be created in the first place, and then failed to regulate their own system accordingly? How could they have thought that money printing and debt creation could create wealth instead of just more and more debt? How could fiscal authorities have stood by and attempted to balance budgets as opposed to borrowing cheaply and investing the proceeds in infrastructure and innovation? It has been a nursery rhyme experience for sure, but more than likely without a fairytale ending. William H. Gross, How Could They? Janus Capital December 2014

In this issue

Phisix: Tremors Rock Philippine Casino Stocks, Malaysian Financial Markets

-Stock Market Drivers: Liquidity, Credit and Confidence

-Examples of Liquidity, Credit and Confidence: China, Japan, Europe and US

-US Treasury Arm Warns on Financial Instability, BOJ-ECB Internal Split Deepens, Moody’s Downgrade JGBs

-Malaysian Ringgit Crashed; Malaysian Stocks Smashed!

-Cracks in the Philippine Casino Bubble: Philippine Casino Stocks Crushed!

Phisix: Tremors Rock Philippine Casino Stocks, Malaysian Financial Markets

Stock Market Drivers: Liquidity, Credit and Confidence

Has economic or earnings growth really been driving stocks?

Establishment institutions amplified by media have imprinted on public consciousness of such relationship, without having to prove its casual connections except to assume its existence.

Everybody says it, so it must be true. And like religion, anyone who defies such deeply held beliefs would be treated as blasphemer. For the consensus reality must be abandoned for the sake of convenience.

First of all there won’t be massive mispricing of the stock market if growth indeed mattered. The basic reason for overvaluations has been that stock markets returns have vastly outpaced corporate earnings and economic growth, the result of which have been multiple expansions. This is elementary. Yet the establishment persist to regale the unwitting and hapless public with the ‘G-R-O-W-T-H’ regardless.  Yet the establishment does not reveal to the public their interests in promoting these.

This leads us to the subsequent factor: the WHY.  The reason behind multiple expansions have been because momentum. Momentum signifies the piling up of money on winning trends. They are products of the assumption of trend continuity (linear thinking) and of the survivorship bias—a cognitive error which focuses on the winners at the exclusion of non-winners or even risks.

Dismissing the risks from piggybacking on momentum has not escaped even the Philippine central bank, Bangko Sentral ng Pilipinas chief Amando Tetangco Jr., who recently warned: So in a period of low volatility such as what we have been experiencing, practice the discipline of setting limits. This discipline will not only help you to avoid the pitfalls of “chasing the market”.[1]   In a follow-up speech he admonished that yield chasing has been a stock market and real estate phenomenon.

For the Philippines, there has been third factor: manipulation of the index. Entities benefiting from today’s risk appetite has been goading the public to “chase the market” via manipulation of the stock market index.

The massaging of the index via the “afternoon delight” pump and marking the close has become so evident if not a regular dynamic. Apparently because it works to the benefit of the consensus, such haven’t been an issue. Regulations[2] yield to convenience. It’s when the honeymoon ebbs or when the tide turns where finger pointing will emerge.

Yet stealth massaging of the index is a sign of overtrading or “chasing the markets”

Lastly it doesn’t take math models to disprove the populist wisdom G-R-O-W-T-H EQUALS a STOCK Market Boom. All it takes is for a keen sense of observation of real events.

In the last global crisis (2007-2008), the Phisix suffered severe losses from a contagion that basically disregarded fundamentals. The Philippine benchmark lost 54% (peak to trough) even when the rate of corporate earnings growth (then at a record) declined by only a margin. Said differently, earnings growth decelerated as the Philippine statistical economy eluded recession.

I wrote then[3]: The Phisix did not suffer a recession or a crisis, yet the local stock market endured MORE losses compared to the epicentre or the source of the crisis—the US markets. In short, there has been no meaningful correlation or even an established causation nexus between corporate profits and the economy relative to the stock market under the local setting.

The Phisix even lost as much as the US S&P 500 even when there was hardly any fundamental impairment except on the export sector. So despite the rout, it was easy to be bullish on the Phisix.

