Martes 25/08/15 el Dow Jones en corrección

[Fenix]

ESPECIAL. Estrategia de Inversión

Análisis de Bankinter
Martes, 25 de Agosto del 2015 - 15:27:00

Aplicamos las siguientes reducciones de exposición (a bolsas) según perfiles de riesgo, siendo idénticos para el Inversor Local que para el Global:

Perfil Agresivo: 75% vs 85%
Perfil Dinámico: 60% vs 70%
Perfil Moderado: 45% vs 50%
Perfil Conservador: 25% vs 30%
Perfil Defensivo: 10% vs 15%

En nuestra opinión, coinciden al menos 4 factores adversos - siendo China el principal de ellos - y no somos capaces de identificar algún detonante positivo que pueda contrarrestarlos a corto plazo.

Considerando que hemos mantenido un enfoque razonablemente acertando con respecto a Grecia y que eso nos ha permitido mantener todas las Carteras Modelo de Fondos con rentabilidades positivas (hasta 20/8: +1% Doméstica Conservadora (la que peor) y +8,3% Global Agresiva (la que mejor), aunque tras las caídas de ayer las cifras serán peores), creemos que debemos anteponer la preservación del patrimonio a la obtención de una rentabilidad adicional, ya que, en las actuales circunstancias, los riesgos no compensan los posibles retornos. Si durante esta semana las caídas de las bolsas no se detuvieran (algo que tememos suceda), la semana próxima volveríamos a reducir exposición. Si se estabilizasen, tal vez no fuera necesario. Pero el ajuste de China es algo necesario sobre lo que hemos venido advirtiendo durante mucho tiempo (¿2 años?) y si es ahora cuando está produciéndose, entonces nuestra estrategia de inversión no puede permanecer ajena al deterioro del contexto.

A medio plazo seguimos defendiendo el actual ciclo expansivo y creemos que el abaratamiento de las materias primas - particularmente del petróleo - será especialmente beneficioso para las economías desarrolladas, pero mientras el mercado discrimina y selecciona países y activos, las bolsas seguirán sufriendo porque no se trata de un ajuste de mercado, sino que es algo serio y estructural que afecta a los emergentes, cuyos modelos de crecimiento están agotados. Esto es lo que subyace realmente: el agotamiento del actual modelo de crecimiento de los emergentes, cuyo detonante es la corrección de los recientes excesos (sobreprecios) en China. Una excelente muestra de este sufrimiento de las bolsas es el aumento del VIX (volatilidad del S&P500) hasta 53%, por encima de los niveles de 2011.

Los 4 factores a que aludimos son los siguientes:

(i) China. Su modelo de crecimiento no es sostenible en el tiempo y parece que ha llegado el momento del ajuste. Venimos advirtiendo sobre este asunto desde hace al menos 2 años, aunque reconociendo nuestra incapacidad para identificar el momento en que se produciría el ajuste... pero sí hemos insistido en que cuando éste se produjera su alcance sería serio. Creemos que el momento es ahora.


China ha empleado todas las medidas de política monetaria (ortodoxas y no ortodoxas) para reconducir la situación, pero no han dado resultado. Ni siquiera 3 sucesivas devaluaciones. China no es Grecia.

China representa el 15,4% del PIB mundial (sólo después de USA, con 19,3%), cuando Japón tiene un peso del 5,4%, Alemania 3,7%, España 1,6%... y Grecia apenas 0,3%. Un aterrizaje brusco de China es mucho más difícil de gestionar que una crisis griega. La desaceleración de la economía china es una realidad preocupante y no sólo un asunto de percepción del mercado. Su PIB 1T y 2T fue +7,0%, que es su objetivo oficial de crecimiento para 2015 desde que en marzo se revisó a la baja hasta ese nivel desde +7,5% al comprobarse que alcanzar ese +7,5% inicial sería imposible. Su PMI Manufacturero desaceleró en julio hasta 50,0 desde 50,2 de junio y mayo, pero el registro privado (antes realizado por HSBC y ahora por un patrocinador denominado Caixin) fue 47,1 en agosto, manteniéndose por debajo de 50 puntos (es decir, indicando contracción económica) desde que en febrero marcó 50,7. Sin ir más lejos, ayer se publicó que el 1S’15 el indicador de producción agregada de los 23 fabricantes de autos cayó por debajo del 100% por primera vez en la historia, con un descenso bastante brusco, además: 94,3% vs 107,4% en el 2S’14.

(ii) Brasil. En recesión tras 4 trimestres consecutivos con PIB negativo (-1,6% en 1T’15) y serios problemas derivados de la corrupción en su sistema político, entre otros aspectos preocupantes. En realidad llevamos varios trimestres advirtiendo sobre la conveniencia de mantenerse al margen de cualquier economía emergente - excepto tal vez India y con reservas de corto plazo - para centrarse en Europa, Estados Unidos y Japón. Lo que está sucediendo con China y su efecto arrastre sobre la economía japonesa llevará a que en nuestra Estrategia de Inversión Semanal del lunes 31 reduzcamos nuestra recomendación desde Comprar hasta Neutral).

(iii) Elecciones en Grecia el 20/9. Los partidos de extrema izquierda que forman/formaban parte de Syriza y que se han escindido defienden la salida voluntaria de Grecia del euro. Conviene no minusvalorar esta posibilidad considerando que: (a) Los griegos pueden querer experimentar con la salida del euro una vez que, desde su particular punto de vista, todo lo demás les ha fallado, y (b) Los partidos de corte izquierdista y extrema izquierda siguen contando con una intención de voto cercana o superior al 40%, de manera que podrían volver a ganar las elecciones, pero aún más sesgados hacia posiciones izquierdistas que se oponen a la permanencia en el euro.

(iv) Incertidumbre política en España: elecciones catalanas el 27/9, con la tensión que eso supone sobre la integridad territorial, y elecciones generales probablemente en Dic. (deberá fijarse fecha definitiva antes del 20/12, pero la Constitución permite ampliar el plazo hasta el 17/1/2016).

Además, esta nueva complicación para el mercado que supone el aterrizaje aparentemente brusco de la economía china tendrá como consecuencia colateral el probable retraso de la primera subida de tipos por parte de la Fed, que es algo que hemos venido defendiendo a lo largo de 2015. La reunión de septiembre parece ahora descartada para realizar este primer movimiento (a pesar de que antes del verano la mayoría del mercado apostaba por ello, aunque no nosotros) y, tras el artículo publicado ayer en el FT por Laurance Summers, ex-Secretario del Tesoro, y lo que está sucediendo en China, se irá consolidando la percepción de que la subida se implementará en la reunión de diciembre, como pronto, que siempre ha sido nuestro escenario más probable.

[Fenix]

Indicadores de sentimiento del inversor

Martes, 25 de Agosto del 2015 - 15:52:00

Fuerte deterioro en los indicadores de riesgo inversor, GRAMI (Global Risk Aversion Macro Index) y EMRA (Emerging Market Risk Aversion Index). Especialmente en este último, que sube hasta su nivel más alto desde finales de 2011. Pero todo esto ya lo saben...

Y sin embargo, aunque en niveles bearish, el indicador de sentimiento NISI (News Implied Sentiment Indicator) ha mejorado ligeramente en la semana.

La situación de fondo no ha cambiado, con muchos inversores aún valorando la oportunidad para retornar al mercado.

José Luis Martínez Campuzano
Estratega de Citi en España

[Fenix]

Right Now, E-Mini Liquidity Is Even Worse Than Yesterday
Submitted by Tyler D.
08/25/2015 - 08:28

If yesterday's liquidity was bad enough to precipitate the biggest wholesale market flash crash, including the historic, first-ever "limit down" triggers for all major index futures, then be very careful what you do today because as of this moment E-mini liquidity is even worse than it was yesterday, not to mention at any other point in the past month, at this time of the day.


Case-Shiller Home Prices Dip In June, Miss For 3rd Month In A Row
Submitted by Tyler D.
08/25/2015 - 09:13

Home prices rose 4.97% YoY in June, according to Case-Shiller's 20-City index, missing expectations for the 3rd month in a row. Price appreciation has now been flat for 5 months - despite surging home sales - as bubblicious San Francisco saw price depreciation once again. Portland amd Denver saw the most appreciation in June. This is the second month in a row of sequential seasonally-adjusted declines in home prices, and along with TOL's dismal report this morning, suggests maybe another pillar of the 'strong' US economy meme is being kicked out... and Case-Shiller warn more than one rate hike by The Fed (or a stock market plunge) will stymie housing considerably.

[Fenix]

How Much Longer Can The Record New Home Sales-To-Price Divergence Continue
Submitted by Tyler D.
08/25/2015 - 10:14

The biggest surprise is today's new home sales data was not in the volumes of new homes sold, but the ongoing gaping divergence between volumes and prices. As we have shown previously, this record spread will have to close one way or another, and with the median new home sales price of $285,900 or virtually unchanged from a year ago, it would appear that new home buyers are finally starting to rebel against prices whose rise has far surpassed the increase in actual sales.


Gold Slammed Back Below Key Technical Support

Submitted by Tyler D.
08/25/2015 10:31 -0400

Since 'everything is awesome' once again, it appears holding 'pet rocks' is no longer of any use... Gold futures have been hammered below their 50-day moving-average this morning as the USD rises...

