Strong Data and Conspicuous Bubble Excess

By Doug Noland

Credit Bubble Bulletin: Strong Data and Conspicuous Bubble Excess

Analysis surrounding economic data is especially interesting these days. As always, there’s ample opportunity to pick and choose data points to support a particular perspective. I hold the view that economic activity is generally more robust than given credit for (especially in bond markets). The analytical community for the most part downplays economic strength. No reason to stir the Fed or the fixed-income markets. Besides, these days most economic data have minimal market impact. Beyond reports on consumer inflation and wage growth, little seems to garner much interest from Federal Reserve officials.

U.S. Manufacturing payrolls increased 36,000 (estimate 8k) in August, the strongest monthly gain since March 2012. Moreover, July growth was revised up 10,000 to 26,000. One must look all the way back to the 2010 recovery for a stronger two-month period of manufacturing job gains. And while overall August payroll gains (156k) lagged expectations (180k), it’s worth mentioning the much stronger number out of ADP. At 236,600 jobs added, August ADP was the strongest since March (255k). One must go back many years to find a stronger August report from ADP.

The US ISM Manufacturing index was reported Friday at a stronger-than-expected 58.8, the highest reading since April 2011. Prices Paid remained unchanged at an elevated 62, with Production up slightly to 61. New Orders were little changed at 60.3. Notably, Employment jumped 4.7 points to 59.9, the strongest reading since June 2011. Manufacturing strength was broad-based, with 14 of 18 industries reporting growth for the month. A Bloomberg article quoted Timothy Fiore, chairman of ISM’s factory survey committee: “Really, really strong month for manufacturing… We’re seeing a significant expansion.” And with an estimated 500,000 vehicles to be scrapped after hurricane Harvey, the auto manufactures no longer face much of an inventory issue. Ford and GM gained about 5% in three sessions.

A headline from a couple weeks back: “Japan Is Now the Fastest-Growing Economy in the G7.” With 4% annualized growth, and the “longest expansion in more than a decade,” the Japanese economy unexpectedly moved to the top of the growth leaderboard. It was short-lived. Canada’s GDP was reported Thursday at a stronger-than-expected 4.5% annualized (y-o-y up 5.3%), the strongest growth since Q3 2011. The expansion was broad-based, with Household Consumption up 4.6% and Exports surging 9.6%.

September 1 – Bloomberg (Carolynn Look): “In a month traditionally reserved for time at the beach, euro-area factories increased output at one of the fastest rates since 2011. A Purchasing Managers’ Index for manufacturing climbed to 57.4 in August from 56.6 in July, IHS Markit said… A surge in export orders, paired with robust domestic demand, put pressure on capacity and forced companies to take on more workers.”

The JPMorgan Markit Economics global manufacturing index rose 0.4 to 53.1, the highest reading since may 2011. Germany’s PMI jumped to 59.3, just below multi-year highs. UK’s manufacturing PMI rose to 56.9 vs. a 55.0 estimate.

Data out of China continues to confirm (Credit-induced) expansion. The Caixin China Manufacturing PMI increased 0.5 to 51.6 in August, the strongest reading since February. Export Orders rose to the highest level since 2010. It’s worth noting that India (51.2), Mexico (52.2) and Brazil (50.9) all posted stronger manufacturing PMIs.

“Soft” data remain robust. “U.S. Consumer Confidence at Second-Highest Level Since 2000.” Conference Board August consumer confidence increased to a stronger-than-expected 122.9. Present Conditions rose to 151.2, the strongest reading since July 2001. European economic confidence jumped to the highest level since the summer of 2007. Meanwhile, German CPI rose to a stronger-than-expected 1.8% in August.

Ten-year Treasury yields rose five bps Friday to 2.17%. For the most part, however, global bond yields have reacted little to stronger-than-expected data. Treasury yields traded as low as 2.10% Friday morning on weaker nonfarm payrolls along with reports out of Frankfurt that the ECB may not have its final plan for winding down QE together until December.

To be sure, global central bankers have brought new meaning to the phrase “behind the curve.” Expectations have the ECB taking a gradualist approach to winding down bond purchases. Who knows if rates will ever be returned to a semblance of a reasonable level. Here at home, despite a 3.0% GDP print and a 4.4% unemployment rate, the market sees the Fed likely done raising rates for 2017 (36% odds of rate hike before year-end). And there’s still no end in sight for the Bank of Japan’s incredible securities purchase program.

The stronger the global economy the more fixated central banks are on CPI. They define “price stability” as a steady 2% rise in an aggregate of consumer prices – even though it’s obvious that relatively stable CPI is not reflective of financial stability or overall pricing dynamics throughout the financial markets and economy. Somehow it’s gotten to the point where central bankers are determined to prolong a radical experiment in monetary inflation, with slightly below target CPI as justification.

