#dowjones

MSM relishes trade of economic depression via pandemic over Trump as POTUS w/ no virus

Trump Derangement Syndrome (TDS) knows no bounds. Yes, the mainstream media (MSM) is celebrating the milestone that the Dow is below the level when Donald Trump was inaugurated.

We have always said that if Trump continued to boast about market gains he would have to wear it on the downside too. Alas, he is being hoisted by his own petard.

Sadly, as much as CNN and others relish the though of Trump out of office, we sincerely doubt the vast majority of Americans would trade a pandemic with catastrophic unemployment over business as usual before the WuFlu with a Trump at the helm.

Markets are forward looking. They anticipate where corporate earnings are likely to be. This market rout has little to do with Trump’s policies in isolation.

We’ve said repeatedly that global central banks have created a debt bomb through reckless monetary policies over the last two decades. They have proved just how little impact cutting rates to zero or throwing $850bn in handouts has on markets. They’re out of ammunition. Confidence is shot. We’re in uncharted territory.

Boeing is the perfect canary in the coal mine. The 737MAX debacle which is imminently due to be on sale again to a market that has effectively vanished. Airlines are cutting routes and it will be up to the zombie lending cycles of aircraft leasing companies to renegotiate rates so they can keep the patient alive. Airlines will push out deliveries.

However before Boeing’s core business troubles, the management embarked on short term incentive chasing buybacks to the tune of $43bn since 2013. The company is trading negative equity and has drawn down ALL of its credit lines ($13.8bn) and now wants a handout.

All of this is the product of two decades of mindless expediency. Governments are just as culpable for allowing greed to override common sense. No lessons have been learnt since 2000 and especially 2008. Blue chips like Boeing and GE are now heading to record lows because of it. Ford Motor is rated junk. How long before Boeing and GE fall foul of the same problem?

We are particularly interested in the next set of results from Parker Hannifin. It is like the global industrial hardware store. All of the major manufacturers use Parker for parts – pumps, hydraulics, pneumatics, valves, hoses etc. When we see Parker’s upcoming report on order flows we can gauge how bad it is at the manufacturing coal face.

This time we are staring at a “global depression” and it would be nice to think the MSM would try to put some context around the ramifications of this virus and the raft of economy killing policies governments around the world are introducing instead of just blaming Trump. Yes, he’s been his normal self during this but is he responsible for the actions of other countries going into shutdowns? Seriously? Do the US Coronavirus stats stack up poorly vs countries like Italy on a relative or absolute basis? No. Moreover COVID-19 cases in the US are a mere fraction of H1N1 swine flu cases which the media made nowhere near the level of hysteria as now. It’s a disgrace how far the media will go for clickbait.

Had the world’s central banks behaved sensibly to stop excessive debt and allowed markets to function freely, this pandemic would have had far less effect than it is now because we would have had the ammunition to fight this war of attrition. Now all our governments and regulators are doing is moving phantom armies across maps trying to stop economic Armageddon.

“Simplicity of ETFs” doesn’t always equate to more safety vs “Complexity of CDOs”

Remember how we were told how CDOs and synthetic CDOs were so mathematically complex that only a mythical hermit in the Himalayas could decode them?

Thank god we saw an explosion “as it says on the tin” exchange-traded-funds (ETFs) thrust upon us. So simple. Pick a basket of stocks, indices or commodities and one could get access to a whole range of products under that banner. One might feel that the S&P500 will go up so will look to buy a leveraged product of 2x or 3x to maximise returns. Even better the ETFs were far cheaper fees wise too.

Unfortunately, to hedge the risk of doubling exposure requires liquidity in the derivatives market. When markets panic and start sinking, the ability to keep the product true to its promises becomes quantum leaps harder. The explosion in the spreads on derivatives pricing (delta bleed) of the hedged products puts more downward pressure on the market.

Looking to ETF activity in the market, for the first week of March they comprised 34% of total activity up from 24% in February.

This is why ETF volatility on the downside is so much worse. By its design, an ETF ‘replicates’ the cash index it tracks. If the S&P500 falls by 2%, the S&P500 ETF product is designed to copy it. So it is always lagging, not leading.

Therefore if the market is having a coronavirus based sell-off, what might have been a 4% decline (big but not diabolical) turns into a 7% correction, especially when the leveraged products chime in. They might be small at 2% of the traded ETF market but the additional pressure starts to compound in the non-leveraged product too.

