Just the Facts

By Doug Noland

Credit Bubble Bulletin: Just the Facts

The S&P500 slipped 0.3% (up 5.2% y-t-d), while the Dow was about unchanged (up 4.5%). The Utilities added 0.3% (up 5.3%). The Banks fell 1.2% (down 1.0%), and the Broker/Dealers dropped 2.4% (up 2.7%). The Transports were little changed (up 0.7%). The S&P 400 Midcaps declined 0.8% (up 2.8%), and the small cap Russell 2000 fell 1.5% (up 0.5%). The Nasdaq100 dipped 0.3% (up 11.4%), and the Morgan Stanley High Tech index declined 0.2% (up 13.3%). The Semiconductors lost 1.2% (up 10.2%). The Biotechs sank 2.5% (up 13.1%). With bullion gaining $5, the HUI gold index rallied 3.3% (up 11.8%).

Three-month Treasury bill rates ended the week at 80 bps. Two-year government yields increased three bps to 1.29% (up 10bps y-t-d). Five-year T-note yields were unchanged at 1.92% (down 1bp). Ten-year Treasury yields slipped a basis point to 2.38% (down 6bps). Long bond yields were unchanged at 3.01% (down 6bps).

Greek 10-year yields declined 11 bps to 6.79% (down 23bps y-t-d). Ten-year Portuguese yields fell 11 bps to 3.87% (up 12bps). Italian 10-year yields dropped 10 bps to 2.22% (up 41bps). Spain’s 10-year yields declined five bps to 1.61% (up 23bps). German bund yields sank 10 bps to 0.23% (up 2bps). French yields fell eight bps to 0.89% (up 21bps). The French to German 10-year bond spread widened one to 66 bps. U.K. 10-year gilt yields fell six bps to 1.08% (down 16bps). U.K.’s FTSE equities index added 0.4% (up 2.9%).

Japan’s Nikkei 225 equities index dropped 1.3% to a four-month low (down 2.4% y-t-d). Japanese 10-year “JGB” yields slipped a basis point to 0.06% (up 2bps). The German DAX equities index dipped 0.7% (up 6.5%). Spain’s IBEX 35 equities index added 0.6% (up 12.6%). Italy’s FTSE MIB index fell 0.9% (up 5.5%). EM equities were mixed. Brazil’s Bovespa index lost 0.8% (up 7.0%). Mexico’s Bolsa jumped 1.6% (up 8.1%). South Korea’s Kospi slipped 0.4% (up 6.2%). India’s Sensex equities index added 0.3% (up 11.6%). China’s Shanghai Exchange jumped 2.0% (up 5.9%). Turkey’s Borsa Istanbul National 100 index declined 0.5% (up 13.3%). Russia’s MICEX equities index advanced 1.2% (down 9.5%).

Junk bond mutual funds saw inflows surge to $2.375 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined four bps to 4.10% (up 51bps y-o-y). Fifteen-year rates declined three bps to 3.36% (up 48bps). The five-year hybrid ARM rate added a basis point to 3.19% (up 37bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 4.19% (up 51bps).

Federal Reserve Credit last week slipped $1.6bn to $4.435 TN. Over the past year, Fed Credit declined $8.8bn (down 0.2%). Fed Credit inflated $1.617 TN, or 58%, over the past 230 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $7.2bn last week to $3.214 TN. “Custody holdings” were down $43.4bn y-o-y, or 1.3%.

M2 (narrow) “money” supply last week expanded $12.3bn to a record $13.418 TN. “Narrow money” expanded $777bn, or 6.2%, over the past year. For the week, Currency increased $4.3bn. Total Checkable Deposits dropped $25bn, while Savings Deposits jumped $31.4bn. Small Time Deposits were little changed. Retail Money Funds added $1.8bn.

Total money market fund assets declined $6.0bn to $2.648 TN. Money Funds fell $91bn y-o-y (3.3%).

Total Commercial Paper gained $6.7bn to $993bn. CP declined $109bn y-o-y, or 9.9%.

Currency Watch:

The U.S. dollar index gained 0.8% to 101.13 (down 1.2% y-t-d). For the week on the upside, the Mexican peso and Japanese yen increased 0.3%. For the week on the downside, the South African rand declined 2.5%, the Australian dollar 1.7%, the British pound 1.4%, the South Korean won 1.4%, the Swedish krona 1.1%, the New Zealand dollar 0.9%, the Brazilian real 0.8%, the Norwegian krone 0.7%, the Swiss franc 0.6%, the Canadian dollar 0.6%, the euro 0.6% and the Singapore dollar 0.6%. The Chinese yuan declined 0.19% versus the dollar this week (up 0.64% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index advanced 1.2% (down 1.4% y-t-d). Spot Gold added 0.4% to $1,254 (up 8.9%). Silver fell 1.5% to $17.99 (up 12.6%). Crude jumped $1.69 to $52.29 (down 2.9%). Gasoline rose 2.3% (up 4%), and Natural Gas gained 1.8% (down 13%). Copper slipped 0.3% (up 6%). Wheat declined 0.6% (up 4%). Corn fell 1.3% (up 2%).