Gold down on heavy volume...

Silver is not escaping the damage either - having broken support yesterday...

Which is interesting since stocks are also being sold...

[Fenix]

Chinese Central Banker Blames Fed For Market Rout
Submitted by Tyler D.
08/25/2015 - 11:46

While the western mainstream media meme is that "this is all China's fault" - despite the fact that the real break happened after the FOMC Minutes last week - Xinhua reports that China central bank blames wide-spread expectations of a Fed rate hike in September for the global market rout... demanding The Fed "remain patient."


Hedge Fund Hotel California: Smart Money Darlings Crash Up To 42% In One Week
Submitted by Tyler D.
08/25/2015 - 11:02

While the "hedge fund" hotel strategy works on the way up, when everyone makes roughly the same profits, it is on the way down when these hedge fund hotels become "Hotel California" - hedge funds can check out, and sometimes they can even leave... with massive losses. According to a Bloomberg analysis, many of these hedge fund hotel stocks, or companies where hedge funds hold a combined stake of at least 25%, suffered declines of as much as 42 percent in the recent stock market rout.

[Fenix]

BTFD?
Submitted by Tyler D.
08/25/2015 - 12:01

The bubble headed bimbos and brainless stock touting twits will be in ecstasy today as the ever predictable rebound is under way. The market will soar by over 500 points at the opening as the excuse of the day is China’s desperate interest rate cut to try and stem their downward spiraling economy and markets. The Wall Street captured boob tube brigade will tell their almost non-existent viewership that all is well. The terrifying plunge is in the past. The economy is great. Housing is strong. Stocks are now a bargain. It’s the best time to buy. Now here are some facts...



"It Feels Like 1997" Warns Art Cashin, "Watch High Yield"
Submitted by Tyler D.
08/25/2015 - 12:21

"It's not necessarily out of control yet. But if they do not provide some stability pretty soon it will begin to affect not only the markets over there, but - as we saw today and somewhat last week - it affects markets all around the world. Financial Markets are correlated. We learned that back in 2008 When the fall of Lehman spread all around the globe."

[Fenix]

Mapping China Contagion: The Flowchart
Submitted by Tyler D.
08/25/2015 - 13:50

If the last two weeks have taught us anything at all (other than that a Reg FD violation is called a "scoop" when it involves Jim Cramer and Tim Cook), it’s that China quite clearly matters - and it matters quite a lot.


Global Markets To Fed: No Rate Hike, The Strong Dollar Is Killing Us
08/25/2015 12:58 -0400
Submitted by Charles Hugh-Smith

Global markets are puking at the prospect of higher yields in the U.S.

There are many reasons for global markets to melt down, but one that doesn't get enough attention is the strong dollar. In effect, global markets are telling the Federal Reserve: don't raise rates--the strong dollar is killing us.

Here's the dynamic that's killing emerging markets' currencies and stocks, the China Story and U.S. corporate profits. In the glory years of a declining U.S. dollar (USD), a vast global carry trade emerged as speculators borrowed money in USD and invested it in high-yield emerging market assets such as stocks, bonds and real estate.

This carry trade was a two-fer: not only were yields much higher in emerging markets, the appreciation of local currencies against the USD provided a currency gain on top of the higher yield.

As the yuan strengthened against the USD, an enormous river of capital flowed into China to take advantage of the revaluation and higher yields in China. How much of this money was borrowed USD is unknown, but it's estimated that Chinese corporations alone borrowed $1 trillion in USD to profit from higher yields in China.

The virtuous benefits of a weakening USD extended to U.S. corporations, which reap 40% to 50% of their total profits from sales overseas. As the USD weakened, U.S. corporations reaped the currency gains every time they reported overseas sales in USD.

Everybody won with the weakening dollar, except the U.S. consumer, who paid more for imported goods.

But a funny thing happened in late summer 2014--the USD started rising against other currencies--by a lot. Suddenly all those profitable carry trades reversed.

Emerging markets remained in a trading range for much of 2011-2015, but the strengthening dollar was eating away at the carry trades beneath the surface.

Meanwhile, over in the S&P 500, stocks rose steadily from mid-2011 to mid-2015. But beneath the surface strength of the past year, market technicians noted a deterioration of indicators. Commentators started noting the rising dollar's negative impact on U,S. corporate profits.

Now the carry trades have been abandoned, and market participants are looking at a Fed rate hike with fear and loathing. Why? The USD has already strengthened by 20%. A tick up in U.S. yields would only make the dollar more attractive globally, as traders would get the currency appreciation and a higher yield.

Global markets are puking at the prospect of higher yields in the U.S. The damage delivered by the rising dollar has been severe; a move higher from here might prove fatal to emerging markets and faltering U.S. corporate profits.

[Fenix]

For Saudi Arabia, The Music Just Stopped: Scramble To Slash Spending Begins As Oil Math Reveals Dire Picture
Submitted by Tyler D.
08/25/2015 - 14:40

With declining crude revenues clashing head on with the cost of simultaneously financing the state while intervening militarily in Yemen, the Saudis are looking to tap the bond market (a move which could increase debt-to-GDP by a factor of 10 by the end of next year) and some are speculating that the riyal’s dollar peg could ultimately prove unsustainable. Now, as Bloomberg reports, "Saudi Arabia is seeking to cut billions of dollars from next year’s budget because of the slump in crude prices."




Is The Correction Over?
08/25/2015 13:57 -0400

Submitted by Lance Roberts

As I discussed yesterday, the now "official correction" was not a surprise. It was something that I have been discussing repeatedly over the last several months. The only surprise was the magnitude of the opening drop.

The question on everyone's mind now is simply whether the correction is over, or is there more to come?

The honest answer is that no one really knows. The bulls are "hoping" that the worst is over and that the current bull market will resume its upward trend. However, there is ample evidence suggesting that something else may be afoot from slowing domestic and international growth, collapsing commodities and falling inflationary pressures.

Furthermore, from a fundamental standpoint, earnings growth is deteriorating, and valuation expansion has ceased. As I addressed in "Shiller's CAPE - Is There A Better Measure:"

"The need to smooth earnings volatility is necessary to get a better understanding of what the underlying trend of valuations actually is. For investor's periods of 'valuation expansion' are where the bulk of the gains in the financial markets have been made over the last 114 years. History shows, that during periods of 'valuation compression' returns are much more muted and volatile.

Therefore, in order to compensate for the potential 'duration mismatch' of a faster moving market environment, I recalculated the CAPE ratio using a 5-year average as shown in the chart below."

PE-Ratio-5yr-CAPE-082515

"There is a high correlation between the movements of the CAPE-5 and the S&P 500 index. However, you will notice that prior to 1950 the movements of valuations were more coincident with the overall index as price movement was a primary driver of the valuation metric. As earnings growth began to advance much more quickly post-1950, price movement became less of a dominating factor. Therefore, you can see that the CAPE-5 ratio began to lead overall price changes.



As I stated in yesterday's missive, a key 'warning' for investors, since 1950, has been a decline in the CAPE-5 ratio which has tended to lead price declines in the overall market."

Yes, I know...low interest rates, Central Bank interventions, etc., etc. have changed all that and "this time is different." Let me assure its not. Unfortunately, the truth of that statement will only be recognized after a great deal of pain.

But that is a longer term dynamic that will take some time to play out and does not answer the immediate question about whether the current correction is over.

In such a short time-frame fundamentals and economics are of relatively little value. So we really must focus our analysis on price dynamics.

As I addressed in this past weekend's newsletter (subscribe for FREE E-Delivery):

"The time has now come to start moving more heavily to cash. As I will discuss throughout this weekend's missive, including the 401k-Plan Manager, it is now time to 'OPPORTUNISTICALLY' REDUCE PORTFOLIO ALLOCATIONS.



As noted in the chart below, the markets are now once again extremely oversold."

SP500-MarketUpdate-082515

"As I have often stated in the past, by the time a market signal is given in the market, the markets are very likely at a point of extreme oversold or bought conditions. Therefore, it is always better to use the subsequent relaxation of those extreme conditions to add or reduce portfolio exposure.



This is why it is never a good idea to 'panic' when something initially goes wrong. With the markets now deeply oversold, it is VERY likely that the markets will bounce next week. The problem, for those with 'buy and hold' bullishly biased strategies, is the 'bull market' has now ended...at least for now.

As shown in the chart above, the bounce from these oversold levels will run into a substantial amount of overhead resistance where the rally will very likely fail. THIS WILL BE THE POINT to take some actions to rebalance/reduce portfolio equity risk as needed.

Important Note: I am NOT suggesting that one liquidate all holdings and go solely to cash. However, I am suggesting that if the recent market decline sent shockwaves through your nervous system, you likely have an excessive amount of "risk" in your portfolio. It is also just good portfolio management to take profits from winners (let winner's run) and sell laggards (cut losers short.)

To put a post-crash rally into perspective, let's take a look some previous crashes to see "what happened next."

1987

SP500-1987Crash-082515

After the initial crash in 1987, a 36.4% drop from the peak, the markets immediately bounced back to previous resistance levels, and the began a more normalized decline back to the previous lows.