Yet during those days what mattered: the shriveling of global liquidity or domestic economic or earnings growth? Apparently history lost its relevance. Why?  Because this time is different?

Examples of Liquidity, Credit and Confidence: China, Japan, Europe and US

Today, Philippine statistical economic growth has been petering out, yet the sustained assault by the bulls on 7,400.

Statistical economic growth data measures the formal economy. Therefore, a slowdown on statistical GDP should generally translate to a decline in earnings of publicly listed corporations.

So what’s the reason to justify upside momentum? That the decline in economic growth has been an anomaly? Or has been that credit growth continues to grow in the opposite direction with economic growth? Has the sustained swelling of the rate of credit growth been funneled to “chasing the markets”?

More examples.

As of 3Q, Japan entered a ‘technical’ recession. Yet the Nikkei has been 10% up year to-date, has amazingly soared by 23% from the mid-October lows and as of Friday has been at 7 year highs. From the mid-October lows the Japanese yen has collapsed by 13.04% vis-à-vis the US dollar. Why? Because the Japanese government has been inflating or flooding liquidity into the system. The Japanese government via the Bank of Japan (BoJ) expanded her program to purchase government bonds (JGB) to 80 trillion yen, the stock market via exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) worth 3 trillion yen (tripled compared with the past) and about 90 billion yen (tripled compared with the past), respectively[4].

Playing the role of ‘greater fool’, as of the last 3 trading days, the BoJ bought 37.4 billion yen ($309 million) in exchange-traded funds, according to Nikkei Asia[5]. This should add to the “roughly 7.2 trillion yen in stocks and ETFs at the end of September, fast approaching the 7.5 trillion yen held by Nippon Life Insurance. The BOJ is expected to become the second-largest holder of Japanese stocks, after the Government Pension Investment Fund. A public pension fund and the central bank will thus be corporate Japan's top two shareholders.” (bold added)

As you can see, none of the above has been about growth. Rather all of the above has been about the BoJ’s massive redistribution of resources via money printing to reward owners of bonds, real estate and equities, as well as, speculators at the expense of the average citizenry.

All these, like its antecedent in April 2013 have been anchored on, or peddled by the establishment on HOPE. And given that the Japanese government “will become the second-largest holder of Japanese stocks” implies two things; first, stock markets will become even more politicized thereby eroding its function as discounting mechanism, and second, market risks will now become a burden of taxpayers, pension beneficiaries and currency holders.

How about China?

The drastically slowing highly levered Chinese real (and not statistical) economy has compelled the People’s Bank of China (PBoC) to do a series of easing measures.  As I recently pointed out the Chinese government has launched “targeted easing” last June, has resorted to selective bailouts of firms which almost defaulted last July, imposed price controls on stock market IPOs last August, injected $125 billion over the last two months.

The much ballyhooed China-Hong Kong connect also went onstream November 17 where the Chinese government also liberalized fund flows on IPOs conducted overseas to ensure money overseas can be repatriated with ease.

The Chinese government via the PBoC has also refrained from sterilizing funds injected to system.

I have also pointed out that the Chinese government has been manipulating the stock market via the Initial Public Offerings (IPO) by dictating on the prices of companies offering shares to the public. Since there have been signs of ballooning credit strains in the system, IPOs has become a fashionable route to raise alternative source of funding. The IPOs have essentially been set by the government at lower prices than market prices, thereby fueling outsized demand where the public deems this as “sure profit source”.

The Nikkei Asia affirmed this interventionist route last week which they say “has been fueling an overheating of IPO stocks”.

In addition, the frenzied demand for IPOs has been reached nearly 5 year highs, that’s only for IPOs issued between Nov. 24-28 which totaled about 1.43 trillion yuan ($232 billion). And because of soaring demand for credit to speculate on IPOs the PBoC has injected 50 billion yuan into the system last November 21[6]. The PBoC also refused to conduct open market operations which means that the Chinese central bank continues to feed to the huge demand for credit used to speculate on IPOs.

While IPOs has functioned as the trigger, credit has fueled a Viagra like 90 degree skyrocketing of the Chinese stock market, as seen via the Shanghai Composite index.