Trump Administration Watch:

April 4 – Reuters (David Brunnstrom, Matt Spetalnick and Ben Blanchard): “When U.S. President Donald Trump meets Chinese President Xi Jinping this week, their summit will be marked not only by deep policy divisions but a clash of personalities between America’s brash ‘tweeter-in-chief’ and Beijing’s cautious, calculating leader. They may have one thing in common: their rhetoric about restoring their nations to greatness. But the two men differ in almost every other respect, from their political styles to their diplomatic experience, adding uncertainty to what has been called the world’s most important bilateral relationship. Five months after his election on a stridently anti-China platform, Trump appears to have set himself on a course for collision rather than conciliation with Xi, raising doubts as to whether the world’s two biggest economies can find common ground.”

April 3 – Financial times (Song Jung-a, Ben Bland and Tom Mitchell): “Donald Trump’s warning that he could take unilateral action to eliminate North Korea’s nuclear threat has sparked alarm among some analysts in Asia about the implications for South Korea, Japan and China of a military conflict with Pyongyang. ‘China has great influence over North Korea. And China will either decide to help us with North Korea, or they won’t,’ Mr Trump told the Financial Times… ‘If China is not going to solve North Korea, we will.’ The comments by the US president came weeks after Rex Tillerson, secretary of state, declared during a visit to Asia that the US policy of ‘strategic patience has ende’. Mr Tillerson said that Washington would not rule out any option in response to provocations by North Korea.”

April 6 – Bloomberg (Elizabeth Dexheimer): “In a private meeting with lawmakers, White House economic adviser Gary Cohn said he supports a policy that could radically reshape Wall Street’s biggest firms by separating their consumer-lending businesses from their investment banks, said people with direct knowledge… Cohn, the ex-Goldman Sachs Group Inc. executive who is now advising President Donald Trump, said he generally favors banking going back to how it was when firms like Goldman focused on trading and underwriting securities, and companies such as Citigroup Inc. primarily issued loans… The remarks surprised some senators and congressional aides who attended the Wednesday meeting, as they didn’t expect a former top Wall Street executive to speak favorably of proposals that would force banks to dramatically rethink how they do business.”

April 5 – Reuters (Roberta Rampton and Jeff Mason): “‘We’re going to be coming out with some very strong – far beyond recommendations – we’re going to be doing things that are going to be very good for the banking industry so that the banks can loan money to people who need it,’ Trump told a meeting with a business leaders… ‘We’re going to do a very major haircut on Dodd-Frank. We want strong restrictions, we want strong regulation. But not regulation that makes it impossible for the banks to loan to people that are going to create jobs,’ Trump said.”

April 4 – Bloomberg (Matthew Townsend, Ben Brody, and Elizabeth Dexheimer): “Donald Trump’s surprising election and his promise to overhaul the U.S. tax code set off celebrations across corporate America — but some industries had barely applauded before they began gearing up for a fight. Trump’s win gave Republicans control of the U.S. government for the first time in a decade and quickly drew attention to a tax plan that House Speaker Paul Ryan unveiled last summer with little fanfare. Ryan’s radical tax-code rewrite would replace the corporate income tax with a 20% tax on businesses’ domestic sales and imports; their exports would be exempt. Cue the alarm bells for import-heavy companies like Wal-Mart Stores Inc., Target Corp. and Nike Inc. Retailers, apparel-makers, shoemakers, automakers and others unleashed one of their most robust lobbying and public-relations pushes in recent memory against the so-called ‘border-adjusted’ tax.”

Continue reading Just the Facts

We Need to Define the ‘Shadows’, and All Parts of Them; or, ‘Rising Dollar’ Kills Another Recovery Narrative

By Jeffrey Snider of Alhambra

JP Morgan’s CEO Jamie Dimon caused a stir yesterday with his 45-page annual letter to shareholders. The phrase that gained him so much widespread attention was, “there is something wrong with the US.” Dimon mentioned secular stagnation and correctly surmised it was the right idea if for the wrong reasons. He then gave his own which included a litany of globalist agenda items, including not enough access to mortgages.