This is not surprising as investors caught in the initial plunge are "psychologically traumatized" and look for an opportunity to flee to safety. The subsequent two-year recovery back to old highs became more volatile.

1998

Very similarly, the crash in 1998, spurred by the "Russian Debt Default", consisted of a 20%+ dive from the previous peak only to find support at the lows from the beginning of the year.

SP500-1998-Crash-082515

The initial bounce from the lows failed once again, as investors fled for the "safety" of cash, and new lows were found.

2010 and 2011

While the media has been pointing out the similarities of Monday's 1089-point plunge to the May, 2010 "flash crash;" the 2011 "debt ceiling debate" crash is also worth noting.

SP500-2010-2011-Crash-082515

As noted, in both cases the markets suffered substantial declines to test previous support levels. The difference this time was that the declines were halted by the Federal Reserve's monetary interventions. However, importantly, in both cases, the initial decline led to a sharp bounce before the markets then set new lows.

There Is A Difference

In all cases above, valuations were in expansion mode as shown in the 5-year CAPE ratio above. The difference this time is that valuations are contracting which is more historically coincident with the onset of much deeper reversions.

The sharp "reflexive" rally that will occur this week is likely the opportunity to review portfolio holdings and make adjustments before the next decline. History clearly suggests that reflexive rallies are prone to failing and a retest of lows is common. Again, I am not talking about making wholesale liquidations in accounts. However, I am suggesting taking prudent portfolio management actions to raise some cash and reduce overall portfolio risk.

If the next decline finds support within the confines of the ongoing bull market, equity risk can simply be increased. The penalty for being underexposed initially will be minor within the context of the broader trend.

However, if the six-year bull market did indeed just conclude for now, you will be thankful for having a bit of extra cash in coffers.

[Fenix]

Everyone Has A Plan Until...
08/25/2015 14:30 -0400

Via ConvergEx's Nick Colas,

Every Federal Reserve Chair since 1979 has faced a notable challenge in the first 12-20 months of their tenure – something akin to capital markets “Bullies” hazing the new kid at school. Paul Volcker had the 1979-1980 Iranian oil shock/recession, Alan Greenspan the 1987 Stock Market Crash, and Ben Bernanke the 2007 Financial Crisis.



Their responses shaped market perceptions about Federal Reserve priorities and set the stage for the remainder of their tenures, from Inflation-Fighting Volcker to Save-the-World Bernanke.



Now, it is Chair Yellen’s turn, with today’s selloff throwing down the gauntlet in front of the Federal Reserve. At stake is the Federal Reserve’s relationship with equity markets not just now, but for years to come. Paul Volcker famously pushed the country into recession in 1981-1982 to dampen inflation, but both Greenspan and Bernanke were much more equity-friendly during their tenures.



How will Chair Yellen’s Fed face the market’s challenge? It will likely take months to find out, so today we update our “Have U.S. stocks bottomed” checklist. The answer: not yet.

Former heavyweight champ Mike Tyson is a man of few words, but he does have one great saying: “Everyone has a plan until they get punched in the mouth.” Less well known is his second line: “Then, like a rat, they stop in fear and freeze”. My own father, a man of about as many words as Iron Mike, had his own version: “Never trust a man who hasn’t been punched in the face.” Either way, the sense is the same. Everyone faces adversity, and how you respond to it both reveals and helps build your character.

The same, albeit less pugilistic, lesson holds true for Federal Reserve Chairs. Ever since Paul Volcker took the top job at the Fed in 1979, markets and geopolitical events have conspired to challenge new U.S. central bank heads almost right out of the box. Here are the case studies:

Paul Volcker got the big office at the Marriner Eccles Building on August 6th, 1979. The Iranian revolution was underway at the time, spiking oil prices to $40/barrel (yep, right around where they sit today). The country was in recession, the hostage crisis that demoralized the nation began in November, and despite all that Volcker pushed interest rates to 20% in June 1981 to dampen runaway inflation. That lead to a second recession in the early 1980s, but inflation has been low and generally contained for the last 30 years. No one has seriously doubted the Fed’s inflation fighting playbook since Volcker’s tenure.



Alan Greenspan took over on August 11, 1987. Two months later, the U.S. equity market crashed with Dow Jones Industrial Average falling 508 points (22.6%) on Monday, October 19th. This was back when small specialist operations dominated floor trading for stocks, and market participants worried that market losses might bankrupt some of these players. Before the open on Tuesday, Greenspan’s Fed issues a short statement: “The Federal Reserve consistent with its responsibilities as the Nation’s central bank affirmed today its readiness to serve as a source of liquidity to support the economic and financial system”. It also cut Fed Funds to 7.0% from 7.5% and NY Fed President E. Gerald Corrigan personally calls Citicorp chairman John Reed and others to encourage them to lend freely to the securities industry. The message was clear: the markets and the economy were intertwined, and the Fed understood that linkage in the context of its Congressional mandate. No one has doubted the importance of equity market performance to Fed policy since Greenspan’s time in office.



On February 1, 2006, it was Ben Bernanke’s turn at the helm. His honeymoon was a relatively long one; U.S. equity markets rallied until October 2007. The rest of the story you know well, for that 20 month quiet spell quickly morphed into the disaster that was the Financial Crisis. During the interregnum between Bush and Obama presidencies, it was the Federal Reserve that kept the lights on for the U.S. financial system. After that, he worked to expand the Fed’s balance sheet from its pre-Crisis $890 billion to its current $4.5 trillion in the hopes of sparking economic growth. Ever since then, there has been little doubt that the Federal Reserve will do whatever it takes to hold the financial system together.

And now, it seems to be Chair Janet Yellen’s turn to face her first critical challenge. She has been in office since February 3, 2014 and the S&P 500 peaked in May 2015, so her market honeymoon was almost as long as former Chair Bernanke. Still, the 10% move lower for the S&P 500 and 11% for the NASDAQ in just the last 5 days is a clear sign that markets have grown disenchanted. But why? Three reasons fall to hand:

Issue #1: Low interest rates have juiced equity valuations to levels more consistent with a rapidly growing global economy than one still stuck in first gear. Assuming that the S&P 500 can still do $120/share, the U.S. stock market’s valuation is 16x earnings with today’s pullback. That should be low enough to hold markets together, save one critical problem: analysts expect revenues for U.S. companies to decline for the next 2 quarters. That makes U.S. stocks more of a “Value” play than “Growth”, and the historical valuation range for value is more like 12-14x earnings – not 16x.



Issue #2: The persistent decline in oil and other commodity prices threatens to reintroduce the specter of deflation into global economies. In a world that still fears a Japan-style round of declining prices, that is a meaningful concern.



Issue #3: And yes… China. Stock market declines there are worrisome, of course, but more meaningful is that the Chinese government is having so much trouble containing the fallout and stabilizing financial markets. Western fund managers and analysts tend to think of this economy as a ‘Black box’, but when that container starts to sputter they are not in a position to know if it is a minor problem or something larger and more foreboding. Add to that the importance of China to global commodity producers (see Issue #2) and as a growing end market (see Issue #1), and it is easy to see how the selloff there dampens investor enthusiasm elsewhere.

After today’s action, it seems pretty clear that capital markets have a disagreement with the Federal Reserve. The latter thinks things are pretty good and it is time to raise interest rates. The former begs to differ. Two weeks ago we assembled a list of various market-based indicators that outlined this squabble, and we continue to believe that this is also a good checklist for those interested in finding a near term bottom for U.S. equities.

1. Crude oil prices. With a close at $38, oil is well below the $40 level we think divides market sentiment on a growing versus contracting global economy.



Verdict: Oil needs to find a bottom – meaning no new low for at least a week – before equities can bottom.



2. 2 Year Treasury Yields. Two weeks ago these were 68 basis points; now they are 58 basis points. At 50 basis points, they would signal almost complete confidence that the Fed was not going to raise rates any time soon. That should be bullish for stocks.



Verdict: we’re getting close, but not there yet.



3. 10 Year Treasury Yields. With a close today at 2.01%, we are on top of our 2% target for long rates as a “Buy” signal for equities.



Verdict: Our first “Buy” signal for stocks! With yields this low, the S&P 500 now sports a yield higher than 10 year notes: 2.1%.



4. 10-2 Treasury Spread. At 143 basis points between 2 year and 10 year notes, the yield curve has flattened only modestly from two weeks ago when the spread was 147 basis points. Something tighter – like the 138 average of February – April timeframe would be a clear buy signal for stocks.



Verdict: not there yet.



5. Dollar/Euro exchange rate. Two weeks ago the euro fetched $1.104; now it is $1.159. Ordinarily, that would be healthy for U.S. stocks as a weaker dollar translates into better offshore earnings on a USD income statement. Today, it was more a sign of fund flows out of U.S. dollar assets.



Verdict: we’ll take this one as positive for equities.



6. S&P 500. Our near term target for the S&P 500 two weeks ago was 1956. Since then, there’s been a lot more technical damage, which simply means that investors are surprised they’ve lost more than they imagined possible.



Verdict: despite being 10% cheaper than a week ago, many investors will probably wait a week to see if current levels hold.