The focus should instead be on the stability of prices more generally, certainly including securities and asset prices. It seems rather inarguable. Central bankers should incorporate a broad mosaic of indicators of financial conditions. These would include money and Credit growth, securities market risk premiums, debt issuance and asset market trends, along with indications of speculative leveraging, destabilizing flows, risk embracement, aggressive risk intermediation and other excesses.

Alan Greenspan fashioned an asymmetrical approach to rate adjustment: slash them aggressively in the event of de-risking/de-leveraging in the markets, while raising them cautiously to ensure that markets are not at risk from tightening financial conditions. This was a Godsend to financial speculation. The Bernanke Fed took things a giant leap deeper. The Fed was prepared to push back against any tightening of financial conditions. “Asymmetrical” doesn’t do justice. In the event of ongoing ultra-loose financial conditions and resulting asset price instability, the Fed (and their central bank compatriots) can sit back and completely disregard escalating monetary disorder (while clasping hands and repeating “CPI below target”).

Things turn crazy late in Bubble episodes – especially, as we’re witnessing, in the “Granddaddy of All Bubbles.”

August 23 – Financial Times (Joe Rennison): “Hedge funds are embracing an esoteric credit product widely blamed for exacerbating the financial crisis a decade ago, as low volatility and near record prices for corporate debt tempt them into riskier areas to seek higher returns… The surge in activity reflects the effort by investors to generate a higher rate of return during a period of historically low volatility in credit markets, compounded by low fixed rate yields… Tranches with less exposure to defaults might only offer a 0.3 to 0.5% annual return but investors ‘lever’ the position by paying only a proportion of the deal value as collateral. While that increases the risk of safer tranches, investors are using less leverage than was case before the financial crisis, traders say. Leverage up to 20 times is now typical, pushing returns above 5%.”

August 28 – Wall Street Journal (Christopher Whittall and Mike Bird): “The synthetic CDO, a villain of the global financial crisis, is back. A decade ago, investors’ bad bets on collateralized debt obligations helped fuel the crisis. Billed as safe, they turned out to be anything but. Now, more investors are returning to CDOs—and so are concerns that excess is seeping into the aging bull market… Desperate for something that pays better than basic government bonds, insurance companies, asset managers and affluent investors are scooping up investments like synthetic CDOs, bankers say, which had largely become the preserve of hedge funds after 2008… The fastest growth this year has come in credit—the epicenter of the 2007-08 crisis. The top 12 global investment banks had around $1.5 billion in revenue in structured credit in the first quarter, according to Coalition, more than doubling since the first quarter of 2016. Structured equities are largest overall, a business dominated by sales of derivatives linked to moves in stock prices, with revenue of $5 billion in the first quarter.”

According to Dealogic, U.S. corporate debt sales have surpassed $1.2 TN y-t-d and remain on record pace. How much is demand for these debt securities driven by the popularity of various structured finance vehicles, including a rejuvenated CDO marketplace? How much leverage is accumulating when “up to 20 times is now typical” for “safe” tranches? How have years of ultra-loose monetary policy, along with Fed’s assurances to “push back” against any tightening of financial conditions, distorted the entire structure of the corporate debt marketplace?

Friday from the Financial Times (Kadhim Shubber), under the headline “This is What Watching a Bubble Feels Like… Behold the Madness:”

“’The OMG token sale, which raised $25 million, took place in July and initially one OMG token was worth around $0.27. Today, the value is at more than $11, giving a return of more than 40X to anyone who bought in at the ICO stage. Qtum raised $15.6 million worth of crypto in March. Its QTUM token was worth $0.30 initially, but today that price is above $17.’ That’s via TechCrunch, which says OMG and Qtum are the first initial coin offerings to breach a $1bn market cap. It dubs them ‘ICO unicorns’. Apparently the price rises are a ‘massive respectable return for those who speculated’. Never mind that ‘neither company has an actual product in the market right now’.”

August 29 – Bloomberg (Sho Chandra): “Unless you’ve been living under a rock, you’re probably aware that bitcoin and a number of other digital currencies have seen some pretty crazy runs this year. Bitcoin, the best-known digital currency, has surged 358%. While staggering, lesser-known competitors have seen even bigger gains, such as the more than 4,000% increase for ethereum. Bespoke Investment Group contrasted the rise in bitcoin with infamous bubbles such as the tech market in the late nineties. There’s almost no comparison. Tech stocks rose just over 1,000% over the entire course of their bubble, and bitcoin is already up more than twice that.”

