Month: September 2016

September 30, 2016September 29, 2016

September 23 – September 29, 2016

Venezuela on the brink.

This post is number 52. A full year down and I hope that you’ve found value in the Janus Observer. Thank you for everyone that has been following this blog. More to come.

Sincerely,

J. Duff Janus

Headlines

FT – Niger Delta militants attack oil pipeline 9/24. “Attacks on oil installations have cut production by 40% this year.”
Bloomberg – OPEC Agrees to First Oil Output Cut in Eight Years 9/28. OPEC has agreed to cut production by about 750,000 barrels a day starting in November.

Briefs

David Crow of the Financial Times covered BlackBerry’s recent decision to hang up its handset business.

BlackBerry is dropping its hardware division and will focus on software and services.
“At its zenith in 2008, BlackBerry accounted for one in every five smartphones sold…”
“As sales soared, the company’s market value hit $80bn, compared with roughly $4bn today.”
Going forward the company is striking licensing deals in Indonesia to manufacture and promote its devices in the country – BlackBerry is pursuing a similar strategy in India and China.

Anjie Zheng of the Wall Street Journal highlighted how the high office rents in Hong Kong are leading some mainland Chinese companies to buy the building instead.

“At an annual $278.50 a square foot for prime office space, rental rates are on average nearly 80% higher in Hong Kong than in Manhattan, according to an annual ranking by property consultancy Knight Frank.”
“Chinese interest has pushed up Hong Kong building prices to the point that they are rarely attractive investment opportunities to other companies, said Denis Ma, head of research at Jones Lang LaSalle in Hong Kong.”
“The flurry of buying by mainland investors has pushed the yields, or the amount made on rents divided by the price of a building, down to 2.5% to 3% from 4% just four years ago, said Mr. Ma.”

Tracy Alloway of Bloomberg pointed out how something as benign as improving efficiencies resulting from standardization in the oil and gas industry has become a major factor in bringing down oil prices.

“Even as oil producers have planned $1 trillion worth of spending reductions between 2015-to-2020 – cutting staff, delaying projects, and squeezing contractors-they’ve continued to green-light new wells from the Norwegian Sea to Brazil, and from Uganda to the Gulf of Mexico. Those initiatives mean oil production will continue to grow, adding to the supply glut and putting downward pressure on prices.”
Bottom line: industry standardization and joint efforts in improving efficiency.
“At Statoil, the three wells drilled at its Snorre B platform cost an average 170 million kroner ($21 million) compared with about 490 million kroner for previous projects, according to the Stavanger, Norway-based company. That means oil obtained by the platform, which began pumping some 80,000 barrels a day, costs an average of $10 a barrel.”

Special Reports / Opinion Pieces

Mauldin Economics & Geopolitical Futures – Crisis & Chaos: Are We Moving Toward World War III? (Video) – George Friedman 9/26

Graphics

Visual Capitalist – UBS Global Real Estate Bubble Index – Jeff Desjardins 9/27

FT – Rhode Island cuts its hedge fund program by two-thirds – Mary Childs 9/28

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Venezuelan oil major’s debt swap: the beginning of the end? Robin Wigglesworth and Andres Schipani. Financial Times. 25 Sep. 2016.

“The head of Petroleos de Venezuela (PDVSA) last week unveiled plans to swap more than $7bn of bonds maturing next year with longer-dated debts due in 2020. To sweeten the deal for investors, PDVSA offered up its US subsidiary Citgo Petroleum as collateral.”

“S&P (the ratings agency) said it would constitute a default by PDVSA, and many analysts see the move as a curtain-raiser the move as a curtain-raiser for an inevitable restructuring of Venezuela’s national debts.”

“S&P last week lowered its grade on the affected bonds to triple-C, one of the lowest rungs possible, and said that if the swap goes through it would be considered a ‘distressed exchange’ and therefore a formal default. This would not directly affect the country’s creditworthiness, but S&P warned that a ‘sovereign default seems inevitable.'”

“PDVSA’s proposed debt swap is also complicated by the proposal to offer up to 50.1% of Citgo as security of bondholders who agree to the deal. Firstly, it is already the state oil company’s main ‘seizable’ asset in case of default; secondly, if it is fully pledged to underpin the bond swap then it would in practice deprive other bondholders of their main security.”

“Lawyers say this would therefore probably fall foul of the ‘negative pledge’ clause in PDVSA’s existing bonds. Tellingly, the 442 pages of documentation on the debt swap lists no law firms or investment banks involved.”

“If the deal collapses, then it worsens Venezuela’s predicament. Absent a deal, the country and PDVSA will jointly have to come up with some $15bn over the next 14 months for debt repayments. Although the government does not guarantee PDVSA’s debts, some lawyers say that in practice it would be hard to disentangle a full default and restructuring of the oil company from its parent, the state.”

“The country’s reserves are ‘critically low’ at $11.9bn, S&P notes, down from $16bn at the start of the year. And most of the reserves are in gold, which are hard to liquidate in a hurry without crashing prices.”
Other Interesting Articles

The Economist

A trans-Pacific obsession – Bottling hipness: Japan ponders the true meaning of Portland
Banyan – A ham-fisted hegemon: Despite its economic and military might, China lacks the finesse to shape Asia to its liking
Autonomous car insurance – Look, no claims! Self-driving cars are set radically to change motor insurance
- “The motor-insurance market may shrink by 60% by 2040, according to KPMG, an accounting firm.”
Asian markets – Chinese sneezes: Financial contagion from China now rivals that from America

Bloomberg – Blackstone’s Top Dealmaker Says Now Is The Most Difficult Period He’s Ever Experienced 9/27

Contra Corner – Dangerous Bubbles in Plain Site 9/27

Economist – Italy’s constitutional referendum 9/28

FT – China’s economic fate rests on its housing market 9/22

FT – How to value (worthless) Venezuelan oil bonds 9/23

FT – Wounds from the 2008 financial crisis are still bleeding 9/23

FT – Perry Capital to shut down after 28 years 9/26

FT – InterContinental drops on Airbnb fears 9/26

FT – China cities move to halt housing market frenzy 9/26

FT – Stretching the truth in Chinese literature 9/26
FT – How would a Fed rate hike affect consumers? 9/27