7. CBOE VIX Index. Two weeks ago we said we wanted to see the CBOE VIX Index over 20 (its long run average back to 1990) for 5 consecutive days before we thought a bottom was in place.



Verdict: three more days to go, but not a Buy yet.



8. Fed Funds Futures. If Chair Yellen came out tomorrow and said “Recent developments in global financial markets make it clear that a September rate increase would be premature”, we believe stocks would rally. That is because Fed Funds Futures still ascribe some possibility that the Fed will move next month: 24%, to be exact.



Verdict: once Fed Funds Futures give the chance of a September hike 10% or less, stocks should bottom. We aren’t there yet.

On points, 6-2 to be precise, our indicators show that U.S. equity markets are still in for more volatility in the days ahead. As for the larger issue of how the Fed responds to this bout of market volatility, well… I am sure they have a plan.

[Fenix]

Trump Top But Sanders Surges As Hillary 'Hope' Hammered In New Hampshire
Submitted by Tyler D.
08/25/2015 - 15:50

A stunning 78% of Democrats in New Hampshire view Bernie Sanders favorably in the latest polls. As The Hill reports, Hillary Clinton was viewed favorably by that percentage in April, but that has dropped 15 percentage points among Democrats. With Sanders topping Clinton by a 44 to 37 percent margin (VP Joe Biden garnered 9%), and Trump support among Republicans at 35%, it appears serial lying is not paying off for the Oligarchy (for now)...


This Could Be Very Bad News Ahead Of China's Open Tonight
Submitted by Tyler D.
08/25/2015 - 16:25

"China halts intervention in stock market so far this week as policy makers debate merits of an unprecedented government campaign to prop up share prices and what to do next, according to people familiar with situation. Some leaders support argument that stock market is too small relative to broader economy to cause crisis, says one of the people, who asked not to be identified as deliberations are private Leaders also believe intervention is too costly, person says."

[Fenix]

"It's Still September" Ignore Fed Rate-Hike Warnings At Your Own Peril
08/25/2015 16:45 -0400

Via Scotiabank's Guy Haselmann,

Hold onto your bootstraps. Markets are setting themselves up for a surprise as the Fed is still likely to hike rates in September. Today’s ‘risk-on’ move is a function of those expecting delay. Rising levels of market volatility are here to stay and will be magnified by this ‘surprise’. Those ignoring the warnings of a rate hike by Fed officials do so at their own peril.

Many FOMC members have said that they expect “bumpiness” when they raise rates for the first time in nine years. They probably believe recent market volatility is partially explained by the fact that the September FOMC meeting is approaching and some investors were preparing themselves.

The Fed has adequately prepared the market for a hike. Delaying the hike once again would cause harm to financial markets. It would not be healthy to price out a hike completely, only to have to price it in again at a later date. Confidence would be damaged.

Moreover, I do not believe the Fed will opt to wait until the December meeting, because it would cause year-end balance sheet and liquidity issues that it would prefer to avoid. Waiting until 2016, also has its draw-backs, due to over $200 billion in Treasury securities set to mature. ‘One and done’ is more of a possibility to me than a delay.

The Chinese slowdown and troubles in emerging market countries is unlikely to prevent a hike because those countries are taking their own set of actions to confront their respective challenges. As the owner of the world’s reserve currency, the Fed must show leadership and be the first major central bank to move.

Unfortunately, this morning’s euphoria in US markets was partially due to the combination of many economists pushing out their expectations of the first rate hike until 2016 (some believe 2017), and partially due to China cutting rates. If they are correct, then financial conditions must deteriorate materially.

Therefore, today’s euphoria may be misplaced at this point in the cycle. Over-dependence on exceedingly accommodative monetary policy is one of the reasons financial markets conditions are in the position they are in today. This will be a point of discussion at the September FOMC meeting.

Guidance on ‘lift-off’ has moved so many times over the past several years that there are many investors who believe that the Fed will not be hiking for many years. For many investors the motto ‘I will believe it when I see it’ is the reason why many investors ‘buy the dip’ and why weak economic data sends equity markets soaring (it has meant more Fed). Central banks need to break the cycle of markets rising due to expectations of continuous stimulus. FOMC members are aware of this and seem prepared to end this unhealthy cycle.

Those buying over-priced equities today must believe that the Fed will not hike in 2015 and/or believe that QE4 is an option if needed. Both could be a much higher hurdle then many realize. If I am correct, too many are over-estimating the upside in equities and under-estimating the downside. It is time to pare risk, own long bonds, raise cash, and seek quality securities.

Those calling for delaying a hike have become more vocal. Many cite the drop in inflation break-even spreads as an indication that the Fed is failing on its inflation mandate. Inflationary expectations have fallen back to levels comparable to when the Fed implemented past QE programs. This partially explains why some started calling for QE4 yesterday. (As I stated yesterday, the chance are minuscule)

However, simple comparisons are not so straight-forward. FOMC conversations focusing on inflationary expectations are very different today than they were a few years ago. In prior notes, I argued why the Fed’s zero interest rate policy might even be counter-productive to its dual mandates.

Regardless, monetary policy cannot restrict itself to reacting to short term inflation fluctuations. Policy must promote the more important goal of economic growth, which requires financial stability. Without financial stability, the Fed’s chances of achieving its dual mandates are small.

Seven years of extraordinary monetary accommodation has led to a misallocation of resources. One only has to ask where the funds are being deployed from the annual $1 trillion+ in corporate bond issuance since 2009 to see those risks. The ramifications are immeasurable and will be unknown for many years.

Stanley Fischer is unflappable. He will be a steady voice, unmoved by the market’s gyrations. He will cite near full-employment and the fact that 246,000 jobs per month have been created during the past year. He fully understands the psychology of the marketplace and the damage that could be caused by letting market volatility derail their plans for a hike and retreat from the emergency rate of zero.

Mr. Fischer and other FOMC members are meeting in Jackson Hole Wyoming this week. Comments from the conference could easily be consistent with prior Fed messages that a September lift-off seems reasonable. If this occurs, today’s market Euphoria will wither and reverse. As the market re-introduces the pre-meeting potential of a hike - or experiences an actual September 17th hike - the 30 year Treasury will regain its legs, while equities and credit securities resumes their sell-off.

“It’s a hard rain’s a-gonna fall” – Bob Dylan

[Fenix]

Dollar Depeg Du Jour: 32-Year Old Hong Kong FX Regime In The Crosshairs
Submitted by Tyler D.
08/25/2015 - 17:43

Because no discussion of global dollar pegs and entrenched FX regimes would be complete without mentioning the Hong Kong dollar...



Cutting Through The HFT Lies: What Really Happened During The Flash Crash Of August 24, 2015

Submitted by Tyler D.
08/25/2015 17:32 -0400

One of the fallacies being propagated about yesterday's flash crash, is that somehow HFTs came riding in as noble white knights and rescued the market from a collapse instead of actually causing it. This particular lie is worth a few quick observations and explanations of what really happened.

What did not happen, is what Doug Cifu, the CEO of HFT titan Virtu, the firm which as we have profiled repeatedly in the past has lost money on 1 day in 6 years...

... told CNBC when he said it wasn't Virtu's fault the market did not work for anyone as a result of countless HFT glitches: "we don't cause volatility, as a market maker we're absorbing volatility and we think we soften it."

The most amusing bit was when Cifu said that "we're really just in the role of transferring risk from natural buyers to natural sellers." Considering Virtu and its "special sauce" has never actually taken on risk with its trading record, discussing risk is a little rich for the owner of the Florida Panthers, and here's why: in a note by Credit Suisse's Laura Prostic (the typos are because she is in S&T) we now know precisely what happened:

HFT is typically 50% of overall volm, but they have to walk away in this heightened vol envt, which dramatically reduces liquidity. Hightened vol was mainly unwinding of hedges, not panic.

Anyone who actually trades (and is not part of the Modern Market initiative) knows that this precisely what happens every time there is a spike in market vol: HFTs simply walk away leading to the dreaded "HFT STOP" moment, creating a feedback loop of even less liquidity, and even more volatility, until circuit breakers are finally hit or asset prices hit limits. Yesterday, for the first time in history, not only the S&P500, but the Nasdaq and the DJIA all hit their particular "limit down" triggers.

Credit Suisse also directly refutes what Doug Cifu said: HFTs, far from not causing volatility, merely step aside when volatility surges thus leading to such stunners as VIX soaring above 50 overnight (with the CBOE too ashamed to even report what it would have been in the first 30 minutes of trading).

This also ties in with the summary in our last night's post comparing the flash crashes of 2010 and 2015:

The good news is that with liquidity inevitably collapsing ever further to a state of near singularity with ongoing central bank interventions, and with markets broken beyond repaid, we will very soon have a repeat flash crash like today, one which will provide enough satisfactory answers to the question of just happened that lead to a market that was completely broken for nearly an hour, and where the VIX was so very off the charts, the CBOE was afraid to show it for at least thirty minutes.



One thing is certain though: while the market dies a slow, painful, miserable death, the biggest HFTs will continue pocketing millions. Such as Virtu: "Virtu Financial Inc., one of the world’s largest high-frequency trading firms, was on track to have one of its biggest and most profitable days in history Monday amid a tumultuous 24 hours for world markets, according to its chief executive."

