Weekly Commentary: Core of the Core

There just can’t be a more fascinating endeavor in finance (anywhere?) than analyzing Credit and speculative Bubbles. Such undertakings do not come without challenges.

I’ve enjoyed Barry Eichengreen’s “Hall of Mirrors – The Great Depression, The Great Recession and the Uses – And Misuses – of History.” Curious title. I’m envious of Eichengreen’s talents as a writer. And his book is replete with entertaining insight from critical periods in history. Eichengreen as well perpetuates a distorted view of the “Roaring Twenties” period.

Similar to today, there was a critical debate in the late-twenties. Was the stock market an indicator of newfound prosperity – or was it instead an out of control speculative Bubble? Was the Credit system sound or unsound? How about the underlying economic structure? Was the Federal Reserve adroitly managing the economic boom or was it instead unwittingly feeding a catastrophic Bubble? Could the bustling U.S. economy and markets just ignore negative global developments?

Despite being right on key issues, history has been especially unkind to those from the late-twenties that argued that Credit was unsound, the stock market was a Bubble and the economy was an accident in the making at the hand of Federal Reserve money and Credit mismanagement – that it all in the end would come crashing down. Curiously, accuracy doesn’t seem to be a priority for most that recount this period. History has unfairly clumped the “naysayers” in a basket and dubbed them “liquidationists.” Ben Bernanke lambasts that period’s misguided “Bubble poppers.” And historical revisionism has painted the twenties as the “golden age of capitalism.” If only the Fed had printed sufficient money and saved the system from the Great Depression…

Strangely, Eichengreen simplifies the revisionist view to about one sentence where he claims that responsibility for the crash and Depression rests with adherents to an ill-advised “real bills doctrine.” Why an economic historian would chose to so readily dismiss such rich and pertinent debate regarding Credit dynamics and repercussions; financial flows, market speculation and Bubbles; and monetary management, is beyond me.

Eichengreen then annoys: “[Roger] Babson believed that Newton’s third law of physics applied to financial markets: to every action there is a reaction, and therefore what goes up must come down. Babson had been predicting a decline in stock valuations since the market took off in 1927. He was the first to acknowledge that his pessimism was hardly news. As he put it on September 5 [1929] in introducing his remarks, ‘I am about to repeat what I said at this time last year and the year before.’ Even a stopped clock is right twice a day…”

The “even the stopped clock…” nonsense became too popular with the arrival of financial crisis in 2008. I remember it as well from the bursting of the tech Bubble in 2000. Bullish proponents were quick to point out that the “bears” had been “saying the same thing for years.” Even as “naysayers” are proved correct, the determination to discredit remains as intense as ever. And all the misinformation and revisionism really deters from the learning process.

Not surprisingly, we keep making even more atrocious policy mistakes. The issue is not some bull versus bear shoving match. And it should not be about competing ideologies. Instead, the issue of whether a boom is sound or an inflating Bubble is of profound consequence. Whether policymakers are fostering sustainable recovery or merely fueling an unsustainable boom is absolutely critical. The Bubble Issue should be front and center for analysis and debate. And, in the end, the Bubble prognosis should be recognized as right or wrong – not at a point in time but with regard to the overall cycle.

There are Bubble analyst facts of life. First of all, you and your analysis will be discredited, and the bigger the Bubble the more complete and utter the disparagement. You see, Bubble periods tend to evolve over years. Major Bubble episodes – as we’ve witnessed – can endure for as long as six or seven years. And, importantly, post-bust policymaker measures can reflate Bubble Dynamics, leading to serial Bubbles (i.e. “tech” to mortgage finance to global government finance). So if you have a series of Bubbles with six or seven year lives, you’re discussing an overall Bubble span of a couple decades (or more). What analyst can survive 20 years of what the vast majority sees as irrefutable prosperity only occasionally interrupted by central bank resolvable issues?

I have posited my case for the “Granddaddy of All Bubbles.” I believe the current “global government finance Bubble” is the finale of a historic multi-decade Bubble period. And each week I see important confirmation to the thesis that this global Bubble has been pierced. Ominous storm clouds are building in global Credit, throughout global markets, in economies, within societies and all about geopolitics. Things are turning serious, and any talk of a stock market correction completely misses the point. The entire bull thesis is coming under fire.

Even in the harshly depleted “bear camp,” I sense Bubble fatigue. In general, backdrops conducive to crisis can linger for so long that fears naturally fade as optimism and complacency take full control. In this regard, this period has been extraordinary. Our odd world of Trillions of central bank liquidity thrown at global markets has crises dynamics moving at a crawl. Over the past year, things at times seem to be playing out in super slow-mo in HD.

This was a key week from the perspective of my analytical framework. The crisis broke through to the “Core of the Core.” I would expect crisis dynamics to now speed up. I’ll try to explain.

In general, “Periphery to Core” analysis holds that financial crises originate at the “Periphery,” home to the riskiest and most vulnerable borrowers. Risk aversion, de-risking/de-leveraging and financial outflows then see the tightening of financial conditions at the “Periphery” begin to gravitate toward the “Core.” This framework was especially valuable in the early-2000s, as the incipient “tech Bubble” saw problems in telecom debt erupt into a full-fledged corporate debt crisis (by 2002). “Periphery to Core” dynamics were much more apparent as the 2007 subprime dislocation evolved into the so-called “greatest financial crisis since the Great Depression.”

