Doug Noland: 2016 Year in Review

While they surely received zero consideration, I’d award global central bankers “2016 Person of the Year.” Understandably, most see “The Year of Donald Trump” or “The Year of Global Populism.” Yet from my analytical perspective it was “Yet Another Year of Desperate Central Bankers.” 

…But with global QE in the neighborhood of $2.0 TN annually and hundreds of billions flowing out of China, the vulnerable Periphery enjoyed a liquidity windfall. Global fragilities were in the short-term ameliorated by unprecedented global rate and liquidity dynamics. The year began with the world at the precipice of a bursting Bubble. The bottom line is that the global Bubble persevered and then inflated significantly.


When looking back on a year, it’s only natural that events later in the year receive added emphasis. The DJIA made it within 23 points of the 20,000 benchmark as the year wound down. All major U.S. equities indices posted all-time highs in December – the Dow, S&P500 and Nasdaq, as well as small and mid-cap indices. After trading as low as 667 back in March 2009, the S&P500 closed out 2016 at 2,239. Over this period the small cap Russell 2000 inflated about four-fold to end the year at 1,357.

The broader market shined in 2016, with the small cap Russell 2000 and S&P400 Mid-Cap indices gaining 18.7% and 19.5%, respectively. Also outshining the S&P500, junk bonds enjoyed their best performance since 2009, with the HYG (high-yield ETF) returning 13.4%. The TLT (long-term Treasury ETF) eked out a 1.0% gain for the year, while the LQD (investment-grade corporate ETF) returned 6.1%.

The S&P500 rallied almost 10% post-election, with the small caps doubling that percentage gain. Trump trepidation may have temporarily pushed the DJIA down almost 1,000 points election night, but post-election optimism rallied right along with market prices. Reagan-style deregulation, along with tax reform, fiscal stimulus, infrastructure spending and trade reform are viewed as ushering in a fundamentally improved environment for corporate America and the U.S. economy overall.

Importantly, the economic backdrop was supportive of market optimism. At 3.5%, Q3 GDP was the strongest in two years. GDP has shown strong momentum, rising from Q1’s 0.8% and Q2’s 1.4%. At 4.6%, November’s unemployment rate was the lowest going back to boom-time August 2007. On the back of surging stock prices, consumer confidence jumped to the highest level since August 2001. Auto sales were on track to reach an annual record 17.5 million units. Home prices have returned to record levels, with existing home sales the strongest since 2007.

It’s reasonable to posit that U.S. lending conditions have become the loosest since (at least) 2007, helping to explain the strength in auto and home sales along with the general economy. It’s worth noting that the 2016 U.S. fiscal deficit rose a third to $587 billion, or 3.2% of GDP. Revenues increased 1%, while spending jumped 5%.

As of the end of Q3, the U.S. economy was on track for the strongest Credit growth since 2008. Q3 seasonally-adjusted and annualized (SAAR) Non-financial Credit growth reached $2.679 TN (about $2.375 TN SAAR over three quarters) the strongest expansion since 2007’s record $2.503 TN. Household mortgage Credit has been expanding the most rapidly since 2007. M2 “money” supply increased over $900bn in 2016, expanding about 8.0%. Clearly, U.S. rates have been held way to too low for way too long.

Ultra-loose finance was a global phenomenon. According to the Financial Times, global debt issuance reached an all-time high $6.60 TN, surpassing 2006’s record. Global corporate issuance was up 8% from 2015 to $3.60 TN. The year supported the view that things tend to get crazy near the end of epic Bubbles.

A summarizing December 30th Bloomberg headline: “A Year in China Markets: Yuan Down, Stocks Down, Bonds Faltering.” For the year, China’s currency declined 6.6%, “the most in two decades.” The yuan began the year weak and end the year weaker. “Money” flooded out of China at the beginning of 2016, then somewhat stabilized before the floodwaters began to rise again during the fourth quarter.