I agree fully with Mr. Dimon in those two respects, meaning first that there is surely “something” wrong that has caused a depression and second unlike economists he is right to suggest it isn’t a permanent condition. Getting that far, however, he stops short of going to the one place where irregularity is real and relevant – his own domain. Like Fed officials, there can be no accounting for money.

This wasn’t always the case even from this particular bank CEO. One of the reasons this particular shareholder letter stands out is not just for its pessimism but more so the suddenness of it. Dimon has been almost unique in his positivity, suggesting that also like policymakers the “rising dollar” period finally convinced him of its folly.

Back in October 2014, it was Jamie Dimon who bullishly stood on the American economy, though at that time it took no courage or insight to take such a position. Almost everyone was optimistic then even if most, including insiders and economists, really didn’t know why. The year was awash in confirmation bias as well as the circular, self-referential logic that so often goes with it: stock prices are rising because the economy is getting better, and the economy is getting better because stock prices are rising; the Fed thinks the recovery has arrived because banks think the recovery has arrived because Fed officials believe the recovery has arrived.

What Dimon said in 2014 was, “I’m a long-term bull on the US economy.” From that one statement you can understand the spotlight now on his current position which is the opposite of it. Secular stagnation or whatever you want to call it is at best low growth and opportunity as the basis or trend, a wholly unique condition for American economic experience outside of the Great Depression. Again, the “rising dollar” didn’t kill the recovery so much as so heavily damage the economy so as to kill the narrative of recovery.

In October 2014, however, there was one concern that Dimon did express, curiously one that seems left out of his current position.

However, he [Jamie Dimon] sees one thing that could derail the recovery: The $3.2 trillion ($15 trillion globally) nonbank financial system, or “shadow banks.”

However, asked what keeps him up at night, he said nonbank lending poses a danger “because no one is paying attention to it.” He said the system is “huge” and “growing.”

It’s actually not all that unusual that the CEO of JP Morgan would talk about “shadow banks” as if the term applied only to firms other than JP Morgan. I have no doubt that JPM’s management believes that their bank is a bank and not a full part of the shadow system. It is one reason, and a big one, why when discussing “dollars” it may seem like the “dollar” participants themselves appear to have no idea about it. One reason why the “shadow” system remains in the shadows is because everyone believes it only applies to some other guy.

Beyond that, the shadows are much more than just lending and mortgages. From Dimon’s perspective, JP Morgan is out of that business, having divested itself and client money of things like the former SIV Sigma, the off-balance sheet conduits that funneled resources into the housing bubble. The shadow system, however, was not a singular, temporal quirk of an otherwise traditional banking system; it was a feature of the wholesale revolution that overthrew most banking dynamics. It’s a condition that decades after it intensified remains a mystery due to nothing more than uncorrected convention about money (and Positive Economics).

The shadows remain our stagnation problem, for secular stagnation is truly eurodollar stagnation, but to which JP Morgan has played an enormous part. If we define shadow banking as only relating specifically to housing bubble era behavior, then Dimon would be correct to assume the global monetary problem is somebody else’s doing. There is so much more to it, as I discussed earlier today.

Unlike some banks, JP Morgan’s balance sheet at least until 2014 was still growing, though at a much, much slower rate than during the precrisis period. During the past two years of the “rising dollar”, despite starting it with so much optimism, JPM’s balance sheet contracted sharply in 2015, more even than in 2009, and only partially rebounded in 2016.

In terms of the true guts of the eurodollar system, the fullest extent of the shadows, JPM has only been retreating and in the past few years severely – including 2016.

The bank is but another anecdote for restricted balance sheet capacity matching up with the non-traditional monetary indications of “tightness” or even shortage. From the individual perspective of JP Morgan, what they are doing cutting back in risk capacity is mere prudence (risk v. reward), leaving it to the outside world, mostly the Federal Reserve, to deal with whatever total monetary issues. From the standpoint of traditional banking, JPM’s activities bear no resemblance to the “dollar shortage” or even the prospects for one.

It is what makes this problem so intractable, because the people closest to it don’t appear capable of grasping its true nature and thus the implications of what they do (and don’t do). It creates vast dissonance, where those inside the system claim there is nothing wrong with system so that a great many outside the system, especially in the media, simply accept the claim as unchallengeable. As such, “we” spend an entire decade looking everywhere else for answers.

Dimon’s October 2014 fears have been proved totally correct with but one exception – JP Morgan is not just a bank but a shadow player, too.

A Second Confidence Experiment

By Jeffrey Snider of Alhambra

The ISM Manufacturing Index declined slightly for March 2017, pulling back by 0.5 points after registering a multi-year high in February. The difference between the index and troubling auto sales, for example, is another reminder of what is truly a large disparity between economic statistics and sentiment. The ISM version of a PMI is considered more reliable because it asks more pointed questions, including if you are experiencing greater sales today than a year ago.