“Periphery to Core” analysis turned much more complex and nuanced throughout this prolonged global government finance Bubble period. Typically, stress at the “Periphery” begins a process that begins to weigh on the “Core.” But in this phase of unprecedented central bank monetary inflation (“money printing”), trouble at the Periphery has elicited aggressive policy responses that have tended only to stoke Bubble excess at the Core.

I found it helpful to further delineate sector dynamics – to incorporate “Periphery of the Periphery” and the “Core of the Periphery.” Similarly, there is the “Periphery of the Core” and the “Core of the Core.” Over recent months, heightened stress had made it to the “Periphery of the Core” (Greece, commodity-related stocks and high-yield debt, in particular). Yet the “Core of the Core” had remained immune to global forces – that is until this week.

First of all, the “Periphery of the Periphery” is an unfolding unmitigated disaster: With EM generally encompassing the global “Periphery,” the likes of Venezuela, Ukraine, and Argentina demonstrate accelerated deterioration. More importantly, conditions at the “Core of the Periphery” – the likes of Brazil, Mexico, Russia, Malaysia, etc. – now suffer rapid “vicious cycle” deterioration. Markets have turned illiquid and the “hot money” wants out. Confidence has waned that central banks can keep currency and securities markets orderly. So it appears “Core of the Periphery” dynamics have reached the point where crisis dynamics shift from “slow-mo” to high-speed. This week saw the Russian ruble sink 3.8%, the Brazilian real 2.5%, the Colombia peso 2.0% and the Malaysian ringgit 2.7%. Brazil stocks were hit for 4.5%.

Analytically, China occupies an integral spot in both the “Core of the Periphery” and the “Periphery of the Core.” China’s unfolding financial and economic crisis will either directly or indirectly impact virtually all global markets and economies. I see the ongoing energy and commodities collapse supporting the view of the end of the historic Chinese Bubble period.

The bursting of China’s equities Bubble marks a momentous global Bubble inflection point. China’s reflationary measures over the past year (in particular) worked primarily to spur precarious speculative excess in Chinese stocks, in the process stoking optimism that Chinese reflationary measures would work to reflate commodities and “Periphery” economies. China’s “Terminal Phase” was extended, while EM adjustment was postponed. In the end, China’s misguided policies only worsened Bubble Fragilities, in China, throughout the “Periphery” and elsewhere. After a hiatus, Bursting Bubble Dynamics have reemerged with a vengeance. The risks that arise with China’s extraordinary response to collapsing stock prices only compounds mounting global uncertainties.

Here at home, the S&P 500 Media Index traded at 640 on Wednesday, sank to a low of 565 on Thursday before ending the week down 7.4% at 587.26. Core stock holdings such as Disney, Viacom, Time Warner and CBS were taken out to the woodshed.

Thursday from Bloomberg (Oliver Renick Callie Bost) under the headline “Another Pillar of the Bull Market is Collapsing”: “Until Tuesday, media shares were the best-performing shares of the bull market, rising 531% to eclipse automakers, retail stores and banks. The industry’s market capitalization was about $650 billion, compared with $135 billion in March 2009. That value is evaporating. In just five stocks — Disney, Time Warner Inc., Fox, CBS and Comcast Corp. — almost $50 billion of value was erased in two days. Viacom slid 14% on Thursday alone, its biggest drop since October 2008. The selloff is a blow to investors who have seen breadth dry up and the number of advancing industries narrow. More than 100% of this year’s increase in the S&P 500 is attributable to two sectors, health-care and retail, the tightest clustering for an advancing year since at least 2000…”

Media stocks reside importantly at the “Core of the Core.” Though not generally recognized, today’s media industry is extraordinarily Credit sensitive. As financial conditions loosen, media companies are among the first to benefit. When corporate managements are incentivized to borrow freely, advertising and marketing budgets are immediate beneficiaries. And I would argue that the current Bubble creates an extreme case of an already powerful dynamic.

When the Fed slashed rates and began aggressively printing “money” after the mortgage finance Bubble collapse, corporate Credit conditions loosened profoundly. And with managements hesitant to move forward with long-term capital investment, the much easier course was to borrow and boost advertising (and, of course, repurchase shares). This helped spur impressive revenue growth throughout the media industry, which in combination with ultra-easy corporate Credit conditions incited a major industry M&A “arms race.” Throw in the proliferation of new technologies and Internet “media” and one had the makings for a full-fledged – and systemically important – media Bubble.

With ad dollars slushing all about the system, the value of media franchises inflated tremendously – cable, wireless, satellite, professional sports, college athletics, Internet, “Hollywood,” etc. It’s the age of the billion-dollar sports franchise, the $100 million professional athlete and movie star, multi-million dollar annual pay packages for professional as well as college coaches. The fortunate few have enjoyed incredible pay inflation, boosting national income and GDP along the way.

Between inflated franchise values, inflated stock prices and inflated compensation, it’s just an incredible amount of perceived value propped up with endless advertising dollars. Indeed, a strong case can be made that “media” has been one of the most inflated and distorted sectors throughout this Bubble period. For me, “media” and all the related technologies evolved into the poster-child for the U.S. Bubble – for “Core” Bubble distortions and imbalances – for the maladjusted U.S. “services” Bubble economy structure. And it all absolutely requires ongoing monetary inflation.