The Shanghai Composite has been up by a staggering 38% year to date, a 3 year high, up a stunning 46% from the lows of March which has only been marginally different from the June lows. It’s been a vertical climb for the SSEC!

Retail investors have been stampeding to open stock market accounts “at the fastest pace in three years, official data shows”[7]. Such dash for easy money gains has prompted Chinese punters to acquire a stunning RECORD margin debt. From Bloomberg[8]: Investors bought 99.7 billion yuan ($16 billion) of shares using margin debt on the Shanghai Stock Exchange yesterday, taking the outstanding value of share purchases through borrowed money to a record 552.1 billion yuan, according to data from the bourse (bold mine)

Gee. It took quite some years for US stock punters to bring margin debt into record levels while it took only a few months for Chinese peers to do the same!

And as daily trading turnover to above 1 trillion yuan ($163 billion), paradoxically Chinese authorities warns of irrationality and market risks. From another Bloomberg account[9], “Illegal activities including stock manipulation have recently been “raising their head” and investors should invest rationally, Deng Ge, a spokesman for the China Securities Regulatory Commission, said in a statement on the agency’s website. A stable market is important for the economy, Ge said…I hope investors, especially small and medium investors that are new to the market, invest rationally, respect the market, fear the market and bear in mind the risks present in the stock market,” Ge said.

Huh? Juice up the stock markets by distorting IPO prices, and feed them with credit—then cry foul?!! Blame markets instead of policies that have driven the market’s incentive to ramp up on a speculative orgy?

And as for market manipulation, historian Charles Kindleberger reminds us[10]: The propensities to swindle and be swindled run parallel to speculate during a boom.

Said differently when people become greedy, greed make them vulnerable to unscrupulous activities hatched by entities who recognize of such opportunities. In short, greed engenders fraud.

Yet it’s been a sad plight for the average Chinese, which the Wall Street Journal describes as being caught in chasing one bubble after another[11]: Chinese investors have long chased the best-performing assets. They dumped stocks to buy into a property boom before the global financial crisis, and when the housing market cooled about two years ago, they piled into high-yield but risky bank loans packaged as wealth-management and trust products…

The Chinese government’s financial repression policies have only been diverting precious Chinese savings into needless speculation that consumes their capital—all for the sake of short term political objectives.

And as I have repeatedly been pointing out here, China’s approach to solve her debt problem has been to offer even MORE debt. Such appears as a validation of my theory of the politics of monetary easing policies: I recognize the problem of addiction but a withdrawal syndrome would even be more cataclysmic.

And as Janus fund manager Bill Gross points out above: how can debt problems be solved with even more debt?

To sum it up, since 2008, stocks have NOWHERE been about G-R-O-W-T-H, but about LIQUIDITY and CREDIT from which CONFIDENCE or MOMENTUM has been a product of. Expand liquidity and or credit, then financial assets (stocks, real estate, bonds etc…) booms, regardless of the direction of the economy.

Hounded by negative real rates via zero bound (financial repression), the public response to such policies have been to chase on yields even when they have been pillared from gross misperceptions.

Yet take away credit and liquidity, the illusion of CONFIDENCE and MOMENTUM evaporates.

The same factors can be seen in Thailand whose economy has been walking a tightrope between stagnation and recession but whose stocks, via the SET, like the Philippines (whose chart also has been replica of the Phisix) have been approaching milestone highs. The SET has been up 23% y-t-d as of Friday.

The Eurozone’s economy have also been bobbing and weaving out of stagnation and recession but whose stocks have been at 7 year highs due to “speculation the European Central Bank will consider quantitative easing at its January meeting”, or bluntly said, HOPES based on political elixir from the ECB to bailout financial market holders.

The US has been no different, stocks rising to record after record on inflationary record credit boom that has been backed financial engineering record buybacks, M&As and LBOs even as the economy has been spruced up by mostly government spending in 3Q.

Yet as of the 3Q, according to the Financial Times[12] companies spent roughly $238bn on dividends and buybacks, with the latter making up nearly 63 per cent of the total. The preliminary figure ranks second only to the first quarter of 2014, when company expenditures on the two reached $241.2bn.

