…the
turning of a financial cycle can be quite abrupt due to another
feature of debt: its close link with risk-taking and the
amplification of market dynamics. During boom times, when asset
prices are rising and financial markets are tranquil, borrowers may
be lulled into a false sense of security. We could dub this the
“illusion of sustainability” whereby even large debt levels
appear sustainable when credit conditions are easy and asset prices
soar. The illusion of sustainability blinds both borrowers and
lenders. But as the cycle turns, the combination of falling asset
prices and more turbulent markets means that what was viewed
previously as sustainable levels of debt begins to look much more
challenging. The decline of profitability, mentioned before, is
particularly relevant here. This realisation may elicit deleveraging
and outflows that amplify the downward cycle. Policymakers can try to
stem the decline in asset prices by loosening monetary policy to turn
back the tide, but the already large stock of debt means that
monetary policy becomes less effective.—Jaime Caruana General
Manager, Bank for International Settlements
I
recently wrote that due to my computer predicament I might not be writing this week. But current events
have been so compelling for me to miss out. Nevertheless a condensed outlook
In
this issue
Phisix
6,800: Global Central Banks Lose Control! Chart Porn of Fast and
Furious PSEi Bear Market Rallies
-Central
Banks Lose Control as Developed Economy Stocks Nosedive!
-NIRP
has Failed; Why NIRP will Crash the Markets!
-Chart
Porn: Fast and Furious Bear Market Rallies (1994-2016)
Phisix
6,800: Global Central Banks Lose Control! Chart Porn of Fast and
Furious PSEi Bear Market Rallies
Central
Banks Lose Control as Developed Economy Stocks Nosedive!
Unlike
most of the establishment, at the least one of the highest official
of the central bank of central banks, the Bank for International
Settlements (BIS), Mr Carauana1,
understands: Balance sheets matter!
This
means that regardless of central bank’s sustained ramming down into
the public’s throats of its credit easing policies, for entities
that have been hocked to its eyeballs, you can lead the horse to the
water, but you cannot make it drink. In short, credit
expansion is limited by the capacity of an entity to earn and pay for such liabilities.
Yet
private sector balance sheet expansion through excessive leveraging
embodies a major symptom of unproductive activities or the
misallocation of resources. And for as long as real savings remain
enough to fund the capital consumption or the wealth transfer
process, the “boom” phase will account for as the “illusion of
sustainability” that masks on the progressing entropy of
malinvestments or the almost wholesale blinding of borrowers and
lenders. The blinding from the “illusion of stability” includes
regulators, politicians and media as well.
However,
if something can’t go on forever, it will stop. The laws of
economics will force such uneconomic activities to surface. Real savings will be consumed. And the
reversal of the “illusion of sustainability” will be evident in
the character of self-reinforcing “turbulent markets”,
particularly the feedback mechanism of financial losses, deleveraging
or liquidations, outflows, and credit strains.
Recent
attempts by central banks to subsidize stock markets through negative
interest rates appear to have hit a wall
Last
week I wrote2,
(italics original)
My
point is that these central bank policies to subsidize the stock
markets via monetary policies, as shown by the experiences of Japan,
China and Germany, have conspicuously been increasingly
afflicted by
the laws
of diminishing returns.
The narrowing windows
of gains only punctuate on the risk of severe or dramatic downside
‘flight’ actions overtime. Yet central banks refuse to heed
reality. But they continue to focus instead on the short term. The
result should be the worsening of the unintended consequences from
present day ‘rescue’ actions…
While
there may be residual vestiges of the BoJ NIRP’s honeymoon effect,
given this week’s asymmetric responses, signs are that last two
week’s central bank panacea may not last. Perhaps not even a month.
If
so, in the next transition from fight to flight, then this would mean
that the ensuing cascade should be sharp and fast as central banks
have effectively lost control!
Just
what happened to the much ballyhooed magic of central bank
intervention last week?
Equity
markets of nations under NIRP were in a funk! Much of the year
to date losses came from last week’s amazing meltdown.
And
most importantly, the deficits incurred by Japan’s Nikkei 225
emerged even prior to the announcement of the
dismal US jobs report.
Recall
that the Bank of Japan (BoJ) has been the
latest developed economy to embrace Negative Interest Rate Policy
(NIRP). It did so in response to its crashing stock markets.
Yet
part of the BoJ’s stock market rescue mission has been implicitly
directed at the world’s largest pension fund, the Japan’s
Government Pension Investment Fund (GPIF).
As noted
before, the Abe administration nudged or pressured the GPIF to
makeover its portfolio by selling its JGBs or government bond
holdings in order to replace them with domestic and global equities.