For a while now I’ve viewed the “media” Bubble as vulnerable to an inevitable tightening of financial conditions. But the Fed and global central bankers for almost seven years have stuck with ultra-loose monetary policy. This ensured the “media” Bubble inflated to self-destructive extremes. In short, there’s today extreme overcapacity for what is an unsustainable Bubble in advertising expenditures (more ad spending, more perceived wealth to spend on more ads). Now advertising spending has begun to slow, an early consequence of a deteriorating backdrop. And as Credit conditions begin to tighten more generally, advertising and marketing budgets will suffer. Perceived wealth will evaporate, M&A appeal will disappear and this bastion of Credit growth and spending will succumb to new realities.

Let’s expand on the “Core of the Core” theme. This week also provided additional support for the view that risk aversion is now moving decidedly toward the Core. Commodities losses – notably energy and precious metals – are leading to a major exodus from commodity hedge funds. More importantly, commodity losses have hit some of the large fund complexes. A more generalized flight out of the hedge fund industry would be a major Bubble development.

The hedge funds are major players in media industry stocks and bonds. Especially after losses in EM, energy and commodities, a stampede out of media securities would have major ramifications. And, rather suddenly, markets now suffer from Crowded Trade Dynamics and dislocations. Some of the “Core” Wall Street Darlings – from Apple to Tesla to Biogen – have suffered major declines. The biotech Bubble is now deflating. The vulnerable tech Bubble is oscillating. And as losses mount, there will be impetus to sell first and ask questions later. Fund outflows could become a major issue. This week also saw the small caps hit for 2.6%. When de-risking/de-leveraging dynamics begin to attain momentum and liquidity becomes a worry, the beloved small cap universe abruptly turns unappealing.

The “Core of the Core” prognosis goes beyond equities. With energy and commodities-related bonds taking another leg lower, junk bond funds saw their second straight week of meaningful outflows. The riskiest universe of junk borrowers – those most vulnerable to a tightening of Credit conditions – is under intense pressure. More attention is also being paid to mounting losses in the popular master limited partnership area. And with Puerto Rico defaulting, flows turned negative this week in muni funds as well. Even investment-grade corporate bond funds this week saw outflows (from the “Core of the Core”). Credit concerns are spreading.

August 7 – Bloomberg (Michelle Davis Carolina Millan): “Pressure from sliding commodities prices is spreading from the junk-bond market to a broader gauge of U.S. corporate-credit risk. The cost to insure against default on high-grade bonds as measured by the Markit CDX North American Investment Grade Index rose to 75.1 basis points, the most since December. The Bloomberg Commodity Index fell for the third straight day, touching its lowest level since 2002.”

For the Week:

The S&P500 declined 1.2% (up 0.9% y-t-d), and the Dow sank 1.8% (down 2.5%). The Utilities gained 1.1% (down 2.7%). The Banks were little changed (up 5.3%), while the Broker/Dealers fell 2.0% (up 3.2%). The Transports lost 1.7% (down 9.7%). The S&P 400 Midcaps declined 1.0% (up 2.5%), and the small cap Russell 2000 was hit 2.6% (up 0.2%). The Nasdaq100 fell 1.5% (up 6.7%), while the Morgan Stanley High Tech index was little changed (up 5.1%). The Semiconductors declined 1.5% (down 7.3%). The Biotechs were slammed 4.7% (up 18.1%). Though bullion declined less than a dollar, the HUI gold index sank another 3.9% (down 34.5%).

Three-month Treasury bill rates ended the week at six bps. Two-year government yields rose six bps to 0.72% (up five bps y-t-d). Five-year T-note yields increased four bps to 1.57% (down 8bps). Ten-year Treasury yields slipped two bps to 2.16% (down one basis point). Long bond yields fell nine bps to 2.82% (up 7bps).

Greek 10-year yields declined 26 bps to 11.33% (up 159bps y-t-d). Ten-year Portuguese yields rose six bps to 2.43% (down 19bps). Italian 10-yr yields increased six bps to 1.83% (down 6bps). Spain’s 10-year yields jumped 15 bps to 1.98% (up 37bps). German bund yields added two bps to 0.66% (up 12bps). French yields added three bps to 0.96% (up 13bps). The French to German 10-year bond spread increased a basis point to 30 bps. U.K. 10-year gilt yields slipped three bps to 1.85% (up 10bps).

Japan’s Nikkei equities index gained 0.7% (up 18.8% y-t-d). Japanese 10-year “JGB” yields increased two bps to 0.41% (up 9bps y-t-d). The German DAX equities index rallied 1.6% (up 17.2%). Spain’s IBEX 35 equities index was unchanged (up 8.7%). Italy’s FTSE MIB index added 0.7% (up 24.7%). Emerging equities markets were mixed. Brazil’s Bovespa index sank 4.5% (down 2.9%). Mexico’s Bolsa increased 0.2% (up 4.0%). South Korea’s Kospi index lost 1.0% (up 4.9%). India’s Sensex equities index increased 0.4% (up 2.7%). China’s Shanghai Exchange recovered 2.2% (up 15.8%). Turkey’s Borsa Istanbul National 100 index fell 1.9% (down 8.5%). Russia’s MICEX equities index gained 1.3% (up 21%).

Junk funds this week saw outflows of $1.2 billion (from Lipper), the second straight week of significant negative flows.

Freddie Mac 30-year fixed mortgage rates dropped seven bps to a two-month low 3.91% (up 4bps y-t-d). Fifteen-year rates fell four bps to 3.13% (down 2bps). One-year ARM rates gained two bps to 2.54% (up 14bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates one basis point higher to 4.10% (down 18bps).