But PMI’s even in that format can be misleading because there is no further quantification. If sales drop 10% one year for 50% of respondents and then rebound 1% the next year for the same half proportion, the PMI will clearly look so much better in the latter year even if the overall economy might not truly be that much different; at least not meaningfully so.

As noted a few months ago, this disparity is pronounced especially over the past five years following the initial 2012 slowdown. It is consistent with the pattern of economy where it slows or even contracts and then only partially rebounds afterward. Sentiment thus appears more highly tuned to the relative difference rather than a more comprehensive assessment of activity and therefore its possible sustainability.

Durable goods orders, an almost perfect historical proxy for the ISM, are still averaging just 2% growth (through February 2017). That is clearly better than the -2% average of February 2017, but in reality it isn’t truly a different set of circumstances. And yet, the ISM at 57 and above suggests something more like 2010, 2004, or 1999 when new orders for durable goods were growing at 10+% in sustained fashion.

Continue reading A Second Confidence Experiment

Q1: Sure Bets That Weren’t

By Doug Noland

Credit Bubble Bulletin: Q1: Sure Bets That Weren’t

An intriguing first quarter. The year began with bullish exuberance for the Trump policy agenda. With the GOP finally in control of Washington, there was now little in the way of healthcare reform, tax cuts/reform, infrastructure spending and a full-court press against regulation. As Q1 drew to a close, by most accounts our new Executive Branch is a mess – the old Washington swamp as stinky a morass as ever. And, in spite of it all, the global bull market marched on undeterred. Everyone’s still dancing. From my perspective, there’s confirmation that the risk market rally has been more about rampant global liquidity excess and speculative Market Dynamics than prospects for U.S. policy change.

It’s not as if market developments unfolded as anticipated. Key “Trump trades” stumbled – longs and shorts across various markets. The overly Crowded king dollar faltered, with the Dollar Index down 2.0% during Q1. The Mexican peso reversed course and ended the quarter up 10.6% versus the dollar, at the top of the global currency leaderboard. The Japanese yen – another popular short and a key funding instrument for global carry trades – jumped 5% . China’s renminbi gained 0.84% versus the dollar. WSJ headline: “A Soaring Dollar and Falling Yuan: The Sure Bets That Weren’t”

Shorting Treasuries was another Trump Trade Sure Bet That Wasn’t. And while 10-year yields jumped to a high of 2.63% on March 13, yields ended the quarter down six bps from yearend to 2.39%. Despite a less dovish Fed, a hike pushed forward to March, and even talk of shrinking the Federal Reserve’s balance sheet – bond yields were notably sticky. Corporate debt enjoyed a solid quarter. Investment grade bonds (LQD) gained 1.2% during the quarter, with high-yield (HYG) returning 2.3%.

The S&P500 gained 5.5% during Q1. And while most were positioned bullishly, I suspect many hedge funds (and fund managers generally) will be disappointed with Q1 performance. There was considerable Trump Trade enthusiasm for the higher beta small caps and broader market. Badly lagging the S&P500, it took a 2.3% rise in the final week of the quarter to see the small cap Russell 2000 rise 2.1% in Q1. The mid caps (MID) were only somewhat better, rising 3.6%.

Technology stocks had been low on the list of Trump Trades going into the quarter, perhaps helping to explain a gangbuster Q1 in the markets. The popular QQQ ETF (Nasdaq100) returned 12.0% during Q1. The Morgan Stanley High Tech index rose 13.5%, and the Semiconductors jumped 11.6%. The Biotechs (BTK) surged 16.0%.

A Trump Trade darling entering 2017, the financials struggled during Q1. March’s 4.0% decline reduced the bank stocks’ (BKX) Q1 gain to an unimpressive 0.3%. Somewhat lagging the S&P500, the broker/dealers (XBD) posted a 5.4% Q1 advance. The NYSE Financial Index gained 3.7%, while the Nasdaq Bank Index dropped 3.1%.

King dollar bullishness had investors underweight the emerging markets (EM) going into 2017. A weakening dollar coupled with huge January Chinese Credit growth helped spur a decent EM short squeeze. Outperformance then attracted the performance-chasing Crowd. By the end of March, EM (EEM up 12.5%) had enjoyed the best quarter in five years (from FT).

Continue reading Q1: Sure Bets That Weren’t

It’s the End of the Quarter, Do You Know Where Your Money is?

By Heisenberg

Ok, so it’s Friday. And it’s the end of the month. And it’s quarter-end.

Let’s get some data out of the way first.