This comes as corporate bond issuance hit new records last week based on Reuters’ tabulation.

But media just love the headlines, they simply ignore that the latest 2012 high US job growth has been more about consumption side of the economy rather than the productive side, e.g. Professional Services excluding temp help: +63K, of which administative assistants +12K, bookkeepers +16.4K; Retail Trade: +50K; Leisure and Hospitality: +38K, of which waiters and bartenders +26.5K; Manufacturing: +28K; Temp Help: +22.7K[13].

Yet it’s a wonder how the oil and energy industry (also the material industry) will respond to still collapsing prices or how they will affect economic activities. So far, new oil and energy permits have plummeted 40% (!), and so with Shale permits down 15% for across all major oil formations last month. Shale oil at the Bakken oil field at North Dakota has seen prices even plunge to $49.69 last November 28 (!), according to a Bloomberg report. That’s way (24%) below the $65.63 WTIC oil quoted last Friday. Yet from 2007-2012, about 16% of job growth came from the oil gas industry which outperformed the other sectors, according to the EIA[14]. If the oil industry retrenches this will impact jobs as well as other sectors attached to them.

Also the consensus seems to ignore that credit expansion not only affects asset prices, but how they inflate profits, earnings, income and taxes.

In short, an inflationary boom has widespread repercussions.

As for a credit driven stock market boom, the Austrian economist Fritz Machlup taking on the lens of the 1929 stock market warned[15], (bold mine)

If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time.In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and amortization current amortization allowances is fairly inelastic, and optimism about the development of security prices, inelastic would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.

US Treasury Arm Warns on Financial Instability, BOJ-ECB Internal Split Deepens, Moody’s Downgrade JGBs

As the consensus remains mesmerized by booming stocks, there hardly goes a week where political entities elevate mentioning risks from current conditions.

For the consensus, ignoring risks prolongs the honeymoon. It’s unfortunate to say that this signifies denial. Denial of reality is hardly helpful for investing.

Well the new research arm of the US Treasury department, The Office of Financial Research, a creation of 2010 Dodd-Frank law, warned that the US financial system “growing more vulnerable to debilitating shocks”[16]. They cited “new regulations make lending cash and securities more expensive” as well as ballooning debt from low interest rates, specifically “rapid expansion in corporate credit” that is being extended, increasingly, by nonbank entities that remain outside the reach of regulators. The outfit has been worried of a “sudden rise in interest rates” that may affect the credit markets “as the Fed inches closer to ending a prolonged period of low rates”

As I will keep repeating here, it doesn’t take interest rate to rise for debt to become problematic. It only takes the inability to service even the principal, or just plain loss of confidence; to borrow from historian Mr. Kindleberger, a causa proxima—some incident that snaps the confidence of the system[17].

The Polish central bank likewise warned of “growing imbalances” in her commercial property market where despite increasing vacancy rates and where “supply outstrips demand” developers continue to add new projects[18]. Ironically Polish central bank recently cut rates either to ignite debt based demand or to lower the cost of servicing debt. So the Polish central bank misreads the symptoms for the disease.

My hunch is that Polish developers and financiers might have entered into a “debt trap”. Developers need to keep building, while financers need to keep the greasing the debt cog, otherwise the gravity of debt problems surfaces. It’s part of Minsky’s Ponzi finance scheme that anchors on the deepening reliance on the recycling of debt to finance operations and on dependence on asset sales as compliment.

In short, the Polish central could be buying time and hoping for a deus ex machina rescue to her domestic bubbles.

The more interesting part has been Moody’s downgrade of Japan’s debt over “uncertainties whether Japan will achieve its deficit-reduction goals and succeed in boosting growth” further noting that “increasing risks of a rise in bond yields that could make it harder for Japan to manage its debt”[19].

Media says that this represents the first downgrade for Japan by one of the top-three ratings companies since Abe came to power in December 2012.  

But it looks as if Moody’s has been depending on a second increase in the Japan’s sales tax for them to make this call. Raising taxes doesn’t necessary entail higher revenues. Raising taxes only compound on the burdens of Japan’s already heavily strained debt suffocated economy.