Federal Reserve Credit last week declined $9.0bn to $4.448 TN. Over the past year, Fed Credit inflated $81.9bn, or 1.9%. Fed Credit inflated $1.637 TN, or 58%, over the past 142 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $27.7bn last week to $3.356 TN. “Custody holdings” were up $62bn y-t-d.

M2 (narrow) “money” supply expanded $12.1bn to a record $12.074 TN. “Narrow money” expanded $613bn, or 5.4%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits rose $8.5bn, and Savings Deposits added $3.2bn. Small Time Deposits increased $1.0bn. Retail Money Funds added $0.7bn.

Money market fund assets jumped $21.3bn to an almost five-month high $2.669 TN. Money Funds were down $64bn year-to-date, while gaining $102bn y-o-y (4.0%).

Total Commercial Paper rose another $8.4bn to a seven-month high $1.067 TN. CP increased $28bn over the past year.

Currency Watch:

August 7 – Bloomberg: “China said it will let the market play a bigger role in setting exchange rates and allow more flexible movement of the nation’s currency. The People’s Bank of China will maintain stability of the yuan ‘at a reasonable equilibrium level,’ it reiterated in its quarterly monetary report… A 28% slump in the Shanghai Composite Index of shares from a mid-June peak has boosted outflows, as China’s foreign-exchange reserves declined for a third month to $3.65 trillion in July… The IMF said this week the yuan trails its global counterparts in major benchmarks and that ‘significant work’ in analyzing data is needed before deciding whether to add the currency to its Special Drawing Rights basket. Its staff members on Tuesday proposed delaying any expansion of the basket by nine months, until September 2016…”

The U.S. dollar index added 0.4% to 97.56 (up 8.1% y-t-d). For the week on the upside, the Australia dollar increased 1.5%, the New Zealand dollar 0.5% and the South African rand 0.4%. For the week on the downside, the Brazilian real declined 2.5%, the Swiss franc 1.8%, the Swedish krona 1.6%, the Norwegian krone 1.1%, the British pound 0.8%, the Canadian dollar 0.3%, the Mexican peso 0.3% and the Japanese yen 0.3%.

Commodities Watch:

August 5 – Bloomberg (Sofia Horta E Costa): “Dear commodities investors: Welcome back to 2008! The meltdown has pushed as many commodities into bear markets as there were in the month after the collapse of Lehman Brothers Holdings Inc., which spurred the worst financial crisis seven years ago since the Great Depression. Eighteen of the 22 components in the Bloomberg Commodity Index have dropped at least 20% from recent closing highs, meeting the common definition of a bear market. That’s the same number as at the end of October 2008, when deepening financial turmoil sent global markets into a swoon. A stronger U.S. dollar and China’s cooling economy are adding to pressure on raw materials. Two of the index’s top three weightings — gold and crude oil — are in bear markets. The gauge itself has bounced off 13-year lows for the past month.”

The Goldman Sachs Commodities Index sank 3.4% to a new multi-year low (down 12.6% y-t-d). Spot Gold was little changed at $1,094 (down 7%). September Silver increased 0.5% to $14.82 (down 5%). September Crude sank $3.25 to $43.87 (down 18%). August Gasoline was bludgeoned for 8.4% (up 10%), while September Natural Gas gained 2.9% (down 3%). September Copper lost 1.3% (down 17%). September Wheat recovered 2.3% (down 13%). September Corn increased 0.7% (down 3%).

Greece Crisis Watch:

August 5 – Bloomberg (Sofia Horta E Costa): “Greek banks extended a rout that has wiped out more than half their value this week, sending the nation’s stocks lower for a third day. Piraeus Bank SA and Alpha Bank AE plunged at least 29%… National Bank of Greece SA climbed 2.3%, rebounding after a 50% tumble in two days. While about half of the 60 stocks listed on the benchmark ASE Index climbed, the lenders’ losses dragged the gauge lower. The ASE fell 1.4%… The index tumbled the most since at least 1987 on Monday, when the exchange reopened after a five-week shutdown. An index of Greek banks has fallen to its lowest level since at least 1995.”

August 6 – Reuters (Paul Carrel): “The German government has growing doubts a deal on a multi-billion-euro bailout for Greece can be agreed in the next two weeks, meaning Athens would need to secure a bridge loan, Bild daily reported… ‘That is not achievable,’ the newspaper quoted a government source as saying of the Aug. 20 deadline for agreeing the new bailout. A 3.5-billion-euro ($3.82bn) debt payment to the European Central Bank falls due on Aug. 20 and without a bailout deal, Athens will need bridge financing.”

China Bubble Watch:

August 4 – Wall Street Journal (Lingling Wei): “As China’s summer stock slide deepened, threatening a key plank of Beijing’s plan to overhaul the world’s second-largest economy, the country’s premier pounded the table and demanded that regulators get their act together. Meeting with senior financial and economic officials in Beijing on July 4, Li Keqiang criticized them for failing to anticipate the severe market plunge, officials with knowledge of the gathering said. Then he urged them to act in a coordinated way to stanch the bleeding, these officials said. ‘I want strong measures to rescue the market,’ ordered the usually mild-mannered premier… At the meeting were those in charge of China’s central bank, the country’s securities and banking regulatory agencies and the Finance Ministry. The regulators, who had previously acted in isolation and sometimes at cross-purposes, responded. The People’s Bank of China unleashed a flood of money aimed at a state agency tasked with propping up share prices and investors who borrow to buy shares, while the securities regulator halted new listings and state-owned companies and brokerages pledged to buy up shares.”

