Doug Noland: Well, That’s Some Weird… Stuff

Excerpts:

Especially in the current backdrop, market melt-ups come replete with risk. For one, most have now turned crazy bullish. Ignoring risk continues to be rewarded…

I often highlight the late-cycle phenomenon characterized by extreme divergence between inflating securities prices and deflating economic prospects. I have surmised this gulf is the greatest since 1929. And this chasm has only widened since the election, especially during Monday’s session.

The Pfizer news showered gasoline upon the bonfire. It was a melt-up dislocation and short squeeze as intense as I’ve witnessed over recent decades. Segments of the market traded as if some hedge fund and sophisticated derivative strategies were “blowing up”. As for long/short strategies, things went from bad to cataclysmic. From Bloomberg: “…Market winners and laggards switched positions at the fastest rate on record Monday.” Attacked savagely, the persecuted bears were hit with a fateful blow. A “bear” ETF lost 11% of its value in a chaotic Monday trading session.

Sure enough, such a market outcome “statistically never could happen.” In reality, such a freakish backdrop created a high likelihood of just this kind of mayhem and market dislocation (either up or down).

The pandemic has profoundly impacted market dynamics. An already acutely speculative marketplace has been only further emboldened. Not only has “the Fed has the market’s back” view been solidified. After a $3 TN ballooning of the Fed’s balance sheet, there is no doubting the Fed’s capacity to deliver an effective market backstop.

A contested election and upheaval in Washington – no problem. Covid infections spiraling out of control throughout the entire country – not a market concern. The prospect of a dark, Covid winter with social strife and economic vulnerability today seems the furthest thing from Mr. Market’s triumphant mind.

Things, however, will just not play out to match bullish hopes and dreams. The pandemic will pass. But it will leave deep and lasting scars. The current Bubble has been inflating for a very long time. Structural impairment has worsened over time, with the greatest damage now inflicted during pandemic “Terminal Phase Excess.”

At this point, markets are scary dysfunctional. Melt-ups lay the groundwork for breakdowns. And the longer markets disregard reality, the more destabilizing the eventual reckoning. There’s a major economic crisis shoe to drop when market Bubbles succumb.


The “average stock” Value Line Arithmetic Index jumped 6.4% for the week. The NYSE Arca Oil Index surged 19.8%, with the Philadelphia Oil Services Index up 17.4%. The KWB Bank Index rose 11.5%, as the Nasdaq Bank Index advanced 13.6%. The Bloomberg REIT Index jumped 6.8%.

The S&P600 Small Cap Index gained 7.5% for the week, as the S&P400 Midcaps rose 4.3%. The Bloomberg Americas Airlines Index jumped 12.9%. The JPMorgan Leisure Travel Index surged 15.3%. Major equities indices rose 13.3% in Spain, 11.9% in Austria, 11.5% in Greece, 10.5% in Belgium, 8.5% in France, 6.9% in the UK and 4.8% in Germany. Turkish stocks surged 8.3%. Crude (WTI) prices jumped 8.1%. Meanwhile, Zoom was down 19%, Netflix 6.2%, Facebook 5.6%, Amazon 5.5%, and Tesla fell 5.0%. Well, That’s Some Weird… Stuff.

I have no interest in disparaging Pfizer’s (and BioNtech’s) Monday announcement of 90% effectiveness for their Covid vaccine. It’s encouraging news. But it is a two-shot vaccine that reportedly can induce strong post-shot reactions. Moreover, logistical challenges await a vaccine requiring extreme cold storage (negative 100 Fahrenheit). There will be limits to its availability, but mainly I expect a majority of American’s initially to approach Covid vaccines with caution. While many questions remain unanswered, the bottom line is 90% effectiveness bodes well for Covid vaccines generally.

Monday’s market reaction to the news doesn’t bode so well for general market stability.

