Financial Strategist: Trade War Could Usher In Dire Financial Crisis MUCH SOONER

According to a Societe Generale strategist Albert Edwards, a trade war would bring about a financial crisis a lot sooner than anyone expected. Edwards has warned in the past that currency devaluation could spark an economic recession worse than 2008, and now he’s sounding the alarm about Donald Trump’s trade policies.

Edwards now points to the Trump administration’s trade policy as yet another catalyst that could hasten the next crisis. Recent tariffs the US imposed on steel and aluminum imports threaten a full-scale trade war, he claimed.  While tariffs and taxes always get passed onto the American consumer in the form of higher costs for goods, it is unfortunate that the tariff talk is ongoing.

The US could also turn on other trading partners as Trump continues to advance his “America First” agenda, reported the Financial Tribune. “Boiling away in the background is Germany’s, and now also the eurozone’s, outsized trade surpluses” with the US, Edwards said. He added, “Expect Trump to soon turn his protectionist fire on both Germany and the EU. That will be messy.”But there is some good news many in the mainstream media continue to ignore:

While much of what Trump is announcing today has already been leaked, here are the details of the import tariffs Donald Trump formally adopted on steel and aluminium imports which allow US allies to negotiate and apply for exemptions, a sign of the growing concern that the president was alienating America’s closest international partners, and that 2 of the 4 largest foreign suppliers of steel will be exempt. –Zerohedge

“A trade war and competitive currency devaluation was always going to be the end game in our Ice Age thesis as a global deflationary bust destroyed wealth, profits, and jobs,” Edwards said in a note on Thursday. “But it looks as if it might be arriving sooner than we had anticipated.”

China exports just 1.1% of its steel to the United States, therefore, the tariffs are considered unlikely to do any serious damage to Chinese businesses. The more immediate fuel for a trade war, Edwards said, is retaliatory action against China by the US for alleged intellectual property theft. The Nikkei Asian Review reported Wednesday that the US was set to impose tariffs on $60 billion worth of Chinese products as punishment. Yet remember, a tariff isn’t going to punish the Chinese; it will punish the American consumer as prices go up to cover the cost of the new tax.

A White House official says there will be no significant downstream price effects, and thus no significant downstream job effects, according to Zerohedge. But that expectation counters multiple statements and prognostications from several companies and industry groups that use steel and aluminum, as well as lawmakers representing them, who have warned the tariffs will harm their businesses or industries.

ECB Trapped: Steinhoff Liquidity Collapses As Lenders Pull Credit Lines

When yesterday we discussed the latest troubles facing embattled retailer Steinhoff, whose bonds are owned by none other than the ECB, we said that while the company"s bonds mature in 2025, its bankruptcy is at most months away. In retrospect, and in light of the latest news, that may have been optimistic, because it now appears that a bankruptcy may be imminent and is at most just weeks away. According to Bloomberg, Steinhoff - which is facing an accounting scandal that led to the recent departure of its CEO and destroyed most of the company"s value - said lenders are starting to cut off support.

The reason why Steinhoff is suddenly facing not only a solvency but liquidity crisis is that the company which owns Conforama in France, Mattress Firm in the U.S. and Poundland in the U.K. isn’t yet able to assess the magnitude of financial irregularities disclosed two weeks ago, it said in a presentation to lenders in London on Tuesday (presentation below). The South African company also said it didn’t know when it would be able to publish audited results for 2017 and 2016, nor whether additional years will need to be restated.

Furthermore, Steinhoff also revealed that it didn’t have “detailed visibility” of the cash flows of individual operating companies. The units rely on the company for working capital and “the forecast position for each operating company is evolving daily,” it said. PricewaterhouseCoopers has been hired to investigate the accounts, while AlixPartners LLP is working on an analysis of the cash flow.

In short, the company is flying blind with no budgeting and no corporate overnight.

The presentation also said that the company is still grappling with the task of getting to the bottom of the crisis, which has led to the resignations of CEO Markus Jooste and billionaire Chairman Christo Wiese. As Bloomberg adds, Steinhoff said earlier Tuesday that Chief Operating Officer Danie van der Merwe, 59, had been made interim CEO to helm the recovery attempt, while Conforama boss Alexandre Nodale will serve as his deputy in a new four-member management board.

Needless to say, the last thing secured creditors want, is not knowing the "revised" value of the collateral that secures their loans, especially in the case of a rollup which "suddenly" turned out to also be fraud. Hence: everyone is rushing to get out the back door. Predictably, Steinhoff"s shares - already decimated - resumed their plunge, and ended their recent dead cat bounce by slumping more than 205% in Frankfurt to the lowest since Dec. 8 before paring losses to trade 12 percent lower.

Finally, Steinhoff revealed that it had outstanding debt of 10.7 billion euros ($12.7 billion) as of Dec. 14, the slide below revealed. Almost 4.8 billion euros of that was in Steinhoff Europe AG, an operation based in Austria. About 690 million euros in notional facilities have been rolled over to date, according to the presentation.

As a reminder, the ECB is a creditor to Steinhoff Europe AG Austria.

Which brings us to the question he brought up yesterday: will, or rather when now that Steinhoff"s bankruptcy now appears imminent, will the ECB sell its Steinhoff bond holdings? As we showed yesterday, Mario Draghi appears to be getting ready to do just that. As BofA pointed out, Draghi seems to be taking a more defensive stance with regards to owning Fallen Angel bonds like Steinhoff"s.