Moody’s seem clueless to how the BoJ’s policies have been destabilizing the economy. The collapsing yen has prompted bankruptcies to hit a record high last November straining both small and medium sized companies, according to the Japan Times[20]. To add even exporters have raised concerns over the yen’s torrid decline citing, ‘will push up prices of imported goods and materials, hitting households already struggling with a decline in buying power caused by the inflation-stoking policies of Prime Minister Shinzo Abe’[21].

If many more companies continue to fold, there won’t be anyone (companies and consumers) to tax. So where the heck will the spendthrift government gets its revenues, except to keep borrowing from mostly the Bank of Japan (BoJ)?

Yet an even more interesting development has been signs of growing dissension WITHIN the ranks of the Bank of Japan.

Former BoJ officials have reportedly broken out of the “general silence” to sound off alarm bells over Kuroda’s recent policies. An official analogized Kuroda’s policies “like a car driving down the highway without brakes…And that car has just been needlessly filled up with extra gas”. Former BoJ chief economist Hideo Hayakawa says Kuroda’s policies are heading in a “precarious direction”[22].

The Wall Street Journal reports that dissension within the ranks of BOJ, “bank is not limited to the four board members”

And one of the board members, Takehiro Sato who recently voted against Kuroda trenchantly stated in public that “Prices reflect the temperature of the economy, not a variable that can be directly controlled by a central bank” and recommended that to boost economy required “structural overhaul of various economic entities”. Contra Kuroda, Sato san sees the weakening yen a “risk” and “headwind”[23].

Moody has been first to take action and will not be the last. My guess is that credit-rating agencies will be on a rush to downgrade Japan’s debt very soon.

Well as a sign of parallel universe, ironically Moody’s downgrade has even sent Japanese stocks flying!

Discord among policymakers has not just been a BOJ affair. The European Central Bank (ECB) appears to be suffering from the same affliction.

The ECB appears to have dilly-dallied on implementing a US version of QE last week[24]. The ECB sent out ambiguous communications like “wait until next quarter before assessing if additional stimulus measures are needed” which sent stocks reeling. In a few hours, the ECB reported more specific targets particularly in January where the central bank would consider “a package of broad-based asset purchases including sovereign debt”.

ECB President Super Mario Draghi followed this up stating that since policy makers “won’t tolerate” a prolonged period of low inflation, officials discussed buying “all assets but gold”.

It turns out the reason for the initial dawdling may have been due to a broadening internal ECB rift. German media published that Super Mario has ‘lost majority of the Executive Board’.

The ECB chief in no time countered in a press release that “he would not allow opposition from Germany or anyone else to stop it”. The Bundesbank president Jens Weidmann in a quid pro quo rebutted to warn against copying the money printing used in the United States and Japan[25]

Mr Wedsmann was joined by fellow German ECB policymaker Sabin Lautenschlaeger in opposing Super Mario

Meanwhile the European Court of Justice has also been slated to deliver a non-binding ruling on Jan. 14 about the legality of the ECB’s OMT program.

The bottom line there is no free lunch for money printing. Natural barriers will emerge to eventually prevent debt overload or from a full-scale destruction of the monetary system. So risks have been mounting fast even if European stocks are at 7 year highs.

The higher stocks are, the greater the risks.

Malaysian Ringgit Crashed; Malaysian Stocks Smashed!

Things are really getting to be interesting.

For one, booming stocks in major markets have hardly been shared by the rest of the world.

Second, global markets appear to exhibit developing signs of extreme divergences. While developed economy stocks have been on a melt-UP mode, commodity-casino related stocks have been melting DOWN.

What seem even more interesting has been milestone highs of the US dollar against some Asian currencies.

The US dollar-Indonesian rupiah (USD-IDR) just surpassed 2009 levels (12,275) and seems fast approaching 12,600! [left window]

But contrary to 2008-9 where Indonesian stocks (JCI) had been at the bottom from a selling frenzy, Indonesia’s JCI have now been drifting at fresh record highs.

The rupiah has been down by .77% this week.