August 6 – Reuters (Li Zheng and Nicholas Heath): “Bad loans at Chinese banks rose 35.7% during the first half of 2015 as economic growth remained sluggish and manufacturers struggled, the chairman of the banking sector regulator said. Shang Fulin, chairman of China Banking Regulatory Commission (CBRC), told an internal meeting last week that non-performing loans (NPLs) at banks rose 322.2 billion yuan in the first six months of the year to 1.8 trillion yuan ($289.9bn)… He also said the banks’ profit growth in the first-half slowed by 13.03 percentage points from a year ago, with total net profits amounting to 1.1 trillion yuan in the first six months. ‘In the bigger context of (China’s) economic slowdown, the whole truth of the banking sector’s credit risks is beginning to emerge,’ Shang said…”

August 7 – Bloomberg: “China has been struggling to tame its shadow banks for years. Now, a stock market crash has hamstrung some of the fastest growing ones in a matter of weeks. Loans from sources such as online lenders for equity purchases have plunged by at least 700 billion yuan ($113bn), a drop of 61% from this year’s peak, after authorities banned them from funding stock buying in July, according to a Bloomberg survey… Peer-to-peer Internet lending for the purchases had more than tripled to 8 billion yuan in the second quarter… The reversal has helped cull riskier lenders in China’s online market, which was surging before the equity rout wiped out more than $4 trillion. President Xi Jinping has already curbed traditional forms of unregulated funding — such as trust loans — as part of his effort to wean the economy from debt-fueled growth after corporate defaults mounted… Chinese shadow banks’ push into Internet finance comes as the slumping real estate industry, which accounts for about a third of the economy, demands less cash. The lenders’ business with local governments has also suffered as President Xi rolls out municipal bonds they can go to instead for financing. ‘Funding demand for the property sector and local government financing vehicles has come down,’ said Liao Qiang, a banking analyst at Standard & Poor’s… ‘The golden days for shadow banking lenders with high return and low risk are over.’”

August 6 – Bloomberg: “China Securities Finance Corp., the government agency mandated to buy stocks to stem a market rout, is seeking access to an additional 2 trillion yuan ($322bn), said people with knowledge of the matter. The extra funding would add to the 3 trillion yuan already made available by the government, according to the people, who asked not to be identified because the target hasn’t been made public. The 5 trillion yuan total may change depending on market conditions, they said.”

August 3 – Bloomberg (Ye Xie, Lee Spears and Zhe Huang): “Chinese regulators restricted short selling of stocks, freezing out day traders, in their latest step aimed at stabilizing the world’s second-largest equity market. Investors who borrow shares must now wait one day to pay back the loans…This prevents investors from selling and buying back stocks on the same day, a practice that may ‘increase abnormal fluctuations in stock prices and affect market stability,’ the Shenzhen exchange said. Under the old T+0 rule, ‘you can go short in the morning and cover your shorts before market close the same day and lock in your profit, if your bet is right,’ Xian Liang… portfolio manager at U.S. Global Investors Inc., said… ‘Now with T+1, you can’t cover your short position in the same day, and have to wait till next day at the earliest. This new rule should discourage speculative short sellers — day traders — and help mitigate intraday volatility.’ China is taking unprecedented measures to stem a stock rout that has wiped out almost $4 trillion in market value since mid-June.”

Fixed Income Bubble Watch:

August 4 – New York Times (Mary Williams Walsh): “While Puerto Rico’s first bond default in its history reverberated through the financial markets on Tuesday, another move by the cash-poor island may provide a clue to where the next trouble spot lies. After openly acknowledging on Monday afternoon that it had not made a $58 million bond payment, the government quietly disclosed in a financial filing later that afternoon that it had temporarily stopped making contributions of $92 million a month into a fund that is used to make payments on an additional $13 billion in bond debt… Unlike the bond payments that went into default on Monday, the ones coming due are on general obligation bonds — the kind many investors have been led to believe would never go into default because the issuer’s full faith, credit and taxing authority stand behind them. Puerto Rico issued such bonds over the years to raise money for a variety of government projects, and investors bought them eagerly because the island’s constitution explicitly guaranteed that such bonds would be paid.”

August 7 – New York Times (Marry Willliams Walsh): “Two mutual fund companies that hold Puerto Rico’s bonds wrote to senior officials on the island on Thursday, demanding full payment on bonds that defaulted earlier in the week. ‘The path that the current administration has chosen will steer Puerto Rico towards litigation and create further deterioration in the capital markets’ trust in Puerto Rico, potentially leading to years of economic turmoil,’ the senior vice presidents of OppenheimerFunds and Franklin Advisers said in a joint letter… Financial institutions that hold Puerto Rico’s debt have been questioning its intentions since late June, when the island’s governor… announced that Puerto Rico was in ‘a death spiral,’ and he had to negotiate a moratorium on its $72 billion of debt.”

August 4 – Bloomberg (Christine Idzelis): “Wall Street’s leveraged-finance bankers are getting little love these days from the buyout titans that helped turn their market into an $800 billion behemoth. The U.S. leveraged loan market is heading for its slowest year since 2012, with $236.1 billion of debt sold to institutional investors in 2015, down about 40% from this time last year… The $37.5 billion of loans financing leveraged buyouts this year is down from about $58.4 billion… Fewer loans are getting done partly because private-equity firms are being outbid by cash-rich companies that tend to finance purchases in the investment-grade bond market, according to Craig Packer, head of Americas leveraged finance at Goldman Sachs…”

August 4 – Dow Jones (Andrey Ostroukh): “Russia’s consumer prices accelerated again in July, driven by a one-off increase to utility tariffs… Consumer prices rose 15.6% In July compared with the same month in 2014, climbing higher from the June reading of 15.3%, closer to the May level of 15.8%.”