Note that the CSPP Q&A has been updated as of 29th November 2017, and the paragraph on ECB selling now reads as follows:

Q1.5 Will the Eurosystem sell its holdings of bonds if they lose eligibility?

The Eurosystem may choose to, but is not required to sell its holdings in the event of a loss of eligibility, e.g. in case of a downgrade below the credit quality rating requirement.

Previously this phrasing was far more specific, with forced selling (or otherwise) not even presented as an option:

Q8 Will the Eurosystem sell its holdings of bonds if they lose eligibility? For example, if they are downgraded and lose investment grade status?

The Eurosystem is not required to sell its holdings in the event of a downgrade below the credit quality rating requirement for eligibility.

Of course, once the ECB breaks the seal and it become public knowledge that the world"s biggest hedge fund not only buys - as everyone had known - but also sells when it has to, all hell could break loose for those IG bonds on its books which are about to be downgraded to junk by one or more rating agencies, leading to the perilous scenario we described yesterday, in which "fallen angels" become very painful "falling knives."

Until then, we will just keep an eye on Mario Draghi for the answer how long he can continue to burn taxpayer money by holding insolvent bonds and pretending that nothing has changed...

* * *

Steinhoff"s full presentation to (evaporating) investors is below (link)

Gundlach Reveals His Favorite Trade For 2018

One day after Stanley Druckenmiller confessional to CNBC that as a result of central planning and markets that make no sense, the legendary hedge fund manager had a "terrible" year, and his "first down year in currencies ever" (he also said many not very nice things about bitcoin), it was Jeffrey Gundlach"s turn to confess some of his more controversial views. And so, the man who two years ago correctly predicted the Trump presidency, first discussed his best investment idea for the new year. To those who listened to his latest DoubleLine investor presentation last week, the answer will hardly be a surprise: namely commodities, because they"re "historically, exactly where you want it to be a buy."

"I think investors should add commodities to their portfolios," Gundlach says on CNBC"s Halftime Report.

Gundlach said commodities are just as cheap relative to stocks as they were at historical turning points, while the macroeconomic backdrop also supports the case for commodities; he was referring to the following chart which he highlighted last week.

Echoing his presentation from last week, Gundlach said that once "you go into these massive cycles... the repetition is almost eerie. And so if you look at that chart the value in commodities is, historically, exactly where you want it to be a buy."

Investors should add commodities to their portfolios. There is a really remarkable relationship between a market cap or the total return of the s&p 500 and the total return something like the Goldman Sachs commodities index. The cyclicality is really repettiive.

Gundlach also noted that commodities are just as cheap relative to stocks as they were at turning points in previous cycles that began in the 1970s and 1990s. The S&P Goldman Sachs Commodity Index is up 5% this year, versus the S&P 500"s 19% gain.

There is also a fundamental case for investing in commodities, Gundlach said. He pointed out that global economic activity is increasing, a tax cut could boost growth and the European Central Bank is implementing "absurd" stimulus policies in the euro zone.

Jeffrey Gundlach: Investors should add commodities to their portfolios from CNBC.

In addition to his favorite trade, Gundlach touched upon several other topics including:

What drives the dollar:

"Short-term fed moves are not what drives the dollar. It correlates much more to what the bond market thinks vis-à-vis the fed say 18 months forward. So if you actually rook at the bond market pricing for 2019 now, there’s a pretty big discrepancy between the bond market and the fed, so that’s going to be really interesting in driving the dollar, and this time i think the bond market is going to be right."

Why the markets are so calm:

"I think it’s because of central bank pegging of rates and quantitative easing going on full bore in  europe and in japan. One of the charts that i love to reference is the nearly linear rise in central bank balance sheet holdings ever since 2011, where the Fed stopped quantitative easing back three years ago, and japan and the ecb just took over the slack, and it’s just a linear rise."

 

Jeffrey Gundlach: This has been a great year for investors from CNBC.

On ECB president Mario Draghi:

"That’s going to slow things down a little bit, but the real worry from the central bank activity would be forward about a year. Because Mr. Draghi has said astonishingly that they’re going to continue 30 billion euros per month of quantitative easing at least until September and then he threw  in, just to put a cherry on top of the cake of stimulus, he said, and negative rates well past the end of quantitative easing. Which means – sounds to me you’ll have negative rates as long has Mr. Draghi is around which is a little under two years."

On tax cuts and bonds:

"If there is a net tax cut, it has to be bond unfriendly. we already have growing bond supply. we’ve been liiving in a world for the last three years thanks to quantitative easing of negative net bond supply, really, from sovereign bonds in the developing world. and that’s gonna flip because the fed is now letting bonds roll off, the budget deficit is increasing, a tax cut would increase the deficit further, and to the extent that a tax cut might be stimulative to the economy, that’s bond unfriendly, because bonds don’t like economic growth and also it’s more bonds, expanding the deficit, so even more supply."

On tax hikes and risk:

"If i"m correct and i’m going to receive a seven-point bump in my tax rate, which is actually about a 15% tax increase, i have a feeling that i’m probably going to be less able and willing to buy risky assets or buy all the other things that are bubbling up these days, and maybe that side of the narrative will start showing up."

Jeffrey Gundlach: Tax plan could have unintended consequences from CNBC.