It’s been vastly a different story for the Malaysian currency, the ringgit, which has been brutally pummeled this week.  This week, the USD-ringgit soared 2.6% to a NEW four year high!  Alternatively said, the ringgit CRASHED! [right window]

But instead of record highs as the JCI, the Malaysian stock exchange as measured by the FTSE Bursa Malaysia experienced a meltdown this week. The KLSE cratered 3.93% for the week!

The FTSE KLSE chart illustrates of a massive breakdown from portentous head and shoulder pattern.

The Malaysian index which was largely unscathed by the 2013 taper tantrum and has been the first to break to new highs among her ASEAN peers and has been down by 7.5% from the peak. Now it seems as the first to weaken.

Media blames Malaysia’s recent stock market woes on crashing oil prices and the attendant fiscal concerns from its fallout.

Malaysia’s commodity exports consist of Petroleum products with a 9.5% share of total exports, LNG 8.3%, Palm oil 6.2%, crude petroleum 4.5% and rubber products 2.3% for a total of 30.8% of total exports[26]. Manufacturing consist of most of the other non-mining non petroleum exports.

In addition, falling commodity prices have raised concerns over Malaysia’s chronic budget deficits. The Nikkei Asia reports that “Resource-related companies account for slightly more than 30% of the government's income”, which implies that falling commodity prices will translate to bigger deficits. Also in anticipation of this, the Malaysian government reportedly scrapped subsidies for gasoline and diesel[27] this December. Like the Philippines, Malaysia’s 3Q economic growth output sizeably dropped to 5.6% from 6.5% in 2Q

While falling commodity prices may have material impact on the real economy, unless Malaysia’s other industries have strong ties with them, they should hardly be reflected on Malaysia’s major benchmark because the share of oil & gas consist of only 6.7% of the KLSE basket.

The biggest weighting has been in Banks 23.85%, Telco 13.04%, Industrial 9.5%, Food & Beverage 8.12% and Travel and Leisure 7%. These 6 industries constitute 68.21% of the KLSE according to FTSE[28].  (left)

Meanwhile in terms of corporate representation, banks have also the largest share among the biggest market caps, followed by telcos and electricity travel and leisure and oil. Petronas has only a 3.48% share.

A glimpse of the charts suggests that Malaysia’s banks have hardly been in good shape. Even prior to the oil collapse Public Bank BHD the Malayan Bank and the CIMB group have been floundering since the July highs. The latter has been in a bear market.

A month ago I projected[29] that pressures on Asian currencies are likely to weigh on the region’s risk assets. Here I noted of a potential weakness of Malaysian financial assets due to her onerous debt burden, I wrote: Malaysia has a credit bubble. Malaysian overall debt comprises about 200% of her GDP with the largest share being household debt. Household debt has soared to 86% in 2013 from 80% in 2012. This should be larger today given the acceleration of loans to the private sector.

Mainstream media has even openly talked about Malaysia’s Savings Retirement Crisis referring to property bubbles and high debt burdens as taking a toll on the average Malaysians[30].

So it seems a question whether these sinking bank stocks could be a symptom of a systemic problem or just another blip. By systemic problem I am denoting of either a deflating property bubble being exacerbated by oil-commodity weakness or the other way around—crashing oil prices serving as the proverbial pin to prick on Malaysia’s property bubble.

Curiously, Malaysia’s major telecoms which had been in record or near record highs stumbled big this week as shown by the charts of Axiata Group, Digi.com and Maxis BHD. The same holds true with electricity firm Tenaga Nasional BHD.

Meanwhile gaming and hotel giant Genting Malaysia, like her regional casino peers have been struggling (but to a lesser extent relative to her contemporaries). Petronas, Malaysia’s largest oil company has been on a decline also since July.

Last week’s stock market carnage seems like a broad based phenomenon. Even telecoms and electricity companies which previously diverged from the rest got smoked. This marks a sudden shift in sentiment. And if Malaysia’s currency and stocks should continue to remain under pressure, then actions in the financial markets may eventually spillover to or reflect on the real economy.

And if Malaysia’s markets crumbles, will these have a contagion on the region?

