Here Are The Negatives In The Republican Tax Plan, According To Wall Street

Judging by the market"s euphoric reaction this morning, the Senate"s passage of the tax bill on Saturday is nothing but good news for stocks (well, maybe not the Nasdaq). And indeed, banks - whose effective tax rate is around 30% - and other tax-sensitive companies are surging, with banks are outperforming and  sending the KBW bank index up as much as 2.8% to a fresh decade-high (BofA up as much as 3.9% to the highest since Oct. 2008; JPM up as much as 3.4% to record high; Citigroup up as much as 2.7% to highest since Dec. 2008). Even so, as Bloomberg reports, some analysts are sounding a few warnings. Their concerns include: a delay in potential benefits; the need to make fixes in a highly partisan environment; and curbing R&D credits.

Here are the negatives in the Republican tax plan, according to Wall Street:

WELLS FARGO (Christopher Harvey)

• Sees difference between House, Senate timing of corporate tax cut (2018 vs 2019) as significant, with Senate’s 2019 likely to prevail; that means tax overhaul’s potential direct impact to 2018 corporate earnings is likely to be zero


• Feels "great rotation" (out of tech, and into tax-sensitive issues such as banks, small-caps, value-oriented stocks) will need to pause


• Senate’s depreciation policy may counterbalance timing of the corporate tax cut to a degree; notes Senate allows for full expensing of capital investments starting in 2018; in a higher tax environment (no change until 2019), that may pull some spending forward, aiding 2018 growth; also sees strong 1H M&A

COMPASS POINT (Isaac Boltansky)

• A "concerning theme" is emerging: the likely need for fixes next year, while "it isn’t exactly clear how those changes will be made"


• Structural defects in final bill are probable, given it’s being drafted at "warp speed," and most pieces of sweeping legislation require technical corrections; recently, however, lawmakers have been unable to reopen primarily partisan bills (like Dodd Frank, ACA)


• Sees conference committee process as potentially volatile, but expects quick movement, with Trump signing a bill this year

BLOOMBERG INTELLIGENCE (Andrew Silverman)

• Downsides include AMT inclusion, which haircuts or prevents some businesses from being able to take deductions and depreciation (including the R&D credit, which GOP had said they wanted to preserve)


• Also notes slashing state and local tax (SALT) deduction; higher-than-est. repatriation rates (bad for tech, pharma cos.); haircut on taking net operating losses


• Senate bill changes how non-profits and pensions are taxed, likely increases taxes substantially on "unrelated business taxable income"

HORIZON INVESTMENTS (Greg Valliere)

• House/Senate conferees, who will start work on Monday, have "enormous number" of issues to resolve, including whether individual provisions are permanent, whether mortgage deduction will get haircut, when corporate rate cuts begin (2018 or 2019?)


• Veteran tax lobbyists were "incredulous" this weekend over Senate-passed tax bill, which was "hastily patched together with enormous unintended consequences," including retaining corporate AMT, which effectively would kill the R&D tax credit


• Adds bill is still being written and corrected; numbers don’t add up; Republican leaders, led by Paul Ryan, "have made no secret about their next goal," which is major overhaul of the welfare state, including curb growth of Social Security, Medicare, Medicaid as deficits rise; "Democrats, eyeing the next two elections, are salivating"

MOODY’S (Nick Samuels)

• Senate’s overhaul is negative for state and local government finances (most sharply in high-tax states like Calif., N.Y., N.J.)


• Change to SALT deduction would reduce disposable income for many taxpayers, likely outweighing positive effect of lower federal rates on consumption


• SALT change would also hurt financial flexibility by increasing political resistance to tax increases at state, local level

MOODY’S (Christina Padgett)

• Diminished interest deductibility, which is more punitive to highly-leveraged companies, is likely to have negative implications for low-rated speculative grade cos., may outweigh benefits of lower corporate tax rate


• Spec-grade companies pay relatively little in taxes in part due to tax shield from interest deduction


• Leveraged buyouts and industry sectors with highest leverage, weakest coverage of interest expense are among most vulnerable

HEIGHT SECURITIES (Ed Groshans)

• Senate-passed bill amends tax law covering interest deductions on home equity indebtedness


• This "seemingly innocuous" amendment would prevent homeowners from deducting interest on mortgages that are refinanced


• Would likely reduce refinancings for borrowers who’d prefer to maintain mortgage interest deduction for tax purposes

MELIUS (Carter Copeland)

• While tax overhaul may bring some extra profits to defense co. bottom lines and cash flow to shareholders, it may also make the future budget situation much tighter for the Department of Defense by removing "wiggle room in the annual fight for funding"

Source: Bloomberg

Amazon Strikes Again: CVS To Buy Aetna For $69BN In Year"s Largest Deal, "Reshaping Health Care"

A deal that was months in the making is finally official, with Aetna"s board of directors approving on Sunday the health insurer’s sale to drugstore chain operator CVS Health Corp for approximately $207 per share in cash and stock, in a deal worth $67 billion, multiple news sources reported on Sunday afternoon. The purchase price represents a premium of 29% to where Aetna shares were trading before the WSJ first reported that the two companies were in talks in October.

The deal will be this year’s largest corporate acquisition, and in combining one of the nation’s largest pharmacy benefits managers (PBMs) and pharmacy operators with one of its oldest health insurers, will "reshape health care" by bringing a large insurer and a big provider of pharmacy services under one roof.

According to the agreed terms of the deal, which will be announced later on Sunday, Aetna shareholders will receive $145 per share in cash and 0.8378 CVS Health shares for each Aetna share. According to Reuters, "Aetna shareholders will own about 22% of the combined company, while CVS shareholders will own the remainder." As part of the acquisition, three Aetna directors, including Aetna’s Chairman and CEO Mark Bertolini, will join CVS’s board of directors. After the deal closes, Aetna will operate as a separate unit run by members of the current management.

The acquisition will be financed with a mix of cash and debt. Barclays, Goldman Sachs and Bank of America have committed to provide $49 billion of financing, Bloomberg reported.