On stimulating the economy:

"While we’re not probably going to get 3% real for the year, we’ve had it for two quarters in a row. and gdp now at the atlanta fed has been bouncing around but it’s around 3% for the third quarter. when is the last time we had something like 3% growth for three quarters in a row? it’s a long time. why would you be stimulating the economy?"

Finally on bitcoin:

Is it "Late 2007" For the Everything Bubble?

Timing the end of a major bubble is extraordinarily difficult as it entails figuring out when a critical mass of investors shift from greed to fear.

Having said that, we’ve recently seen a number of developments that would suggest we’re near the end of the current Bond Bubble.

Back in June the world saw the unveiling of perhaps the single most insane investment of all time: the 100-year bond.

To make matters more insane, the countries that were issuing these bonds (Argentina and Austria) both have experienced numerous sovereign dent crises in the last 100 years.

More recently, Austria almost went bust in 2015. And Argentina only just resolved issues with debt-holders from its 2001 default last year (2016).

Of course, 100-year bonds are not entirely new: Belgium and Ireland issued 100-year bonds last year (2016).

However, both of these issues were via private placements (meaning the bonds were sold at set prices to a select group of investors).

By way of contrast, both Argentina and Austria issued their 100-year bonds on the open market to anyone and everyone. Even more insane, both debt issues experienced tremendous investor demand!

Argentina sold $2.75 billion of a hotly demanded 100-year bond in U.S. dollars on Monday, just over a year after emerging from its latest default, according to the government.

The South American country received $9.75 billion in orders for the bond, as investors eyed a yield of 7.9 percent in an otherwise low yielding fixed income market where pension funds need to lock in long-term returns.

Source: Reuters

Austria has sold €3.5bn of 100-year debt in the largest century bond to hit the markets to date, the latest indication of hot investor demand for very long-dated debt. Bids from potential investors reached €11.4bn, dealmakers said.

Source: Financial Times

Let’s put this in very simple terms… two countries, both of which struggled with sovereign debt issues in the last four years, saw investors place between $3 and $4 in bids for every $1 in new debt issuance… on 100-year bonds.

This is beyond insanity. It is the textbook definition of a bubble. And it indicates we are nearing the end of the line for this current bubble.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Eric Peters: "Today"s Central Bank Vol Suppression Will End In Spectacular Fashion"

After his provocative admission published earlier that he now checks "Breitbart daily and InfoWars too... You can no longer understand America unless you do", One River"s CIO Eric Peters published the following anecdote revealing an earlier moment of his life, when as a currency trader, he learned a valuable lesson following the spectacular blow up of Europe"s Exchange Rate Mechanism, or ERM, and why the lesson from some 25 years ago, leads Peters to conclude that "Today’s central bank volatility suppression regime resembles it, and will end in spectacular fashion".

Anecdote:

 

“Let’s step into my office,” he said. So I did. He was my boss. “The firm’s most important client needs help.” I listened, uninterested, unconcerned about clients, their problems. Barely cared about my boss. I had a game to play, solo sport, and loved it to the exclusion of all else.

 

“They need to do a very large trade.” A twenty-six-year-old proprietary trader’s mind is rather primitive. Which is good and bad. Being young and dumb allows you to see things elders can’t. And take risks one rarely should. In 1992, I’d done both. “They need to buy three hundred million Mark/Lira.”

 

Europeans established a mechanism to lock their exchange rates into narrow ranges to reduce market volatility and promote economic convergence. In theory it worked, in practice it didn’t. Politicians named it the ERM.

 

“What would you like to do?” he asked, calm. I stood there, processing. Such a sum was extraordinary even before the ERM blew up, which it just had. For months, I’d bought options in anticipation of its demise. Honestly, it was obvious.

 

The ERM encouraged speculators to build massive leveraged carry positions, discouraged corporations from hedging exchange rate risk, suppressing volatility and interest rate spreads everywhere. The process was reflexive.

 

Today’s central bank volatility suppression regime resembles it, and will end in spectacular fashion. All such things do.

 

“I want to buy more!” I answered. My foreign-exchange options left me long the exact amount our client needed to buy. No other bank would sell them such a large sum. So naturally, I wanted more.

 

“You should sell them your whole position,” he told me, firm. I couldn’t understand, it made no sense. “Big customer orders like this usually mark the highs - never forget it,” he said. I left his office angry, irate, sold my whole position. And he was right.

Breslow: "The Answer To This Question Will Drive Just About Everything"

Having passed the first hurdle this morning (PCE did not drop further), The Fed"s December hike is now locked and loaded, but, as former fund manager Richard Breslow notes, at the end of the day, the real elephant in the room is if, when and how fast the big central banks shift toward policy normalization. Everything else is derivative. Get this one right and quibbling over some sector rotation or the relative prospects of the Australian versus New Zealand dollars pale in comparison.  

The answer to this question will drive just about every other market.

Via Bloomberg,

It’s an interesting issue to contemplate as we wind down a year when sovereign yields, with the exception of China, have been moribund, at best.

All eyes have correctly been on the yield curves but it could very well be that the focus needs to change.

And if it does, it could happen quickly because, unlike previous episodes it’s likely to be a generalized phenomenon rather than country specific. It’s hard to discount one central bank’s normalizing steps should it come to pass that everyone is looking to join in.

We know that the Fed wants to get official rates up. Nothing in the latest communications should have disabused anyone of that notion, even as the market continues to discount the trajectory. Pooh-poohing the trajectory is only a viable course of action if the ECB and BOJ continue to soften the FOMC’s actions.