We got PMIs out of China overnight and that turned out pretty well. Here are the bullets:


And the more granular breakdown:

  • New orders increased to a nearly three-year high of 53.3 from 53
  • New export orders rose to 51, the highest in almost five years
  • Input prices fell a third month, falling to 59.3 after hitting a five-year high in December. That suggests producer prices may be peaking at an eight-year high
  • Among gauges for firms, the reading for large enterprises was strongest at 53.3 while medium-sized companies stood at 50.4 and small firms at 48.6

“Judging from the NBS PMIs, March activity growth appeared to be solid, and inflationary pressures in the manufacturing sector softened,” Goldman wrote after the data hit, adding the following caveat: “The NBS manufacturing PMI tends to increase in March when the Chinese New Year holiday is at a similar date as this year. We will wait for other indicators such as trade and IP to confirm the trend.” For now, the picture looks like this:


Meanwhile, still on the data front, we got inflation data for the eurozone. That’s important for obvious reasons and is especially interesting in the context of this week’s sudden dovish turn in ECB rhetoric. Here are the numbers:

  • Eurostat reports March flash CPI +1.5% y/y vs Feb. final +2% y/y.
  • Forecast range 1.5% to 2% from 52 economists
  • Eurozone March core CPI ex energy, food, alcohol and tobacco +0.7% y/y; Feb. +0.9% y/y; est. +0.8% y/y


“For the ECB, it’s clearly an argument for the doves,” Frederic Pretet, inflation and rates strategist at Scotiabank said. “Some policy makers will see the data as an argument to justify the ongoing stimulus and suggest that the debate on tapering is premature for the time being.” EURUSD headed lower following the print. Panning out a bit, here’s what the picture looks like going back to one “unnamed” official’s stealth dollar bailout on Wednesday:


Speaking of the dollar and weakness, this wasn’t a particularly good quarter for the greenback. While the Bloomberg Dollar index edged up to the highest level in more than a week on Friday as supporting month-end flows outweighed profit-taking interest after yesterday’s rally, this is still on track to be the worst quarter in a year for the index. By contrast, gold is heading for its best quarter in a year. Have a look at the juxtaposition (note: the dollar is down more against the broader Bloomberg index because emerging markets continued to do well):


Looking out across regional equities, Asian shares were lower as market struggled to reconcile Trumpspeak, conflicting economic signals out of Japan (decent CPI print versus lackluster household spending), and the upbeat data out of China. European shares are mostly red.

  • Nikkei down 0.8% to 18,909.26
  • Topix down 1% to 1,512.60
  • Hang Seng Index down 0.8% to 24,111.59
  • Shanghai Composite up 0.4% to 3,222.51
  • Sensex down 0.02% to 29,640.20
  • Australia S&P/ASX 200 down 0.5% to 5,864.91
  • Kospi down 0.2% to 2,160.23
  • FTSE 7332.01 -37.51 -0.51%
  • DAX 12250.52 -5.91 -0.05%
  • CAC 5075.86 -13.78 -0.27%
  • IBEX 35 10372.90 -33.00 -0.32%

Here’s the econ and Fed speaker schedule for the US:

  • 8:30am: Personal Income, est. 0.4%, prior 0.4%
  • 8:30am: Personal Spending, est. 0.2%, prior 0.2%
  • 8:30am: Real Personal Spending, est. 0.1%, prior -0.3%
  • 8:30am: PCE Deflator MoM, est. 0.1%, prior 0.4%
  • 8:30am: PCE Deflator YoY, est. 2.1%, prior 1.9%
  • 8:30am: PCE Core MoM, est. 0.2%, prior 0.3%
  • 8:30am: PCE Core YoY, est. 1.7%, prior 1.7%
  • 9:45am: Chicago Purchasing Manager, est. 56.9, prior 57.4
  • 10am: U. of Mich. Sentiment, est. 97.6, prior 97.6
  • 10am: U. of Mich. Current Conditions, prior 114.5
  • 10am: U. of Mich. Expectations, prior 86.7
  • 10am: U. of Mich. 1 Yr Inflation, prior 2.4%
  • 10am: U. of Mich. 5-10 Yr Inflation, prior 2.2%
  • Revisions: Industrial Production


  • 9am: Fed’s Dudley Speaks to Mike McKee in Bloomberg TV Interview
  • 10am: Fed’s Kashkari Answers Questions at Banking Conference
  • 10:30am: Fed’s Bullard Speaking in New York

Retailing in America: Game Theory in Reverse

By Danielle DiMartino Booth

Game Theory, Danielle DiMartino Booth, Money Strong, Fed Up

Toro, toro? Hankering for Hamachi?