With Aetna currently employing 49,500 while CVS has 204,000 full and part-time employees, the combined company will boast a quarter million workers, if only for the time being. The deal, which is expected to close in the second half of 2018, will create cost savings of about $750 million, which means tens of thousands of layoffs.

Some more on the companies" background: CVS, with annual revenue of $178 billion, is a major pharmacy-benefits manager in addition to its vast collection of drugstores, some of which already have retail clinics. Aetna, with revenue of around $63 billion, is the third-largest U.S. health insurer, providing coverage to around 22.2 million members enrolled in employer, Medicare, Medicaid and other plans.

The deal comes as healthcare payers and pharmacies are responding to rapidly changing factors, including Obamacare, rising drug prices "and the threat of competition from online retailers such as Amazon.com", Reuters noted. In fact, as Morgan Stanley pointed out two weeks ago, Amazon"s imminent entry into the healthcare sector has been cited as one of the primary catalysts behind the AET/CVS deal:

As a reminder, this is how Morgan Stanley summarized the rationale behind the just announced merger:

Drug retailers have the most opportunities to adjust their business models and lower cost structures to defend against Amazon. Within the drug supply chain, the threat of Amazon’s entry into drug retail is accelerating vertical integration, and is cited as a driver behind the rumored CVS/Aetna merger. In our view, the combination would diversify profits away from the supply chain, help create a narrow preferred network, and act as a first step in repurposing the retail footprint to create a new healthcare-retail delivery model. If drug retailers don"t change  this model, we estimate ~10% risk to profits. CVS has also announced free same-day delivery in New York City, proactively preparing for a potential Prime Now entry, in our view.

As a result, the deal “feels more defense than offense,” Ana Gupte, an analyst with Leerink Partners LLC, said recently. In Aetna’s case, “I don’t see a path to growth” in its current configuration, she said.

“One of the problems with the health-care system is it’s so fragmented and there’s so little coordination,” Bessemer Ventures" Steve Kraus told Bloomberg. “A better vertically integrated less-siloed system is a good thing in my mind.”

In this context, Reuters points out that CVS plans to use its low-cost clinics to eventually save more than $1 billion per year on health care costs for Aetna’s roughly 23 million medical members. It adds that a combined insurer and PBM will also likely be better placed to negotiate lower drug prices, and the arrangement could boost sales for CVS’s front-of-store retail business.

It"s not just imminent layoffs however, as the combined company expects to invest billions in the coming years to add clinics and services, largely financed by diverting funds away from other planned investments.

That could eventually cut costs substantially, with the clinics serving as an alternative to more expensive hospital emergency room visits.

 

Meanwhile, deeper collaboration between Aetna’s insurance business and CVS’s PBM division could drive down drug costs by adding clients and boosting the PBM’s leverage with drugmakers.

In recent years, independent PBMs have been criticized for keeping drug prices high amid potential conflicts of interest with insurance company clients, because they could potentially keep cost savings from drug negotiations rather than passing them on to patients.

Alternatively, PBM margins have been pressured and health insurers have sought to cut costs amid steep prescription drug price rises and requirements to care for even the sickest patients under the Affordable Care Act.

* * *

Analysts cited by Reuters said the CVS-Aetna deal could prompt other healthcare sector mega-mergers, as rivals scramble to emulate the strategy.

It could spur a merger between Walgreens Boots Alliance Inc and Humana Inc, or between Humana and Wal-Mart Stores Inc, Ana Gupte, analyst at Leerink Partners, said recently.

On Nov. 30, Express Scripts Holding Co.’s top executive said the company would be open to a deal at the right price, though wasn’t actively looking for one. “We don’t need to sell to be very successful in the future, but we are always open to others who may all of sudden conclude they want what we have,” Express Scripts CEO Tim Wentworth said in an interview. He also mentioned the possibility of partnering with Amazon on a drug distribution arrangement.

The deal, and any subsequent follow through, is not without risk of regulatory intervention: last year Aetna tried to buy rival Humana Inc to gain leverage to control costs, but antitrust regulators killed the deal as well as a proposed merger between Anthem and Cigna. Furthermore it is unclear if the DOJ, which recently sued to block the Time Warner-AT&T deal, won"t issue another antitrust veto. That could happen if the DOJ shifts its attention to vertical mergers:

Although CVS and Aetna’s planned merger does not directly consolidate the health insurance or pharmaceutical industries, the U.S. Department of Justice has been taking a closer look at so-called vertical mergers, where the companies are not direct competitors.

 

Last month, the Justice Department sued to block AT&T Inc’s planned $85.4 billion merger with Time Warner Inc, saying the integration of a content producer with a distributor could reduce consumer choice.

Reuters concedes that "the CVS-Aetna deal could attract similar scrutiny if regulators feared it could block Aetna customers from frequenting other pharmacies or contracting with other PBMs" even as four antitrust experts said there is little doubt the deal will be approved, although it might need to meet conditions to convince antitrust enforcers to sign off.

It is unclear whether it would be evaluated by the U.S. Federal Trade Commission or the Justice Department but that decision might be made based on which agency is less busy, said Matthew Cantor of law firm Constantine Cannon.

 

“(The companies) want the FTC to get it. The reason that the FTC is better at this point is that the Justice Department has just broken with decades of precedent of how to deal with vertical mergers,” said Cantor, referring to the decision to refuse conduct remedies and file a lawsuit to stop AT&T from buying Time Warner.

According to Bloomberg Intelligence"s Jennifer Rie, the CVS-Aetna deal antitrust prospects may depend on which U.S. regulator is tasked with reviewing it.

The Federal Trade Commission has been less critical of consolidation among companies in adjacent businesses, known as vertical consolidation. The Justice Department, on the other hand, last month sued to block the merger of AT&T Inc. and Time Warner Inc., a vertical deal.

 

Michael Newshel, an analyst at Evercore ISI, said the DOJ effort to block the AT&T-Time Warner deal does raises concerns but a CVS-Aetna deal does have a path forward. Aetna would likely need to divest some or all of its Medicare drug plan business, he said.