Chinese stocks also had a rough year. The Shanghai Composite dropped 11.3%, with the CSI Smallcap 500 Index down 17.8%. China’s growth-oriented ChiNext index was hit even harder, sinking 27.7%. Chinese international reserves dropped another $280 billion during the year to $3.330 TN. Reserves have declined a stunning $940 billion since the June, 2014 peak.

With year-end optimism dominating, it’s easy to forget that China was in the process of bringing global markets to their knees early in the year. According to the Financial Times, global markets lost $4.0 TN in the first ten trading sessions of 2016 – the “worst-ever” start to a trading year. The Shanghai Composite sank a quick 25% in January, with fears of a bursting Chinese Bubble hammering global markets. The S&P500 dropped 11%, the worst start to a year in decades. The Nasdaq Composite fell 16%. By early February, crude was already down almost 30%. The GSCI commodities index lost 14%, trading to a low going all the way back to 2004.

As fears rose of a bursting global Bubble, bank stocks fell under heavy selling pressure. U.S. banks (BKX) and broker/dealers (XBD) were each down over 20% in the year’s initial weeks. The Hang Seng China Financials index sank almost 25%. Japanese banks were under even more intense selling pressure, with the TOPIX-Banks Index falling 35%. European stocks (STOXX 600) dropped almost 30%. By mid-February, Germany’s behemoth Deutsche Bank was sporting a y-t-d loss of almost 40% – and it was making folks nervous.

Again, year-end optimism clouds our memories and interpretations of early-year market behavior. But my view at the time was that the global Bubble was faltering. The great Chinese Bubble was at serious risk of implosion, with stocks crashing, the economic boom faltering, bond defaults multiplying and “money” trying to exit as fast as possible. In short, China’s debt Bubble was at acute risk of crashing, imperiling some of that nation’s largest banks – huge institutions that now populate the top of the list of the world’s largest banks.

While they surely received zero consideration, I’d award global central bankers “2016 Person of the Year.” Understandably, most see “The Year of Donald Trump” or “The Year of Global Populism.” Yet from my analytical perspective it was “Yet Another Year of Desperate Central Bankers.” Recall that market sentiment early in the year held that central banks had largely expended their ammo. There was even talk of “quantitative tightening.” The Fed had commenced a tightening cycle and EM central banks were under pressure to sell Treasuries and other reserve assets to help stabilize their currencies. Meanwhile, the BOJ and ECB had already pushed rate cuts and QE to their limits – or so it seemed. Ominously, markets were faltering in the face of, seemingly, peak “whatever it takes.”

With Japanese unemployment at 3.3%, the Bank of Japan on January 29th did the previously thought impossible (and something Kuroda had said the prior week was not even being considered) – rates were pushed into negative territory with a warning that they could go even lower. Reuters: “BOJ stuns markets with surprise move to negative interest rates.” BOJ Governor Haruhiko Kuroda, responding to unstable global markets: “What’s important is to show people that the BOJ is strongly committed to achieving 2% inflation and that it will do whatever it takes to achieve it.”

Reuters: “Kuroda said the world’s third-biggest economy was recovering moderately and the underlying price trend was rising steadily. ‘But there’s a risk recent further falls in oil prices, uncertainty over emerging economies, including China, and global market instability could hurt business confidence and delay the eradication of people’s deflationary mindset,’ he said.”

Draghi’s ECB entered the fray on March 9th. Determined to “beat market expectation,” ECB doves pushed the hawks completely out of the way to boost monthly QE by 20bn euros (second increase in three months), slash rates, introduce a new LTRO lending program, and add corporate debt to its buy list. Mario Draghi rather proudly stated: “We have shown that we are not short of ammunition.”

The FOMC refrained from rate normalization during January and March meetings, as the tone was set for “whatever it takes” central banking worldwide. The subsequent global market rally was interrupted by the previously thought impossible, a majority in the UK voting on Thursday, June 23rd to exit the EU.