But what happens if traders begin to realize that these central banks are far less dovish and scared than their official communiques suggest? I’ve got news for you, their speeches don’t line up with the post-meeting press conferences. Especially as they introduce alternative theories on the externalities of negative rates. And they’ll have a pretty good case to argue that they warned us.

We talk a lot about trades for the new year. The risk reward of taking a bearish view on rates is tempting from a technical point of view quite aside from the fundamental fact that global growth rates keep being revised up. And let’s face it, the consensus love-fest with emerging markets is predicated on a long global-growth outlook.

Ten-year U.S. Treasury yields are pathetically low, having failed to even sustain above 2.4%, let alone take a run at 3%. That’s the glass half-empty scenario.

On the flip-side, from a purely technical standpoint, resistance at 2.3% looks unquestionably impressive.

It seems almost laughable to talk about Bund and JGB yield upside but the charts argue that 30 and zero basis points, respectively, look like much more formidable lines in the sand than comparable support.

And since we all love a good conspiracy story, check out today’s Eonia fixing which jumped 6 basis points. (implying rate-hikes)

 

 

Aberration? Probably. Canary? Unlikely. But how cool would that be? All we do know is it was verified by the EMMI and we need to wait for further data.

 

But one thing we do know is the fixing was followed by some heavy volume block selling of the December Euribor contract (rate-hike bets).

 

 

An inexpensive trade, to be sure, but someone big wants to see what’s up.

The U.S. isn’t the only place where unemployment continues to improve and, at some point, fixed-income prices just might try to match up better with the economic story we are buying into for the new year.

DB"s "2018 Credit Outlook" - Killer Charts Point To Bearish Not Benign Conclusion

DB’s Jim Reid has released his “2018 Credit Outlook”. In our first pass on this 60-pager earlier, we noted that Reid characterised 2017 as the most “boring year ever”, since it will go down as one of, if not the least, volatile year for the majority of asset classes.

Heading into 2018, Reid characterises risk assets as a tightrope walker who’s successfully negotiated a hire wire since the 2008 crisis. However, the confidence of our risk asset funambulist was always fortified by the knowledge that there was a huge safety net direct beneath him in the shape of the central bank put. In Reid’s own words.

The best analogy for our view on 2018 is that risk assets are like a highly skilled but still relatively inexperienced tightrope walker. Our tightrope walker started his career immediately after the GFC and earned his apprenticeship in very difficult conditions with lots of crosswinds but with the knowledge that a huge safety net existed beneath him. This allowed him to walk across the narrow line with slow but ever-increasing confidence, skill and aplomb. In our analogy the safety net is the central bank put that has continued to help financial markets’ confidence over the last several years in spite of very challenging conditions.

As the tightrope walker steps from December 2017 into January 2018, he’s going to notice a disconcerting change in his safety net.

However in 2018 our tightrope walker will have to move onto the next phase of his career where the structural support of the safety net will likely be slowly weakened. Every time he looks down he’ll figuratively see a central banker loosen or take away a supporting rope. As such his skills and confidence are likely to be tested more than in recent years.

Reid is specifically referring to the growth in the size of the big four DM central bank balance sheets, i.e. the Federal Reserve, ECB, Bank of Japan and the Bank of England. At the end of 2017, the combined size of the big four’s balance sheets is estimated to reach about $14.9 trillion, an increase of about $1.8 trillion on the end of 2016. That’s about to change radically, as he notes.

Assuming fairly neutral and consensus assumptions, central bank balance sheet growth will fall sharply over the next 12-24 months from the near peak levels currently seen.

The chart below shows that on a rolling twelve-month basis, growth will fall sharply, beginning in 2Q 2018. By the end of 2018, DM estimates that the rolling twelve-month growth will have declined about 75% from its 2017 level to about $450 billion. By August 2019, growth will have declined to zero according to DB’s estimate.

As the report notes, this “represents a changing of the guard for ultra-easy policy”. The problem for Reid’s tightrope walker is that he’s come so far, there’s no turning back, even if he knows the risk of a catastrophe is only going to increase for the best part of the next two years. From Reid’s perspective, the threshold in terms of higher risk will be crossed as we move from Q2 2018 in the second half of next year.

So barring an external shock the ECB will be relatively dormant until late in Q2 when speculation will start to mount about what comes next after the current QE extension to the end of September 2018. DB’s expectation is for a quick and full taper in Q4 and the first policy rate hike in June 2019. As such, as we approach the June meeting - which will probably be the earliest that any announcement will occur - more hawkish speculation will likely start to mount about the future of the program. Indeed by the time we get to H2 2018 we’ll potentially be seeing a very different global QE picture to that we’ve been used to in the recent past. By then the Fed will be well into its gradual, but slowly increasing run down of its balance sheet.

As the report notes, the slowdown in QE purchases in 2017 will likely coincide with significantly different conditions to the most recent example in 2014-15.

While markets went through similar balance sheet wind downs through 2014 and into 2015 - driven predominantly by the Fed and ECB - not only was the stock of global QE lower with less central banks conducting such operations, we also had a situation where the tapering was consistent with a reduction in government issuance.

Fast forward to 2018 and a reduction of purchases across the globe could be occurring at a time when there is a move to increase government spending even if this isn’t yet showing up in the forecasts. The US tax plans haven’t been finalized as we go to print but an unfunded tax cut is our base case which will add to the deficit and eventually to treasury issuance. In the UK the budget - seen just before we went to print - included some loosening of the fiscal purse, as the current administration deal with Brexit risks and a population tired of austerity. Even in Germany, the recent election uncertainty and eventual coalition could include some fiscal stimulus.