FT – Evergrande: never more 9/27

FT – Deutsche Bank and Twitter are lost in the past 9/28

FT – How the BlackBerry phone era came to an end 9/28

NYT – An Online Education Breakthrough? A Master’s Degree for a Mere $7,000 9/28

WSJ – The Looming Storm in Insurance 9/23

WSJ – Another $10 Billion Hong Kong Stock Market Mystery 9/26

WSJ – Chinese Insurers’ Short-Term Strategy Is Getting Old 9/28

September 23, 2016September 22, 2016

September 16 – September 22, 2016

Chinese corporate debt…geez…Someone’s going to have to take a haircut. US pension crisis.

Headlines

WSJ – China’s Property Bubble Keeps Getting Bigger 9/19. “With so many parties including banks and local governments all depending on real estate, it may not make sense for them to pop the bubble.”
WSJ – China Capital Outflows Bubbles Below the Surface 9/20. “China’s outflows this year are north of $400bn, which is reflected both in a $190bn decline in the country’s foreign-exchange reserves and a weaker yuan, down about 3% this year against the dollar and more than 6% against a basket of currencies.”
FT – Drugmaker raises price of acne cream to $10,000 a tube 9/20. Chicago-based Novum Pharma has raised its price on Aloquin nearly 3,900% since May of 2015 and yet it still manages to “cost” consumers about $35 after rebates, coupons, etc.; seriously…
FT- Petrobras cuts planned investment by a quarter 9/20. “With $124bn of gross debt at the end of June, Petrobas now ranks as the world’s most heavily-indebted oil company.”

Briefs

Jeevan Vasagar of the Financial Times covered how a toxic haze killed about 100,000 people in Southeast Asia in 2015.

A recent study that was published in Environmental Research Letters, a top academic journal, indicated that the “toxic haze that spread across Southeast Asia from Indonesia forest fires last year caused the deaths of about 100,000 people across the region.”
“The death toll was concentrated in Indonesia, which had about 92,000 excess deaths from persistent haze that choked the region between July and October, according to researchers at Harvard and Columbia.”

Gabriel Wildau of the Financial Times highlighted the BIS’s recent report on China’s debt levels.

“What the BIS (Bank for International Settlements) terms the country’s ‘credit gap’ is now three times higher than the typical danger level, the research shows.”
“The BIS rates a reading above 10% as cause for concern; China’s gap hit 30.1% in March.”
“The International Monetary Fund estimated in June that Chinese companies that had borrowed a collective $1.3tn did not have enough earnings before interest, taxes, depreciation and amortization to meet interest payments.”
“China first breached the 10% threshold in 2009 and has not yet experienced a crisis. Many analysts believe that the country’s low level of foreign currency debt and its government-controlled banking system make crisis less likely.”

Mani of ValueWalk discussed Nomura’s recent analysis on China and that the “only one practical way to reduce the stock of outstanding debts: defaults.”

“China Debt Default? To alleviate its debt problem, China should adopt appropriate macro-economic policies encompassing currency depreciation and cutting interest rates to an ultra-low-level within two to three years, believe Nomura analysts. Yang Zhao and team said in their September 14 research piece titled “China: Solving the debt problem” that they believe RMB depreciation will continue and forecast USD/CNH at 7.1 at the end of 2017.”

Hudson Lockett of the Financial Times illustrated the scale of potential shadow finance losses that lurk in China.
- “Losses from bad debt in China’s shadow financing sector could amount to 3.7% of GDP, according to a new analysis of off-the-books lending and investment.”
- “The new report from CLSA also estimates shadow financing in China grew to Rmb54tn ($8.1tn) by the end of 2015 – equivalent to 79% of gross domestic product, with 64% of the total originating at or relating to mainland banks.”
- “The firm also reiterated its May estimate for Chinese banks’ non-performing loan ratio of 15%, or Rmb11.4tn, assuming the same recovery ratio of 40%, which would entail potential losses of 10% of GDP. The total losses when combined with those from bad debt in shadow financing would come to 13.7% of GDP.”
Takashi Nakamichi and Rachel Rosenthal of the Wall Street Journal discussed the Bank of Japan’s recent bond-rate target in its policy revamp.
- “The Japanese central bank, which has struggled for nearly two decades to bring about steady inflation, said Wednesday it wants to keep the yield on 10-year Japanese government bonds at zero, and will adjust the pace of its bond buying as needed to achieve that.”
- “The long-term-rate target, the first in the BOJ’s century long history, challenged conventional wisdom that rates in the huge government-bond market are ultimately set by market forces and can’t be fully controlled by an official entity. Central banks are usually assumed to have much more control over short-term rates, and many around the world target rates for debt with a term of less than a year.”
- “One worry: ‘In theory, they could be forced to buy an unlimited amount of bonds,’ said Marcel Thieliant, Japan economist at research firm Capital Economics in Singapore.”
- “Mr. Kuroda called the new policy a ‘reinforcement’ of easing. The BOJ also took the unexpected step of saying it would aim for inflation to exceed 2% instead of merely hitting it, a nod to calls from some U.S. economists for a higher target.”
Peter Wells of the Financial Times highlighted that the universe of negative-yielding sovereign debt just fell to $10.9tn.
- “The universe of negative-yielding sovereign debt fell to $10.9tn as of September 12, a drop of $1tn since June 27 largely due to yields on some longer-dated maturities moving back into positive territory, according to a new report from Fitch Ratings.”
- “Of the countries afflicted by negative yields, Switzerland has 95% of its outstanding debt trading with a yield below zero.”
- “Fitch also calculates that as a result of low and negative yields, investment income for sovereign investors globally are ‘prospectively earning nearly $500 billion less annually in investment income than they would have earned with yields available in 2011.’ The investment-grade sovereign debt market is $38bn.”

