Bubble Watch: US Margin Debt Now Equal the Economy of Taiwan

When Central Banks attempted to corner the sovereign bond market via ZIRP and QE, they forced ALL risk in the financial system to adjust lower.

Remember, in a fiat-based monetary system such as the one used by the world today, sovereign bonds NOT gold are the ultimate backstop for the financial system.

And for the US, which controls the reserve currency of the world, sovereign bonds, also called Treasuries, represent the “risk-free” rate of return for the entire world.

So when the Fed moved to corner this market, forcing the yields on these bonds to drop to all-time lows, it was effectively forcing ALL risk in the US financial system to adjust to an abnormal risk-profile.

Put simply, the Fed created a bubble in bonds, which in turn fueled a bubble in everything.

Yes, everything… corporate bonds, municipal bonds, stocks, even consumer credit. Indeed, nine years into this insanity things have reach such egregious levels of excess that even tertiary debt instruments such as margin debt have reached levels greater than ever before.

What is margin debt?

Margin debt is money that stock investors borrow in order to buy stocks. It is direct leverage. And it just hit a new record… or $561 billion.

To put this number into perspective, it is:

• Equal to the entire economy of Asian powerhouse Taiwan.

• Nearly greater than the amount of margin debt borrowed at the peak of the last bubble in 2007 50%.

• DOUBLE the amount of margin debt borrowed at the peak of the Tech Bubble.

Now, no one in their right mind would argue that late 2000 or late 2007 were periods of fiscal restraint.

Well, today investors are borrowing hundreds of billions or dollars MORE to invest in the stock market than they were at those times.

As I explained in my bestseller, The Everything Bubble: the Endgame For Central Bank Policy, the bubble in bonds is what finances this entire mess.

By creating a bubble in bonds, the US Federal Reserve has created a bubble in EVERYTHING because borrowing costs are at absurdly low levels.

This is why I coined the term The Everything Bubble in 2014. It’s also why I wrote a book on this issue as well as what’s coming down the pike: because when this bubble bursts (as all bubbles do) the policies Central Banks employ will make those from 2008-2015 look like a cakewalk.

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

 

 

 

"Daggers Are Falling From The Sky" - China Stocks, Bonds Tumble After National Congress Ends

Who could have seen this coming?

After weeks of "calm" - demanded by The People"s Party - and well-managed "National Team" ramps top "prove" how much Xi"s plan for the nesxt five years is being received, the end of China"s National Congress has been met with... a plunge in stock and bond markets.

 

 

This is the biggest drop in the Chinese market in 11 weeks...

But it"s not just stocks. The Chinese bond market is getting slammed...

China 10Y yield is up 6 days in a row (the biggest surge in rates since May) to their highest since Oct 2014...

With the Chinese yield curve now inverted for 10 straight days - the longest period of inversion ever...

As Bloomberg reports, the situation that’s existed for most of 2017 - sovereign yields rising, and corporate debt remaining relatively resilient - is at risk of cracking. As appetite for bonds of any kind dwindles and authorities roll out measures that target higher-risk investments, company securities are in the line of fire.

Now that the Communist Party Congress is over, China’s bond holders may be about to get hit by “daggers falling from the sky," said Huachuang Securities Co., referring to aggressive deleveraging policies.

 

“It’s very likely we will see a significant increase in corporate yields in the coming year," said David Qu, a market economist at Australia & New Zealand Banking Group Ltd. in Shanghai.

 

"The trigger could be tougher regulations or a default. A majority of non-bank financial institutions’ debt holdings are corporate bonds, so their selloff can lead to severe consequences. Banks are underestimating authorities’ intentions to tighten regulations.”

 

“The deleveraging campaign hasn’t even gone half way, and the risk of banks redeeming entrusted funds could surface at the end of this year," said Qin Han, chief bond analyst at Guotai Junan Securities Co. in Shanghai.

 

"The chance of a selloff in corporate bonds is increasing, which will result in a widening of their yield premium over sovereign notes."

But this is far from over, as we noted earlier, the end of China"s National Congres is also ushering in the end of "coordinated global growth"...

As Citi writes, "China’s Party Congress has concluded and Xi Jinping’s position as President has been consolidated. Given there are no standing committee members in their 50s, it suggests there are no apparent heirs for Mr. Xi, opening the door for him to stay on beyond 2022. One of the key questions in the run up to the congress was that once power was consolidated, would China accelerate its economic reforms. We think this is unlikely but do expect a moderation of growth, with data momentum perhaps set to continue to slow at its current pace. Note how China’s MCI tends to lead Citi’s macro data index for China and our MCI is still tightening."

It gets worse.

As Capital Economics writes in its China Activity Monitor note this week, the firm"s China Activity Proxy (CAP) suggests that growth in China slowed last month to the weakest pace in a year and with property sales cooling and officials continuing their efforts to rein in financial risks, Cap Econ thinks that looking ahead "the economy will slow further over the coming quarters."

CapEco"s ominous conclusion:

Looking ahead, we think growth will continue to slow over the coming quarters. The current props to growth appear shaky. With investment contracting in real terms, industrial output will probably soften over the months ahead. Property sales also look set to weaken further as the government’s purchase curbs continue to expand. This will weigh on construction before long. More generally, with tighter monetary conditions weighing on credit growth, activity looks set to weaken further.

That the past 18 months of coordinated global growth will end in China, is quite symmetric: back in January 2016, as global markets were tumbling, aborting the Fed"s plans to hike rates 4 times in 2016 and resulting in sharp economic slowdowns around the globe, it was the (still mysterious) Shanghai Accord that "saved" the world, and unleashed a burst of unprecedented, and coordinated, growth... which only cost China some $8 trillion in debt.