So we think the tide is turning away from ultra-loose monetary and relatively tight fiscal even if the official fiscal forecasts from most commentators are yet to include much in the way of easing across the globe.

Reid backs up his forecasts with charts for the three key central banks, firstly the Federal Reserve and the Bank of Japan. The chart for the Fed shows that its purchases of Treasuries have never exceeded net supply. In contrast, the BoJ has exceeded net supply during the last four or so years of Abenomics, although the ratio has stabilised at around three times.

Turning to the ECB, the change in ECB purchases versus net issuance will be dramatic as 2018 unfolds.

 

Reid argues that.

Interestingly, if we look at the Fed, BoJ and ECB Government bond purchases versus net supply of domestic Government bonds we can see how the ECB’s removal of QE could be very different to that of the Fed relative to when it started tapering. In addition the supply/demand dynamic for European Government bonds has recently been even more extreme than in Japan…as ECB purchases have recently been seven times net issuance at their recent peak.

So in other words we’ve seen the huge PSPP volume far outstrip the relatively negligible net issuance in the Euro area. While the Fed program was clearly huge in absolute terms, relative to supply it was much more modest. It also declined along with Treasury issuance meaning that yields could be sheltered from the tapering impact.

In Europe we could see government bond QE go from seven times net issuance in Q3 2017 to more in line with it by the end of 2018. As the realisation mounts that ECB QE withdrawal is much more significant in relative terms to that seen in the US in 2014 then fixed income markets could become more vulnerable which may in turn create more volatility and more difficult conditions for credit spreads.
Which…unless we are missing something…sounds very bearish for European credit.

Nonetheless, when it comes to the DB team’s central case for credit spreads in 2018, they are relatively benign. Indeed, DB expects a tightening in Q1 2018, followed by a modest widening from Q2 2018 to the end of the year.

As the report notes, team member “Craig” is more bearish than his colleagues and his views seems more in keeping with the general thrust of the report.

Combining the net purchases versus net issuance data for the Fed, ECB and BoJ, Reid notes.

When we combine these three central bank purchases with net issuance historically in Figure 18 we can see just how supportive the technicals have been for government bonds. This is seemingly peaking out at the end of 2017 and with our forecasts for central bank purchases and a continuation of the 2013-2017 reduction in Government bond net issuance we expect this now to reverse. For choice we think fiscal spending will start to pick up which means these net issuance estimates are probably too aggressive on the downside.

Once again, the correct conclusion would seem to be bearish, although DB seems reluctant to go there. We are even more perplexed when DB cites the risk that inflation will surprise on the upside.

Meanwhile we think the risks to inflation are on the upside…will likely mean that crosswinds pick up as we move through Q2 and into H2 – a period where US inflation might start to more consistently beat on the upside (or at least not consistently miss on the downside) and markets start to think about a June ECB meeting where the end of Euro QE is possibly announced.

Returning to his metaphor of the tightrope walker, DB notes the probability of him remaining on his wire will deteriorate as the year progresses.

If we’re correct on inflation it’s going to be difficult for central bankers to justify anything other than the slow and steady removal of the safety net beneath our intrepid tightrope walker. As such his task will get more difficult purely because his confidence must surely weaken with more risks associated with any fall. As such he’s likely to wobble more. So expect volatility to finally start to increase after surprising many by staying as low for as long as it has done. At this stage the tightrope walker may have enough skill to safely navigate across to the next point (end 2018), however the probabilities of such a successful outcome are likely to be getting lower as the year progresses.

Perhaps Reid has been dissuaded from taking a more bearish stance by the ultra-low environment for volatility which he noted had made 2017 so boring. Indeed, he notes the close correlation between major asset volatility levels and credit spreads.

As we noted in our first pass on DB’s “2018 Credit Outlook”

Reid joins countless other strategists opining on the lack of vol in the past year, asking "why has volatility been so low and can it continue?" His answer is that the most likely reason for volatility being so low is a combination of:

• Synchronised and firm global growth;


• Inflation that has consistently been in the ‘Goldilocks’ range and not accelerating as much as expected in 2017, and;


• Global central bank liquidity which in 2017 has still been close to peak levels.

What Reid neglected to mention is that volatility has itself become a tradeable input – making it reflexive in nature - and one which has been shorted to insane levels, both implicitly and explicitly.

The rapid elimination of the central bank security net coupled with rising inflation are transforming the risk profile for Reid’s tightrope walker, as he acknowledges, and one where the chances of a sustained spike in volatility must be commensurately higher. We know from his writings that Reid is a big Liverpool (soccer) fan, as are we. It’s been a frustrating season so far. So often, the build-up play has been excellent while putting the ball in the back of the net has been elusive. We felt like this about DB"s otherwise impressive report.

Which Europeans Carry The Most Cash?

How much cash do you have in your wallet right now?

Historically, it has been found that the amount of cash people carry is a key indicator of their use of cash. According to research from the European Central Bank, people in the eurozone carried an average of €65 in their wallets in 2016.

You will find more statistics at Statista

As Statista"s Niall McCarthy notes, on a country by country basis, Germans tended to carry the most cash on average, €103.

People in Luxembourg had an average of €102 in their wallets while Austrians had €89.

People in France and Portugal had the least on average with €32 and €29 respectively.