As for other Asian currencies, the USD-Vietnam dong (VND) closed at record highs.  The USD Australian Dollar (AUD), the USD Taiwan dollar (TWN) as well as the USD Singapore dollar (SGD) has reached 2010 highs. The USD Korean won (KRW) ended the week at June 2013 highs. The USD-New Zealand (NZD) has reached the October 2014 highs which basically equals July 2013 highs. The USD Thai baht (THB) closed at near January 2014 highs. The USD Indian rupee (INR) has been climbing but a modest pace, currently at March 2014 highs.

The biggest winner this week (+.75%), aside from the Indian rupee, to defy the region’s trends has been no less than the USD Philippine peso. The peso has almost been unchanged for the year. The Philippines must either be doing something so well, or someone must be spending a huge sum of money to prevent the peso from falling.

I’d bet on the latter. Philippine Gross International Reserves (GIR) last November has fallen to its lowest level since 2012. The peso closed unchanged month on month last November.

Why the need by the BSP to defend the peso? Could it be because of the huge foreign debt exposure/s by some private entities? If so what justifies the implicit subsidies? Financial stability?

I told you, it was a very interesting week.

Cracks in the Philippine Casino Bubble: Philippine Casino Stocks Crushed!

I was under impression that the Phisix would hit 7,400 during the week as stock market operators seem to have plotted a methodical way to reach such level via sustained implementation of marking the close.

On Wednesday, I noted of a remarkable one day crash in Macau’s casino stocks. In particular, MGM China Holdings (HK:2282) -1.95%, Galaxy Entertainment Group (HK:27) -5.06%,  Melco Crown Entertainment (HK: 6883) – 2.62%, Sands China Ltd. (HK: 1928)-5.08%, Wynn Macau Ltd. (HK: 1128) -6.12% and SJM Holdings Ltd. (HK:880) owner of Grand Lisboa -5.84%.

That’s because Macau’s autonomous government’s Gaming Inspection and Coordination Bureau reported a 19.6% slump in revenues for November, which marks the 6th successive monthly hemorrhage. The bad news reportedly has been compounded by a downgrade by certain financial institutions on Macau’s casino stocks.

The following day domestic casino stocks had been slammed.

Yet this has not been limited to Macau. Singapore’s Genting (G13.SI) has likewise been pounded and so as with Marina Bay Sands Resort as seen through stocks of operator Las Vegas Sands.

And this has not just been Malaysia, Singapore and Macau, the US Dow Jones Gambling Index has seen a wicked bear market in spite of record stocks!

Yet domestic consensus see local casino stocks as ‘this time is different’ or that these have been perceived as immune to external developments.

Well they were given a taste of bitter reality. Bloomberry [PSE: BLOOM] operator of Solaire has been drubbed by 8.6% over the week from heavy foreign selling—52% of total traded volume during the two day selloff.  Melco Crown Philippines [PSE:MCP] whose City of Dreams has been reportedly slated for a soft opening this December has been equally whacked 3.87% from foreign selling which accounted for 47% of the two day carnage. Premiere Leisure Group [PSE: PLC] a partner of Melco Philippines and a part owner of Pacific Online System, operator of the software that runs the government run lottery has similarly been clobbered -8.1%.

Casino stocks and PLDT combined to bring the Phisix back again below 7,300.

The casino industry’s falling earnings and stock prices in Asia and in the US reflects on dwindling demand in the face of surging supplies.

As I previously mentioned, there are 5 casinos in the pipeline for Vietnam. In South Korea there are two grand casino integrated resort projects being planned supposedly to “to ride the growing wave of Chinese visitors”

Yet like local projects, most of these will be bankrolled by debt.

As I warned back in my original piece in April 2013[31],

The mainstream ignores the fact that these casinos will be competing with the regional counterparts for essentially the same (regional) market…

And worst, such cumulative bullishness comes in the backdrop of artificially lowered rates, which industry operators and the unwitting public presume will be everlasting.

If foreign demand (mostly the Chinese high rollers which every single Asian nation has been targeting) fails to materialize, then local casinos will be duke it out over a limited domestic market.