In addition to regulatory risk, the combination faces substantial challenges, "including the huge operational task of knitting together the companies’ diverse operations so that customer experiences are smooth and seamless. The deal isn’t likely to deliver as many cost-cutting benefits as combinations with more direct overlap, such as Aetna’s scuttled acquisition of Humana, analysts said. CVS will need to keep much of Aetna’s infrastructure since it doesn’t currently provide health insurance."

As noted by the WSJ, as part of the deal CVS plans to repurpose portions of its pharmacies so they become community health centers where customers can go to get answers to more questions about their health and coverage and how to manage the cost of it. The pharmacies will have space dedicated to wellness, and provide services for things like vision, hearing and nutrition.

Is Tax Reform A Done Deal? This Is What Wall Street Thinks

Following the backing of Sen. John McCain on the GOP tax reform bill, markets have surged to new all time highs as tax-sensitive banks lead the way, with Bloomberg reporting that odds for the tax bill"s passage may increase to "near-certainty" if the Senate can finish its version in the days ahead, citing Evercore ISI.  And speaking of banks, the KBW bank index is up over 1.3% to the highest since Oct. 2007, outpacing the S&P 500’s 0.7 percent gain. This is just more of the same: since Trump"s election, banks have outperformed dramatically with the BKX up 40% vs S&P 500 +24%; top performers include SIVB (+86%), BAC (+68%); Citigroup (+52%); JPMorgan (+51%).

So at least according to bank stocks - and the market - tax reform appears to be a done deal. This is confirmed by online betting market PredictIt, where odds for a tax deal by the end of 2017 have jumped to 76%, up from 40% three days ago.

 

But do Wall Street analysts agree? As the following summary from Bloomberg shows, opinions range from Evercore"s 75% odds of a deal getting done by Q1 at the latest, with some such as Horizon Investments suggesting corporate tax rate may have to settle at 22% (especially if Trump "blows a gasket"), to pessimists such as Bloomberg Andrew Silverman stating that "the Senate will have tough time passing first stab at ax-overhaul, contrary to equity markets’ expectations for successful reform, as many have doubts about the bill and margin for failure is 2 votes."

Here is a full run down of some analyst views on the state of tax reform, courtesy of Bloomberg.

EVERCORE ISI (Terry Haines)

• Taxes on track for Senate approval in next few days; keeps 75% odds tax legislation happens by early 1Q at the latest; odds may increase to near-certainty if the Senate can finish its version of the bill by the end of this week or early next week


• Sees govt shutdown as very unlikely, with odds at most 10%


• Says don’t be distracted by posturing this week on both sides of the aisle; no one in Washington wants a shutdown, full-year spending deal that keeps govt spending stable, but with small increases for defense and domestic spending has been in negotiations for weeks

HORIZON INVESTMENTS (Greg Valliere)

• The one wild card that could disrupt tax reform process is "the increasingly erratic" President Trump, whose tweets this week (Access Hollywood, Obama’s birthplace, fight with U.K. PM May) have alarmed even his supporters; raises issue as Trump "could blow a gasket" if tax bill fails to give him what he wants for business, corporate rate may have to settle at about 22%


• Calls Corker trigger "a terrible idea"; asks whether tax hikes would be welcome if there’s a recession in next few years, or geopolitical issue; notes corporations may find it difficult to make long-term plans if their lower taxes are threatened by Corker amendment

COMPASS POINT (Isaac Boltansky)

• Still believes Senate will clear its tax package this week


• Then, House could consider the measure, pass it in early December, or there may be conference cmte that may bleed into 2018


• Sees conference as likelier path; keeps 75% odds of package being enacted regardless of procedural road ahead

COWEN (Chris Krueger)

• Congressional GOP has seemingly made calculation that "passing nothing on taxes is worse than passing something" 


• Notes "dueling" bills are receiving waves of negative news coverage across Trump and Clinton state papers


• Two questions remain: Tax trigger mechanism, how to pay for "new policy candy" to secure 50 votes

BLOOMBERG INTELLIGENCE (Andrew Silverman)

• Senate will have tough time passing first stab at ax-overhaul, contrary to equity markets’ expectations for successful reform, as many have doubts about the bill and margin for failure is 2 votes


• Too many uncertainties remain to predict a quick passage, and senators won’t know what they’re voting on until after "vote-a-rama," when the bill is rapidly amended on the floor


• Sees debate stretching into 2018

Source: Bloomberg

"Hong Kong House Prices Could Soar Another 10% Next Year" - Have They Just Rung The Bell?

Hong Kong property was in Algebris Investments’ top tier of six most inflated bubbles from its longer list of the world’s fourteen biggest bubbles. The territory is ranked as the most expensive housing market in the world for the seventh successive year in 2017, with the medium home price selling for 18.1 times the median household income, according to Forbes. Last week, we discussed how the record price per square foot for a Hong Kong residence was smashed twice on the same day by the same buyer. The buyer paid HK$600 million, or HK$131,000 per square foot for an apartment in the exclusive “The Peak” district. Later that day, the same buyer paid HK$560m for another apartment measuring 4,242 square feet, equivalent to HK$132,000 per square foot. These two purchases beat the previous record of HK$105,000 per square foot paid on 17 September 2017.

In his analysis, Algebris portfolio manager, Alberto Gallo, used a variety of measures to identify irrational behaviour, two of which are “The trend is your friend” and “Sky is the limit”, both which apply to the latest prognostications for Hong Kong property prices from three of its leading real estate agents. According to Bloomberg.

Hong Kong’s red-hot housing market shows no signs of cooling anytime soon. Prices in the city have climbed 11 percent this year, defying skeptics waiting for the bubble to burst and government attempts to rein in the world’s most expensive housing market through a raft of taxes and mortgage curbs.

If anything, the frenzy has intensified in recent months as investors have poured money into property. Buyers have set new records for everything from luxury homes in the exclusive Peak neighborhood to undeveloped residential land. There have also been blockbuster deals for commercial property in the heart of Hong Kong’s central district. “Now it is very hot, because of the hot money rushing in,” said Raymond Ho, deputy senior director of residential development and investment at Savills Plc. “There is more record-breaking coming.”