US PMIs Tumble To 4-Month Lows, Signal Just 2% GDP Growth

After reassuringly positive Eurozone PMIs, US Manufacturing and Services disapointed with the composite PMI slumping to 5-month lows in November.

• Flash U.S. Composite Output Index at 54.6 (55.2 in October). 4-month low.

• Flash U.S. Services Business Activity Index at 54.7 (55.3 in October). 4-month low.


• Flash U.S. Manufacturing PMI at 53.8 (54.6 in October). 2-month low.


• Flash U.S. Manufacturing Output Index at 54.3 (54.6 in October). 2-month low.

Commenting on the flash PMI data, Chris Williamson, Chief Business Economist at IHS Markit said:

“US businesses reported another month of solid growth in November, putting the economy on course for a reasonable, though by no means stellar, fourth quarter.

 

Current PMI readings are broadly consistent with GDP growing at an annualised rate of just over 2%.

 

 

“There was also good news on hiring, with a slight uptick in employment growth meaning the surveys are indicating non-farm payroll growth of just over 200,000 in November.

 

“Both input costs and selling price inflation picked up, suggesting the upturn is feeding though to higher price pressures, though some of the manufacturing price hikes were attributable to the short-term effects of the hurricane-related supply chain disruptions.

 

“An upturn in new order inflows means we can expect a strong end to the year, though prospects for 2018 remain more mixed. Although expectations about the year ahead slipped lower in the service sector, future optimism hit a two-year high in manufacturing, suggesting the goods-producing sector may start to make a stronger contribution to the economy in coming months.”

Get Out Now: SocGen Predicts Market Crash, Bear Market For The S&P

While the charade of sellside analysts releasing optimistic, and in the case of Barclays and Goldman "rationally exuberant"previews of the year ahead...

... is a familiar, long-running tradition on Wall Street, rarely has the intellectual dishonesty and cognitive dissonance been quite so glaring: take Goldman, which while admitting that valuations have never been higher, and the upside case never more reliant on just one piece of legislation which has a significant chance of not passing (GOP tax reform for those unaware), Goldman still has to temerity to predict not only no bear market in the next three years, but goes so far as to suggest an "irrationally exuberant" target of 5,300 in three years.

And as of this morning, the penguins are on full parade, with virtually not a single big bank predicting the market will drop in the coming year. Here are the latest S&P price targets, EPS forecasts and implied PE multiples, for the year ahead:

• Bank of Montreal, Brian Belski, 2,950, EPS $145.00, P/E 20.3x


• UBS, Keith Parker, 2,900, EPS $141.00, P/E  20.6x


• Canaccord, Tony Dwyer, 2,800, EPS $140.00, P/E 20.0x


• Credit Suisse, Jonathan Golub, 2,875, EPS $139.00, P/E 20.7x


• Deutsche Bank, Binky Chadha, 2,850, EPS $140.00, P/E 20.4x


• Goldman Sachs, David Kostin, 2,850, EPS $150.00, P/E 19x


• Citigroup, Tobias Levkovich, 2,675, EPS $141.00, P/E 19.0x


• HSBC, Ben Laidler, 2,650, EPS $142.00, P/E 18.7x

Good luck with all those 20x P/Es in a world in which rates are rising and central bank balance sheets will start contracting in one year.

Luckily, there is the occasional honest bank, like Macquarie (whose Viktor Shvets has become one of our favorite commentators for his objective, no nonsence analysis) and - as of this morning - SocGen, whose strategist Roland Kaloyan has written a note which warns that with bond yields rising (see the crash in China overnight, where the Shanghai Composite tumbled the most in 17 months on the realization that rising rates is bad for stocks), there is effectively no upside left in stocks, which coupled with the prospect of a US economy recession in 2020 will "crimp returns in 2019" Furthermore, in light of the record vol shorts, SocGen jumps on the VIX-squeeze crash bandwaon, warning vol positioning could "strongly deteriorate the risk reward profile of equity markets."

In not so many words: with little stock upside left, with the threat of rising interest rates slamming P/E multiples, with the economy in deep in late cycle, with equities trading at record valuations, with everyone short vol and just begging for a vol short squeeze, SocGen"s advice is simple: get out now.

Here is SocGen:

We are less enthusiastic about equities heading into 2018 – We do not see much upside on our major equity targets for the next 12 months. We expect stretched valuations and rising bond  yields to limit equity index performances in 2018 and the prospect of a US economic slowdown in 2020 to further cramp returns in 2019. We also raise some concerns about the quantity of shorts on volatility, which could potentially strongly deteriorate the risk reward profile of equity markets.

Specifically, with regards to the S&P, SocGen reports that US equities are now at - or rather about 100 points above - their fair value:

The S&P 500 has reached our target for the end of this cycle (2,500pts) and is now entering expensive territory. Indeed, on all the metrics, US equities are trading at levels only seen during the late-90s bubble. Since Trump’s election, the US equity market has risen 24%, but only half of this came from earnings growth. The other half has been driven by P/E expansion. According to our calculations, the US equity market is already pricing in potential tax reform. The rise in bond yields and Fed repricing should be headwinds against further US equity rerating.

If that wasn"t enough, SocGen also notes that its valuation model suggests "that upside on the S&P 500 is limited: the US equity market is already pricing in a rebound in growth and inflation. The rise in bond yields and Fed repricing should be a headwind against further US equity rerating."