Because the media is so conditioned to compare apples with oranges with these recent declines to those we saw in 1987, 2000 or 2008, periods where relatively tiny levels of ETFs drove volatility, the cash market equity investors can get spooked by the optics of the sell-off which is merely the ETFs/levered ETFs playing catch up. So it can trigger more selling which exacerbates panic under, some might say, false pretences. It starts a chain reaction.

If you wish to learn more about the dynamics of ETF sell-offs please refer to the link here. The CEO of Blackrock, the world’s largest ETF provider infamously said,

leveraged ETFs have the potential to “blow up the whole industry one day.

We are starting to see the evidence emerge. The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility.

It is back toward 2008 highs. The spikes are effectively marking the “delta bleed”. This is why we need to keep an eye on the levels of activity in the ETF market potentially accelerating the extent of the market gyrations. Don’t be fooled into thinking ETFs are safe as houses products.

VIX

Explaining stock market volatility

They say a picture explains 1,000 points…

…the lighter side of market volatility which in reality is probably not far off the mark.

FNF Media wrote back in October 2015,

ETFs are hitting the market faster than the dim-sum trolley can circle the banquet hall. Charles Schwab, in the 12 months to July 2015, saw a 130-fold preference of ETF over mutual funds given their relative simplicity, cost and transparency….

…ETFs, despite increasing levels of sophistication, have brought about higher levels of market volatility. Studies have shown that a one standard deviation move of S&P500 ETF ownership as a percentage of total outstanding shares carries 21% excess intraday volatility. Regulators are also realising that limit up/down rules are exacerbating risk pricing and are seeking to revise as early as October 2015. In less liquid markets excess volatility has proved to be 54% higher with ETFs than the actual underlying indices. As more bearish market activity has arrived since August 2015 we investigate how ETFs may impact given a large part of recent existence has been under more favourable conditions…

CEO Larry Fink of Blackrock, the world’s largest ETF creator, has made it clear that
leveraged ETFs (at present 1.2% of total ETF AUM) have the potential to “blow up the whole industry one day.” The argument is that the underlying assets that provide the leverage (which tend to have less liquidity) could cause losses very quickly in volatile markets. To put this in perspective we looked at the Direxion Daily Fin Bull 3x (FAS) 3x leverage of the Russell 1000 Financial Services Index. As illustrated in the following chart FAS in volatile markets tends to overshoot aggressively

…The point Mr Fink is driving at is more obvious in volatile markets, the average daily return is closer to 10x (in both directions) than the 3x it is seeking to offer. This is post any market meltdown. On a daily basis, the minimum and maximum has ended up being -1756x to 1483x of the index return, albeit those extremes driven by the law of small numbers of the return of the underlying index. Which suggests that in a nasty downturn the ETF performance of the leveraged plays could be well outside the expectations of the holders.”

FNF Media has said for many years, where CDOs and CDSs required the intelligence of a mythical hermit atop a mountain in the Himalayas to understand the complexities, ETFs are the complete opposite. Super easy to understand which inadvertently causes complacency. Unfortunately, as much as they might try to do as written on the tin, the reality could well turn out to be the exact opposite.

Plunging credit quality more troubling than market rout

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The Dow plunged 1175 points (-4.6%) overnight. 4.6% is a lot and yes 4-digit drops optically look worse but off the higher base we get higher (record) point drops. One thing to contemplate in a rising bond yield market is corporate credit quality. Since 2006 the average credit ratings for US corporates issued by the big agencies have seen the number of top rated (to the left) fall while those with deteriorating grades (to the right) soar. That’s right, the 4 categories before “junk” have risen sharply. After many years of virtually free money many corporations have let the waistline grow. When refinancing comes around just how will credit ratings influence the new spreads of corporates who’ve shifted to the right?

The IMF highlighted in 2017  that US companies have added $7.8t in debt & other liabilities since 2010. The ability to cover interest payments is now at the weakest level since 2008 crisis.

This despite near full employment, record level equity markets and every other word of encouragement from our politicians.

However if this is the state of the corporate sector at arguably the sweet spot of the economic cycle CM shudders to think the state of potential bankruptcies that will come when the cycle truly takes a turn for the worse. This is a very bad sign.