Runaway growth has put the city in bubble risk territory, according to the UBS Global Real Estate Bubble Index. Even so, mass-market home prices will rise 8 percent to 10 percent next year, according to property consultancy Colliers International Group Inc. Real estate consultant Knight Frank LLP expects prices of such homes to climb 5 percent next year, while luxury housing advances 8 percent.

Helpfully, Bloomberg has conducted a survey of Hong Kong property bulls to discover their reasoning as to why the “Sky is the limit” for prices.

Here are five reasons why property bulls say the city’s housing market will continue to defy expectations of a slowdown:

1. Demand Outstrips Supply
An average 20,000 new private residential units come to market each year, barely enough to cover the 20,000 mainland Chinese who become permanent residents each year -- allowing them to avoid the punitive stamp duties slapped on foreign buyers -- let alone anyone else. The number of unsold apartments in the third quarter fell to the lowest levels since 2015, according to Bloomberg Intelligence.

2. Money’s Easy
Cash-rich developers are pulling out all stops to entice buyers. At its Cullinan West project, Sun Hung Kai Properties Ltd. is offering buyers finance of as much as 120 percent of the purchase price: 90 percent toward buying the new property, and 30 percent to pay down their existing mortgage. More than 95 percent of the 321 units offered over the weekend sold, Sun Hung Kai said. They were priced about 11 percent higher than a March sale at the same development, according to BOCOM International Holdings Co. Other developers offer rebates to buy furniture or interest-only loans for the first three years.

3. ... and Cheap
In a sign that mortgage wars between banks are raging even amid the prospect of rising interest rates, HSBC Holdings Plc is offering to match low rates from rival lenders. Hong Kong’s largest mortgage lender is offering some clients a rate of Hibor plus 1.28 percent if they get similar terms from other banks. That works out to less than 2 percent.

“These rates are highly affordable and will continue to be, even if the U.S. pushes up rates 25 or 50 basis points,” said Marcos Chan, senior director of head of research for Hong Kong, Southern China and Taiwan at CBRE Inc.

 

4. The Bank of Mom and Dad
The biggest obstacle for new home buyers is coming up with the minimum 40 percent down-payment required by Hong Kong Monetary Authority loan-to-value ratios. Step in the Bank of Mom and Dad. Hong Kong’s de-facto central bank has warned young buyers are increasingly turning to their parents, with home purchases being financed partially by proceeds from refinancing mortgages. That also makes it harder for others whose families aren’t asset-rich to get on the property ladder.

The average number of monthly refinancings rose to 3,100 in the first three quarters of this year from 2,200 in 2016, according to HKMA data.

Through August, the value of refinancing was equal to almost 50 percent of primary sales, according to Cusson Leung, head of research for Hong Kong property and conglomerates at JPMorgan Chase & Co. “We have the sense that most of the financing is going into buying property.”

5. Soaring Land Prices
Aggressive bids by mainland developers keen to build up land banks have pushed Hong Kong prices to records. Non-local developers account for 68 percent of all government land purchases this year, according to Colliers.

In February, two mainland companies paid a record HK$22,118 per square foot for a waterfront site. Those costs will ultimately result in higher apartment prices once developments are completed, causing neighboring property owners to raise their own expectations.

“People translate a land sale into the final built price, and when it is way above the market everyone will raise their own prices,” said Denis Ma, head of Hong Kong research at consultancy Jones Lang LaSalle Inc.

We don’t know when the HK property bubble will burst, but the cascading selling we’ve seen in Chinese financial markets – from government bonds to corporate bonds to equities following October’s Party Congress – is hardly reassuring. Furthermore, as was noted above, Hong Kong mortgages tend to be priced off Hong Kong interbank rates and 1-month HKD Hibor has recently spiked to its highest rate since December 2008, in the midst of the last crisis, which hardly augurs well.

 

WTI/RBOB Slide On Surprise Build As US Crude Production Hits New Record High

WTI/RBOB extended yesterday"s IEA-driven losses after a big crude build reported overnight by API, and DOE did nothing to assuage that with a 1.85mm crude build (admittedly smaller than API"s projected 6.5mm, but notably different from the 2.4mm draw expected), Gasoline also surprised with a build and WTI/RBOB extended losses. Additionally US Crude production rose to a new record high.

Bloomberg Intelligence energy analyst Fernando Valle notes:

Weaker demand drove a negative print for crude and product stocks. Strong refinery runs and rising crude exports were not enough to offset rising U.S. crude production. This latest increase, combined with reduced demand for refined products should put a damper on the oil-price recovery.

API

• Crude +6.513mm  (-2.4mm exp) - biggest build in 9 months


• Cushing -1.803mm - biggest draw in 4 months


• Gasoline +2.399mm (-1.5mm exp) - biggest build in 3 months


• Distillates -2.527

DOE

• Crude +1.854mm (-2.4mm exp)


• Cushing -1.504mm


• Gasoline +894k (-1.5mm exp)


• Distillates -799k

DOE data confirmed API"s reported builds in crude and gasoline (and a big drawdown in Cushing stocks)

US Crude production reached a new record high the previous week - not what OPEC hoped for - and last week"s big surge in the rig count suggests this is not about to slowdown as iot rose 25k b/d to a new record high...

 

WTI was hovering right at $55 heading into the DOE data and broiefly broke below on the print. RBOB is notably weaker...

“All of a sudden it seems that positives are in short supply for market bulls,” PVM Oil Associates analyst Stephen Brennock wrote in emailed report. “Yesterday’s slide is being compounded this morning by a fresh dose of price angst” sparked by the API report

Kyle Bass Warns: Xi Has "Built The Chinese Economy On A Foundation Of Sand"

Earlier this week, Chinese leader Xi Jinping became the third ruler in the communist country’s history to have his named enshrined in its constitution – and the first to receive this honor while still alive. But as China celebrates its most popular, and most powerful, leader since at least Deng Xiaoping, Kyle Bass, hedge fund manager and noted China bear, told Bloomberg the Communist Party will one day regret standing idly by as Xi consolidated his power.