A shocked market pounded the pound down more than 10%, before the British currency ended that Friday’s session down 8.3%. The euro fell 3%, while EM currencies were under heavy selling pressure. Safe haven assets surged. Treasury yields sank to 1.41%, the yen jumped 3.8% and gold rose 4%. Meanwhile, global equities erased $2.0 TN of value. Italian and Spanish stocks were down about 12%, with losses of about 6% for German and French equities. European bank stocks were crushed. The DJIA dropped 611 points on June 24th trading. The Nasdaq Composite was down 202 points, or 4.1%, its worst showing since 2011. Crude sank 5%. It would prove a great buying opportunity for almost all global risk assets.

On August 4th, the Bank of England (with unemployment at 4.9% and market yields collapsing) moved forward with “whatever it takes,” cutting rates and reviving QE. From the UK Guardian: “Carney rebuffed suggestions the Bank was over-reacting to the Brexit vote and implied the UK would fall into recession without the new measures. ‘There is a clear case for stimulus, and stimulus now, in order to have an effect when the economy really needs it,’ he said.” The FTSE 100 ended the year up 14.4% at an all-time high. Not faring as well, the British pound dropped 16.3% versus the dollar.

By August markets took serious comfort from “whatever it takes.” And when it came to global reflation and reversing faltering market Bubbles, global central bankers had received extraordinary assistance from Beijing. Panicked Chinese officials had imposed a series of extreme measures to bolster liquidity and market prices, while adopting various control measures that restricted “money” leaving the country. The so-called “national team” had become an aggressive buyer of Chinese equities. Most importantly, a surge in state-directed lending saw Total Social Financing jump an incredible $525bn in January, spurring what would be a record $1.5 TN of first-half Credit growth – and full-year 2016 Credit expansion approaching an unmatched $3.0 TN.

When it comes to major Credit Bubbles, there’s inherently a fine line between a bursting Bubble and a perilous amplification of Terminal Phase Excess. It’s worth recalling that previous Chinese official efforts to rein in overheated real estate (apartment) markets worked to push excess liquidity into increasingly speculative stock markets. Trading around 2,200 in mid-2014, the Shanghai Composite surged to a peak Bubble 5,380 by mid-2015. Ironically, efforts this year to stabilize faltering equities, mounting Credit stress and a rapidly slowing economy incited a precarious liquidity (speculative blow-off) stampede into real estate and bond Bubbles.

Chinese mortgage finance Bubble excess this year pushed China’s housing Bubble to a state of being completely out of control. Year-over-year prices surged 46% in Shanghai, 35% in Beijing, 51% in Shenzhen and 49% in Nanjing. Despite mounting defaults and Credit stress, the over-abundance of cheap liquidity ensured that Chinese companies continued their aggressive leveraging. Growing another 16.5% during 2016, China now takes claim to the third-largest global bond market. Total repo financing is said to now exceed the amount of available outstanding bonds, in the face of an ongoing rapid expansion of “Shadow Finance” and speculative leveraging.

Total Chinese debt now easily exceeds 250% of GDP. It was also a record year for Chinese outbound M&A – $219 billion (Dealogic). As the year progressed, rapid Credit growth fueled rises in consumer and producer inflation: China’s November PPI was up 3.3% y-o-y, the strongest rise since 2011

As 2016 came to an end, Chinese officials appeared to recognize the dilemma they faced. The talk was how surging home prices posed a risk to social stability, and of the need for more aggressive measures to thwart Bubbles. In particular, “shadow banking” and speculation appear to be in official crosshairs.

The Shanghai Composite dropped 6.4% in December. More ominously, China’s bond markets turned increasingly unstable. Ten-year Chinese government yields surged 50 bps in several weeks (to 3.32%), before a year-end rally had yields closing 2016 at 3.04%. Year-end funding pressures were even more intense than usual.  More importantly, increasingly conspicuous cracks are forming in China’s corporate financing markets. Liquidity, default, fraud and counter-party issues are taking a rising toll. Desperate measures in 2016 to mask systemic debt problems with record amounts of new debt and market intervention will have dire consequences.