Special Reports / Opinion Pieces

Mauldin Economics – The BIS Warns on China – Ambrose Evans-Pritchard 9/19
- “No, I do not think China is going to massively implode, but the world is really not ready for a China that is only growing at 2% or 3% a year. (Even though 2-3% growth would sound pretty good if it was happening in the US.)”
NYT – How Bad Off Is Oil-Rich Venezuela? It’s Buying U.S. Oil – Nicholas Casey and Clifford Krauss 9/20

Graphics

WSJ – Japan’s Central Bank Splits Over Easing Program – Takashi Nakamichi 9/15

Bloomberg – Money Is Pouring Into Property Deals Banks Won’t Touch – Sarah Mulholland and Heather Perlberg 9/18

Economist – Chinese investment: A sponge wrung dry 9/17

WSJ – China Capital Outflows Bubbles Below the Surface – Anjani Trivedi 9/20

FT – Bond bubble brings with it an odor of rotting fish – Robin Wigglesworth 9/20

Bloomberg – Not for Sale: The Best Land in America 9/8

FT – China local governments revive off-budget fiscal stimulus – Gabriel Wildau 9/20

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Who’s next? The science of Chinese corporate defaults. James Kynge. Financial Times. 18 Sep. 2016.

“A total of 41 default cases have hit China’s domestic debt markets in the year to mid-September, more than the previous two years combined, according to Wind Information, a Shanghai-based financial data company. Some 70% of defaults by end-July were by state-owned enterprises, according to IHS, a consultancy.”

“The big picture behind China’s local government debt problem is stark. The liabilities of well over 100,000 companies problem is stark. The liabilities of well over 100,000 companies owned by local governments across the country grew at an average annual rate of 14.1% from 2012 to 2015 to reach Rmb35.4tn ($5.3tn), according to Moody’s research.”

“These are treated as contingent liabilities – or potential liabilities – because although local governments do not guarantee the debts of their corporate subsidiaries, they nevertheless are responsible for generating local economic growth, employment and public services so they would be loath to let an important contributor to such goals go under.”

“But in recent years, some local governments have built up such hefty debt burdens that even if they would like to bail out an important local employer, they may not be able to. Total direct local government debt, according to Moody’s, was Rmb16tn in 2015. Thus direct and contingent liabilities come to Rmb51tn – more than the GDPs of Japan and Germany combined.”

As to which companies to let default… “Nicholas Zhu, vice-president at Moody’s, describes a clear hierarchy of debt vulnerability. The most likely to default would be lossmaking, indebted companies owned by lower-tier governments – at the prefectural, city or county level – that have little revenue and large debts. The problem, however, with lower-tier administrations is that they often publish sparse statistics, so it is difficult to know the true state of their financial health.”

Nomura First Major Bank To Predict China Default Calculates Total debt to GDP at 309%; BIS Sounds The Alarm. Mark Melin. ValueWalk. 18 Sep. 2016.

“Nomura, which estimates China’s total debt – government and corporate debt – is Rmb211.8 trillion or 309% of GDP. The vast majority of this debt is corporate, which from a leverage perspective looks better. Non-financial sector accounted for Rmb158.5tn (231% of GDP, up by 92pp from 2007) and the financial sector for Rmb53.3tn (78% of GDP, up by 49pp).”

“The debt is up nearly 141% since 2007, which leads Nomura to conclude “a rising default rate is inevitable.”

“What this all means is that interest rates are likely to head near zero – the place at which such defaults can find their most advantageous environments. And of course, when interest rates fall, so, too, does the currency values. In the end, it is likely to become one big mess that might have global implications.”

US building up to pension crisis. Robin Wigglesworth and Barney Jopson. Financial Times. 20 Sep. 2016.

“The number are severe. According to the National Institute on Retirement Security, nearly 40m working-age households – 45% of the total – had no retirement savings whatsoever in 2013, whether an employer-sponsored 401(k) plan or an individual retirement account (IRA).”

“If you look for the black hole in the pension system, this is it. And these are the most vulnerable people in society.” – David Hunt, chief executive of PGIM, Prudential Financial’s asset management arm.

“Indeed, while younger people are less likely to have some sort of a retirement nest egg than older Americans, the biggest factor is income. Households with a retirement account have a median income of $86,235, while those without one have a median income of $35,509, according to the NIRS.”

“We have a crisis unfolding here. We’re asking people to set aside precious resources they don’t have… For millions and millions of Americans, the only thing they’ll have is Social Security.” – Russ Kamp, a pensions consultant

Social Security “together with the Supplemental Security Income program account for over 90% of the income for the bottom quarter of retirees, according to the NIRS.”

“But Social Security’s future is as uncertain as it is politically divisive. When it was set up, retirees would only have to be supported for less than 13 years on average. These days the average American can expect to draw Social Security for almost two decades, and unlike traditional public sector pension plans, it operates on a pay-as-you-go basis.”

“Citi estimated earlier this year that the unfunded liabilities were over $10tn.”