As we previously reported, while Virtu may have fabricated its role in yesterday's events, there was one truth: it had an amazingly profitable day because as a result of the total chaos, HFTs were able to frontrun block orders from a mile away and as a result of soarking bid/ask spreads, Virtu raked in millions by simply capitalizing on the chaos it and its peers have created. As Cifu said then "Our firm is made for this kind of market." We quickly corrected him: "your firm made this kind of market."

But back to the lies: earlier today the WSJ reported the following:

The speed and depth of the drop harked back to the flash crash of May 2010, when program-driven trading produced a self-reinforcing wave of selling. This time around, high-frequency trading firms like Virtu Financial Inc. and Global Trading Systems LLC were buyers that helped U.S. stocks rebound midday from their early slump.



“We were catching those falling knives,” said Ari Rubenstein, co-founder of Global Trading Systems.

Actually no. What happened is that in early trading the entire market was in freefall, and the only thing that saved it was the various major market indices hitting their limit down levels for the first time in history - not even during the Flash Crash of 2010 did this happen. The following Nanex chart documents this beyond a doubt.



If HFTs did anything, it was merely to frontrun the buy orders once the selling wave - halted thanks to limit downs being hit - had exhausted itself, and the buying scramble was unleashed around 9:35am leading to a 5% move in less than 10 minutes! It was here that Virtu made its colossal profits, however not from taking the least amount of risk, but merely from frontrunning order flow into a stil chaotic market with gargantuan bid-ask spreads, which incidentally not only does not provide liquidity, but reduces it as it competes with other buy offers for any market offers, also known as "providers" of liquidity, only to immediately flip the transaction to those buyers which Virtu knew with 100% certainty were just behind it. In any other market this would be illegal, except for one in which Reg NMS has made such frontrunning perfectly legal (courtesy of billions spent by the same HFTs who now benefit from it).

So what was the real contribution of HFTs: an unprecedented failure of ETFs to trade with their underlying securities and vice versa. As we said yesterday: "for minutes at a time, there was an unprecedented disconnect in ETF fair value as hedge funds sold off ETFs however correlation arbitrageurs were unable to capitalize on the discrepancy with the underlying leading to historic, and extremely lucrative divergences."

Others added:

... experts are still scratching their heads over what may have caused these ETFs to nosedive. One possible explanation is that liquidity providers -- think high-speed traders and other Wall Street firms -- charged with stabilizing the market weren't there when needed. That's what happened during the flash crash of 2010. "When markets get hairy, sometimes those liquidity providers step out of the way to avoid getting run over," said Matt Hougan, CEO of ETF.com.

So while we await for the first clear break of the ETF model, thanks to none other than HFTs, here is a visual example of what really happened: some 220 ETFs which all fell by 10% yesterday!



But it wasn't just the "transitory" failure of the ETF model: yesterday the Nasdaq ETF, the QQQ, had its widest 1 minute price swing in history. Yes, the NASDAQ!



And just in case there is still any confusion if yesterday's event was indeed a flash crash, the answer is yes, most certainly, as can be seen by the 15% tumble in QQQs right at the open. That, ladies and gentlemen, is the definition of a flash crash.

Again: thank you HFTs.

With that we leave matters into the SEC's capable hands which we know will do absolutely nothing until the time comes when the next marketwide crash does not see a promptly rebound, and the time to finally point the finger at the HFTs comes. It's just a matter of time, plus someone has to be a scapegoat for the real, and biggest, market manipulator in history: the Federal Reserve.

And since, naturally, the complicit and corrupt SEC won't do anything, expect another wave of retail investors to drop out of the market forever and to never come back, having seen yet again what a truly broken and rigged casino it has become.

Finally, while we are delighted that firms like Virtu make outside profits on days in which the market crashes and leads to untold losses for retail investors, we have just one simple request - please don't take us for fools anymore: by now everyone knows all of your tricks, and can see right through your bullshit.

So, dear Virtu, frontrun whoever you have to, other HFTs, hedge funds, mutual funds, or whoever else is left in this quote-unquote market, and have another Madoff year (one with zero trading losses) but you will have to do it without what was once called the "investing public." They are now permanently gone until two things happen: i) the market is once again a market, not artificially propped up by $14 trillion in central bank liquidity which makes every asset "price" a illusion, and ii) HFT frontrunning is no longer legal, endorsed and blessed by the SEC, the regulators and all law enforcement agencies.

[Fenix]

So This Is Why The "Smart Money" Was Selling The Most Stocks In History
Submitted by Tyler D.
08/25/2015 18:20 -0400

Precisely two months ago, we reported something very troubling, namely that "The "Smart Money" Just Sold The Most Stocks In History." This is what BofA reported at the time: "BofAML clients were big net sellers of US stocks in the amount of $4.1bn, following four weeks of net buying. Net sales were the largest since January 2008 and led by institutional clients—after three weeks of net buying, institutional clients’ net sales last week were the largest in our data history."

Just to make sure the message was heard loud and clear we followed up ten days later with "The "Smartest Money" Is Liquidating Stocks At A Record Pace: "Selling Everything That’s Not Bolted Down"

We got definitive confirmation that the truly "smartest money in the room", those who dabble not in the bipolar public markets but in private equity had indeed started "selling everything that is not nailed down" several years ago hitting a climax this past quarter, when Bloomberg reported that two years after Leon Black's infamous statement, "other private-equity firms are following suit - dumping stakes into the markets at a record clip."

According to Bloomberg data, firms including Blackstone Group and TPG have been "capitalizing on record stock markets around the world to sell shares, mostly in their companies that have already gone public. Globally, buyout firms conducted 97 stock offerings in the second quarter, more than in any other three-month period."

What happened next should not have been a surprise to our readers: as we reported shortly thereafter, the divergence between the "smart money flow" and the S&P 500 - which at this point was merely reflecting HFT momentum ignition traps and the occasional stray retail investor - had reached unseen proportions:



So following the biggest (and only) market correction in years, the biggest weekly surge in the VIX ever, the second wholesale market flash crash in history coupled with the first ever limit down trade in the Nasdaq and the E-Mini, not to mention the biggest intraday bearish reversal since Lehman, it would appear that the "smart money" was aptly named (and hopefully wasn't selling to you).

And, lo and behold, following the dramatic market moves of the past two weeks, the S&P has finally caught up with the Smart Money flow.



A quick reminder of the "Smart Money Flow" index in question:

The Bloomberg Smart Money Flow Index is calculated by taking the action of the Dow in two time periods: the first 30 minutes and the close. The first 30 minutes represent emotional buying, driven by greed and fear of the crowd based on good and bad news. There is also a lot of buying on market orders and short covering at the opening. Smart money waits until the end and they very often test the market before by shorting heavily just to see how the market reacts. Then they move in the big way. These heavy hitters also have the best possible information available to them and they do have the edge on all the other market participants. To replicate this index, just start at any given day, subtract the price of the Dow at 10 AM from the previous day's close and add today's closing price. Whenever the Dow makes a high which is not confirmed by the SMFI there is trouble ahead.

Starting sometime in February, the smart money started getting out of Dodge, and yes, "there was troubled ahead."



Is China Quietly Targeting A 20% Devaluation?

Submitted by Tyler D.
08/25/2015 19:08 -0400

When China took the "surprising" (to anyone who was naive enough to think that the country’s economy isn’t in absolute free fall) step of resorting to a dramatic yuan devaluation on the heels of multiple ineffectual policy rate cuts, Beijing pitched the move as a "one-off" effort to erase a ~3% persistent dislocation in the market.

Seeing the effort for what it most certainly was - a tacit admission of underlying economic malaise and a last ditch effort to rescue the export-driven economy via an epic beggar thy neighbor along with the whole damn EM neighborhood competitive devaluation - analysts were quick to note that the PBoC may ultimately be targeting a 10% or more depreciation in order to provide a sufficient boost to exports.

Well, official protestations to the contrary, it appears as though even some Party agencies are assuming a much weaker yuan both over the near- and medium-term. Here’s Bloomberg:

Some Chinese agencies involved in economic affairs have begun to assume in their research that the yuan will weaken to 7 to the dollar by the end of the year, said people familiar with the matter.



The research further factors in the yuan falling to 8 to the dollar by the end of 2016, according to the people, who asked not to be identified because the studies haven’t been made public.



Those projections -- which suggest a depreciation of more than 8 percent by Dec. 31 and about 20 percent by the end of 2016 -- were adopted after the currency was devalued this month and compare with analysts’ forecasts for the yuan to reach 6.5 to the dollar by the end of this year.



While the rate used in the research isn’t a government target, it suggests China may allow the yuan to fall further after a depreciation in which the currency was allowed to weaken by nearly three percent on Aug. 11 and 12. The yuan weakened for a second day in Shanghai to 6.4124.



“It wouldn’t be totally unreasonable for China to allow a weakening like this,” said Zhou Hao, an economist at Commerzbank AG in Singapore, referring to the 7 level against the dollar at the end of this year. “A certain level of depreciation can be accepted according to China’s international payments situation, but it may bring unforeseeable pressure on foreign debt repayments and capital outflows.”



The rate used in the research constitutes reference levels used for economic assessments and projections, according to the people. The PBOC didn’t respond to a fax seeking comment.