November 13 – Bloomberg (Justina Lee): “Jon Quigley says he probably should have known something big was coming — even if his risk models didn’t. Just a day after the Great Lakes Advisors manager watched CBS’s ‘60 Minutes’ about America’s unprecedented efforts to deploy a vaccine when it comes, Pfizer Inc. revealed significant progress on its pandemic cure. That revelation spurred the biggest moves ever in Quigley’s $3.9 billion portfolio. While stock benchmarks cheered the news, Wall Street’s most popular styles of quant trading got hit by a historic storm. ‘Events happened that statistically never could happen,’ said the chief investment officer of disciplined equities… Quigley spelled out the odds to clients in a note. As he computed it, the crash in the momentum factor was so rare that writing out the chances of occurrence on any given day required a 16-digit number — followed by 63 zeroes.”

Monday’s Pfizer announcement followed pivotal elections by only a few trading sessions – an election I have posited as the most hedged individual event ever. Markets were already in a state of acute instability prior to the news, having been spurred sharply higher by the unwind of hedges and short positions.

Those positioned bearishly had suffered only deeper impairment, while derivatives markets were moving toward dislocation. Holders of puts were in liquidation mode, while those that had written out-of-the-money call options (and similar derivatives) were facing rapidly escalating exposure. In the leveraged speculating community, the more sophisticated strategies were performing poorly. In particular, long/short strategy performance was suffering the effects of a brutal short squeeze along with violent rotations. A marketplace consumed with momentum was all Crowded together in the favored technology and “stay-at-home” stocks.

The Pfizer news showered gasoline upon the bonfire. It was a melt-up dislocation and short squeeze as intense as I’ve witnessed over recent decades. Segments of the market traded as if some hedge fund and sophisticated derivative strategies were “blowing up”. As for long/short strategies, things went from bad to cataclysmic. From Bloomberg: “…Market winners and laggards switched positions at the fastest rate on record Monday.” Attacked savagely, the persecuted bears were hit with a fateful blow. A “bear” ETF lost 11% of its value in a chaotic Monday trading session.

Sure enough, such a market outcome “statistically never could happen.” In reality, such a freakish backdrop created a high likelihood of just this kind of mayhem and market dislocation (either up or down).

Especially in the current backdrop, market melt-ups come replete with risk. For one, most have now turned crazy bullish. Ignoring risk continues to be rewarded. Equities funds attracted a record $44.5 billion over the past week (ending Wednesday). State Street’s SPDR S&P 500 ETF (SPY) received Monday inflows of $9.8 billion. Meanwhile, Wall Street strategists are climbing over each other to raise market targets.

I often highlight the late-cycle phenomenon characterized by extreme divergence between inflating securities prices and deflating economic prospects. I have surmised this gulf is the greatest since 1929. And this chasm has only widened since the election, especially during Monday’s session.

The pandemic has profoundly impacted market dynamics. An already acutely speculative marketplace has been only further emboldened. Not only has “the Fed has the market’s back” view been solidified. After a $3 TN ballooning of the Fed’s balance sheet, there is no doubting the Fed’s capacity to deliver an effective market backstop.

A contested election and upheaval in Washington – no problem. Covid infections spiraling out of control throughout the entire country – not a market concern. The prospect of a dark, Covid winter with social strife and economic vulnerability today seems the furthest thing from Mr. Market’s triumphant mind.

As readily espoused by the bullish punditry, markets are a discounting mechanism – and these days are doing what they’re supposed to do: price securities for the eventuality of a favorable post-vaccine economic landscape. Look past the valley. Robust recovery is only an issue of when.

And that’s what makes this pandemic market environment unique. This is a horrendous pandemic inflicting terrible damage to health, the economy and social stability. But it will pass – and in the meantime the Fed is happy to print Trillions. Fiscal authorities have gladly disbursed Trillions more. No matter how bad things get, speculative markets can imagine nothing but (oodles of “money” and) blue skies ahead.