And
because of the GPIF’s accommodation of the Abe administration, its
portfolio switch has caused the pension fund to report a quarterly
loss of 5.59% in the second quarter as equities underperformed. This
according to the Japan
Times accounts for “its
worst quarterly result since at least 2008”.
Yet
lower equity prices mean more losses for the pension fund to come.
And more losses imperil funds for Japan’s retirees.
Moreover,
the opportunity cost for such portfolio switch has been to give up on
significant gains in bonds as the NIRP adaption has spurred Japanese
Government Bonds (JGB) from
the shortest end up to 9 years into sub-zero yields! As of last
week, nearly
$6 trillion of Japanese and European sovereign bonds have traded
at sub-zero yields!
So
as stock markets wilt, financial market participants gravitated to
treasuries for safehaven. And don’t forget gold’s surge!
Additionally,
by
reversing its stance from an earlier denial to employ such policy,
the BOJ intended to deliver a “shock and awe” to risk assets, as
well as, to the USDJPY (yen).
Talk
about the law of unintended consequences.
The
Nikkei’s honeymoon period from the NIRP turned out to be just a
three day tryst!
As
of Friday, the Nikkei traded lower than when the NIRP was announced
(middle window). Yet Nikkei
225 futures point to a 3% meltdown on Monday’s opening.
Yet
last week’s jawboning by the BoJ
last week “to
expand stimulus further and is prepared to cut interest rates deeper
into negative territory, signalling a readiness to act again to hit
his
ambitious inflation target”, as well as, by the ECB’s Mario
Draghi who
said anew that the ECB “will
not surrender to low inflation” and vowed to ease further in March,
apparently fell into deaf ears as stock markets went into a selling
binge.
Financials
markets have apparently grown weary of these central bank elixirs!
And
as with the Nikkei, the USDJPY
was dumped (upper window).
I
warned that “Japan’s
aging pensioners will serve as the ‘greater fool’ when stock
market collapses”. And this may soon come true as sustained stock
market losses will likely widen on the GPIF’s deficits.
NIRP
has Failed; Why NIRP will Crash the Markets!
And
here’s more. When central bank magic fails, its repercussions will
spread throughout the global financial markets.
One
of the unintended consequences of ZIRP-NIRP activist monetarism has
been to put tremendous pressure on banking industry.
Last
week, the banking index of Japan’s Topix
bank, the US BKX
and the Euro
Stoxx 600 Bank index profusely bled! The indices shed a shocking
-13.74%, -3.9% and -6.2% respectively! The three indices are now in
bear markets.
Yet
a furtherance of such dynamic entails further tightening in the
global financial system. And yes this, in spite of the NIRP!
NIRP
will not only crimp on bank margins, it massively skews on the
pricing signals of the credit and risk markets, distort on the
functionality of payment and settlements (such policies would
encourage early payments, excess payments and deferred collection as
warned by the NY
FED), increase administrative
cost of maintaining bank accounts as banks looks for alternative
fees to make up for lost income from interest rate arbitrages (e.g.
higher fees on ATM and etc…), disrupt on wholesale
financing
(e.g. repos, money markets) or banking system’s liquidity and
compel the public to eventually hold cash. This comes even if
governments impose cash controls. Last week the German
goverment proposes to limit cash transaction to €5,000 (USD
5,450) while the EU
also plans to expand cash controls.
Worst,
NIRP attempts to destroy the essential financial concept of “time
value of money” or as Investopedia defines “money
available at the present time is worth more than the same amount in
the future” or present discounted value.
In
the context of Austrian economics, “time value of money” is
equivalent to orginary interest or the “discount
of future goods as against present goods” which accounts for the
tradeoff between “want-satisfaction
in the immediate future and the value assigned to want-satisfaction
in remote periods of the future”
And
this is why NIRP will fail. As the great Ludwig von Mises presciently
warned3.(bold
mine)
If
there were no originary interest, capital goods would not be devoted
to immediate consumption and capital would not be consumed. On the
contrary, under such an unthinkable and unimaginable state of affairs
there would be no consumption at all, but only saving, accumulation
of capital, and investment. Not the impossible disappearance of
originary interest, but
the abolition of payment of interest to the owners of capital, would
result in capital consumption. The capitalists would consume their
capital goods and their capital precisely because there is originary
interest and present want-satisfaction is preferred to later
satisfaction.
Therefore
there cannot
be any question of abolishing interest
by any institutions, laws, or devices of bank manipulation. He
who wants to "abolish" interest will have to induce people
to value an apple available in a hundred years no less than a present
apple. What can be abolished by laws and decrees is merely the right
of the capitalists to receive interest.