Other Interesting Articles

Bloomberg Businessweek

Not for Sale: The Best Land in America

The Economist

A giant problem: The rise of the corporate colossus threatens both competition and the legitimacy of business
- “The share of GDP generated by America’s 100 biggest companies rose from about 33% in 1994 to 46% in 2013. The five largest banks account for 45% of banking assets, up from 25% in 2000.”
Extinctions to order – Gene-ocide: The promise and peril of “gene drives”
Water in India – A kink in the hose: Shrinking supply and rising demand stir anger
Multinationals in Venezuela – Stay or go
Wages in Japan – Behind a pay wall: Raising Japanese wages is harder than it looks
American property – The REIT stuff: Explaining the boom in property-based investment trusts

Civil Beat – Kirstin Downey: Here’s What Hawaii’s Housing Crisis Looks Like 9/22

Contra Corner – Another Way of Looking at Household Income Shows Virtually No Gain 9/22

FT- Libor as a real alternative with money market rates at 2009 level 9/18

FT – China’s addiction to debt threatens the economy 9/19

FT – Monte dei Paschi shares drop below 20 cents as recapitalization stalls 9/20

InvestmentNews – Top hedge fund (Robert Citrone) forecasts biggest market correction since 2008 9/21

NYT – A Trump Empire Built on Inside Connections and $885 Million in Tax Breaks 9/17

WSJ – The Market Gets Caught in a Squeeze Play 9/18

WSJ – Why Global Rule Makers See Risks in European Banks 9/19

WSJ – The China Box-Office Boom That Wasn’t 9/20

WSJ – Bank of Japan Makes Yield Curve Maneuvers in the Dark 9/21

September 16, 2016September 16, 2016

September 9 – September 15, 2016

It appears there is no “too big to fail” in South Korea. US inflation coming only from a few unproductive sectors. China’s credit hose targeted at housing.

Headlines

NYT – Oceans Are Absorbing Almost All of the Globe’s Excess Heat 9/12. “Since 1955, more than 90% of the excess heat retained by the Earth as a result of increased greenhouse gases has been absorbed by the oceans, leaving ocean scientists like Eric Leuliette at the National Oceanic and Atmospheric Administration feeling that 90% of the climate change story is being ignored.”
NYT – ‘Lula,’ Brazil’s Ex-President, Is Charged With Corruption 9/14. It was only a matter of time once Rousseff went down.

Briefs

Richard Barley of the Wall Street Journal wrote an interesting piece on how bond markets are just waking up to their own craziness.

“Yields on “junk”-rated euro-denominated debt hit a record low of 3.35% last week.”
“Traditional signals of risk aren’t as reliable as they might be in markets that have been so distorted by central-bank policies.”
“Take the developments in junk bonds. Ultralow yields and issuance of PIK (payment-in-kind) notes might usually suggest a market that is too bullish for its own good. Demand was so strong for Schaeffler’s (bearings maker) sale that it was able to sell €3.6 billion of debt in euros and dollars, versus an originally planned €2.5 billion; in the process it refinanced debt that carried rates ranging from 5.75% to 6.875% with notes paying from 2.75% to 4.75%. Moreover, it Ardagh’s (packaging group) case, some of the proceeds were used to pay a dividend to shareholders, another sign that borrowers have the upper hand.”

Ben Bland of the Financial Times highlighted how Hong Kong is losing its status as China’s ‘great mall.’

“Retail sales in Hong Kong fell by 10% in the first seven months of the year, compared with the same period in 2015, with purchases of jewelry and watches declining by 22%.”
“‘Our customer flow has dropped 60-70%’ since the peak of Chinese luxury spending in 2013, says manager (Kingdom Jewelry) Jacky Sze. ‘I don’t have much hope for the rest of this year, or next.'”

The Economist gave some perspective on Turkey’s Gulen purges.

First there was the failed coup d’etat on President Recep Tayyip Erdogan, now there is the purge of detractors and then sum…
For those not familiar, the coup is being blamed on the Gulen community, aka the cemaat, an Islamist sect that promotes an interchange/dialogue with science. The imam that founded the movement is Fethullah Gulen who now lives in Pennsylvania.
Over 100,000 Gulen sympathizers have been rounded up so far.
“According to one minister, the state has seized more than $4 billion-worth of Gulenist assets.”
And following on the maxim to ‘never waste a good crisis.’ President Erdogan is also targeting Kurdish minorities.
However, for a little bit of context, the “secular Turks (of which President Erdogan is one) have no love for the Gulenist, who targeted them in their own purges in the 2000s.”

Also in the Economist was a piece on how shipping profits are going overboard.
- “Of the biggest 12 shipping companies that have published results for the past quarter, 11 have announced huge losses. Several weaker outfits are teetering on the edge of bankruptcy.”
- “The industry could lose as much as $10 billion this year on revenues of $170 billion, reckons Drewry, a consultancy.”
- Essentially, two primary forces are at play 1) world trade is down/slowing and many multinationals are creating manufacturing operations near their customers, and 2) there is overcapacity in the industry from the recent commodity boom.
- As a result, “sending a container from Shanghai to Europe now costs half of what it did in 2014.”

Special Reports / Opinion Pieces

FT – The twisted logic of negative interest rates – John Kay 9/9
- “All told, the primary effect of monetary policy since 2008 has been to transfer wealth to those who already hold long-term assets – both real and financial – from those who now never will. This week’s debt sale reinforces this. Henkel and Sanofi are not borrowing at negative interest rates to invest in new productive facilities. Both companies have large cash piles, and the cash generated from their operations far exceeds their investment needs.”
FT – Mongolia: Living from loan to loan – Lucy Hornby 9/12
- “Mongolia was a darling among emerging markets during the commodities boom. Foreign miners flocked to exploit the mineral wealth under its grasslands and deserts, pushing up growth in gross domestic product by 17% in 2011. But after a debt-fueled spending spree at the peak of the cycle, the landlocked country is now one of the worst hit by the downturn.”
- “Mongolia’s efforts to extricate itself highlight the dangers of the ‘resource curse’ – the notion that countries blessed with tremendous natural resources find themselves at the mercy of wealth-destroying boom-bust cycles.”

Graphics

FT – Air pollution deaths cost global economy $5tn annually – Shawn Donnan 9/8

Bloomberg – San Francisco Housing Frenzy Shifts Across the Bay to Oakland – Alison Vekshin 8/22

WSJ – Paradise Lost: Why the Good Times Are Over for Global Bonds – Richard Barley 9/14

FT – Vantage to break famine for energy IPOs – Eric Platt and Ed Crooks 9/14

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Seoul signals tougher stance with Hanjin demise. Song Jung-a. Financial Times. 11 Sep. 2016.