August 30 – Bloomberg: “The rise of initial coin offerings in China has disrupted the social economic order and poses a financial risk, a domestic trade group said. Institutions have misled investors to raise funds through ICOs, the National Internet Finance Association of China, an organization endorsed by the State Council and top finance and banking watchdog, said… Unauthorized by regulators, some of the ICOs are suspected of fraud, illegal equity offerings and fundraising, the group said… ‘ICO projects have unclear assets, no investor suitability standards and gravely lack information disclosure and therefore have relatively high risks,’ the association said. ‘Investors should keep a clear mind, stay on high alert for frauds and report any wrongdoings to the police department.’”

The unfolding cryptocurrency Bubble has been feeding off ultra-loose financial conditions and a mindset of speculation that has become deeply entrenched (from years of free “money”). It’s become a full-fledged mania, although its significance will be downplayed by those pointing to the relatively small scope of the market. While not quite as outrageous, there are myriad indicators pointing to precariously loose monetary conditions and late-stage Bubble Excess (where market cap is quite meaningful).

Biotech stocks (BTK) surged 9.0% this week, pushing y-t-d gains to 37.7%. The Nasdaq Biotech index (PE 107) this week saw 10 stocks (out of 160) gain better than 20% and 43 rise double-digits. About any company in the process of developing a new cancer treatment saw its stock soar.

Biotech is not alone in indicating Bubble danger. The Morgan Stanley High Tech Index surged 2.6% this week to new all-time highs, boosting y-t-d gains to 28.7%. The Semiconductor index jumped 3.6%, increasing 2017 gains to 23.5%. The Nasdaq Composite rose 2.7% (up 19.6% y-t-d) and the Nasdaq100 advanced 2.8% (up 23.1%).

August 29 – CNBC (Andrea Riquier): “U.S. home price growth picked up steam in June as strong demand continued to buoy the market. The S&P/Case-Shiller 20-city index rose a seasonally adjusted 5.7% in the three-month period ending in June, compared with a year ago, the same rate of change as in May. The national index rose 5.8%, compared with a year ago, up from a 5.7% annual increase in May. Nine cities had stronger annual price growth in June than in May, and western metros remained on top, with annual price gains ranging from 13.4% in Seattle to 7.7% in Dallas. Seattle prices are rising so rapidly that they have left No. 2 Portland in the dust.”

I may be biased by what I see locally – and by generally overheated housing markets along the entire West Coast – but I believe a powerful inflationary bias and Bubble Dynamics have taken hold in many markets around the country. This is an important consequence of timid central bankers and low bond yields. Recent housing sales have somewhat disappointed, but this has likely been impacted by the lack of inventory in strong markets. It’s taking time for builders to catch up with robust demand (homebuilder index up 13.8% y-t-d).

There is ample support for the global Bubble thesis. Emerging market equities (EEM) rose this week to three-year highs. Brazil’s 1.2% rise increased y-t-d gains to 19.4%. India’s almost 1% gain took y-t-d returns to 19.8%. So far this year, stocks in Turkey have gained 41%, Poland 26%, Hungary 17.9%, Romania 14.6%, Hong Kong 27.1%, South Korea 16.4%, Taiwan 14.5%, Indonesia 10.7%, Philippines 16.3%, Vietnam 18.6%, Mexico 11.9%, Argentina 40%, Chile 24.6% and South Africa 13.9%.

In any other environment, surging securities and asset prices coupled with synchronized global economic momentum would see bond prices under pressure. But with global central bankers fixated on consumer price indices and the bond market confident in inflation dynamics, fixed income has been about as comfortable as one could imagine.

Perhaps central bankers have just decided to sit back and let these Bubbles run. I hold out some hope that they will recognize their predicament and begin to signal a desire to get back to the process of “normalization.” We’re at the late phase of the Bubble – where bond markets are sniffing out trouble (bursting Bubbles and mounting geopolitical risks). But it’s the bond market’s keen sense of smell that keeps yields artificially low, ensuring exactly the loose financial conditions necessary to sustain perilous late-stage Bubble excess.

A Thursday Bloomberg headline: “The Bond Market’s Biggest Rally of 2017 Amazes Traders.” By Friday afternoon fixed income did seem to be awakening somewhat to reality. Also from Bloomberg: “Junk Bonds Face Wave of Supply Just as Investors Turn Sour.” It’s interesting to ponder how the world might change when investors turn sour on corporate Credit and fixed-income more generally. It may not these days be the most conspicuous of Bubbles – but it’s surely among the biggest and with the most far-reaching consequences.

 

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