Doug Noland: Crowded Longs, Shorts and a New Z1

It was a week that saw Mario Draghi cling stubbornly to ultra-dovish monetary policy, the UK’s Brexit strategy thrown into even greater disarray after Prime Minister May’s failed election gambit, and the former Director of the FBI essentially testify that our President is a scoundrel. And then there’s the Middle East…

In the midst of it all, after trading at a 24-year low 9.37 Friday morning, an abrupt reversal had the VIX ending the week at 10.70. Looking at the S&P500’s slight (0.3%) decline for the week, one might be tempted to think comfortably “boring.” Market internals, though, were anything but boring or comforting. Friday’s session saw the Nasdaq 100 (NDX) swing wildly. After trading to an all-time high 5,898 in the first hour of U.S. trading, the index sank over 4.0% to 5,658 before closing the session down 2.44% at 5,742. Amazon traded in an intraday range of 1013 to 927. Looking at “FANG” plus Microsoft and Apple, major market cap was evaporating in a hurry. By the end of Friday’s session, Facebook had declined 3.3%, Apple 3.9%, Amazon 3.2%, Microsoft 2.3%, Netflix 4.7% and Google 3.4%. The semiconductors (SOX) traded at a multi-year high 1,149 early in Friday’s session, then sank 7.0% before recovering somewhat to close the day down 4.3% at 1,090. Biotech (BTK) rose 1.5% in the morning to an all-time high and then closed the session slightly lower.

Yet it was not just Friday – and not only tech. After trading Tuesday morning at a low of 88.38, bank stocks (BKX) surged over 6% before closing the week up 4.9% to 93.79. The broker/dealers jumped 3.6% this week. The small cap Russell 2000 traded Tuesday morning at a low of 1,387 before rallying 3.3% to end the week with a gain of 1.2%.

It was an unpleasant day and week for the Momentum Crowd all crowded into outperforming technology stocks. It was even worse for those long momentum and short the underperformers. Long tech versus short financials had been a big winner until the late-week “rip your face off” – with Friday trading seeing bank stocks up 2.3% and the Morgan Stanley High Tech Index down 3.0%. Long big technology against short small caps had also been easy money – until the last few sessions. This week saw the NDX drop 2.4%, while the small cap Russell 2000 gained 1.2%. And it’s worth noting some of Friday’s winners: Dillards (10.2%), Urban Outfitters (7.8%), J.C. Penny (6.8%) and Barnes & Noble (6.0%) – all heavily shorted in the despised retail sector. Moreover, the leading gainers in the S&P500 – including Kohl’s (7.2%), Chesapeake Energy (4.9%), Nordstrom (5.7%), Tractor Supply Company (4.7%) and Murphy Oil 4.7% – are popular short targets. It was a rotten day and a poor week for many long/short strategies.

As for the ECB decision and the UK election, I’ll this evening posit the briefest of thoughts. Mario Draghi has been kicking the can down the road since 2012, and he clearly is in no mood to see what happens when his leg turns weary. We’ll apparently have to wait until later in the year to have a clearer understanding of the ECB’s stimulus program end-game. The Wall Street Journal ran an interesting pre-meeting article – with the catchy headline “ECB Critic Holds His Tongue as Race Nears for Bank’s Top Job” – discussing how the Germans have set their sights on the end of Draghi’s term in 2019.

June 7 – Wall Street Journal (Tom Fairless): “Jens Weidmann, the German central-bank chief who made his name by loudly attacking the European Central Bank’s crisis-fighting efforts, has become a quiet defender of the ECB against its German critics. The shift has been subtle. Mr. Weidmann still criticizes the bank’s radical stimulus measures. But his tone has softened as evidence accumulates that the ECB’s policies are working—and as the race to become the institution’s next president approaches. ‘There is currently no doubt that an expansionary monetary policy stance is appropriate,’ Mr. Weidmann said…, while suggesting he might not agree with his colleagues on the details. Only five years ago, he was boasting of clashes with fellow policy makers, and comparing easy-money policies to drugs and alcohol. As ECB officials gather Wednesday and Thursday in Estonia, what was once a bitter argument over the bank’s far-reaching monetary stimulus is expected instead to be a pragmatic discussion about whether to start reducing it.”

And why the big surprise from the dismal Conservative party showing in the UK election? Has there been any brightening of the underlying dour public mood? Folks suddenly content with the “establishment,” “elites” and the status quo? Feelings the “system” is working more fairly? Market and media complacency returned after Emmanuel Macron’s huge market-pleasing victory in the French presidential election. I would suggest the Mr. Macron owes his presidency and apparent mandate to Mario Draghi. I wouldn’t, however, wager on a long honeymoon period – let along some new golden age in French (and European) policy management. The political instability that had pundits fretting coming into 2017 is merely in a bit of remission. Wait until the ECB tap goes dry and the Draghi Bubble bursts.

Closer to home, there was a new Federal Reserve “flow of funds” Z.1 report this week. From my perspective, interesting data raised more questions than were answered.

Certainly not inconsistent with downshifting GDP (Q1 1.2% vs. Q4 2.1%), Credit growth somewhat fell off a cliff. Total Non-Financial Debt (NFD) growth slowed to a 1.4% pace in Q1, down from Q4 2016’s 2.8% to the slowest expansion in years. In seasonally-adjusted and annualized (SAAR) dollars, NFD expanded $676bn in Q1, down from $1.338 TN in Q4 and $2.406 TN in Q1 2016. Seeing such data, I would normally be chronicling a dramatic tightening of Credit Availability and financial conditions. It’s yet another example of these being the most abnormal of times.