“Hanjin’s move to seek bankruptcy protection last month was the first time a big container shipping line had done so for 30 years, and it caught out many in the industry. As recently as a couple of months ago, shipping executives considered the failure of Hanjin Shipping – the world’s seventh-largest container line and South Korea’s largest – unthinkable.”

“Hanjin Shipping and its rival Hyundai Merchant Marine handled the bulk of South Korea’s exports, which account for more than half of the country’s $1.4tn economy.”

“Until now, Seoul has spent decades keeping lossmaking companies afloat with cheap state loans. In the case of its embattled shipbuilders, it has injected billions of dollars, despite next to no progress in turning them around.”

“How Seoul ultimately handles Hanjin Shipping’s collapse will set the tone for future restructuring of Korea Inc.”

“Many of the country’s smokestack industries – including steel, chemicals and construction – are similarly suffering from overcapacity.”

“The government has set up the principle that it will no longer support ailing companies with taxpayers’ money just because they are too big.” – Yoo Il-ho, South Korea’s finance minister

Alphaville – Least productive sectors only thing keeping inflation going. Matthew C. Klein. Financial Times. 12 Sep. 2016.

Since 1990 “…the bulk of the growth in employment can be attributed to a few sectors where productivity is either low or unmeasurable, a whopping 88% of the total rise in the price level boils down to four sectors of the US economy.”

1) Healthcare services, 2) Housing, 3) Education, and 4) Prescription drugs

“In January 1990, those four product categories only accounted for 30% of the money spent on consumption by the average American.”

And within education the main culprit has been the textbook. Akin to prescription drugs, supply in both industries is tightly controlled by regulation.

“By contrast, thanks to astounding technological innovation, television prices have plunged at an average rate of 12% each year since 1990 and computer prices have fallen more than 18% per year.”

“In general, the prices of durable goods are about a third lower now than in 1990, while the prices of nondurable goods excluding commodity products (food, drinks, and fuel, which tend to rise at the same rate as the broader price level over time) and excluding prescription drugs, have also fallen, albeit not by as much. Inflation outside of healthcare and education has generally been modest, with the notable exception of a few small professional services such as tax preparation, lawyers, and funeral homes.”

China’s Credit Fire Hose Floods Housing Market. Anjani Trivedi. Wall Street Journal. 15 Sep. 2016.

“More than 70% of new loans in August were to households, much of that in the form of mortgages, going by historical averages, a remarkable shifting of the fire hose of credit. It also helps explain why China’s property market has raced higher despite broader economic worries.”

“China’s stock of mortgages stood at 16.9 trillion yuan ($2.5 trillion) as of June 30. Almost a quarter of that was built up in just the past year, according to ANZ. Mortgage loans outstanding now account for 18% of total loans, the highest since at least 2008.”

“Local regulators are imposing clampdowns on mortgage lending and property speculation in the hottest cities such as Shanghai and Shenzhen. They are right to do so, as this leg of China’s multi-decade property bubble is clearly being fueled by leverage in a way that it wasn’t in the past.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Building materials – Top of the tree: The case for wooden skyscrapers is not barking

Bloomberg – How Big Sugar Enlisted Harvard Scientist to Influence How We Eat – in 1965 9/12

Bloomberg – What’s Wrong With America’s Dream of City Living 9/14

Economist – Why does Thailand keep changing its constitution? 9/12

FT – When will the ECB run out of bonds to buy? 9/8

FT – China infrastructure investment model under fire 9/10

FT – Twitter and tech: hardly working 9/11

FT – What investors should know about R star 9/11

FT – Oil market braces for Kashagan field’s October debut 9/12

FT – The Swiss and negative rates: how is the experiment going? 9/12

FT – Philippines pivots away from the US 9/13

FT – Japan opens door to temporary foreign workers 9/13

FT – Manias make markets dance to a different tune 9/13

FT – Mythbusting Uber’s valuation 9/13

FT – China retail: shops will drop 9/14

Trepp – Non-Traded REITs on slowest capital-raising pace in 12 years 9/9

WSJ – Bank of Japan Has Enlarged Target in Corporate Bonds 9/12

Yahoo Finance – The internet is creating a demographic ‘seismic shift’ that is too big to ignore 9/12

Yahoo Finance – Billionaire Paul Singer warns of the ‘biggest bubble in the world’ 9/13

September 9, 2016September 8, 2016

September 2 – September 8, 2016

Whoa, that’s a lot of corporate debt… So, who is going to pay for China’s corporate debt balance? High Yield Bond Market decoupling from reality.

Headlines

WSJ – Hanjin’s Demise: Why Global Shipping Glut Isn’t Going Away 9/2. “Despite efforts to consolidate and idle fleets, container ship capacity is growing at 3.2% a year, while demand for container cargo is a tepid 1.8%…”
WSJ – Now Companies Are Getting Paid to Borrow 9/6. First governments, now companies (in this case Sanofi and Henkel) are issuing debt at negative yields…thank you very much.

Briefs

Mark Melkin of ValueWalk covered a trend that the world seems to be following that Japan is leading.

“The ‘Japanization’ of the global economy marked by transition to low growth and low inflation has started to attract investor attention as a phenomenon in recent years. There has been scarcely any nominal GDP growth over the past 20 years in the Japanese economy.” – Daiju Aoki, analyst at UBS Japan
“Demographics are triggering the lack of GDP growth. As a society ages, its population becomes more dependent on government services and less productive in terms of generating goods and services.”
Japan’s peak worker to dependent ratio was in 1990.

Robin Harding of the Financial Times highlighted how the Bank of Japan vows to keep on keeping on with the easing of monetary policy.