Unlike Macau’s casinos which have been there for awhile, local casinos will be faced with huge liabilities.

The question here is how debt will be repaid? Bloomberry according to 4-traders has Php 20.693 billion of debt. Melco Crown has 12.5 billion as of December 2013 based on Financial Times data. The next question is to whom have these monies been owed? How much to the banks and how much via bonds? Who are the bond holders? In the case of bonds, given that Philippine capital markets have been shallow, outside foreigners, bond holders are likely to be a limited number of financial institutions or elite clients of banks or financial institutions. In short, the circulation of debt instruments will be held by a concentrated group of entities or individuals.

Limited market combined with huge liabilities will serve as a lethal combination for                         grand projects borne out of debt financed zero bound

rates.

Has this week’s domestic casino stock market crash opened the Pandora’s Box of debt deflation?

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[1] See Phisix: As Mania Rages, BSP Chief Warns on “Complacency” and “Chasing the Market”!! August 24, 2014

[2] Security and Exchange Commission CHAPTER VII Prohibitions on Fraud, Manipulation and Insider Trading SEC Regulations Code Republic of the Philippines

[3] See Dealing With Financial Market Information February 27, 2011

[4] See Phisix: BoJ’s QE 2.0 Hail Mary Pass Sends Global Stocks Skywards! November 3, 2014

[5] Nikkei Asia Bank of Japan's bigger role in stocks has some concerned December  5, 2014

[6] See Chinese Government Sticks to the IPO Route to Inflate Stock Market Bubble December 3, 2014

[7] Bloomberg.com Chinese Stock Turnover Exceeds 500 Billion Yuan as Index Gains December 3, 2014

[8] Bloomberg.com China Stocks Rise Most Since 2012 as Sinopec Jumps With Brokers December 4, 2014

[9] Bloomberg.com China Regulator Urges Caution on Stocks as Trading Hits Record December 6, 2014

[10] Charles Kindleberger, The Emergence of Swindles Manias, Crashes and Panics, Third Edition, p.66

[11] See Chinese Stocks Skyrockets on STIMULUS HOPES, European Stocks follow China’s Footsteps December 2, 2014

[12] Financial Times Return of the buyback extends US rally December 4, 2014

[13] Zero Hedge Where The Jobs Were: Secretaries, Waiters, Retail, Education, Leisure And Temp-Help December 5, 2014

[14] EIA Oil and gas industry employment growing much faster than total private sector employment August 8, 2013

[15] Fritz Machlup The Stock Market, Credit And Capital Formation p.92 Mises.org

[16] See US Government’s Treasury Department Arm warns on Heightened 'Financial Stability Concerns' December 5, 2014

[17] Kindleberger, op cit p. 92

[18] See Polish Central Bank Warns of Domestic Commercial Property Bubble December 3, 2014

[19] See Moody’s Downgrades Japan’s Credit Ratings, Stocks Rally December 2, 2014

[20] Japan Times Bankruptcies caused by weakening yen set new record in November December 5, 2014

[21] Japan Times Manufacturers spout warnings as yen drop pads profits December 6, 2014

[22] Wall Street Journal Real Time Economics Blog Ex-BOJ Officials Concerned About ‘Precarious’ Easing December 5, 2014

[23] Wall Street Journal BOJ Policy Maker Says Specific Targets ‘Unreasonable’ December 5, 2014

[24] See ECB Waffles, Stocks Vacillate; ECB Divisions Mount December 5, 2014

[25] Reuters UPDATE 1-Germany warns ECB against copying U.S.-style money printing CNBC.com

[26] Malaysian External Trade Development Corporation Top 10 Major Export Products, 2014

[27] Nikkei Asia Price downtrend dents Malaysian stocks, stirs public finance worries December 5, 2014

[28] FTSE FTSE Bursa Malaysia KLCI FTSE.com November 28, 2014

[29] See Phisix: Weakening Asian Currencies to Weigh on Region’s Risk Assets November 10, 2014

[30] See Video: A Look at Malaysia’s Savings Retirement Crisis  November 22, 2014

[31] See The Philippine Casino Bubble April 11, 2013