“Today Xi is celebrated in media reports, but when future historians look back, he will be blamed for recklessly building the Chinese economy on a foundation of sand,” Bass, founder of Hayman Capital Management, said in an email Wednesday.

“Xi desperately seeks credibility, but true developed economies do not impose severe capital controls or move short-term rates hundreds of basis points overnight in attempts to manipulate their own currency.”

Xi, who launched the twice-a-decade National Party Congress last week with a three-hour speech where he laid out his vision for “communism with Chinese characteristics in a new era,” the philosophy that was enshrined in the country’s constitution by a unanimous vote. In a move that seemingly confirms suspicions that Xi plans to break with precedent and seek a third term after his second ends in 22, Xi appointed five new members to the Politburo,

China’s most powerful body, all of whom are too old to be viewed as credible heirs. Typically, Chinese leaders have pointed to a successor or possible successors by the time they begin their second term, ensuring that there’s a clear path of leadership transition.

Of course, Bass and others have been highly critical of the Communist Party’s heavy handed tactics. For example, the PBOC and the Chinese ‘National Team’, which exert powerful influence over the company’s financial market, have successfully tamped down equity market trading volume and volatility in the runup to the Congress, while guiding the yuan higher against the dollar.

However, China’s closed financial system and manipulated markets aren’t the only target of Bass’s criticism. He also pointed to China’s ever-growing pile of debt. Borrowing has swelled to 260 percent of gross domestic product at the end of 2016, Bloomberg Intelligence data show. Earlier this year, the country’s soaring debt burden inspired Moody’s Investors Service and S&P Global Ratings to downgrade the country’s sovereign credit rating.

In an interview earlier this month, Bass, who has called for a 30% drop in the Chinese yuan, said he expects the government to relax its grasp on the exchange rate after the National Party Congress. He said he believed once Xi consolidates power, he’ll allow natural economic forces to reassert themselves in the country’s banking system.

Since the yuan joined the IMF’s Special Drawing Rights basket a year ago, China has made little progress in making its currency more convertible and accessible. To wit, the yuan remains a secondary currency for settling global payments.

“China remains an emerging backwater when it comes to global currency settlements,” he said Wednesday.

As Bloomberg pointed out, Bass, who made a fortune betting against U.S. subprime mortgages, said in early 2016 that losses in Chinese banks could be four times bigger than those suffered by American lenders during the global financial crisis. He has said that crucial figures, like the share of non-performing loans, have been understated.

“Recklessly growing a banking system in pursuit of global economic growth and respect will cause severe financial instability in the years to come,” he said on Wednesday.

 

“The dangerous $40 trillion credit experiment with Chinese characteristics will run its course.”

As reported earlier this month, Bass has stuck to his pessimistic views on China (though he has moderated his view a bit, pushing back his expected timeline for signs of instability in the country’s debt market to emerge) while other noted bears reversed their positions as the next big yuan devaluation failed to materialize.

While China bears have underestimated the nation’s unique ability to control its market, the sheer pace and volume of credit creation can’t possibly be sustained forever, Bass said.
 

Pay-TV Companies Tank As Subscriber Losses Surge To Record Highs In 2017

As the broader markets casually melt-up to new record highs with each passing day, one small corner of the equity market is in full on meltdown mode: cable and satellite pay-tv providers.  Down anywhere from 3-10% on the week, investors in this space seem to be finally admitting that record subscriber losses, quarter after quarter, just may end up being a bad thing.

As Bloomberg points out this morning, pay-tv subscriber losses are expected to set a new record in 2017, surpassing the 1.7mm homes that "cut the cord" in 2016, as industry analyst Craig Moffet warns "it is becoming increasingly clear that the wheels are falling off..."

Barring a major fourth-quarter comeback, 2017 is on course to be the worst year for conventional pay-TV subscriber losses in history, surpassing last year’s 1.7 million, according to Bloomberg Intelligence. That figure doesn’t include online services like DirecTV Now. Even including those digital plans, the five biggest TV providers are projected to have lost 469,000 customers in the third quarter.

AT&T sank 6.1 percent, the biggest one-day loss since November 2008. Dish, which also provides satellite service, declined 5.1 percent. Viacom dropped 2.5 percent while AMC Networks Inc. fell 6.8 percent after Guggenheim Securities LLC downgraded the two stocks to neutral from buy.

Dallas-based AT&T is pushing headlong into TV programming by acquiring HBO and CNN owner Time Warner Inc. in an $85.4 billion deal. Chief Executive Officer Randall Stephenson has argued that the acquisition will let AT&T create compelling video packages for mobile subscribers and provide valuable targeting information for advertisers.

“It is becoming increasingly clear that the wheels are falling off of satellite TV,” said Craig Moffett, an analyst at MoffettNathanson LLC, in a research note.

AT&T set off the selling panic earlier this week when they announced they would lose 390,000 pay-tv customers in 3Q 2017 alone.  As a reminder, AT&T purchased DirectTV for $48.5 billion just 3 years ago...something tells us shareholders might like a "do-over" on that colossal misallocation of capital.

AT&T, whose ownership of the DirecTV satellite service makes it the biggest U.S. pay-television provider, said late Wednesday it will report a third-quarter loss of 390,000 satellite and cable customers, echoing a similar warning weeks earlier from Comcast Corp. The same night, Viacom cautioned that its distribution deal with Charter Communications Inc., the second-biggest cable U.S. company, may lead to a blackout, potentially testing whether millions of viewers are willing to go without MTV and Nickelodeon.

Shares of both companies retreated Thursday, contributing to a broader selloff in the sector. The S&P 500 Media Index, which includes Comcast and ESPN owner Walt Disney Co., slid 2.3 percent to the lowest level since December.

Meanwhile, the bigger question that remains to be answered is whether cable providers will finally use this customer backlash to push back on content providers who have managed to force ridiculous annual price increases down the throats of American consumers for decades...Citi analyst Jason Bazinet seems to think so...