“Mr. Kuroda, governor of the BoJ since 2013, claimed the central bank’s policies ‘have contributed significantly to the positive turnaround in Japan’s economy’ and said there was no chance of reducing the level of monetary accommodation.”
“‘It is often argued that there is a limit to monetary easing but I do not share such a view,’ Mr. Kuroda told an audience in Tokyo. He said there was ample room for the BoJ to buy more government bonds, to cut interest rates further, or to buy other assets such as corporate bonds, equity and real estate funds.”
“Yet despite the high level of monetary stimulus, the latest date show a 0.4% fall in the consumer price index compared with a year ago, and a slowdown in inflation even excluding volatile food and energy prices.”
“Mr. Kuroda argued that the failure to hit 2% inflation so far is because of three shocks: falling oil prices since summer 2014, weakness in demand after raising Japan’s consumption tax in April 2014, and a slowdown in emerging markets from summer 2015.”
“Given that, said Mr. Kuroda, ‘it is imperative for the Bank firmly to maintain its commitment to achieving the price stability target of 2% at the earliest possible time.”

Katie Martin of the Financial Times illustrated a plea by Citi for central banks to not buy so many bonds.

“Please don’t buy so many bonds, Mr. Central Banker. It is rapidly becoming a case of ‘too much of a good thing’.” – Hans Lorenzen, credit strategist at Citi Research
Private investors are being crowed out…
And markets are being driven by macroeconomic policies more and more…

Brian Blackstone and Tom Fairless of the Wall Street Journal posed the question: Could the European Central Bank start buying stocks?
- As the European Central Bank (ECB) is running up against its self-imposed limits on how much of a country’s debt it can hold and since there simply aren’t enough bonds they can buy that qualify under their guidelines, the ECB is contemplating buying European equities.
- “Some central banks already invest in equities. Switzerland’s central bank has accumulated over $100 billion worth of stocks, including large holdings in blue-chip U.S. companies such as Apple and Coca-Cola.”
- The Bank of Japan holds ¥10.182 trillion (approx. $98 billion) of “individual stocks and exchange-traded funds as of Aug. 20, in terms of book value.”
- Though “economists have been split over the costs and benefits. Some say that Japan’s capital market can no longer accurately price the value of stocks; too much BOJ money has flown into some specific companies. Others say it has helped prop up share prices, thus producing ‘wealth effects’ to help the economy fight deflation.”
- Interesting times.

Costa Paris and Erica E. Phillips of the Wall Street Journal highlighted how Hanjin’s shipping troubles has resulted in about $14bn of cargo stranded at sea.

“Since Hanjin Shipping Co. of South Korea filed for bankruptcy protection there last week, dozens of ships carrying more than half a million cargo containers have been denied access to ports around the world because of uncertainty about who would pay docking fees, container-storage and unloading bills. Some of those ships have been seized by the company’s creditors.”
According to Lars Jensen, chief executive of SeaIntelligence Consulting in Copenhagen, “43 Hanjin ships are en route to scheduled destinations with no guarantees that they will be allowed to unload. An additional 39 are circling or anchored outside ports. Eight ships have been seized by creditors.”
All told about $14 billion worth of cargo is stranded at sea with the crews running short on rations…

Special Reports / Opinion Pieces

FT – Taking the Long View in investing: eight lessons – John Authers 9/1
- “To sum up ten years in one paragraph: a historic speculative bubble in credit finally burst, and the US came out ahead thanks to looser monetary policy and swift action to fix its banks, while emerging markets slowed down, and Europe was left behind thanks to its bloated banking system and badly designed currency.”
NYT – Flooding of Coast, Caused by Global Warming, Has Already Begun – Justin Gillis 9/3
- “Once impacts become noticeable, they’re going to be upon you quickly. It’s not a hundred years off – it’s now.” – William V. Sweet, National Oceanic and Atmospheric Administration

WSJ – Chinese Billionaire Linked to Giant Aluminum Stockpile in Mexican Desert – Scott Patterson, John W. Miller, & Chuin-Wei Yap 9/8
- So it turns out there is nearly one million metric tons of aluminum being stored in Mexico. “The stockpile, worth some $2 billion and representing roughly 6% of the world’s total inventory.”

Graphics

Fidelity – Five scenarios for stocks – Jurrien Timmer 8/25

FT – Emerging markets on track to set sovereign debt record – Elaine Moore 9/4

FT – Brazil hopes gambling will reverse its fortunes – Samantha Pearson 9/5

WSJ – Now Companies Are Getting Paid to Borrow – Christopher Whittall 9/6

FT – Why emerging market bonds are not the answer for the yield-starved – Jonathan Wheatley 9/6

FT – Inflation-linked gilt returns have gone through the roof – Joel Lewin 9/6

FT – Three things that could derail the eurozone’s recovery – Mehreen Khan 9/7

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

China: the former EM darling. James Kynge. Financial Times. 1 Sep. 2016.

“For most of the last 15 years, China was a darling for emerging market investors as its demand for commodities lifted the economic fortunes of countries in Latin America, Africa and Asia. But now, as China struggles with the hangover from its debt-fueled boom, fund managers are increasingly shunning Asia’s giant.”

“The main deterrent is China’s corporate debt. Although this issue has been well-flagged in recent years, disquiet over its size and sustainability is deepening. A recent report by S&P Global Ratings, the rating agency, estimates that China’s total outstanding corporate debt in 2015 was $17.8tn, or 171% of GDP, making China’s corporate debt mountain by far the world’s largest in both absolute and relative terms.”

“Not only is the ratio of Chinese company debt to GDP more than double that in the US and eurozone, it is projected to grow far more quickly as an increasing number of heavily-indebted corporations ramp up their borrowing simply to repay debts that are coming due. By 2020, China’s outstanding corporate debt will be $32.6tn, while its share of global company borrowings will have risen to 43% from 35% last year, according to S&P estimates.”

“The S&P report estimates that $13.4tn, or nearly half, of total credit demand in China by 2020 will be for refinancing purposes.”

While there are many differences of opinion as to how this shakes out, with either a major meltdown or some internal growing pains (and everything in between), we shall see. Either way, keep an eye on this one.

Does It Matter If China Cleans Up Its Banks? Michael Pettis. Mauldin Economics. 31 Aug. 2016.

This article really follows the one above and I highly recommend reading the whole thing.