August 6 – Bloomberg (Matthew Monks): “Energy explorers reeling from the rout in oil prices are looking for liquidity in an obvious place: their rocks. Having exhausted other ways to raise cash as a glut of global supply depresses prices, a slew of producers… announced more than $2.4 billion in asset sales last month… Selling oil and gas fields to pay off lenders and fund new drilling — often a wildcatter’s option of last resort — is surging after a six-month lull. There’s more to come — by one estimate, another $20 billion this year — as executives at Occidental Petroleum Corp., Whiting Petroleum Corp., Penn Virginia Corp., Exco Resources Inc., Chesapeake Energy Corp. and Ultra Petroleum Corp. have all said in recent weeks that they are selling assets or exploring sales. The surge shows how the industry’s two-pronged strategy for staying financially healthy since oil prices started tanking — raising capital while tightening belts — may not be enough, particularly for companies with a lot of outstanding debt.”

August 7 – Reuters (Terry Wade and Anna Driver): “Business is so tough for oilfield giants Schlumberger NV and Halliburton Co that they have come up with a new sales pitch for crude producers halting work in the worst downturn in years. It amounts to this: ‘frack now and pay later.’ The moves by the world’s No. 1 and No. 2 oil services companies show how they are scrambling to book sales of new technologies to customers short of cash after a 60% slide in crude… In some cases, they are willing to take on the role of traditional lenders, like banks, which have grown reluctant to lend since the price drop that began last summer, or act like producers by taking what are essentially stakes in wells. At Halliburton, some of the capital to finance the sales will come from $500 million in backing from asset manager BlackRock, part of a wave of alternative finance pouring into the energy industry that one Houston lawyer said… allows companies to ‘keep the engine running.’”

U.S. Bubble Watch:

August 5 – Bloomberg (Michelle Jamrisko): “The trade deficit in the U.S. widened in June as the strong dollar lifted imports and hobbled exports, representing a hurdle for economic growth. The gap grew by 7.1% to $43.8 billion, the largest in three months…”

August 7 – Bloomberg (Brian Chappatta): “Municipal-bond investors are learning that when cash gets tight, promises are made to be broken. Puerto Rico’s default Monday on bonds sold by its Public Finance Corp. underscored the risks of debt backed only by a legislature’s pledge to repay. Two days later, Chicago’s Metropolitan Pier and Exposition Authority’s rating was cut to near-junk from AAA by Standard & Poor’s because Illinois hasn’t appropriated the money to pay its bonds amid a stalemate over the budget. Unlike with general obligations or debt that has a claim to specific revenue, buyers have little recourse if politicians walk away from appropriation bonds, a $197 billion niche of the municipal market. Vadnais Heights, Minnesota, and Menasha, Wisconsin, have already done so. In bankrupt San Bernardino, California, investors may recover one cent on the dollar. ‘Appropriation debt is scarier than people want to think it is,’ said Matt Dalton, chief executive officer of… Belle Haven Investments…”

August 5 – Bloomberg (Asjylyn Loder): “It’s the oil crash few saw coming, and few have been spared as it erased $1.3 trillion, the equivalent of Mexico’s annual GDP, in little more than a year… State pension funds and insurance companies have also been hard hit. Investment advisers, who manage the mutual funds and exchange-traded products that are staples of many retirement plans, had $1.8 trillion tied to energy stocks in June 2014… ‘The hit has been huge,’ said Chris Beck, chief investment officer for small- and mid-capitalization companies for Delaware Investments… ‘Everybody was thinking that oil would stay in the $90 to $100 a barrel range.’…Since June 2014, the combined market capitalization of 157 energy companies listed in the MSCI World Energy Sector Index or the Bloomberg Intelligence North America Independent Explorers & Producers Index has lost about $1.3 trillion.”

August 2 – Financial Times (Eric Platt and Kadhim Shubber): “The sharp rise in the US dollar may slice more than $100bn off dollar-denominated revenues at some of America’s largest multinationals this year, a sum larger than the sales of Nike, McDonald’s and Goldman Sachs combined, according to a Financial Times analysis. In the first half of the year, 10 of the largest American multinationals have had their sales reduced by a combined $31bn… and concerns have mounted that a move by the Federal Reserve to lift interest rates later this year will push the dollar higher. ‘Large multinationals are taking a hit from the stronger US currency,’ David Lebovitz, market strategist with JPMorgan Asset Management, said. ‘You have downward pressure on the euro and yen coming from central banks in those regions and given a relatively unfavourable backdrop in emerging markets, we’re seeing currency depreciation there.’ Companies within the S&P 500 earned roughly 48% of their revenues abroad in 2014… A weak US dollar in years past had bolstered American multinationals, which benefited when they translated sales earned abroad back into the greenback.”

August 7 – Bloomberg (Joseph Ciolli): “An energy investment vehicle best known for providing reliable cash payouts is running out of gas. The Alerian MLP Index has retraced half of the 254% gain it realized over a six-year period starting November 2008. The gauge, which tracks 50 master-limited partnerships, is 22% below its 200-day moving average… MLPs, which are structured to operate pipelines without paying federal income tax by passing earnings to investors, have partly been collateral damage amid 13 straight weekly declines for Standard & Poor’s 500 Index energy companies. That’s the longest streak of losses for the group in data going back to 1989.”