Household mortgage Credit expanded at a 3.0% rate during Q1, second only to Q4’s 3.2% going all the way back to the pre-crisis era. Consumer (non-mortgage) Credit expanded at a 6.5% pace, matching Q4 (strongest since Q3 ’15). Corporate borrowings bounced back strongly from Q4’s abrupt stall (0.2%). Q1’s 6.9% growth rate surpassed Q3’s 6.3% and was the strongest expansion of Corporate borrowings since Q1 ’16 (10.7%). Data just don’t speak to a tightening of Credit conditions.

Q1 saw Federal government borrowings contract at a 3.3% pace and State & Local borrowings fall at a 3.5% rate. It was this atypical decline in government Credit that largely explains Q1’s tepid overall Credit expansion. At least at the federal level, a significant drawdown in deposits helps to explain the one-quarter hiatus from market borrowings. A Q2 bounce back in government borrowings should push system Credit growth significantly higher.

To see booming securities markets in the face of 1.2% pace NFD growth is strange indeed. But while overall Non-Financial borrowings slowed to a crawl, the financial sector seemed to be frantically scurrying about. The Domestic Financial Sector’s “Net Acquisition of Financial Assets” surged an unusual SAAR $4.840 TN (vs. Q4’s $291bn and Q3’s $2.716 TN). After three straight quarters of contraction, Net Interbank Assets expanded an extraordinary SAAR $1.589 TN. The Financial Sector also increased Miscellaneous Assets SAAR $1.811 TN, while expanding Debt Securities holdings SAAR $452bn and Fed Funds and Repos SAAR $158bn.

Depository Institutions’ Loans expanded a robust SAAR $924bn during Q1, up from Q4’s SAAR $595bn but somewhat below Q1 ‘16’s booming $1.241 TN. Clearly, booming asset markets had much more to do with a booming financial sector than a robust real economy. It would be quite unusual for booming markets not to provide some degree of economic stimulus, though bubbling markets create myriad fragilities.

Securities markets remain the epicenter of this cycle’s historic inflation. Q1 saw Equities increase a nominal $939bn to a record $40.755 TN. This boosted Equities as a percent of GDP to a record 214%. This compares to the previous peak levels from 2007 and 1999 of 181% and 202%. Total Debt Securities increased nominal $320bn during Q1 to a record $41.464 TN. Debt Securities-to-GDP at a near-record 218% has been relatively stable over recent quarters. Total (Debt and Equities) Securities ended Q1 at a record $82.220 TN and a record 432% of GDP. This compares to the cyclical peaks of 379% at Q3 2007 and 359% at Q1 2000.

The Household Balance Sheet continues to be a centerpiece of U.S. Bubble Economy analysis. U.S. Household Assets ended Q1 at a record $110 TN, increasing $2.383 TN during the quarter. And with Household Liabilities up $36 billion (to $15.152 TN), Household Net Worth surged another (remarkable) $2.347 TN during the quarter to a record $94.835 TN. It’s worth noting that Household Net Worth has now inflated $39.1 TN, or 70%, since Q1 2009.

Over the past year, Net Worth inflated $7.259 TN, or 8.3%, one of the largest one-year gains on record. By major component, Household Financial Assets increased $1.781 TN during Q1 to a record $77.115 TN, with a notable one-year rise of $5.734 TN (8.0%). At 125% of GDP, Real Estate holdings gained $499bn during the quarter to a record $26.866 TN, with a large one-year rise of $1.794 TN (7.2%).

Q1 Household Net Worth reached a record 498% of GDP. For comparison, Net Worth/GDP ended the (“decade of greed”) eighties at 379%, Bubble year 1999 at 446% and peak mortgage finance Bubble 2007 at 461%. Unless something dramatic unfolds over the next few weeks, Net Worth/GDP will have cruised through 500% during Q2. It’s worth noting that Household Total Equities (equities and mutual funds) holdings have doubled from 2009 levels to approach the record 129% of GDP from year-end 1999.

Helping to offset tepid domestic Credit, Rest of World (ROW) had strong Q1 flows into U.S. financial assets. At SAAR $1.20 TN, Q1 ROW flows compare to an outflow of SAAR $187bn in Q4 and an inflow of SAAR $501bn in Q1 2016. Curiously, Treasury purchases (SAAR $344bn) dominated flows into U.S. debt securities and were the strongest since 2014. Purchases of U.S. corporates slowed to SAAR $132bn, down from Q4’s SAAR $433bn. After big Q4 outflows (SAAR $480bn), ROW increased U.S. equities holdings SAAR $219bn during Q1. It’s difficult to comprehend that ROW holdings of U.S. financial assets have grown to almost $25 TN, inflating about ten-fold from the mid-nineties.

Returning to the markets, players will spend the weekend pondering whether Friday’s tech swoon was a mere flash in the pan or the beginning of something more serious. That intense selling manifested from market dynamics rather than in response to some news event might make it more difficult to spin. Rotations have become a common feature of this speculative marketplace, and the bulls will spin rotations positively. This week saw previous underperformers gain momentum, while the highflyer Wall Street darlings saw melt-ups rather abruptly indicate potential trouble below. When the Crowded Trade phenomenon has finally made it to the top of the food chain – to a select group of speculative favorite megacaps – a big rotation away from the darlings will present a formidable market challenge. From my vantage point, such dynamics are consistent with equities (and risk markets) working toward putting in a major top.


Original Post 10 June 2017

Categories: Doug Noland, Perspectives