Doug Noland’s thoughts are always interesting. But some times more than others.
The former manager of the Prudent Bear fund and now proprietor of the Credit Bubble Bulletin website, Noland has been posting a weekly critique of the circus that is the global financial system for what seems like forever.
During the long, long expansion phases of the past few bubbles, it’s been hard to read his posts without feeling a tinge of sadness. You know he’s right, but you also know that it might be a while before he’s proven so and in the meantime everyone is having too much fun to listen.
But when the bubble bursts, Noland’s analysis morphs from cry in the wilderness to real-time chronicle of financial catastrophe. For like-minded readers, this is more than just educational; it is, in a schadenfreudian sense, fun. Now is emphatically one of those times, so here are a few excerpts from his most recent CBB:
For the most part, global finance is comprised of a labyrinth of IOUs. And IOU value hinges on confidence, faith and trust. Over recent years too much of global finance has been underpinned – directly and indirectly – by concerted efforts of the world’s central bankers. Trillions of newly minted government finance have been validating tens of Trillions more of private-sector obligations and asset prices. Now, faith in the almighty power of central bank Credit and fiscal deficits, unquestioned for far too long, has begun to dim. The unfolding global crisis of confidence expanded and accelerated this week.
Global financial tumult has now attained sufficient momentum so that even U.S. markets can no longer remain comfortably oblivious. Yet, for most in the U.S. there remains little worry: the economy is sound, housing is booming, Silicon Valley is heroic, the banking system is rock solid, and the corporate sector is awash in cash. The U.S. economy is viewed as insignificantly exposed to China’s economic slowdown – and to global issues for the most part. Analysts speak of a “normal” stock market pullback – yet another buying opportunity. There is, however, little normal about current global financial, economic and geopolitical backdrops.
According to SNL Financial, Chinese banks now hold four of the top five spots on the list of the world’s largest banks. Pulling data from year-end 2014 balance sheets, the big four Chinese banks – Industrial & Commercial Bank of China, China Construction Bank, Agricultural Bank of China and Bank of China – ended 2014 with assets of 87.59 TN yuan, or $13.7 TN. China’s big four saw combined Total Assets expand 64% in four years, with Loans up 80%. Estimates place total China banking system assets at $172 TN yuan to end 2014, or about $27 TN at today’s exchange rate. Since the end of 2008, banking assets have swelled 175%. Estimates show “shadow banking” assets having ballooned to the neighborhood of $5.0 TN. A bursting Chinese Super Bubble is a systemic issue – for the global economy, for global markets and for global finance. Rather quickly, China’s $3.7 TN international reserve position doesn’t seem as all-powerful.
As an analyst of Credit and (serial) Bubbles going back 25 years, there’s a recurring theme that is especially pertinent these days. Financial and economic Bubbles invariably prove much more resilient than Bubble analysts presume. And, at the end of the day, the excesses and consequences go beyond what even the hardcore “bears” could anticipate. The adage around our office became: “It’s Always Worse Than You Think.”
I expected a reversal of “hot money” flows and leverage that flowed freely into Mexico in the early-nineties to end in financial turmoil. The Mexican collapse unearthed excesses even worse than assumed. I fully expected the Asian Tiger Bubbles to implode. That fiasco proved much worse than anticipated. I saw the 1998 crisis coming. I knew major speculative excess had set the stage for financial dislocation. Yet I was shocked to learn of the egregious leverage employed by what was at the time one of the world’s most respected hedge fund complexes (LTCM). I knew Argentina was in trouble in 2000, but things were much more fragile than anticipated. I was confident that the mortgage finance Bubble would burst with devastating consequences. But, once again, boom-time excesses and shenanigans proved beyond even my hardcore (“wacko”) bearish expectations.
I really fear for the unwind of the “global government finance Bubble” – the grand finale of a multi-decade period of serial Bubbles. It’s history’s first systemic global Bubble, encompassing the world’s Credit systems, securities markets and monetary systems more generally. Excesses have engulfed the heart of “money” and Credit throughout both the “developing” and “developed” world. Central banks (of all stripes) have printed Trillions of “money” and Trillions more have been created in the process of leveraging securities and other assets. This type of monetary inflation invariably incentivizes destabilizing speculation, fraud, malfeasance and wealth redistribution. It’s fomented a geopolitical tinderbox.