In practical terms, this means that SocGen is predicting that the S&P, which is already 100 points above the bank"s year end target of 2,500, will tumble to 2,000, or more than 20%, before rebounding modestly to 2,200 just as the US economy succumbs to a recession, at which point all bets are off. And not just the S&P, but virtually all major European bourses are due for a bear market in the coming 12 months.

Here are some of the key arguments behind SocGen"s bearish outlook, first a familiar discussion of the risk posted by the biggest vol short ever observed.

Equity volatility, both realised and implied, has been edging ever lower for quite some time now. Being invested in a simple systematic short VIX future volatility has been strongly rewarding: +290% over the last two years. However, when the tide turns (i.e. VIX spikes), the drawdown can be significant. The quantity of short positioning on VIX open in the market (see right chart) would potentially amplify any spike of the VIX.

The risk of a VIX surge ties into the question of how the market"s risk/return profile will be shaped in the coming year based on what the prevalent VIX level is:

The risk /reward ratio as measured by the Sharpe ratio has been very attractive for US equities: good expected return supported by reasonable valuation and EPS growth, a very low Fed fund rate and an ultra-low volatility regime. At the current 12-month forward P/E, we factor in our Fed Fund scenario (2.25% by end-2018) and a different volatility regime. A change of VIX regime from 10% to 15% would push the US equity Sharpe ratio back to its historical average.

Then there is the already record stretched valuations, something even Goldman admitted earlier this week, with "US equities trading above their long-term average and at a level only seen during the dotcom bubble."

US equities have not been in attractive territory valuation-wise for a while. Indeed, on all the main valuation metrics, US equities are trading above their long-term average and at a level only seen during the dotcom bubble. However, expected earnings growth for the next 12 months (12%) is below the 20y annual earnings growth average (14%).

The last risk is that bond yields are going higher, forcing a contraction to PE multiples, as investors shift away from equities into bonds, as the dividend yield on US stocks at 2.0%, is now lower than the 10Y yield  of 2.3%.

Under our scenario, US Treasures will reach 2.70% at the end of 2018. This should be a headwind for equity markets. Indeed, our US equity risk premium is at 2.9%, one standard deviation below the long-term average . Any increase in bond yields would push the equity market further into expensive territory relative to bonds The dividend yield offered by US equities (2.0%) is already lower than the current US longterm bond yield (2.3%).

Finally, SocGen points out something that few other analysts  have admitted: half the S&P rally since the Trump election has been on the back of multiple expansion, with just 48% the result of earnings growth. Furthermore, as SocGen calculates, assuming tax reform passes, a decrease in the US tax from 35% to 20% as planned by Trump’s tax reform would theoretically boost earnings by 8.5%. The 12-month forward P/E has risen 12% over the last 12 months. In other words, contrary to conventional wisdom, more than 100% of Trump"s tax reform is already priced in.

Since Trump’s election, the S&P 500 has risen 24%. Only half of this performance has been driven by earnings growth; the other half is from P/E expansion. Assuming that analysts have not factored tax reform into their earnings forecasts, tax reform expectations have been the driver of P/E expansion. The S&P 500 index tax rate is currently 26.6%. Assuming that US companies generate 43% of their profits abroad (here) and pay 35% of their US profits on taxes (i.e. with no loopholes for US profits), the average tax rate outside the US would be 15.5%. A decrease in the US tax from 35% to 20% as planned by Trump’s tax reform would thus theoretically boost earnings by 8.5%. The 12-month forward P/E has risen 12% over the last 12 months.

Separately, turning to Europe, Socgen acknowledges the euro zone"s economic recovery is in full swing but - in yet another bearish thesis - argues that the current valuations don"t leave "much meat on the bone" and that the expected rise in the Euro could also weigh on exporters in particular, and European stocks in general. Additionally, with the European Central Bank set to progressively unwind its stimulus package, investors are increasingly wary of the amount of debt some companies have accumulated thanks to historically low interest rates.

Cable group Altice, whose shares have collapsed more than 50% in the last 30 days due to concerns on its €50 billion euros pile of debt, and whose debt plunge has been seen by some as the catalyst for the recent junk bond swoon, is an example of what is likely to come, Societe Generale said.

And while the French bank saw pockets of growth in Germany, France and in sectors such as financials, but warned that political risks are still present, notably in Spain with the Catalonia crisis and Italy which faces general elections in 2018. Oh, and the UK too: "We also recommend staying away from the UK as Brexit negotiations are accelerating and several scenarios are possible: only a soft Brexit would be supportive for the FTSE 100.

And yet, after all that, not even Socgen is willing to bite the bullet, and warn that ahead of what clearly is "a bear market is coming" call, investors should dump risk: so ingrained is the desire to run with the penguin herd, that even the most contrarian calls are doused in such a big layer of caveats, Arnold could easily driver his hummer on top of.

To wit: "But then again, should we be outright bears? After all, we do see some value pockets in the market and some specific themes (M&A, consumer in the eurozone)."

Which almost explains the report"s cover page...

BofA"s Apocalyptic Forecast: Stocks Flash Crash, Bond Bubble Bursts In H1 2018, War May Follow

Having predicted back in July that the "most dangerous moment for markets will come in 3 or 4 months", i.e., now, BofA"s Michael Hartnett was - in retrospect - wrong (unless of course the S&P plunges in the next few days). However, having stuck to his underlying logic - which was as sound then as it is now - Hartnett has not given up on his "bad cop" forecast (not to be mistaken with the S&P target to be unveiled shortly by BofA"s equity team and which will probably be around 2,800), and in a note released overnight, the Chief Investment Strategist not only once again dares to time his market peak forecast, which he now thinks will take place in the first half of 2018, but goes so far as to predict that there will be a flash crash "a la 1987/1994/1998" in just a few months.

