Ambrose Evans-Pritchard reports on a statement by Zhou Xiaochuan, the governor of the People’s Bank (PBOC):
Mr Zhou told China Daily that asset speculation and property bubbles could pose a “systemic financial risk”, made worse by the plethora of wealth management products, trusts, and off-books lending.
He warned that corporate debt had reached disturbingly high levels and that local governments were using tricks to evade credit curbs.”If there is too much pro-cyclical stimulus in an economy, fluctuations will be hugely amplified. Too much exuberance when things are going well causes tensions to build up. That could lead to a sharp correction, and eventually lead to a so-called Minsky Moment. That’s what we must really guard against,” he said.
The function of the central bank is to remove the punch bowl just as the party really gets going (William McChesney Martin jr., Fed chair 1951 – 1970). It looks like the PBOC may have left it too late:
Non-financial debt has galloped up to 300 per cent of gross domestic product – uncharted territory for a big developing economy.
The International Monetary Fund says debts in the shadow banking system grew by 27 per cent last year.
Less widely known is that the “augmented” budget deficit – including local government spending and the deficits of quasi-state entities – has jumped to 13 per cent of GDP. This is an astonishing level of fiscal stimulus at this stage of the economic cycle. It was around 6 per cent in 2010….
What this means is that public and quasi-public debt in China is growing at the rate of 13% of GDP. China has achieved its growth targets but at what cost to economic stability? There are no free lunches, especially from the “perpetual leveraging doomsday debt machine”.
The ASX 300 Metals & Mining index breached its new support level at 3300, warning of a bull trap. Penetration of the rising trendline would test primary support at 3100.
The divergence between iron ore and miners was bound to end and a correction of the Metals & Mining index is now likely. Iron ore below support at $62 warns of a test of primary support at $53. Declining Twiggs Trend Index signals selling pressure.
The ASX 200 encountered resistance at 5900. Retracement is likely to test the new support level at 5800 (top of the narrow ‘line’ formed over the last four months). Twiggs Money Flow reversal below zero would be a bearish sign.
The ASX 300 Banks index are testing resistance at 8800. Respect of resistance would warn of another test of primary support at 8000.
If banks and miners both turn bearish, the index is likely to follow.
Bill Evans at Westpac sums up their outlook for the Australian economy:
….Constraints on growth next year are likely to centre on a lack lustre consumer who struggles under the weight of weak wages growth; high energy prices and excessive leverage. Conditions in housing markets, particularly in the eastern states, are likely to soften while the residential construction boom will turn down.
We are also less euphoric about growth prospects for our major trading partners than seems to be the current consensus. We expect China’s growth rate to slow from 6.7% to 6.2% as the authorities step up policies to slow its long running credit boom.
Yet the ASX 200 broke out of its line formed over the last 4 months, signaling a primary advance.
Miners are advancing, with the ASX 300 Metals & Mining Index breaking resistance at 3300.
The ASX 300 Banks Index is headed for a test of 8800. Upward breakout would complete a bullish outlook for the ASX 200.
Stephen Koukoulas says Australians have little to worry about high household debt:
….According to the latest data complied by the RBA, household assets are growing very strongly, aided by a building up in savings, unrelenting growth in superannuation holdings, growth in bank deposits and of course, from rising house prices.
While household debt is indeed just under 200 per cent of disposable income, household holdings of financial assets, which includes superannuation, direct share holdings and deposits, is now over 400 per cent of income…..
….The total value of housing in Australia is …. over 500 per cent of disposable income.
…. for every $1 of debt that the house sectors has, they have $5 of assets, which is a loan to value ratio of 20 per cent.
…..while the asset side of the household balance sheet remains healthy, the debt side will remain a non-problem.
That’s the problem with averages, they conceal a multitude of sins. Many Australians own houses without a mortgage. Probably the same group own most of Australia’s financial assets. They are financially secure, no doubt, and help to make the averages look reasonable.