I allow my mind to imagine the type and poor quality of assets on (bloated) Chinese, Brazilian, Russian, Asian and EM bank balance sheets – yet it’s surely a lot worse. I ponder how desperate governments will use their state directed lenders to stimulate and obfuscate – and then I contemplate the scope of future government bailouts. On a global basis, I believe there is today more speculative leverage in global currencies and securities markets than ever – and I fear my bearish imagination might only scratch the surface. There have been too many years of financial manipulation, innovation, experimentation and exploitation – on an unprecedented globalized scale.
This week saw the first serious cracks unfold in the global financial “system.” I was compelled to calculate this week’s stock price declines from SNL Financial’s list of the 10 largest global banks: 1) Industrial & Commercial Bank of China 6.1%; 2) China Construction Bank 6.9%; 3) Agricultural Bank of China 4.9%; 4) HSBC 6.6%; 5) Bank of China 6.1%; 6) JPMorgan Chase 6.2%; 7) BNP Paribas 4.4%; 8) Mitsubishi UFJ Financial Group 7.5%; 9) Bank of America 9.0%; and 10) Barclay’s 6.4%.
It’s worth noting that Hong Kong’s Hang Seng China H-Financials Index sank 8.2% this week, with double-digit declines from Ping An Insurance Group of China and Bank of East Asia. Asian financial hub Singapore saw its stock market under significant pressure, with the Straits Times Index sinking 4.6%. The major Singapore bank stocks were hit (DBS Bank 5.0%, OCBC Bank 6.8% and United Overseas Bank 7.1%).
The systemic nature of the unfolding global crisis turned coherent this week. Crude oil sank below $40, as energy-related debt came under greater selling pressure. Saudi Arabia (3-year high), Qatar and Bahrain all saw a meaningful increases in sovereign CDS. Here at home, energy-sector Credits were under further pressure. Contagion was given an extra thrust from “money” this week exiting corporate debt, EM and U.S. equities funds. Spreads widened significantly throughout corporate Credit. And the weaker the Credit the more intense the spread blowout. Indicative of serious “risk off” de-risking/de-leveraging momentum, the XBD equities Securities Broker/Dealer Index sank 7.1% this week.
Brazil CDS rose to the highest level since 2009, as Banco do Brasil’s stock sank to multi-year lows. Colombia CDS rose to a four-year high. Malaysia CDS moved to the high since 2011. Importantly, as contagion hems in the “Core of the Periphery,” cracks widened this week as well in EM darling Mexico. The Mexican peso sank 3.7% to an all-time low versus the dollar. Mexican stocks were hit for 3.6%. The Colombian peso sank 3.8% and the Chilean peso fell 2.0%. The Russian ruble was slammed 6.5% to a record low. As political and social instabilities mount, the vulnerable Turkish lira sank 3% to a record low. Kazakhstan’s tenge collapsed almost 25% on Thursday’s devaluation.
With the “Periphery” in serious trouble, contagion has begun to afflict even the “Core of the Core.” U.S. financial stocks were hammered. The Nasdaq 100 sank 7.4%, quickly pushing 2015 returns negative. Everyone’s (Crowded) favorite “Fab Five” – Apple, Google, Amazon, Netflix and Facebook – were slammed. The Morgan Stanley High Tech Index dropped 7.1% and the Biotechs lost 6.6%. There was seemingly no place to hide – big cap, mid- or small – high beta or low – growth or “defensive.” The Transports fell 5.4% and Utilities dropped 5.2%. Media stocks had another rough week. Treasuries won big, as spreads widened throughout the Credit market.
Air is now streaming from European Bubbles. The beloved German DAX equities index was hammered 7.8%, with a two-week decline of 12%. France’s CAC 40 posted a two-week fall of 10%. This week saw Italian stocks drop 6.5%. Spanish stocks were down another 5.6%, having now given back all of what was recently a 13% 2015 gain. Portuguese 10-year bond yields jumped 20 bps, with spreads widening meaningfully across Europe’s periphery. Italian and Spanish spreads to German bunds widened 14 bps and 10 bps. The French to German spread widened seven bps. European junk bonds, an ECB-induced speculator favorite, were under pressure this week.
The leveraged speculators, having already struggled with energy, metals and commodities collapses, now seem upside down on a number of popular Crowded Trades. As de-risking/de-leveraging dynamics took hold, this week saw the yen jump 1.8% and the euro surge 2.5%. These are popular/Crowded “funding”/short/“carry trade” currencies, and this week’s gains provide an important indictor of financial contagion enclosing upon the Core. Gaining $46, Gold seems to be a prescription for what ails waning confidence in unfettered electronic global finance.