Importantly, so long as market imagination fancies a sensational future, booming markets support confidence, spending and investment. The resulting loose financial conditions ensure that even weak borrowers (individuals, corporations, municipalities and others) enjoy access to cheap finance. This bolsters business spending, while obscuring the scope of a festering Credit debacle. Moreover, wealth effects continue to underpin economic recovery. And let’s not overlook the rapidly inflating Bubble in housing markets across the country.

Things, however, will just not play out to match bullish hopes and dreams. The pandemic will pass. But it will leave deep and lasting scars. The current Bubble has been inflating for a very long time. Structural impairment has worsened over time, with the greatest damage now inflicted during pandemic “Terminal Phase Excess.” At this point, markets are scary dysfunctional. Melt-ups lay the groundwork for breakdowns. And the longer markets disregard reality, the more destabilizing the eventual reckoning. There’s a major economic crisis shoe to drop when market Bubbles succumb.

Friday’s reporting had a daily record 182,000 of new infections (worldometer), with the seven-day average now surpassing 132,000. Hospitalizations nationally posted new records on four straight days (having doubled in a month to almost 69,000). Daily cases are spiking higher in a growing number of states, with particularly troubling increases in Wisconsin, Illinois, Minnesota, Michigan, Ohio, Pennsylvania, Indiana, Iowa, Kansas, Nebraska, North Dakota, South Dakota, New Mexico, Colorado, Wyoming, Utah, and Massachusetts. A message from Ohio Governor Mike DeWine: “We are facing a monumental crisis in Ohio.”

New restrictions were imposed in New Jersey, Oregon, New Mexico, Idaho, Virginia, and elsewhere. The West Coast states issued a joint travel advisory, while California is warning of tougher measures to come. Northeast governors are planning a weekend “emergency summit meeting.” New York City will likely close schools Monday.

The Covid crisis is again reaching fever pitch, which was previously associated with stronger compliance and peak daily infections. But this time is different. Virtually the entire nation is experiencing rapidly rising case numbers, and we’re heading right into the winter season. Hospitals are filling. On a national basis, resources will be in short supply and difficult to shift to hot zones. It’s all ominous.

Speaking of ominous, interesting developments this week out of China, along with the release of October Credit data.

China experienced a broad-based Credit slowdown in October. Aggregate Financing expanded a weaker-than-expected $215 billion, down from September’s $526 billion and the slowest growth since February. It’s worth noting last October was 2019’s weakest monthly Credit expansion ($131bn). For the first 10 months of 2020, Aggregate Financing surged $4.696 TN, 45% above comparable 2019 and 64% ahead of comparable 2018 growth. Aggregate Financing was up $5.315 TN over the past year – a historic Credit binge. The 13.7% year-over-year growth rate was the strongest in years.

New Bank Loans slowed to a below-expectations $103 billion, down from September’s $281bn, and the slowest growth in a year. The year-to-date expansion increased to $2.511 TN, 19% ahead of comparable 2019. One-year growth slowed slightly to 12.9%. Two-year growth was at 26.9%, with five-year growth of 83.6%.

Consumer Loan growth slowed to $66 billion, down sharply from September’s $147 billion and the weakest reading since February’s contraction. Year-to-date growth of $992 billion was 7.4% ahead of comparable 2019. Consumer Loans expanded 14.6% y-o-y, with two-year growth of 32%, three-year 56%, and a five-year expansion of 135%.

Corporate Loans dropped to $35 billion, down from September’s $143 billion to the weakest growth in a year. Year-to-date growth of $1.633 TN was 29% ahead of comparable 2019 and 49% above comparable 2018.

M2 money supply contracted $218 billion during October, the largest monthly contraction since July 2014. This reduced year-to-date M2 growth to $2.469 TN, or 11.7% annualized. M2 expanded $1.798 TN over comparable 2019. M2 expanded $3.088 TN, or 10.5%, year-over-year.