Let me try and paraphrase: imagine you’re a new company and you want to take on debt to help you grow the business. Okay, sounds good and it works. The additional debt allows you to buy assets that help you to become more productive and hence grow sales/profits faster than the amount of debt and its associated servicing costs. Boom, you’re a hero and making lots of money.

So you do this some more and some more and some more. Eventually, your rate of productivity slows for every piece of debt you take on. Oh and did I mention that because you’ve been rolling over the debt to really juice growth, now your debt balance is quite a bit bigger than your total sales.

Fortunately, your cost of debt is low and you can keep on operating, but your lender is no longer willing to extend you credit, so you start talking to your suppliers to provide you with “credit-like” loans – meaning, hey why don’t you front me some money to buy more products from you and I’ll pay you back once I sell the goods to my customers.

Okay, this keeps on working, but eventually you’re running out of good options so you start looking for your highest possible rate of return projects regardless of the risk… ‘Come on lucky number 7.’

Oh and as to the debt, well, you’ve accumulated so much of it that it has become the lender’s problem and it’s such a big problem that it’s also their depositors’ problem (your mom and pop savers).

So what do you do and who is going to take the ‘haircut’…

The High Yield Bond Market Has Never Been This Decoupled From Reality. Tyler Durden (alias). Zero Hedge. 3 Sep. 2016.

From JPMorgan’s Peter Acciavatti: “Recovery rates in 2016 are extremely low… for high-yield bonds, the recovery rate YTD is 10.3% (10.5% senior secured and 0.5% senior subordinate), which is well below the 25-year annual average of 41.4%… As for loans, recovery rates for first-lien loans thus far in 2016 are 24.5%, compared with their 18-year annual average of 67.2%.”

From Edward Altman of NYU’s Stern School of Business: “Our approach to recovery rates is not centered on sectors. What we’ve looked at carefully over 25 years is the correlation between default rates and recovery rates. As you would expect, when the former rise to high or above-average levels, you always observe the latter dropping to below-average levels. This strong inverse relationship is as much a function of supply and demand as it is of company fundamentals. So if we are expecting a higher default rate in 2016 and even 2017, then we would expect a lower recovery rate. Already in 2015, the recovery rate dropped dramatically relative to 2014 even though the default rate was below average; we saw a 33-34% recovery rate versus the historical average of 45%, measured as the price just after default.”

“In the 30-year life of the so-called junk bond market, the chasm between reality and central-planner-created markets has never been wider.”

Bottom line, despite being able to collect less and less on defaulting debt (meaning you would ordinarily be less eager to buy more high yield debt or at least want greater compensation for the risk), pricing for high yield debt continues to rise…

Other Interesting Articles

Bloomberg Businessweek

The Economist

Uberworld: The world’s most valuable startup is leading the race to transform the future of transport

Bloomberg – Another Sign Manhattan Real Estate Is Feeling the Pain 8/31

Bloomberg – Saudi Arabia Said to Weigh Canceling $20 Billion of Projects 9/6

CoStar – Blackstone’s New Non-Traded REIT Begins Selling Shares 9/7

Economist – That 2008 comparison (again) 9/6

FT – Pension solution lies in long-term thinking 8/30

FT – HK property developer hangs hopes on art market 9/3

FT – Shanghai divorces highlight China’s property conundrum 9/4

FT – Why negative interest rates sometimes succeed 9/5

FT – Bank of Japan: great expectations 9/5

FT – Analysts laud ‘remarkable’ pick-up in emerging markets 9/5

FT – China banks shed staff and slash pay in cost-cutting drive 9/6

FT – Rocket’s writedown raises red flags 9/6

InvestmentNews – Ex-CFO at REIT formerly controlled by Nicholas Schorsch indicted 9/8

NYT – Sonia Sotomayor and Elena Kagan Muse Over a Cookie-Cutter Supreme Court 9/5

NYT – Subprime Lender, Busy at State Level, Avoids Federal Scrutiny 9/6

WSJ – Bank of Japan’s New Unease With Negative Rates 9/5

WSJ – The Problem With Dividend Stocks 9/5

WSJ – Why Chinese Bank Stocks Can’t Fly Too High 9/6

WSJ – How China Insurance Crackdown Could Rain on Deal-Making Parade 9/7

WSJ – Europe’s Bond Market: Even Further Through the Looking Glass 9/7

WSJ – Goldman Sachs Has Started Giving Away Its Most Valuable Software 9/7

September 2, 2016September 2, 2016

August 26 – September 1, 2016

A novel way of paying off debt – issue more of it, the savings are already accruing. It’s official, Nigeria is in a recession.

Headlines

WSJ – Food Price Deflation Cheers Consumers, Hurts Farmers, Grocers and Restaurants 8/29. “The U.S. is on track this year to post the longest stretch of falling food prices in more than 50 years…”
Visual Capitalist – Interactive: What Futuristic Tech Will You See In Your Lifetime? 8/30. This is fun.
WSJ – Google Takes on Uber With New Ride-Share Service 8/30. Things are about to get a little less chummy in the Bay Area.
NYT – Dilma Rousseff Is Ousted as Brazil’s President in Impeachment Vote 8/31. It’s official, Rousseff is no longer President of Brazil following a 61 to 20 vote by the Senate that convicted Ms. Rousseff on charges of manipulating the federal budget.
NYT – Scheduled Flights to Cuba From U.S. Begin Again, Now With Jet Engines 8/31. Regular air service from the U.S. into Cuba just resumed after a more than 50 year hiatus.

Briefs

Steven Russolillo of the Wall Street Journal points to why math doesn’t work for current stock market valuations.