August 3 – Wall Street Journal (Matt Jarzemsky and Matt Wirz): “It is shaping up as a cruel summer for debt investors wagering on a rebound in the oil-and-gas business. Funds managed by Franklin Resources Inc., Blackstone Group LP and Oaktree Capital Group LLC, among others, are facing paper losses on substantial investments this year in exploration-and-production companies. The sector is coming under further pressure as oil prices have turned downward again, dropping below $46 a barrel in New York to a four-month low. Many of the investments amounted to a doubling down on existing stakes, as the firms committed hundreds of millions of dollars to lend to or invest in energy companies whose debt they already held.”

August 4 – Wall Street Journal (Annamaria Andriotis): “J.P. Morgan… is loosening its underwriting criteria for big mortgages, as lenders ramp up competition to grab a bigger share of the high-end housing market. The nation’s largest bank by assets plans to announce Wednesday that it is lowering the minimum credit score and down payment it requires for mortgages as big as $3 million. The… moves follow similar steps at Bank of America Corp., Wells Fargo & Co. and other banks on requirements for ‘jumbo’ mortgages—those that exceed $417,000 in most parts of the country or $625,500 in pricier markets… By dollar volume, jumbo mortgages given out by lenders last year accounted for about 20% of all first-lien mortgages, used mostly to purchase or refinance a home, according to Inside Mortgage Finance. That is up from 5.5% in 2009. The last time jumbo mortgages accounted for a larger share was in 2005.”

August 5 – CNBC (Robert Frank): “How many Ferraris is too many Ferraris? The world may find out next week. A record 112 classic Ferraris are headed to the auction blocks at the Concours d’Elegance in Pebble Beach and Monterey, California—marking the latest test for the increasingly frothy collectible car market. It may also signal whether the Ferrari boom of the past decade, with records set almost every year, can keep gaining speed.”

Global Bubble Watch:

August 7 – Bloomberg (Javier Blas): “When even Cargill Inc., the world’s largest grain trader, decides to liquidate its own hedge fund, that’s a sign that commodity speculators are in trouble. Hedge funds focused on raw materials lost money on average in the first half, the Newedge Commodity Trading Index shows. Diminishing investor demand spurred Cargill’s Black River Asset Management unit to shut its commodities fund last month. Others enduring redemptions include Armajaro Asset Management LLP, which closed one of its funds, Carlyle Group LP’s Vermillion Asset Management and Krom River Trading AG. While hedge funds are designed to make money in both bull and bear markets, managers have a bias toward wagering on rising prices and that’s left them vulnerable in this year’s slump, said Donald Steinbrugge, managing partner of Agecroft Partners LLC.”

August 6 – Financial Times (Emiko Terazono): “July has been another bad month for commodities. Not only have markets taken a battering, with gold and oil leading the fall, but some well known hedge funds told investors they were closing their doors. Black River Asset Management, owned by agricultural trader Cargill, closed its commodities fund, along with three other funds, and Armajaro Asset Management said it would shut its $450m commodities hedge fund after losing 11% in the first half. Meanwhile private equity group Carlyle parted ways with the founders of its Vermillion commodities firm after assets dwindled. It is another blow for the sector, which has faced weak returns since 2011. Investors have left in droves, seeking better returns elsewhere. HFR, a hedge fund research group, reports net outflows from the sector of $3.4bn in 2014. ‘The basic problem is the lack of investors. Their experience of the commodities sector has generally been poor over the past few years,’ says Michael Coleman, managing director and founder of RCMA Asset Management… Hedge funds rode the commodities supercycle from the early 2000s, with double digit returns every year. Investors looking for alternative investments piled in, with the flood of money going into the sector leading some governments and non-governmental organisations to blame speculative trading on commodities markets for causing undue price volatility.”

August 4 – Financial Times: “Debt is funding more acquisitions than ever before, according to… Dealogic. Worldwide acquisition-related debt issuance has reached $290bn so far this year, which is the highest year-to-date total on record and triple the amount seen at this time last year… Equally the number of deals has risen 46% over the same period in 2014, which, according to Dealogic, is the third year in a row that activity has grown. With interest rates low in the US — at least for the time being — and the European Central Bank’s launch of quantitative easing, credit is cheap. At the same time for many companies organic growth is hard to come by, prompting companies to look at acquisitions for growth.”

August 2 – Reuters (Wayne Cole): “Home prices across Australia’s capital cities surged in July as demand in Sydney and Melbourne remained red hot, presenting an increasingly high hurdle to further cuts in interest rates even as the wider economy struggles. Annual growth in home values picked up to 11.1%, from 9.8% in June. Most of the gains were concentrated in Sydney, where prices were up over 18% for the year, while Melbourne advanced by 11.5%. The second straight month of sharp price rises comes as regulators tightened the screws on investment lending by banks aiming to temper a boom in borrowing for buy-to-let.”

August 2 – Financial Times: “There’s just no let up in New Zealand house prices, with prices rising at their fastest pace since 2007. Prices rose 10.1% in the three months to July 31 from a year earlier… The July reading was the fastest pace of price growth since November 2007. That’s an auspicious time, given it’s when global sharemarkets hit their peaks before the onset of the financial crisis.”