With October a seasonally slow month for lending and Credit growth more generally, we shouldn’t at this point read too much into weak data. Yet policymakers have clearly moved to pull back on stimulus measures. Consumer loans declined meaningfully during October, held in check at least partially by measures to tighten mortgage Credit.

Faith that Beijing has everything under control runs as deep as ever. But China’s Credit growth has been averaging an incredible $470 billion monthly over the past 10 months. This Credit onslaught has kept a lot of weak companies solvent. It has also stoked a stock market mania and additional apartment Bubble excess. Policymakers are not oblivious to these risks and have moved to cautiously rein in lending and speculative excess. But history informs us that attempts to let some air out of Bubbles are fraught with risk. For a historic and prolonged Chinese Bubble, fragilities and vulnerabilities are acute.

November 13 – Bloomberg: “China’s ex-finance minister said it’s time to consider withdrawing the monetary stimulus injected into the economy this year and fine-tune fiscal policies as the recovery strengthens… ‘It is time for China to study an orderly exit of loose monetary policies,’ Caixin quoted Lou Jiwei, who was finance minister from 2013 to 2016, as saying… That doesn’t mean it would be an immediate exit, he added. The challenge is to carefully manage the pace of the exit, Lou said, given high debt levels in the economy. If liquidity is withdrawn too soon it could trigger debt crises, he said.”

November 13 – Bloomberg: “The surprise default of a state-run Chinese coal miner and a slump in bonds of a prominent chipmaker took center-stage this week, deepening concerns over the health of state-owned enterprises. Dollar bonds of several Chinese state-owned firms tumbled Wednesday after Yongcheng Coal & Electricity Holding Group’s onshore default and rising stress at a prominent chipmaker triggered broader concern about the sector. Tsinghua Unigroup’s dollar bonds extended their recent plunge on Thursday amid growing concern over the company’s future and its ability to repay its debts.”

November 10 – Bloomberg (Zheping Huang and Coco Liu): “Xi Jinping’s Communist Party stepped up efforts to rein in some of China’s most powerful companies, jolting investors and dealing a blow to the country’s richest entrepreneurs. Beijing… unveiled regulations to root out monopolistic practices in the internet industry, seeking to curtail the growing influence of corporations like Alibaba Group Holding Ltd. and Tencent Holdings Ltd. The rules, which sent both stocks tumbling over two frenetic days and sparked a wider selloff in Chinese equities, landed about a week after new restrictions on the finance sector triggered the shock suspension of Ant Group Co.’s $35 billion initial public offering.”

From Bloomberg: “PBOC Deputy Governor Liu Guoqiang said last week that ‘[stimulus] exit is a matter of time and it is also necessary.” China’s 10-year sovereign yields jumped seven bps this week to a one-year high 3.26%. Three-month “repo” rates (3.30%) rose to the high since December. According to Bloomberg, “The interest rate on 1-year negotiable certificates of deposits issued by AAA-rated companies climbed to the most expensive since June 2019.”

There were indications this week of the start of a consequential tightening of financial conditions. From Bloomberg: “China State Banks Said to Cut Corporate Bond Exposure Amid Rout – A number of Chinese banks are cutting their holdings of corporate bonds, with some focusing on notes sold by state-owned firms, after a string of defaults roiled the market…” Also Friday from Bloomberg: “Stress in China’s Credit Market Spills Over to Financial Stocks – The default of a Chinese coal miner has triggered mounting concern over the health of state-owned firms and their lenders. The SSE 50 Index of Shanghai’s largest stocks slumped as much as 2.3% on Friday, led by banks and insurers.”

Is it a coincidence that Credit issues are erupting in the wake of one month of slowing Credit expansion – with the first hint of a winding down of massive policy stimulus? It’s certainly ominous. Beijing moved aggressively to contain Covid, and then historic Credit growth spurred economic recovery. But over $4.5 TN of new Credit in 10 months only exacerbates China’s financial and economic fragilities. With U.S. elections and Covid, China has been off the radar. Time to pay attention.

Original Post 14 November 2020


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