Have an urge for uni? In Midtown? Well then, head west, to 8th Avenue to be precise. And keep walking, west that is. But go easy on the sake if you’ve got a sushi crawl in mind. No fewer than six fine purveyors of some of the best raw fish on the isle of Manhattan await you. Clearly the law of game theory applies to more than just clusters of gas stations.

Not sure you’d agree, but game theory made the study of economics engaging. The brain teaser’s roots date back to the 1920s with the work of John von Neumann. His work culminated in a book he co-wrote with Oskar Morgenstern which delves into the oxymoronic theory in its most straightforward form – a ‘zero-sum’ game wherein the interests of two players are strictly opposed.

But it was John Nash who elevated the theory to fame. The eminent Nash Equilibrium added practicality to the theory and opened the door to nuance. The ‘players’ were numerous and shared both common interests and rivalries. Hence six sushi spots in one square block and a handful more a few steps in either direction.

But what happens when game theory hits reverse gear? Is such a thing possible? The answer may be coming soon to a mall near you, maybe even one with its theatre and Sears still standing. Huh?

Developed in 1973, Valley View Mall rose to be a retail darling on the 1980s Dallas shopping scene. Even its name worked well with an iconic mall-era film (Why Valley Girl, of course! (Retailing in America:  Valley Girl (Interrupted) Foley’s, Macy’s Bloomingdale’s anyone? All of these icons anchored Valley View at one point or another.

But that was then, in a pre-Amazon world, when people clearly got out more and discretionary spending was more discrete. In December 2016, the mall literally began to be bulldozed, albeit with two tenants still operating amidst the dust storm – Sears and AMC Theatres. On March 21st, the world learned that it could soon be just the theater left standing.

Though the Valley View Sears will still be open today from 11 am to 8 pm, odds are the retailer will not be with us in a year’s time. On March 21st, Sears Holding Corporation submitted a filing with its regulators that it has “substantial doubt” it can continue as a “going concern.”

Don’t recall companies being charged with making their own death throes’ announcements from your Accounting coursework? You are correct. Meet the new and improved U.S. accounting rules that have just come into effect for public companies reporting annual periods that ended after December 15, 2016, Sears included. The change shifted the onus to disclose from a given company’s auditors to its management.

It was telling that the Sears news fell on the very same day discount retailer Payless announced it could soon file for bankruptcy protection. That same day, the less ubiquitous Bebe female fashion chain said it too was ‘exploring strategic options,’ typically code for that same ill-fated Chapter in the court system.

Did Sears strategically time its disclosure? Not in the least according to the retailer’s CFO Jason Hollar. The day after the disastrous disclosure, he blogged out that the ‘going concern’ reference simply complied with regulators’ requirements that investors be apprised of any risks looming over the horizon. Hollar went so far as to say that Sears is a, “viable business that can meet its financial and other obligations for the foreseeable future.” Don’t shoot the messenger, but selling Craftsman, the last valuable jewel in the once encrusted crown, certainly doesn’t suggest that much of a ‘future.”

Unless, that is, the reassurances come down to CEO Edward Lampert trying his level best to play game theory in reverse. That would entail capitalizing on the dying chain’s real estate holdings before the rest of the players on life support clue in to just how dire the situation will soon be across the full commercial real estate spectrum. Lampert does, after all, run a hedge fund that happens to be the retailer’s second-largest shareholder. You would agree, the best managers excel at games.

One does have to marvel at the degree of denial among retailers when websites such as deadmalls.com actively track shuttering structures.

At the opposite end of the denial spectrum sits Boston Fed President Eric Rosengren, who is and has been publicly worried about an entirely different sort of challenge facing the real estate market.

It’s no secret that apartment prices are soaring. Over the past year, prices have risen 11 percent, leading the broad market. While that increase may seem benign in and of itself, consider how the sector has fared over the course of the recovery: prices have recouped an eye-watering 240 percent of their peak-to-trough losses. In sharp contrast, retail has performed the worst; it’s only recovered 96 percent of its losses.

Rosengren is rightly worried that the “sharp” increase in apartment prices could catalyze financial instability. He went on to say that, “Because real estate holdings are widespread, and the monetary and macro-prudential tools for handling valuation concerns are somewhat limited, I believe we must acknowledge that the commercial real estate sector has the potential to amplify whatever problems may emerge when we at some point face an economic downturn.”

If you would indulge a translation: The bubble in commercial real estate (CRE) could trigger systemic risk, which of course, no central bank can contain.

The ‘macro-prudential’ tools to which Rosengren refers include rules and caps on banks’ exposure to CRE. Odds are, however, that the horse has already fled the barn. Over the past five years, CRE lending has been running at roughly double economic growth, a dangerous dynamic. The result: banks’ exposure to CRE has reached record levels. Last year alone, bank holdings of CRE and multifamily mortgages rose nine and 12 percent, respectively.