But such decrees would bring about capital consumption and would
very soon throw mankind back into the original state of natural
poverty.
Now
you see the truth behind the push for ‘financial inclusion’ in
emerging markets like the India or the Philippines?
First,
bring the majority into the formal banking system. Next, impose ZIRP
and NIRP. Then Ban cash. Also, impose all forms of capital controls.
The
end result (or the ultimate goal) is the (full) CONTROL by the
establishment of private sector’s savings! Authorities
and their establishment agencies can charge myriad fees at will,
monitor every movement of funds of the account holder, eventually
they will direct monetary flows (control transactions or everyone’s
business), they will garnish accounts which they see as acting
against their mandates or rules, and or simply confiscate or tax
private sector’s resources during times of distress.
Events
at the developing world have been showing the way!
Yet
the basic laws of economics ensure that financial totalitarianism
will be met by mountains of obstacles.
Proof?
The global banking system’s dilemma in the face of ZIRP-NIRP has
been spotlighted by this news report from the Financial Times4.
(bold mine)
Share
prices of major banks have
plunged this week, with Credit
Suisse hitting
a 24-year low and Deutsche falling to 2009
prices. Santander, BBVA and UniCredit also
traded at levels last seen during the eurozone crisis.
Bank
weakness is
truly global.
US banks were downbeat on fourth-quarter earnings and the S&P
financials are down more than 12 per cent in 2016. Indices for
European and Japanese banks have lost nearly a quarter of their value
this year.
Ultra-loose monetary policy, including the adoption of negative rate policy in Japan and expectations of further easing in Europe, has heightened fears for global economic growth. Lower long-term interest rates also reduce the earning power of banks. US financials have been hit hard by a lower net interest margin outlook while investors worry that the commodity plunge will intensify credit losses for the sector.
Ultra-loose monetary policy, including the adoption of negative rate policy in Japan and expectations of further easing in Europe, has heightened fears for global economic growth. Lower long-term interest rates also reduce the earning power of banks. US financials have been hit hard by a lower net interest margin outlook while investors worry that the commodity plunge will intensify credit losses for the sector.
“This
is totally linked to the rates environment,” said Lloyd Harris, a
credit analyst at Old Mutual Global Investors. “At the end of last
year, you were positioned for a rising rate environment. The equity
market this year reflects that those expectations around higher rates
have diminished.”
Bradley
Golding, managing director at Christofferson, Robb & Co,
highlighted that bank profitability is reduced as leverage and
capital constraints leave lenders competing for the same business
opportunities.
“The
yield curve used to steepen in a recession and spreads used to widen,
so even if you lost money on your existing book, new loans were done
at a profitable level. Quantitative easing really hasn’t allowed
that to happen,” said Mr Golding.
In
mid-January, Italy provided an early indicator of the trauma ahead
for bank investors, with Monte
dei Paschi hitting
a record low on the back of concerns about non-performing loans.
Weakness
in equity prices has extended to the riskiest bank bonds.
The €95bn market for so-called additional tier 1 bonds, which
convert to equity or are written down when a bank’s capital falls,
has endured dramatic losses this year.
Policies
from panicking central banks have now caused disorder, distress and a
tizzy at the financial markets. Curiously, these policies have been
designed to protect them. Now it appears to have backfired.
And
stock market anxiety has now spread. In the US, the once crowd or
momentum favorites or the index drivers, the FANG (Facebook,
Amazon, Apple,
Netflix and
Google) has
likewise fallen to the strains from recent wave of selling. Linkedin
crashed an astounding 44% last Friday! [there is more to discuss
but I’m short of time]
And
interestingly, all these have been occurring even as the USD has
weakened. The USD sank by a hefty 2.6% this week.
Of
course, the USD has signified today’s most
crowded trade. And any reversal from a crowded trade will imply
extended and amplified volatility.
And
with massive shorts against EM currencies, the unwinding of the
crowded trade positions (short EM) translated to big rallies. Asian
currencies rallied strongly. And part of the rallying Asian
currencies got reflected on stocks. Indonesian JKSE soared 3.98%,
Philippine Phisix jumped 1.16% and the Thai Set added .41%. Meanwhile
the Malaysian KLSE lost -.32% this week.
The
Indonesian rupiah gained 1.12%, the Philippine peso .14% and the Thai
baht +.29%. On the other hand the Malaysian ringgit slid .13%.