A dollar-yuan rate of 7 would be a more than 8 percent depreciation from Tuesday’s level. At an Aug. 13 briefing on the yuan, PBOC Deputy Governor Yi Gang dismissed the idea that China would devalue the yuan by 10 percent to boost exports, calling it “nonsense.”

Yes, "nonsense", just like how Chinese QE "doesn't exist" despite the fact that untold billions in stocks have been transferred from CSF to the sovereign wealth fund just so the PBoC can continue to insist that its balance sheet isn't expanding.

In any event, a more dramatic devaluation may ultimately be necessary not only to boost exports, but to alleviate the necessity of interveing constantly to arrest the yuan's slide. As BNP's Mole Hau put it in a note out Monday, "what appears to have happened is that, whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term." Which explains why the FX reserve drain may well be continuing unabated causing the massive liquidity crunch that's forced the PBoC to inject hundreds of billions of liquidity via reverse repos and ultimately forced today's RRR cut.

Of couse as we said earlier today, "while global markets received China's announcement with their typical 'a central bank just came to our rescue' exuberance, the reality is that as least today's RRR cut will have zero impact on spurring aggregate demand, and is merely a delayed response to FX interventions that have already taken place [which means] for China to net ease, it will have to do more, much more [but] ironically, doing so, will merely accelerate the capital outflows as a result of the ongoing plunge in the CNY, which leads to the circular logic of China's intervention ... the more it intervenes in an attempt to stabilize every aspect of its economy and finance, the more it will have to intervene, until either it wins, or something snaps."

Ultimately, that "something" may end up being the daily yuan management effort because the intervention game is getting expensive and incremental easing will only make it more so.

A free float may be the better option and if the passages excerpted above from Bloomberg are any indication, the yuan is going to be much, much lower by the end of next year one way or another. The only question is how much pain China incurs on the way there. We'll close with the following quote from SocGen:

If the PBoC wants to stabilise currency expectations for good, there are only two ways to achieve this: complete FX flexibility or zero FX flexibility. At present, the latter is also increasingly unviable, since the capital account is much more open. Therefore, the PBoC has merely to keep selling FX reserves until it lets go.

[Fenix]

"Biggest Rally Of 2015" Crashes Into Biggest Reversal Since Lehman
Submitted by Tyler D.
08/25/2015 - 16:06




1929 And Its Aftermath - A Contra-Keynesian View Of What Really Happened
08/25/2015 18:45 -0400

Submitted by Murray N. Rothbard
[First published in Inquiry, November 12, 1979.]

A half-century ago, America — and then the world — was rocked by a mighty stock-market crash that soon turned into the steepest and longest-lasting depression of all time.

It was not only the sharpness and depth of the depression that stunned the world and changed the face of modern history: it was the length, the chronic economic morass persisting throughout the 1930s, that caused intellectuals and the general public to despair of the market economy and the capitalist system.

Previous depressions, no matter how sharp, generally lasted no more than a year or two. But now, for over a decade, poverty, unemployment, and hopelessness led millions to seek some new economic system that would cure the depression and avoid a repetition of it.

Political solutions and panaceas differed. For some it was Marxian socialism — for others, one or another form of fascism. In the United States the accepted solution was a Keynesian mixed-economy or welfare-warfare state. Harvard was the focus of Keynesian economics in the United States, and Seymour Harris, a prominent Keynesian teaching there, titled one of his many books Saving American Capitalism. That title encapsulated the spirit of the New Deal reformers of the ’30s and ’40s. By the massive use of state power and government spending, capitalism was going to be saved from the challenges of communism and fascism.

One common guiding assumption characterized the Keynesians, socialists, and fascists of the 1930s: that laissez-faire, free-market capitalism had been the touchstone of the US economy during the 1920s, and that this old-fashioned form of capitalism had manifestly failed us by generating, or at least allowing, the most catastrophic depression in history to strike at the United States and the entire Western world.

Well, weren’t the 1920s, with their burgeoning optimism, their speculation, their enshrinement of big business in politics, their Republican dominance, their individualism, their hedonistic cultural decadence, weren’t these years indeed the heyday of laissez-faire? Certainly the decade looked that way to most observers, and hence it was natural that the free market should take the blame for the consequences of unbridled capitalism in 1929 and after.

Unfortunately for the course of history, the common interpretation was dead wrong: there was very little laissez-faire capitalism in the 1920s. Indeed the opposite was true: significant parts of the economy were infused with proto–New Deal statism, a statism that plunged us into the Great Depression and prolonged this miasma for more than a decade.

In the first place, everyone forgot that the Republicans had never been the laissez-faire party. On the contrary, it was the Democrats who had always championed free markets and minimal government, while the Republicans had crusaded for a protective tariff that would shield domestic industry from efficient competition, for huge land grants and other subsidies to railroads, and for inflation and cheap credit to stimulate purchasing power and apparent prosperity.

It was the Republicans who championed paternalistic big government and the partnership of business and government while the Democrats sought free trade and free competition, denounced the tariff as the “mother of trusts,” and argued for the gold standard and the separation of government and banking as the only way to guard against inflation and the destruction of people’s savings. At least that was the policy of the Democrats before Bryan and Wilson at the start of the 20th century, when the party shifted to a position not very far from its ancient Republican rivals.

The Republicans never shifted, and their reign in the 1920s brought the federal government to its greatest intensity of peacetime spending and hiked the tariff to new, stratospheric levels. A minority of old-fashioned “Cleveland” Democrats continued to hammer away at Republican extravagance and big government during the Coolidge and Hoover eras. Those included Governor Albert Ritchie of Maryland, Senator James Reed of Missouri, and former Solicitor General James M. Beck, who wrote two characteristic books in this era: The Vanishing Rights of the States and Our Wonderland of Bureaucracy.

But most important in terms of the depression was the new statism that the Republicans, following on the Wilson administration, brought to the vital but arcane field of money and banking. How many Americans know or care anything about banking? Yet it was in this neglected but crucial area that the seeds of 1929 were sown and cultivated by the American government.

The United States was the last major country to enjoy, or be saddled with, a central bank. All the major European countries had adopted central banks during the 18th and 19th centuries, which enabled governments to control and dominate commercial banks, to bail out banking firms whenever they got into trouble, and to inflate money and credit in ways controlled and regulated by the government. Only the United States, as a result of Democratic agitation during the Jacksonian era, had had the courage to extend the doctrine of classical liberalism to the banking system, thereby separating government from money and banking.

Having deposed the central bank in the 1830s, the United States enjoyed a freely competitive banking system — and hence a relatively “hard” and noninflated money — until the Civil War. During that catastrophe, the Republicans used their one-party dominance to push through their interventionist economic program. It included a protective tariff and land grants to railroads, as well as inflationary paper money and a “national banking system” that in effect crippled state-chartered banks and paved the way for the later central bank.

The United States adopted its central bank, the Federal Reserve System, in 1913, backed by a consensus of Democrats and Republicans. This virtual nationalization of the banking system was unopposed by the big banks; in fact, Wall Street and the other large banks had actively sought such a central system for many years. The result was the cartelization of banking under federal control, with the government standing ready to bail out banks in trouble, and also ready to inflate money and credit to whatever extent the banks felt was necessary.

Without a functioning Federal Reserve System available to inflate the money supply, the United States could not have financed its participation in World War I: that war was fueled by heavy government deficits and by the creation of new money to pay for swollen federal expenditures.

One point is undisputed: the autocratic ruler of the Federal Reserve System, from its inception in 1914 to his death in 1928, was Benjamin Strong, a New York banker who had been named governor of the Federal Reserve Bank of New York. Strong consistently and repeatedly used his power to force an inflationary increase of money and bank credit in the American economy, thereby driving prices higher than they would have been and stimulating disastrous booms in the stock and real-estate markets. In 1927, Strong gaily told a French central banker that he was going to give “a little coup de whiskey to the stock market.” What was the point? Why did Strong pursue a policy that now can seem only heedless, dangerous, and recklessly extravagant?

Once the government has assumed absolute control of the money-creating machinery in society, it benefits — as would any other group — by using that power. Anyone would benefit, at least in the short run, by printing or creating new money for his own use or for the use of his economic or political allies.

Strong had several motives for supporting an inflationary boom in the 1920s. One was to stimulate foreign loans and foreign exports. The Republican party was committed to a policy of partnership of government and industry, and to subsidizing domestic and export firms. A protective tariff aided inefficient domestic producers by keeping out foreign competition. But if foreigners were shut out of our markets, how in the world were they going to buy our exports? The Republican administration thought it had solved this dilemma by stimulating American loans to foreigners so that they could buy our products.

A fine solution in the short run, but how were these loans to be kept up, and, more important, how were they to be repaid? The banking community was also confronted with the curious and ultimately self-defeating policy of preventing foreigners from selling us their products, and then lending them the money to keep buying ours. Benjamin Strong’s inflationary policy meant repeated doses of cheap credit to stimulate this foreign lending. It should also be noted that this policy subsidized American investment banks in making foreign loans.