More worrisome yet is that the most concentrated cohort – those with more than 300 percent of their risk-based capital at risk – is banks with less than $50 billion in assets; most have assets south of $10 billion. How exactly will small banks confront a systemic risk conflagration? That pesky potential presumably is what’s robbing Rosengren of sleep at night. He might just remember that small German lenders called Landesbanks were where subprime bombs detonated unexpectedly way back when.

Beginning to connect the dots? All of this lending has led to massive amounts of building. After troughing at an annualized rate of 82,000 units in late 2009, multifamily starts hit a 387,000-annualized rate last year – a neat 372 percent rebound. Permits data suggest 2017 will push an equal number of units onto the market while 2018 looks to be about three percent below these lofty decade-high levels. There are similar supply stories in the hotel sector, which has led to the beginning of the end for lodging. Indeed, prices across the full CRE market have begun to fall for the first time since 2009.

Take all of these moving pieces into account and ask yourself, is it any wonder retailers are rushing the exits, all but falling over one another to accelerate announcements of thousands of store closures? As ugly as the situation is today, if widespread panic promises to present itself, prospects for retailers will get that much nastier. Demolition specialists will soon forget what it was to have down time and headlines screaming about malls sold for $1 will lose their novelty.

Is Sears’ Lampert craftily capitalizing on a trend he saw coming first, giving new meaning to ‘first mover advantage’? Is retail on the receiving end of reverse game theory? John Nash would be so proud.

Bi-Weekly Economic Review

By Joseph Calhoun of Alhambra

A failure on tax reform would not just take us back to the ex-ante, pre-election status quo

The Fed did, as expected, hike rates at their last meeting. And interestingly, interest rates have done nothing but fall since that day. As I predicted in the last BWER, Greenspan’s conundrum is making a comeback. The Fed can do whatever it wants with Fed funds – heck, barely anyone is using it anyway – but they can’t control what the market does with long term rates. At least not without making a commitment like the BOJ did with JGBs to cap the 10 year rate. Of course, the BOJ now owns 42% of the Japanese government bond market so there is that. But I digress; the point is that that the yield curve flattened since the last update, growth expectations falling.

The rally in the long end of the curve has been attributed to a partial unwinding of the Trump trade and that is probably at least partially true. But the simpler, Occam’s Razor explanation, is that the market is reacting negatively to the rate hike. Higher rates in the context of slowing loan growth, peaking auto sales and a sluggish real estate recovery may not be the best idea for an economy struggling to grow at even the reduced pace of the last few years. And while growth and inflation expectations did rise after the election, the bond market was never on board with the administration’s dreams of a return to the 3.5 to 4% growth Americans expect. At the recent peak of 2.62% nominal and 0.75% real (TIPS), the 10 year note was already skeptical of the efficacy of the Trump agenda.

The economic data since the last update was a bit less optimistic than recently but discovering that required digging into the details. Housing starts, for instance, were reported up from the previous month and year over year. But permits were down on the month and peaked 2 years ago as multi-family construction appears to be stalling. And while it isn’t directly related, the FHFA housing price index was flat last month and the year over year rate of change has peaked. If demand for housing is that robust, why aren’t prices going up? Further, new homes sales were also reported up and better than expected but the median price fell 3.9% on the month and 4.9% year over year. Average price by the way jumped 9.9% to an all time high of $390,400 but that is a function of the mix of houses sold. Like a lot of other sectors, the high end of the housing market is doing pretty well while the rest of it is not.

On the goods side of the economy, industrial production figures and durable goods orders painted the same mixed picture. IP was flat on the month but the manufacturing part was higher with strength in business equipment but the durables report showed capital goods orders falling. We continue to see positive sentiment at the business and consumer levels but it isn’t translating – yet – into actual activity. I suspect some of that is due to, ironically, expectations regarding potential economic policy changes. For instance, we’ve seen a pretty big drop-off recently in the growth of C&I (business) loans. Could that be due to uncertainty regarding the deductibility of interest charges? That’s part of the Republican tax reform and a prudent company might want to wait and see if that passes before taking on new debt. More generally, the proposed tax reform also allows expensing of capital investments. What if tax reform is delayed and doesn’t apply to 2017 investments? Companies seem to be taking a wait and see approach.

Even the strongest and most consistent of economic statistics – employment – showed some cracks over the last two weeks. We had a pretty good employment report a few weeks ago but the Labor Market Conditions Index, reported two weeks ago today, is barely above zero. It isn’t indicating any big problems but it definitely downshifted in late 2015 and hasn’t recovered. Weekly jobless claims have been climbing recently although 258,000 is still a very low number if well off the recent lows. The JOLTS report did show a rise in job openings but the current level is basically the same as two years ago although the hiring rate was up some.