But there are vast numbers of Australians in the mortgage belt with low financial assets and high loan-to-value ratios (LVRs) on their household mortgage. Any rise in interest rates would cause them financial stress and the impact of this would flow through the entire economy.
Almost 50,000 households are at risk of defaulting on their home loans in the next 12 months and nearly a third of homeowners are in mortgage stress, new figures show.
The latest mortgage stress and default modelling from Digital Finance Analytics for the month of September reveals more than 905,000 households are estimated to be in mortgage stress — 45,000 more than there were the month prior.
….Of those households, 18,000 are in severe stress, which means they are unable to meet home loan repayments with their current income.
By David Llewellyn-Smith (“Houses & Holes”)
Reproduced with kind permission from Macrobusiness:
Great stuff today from the always entertaining and cross-disciplinary Viktor Shvets at Macquarie:
Investors seem to be residing in a world without any notable perceived risks. It is an extraordinary and unprecedented situation, particularly given unresolved issues of over leveraging and associated over capacity as well as profound disruption of business and economic models, which are not just depressing inflation but also causing extreme political and electoral outcomes while feeding Maslowian-type disappointments across labour markets.
What can explain such lack of concern regarding potential risks?
In our view, the only answer is one of investors’ perception that, as we discussed in our preview of 2H’17, ‘slaves must remain slaves’ and hence, neither Central Banks nor other public institutions can afford to step aside but need to continue to guarantee asset price inflation. In its turn, this can only be achieved by ensuring that volatilities are contained (as they are the deadliest enemy of an ongoing leveraging) and liquidity is expanding at a sufficient pace to accommodate nominal demand.
The optimists would argue that the productivity slowdown that the world experienced over the last decade was primarily caused by the global financial crisis (GFC) and that we are starting to turn the corner. Hence, optimists argue that velocity of money is likely to improve, and this would allow Central Banks to gradually (and very carefully) withdraw liquidity and rate supports. While this is the ‘dream outcome’ from Central Banks’ perspective, we don’t see any convincing evidence that this is occurring.
We maintain that the best explanation for investors’ perception that risks are low is that a combination of Central Banks’ liquidity (still running at ~US$1.5-2.0 trillion per annum), an assumption that Central Banks would swiftly reverse their policies at the slightest sign of volatility reemerging, and China’s real estate and infrastructure investment, act as ‘risk buffers’. Investors seem to believe that liquidity cannot be withdrawn, volatility must be arrested and cost of capital cannot go up, and hence, financial assets are in many ways underwritten. While Central Banks would like to have a little bit more volatility and a little bit more price discovery, they would be highly averse to shocking what is the highly financialized and leveraged global economy.
While it is hard to back what is essentially a long-term ‘doomsday’ machine, nevertheless, the above describes our view. We remain constructive on financial assets (both equities and bonds), not because we expect a return to self-sustaining private sector led recovery and growth but because we believe that an ongoing financialization is the only politically and socially acceptable answer. In our view, therefore, the greatest risk is one of policy miscalculation.
We remain constructive on financial assets, not because we believe in a sustainable recovery, but because we back the perpetual leveraging ‘doomsday’ machine.
Shvets has been pushing the “long grinding cycle” narrative for a number years now:
Despite all these challenges, Shvets still recommends his clients to invest in certain types of stocks. “The outcomes of the next 10-15 years could be quite dramatic. How do you invest in that climate? There are only two ways of investing. The first is: Assume non-mean reversion. The private sector will never recover. The only thing left would be the public sector cycle.”
This means we can conveniently forget about corporate profits, or valuations like the price-earnings ratio of the S&P 500, as many investors already have done. The only thing that matters is public sector activity in the form of central bank intervention or government stimulus programs.
An extreme example of this cycle is perhaps Venezuela. While the country is going up in flames, people don’t have enough food, and the currency is dissolving itself in a vicious hyperinflation, the stock market actually went up 10 times since the beginning of 2012. Only recently has reality caught up with stocks and the market gave up 15 percent of its gains since the beginning of the year.