“Stock valuations rise and fall, but when an important factor driving market performance is mathematically unsustainable, it is worth a closer look.” Specifically corporate dividends.
“Aswath Damodaran, a professor at New York University’s Stern School of Business, sees this as the market’s biggest risk. Mr. Damodaran, who is considered an authority on valuation, says S&P 500 companies through the first two quarters of the year collectively returned 112% of their earnings through buybacks and dividends. That is the highest since 2008 and well above the 82% average over the past 15 years, he said in a blog post last week.”
“Mr. Damodaran, who likes to be provocative, says with rates this low, traditional valuation metrics are distorted. Instead, the inability of companies to keep paying off their investors will cause the next downturn. ‘This is the weakest link in this market,’ Mr. Damodaran said in an interview. ‘We know cash flows will go down. What we don’t know is what the market is pricing in.'”

Gabriel Wildau of the Financial Times highlighted the growing schism between mobile payment providers and the big banks in China – big data.

“The rise of third-party mobile payments in China at the expense of credit and debit cards is threatening commercial banks’ access to the customer data viewed as crucial to newly emerging financial and consumer business models.”
Further UnionPay, the state-owned settlement network, and other rank and file banks are missing out on the merchant fees that these third-party platforms are redirecting.
“The move by more Chinese consumers to switch from swiping plastic cards to scanning QR codes with mobile wallet apps knocked $20bn from banks’ fee income in 2015, according to Kapronasia, a Shanghai-based fintech consultancy.”
While the fees hurt, the key is that third-party payment providers are “depriving lenders of valuable data on consumption patterns.”

Anjani Trivedi of the Wall Street Journal drew attention to why Chinese banks portfolio shift to more property isn’t necessarily all hunky dory.

China’s big-state lenders are making a shift in their lending portfolios from commercial loans to property. “China Construction Bank (CCB) this week reported residential mortgage lending rose almost 30% in the first half of this year compared with the same period last year. Meanwhile corporate lending fell 2%. At Bank of China, mortgages rose by more than a quarter.”
“On the face of it, banks are moving away from risky lending. That helps their capital cushions because for every loan extended to a company, banks assign a 100% risk-weight. For residential mortgages, banks only have to set aside half that.”
Of course, it helps that residential prices are rising; however, “lending into the property market would make more sense if the mortgage loans weren’t going bad so fast. At CCB, while mortgage nonperforming loans accounted for only 6% of total NPLs, they rose 67% on the year compared with 26% for all loans. And that’s with prices rising nationally, and rising sharply in the biggest cities.”

Leo Lewis and Lucy Colback of the Financial Times covered an interesting development in how the Bank of Japan is distorting the Japanese stock indices through their massive fund flows.
- “From July 29, when the Bank of Japan said it would nearly double its annual purchases of exchange traded funds from ¥3.3tn ($32bn) to ¥6tn, brokers in Tokyo have been selling stocks with a simple, unsettling message.”
- “In an equity market where the central bank is the biggest whale, and where the government in various forms has become the biggest shareholder in a quarter of First Section Tokyo stocks, it’s time to buy the fund flows, not the fundamentals.”
- “Goldman Sachs estimates that the doubling in BoJ buying coupled with the skew towards Nikkei weighting means that the central bank will own at least one-tenth of the equity in 32 companies by this time next year, up from five currently.”
- “The BoJ, according to its current schedule, must buy an average of ¥70bn worth of ETFs every three trading days throughout the year.”
- Helicopter money…

Special Reports / Opinion Pieces

Graphics

FT – Puerto Rico: An island’s exodus – Eric Platt 8/25

Visual Capitalist – Which Countries Are Damaged Most by Low Oil Prices? – Jeff Desjardins 8/26

WSJ – Food Price Deflation Cheers Consumers, Hurts Farmers, Grocers and Restaurants 8/29

WSJ – China’s Private Investment Crash May Be Mirage, but Pain Is Still Real 8/28

Visual Capitalist – Do Newly Built Skyscrapers Signal The Top of the Stock Market? – Jeff Desjardins 8/29

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Falling bond yields save taxpayers $500bn. Eric Platt. Financial Times. 31 Aug. 2016.

“The collapse in sovereign bond yields has saved taxpayers more than $500bn in annual interest expenses, allowing countries to rein in budget deficits and continue government-backed programs that would have otherwise been shelved, according to a new report.”

As of the end of last week there was $13.2tn of debt with negative yields.

“Japan, France, Germany and Switzerland are now paid to issue short-dated sovereign bonds.”

“Benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.” – Robert Grossman, analyst with Fitch, a rating agency

“The median 10-year government bond now yields 1.17%, down from 3.87% five years ago. Japan has saved more than $95bn a year as a result of the decline in rates, while the US, UK and Germany collectively pay $104bn less annually, the study estimates.”

“Central banks have cut interest rates more than 670 times since Lehman Brothers filed for bankruptcy in 2008, or roughly one reduction every three trading days of the year, according to JPMorgan.”

Nigeria falls into recession as economy shrinks in second quarter. Maggie Fick. Financial Times. 31 Aug. 2016.

“Nigeria has slipped into recession for the first time in more than two decades as growth in Africa’s top oil producer shrank for the second consecutive quarter.”

“The economy contracted 2.1% in the three months to the end of June, worse than analysts expected, while inflation hit a 11-year high of 17.1%, underlining the depth of the west African nation’s crisis.”

“Nigeria, which depends on petrodollars for 70% of state revenues and 90% of export earnings, has been battered by the slump in oil prices. The economy shrank 0.4% in the first three months of the year and the International Monetary Fund is forecasting that growth in 2016 will contract 1.8%.”

“The central bank increased the main interest rate by 200 basis points last month in an attempt to combat inflation, but it rose for the ninth consecutive month in July.”

“The continent’s most populous nation was one of the world’s fastest growing economies during the oil boom, but Mr. Buhari (President Muhammadu Buhari) said this month that Nigeria ‘suddenly appears to be a poor country.'”

It’s currency is having difficulties as well, “in the official market, the naira is trading below N300 to the dollar, having lost more than 40% of its value since its peg was lifted in June (to ease the country’s quickly depleting reserves of hard currency), but on the black market the currency is far weaker – it has been trading at below N400 to the dollar this week.”