Still, the economy has performed better the last six months or so and that is reflected in our market indicators as well as the data. The CFNAI, a broad measure of economic activity, turned positive again and the three month average, at 0.25, is nowhere near a recession level. It isn’t anything to celebrate though; it shows growth only slightly – very slightly – above trend.

As I said above, the yield curve flattened slightly since the last update:

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The Inverse of Keynes

By Jeffrey Snider of Alhambra

In fundamental terms of earnings, there is only further confirmation of a lack of growth

With nearly all of the S&P 500 companies having reported their Q4 numbers, we can safely claim that it was a very bad earnings season. It may seem incredulous to categorize the quarter that way given that EPS growth (as reported) was +29%, but even that rate tells us something significant about how there is, actually, a relationship between economy and at least corporate profits. Keynes famously said that we should never worry about the long run for there we will all be dead, but EPS has arrived at the long run and there is still quite a lot of living to do.

As late as October, analysts were projecting $29 in earnings for the S&P 500 in Q4 2016. As of the middle of the earnings reports last month, that estimate suddenly dropped to just $26.37. In the month since that time, with the almost all of the rest having now reported, the current figure is just $24.15 – a decline of over $2 in four weeks. Therefore, 29% growth is hugely disappointing because it wasn’t 55% growth as was projected when the quarter began.

It is also the timing of the downgrades that is important as it relates to both “reflation” and the economy meant to support it. All throughout last year, in the aftermath of the near-recession to start 2016, EPS estimates for Q4 (and beyond) were very stable, unusually so given the recent past. That shows us how analysts, at least, were expecting the economy to go once it got past “global turmoil.” It was the “V” shaped rebound typical for past cyclical behavior.

But it wasn’t until companies actually started reporting earnings that the belief was tested and then found severely lacking. With just $24.15 for Q4, total EPS was for the calendar year less than $95, the ninth straight quarter below the $100 level. More importantly, on a trailing-twelve month basis, EPS don’t appear to be in any hurry (except in future estimates) to revisit the prior peak of $106 all the way back in Q3 2014.

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Stuck in Yesterday

By Jeffrey Snider of Alhambra

Crude oil never did fully embrace “reflation” because it couldn’t, and that tells us something

It is understandable why everyone is right now fixated on Washington. The repeal, or not, of Obamacare is, to paraphrase former Vice President Biden, a big deal. In terms of market expectations, it is difficult to discern by how much. That was to be, after all, but one step of several reductions to the administrative burden on the economy. Maybe as the first it is given outsized importance not because it might deliver the biggest impact, but rather because as the first it can tell us something about the realistic nature of what is supposed to happen differently under a Trump administration.

Even though to this point it has been a disappointment for the “reflation” idea, I believe it is more so a distraction to parts that may be far more important. Attention might better be removed to Oklahoma than DC. As noted yesterday, there has been a sizable shift in the dynamics for oil, far removed from the interminable nature of “stimulus” politics. It has been oil above all else where “reflation” is governed, given the gloss of realism first by its rise from the ashes of last February and then at first its apparent staying power, lingering above $50 for months so as to allow those political hopes a realistic basis by which to cling on for however much longer.

Physical fundamentals are ruthless, though, and have a tendency to ruin mistimed romance. The connected nature of inventory in gasoline and crude point to the underlying truth of today, which toward the end of March 2017 probably should have by now at least started to look like that tomorrow.

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Economics Through the Economics of Oil

By Jeffrey Snider of Alhambra

The last time oil inventory grew at anywhere close to this pace was during each of the last two selloffs, the first in late 2014/early 2015 and the second following about a year after. Those events were relatively easy to explain in terms of both price and fundamentals, though the mainstream managed to screw it up anyway (“supply glut”). By and large, the massive contango of the futures curve that showed up as a result of “dollar” conditions made it enormously profitable to pull crude out of current flow and deposit it wherever storage might be available, even at some considerable cost (so steep was the contango). It was the symbolic intersection between economy and finance which told the world there was nothing good about those times.

This time, however, there is only minor contango in WTI (or Brent) futures and a curve that isn’t much changed over the last year. And still crude is pouring into Cushing at an alarming rate, so much so that by earlier this month oil investors started to leak out of the over-crowded long trade. You have to believe that the unusually steady price of WTI from mid-December forward despite almost everyone being long was related to this once again gaining imbalance – no matter how hard you try to fashion “rate hikes” into a much more robust future economy there is this very visible degree of caution that cries out “not so fast.”

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