‘Buy quality sustainable growth, high returns on equity. Companies capable to generate a high return on equity through margins and without leverage. Don’t worry about the price to earnings ratio, there is no mean reversion,” says Shvets. And don’t own any financials. Good advice. The stock price of the likes of Deutsche Bank and Credit Suisse have been decimated this year.
The share prices of Deutsche Bank AG (DBK) and Credit Suisse AG (CSGN) have both lost almost 50 percent of their value this year (Source: Google Finance).
The other option is to invest along some pretty grim themes which benefit from the new trends identified by Shvets. “People are still going back to 20th-century thematics, it’s so old-fashioned.”
None of the new trends can be described as inspirational or uplifting, but the Macquarie portfolio reflecting the themes has bested the MSCI World Index by almost 30 percent since the beginning of 2015.
“The biggest theme is declining return on humans, the replacement of humans, biotech, augmentation of humans, opium for the people, like computer games and gambling,” Shvets said.
Then there are themes catering to geopolitical risk and potential regional war or civil uprisings, like detention and prison centers, weapons, and drones. Another theme supports the aging demography in the West, so companies holding hospitals, funeral operators, and psychiatric institutions should do well.
On the positives, Shvets notes technological disruptors like Amazon and Google. All those companies should be independent of the government and long-term structural shifts. “They go on no matter what.”
“If you think of gold, the only way gold loses is if normal business and private sector cycles come back. If that is the case, gold goes back $100 per ounce. The other outcomes: deflation, stagflation, hyperinflation are all good for gold.” As for a return to a gold standard, Shvets has more bad news: “Gold standards come back after the war, not before the war.”
In principle I agree therefore the MB Fund is long:
US stocks despite the valuations;
we are underweight Australian assets given interest rates will go to zero or the equivalent in a world of endless oversupply;
investment becomes a matter of discerning the most potent disruptors or the most embedded rent-seekers at the best prices.
Where I disagree is that the business cycle is entirely dead. To my mind, this is a process not a one-off shift, driven by successive crises that shunt de-globalisation and de-privatisation forward with each convulsion. After all, we have not yet had an earnings-destroying event in the US in this cycle so the lack of risk has been real.
Next year China is going to slow and the Fed tighten, at some point one two many times. Mean reversion will come but then so will our next round of socialisation.
“The Federal Reserve left its benchmark interest rate unchanged and said Wednesday that it would begin to withdraw some of the trillions of dollars that it invested in the US economy after the 2008 financial crisis.” ~ Binyamin Applebaum
The Federal Reserve balance sheet ballooned in the last decade to current holdings of $2.5 trillion of US Treasury securities and $1.8 trillion of mortgage-backed securities.
Fed total assets of $4.5 trillion (the red line on the above chart) does not give the full picture. Of the cash injected into the economy, $2.2 trillion found its way back to the Fed by way of excess reserves deposited by banks (the blue line). These deposits earn interest at the rate of 1.25% p.a., providing a secure return on surplus funds. What this means is that the net effect of the balance sheet expansion is the difference between the two lines, or $2.3 trillion.
Even $2.3 trillion is a big number and any meaningful sale of securities by the Fed would contract the supply of money, tipping the economy into recession. So how does the Fed propose to manage “normalization of its balance sheet” without disrupting the economy?
Firstly, the Fed does not intend to sell securities. It will simply decrease the “reinvestment of principal repayments it receives from securities held” according to its June 2017 Normalization Plan.
The amount withheld from reinvestment will commence at $10 billion per month ($6bn US Treasuries and $4bn MBS) and step up by $10 billion each quarter until it reaches a total of $50 billion per quarter.
That means that $100 billion will be withheld in the first year and $200 billion in each year thereafter….”so that the Federal Reserve’s securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.”
Second, the Fed will reduce the level of excess reserves by an appreciable amount in order to soften the impact of the first step. So a $100 billion reduction in investments may only result in a net reduction of say half that figure, after taking into account the decline in reserves.
Third, the federal funds rate will remain the primary tool of monetary policy and will be used to fine tune monetary policy to fit economic conditions.