It’s that ominous dynamic of rapidly rising Credit necessary to stimulate even declining economic growth. But massive Credit did stabilize Chinese economic activity in 2016, playing a major role in the stabilization of global crude and commodity prices – price recoveries that were instrumental in stabilizing global debt concerns that were spreading from commodity-related companies, countries and regions.

It’s worth noting that the popular U.S. high-yield bond ETF (HYG) was down almost 7.0% by mid-February. Emerging market stocks and bonds were trading at multi-year lows. Key EM currencies, including the Mexican peso, South Korean won, South African rand, Indian rupee, Russian ruble, and Turkish lira, were under heavy selling pressure. Remember the fears for Glencore and other companies highly leveraged to commodities?

Well, Glencore’s stock ended 2016 up over 200%. U.S., European and Asian junk debt, for the most part, enjoyed a banner year. The HYG returned 13.4% in 2016, ahead of the 9.3% gain for the EMB (EM bond ETF). EM stocks (EEM) rose 11.7%. The GSCI Commodities Index jumped 27.9%, led by a 45% increase in crude prices. Stocks in Brazil gained 38.9%, Russia 26.8% and Mexico 6.2%. Down a quick 12% to start the year, Canadian stocks ended 2016 with a 17.5% gain, the “Developed World’s Top Market.”

Who back in February would have forecast oil, junk, Brazil and Russia at the top of the 2016 leaderboard? Who would have predicted Friday’s AP headline? “Energy Companies and Banks Led Rally on S&P 500 in 2016.” But it’s always the leveraged and finance-dependent entities “at the margin” that are most sensitive to changing financial conditions. Without extreme “whatever it takes” measures (from global central banks and China) it would be today a very different world. This year’s biggest winners – stocks, bonds, currencies, etc. – could have instead been huge losers, with the Periphery dragging down the Core.

But with global QE in the neighborhood of $2.0 TN annually and hundreds of billions flowing out of China, the vulnerable Periphery enjoyed a liquidity windfall. Global fragilities were in the short-term ameliorated by unprecedented global rate and liquidity dynamics. The year began with the world at the precipice of a bursting Bubble. The bottom line is that the global Bubble persevered and then inflated significantly.

To be sure, Global Monetary Disorder become deeply entrenched. After trading at a 13-year low $26.05, WTI crude more than doubled (“biggest annual gain since 2009”) to trade as high as $54.50 near year-end (OPEC managing the first production cut since 2008). Trading inversely to risk assets, bullion began the year at $1,061, surged to $1,375 (7/11) and then reversed course to end the year at $1,152. After starting 2016 at 111, the HUI gold equities index surged to 286 in July, before reversing course to close the year up 64% at 182. Wild moves were not limited to commodities. The British pound sank 10% versus the dollar on Brexit, to a 31-year low. The Mexican peso collapsed 14% to an all-time low on Trump’s equally stunning win. Draghi’s December move to expand and extend ECB monetary stimulus pushed the euro to a 14-year low against the U.S. currency.

The Japanese yen has for some time been a leading funding currency for global leveraged speculation. The dollar/yen began the year at 120.22 before trading as high as 121.69 on January 29th. Fears of global de-risking/de-leveraging saw the yen rally strongly versus the dollar. This advance was capped by a Brexit induced better than 4% surge that had the dollar/yen trading below 100 on June 24th (first time below 100 since 2013). The dollar/yen began to rally in September, although it traded as low as 101.20 during chaotic U.S. election-night trading. Then an abrupt rally had the dollar/yen trade as high as 118.66 on December 15th, before closing 2016 at 116.96.