Contrasting his preview of 2018 with the almost concluded 2017, Hartnett sets the sour mood with his very first words, stating that he believes "2018 risk asset catalysts are much less bullish than in 2017" for the simple reason that the bearish positioning going into 2017 has been completely flipped: "positioning now long, not short; profit expectations high, not low; policy close to max stimulus; peak positioning, peak profits, peak policy stimulus means peak asset returns in 2018."  He also goes on to point out that the historical omens are poor:

• Bull market in S&P500 would become the longest ever on August 22, 2018 (and the second biggest ever at 2863 on S&P500).


• Equities have only outperformed bonds for seven consecutive years on three occasions in the past 220 years (the last time was 1928 - Chart 1).

Having read Hartnett for many years, we can sense an almost tangible undertone of anger and frustration at central banks for making his bearish forecasts for 2 years in a row go up in a puff of smoke. Which probably explains why one of BofA"s best strategists has decided to double down, and raise the stakes beyond a simple market crash, and to a flash crash, if only for dramatic impact.

But before we get there, here is Hartnett"s explanation why the market will peak in the first half of 2018:

The Big H1 Top

We forecast a H1 top in risk assets as the last vestiges of QE, the passage of US tax reform and robust early year EPS revisions incite full investor capitulation into risk assets. Potential targets are SPX 2863, CCMP 8000, with US government bond yields moving >2.75%.

 

We start 2018 with a pro-risk asset allocation of equities>bonds, EAFE>US, gold>oil, bullish US dollar.

 

We believe the air in risk assets is getting thinner and thinner, but the Big Top in price is still ahead of us. We will downgrade risk aggressively once we see excess positioning, profits and policy.

 

Peak positioning would be signaled by…

• BofAML Bull & Bear Indicator exceeds “sell signal” of 8 (Chart 2);


• Active mutual equity funds start to see inflows;


• BofAML GWIM equity allocation exceeds 63%, an all-time high (currently 61%).

How to know if/when peak profits arrived?

US ISM dips below 55: needs to end 2018 >55 to beat consensus global EPS estimate of 10.5% (Chart 3); Inverted yield curve, which in seven out of seven occasions in the last 50 years has been the prelude to recession.

 

 

More to the point, how to know that peak central bank policy has arrived?

• Q2 peak in G4 central bank liquidity of $15.3tn: net central bank buying of financial assets drops from $1.5tn in 2016 and $2.0tn in 2017 to nearly zero in 2018;


• US tax reform passed, after which investors must discount tighter, not earlier economic policies.

Which brings us to Bank of America"s "big long" trade: volatility, and the stark prediction that in just a few months, a 1987-type flash crash which will wipe out trillions in market cap, is imminent.

The Big Long: volatility

 

Second, we believe that peak positioning, profits, and policy in 2018 will engender peak asset price returns and trough volatility. In 2017, stock market volatility fell to 50-year lows, bond volatility fell to 30-year lows, ETFs accounted for 70% of daily average global equity volume, the AUM of quant hedge funds is now $432bn (up $271bn since 2009).

 

A flash crash (à la ’87/’94/’98) in H1 2018 seems quite likely, in our view, as the major sedative of volatility, the central banks, start to withdraw liquidity.

According to Hartnett, the right way to to trade the upcoming flash cash and the "Big Long is throguh a combination of  long 2yr/short 10yr Treasuries, long TIPS steepener vs flattener in OATei, long SPX put ratio calendar, long Russian equities.

As an added "bonus", in addition to a "big long", the BofA strategist also has a "big short" trade, which perhaps not surprisingly, is in credit.

The Big Short: credit

 

Third, we believe that higher inflation, higher corporate debt levels, higher bond volatility and the end of the QE era will be most damaging for corporate bonds.

 

The big 3 consensus assumptions are: Goldilocks, no Fear of Fed/ECB, and no Mean Reversion. The game-changer is wage inflation, which on our forecasts is likely to become more visible. Wage inflation would shatter consensus via higher credit spreads. 3½% US wage growth, 2½% US CPI, and 2% Eurozone CPI are all inflation levels likely to increase volatility and credit spreads.

For those looking to trade in advance of the bursting of the credit bubble, BofA"s advice: go long CDX HY & iTraxx XOVER.

* * *

Finally, if that wasn"t bad enough, in addition to the combined bursting of the short-vol and long credit bubbles, BofA has one final prophecy: "the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside." Here"s why:

The Big Risk: tech bubble

 

Finally, we believe the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside. The era of excess liquidity, bond yields fall, and the Nasdaq goes exponential. 2018 calls for the big top, big volatility long, big credit short, all once again prove to be way too early. An “Icarus unleashed” bubble nonetheless could end in 2019 with a bear market on hostile Fed hiking, Occupy Silicon Valley and War on Inequality politics.

Translation: the Fed - having created the record wealth, income and class divide that resulted in Brexit, Trump and a wave of nationalism across Europe - is unable to stop, and unleashes civil, and perhaps world war as its final act.

How to hedge against "the biggest risk of all"? Hartnett has two words of advice: buy gold.