Among the exports stimulated by cheap credit and foreign loans were farm products. American agriculture, overstimulated by the swollen demands of warring European nations during World War I, was a chronically sick industry during the 1920s. It had awakened after the resumption of peace to find that farm prices had fallen and that European demand was down. Rather than adjusting to postwar realities, however, American farmers preferred to organize and agitate to force taxpayers and consumers to keep them in the style to which they had become accustomed during the palmy “parity” years of the war. One way for the federal government to bow to this political pressure was to stimulate foreign loans and hence to encourage foreign purchases of American farm products.

The “farm bloc,” it should be noted, included not only farmers; more indirect and considerably less rustic interests were also busily at work. The postwar farm bloc gained strong support from George N. Peek and General Hugh S. Johnson; both, later prominent in the New Deal, were heads of the Moline Plow Company, a major manufacturer of farm machinery that stood to benefit handsomely from government subsidies to farmers. When Herbert Hoover, in one of his first acts as president — considerably before the crash — established the Federal Farm Board to raise farm prices, he installed as head of the FFB Alexander Legge, chairman of International Harvester, the nation’s leading producer of farm machinery. Such was the Republican devotion to “laissez faire.”

But a more indirect and ultimately more important motivation for Benjamin Strong’s inflationary credit policies in the 1920s was his view that it was vitally important to “help England,” even at American expense. Thus, in the spring of 1928, his assistant noted Strong’s displeasure at the American public’s outcry against the “speculative excesses” of the stock market.

The public didn’t realize, Strong thought, that “we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis.” An unexceptionable statement, provided that we clear up some euphemisms. For the “decision” was taken by Strong in camera, without the knowledge or participation of the American people; the decision was to inflate money and credit, and it was done not to help the “rest of the world” but to help sustain Britain’s unsound and inflationary policies.

Before the World War, all the major nations were on the gold standard, which meant that the various currencies — the dollar, pound, mark, franc, etc. — were redeemable in fixed weights of gold. This gold requirement ensured that governments were strictly limited in the amount of scrip they could print and pour into circulation, whether by spending to finance government deficits or by lending to favored economic or political groups. Consequently, inflation had been kept in check throughout the 19th century when this system was in force.

But world war ruptured all that, just as it destroyed so many other aspects of the classical-liberal polity. The major warring powers spent heavily on the war effort, creating new money in bushel baskets to pay the expense. Inflation was consequently rampant during and after World War I and, since there were far more pounds, marks, and francs in circulation than could possibly be redeemed in gold, the warring countries were forced to go off the gold standard and to fall back on paper currencies — all, that is, except for the United States, which was embroiled in the war for a relatively short time and could therefore afford to remain on the gold standard.

After the war, the nations faced a world currency breakdown with rampant inflation and chaotically falling exchange rates. What was to be done? There was a general consensus on the need to go back to gold, and thereby to eliminate inflation and frantically fluctuating exchange rates. But how to go back? That is, what should be the relations between gold and the various currencies?

Specifically, Britain had been the world’s financial center for a century before the war, and the British pound and the dollar had been fixed all that time in terms of gold so that the pound would always be worth $4.86. But during and after the war the pound had been inflated relatively far more than the dollar, and thus had fallen to about $3.50 on the foreign-exchange market. But Britain was adamant about returning the pound, not to the realistic level of $3.50, but rather to the old prewar par of $4.86.

Why the stubborn insistence on going back to gold at the obsolete prewar par? Part of the reason was a stubborn and mindless concentration on saving face and British honor, on showing that the old lion was just as strong and tough as before the war. Partly, it was a shrewd realization by British bankers that if the pound were devalued from prewar levels England would lose its financial preeminence, perhaps to the United States, which had been able to retain its gold status.

So, under the spell of its bankers, England made the fateful decision to go back to gold at $4.86. But this meant that Britain’s exports were now made artificially expensive and its imports cheaper, and since England lived by selling coal, textiles, and other products, while importing food, the resulting chronic depression in its export industries had serious consequences for the British economy. Unemployment remained high in Britain, especially in its export industries, throughout the boom of the 1920s.

To make this leap backward to $4.86 viable, Britain would have had to deflate its economy so as to bring about lower prices and wages and make its exports once again inexpensive abroad. But it wasn’t willing to deflate since that would have meant a bitter confrontation with Britain’s now-powerful unions. Ever since the imposition of an extensive unemployment-insurance system, wages in Britain were no longer flexible downward as they had been before the war. In fact, rather than deflate, the British government wanted the freedom to keep inflating, in order to raise prices, do an end run around union wage rates, and ensure cheap credit for business.

The British authorities had boxed themselves in: They insisted on several axioms. One was to go back to gold at the old prewar par of $4.86. This would have made deflation necessary, except that a second axiom was that the British continue to pursue a cheap credit, inflationary policy rather than deflation. How to square the circle? What the British tried was political pressure and arm-twisting on other countries, to try to induce or force them to inflate too. If other countries would also inflate, the pound would remain stable in relation to other currencies; Britain would not keep losing gold to other nations, which endangered its own jerry-built monetary structure.

On the defeated and small new countries of Europe, Britain’s pressure was notably successful. Using their dominance in the League of Nations and especially in its Financial Committee, the British forced country after country not only to return to gold, but to do so at overvalued rates, thereby endangering those nations’ exports and stimulating imports from Britain. And the British also flummoxed these countries into adopting a new form of gold “exchange” standard, in which they kept their reserves not in gold, as before, but in sterling balances in London.

In this way, the British could continue to inflate; and pounds, instead of being redeemed in gold, were used by other countries as reserves on which to pyramid their own paper inflation. The only stubborn resistance to the new order came from France, which had a hard-money policy into the late 1920s. It was French resistance to the new British monetary order that was ultimately fatal to the house of cards the British attempted to construct in the 1920s.

The United States was a different situation altogether. Britain could not coerce the United States into inflating in order to save the misbegotten pound, but it could cajole and persuade. In particular, it had a staunch ally in Benjamin Strong, who could always be relied on to be a willing servitor of British interests. By repeatedly agreeing to inflate the dollar at British urging, Benjamin Strong won the plaudits of the British financial press as the best friend of Great Britain since Ambassador Walter Hines Page, who had played a key role in inducing the United States to enter the war on the British side.

Why did Strong do it? We know that he formed a close friendship with British financial autocrat Montagu Norman, longtime head of the Bank of England. Norman would make secret visits to the United States, checking in at a Saratoga Springs resort under an assumed name, and Strong would join him there for the weekend, also incognito, there to agree on yet another inflationary coup de whiskey to the market.

Surely this Strong–Norman tie was crucial, but what was its basic nature? Some writers have improbably speculated on a homosexual liaison to explain the otherwise mysterious subservience of Strong to Norman’s wishes. But there was another, and more concrete and provable, tie that bound these two financial autocrats together.

That tie involved the Morgan banking interests. Benjamin Strong had lived his life in the Morgan ambit. Before being named head of the Federal Reserve, Strong had risen to head of the Bankers Trust Company, a creature of the Morgan bank. When asked to be head of the Fed, he was persuaded to take the job by two of his best friends, Henry P. Davison and Dwight Morrow, both partners of J.P. Morgan & Co.

The Federal Reserve System arrived at a good time for the Morgans. It was needed to finance America’s participation in World War I, a participation strongly supported by the Morgans, who played a major role in bringing the Wilson administration into the war. The Morgans, heavily invested in rail securities, had been caught short by the boom in industrial stocks that emerged at the turn of the century. Consequently, much of their position in investment-banking was being eroded by Kuhn, Loeb & Co., which had been faster off the mark on investment in industrial securities.

World War I meant economic boom or collapse for the Morgans. The House of Morgan was the fiscal agent for the Bank of England: it had the underwriting concession for all sales of British and French bonds in the United States during the war, and it helped finance US arms and munitions sales to Britain and France. The House of Morgan had a very heavy investment in an Anglo-French victory and a German-Austrian defeat. Kuhn, Loeb, on the other hand, was pro-German, and therefore was tied more to the fate of the Central Powers.

The cement binding Strong and Norman was the Morgan connection. Not only was the House of Morgan intimately wrapped up in British finance, but Norman himself — as well as his grandfather — in earlier days had worked in New York for the powerful investment banking firm of Brown Brothers, and hence had developed close personal ties with the New York banking community. For Benjamin Strong, helping Britain meant helping the House of Morgan to shore up the internally contradictory monetary structure it had constructed for the postwar world.

The result was inflationary credit, a speculative boom that could not last, and the Great Crash whose 50th anniversary we observe this year. After Strong’s death in late 1928, the new Federal Reserve authorities, while confused on many issues, were no longer consistent servitors of Britain and the Morgans. The deliberate and consistent policy of inflation came to an end, and a corrective depression soon arrived.

There are two mysteries about the Great Depression, mysteries having two separate and distinct solutions. One is, why the crash? Why the sudden crash and depression in the midst of boom and seemingly permanent prosperity? We have seen the answer: inflationary credit expansion propelled by the Federal Reserve System in the service of various motives, including helping Britain and the House of Morgan.

But there is another vital and very different problem. Given the crash, why did the recovery take so long? Usually, when a crash or financial panic strikes, the economic and financial depression, be it slight or severe, is over in a few months or a year or two at the most. After that, economic recovery will have arrived. The crucial difference between earlier depressions and that of 1929 was that the 1929 crash became chronic and seemed permanent.