Yet nowhere was Monetary Disorder more prominent in 2016 than throughout global bond markets. When it appeared global yields could not possibly decline much more, the impossible: They sank a lot lower, hitting historic extremes in the wake of the Brexit vote. UK debt has traded for a very long time, yet never at yields as low as those of 2016. After beginning the year at 1.96%, 10-year gilt yields dropped to 1.22% in early-July. After starting 2016 at 2.27%, 10-year Treasury yields hit a record low 1.36% on July 8th. Japan’s JGB yields sank to negative 29 bps, after starting the year at positive 27 bps. Swiss 10-year yields were a negative five bps to begin the year, but then sank to an incredible negative 63 bps. Bund yields dropped to negative 19 bps (began 2016 at 63bps), as French yields fell all the way to 10 bps (99 bps). Highly indebted Italy saw its 10-year yields sink to an impossibly low 1.04% (1.60%), and Spanish yields fell to an equally incredible 0.88% (1.77%). By August, an impossible $13.4 TN of global bonds were trading with negative yields (FT).

It evolved into a spectacular market dislocation and melt-up, surely fueled by derivative-related trading and a powerful short-squeeze. Typical of blow-off tops with their abrupt reversals, market euphoria proved short-lived. From 2016 lows, Treasury yields surged 124 bps, with British gilt yields up 109 bps. From lows to highs, bund yields rose 59 bps, French yields 77 bps and Spanish yields 73 bps.

Of special note, Italian yields jumped 109 bps from earlier lows, with a year-end rally reducing the 2016 yield rise to 22 bps at 1.82%. Portuguese bonds ended the year at 3.76%, up 124 bps. Providing a good microcosm of “Periphery” instability, Greek bond yields surged to 11.57% in February only to close 2016 at 7.11%. In a few short weeks, Mexican (peso) yields surged 160 bps, with significant yield rises throughout EM.

For the year, the Argentine peso declined 18.6%, the Turkish lira 17.2%, the Mexican peso 17.0%, the Polish zloty 6.3%, the Philippine peso 5.2% and the Malaysian ringgit 4.3%. Mexico was forced to raise rates to support a rapidly sinking peso and counter prospects for an inflationary surge.

Wild markets for the most part didn’t help the struggling leveraged speculating community. A December 28th Bloomberg headline: “The Golden Era of Hedge Funds Draws to a Close With Clients in Revolt.” While most funds again underperformed expectations, the industry got through 2016 without major redemptions. This they owe to central bankers and Chinese officials. And another Bloomberg headline, this one from December 30th: “Actively Managed Funds Take a Beating.” Throughout 2016, and especially after the election, “money” literally flooded into equity index and other passively managed ETFs. Central bankers ensured that managers attentive to risk and risk management had another crummy year.

I expect future historians will see 2016 chiefly through the geopolitical perspective. How can market happenings compete against Brexit, the Trump phenomenon and Renzi’s failed political reform referendum (to name only the most obvious)? But clearly unstable markets, unsettled societies and simmering geopolitical turmoil are more than coincidental. At their roots, all can be traced to a prolonged period of unchecked finance, central bank activism and the general effects of inflationism.

Consequences were on increasing display throughout 2016. There was the rising tide of anti-establishment populism that seemingly became a global phenomenon. There was the deep discontent that led to Brexit and President-elect Trump. This was part of general instability and uncertainty that afflicted financial markets – in the process ensuring “whatever it takes” went to even crazier extremes. And, almost ironically, this is the type of mercurial social and monetary backdrop conducive to powerful markets reversals and attendant bouts of hope and optimism.

December 27 – Bloomberg (Vince Golle): “The last time Americans’ optimism about the stock market registered such a dramatic one-month surge was during the dot-com boom. As stocks reached a record, the share of households anticipating higher equity prices a year from now surged to 44.7% in December from 30.9% a month earlier, the biggest monthly advance since November 1998…”

As an extraordinary year came to an end, confidence overtook caution. Just kind of pushed it aside. Markets became willing to dismiss myriad risks – all the uncertainties associated with China, Italy, rising populism, terrorism, geopolitical, etc. It was as if everyone just turned tired of worrying. There was as well a willingness to imagine the best of President-elect Trump’s policies, while disregarding all the uncertainty that comes with such a unique personality. It’s going to be an incredibly fascinating 2017.

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Categories: Perspectives