After decades of steadily increasing bills and ever-bigger packages of channels, the pay-TV ecosystem is in full-blown crisis mode. AT&T, Dish Network Inc. and others are offering cheaper, online-only versions of cable to lure customers back, but that means having to accept thinner profit margins.

“Those salad days of fat bundles, automatic carriage renewals and customary affiliate steps ups are long gone,” Citigroup Inc. analyst Jason Bazinet wrote in a note this week. “Today, every media and cable firm is jockeying for self-preservation. And we suspect the next chapter in this new era means Charter will drop -- or significantly curtail -- distribution of Viacom’s content.”

Of course, some of these content owners are making the decision to drop the cable bundle much easier all on their own...

Bill Blain Asks "What If Trump's Tax Cuts And Reforms Don’t Happen?"

Submitted by Bill Blain of Mint Partners

“Gentlemen, you can’t fight in here. This is the War Room...”

Europe lurches from crisis to crisis - Unscathed", so what is there to worry about? Tax Reform?

A very clever chum told me yesterday to stop stressing so much about Europe, reminding me of the default position: “Europe lurches from crisis to crisis unscathed.“ He’s right. It doesn’t matter how FUBAR Europe looks, what the Spanish King said, what Poland is doing, what Germany isn’t, or whatever France is smoking….. Crisis is the European normal and it’s not a problem. SNAFU is SOP, as they say..

I will stop worrying about Europe and learn to love the contradictory bluster that characterises the Heart of Brussels.

And with stock markets hitting new highs, corporate bond spreads tighter than the proverbial gnat’s crotchet (in some classes tighter than pre-crisis 2006), VIX (despite a tiny rise y’day), still close to all-time lows, and folk blithely talking about increasing investments in Russia, new Middle East bonds, and asking where they can buy Nigerian regional bonds… what can there possibly be to worry about?
Of course there is the UK… the aged legions of Theresa May fans in Manchester are likely to need deliberators to get them excited about whatever cataclysm of clichés she comes out with today to remedy her reputation as the WORST PRIME MINISTER ever – at least until the next one. (There you go, subtly insulted both parties – don’t say I’m not even handed..)

However, my main worries this morning are the same as they always are… where does this market go next, and where are the likely sources of trouble.

My conclusion is America. 

Regular readers will know I’ve been semi-seriously predicting Thursday 12th October as the day the stock market breaks. That date was arrived at after deep fundamental analysis and wiggly lines drawn on centuries of market charts, the fact it’s a Friday 13th the following day, and a not a little Llagavulin (which I was taking for medicinal reasons: since I started drinking it as a kid in Hot Toddies I’ve not had Ebola once).

The flaw in my analysis thus far is identifying a trigger that’s going to push markets over the edge.

Despite the doom and gloomsters like myself predicting the imminent end of the world, markets don’t look to be anticipating a correction. Quite rightly the macro economists point out most economics are now in growth and looking set for expansion. There is a general agreement among central bankers about normalising monetary policies, while governments are all considering positive fiscal steps.. (except in Europe where positive thinking about fiscal spending remains Thought-Crime).

We’ve got the CNN Fear and Greed index at 92 (Extreme Greed) and Larry Fink of Blackrock assuring us “Markets are fine and will be fine this year..” (Seriously.. an eejit like me can confidently predict the end of everything because I don’t really count and my readers know I’m sort of joking, but why would the leader of the largest fund on the planet say something like that? Oh, because he can… and may just have the market buying power to be right..)

But… what has been driving the stock markets higher? On one hand is normalisation – higher rates infer growth and are de-facto bad news for bonds. The financial press is full of stories about how investors are ramping up short positions against US bonds to record levels in anticipation of a rate hike in December, and the expected tax cuts and reform causing the economy to go into overdrive.. That means more money going into stocks.

Meanwhile, it’s the prospect of these US tax-cuts and reforms that are driving stocks. (In fact I read a great piece yesterday about how the proposed repatriation tax will greatly improve the credit of US corporates, thus driving corporate spreads tighter even as rates rise. Strong credits mean strong stocks – perversely it all makes sense..)

But…

What if Trumps tax cuts and reforms don’t happen?

I am assured by macro economists and Washington Watchers the probability Trump will get his reforms and cuts passed is much higher than the market believes. I’m told it’s inconceivable they won’t happen – Democrats know they make sense, and Republicans need success ahead of the mid-terms next year. American politicians would need to be mad to block them.

Therein lies a problem.

Every last person with a functioning economic mind knows they make sense… but, sadly, that doesn’t necessarily include all the denizens of Capitol Hill. US senators from the less well visited parts of the USA tend to think and preach to the electorate that raising the deficit by a cent is a one-way ticket to hell.

Consider White House budget director Mick Mulvaney’s line: “If we simply look at this as being deficit neutral, then you’re never going to get the type of tax reform and tax reductions that you need to sustain 3 percent growth”… He sums up the problem well – already senators and congressmen are finding reasons to say no. It points to difficult negotiations, compromises and loads and loads of pork barrels.

Others observers, including the Vampyre Squid, believe there are too many vested interests at work in the Washington swamp who will refuse to let go existing deductions to make tax-reform work. It’s worth reading through Goldman’s arguments. They are up on Zerohedge: http://www.zerohedge.com/news/2017-10-03/what-could-possibly-go-wrong-tax-reform-answer-goldman-finds-plenty

If we see more folk taking the view Tax Reform and Cuts are likely to prove yet another non-Triumph for Trump, then the current positive sentiment could take a walloping.

That said, I remain convinced, it will be a correction rather than a crash.. So buying boots ready.

Its nearly 30-years since the Great Storm and Great Crash of 1987 – I remember it well. I was a journalist with Euroweek at the time, and I think I first used the phrase: “It’s a dead-cat bounce.. drop a dead cat out a window and it bounces, but not a lot.” How wrong I was.. stock markets do correct, and typically they rally again when the underlying macro behind them remains strong!