It appears that the Fed will start quite tentatively, withholding only $30 billion in the first quarter, but the longer term targets seem ambitious.
With currency in circulation now growing at an annual rate of $100 billion, even a $50 billion reduction in the first year (net of excess reserves) could leave a big hole.
This is bound to take some of the heat out of the stock market. The plus side is it may restore some sanity to market valuations, but any sudden moves could cause an overreaction.
Even if we compare the reduction to the annual change in M1 money supply, it takes a big bite.
M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler’s checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts.
US hourly wages continue to grow at a subdued 2.5% per year. The Fed will normally only move to tighten monetary policy when annual growth exceeds 3.0%.
Currency in circulation, growing at a healthy annual rate of 7.3%, shows the Fed stance remains supportive.
Turning to corporations (excluding the financial sector), employee compensation remains low relative to net value added (below 70%), while corporate profits are high at 12%. Economic contractions are normally preceded by rising employee compensation and falling profits as in 1999/2000.
The rising Freight Services Index indicates that economic activity is strong.
While a low corporate bond spread — lowest investment-grade (Baa) minus the equivalent Treasury yield — indicates the absence of stress in financial markets.
Some interesting comments from economist Saul Eslake regarding the Australian housing bubble:
“Rising house prices are not of themselves a reason for the market to drop. About two thirds of Australia’s household debt is owned by the top 40 per cent of households, by income distribution. There hasn’t been a lot of lending to people on low incomes,” explains Eslake.
Lending to people on small salaries is one of the reasons housing markets in other countries, such as the US in the sub-prime crisis, have come under pressure in the past.
There has also been a decline in the home ownership rate in Australia that also reduced the chance of a housing bubble popping. According to the 2016 census, home ownership is the lowest it has been since the census of 1954…..
Australia also never experienced the same extent of low-doc lending as happened in the US prior to the financial crisis, where “ninja loans” – no income, no job, no assets – were commonplace.
Similarly, very high LVR lending, another problem in the US, did not occur to the same extent in this market.
“In the US people of surprisingly modest means could get loans valued in excess of 100 per cent of the value of the property. But in Australia it’s very difficult to get a mortgage at more than 80 per cent LVR without mortgage insurance,” says Eslake.
…..An excess supply of housing, which impacted the US and Irish markets, is also missing in Australia.
“In countries housing supply ran a long way ahead of underlying demand. Builders kept building in the expectation of future demand. When the cycle changed, forced sales and excess supply crashed the market,” says Eslake.
For the last 15 years Australia has had a housing shortage. While that’s changing given a record numbers of apartments have been built in the last few years, supply has not yet outstripped demand.
While he does mention risks attached to interest-only mortgages, Saul’s view is that “a correction in the domestic residential property market, at this point in the cycle it seems unlikely.”
I believe there are further assumptions that he has not mentioned:
That banks continue to provide credit at the same rate as they are at present. A slow-down in new credit, precipitated by rising interest rates or falling prices, could cause a contraction.
That the inflow of foreign investment into Australian residential housing continues at the same rate as at present. There are three possible headwinds:
Reluctance on the part of Australian banks to increase exposure to foreign investors.
Tighter monetary policy in China.
And a Chinese crackdown to restrict capital outflows.
That current low interest rates continue. Inflationary pressures are low, so this is not unreasonable at present, but circumstances can change. So can LVRs.
I would describe the situation as reasonably stable at present but increasingly precarious in the long-term as the ratio of household debt to disposable income continues to climb.
Job growth fell to 156,000 for August, from a high of 210,000 in June, according to the latest BLS stats.
Unemployment ticked up from 4.3% to 4.4% for August.
What does this mean? Very little, if we look at our real GDP forecast based on total nonfarm payroll multiplied by average weekly hours worked. GDP growth is slow but steady.
The recently published Philadelphia Fed Leading Index for July has slowed but remains comfortably above the early warning level of 1. The index normally falls below 0.5 in the months ahead of a recession.