Aside
from the intense pushbacks by financial markets on NIRP and on
assurances by central banks of Japan and the EU, the much tempered
expectations that the FED will further raise rates, the massive short
covering on EM currencies, the Chinese government made sure that they
celebrate this week’s New Year Spring Festival by stinging offshore
yuan (CNH) shorts.
Many
high profile hedge funds have announced
short positions on the yuan. Billionaire crony George Soros have
engaged China’s
president Xi Jinping in a public debate as the former declared
a short position against the Chinese currency at the year’s
start.
The
PBoC reported a massive decline to its foreign currency hoard to the
tune
of $118 billion last January. This brings the Chinese
government’s forex reserves to just $3.2 trillion from a pinnacle
of nearly $4 trillion in early 2014.
So
the likelihood that last week’s state intervention on the CNH
market would redound to even lower reserves in February as the
Chinese government desperately puts on a façade on her financial
assets, stocks, bonds, and the currency.
Chinese
financial markets will
be closed for the week in celebration of the Chinese New Year, so
they will hardly be a factor.
Yet
despite her absence, with central banks appears to effectively been
losing control! This only means that the selling pressures on risk
asset will likely crescendo!
To
repeat my warning last week,
If
so, in the next transition from fight to flight, then this would mean
that the ensuing cascade should be sharp and fast as central banks
have effectively lost control!
Decoupling
anyone?
Chart
Porn: Fast and Furious Bear Market Rallies (1994-2016)
Below
is the table that highlights all the bear market rallies from
1994-2016.
The
oversold bounce of the previous two weeks has signified as one of the
most intense
bear market rallies since 1994. In 11 days, the average daily % gains
totaled 1.02%!
Yet
the most powerful and the swiftest bear market rallies, aside from
the most incidences which had the two traits, occurred in 2007-2008.
Since
no two bear markets are the same, it would be futile to report on
statistical correlation.
What
matters are the causal linkages that led to them.
There
had been 3 bear market strikes in 1994-95.
The
3 bear markets were a natural response to the blistering 179%
skyrocketing of the PSEi in 1993! The bear markets wanted to profit
take, yet the easy money environment prevented this from happening. So
from the deferment of the market clearing process, imbalances mounted.
During
the 3 bear market strikes, bulls feverishly and violently pushed the
PSEi back up 24.46%, 24.5% and 31.57%, respectively, in very short
periods of time. Thus the W shaped activities.
It
was in the fourth attempt that bulls managed to prevail…for a
limited period: 1 year and 2 months. However, the 1996 rally marked
the last before the expiration of the 1986-1997 11 year secular bull
market cycle.
The
1997-8 Asian crisis bear market saw two massive bull market
rebellions or fierce countercyclical rallies during its first wave
down, 18.64% and 52.2% correspondingly.
Yet
those bear market rallies accounted for as false positives in terms
of the return of the bull market.
The
bear market cycle that started in 1997 had four major cyclical
rallies on the path to its culmination. Aside from the above, the
spurned rallies of 1998-1999, 2000-2001 and 2001-2002. Rallies during
these cycles declined in scale and duration.
The
GFC inspired 5 fast and furious countercyclical rallies that all went
down the drain.
All
5 eventually surrendered to the bears.
However,
the 2009 return of the bulls, mainly due to BSP easy money policies
led to the bull market which was rattled by 2013 taper tantrum
chapter.
The
rally from taper tantrum bear market resonated with 1994-1995 cycle.
But unlike 1994-95 which responded to a fantastic one year 179%
spurt, the 2013 episode came in response to the 320% return in 3
years and 2 months.
Nonetheless
the rate cut by the BSP in October
2012, which combusted a 10 month 30%+++ money supply growth from
massive credit expansion, salvaged the PSEi taper tantrum away from
bear market and back into the fold of the bulls.
Yet
the 30%+++
money supply rescue of the PSEi from the 2013 bear market only
compounded on the
imbalances seen today.
Most
events do not happen out of random, as they represent consequences of
previous actions.
And
this is why we have a 2016 bear market.
And
the 2016 bear market will unmask “the illusions of stability”.
As
history shows, the most recent vicious rally only reinforces the
denial phase that foreshadows the demise of the 2003-2015 bullmarket.
____
1
Jaime
Caruana General Manager Bank for International Settlements, Credit,
commodities and currencies Lecture at the London School of
Economics and Political Science February 5, 2016
2
See
Phisix
6,700: Ferocious Bear Market Rally Pump; 4Q and 2015 GDP’s
Cosmetic Numbers January 31, 2016
3
Ludwig
von Mises Originary
Interest, Part
Four: Catallactics or Economics of the Market Society, Chapter
XIX. The Rate of Interest, Human Action Mises Institute