Meanwhile, very interesting comment from Bloomberg Intelligence looking at the ECB’s broad employment rate” which is now up on BBerg. They reckons it shows plenty of slack still in the European economy (hence the lack of trad Philips curve inflation). When yoof unemployment remains as elevated as it is across the Med nations, then maybe things in Europe aren’t as good as we think… (Oops, sorry, said I wasn’t going to do Yoorp again..)

China Is Building An Army Of Robot Workers

As wages for Chinese workers’ skyrocket, the country’s manufacturers are scrambling to replace humans with machines, in many cases to preserve thin profit margins that have been choked by debt service.

But according to a report from Bloomberg Intelligence, China’s embrace of automation – its companies are installing machines faster than in any other country – could have unintended consequences for the global economy, as the robots force wages to sink, inequality to balloon, and consumption to collapse.

To be sure, the blistering pace of AI adoption hasn’t dented Chinese wages – at least not yet.  

“Pay gains are intact. Domestic manufacturing workers with a high-school education saw wages rise 53 percent from 2010 to 2014, according to China Household Finance Survey data cited by BI.”

But as one economist explained, the increasing reliance on automation could thwart the Communist Party’s plan to transition to a service-focused economy.   

“By turbocharging supply and depressing demand, automation risks exacerbating China’s reliance on export-driven growth – threatening hopes for a more balanced domestic and global economy,” BI economists Tom Orlik and Fielding Chen wrote.”

However, China’s leaders have embraced a different view. Beijing believes that if it can automate sectors like car manufacturing, electronics, appliances. Logistics and food, its citizens will focus on better service-sector jobs, while also compensating for an anticipated shrinking of the workforce. The Communist Party’s Made In China 2025 plan and a separate five-year plan governing the expansion of its robot workforce were launched last year.

“Robots are at the core of the government’s sweeping Made in China 2025 plan to upgrade factories to be highly automated and technologically-advanced. Replacing assembly-line workers will also help it to offset a shrinking working-age population.”

As part of its plan, China is also hoping to produce more of its own robots, crowding out the foreign firms that presently dominate that market.

“The government also wants to increase the share of Chinese-branded robots in the country’s $11 billion market to more than 50 percent of total sales volume by 2020 from 31 percent last year, and aims to produce 100,000 robots a year by 2020, compared with 33,000 in 2015. That means competition will intensify for foreign firms that supply 67 percent of China’s robots, such as Japan’s Fanuc Corp. and Yaskawa Electric Corp., according to BI.”

While China is quickly catching up to South Korea and other global robotics leaders, the overall population density of robots in China remains below the world average.

In a viral video published back in April, the People’s Daily provided a glimpse into the rapidly approaching future of China"s labor force: The video, also released by the SCMP, shows hundreds of round Hikvision robots, each roughly the size of a seat cushion, swiveling across the floor of the large warehouse in Hangzhou. A worker is seen feeding each robot with a package before the machines carry the parcels away to different areas around the sorting center.

The robots sort more than 200,000 packages a day.

And as engineers continue to make progress building robots that are better suited toward working alongside humans, the robots’ numbers will probably continue to skyrocket.

While the impact on wages has been mild for now, it likely won’t stay that way forever.
 

WTI Algos Uncertain After Gasoline Inventories Draw But Crude Production Surges

WTI crude prices managed to scramble back up to pre-API-tumble levels ahead of DOE"s data dump this morning with all eyes on gasoline inventories, which did not disappoint showing a small draw (in line with expectations) along with crude"s draw which was roughly in line with API and expectations. Production continues to rise to highest since July 2015.

API

• Crude -3.595mm (-3.5mm exp)


• Cushing -462k (+300k exp)


• Gasoline +1.402mm (-1mm exp)


• Distillates +2.048mm

DOE

• Crude -3.33mm (-3.5mm exp)


• Cushing -503k (+300k exp)


• Gasoline -1.22mm (-1.25mm exp)


• Distillates +28k

Builds in products (gasoline and distillates) according to API is weighing on markets (and a big shift from last week"s massive crude draw), but DOE data showed a draw for gasoline (in line with expectations) and a draw for crude (in line with expectations)

Total Crude Oil Inventories dropped to the lowest since Jan 2016... But as is very clear, remains dramatically over-stocked relative to pre-2015 norms...

One crucial data point that Bloomberg"s Javier Blas notes: total U.S. oil stocks (which includes crude, refined products and the volatile "other oils" category) were unchanged last week. That"s not what the bulls need.

Amid all the bluster, we found it ironic that Crude imports from Venezuela climbed 52 percent to 987,000 barrels a day, also the most since April.

U.S. Fuel Demand Fell 0.72% in Past Four Weeks

Despite stabilization in rig counts, US crude production continues to trend higher, jumping to its highest since July 2015 last week...

A weak dollar and some BTFDing in stocks managed to scramble WTI up to the pre-API levels ahead of the DOE data... (NOTE: futures puked a little right before the print). After the data, the machines were confused but the trend for now is higher as $48 stops are run...

But its mostly noise as the algos cant decide which way to trend for now.

Bloomberg Intelligence energy analyst Vince Piazza sums up the mixed picture:

The crude stockpile drop was basically in line with mean estimates.

The net draw across the petroleum value chain is a modest positive.

However, a drop in refinery utilization foretells ebbing of demand, as driving season comes to an end.

The bearish view is reinforced by output above 9.5 million barrels a day and pushing higher, based on management commentary from 2Q earnings calls.

WTI/RBOB Slide After Oil Production Surge Offsets Biggest Crude Draw Since Sept

Following last night"s mixed mesage from API (crude draw, gasoline build), WTI prices have gone nowhere as all eyes focus on DOE data this morning. Confirming API"s trend, crude saw its biggest draw since Sept 2016 but Gasoline, Distillates, and Cushing (most since March) saw builds which upset the machines and sent prices lower. Crude production rose once again to its highest since July 2015.