The S&P 500 is testing resistance at 2480 after a weak correction that respected support at 2400. Bearish divergence on Twiggs Money Flow continues to warn of selling pressure but this seems secondary in nature. Breakout above 2480 is likely and would offer a target of 2540*.
Target 2480 + ( 2480 – 2420 ) = 2540
The Nasdaq 100 is testing resistance at its all-time high of 6000. Bearish divergence on Twiggs Money Flow again warns of secondary selling pressure. Breakout would offer a short-term target of 6250 and a long-term target of 7000.
Target 6000 + ( 6000 – 5750 ) = 6250
The bull market remains on track for further gains.
The S&P 500 continues with a secondary correction that is likely to test the long-term rising trendline and support at 2400. Bearish divergence on Twiggs Money Flow warns of selling pressure but this seems secondary in nature.
Target 2400 + ( 2400 – 2300 ) = 2500
Twiggs Volatility (21-day), at 0.63% for the S&P 500, is way below the 1.5% warning level for elevated market risk.
The yield curve is flattening, with the 10-year minus 3-month Treasury Yield Differential close to 1.0%. But this is still well above the 0.5% early-warning level. A negative yield curve, where the Yield Differential falls below zero, is normally followed by a recession within 6 to 12 months.
Fed monetary policy remains accommodative, with currency in circulation expanding at a healthy annual rate of 6.9%.
The bull market remains on track for further gains.
The ASX 200 continues to consolidate in a narrow line between 5650 and 5800. Declining Twiggs Money Flow warns of selling pressure and breach of support at 5650 would signal a primary down-trend. Follow-through below 5600 would confirm. Breakout above 5800 is unlikely but would test resistance at 6000.
Monthly hours worked are up 1.9% over the last 12 months. Marginally below real GDP but not something to be concerned about unless growth continues to fall.
Iron ore continues its extended bear market rally, suggesting that the next correction is likely to find support above the primary level at 53.
ASX 300 Metals & Mining is also likely to find support above 2750. Respect of support at 3000 would signal a strong up-trend.
The ASX 300 Banks index continues to warn of selling pressure, with declining Twiggs Trend Index and Money Flow below zero. Breach of support at 8500 would signal another test of primary support at 8000.
From our perspective, a fall in housing construction; subdued consumer spending and a drag on services exports from the high Australian Dollar will constrain employment growth through 2018. The [Reserve] Bank sees things differently, expecting recently strong employment growth to persist into 2018, with the unemployment rate expected to fall to 5.4% by the end of 2019 compared to our current forecast that the unemployment rate will in fact be rising through 2018, reaching 6% by year’s end.
Two other domestic factors are important, firstly the Bank is of the view that “wage growth is expected to pick up gradually over the next few years”. That is despite convincing evidence offshore, that countries with full employment, and in the case of the US, an unemployment rate considerably below the full employment rate, are not experiencing wage pressures. This different assessment of household income growth is one of the key explanations behind our more downbeat view of the economic outlook. Secondly, we expect that the wealth effect from sharply rising house prices in NSW and Victoria is about to reverse. There is no argument that household debt levels are elevated. The prospect of very limited further increases of house prices in those markets may start to dampen consumer spending in particular by discouraging households to further subsidise consumption growth by lowering their saving rates…..
Falling housing construction;
Slow consumption growth;
Slow services export growth;
Slow employment growth;
Slow wages growth; and
Slowing house price growth.
I think Bill is right on the money, but there are always other variables like iron ore and Chinese financial markets that can disrupt even the best forecasts.
Iron ore looks set to retrace to test support between 68 and 70. Respect would signal a primary advance but I suspect that support at 60 is likely to be tested.
ASX 300 Metals & Mining is also likely to retrace, but bearish divergence on Twiggs Trend Index warns of selling pressure. Respect of 2950 would signal a primary advance but a test of primary support at 2750 is as likely.
The ASX 300 Banks index retreated below support at 8500. Follow-through would test primary support at 8000. Declining Twiggs Money Flow, with a large peak below zero, warns of strong selling pressure.