What is seldom realized is that depressions, despite their evident hardship on so many, perform an important corrective function. They serve to eliminate the distortions introduced into the economy by an inflationary boom. When the boom is over, the many distortions that have entered the system become clear: prices and wage rates have been driven too high, and much unsound investment has taken place, particularly in capital-goods industries.

The recession or depression serves to lower the swollen prices and to liquidate the unsound and uneconomic investments; it directs resources into those areas and industries that will most-effectively serve consumer demands — and were not allowed to do so during the artificial boom. Workers previously misdirected into uneconomic production, unstable at best, will, as the economy corrects itself, end up in more secure and productive employment.

The recession must be allowed to perform its work of liquidation and restoration as quickly as possible, so that the economy can be allowed to recover from boom and depression and get back to a healthy footing. Before 1929, this hands-off policy was precisely what all US governments had followed, and hence depressions, however sharp, would disappear after a year or so.

But when the Great Crash hit, America had recently elected a new kind of president. Until the past decade, historians have regarded Herbert Clark Hoover as the last of the laissez-faire presidents. Instead, he was the first New Dealer.

Hoover had his bipartisan aura, and was devoted to corporatist cartelization under the aegis of big government; indeed, he originated the New Deal farm-price-support program. His New Deal specifically centered on his program for fighting depressions. Before he assumed office, Hoover determined that should a depression strike during his term of office, he would use the massive powers of the federal government to combat it. No more would the government, as in the past, pursue a hands-off policy.

As Hoover himself recalled the crash and its aftermath,

The primary question at once arose as to whether the President and the federal government should undertake to investigate and remedy the evils. … No President before had ever believed that there was a governmental responsibility in such cases. … Presidents steadfastly had maintained that the federal government was apart from such eruptions … therefore, we had to pioneer a new field.

In his acceptance speech for the presidential renomination in 1932, Herbert Hoover summed it up:

We might have done nothing. … Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. … No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times.

The massive Hoover program was, indeed, a characteristically New Deal one: vigorous action to keep up wage rates and prices, to expand public works and government deficits, to lend money to failing businesses to try to keep them afloat, and to inflate the supply of money and credit to try to stimulate purchasing power and recovery. Herbert Hoover during the 1920s had pioneered the proto-Keynesian idea that high wages are necessary to assure sufficient purchasing power and a healthy economy. The notion led him to artificially raising wages — and consequently to aggravating the unemployment problem — during the depression.

As soon as the stock market crashed, Hoover called in all the leading industrialists in the country for a series of White House conferences in which he successfully bludgeoned the industrialists, under the threat of coercive government action, into propping up wage rates — and hence causing massive unemployment — while prices were falling sharply. After Hoover’s term, Franklin D. Roosevelt simply continued and expanded Hoover’s policies across the board, adding considerably more coercion along the way. Between them, the two New Deal presidents managed the unprecedented feat of making the depression last a decade, until we were lifted out of it by our entry into World War II.

If Benjamin Strong got us into a depression and Herbert Hoover and Franklin D. Roosevelt kept us in it, what was the role in all this of the nation’s economists, watchdogs of our economic health? Unsurprisingly, most economists, during the depression and ever since, have been much more part of the problem than of the solution. During the 1920s, establishment economists, led by Professor Irving Fisher of Yale, hailed the 20s as the start of a “New Era,” one in which the new Federal Reserve System would ensure permanently stable prices, avoiding either booms or busts.

Unfortunately, the Fisherites, in their quest for stability, failed to realize that the trend of the free and unhampered market is always toward lower prices as productivity rises and mass markets develop for particular products. Keeping the price level stable in an era of rising productivity, as in the 1920s, requires a massive artificial expansion of money and credit. Focusing only on wholesale prices, Strong and the economists of the 1920s were willing to engender artificial booms in real estate and stocks, as well as malinvestments in capital goods, so long as the wholesale price level remained constant.

As a result, Irving Fisher and the leading economists of the 1920s failed to recognize that a dangerous inflationary boom was taking place. When the crash came, Fisher and his disciples of the Chicago School again pinned the blame on the wrong culprit. Instead of realizing that the depression process should be left alone to work itself out as rapidly as possible, Fisher and his colleagues laid the blame on the deflation after the crash and demanded a reinflation (or “reflation”) back to 1929 levels.

In this way, even before Keynes, the leading economists of the day managed to miss the problem of inflation and cheap credit and to demand policies that only prolonged the depression and made it worse. After all, Keynesianism did not spring forth full-blown with the publication of Keynes’s General Theory in 1936.

We are still pursuing the policies of the 1920s that led to eventual disaster. The Federal Reserve is still inflating the money supply and inflates it even further with the merest hint that a recession is in the offing. The Fed is still trying to fuel a perpetual boom while avoiding a correction on the one hand or a great deal of inflation on the other.

In a sense, things have gotten worse. For while the hard-money economists of the 1920s and 1930s wished to retain and tighten up the gold standard, the “hard-money” monetarists of today scorn gold, are happy to rely on paper currency, and feel that they are boldly courageous for proposing not to stop the inflation of money altogether, but to limit the expansion to a supposedly fixed amount.

Those who ignore the lessons of history are doomed to repeat it — except that now, with gold abandoned and each nation able to print currency ad lib, we are likely to wind up, not with a repeat of 1929, but with something far worse: the holocaust of runaway inflation that ravaged Germany in 1923 and many other countries during World War II. To avoid such a catastrophe we must have the resolve and the will to cease the inflationary expansion of credit, and to force the Federal Reserve System to stop purchasing assets, and thereby to stop its continued generation of chronic, accelerating inflation.

[Fenix]

Devaluation Stunner: China Has Dumped $100 Billion In Treasurys In The Past Two Weeks

Submitted by Tyler D.
08/25/2015 20:16 -0400

On August 11, China devalued its currency, and in the subsequent 3 days the onshore Yuan, the CNY, tumbled by some 4% against the dollar. Then, as if by magic, the CNY stabilized when China started intervening massively, only this time not through the fixing, but in the actual FX market.

This means that while China has previously been dumping reserves as a matter of FX policy, after August 11 it was intervening directly in the FX market, with the intervention said to really pick up after the FOMC Minutes on August 19, the same day the market finally topped out, and has tumbled into a correction since then. The result was the same: massive FX reserve liquidations to defend the currency one way or the other.

And yet something curious emerges when comparing the traditionally tight, and inverse, relationship between the S&P and the Treausry long-end: the tumble in stocks has not been anywhere near as profound as the jump in yields. In fact, the 30 Year is wider now than where it was the day China announced the Yuan devaluation.

Why is that?

We hinted at the answer on two occasions earlier (here and here) and yet the point is so critical, and was missed by virtually all readers, that it deserves to be repeated once again: as part of China's devaluation and subsequent attempts to contain said devaluation, it has been purging foreign reserves at an epic pace. Said otherwise, China has sold an epic amount of Treasurys in the past two weeks.

How epic? We turn it over to SocGen once again:

The PBoC cut the RRR for all banks by 50bp and offered additional reductions for leasing companies (300bp) and rural banks (50bp). All these will take effect as of 6 September, and the total amount of liquidity injected will be close to CNY700bn, or $106bn based on today's onshore exchange rate. In perspective, the PBoC may have sold more official FX reserves than this amount since the currency regime change on 11 August.

There you have it: in the past two weeks alone China has sold a gargantuan $106 (or more) billion in US paper just as a result of the change in the currency regime!

But wait, there's more: recall that one months ago we posted that "China's Record Dumping Of US Treasuries Leaves Goldman Speechless" in which we reported that China has sold some $107 billion in Treasurys since the start of 2015.

When we did that article, we too were quite shocked at that number. However, we - just like Goldman - are absolutely speechless to find out that China has sold as much in Treasurys in the past 2 weeks, over $100 billion, as it has sold in the entire first half of the year!

In retrospect, it is absolutely amazing that the 10 and 30 Year Bonds have cratered considering the amount of concentrated selling by China.

But the bigger question is how much more does China have left to sell, if this pace of outflows continues. Here is SocGen again:

From an operational perspective, China's FX reserves are estimated to be two-thirds made up of relatively liquid assets. According to TIC data, China held $1,271bn US treasuries end-June 2015, but treasury bills and notes accounted for only $3.1bn. The currency composition is said to be similar to the IMF's COFER data: 2/3 USD, 1/5 EUR and 5% each of GBP and JPY. Given that EUR and JPY depreciation contributed the most to the RMB's NEER appreciation in the past year, it is plausible that

the PBoC may not limit its intervention to selling only USD-denominated assets.


China's FX reserves are still 134% of the recommended level, or in other words, around $900bn (1/4 of total) and can be used for currency intervention without severely impacting China's external position.

Should the current pace of liquidity outflows continue, and require the dumping of $100 billion in FX reserves, read US Treasurys, every two weeks this means China has, oh, call it some 18 weeks of intervention left.

What happens when China liquidates all of its Treasury holdings is anyone's guess, and an even better question is will anyone else decide to join China as its sells US Treasurys at a never before seen pace, and best of all: will the Fed just sit there and watch as the biggest offshore holder of US Treasurys liquidates its entire inventory...