API

• Crude -9.2mm (-3.38mm exp) - biggest draw since Sept 2016


• Cushing +1.7mm (+700k exp) - biggest build since March


• Gasoline +301k (-450k exp) - second weekly build in a row


• Distillates -2.1mm (-250k exp)

DOE

• Crude -8.945mm (-3.38mm exp) - biggest draw since Sept 2016


• Cushing +678k (+700k exp) - biggest build since March


• Gasoline +22k (-450k exp)


• Distillates +702k (-250k exp)

Last week"s surprise build in gasoline (confirmed by API) and big draw in crude (also confirmed by API overnight) remains the big focus and DOE data confirmed it with the biggest crude draw since Sept 2016 but builds in products and at Cushing...

While the builds in produst were modest, they were nevertheless a surprise shift in trend from draws to builds...

Imports from Saudi Arabia jumped 47 percent to 813,000 barrels a day, but remain well under the 1-million barrel figure exceeded through much of the first two quarters of this year.

As Bloomberg"s David Marino notes, the total stockpile draw of 7.32 million barrels brings inventories to the lowest since January 2016, but still more than 200 million barrels above November 2014, when the glut really started building up. A lot of work still to do, as OPEC well knows.

Some more details, courtesy of Reuters: total commercial stocks fell -8.9 million bbl to 466 million bbl in the week to Aug 11 (much faster than normal at this time of year).

Total stocks are now -25 million bbl below 2016 level but... +134 million bbl over 10-yr average.

Stocks are now down -13 million bbl since start of year compared with +40 million rise in 2016 and 10-yr avg of +25 million, as the rebalancing appears to be taking shape.

Meanwhile, refinery throughput unchanged last week"s record 17.6 million b/d.

One number which the market was closely watching were gasoline stocks, which disappointed the bulls by rising fractionally by 22kb, and basically unchanged at 231 million bbl, despite an expectation of a 1mm decline.

As a result, gasoline stocks are now 2.3mm bbl below similar levels last year, but are 19 mm bbls above the 10 year average.

Finally, while domestic production increased again, so did imports, which accelerated by +364,000 b/d to 8.1 million b/d in the week to Aug 11

While rig count growth has stabilized, crude production continues to rise in the Lower 48 (though had dropped in Alaska for 3 straight weeks) but both saw a rise this week (total production up 79k) as Lower 48 production hit its highest since July 2015...

Bloomberg notes that U.S. oil production from major shale plays is set to hit another record at 6.15 million barrels a day next month, according to the EIA. It"s not just the Permian that"s growing, as the agency sees higher output across the board.

WTI Crude prices barely budged from last night"s API print heading into the DOE data, spiked higher on the crude draw but slipped back lower on product builds and production surge...

Heading into the print, "the size of a potential draw in crude inventories is “going to be the most material” aspect of the report, Brad Hunnewell, senior equity analyst at Rockefeller & Co., says, adding that "investors also expect to see a rise in gasoline demand."

However, as Bloomberg Intelligence energy analyst Vince Piazza notes:

No change to our bearish view: long road to recovery still ahead. We still see mid $50-$60s as the threshold for acceleration of U.S output. Commentary from exploration and production company conference calls implies drilling efficiencies are aiding productivity.

Elevated refining utilization has helped deplete bloated inventories across the petroleum value chain during the key seasonal driving period, and exports have helped as well. However, the market is seeing the end to summer, with runs traditionally declining in early fall.

Is The Fed Poised To Ignite A Violent Dollar Rally?

As ther world waits with bated breath for Janet Yellen"s statement this afternoon - whiche is uniformly expected to be a nothing-burger, some are wondering if the recent flip-floppery by Yellen, Draghi (and even Kuroda with his "actual" tapering while lowering inflation expectations) does not leave today open to another modst shift back in The Fed"s "hawkishness". As Bloomberg"s macro strategist warns, this sets the market up for a surprise and as he warns: "Dollar risks are starting to seem skewed all one way: toward an immediate rally."

There’s extremely bearish positioning, that’s failed to adapt to changing circumstances, into event risk that’s structured to surprise in the opposite direction. That’s an explosive mix.

When something seems so obvious, your immediate instinct should be to ask, "what’s the catch?" My problem is that this time, I just can’t see one.

The dollar is poised like a coiled spring against so many other currencies. Some of them have started to retrace on their own -- AUD, JPY and KRW as some examples -- but the FOMC can trigger all the rest at once today.

Investors have suddenly become inordinately focused on disappointing inflation data from the U.S. Inflation prospects have looked subdued for months so it seems completely irrational to expect the FOMC to use a meeting with no press conference to now significantly alter their guidance.

The committee is attempting to normalize policy as a strong labor market and roaring financial assets give it a window to act, not because of runaway inflation.

Exceptionally easy financial conditions show policy makers still have room.

It’s completely fair to argue that they may start fearing deflation again at some point. But this isn’t the meeting that they’ll choose to radically shift the official stance.

And that stance is still that 2017 will see both the beginning of balance sheet reduction as well as another rate hike. Again, that won’t change today.

If anything, the risk is that they give an exact start date for balance sheet tapering and it’s sooner than the market expects. Bloomberg Intelligence notes that an operational advantage of announcing a timeframe this week is that it would allow the Treasury to lay out its intended response in the quarterly refunding statement due Aug. 2.

The market is complacently short dollars as we enter the height of summer illiquidity. That’s despite yields jumping higher on Tuesday, with U.S. terms-of-trade that have been improving all year, and with other major central banks -- the ECB, BOJ and RBA -- emphasizing their dovish credentials.

A dollar rally can be short but violent. The conditions and the catalyst are both primed and ready.

Does Cudmore have high conviction? His answer is clear..

Yes. For a reason.

What’s the alternative? The FOMC sounds slightly more dovish? So what. The market’s already very short dollars. It won’t be inclined to add aggressively to that going into August.

As I wrote on Monday, politics are a red herring and financial assets rarely move in a straight line. Beware the dollar jack-in-the-box.

He may be right - given the extreme "short" dollar positioning (dovish) and what is now a record short speculative position in 2Y Treasury Futures (hawkish)...

The market hopes that Yellen doesn"t misstep.