Declining Twiggs Money Flow also flags strong selling pressure on the ASX 200. Breach of support at 5650 is likely and would signal a primary down-trend. Follow-through below 5600 would confirm.
The Consumer Price Index (CPI) and Core CPI (excluding food and energy) both came in at a low 1.7% p.a. for the 12 months ended July 2017.
Source: St Louis Fed, BLS
Long-term interest rates are trending lower as CPI moderates. Breach of support at 2.10% by 10-Year Treasury Yields would signal another primary decline with a target of 1.80%*.
Target: 2.10% – (2.40% – 2.10%) = 1.80%
Bank credit growth is slowing, to the level where it is tracking nominal GDP growth, avoiding some of the excesses of previous cycles. But if bank credit falls below GDP growth that would warn of tighter monetary conditions and the economy is likely to slow.
Source: St Louis Fed, FRB, BEA
The S&P 500 is testing its long-term rising trendline, while bearish divergence on Twiggs Money Flow warns of selling pressure. But the market appears to have shrugged off Donald Trump’s promises of North Korean “fire and fury” and both of these movements seem secondary in nature. A correction is likely but the primary trend remains on track for further gains.
…The odds of a recession appear low, but so does a significant acceleration in growth. The regulatory environment is loosening, consumer spending appears solid and jobs growth remains strong. As such, we do not expect a recession any time soon. At the same time, however, we see no catalyst to push the economy into a higher gear unless the White House and Congress make progress on their pro-growth agenda.
July labor stats are out and shows the jobless rate fell to a 16-year low at 4.3%. Unemployment below the long-term natural rate suggests the economy is close to capacity and inflationary pressures should be building.
Source: St Louis Fed, BLS
But hourly wage rates are growing at a modest pace, easing pressure on the Fed to raise interest rates.
Source: St Louis Fed, BLS
Fed monetary policy remains accommodative, with the monetary base (net of excess reserves) growing at a robust 7.5% a year.
Source: St Louis Fed, FRB
Our forward estimate of real GDP — Nonfarm Payroll * Average Weekly Hours — continues at a slow but steady annual pace of 1.79%.
Source: St Louis Fed, BLS & BEA
The Nasdaq 100 has run into resistance at 6000. No doubt readers noticed Amazon [AMZN] and Alphabet [GOOG] both retreated after reaching the $1000 mark. This is natural. Correction back to the rising trendline would take some of the heat out of the market and provide a solid base for further gains. Selling pressure, reflected by declining peaks on Twiggs Money Flow, appears secondary.
The S&P 500 is also running into resistance, below 2500. Bearish divergence on Twiggs Money Flow warns of moderate selling pressure but this again seems to be secondary — in line with a correction rather than a reversal.
A quick snapshot of the Australian economy from the latest RBA chart pack.
Disposable income growth has declined to almost zero and consumption is likely to follow. Else Savings will be depleted.
Residential building approvals are slowing, most noticeably in apartments, reflecting an oversupply.
Housing loan approvals for owner-occupiers are rising, fueled no doubt by State first home-buyer incentives. States do not want the party, especially the flow from stamp duties, to end. But loan approvals for investors are topping after an APRA crackdown on investor mortgages, especially interest-only loans.
The ratio of household debt to disposable income is precarious, and growing worse with each passing year.
House price growth continues at close to 10% a year, fueled by rising debt. When we refer to the “housing bubble” it is really a debt bubble driving housing prices. If debt growth slows so will housing prices.
Declining business investment, as a percentage of GDP, warns of slowing economic growth in the years ahead. It is difficult, if not impossible, to achieve productivity growth without continuous new investment and technology improvement.
Yet declining corporate bond spreads show no sign of increased lending risk.
Declining disposable income and consumption growth mean that voters are unlikely to be happy come next election. With each party trying to ride the populist wave, responsible economic management has taken a back seat. Throw in a housing bubble and declining business investment and the glass looks more than half-empty.
Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.