It will only make sense that another major Chinese event will mark the top of this economic mini cycle, and lead to the next global downturn, not to mention spike in market volatility.

Illinois' Kamikaze Bondholders Cheer Massive New $6 Billion Bond Deal: "It Has Turnaround Potential"

Just two days ago we wrote about how, despite a budget deal signed back in July that called for a massive tax hike, Illinois" unpaid payables balance had ballooned to a new all-time record high of $16,046,145,423.20 according the comptroller"s office (see: Illinois Unpaid Vendor Backlog Hits A New Record At Over $16 Billion). 

...which was a 3-fold increase over the past two years.

Given that, you can imagine our surprise to wake up to the latest Illinois Bloomberg headline this morning declaring that all is well in the Prairie State and that bondholders are cheering the upcoming, massive $6 billion new GO bond deal by driving existing bonds to all-time highs.

As Illinois prepares for what may be its biggest debt sale in over a decade, its largest investors are celebrating a rally that’s transformed the state’s bonds from one of this year’s worst performers to one of the best.

Since the state in July resolved a two-year budget impasse that pushed its rating to the brink of junk, debt issued by Illinois and its local governments has vaulted to a 7 percent return this year, more than any other state, according to S&P Municipal Bond Indices. Until June 8, they were the worst performer among the five most-indebted states, which include Texas, California, Florida and New York.

The reversal came after lawmakers enacted a budget -- and raised taxes -- over Governor Bruce Rauner’s objections. They also extended Illinois authority to reduce a record pile of leftover bills by selling as much as $6 billion of bonds. It would be the state’s biggest sale since 2003 if done in a single offering.

Even more surprising was some of the praise offered up by asset managers on a state that, for all practical purposes, appears to be on a inevitable crash course with bankruptcy...this takes "talking your book" to a whole new level.

Nuveen Investments:  “It has turnaround potential,” said John Miller, co-head of fixed-income at Nuveen, which bought more Illinois bonds in late June and July as the budget came together. The firm plans to take a “hard look” at the $6 billion borrowing, calling it a “benchmark-type deal” because it may be one of the largest of the year, according to Miller, who cautioned that the state’s rising pension-fund debts are still posing risks

AllianceBernstein:  “They’ve stopped the bleeding,” said Guy Davidson, director of municipal investments at AllianceBernstein. He said the firm is interested in buying more Illinois debt. “It’s not like we think they have solved their problems. We just think they’ve stabilized their problems.” Davidson said investors are “getting paid more than we think the risk entails”

Wells Fargo Asset Management:  “They’re not under the gun as much as far as ratings go,” saidDennis Derby, a portfolio manager at Wells, which holds $40 billion of municipal debt. The firm would be “more comfortable” if the state took action soon to reduce the $16 billion of unpaid bills

BlackRock:  The tax hike gives the state “more tools” to meet their expenses and obligations, marking an improvement, said Joe Gankiewicz, a credit-research analyst in Princeton, New Jersey, for the company, which oversees about $124 billion of municipal debt. The state’s unfunded retirement liabilities -- $130 billion, according to the Commission on Government Forecasting and Accountability -- remain an issue. “The pension expense is likely to outstrip the organic revenue growth in the state in the coming years,” Gankiewicz said

Perhaps these bondholders overlooked the fact that Illinois" 5 largest publicly-funded pensions are now $130BN underwater and only 37.6% funded?

Ironically, bondholders cheered tax hikes as the savior of Illinois" financial problems but repeated income tax hikes, property tax hikes and the state’s political dysfunction have resulted in record population losses over the last three years...

...to put it into perspective, Illinois loses 1 resident every 4.6 minutes.

Last time we checked, non-residents weren"t on the hook to pay Illinois taxes...

Muni-Bond Market To Trump: "Your Tax Cuts Are Dead"

Authored by Lance Roberts via RealInvestmentAdvice.com,

Since the election, much of the reasoning behind the surge higher in asset prices has been the expected tax cut/reform from the Trump administration which, as the theory goes, would lead to a surge in economic growth, higher inflation, and subsequently higher bond yields.

Unfortunately, given the lack of progress on the ACA replacement/repeal, the harsh pushback and criticism of Trump’s proposed budget, and the ongoing investigations and inner turmoil of the Trump Administration, the likelihood of tax cuts is becoming a much more distant reality. As such, the municipal bond market (and the Treasury market) have begun to aggressively discount the probability of significant tax reform any time soon.

Furthermore, the whole “reflation” trade also seems to come down to a similar agreement about the possibility of the Trump Administration to achieve any of its policy goals.

As shown below, the Dollar/Interest Rate trend is clearly negative.

As RBC macro strategist Mark Orsley wrote Friday:

“I am finding it increasingly difficult to see a near-term catalyst for UST’s to sell off.  In fact, almost all indicators I watch are flashing a warning that a breakdown in yields (longer end) is increasingly probable.” 

I have long been discussing that a move to 2% or below is quite likely (see here) but as Orsley points out:

“Technicals -> two head and shoulder formations point to lower yields. Target of 2.05% on the Feb/March formation, and if 2.17% gives way, the H&S from April/May targets 1.95%. Notice the MACD starting to trend lower…”

He is correct. A breakdown in yields will likely come with the realization that current earnings projections are far too optimistic to support current market valuations which will likely be coupled with concerns of a recessionary onset from further Fed rate hikes.  Any rallies in rates back to 2.4% should likely be used to add additional exposure to bonds for a trade in the weeks ahead.

As Orsley concludes:

“It may seem like a no-brainer to short at these levels into a Fed hike (at least this time the market isn’t going in at the yield highs), but all the above indicators should serve as a warning to bond bears. Despite cleaner short positioning, the pain trade still remains lower yields.“

I agree.