EM Bubble Watch:

August 2 – Financial Times (Joel Lewin): “Emerging markets have been under the cosh this year as China wobbles, the dollar rally gathers pace and falling commodity prices hit exporters. These jitters are beginning to crystallise in credit rating downgrades. Russia was dumped into junk terrain by Standard & Poor’s for the first time in a decade in January and Brazil could soon follow, writes. Later on Friday, it might be Turkey’s turn. Last decade’s emerging market poster boy has been rocked by a crumbling currency, stagnating growth, political uncertainty and war on its doorstep.”

August 5 – Bloomberg (Sebastian Boyd): “Central bankers in commodity-dependent Andes economies aren’t even considering interest-rate cuts to revive growth, even as prices for oil, copper and other raw materials collapse. That’s because the deepening price slump is also dragging down currencies in Colombia and Chile — a swoon that’s fanning inflation and tying policy makers’ hands. Fixed-income traders have now ratcheted up cost-of-living expectations for Colombia and Chile after their tenders sank more than 10% in the past three months. ‘It’s causing a headache,’ Luis Oscar Herrera, the chief Andean region economist at BTG Pactual SA, said… ‘All the Andean countries have headline and core inflation above their target ranges.’ In an interview with local newspaper La Tercer…, Chile central bank President Rodrigo Vergara said rate cuts are completely off the table as the sinking peso fuels price acceleration.”

August 5 – Bloomberg (Isabella Cota): “The Mexican peso fell for a third straight day, headed toward its lowest close on record and prompting the central bank to sell $200 million in extraordinary foreign-exchange auctions to slow the currency’s slide… The most-traded currency in emerging markets has tumbled 9.7% this year, for reasons that include a growing aversion to riskier assets and the plunge in oil prices, which has damped the outlook for energy investment.”

August 5 – Bloomberg (Constantine Courcoulas and Isobel Finkel): “As Turkey’s security risks escalate and squabbling politicians threaten early elections, even Turks are bolting from the lira. Households and companies have increased foreign-currency savings to 43% of total deposits, a level not seen in a decade… The lira has plunged 16% against the dollar this year, the most for the period since 2001. The erosion of domestic confidence signals the biggest laggard among major currencies in Europe, the Middle East and Africa has further to fall, driving a deeper selloff in the worst-performing emerging-market bonds. The exodus from the currency also constrains the central bank from stimulating Turkey’s flagging economy by cutting interest rates, despite a third month of improvements in inflation. ‘Dollarization is an animal that’s hard to tame,’ Manik Narain, a foreign-exchange strategist at UBS Group…, said… “Typically it requires forceful monetary tightening to contain it, which the central bank may be reluctant to engage in right now.”

August 7 – Bloomberg (Simon Harvey and Elffie Chew): “Malaysia’s ringgit posted its worst weekly loss of 2015 and stocks slid by the most since May as investors pulled funds amid a slump in oil and a political scandal involving Prime Minister Najib Razak. The ringgit and the benchmark share index both fell more than 2% t from July 31, with the currency trading at a 17-year low against the dollar… Global funds have dumped $3 billion of equities in 2015, the biggest outflow since 2008, and also cut bond holdings in July. Foreign-exchange reserves fell below $100 billion for the first time since 2010 last month… The 17% slide in the holdings this year has fueled speculation the central bank is buying ringgit to prop up Asia’s worst-performing currency…”

August 3 – Bloomberg (Devon Pendleton and Marcia Klein): “The collapse in commodity prices and the rise of the African middle class has flipped the fortune trends of the continent’s richest people. Commodities tycoons Aliko Dangote and Patrice Motsepe have lost almost $4 billion in 2015… ‘The go-go years of African billionaires whose wealth has been built around oil is over,’ said Martyn Davies, CEO of Johannesburg, South Africa-based investment research firm, Frontier Advisory. ‘We have placed far too much emphasis on a handful of people making significant capital through distorted-priced resources. True wealth creation is where billionaires are created from non-resource assets.’”

Brazil Watch:

August 7 – Bloomberg (David Biller): “Brazil’s consumer prices in July climbed more than analysts expected, as the central bank signaled it will hold rates steady in the face of a looming recession. Monthly inflation as measured by the benchmark IPCA index slowed to 0.62% from 0.79% in June… Inflation in the 12 months through June quickened to 9.56% from 8.89% a month earlier.”

Europe Watch:

August 6 – Bloomberg (Will Hadfield): “Banks and investors in the European Union will have to send trades of some interest-rate swaps to a third party under new rules intended to make financial markets safer. The banks and major investors that hold the derivatives will have to use a third party called a clearinghouse to process their trades, the European Commission, the EU’s executive arm, said… The Group of 20 nations in 2009 mandated clearing for many swaps contracts in an attempt to reduce the damage that would be caused by a major financial institution defaulting on its payments… Financial institutions held OTC swaps with a notional value of $505 trillion at the end of 2014, according to a survey from the Bank for International Settlements.”

Geopolitical Watch:

August 6 – AFP (Nicolas Revise): “The United States warned Thursday it would not tolerate efforts to control sea and air routes in the South China Sea, as Southeast Asian nations debated how hard to pressure Beijing on its island-building. US Secretary of State John Kerry said at a regional summit that open navigation of the strategically important area was an ‘intrinsic right’. ‘Let me be clear: The United States will not accept restrictions on freedom of navigation and overflight, or other lawful uses of the sea,’ he told reporters…, after attending a summit dominated by the flashpoint issue. China has sparked alarm by expanding tiny reefs and constructing military posts, steps viewed by some of its neighbours as violating a regional pledge against provocative actions in the area.”