Beware of the Banker

“Beware of the banker who says he’s not in need of your capital, for those very spoken words are a loud cry for help.”

Bernard Baruch

Join our Larry McDonald on CNBC’s Fast Money, Wednesday May 18, at 5pm.

Our 21 Lehman Systemic Risk Indicators are Screaming Sell

In the face of bold threats of destruction from the PBOC (People’s Bank Of China), some brave souls are paying up for CNH vol (Currency Volatility) today (see the chart below), betting on further yuan depreciation.

The Fed did China a huge favor in shooting the March and June rate hikes between the eyes, thus talking the dollar lower (98.5 to 91.9 from March 2 to May 2).  But the dollar’s surge since has the PBOC flustered. Their punch back to the Fed for not further containing the greenback will be found in some stressful financial conditions. CNY CNH Spread Leading

Over the last year, surges in CNH vol have been followed by a plunging S&P 500. 



VIX Futures 2 vs 8 Month Spread
One important component of our 21 systemic risk indicators is found in the VIX 2 month vs 8 month spread. Deep backwardation (front month trading rich to the outer months) comes with strong equity buy signals, as we noted in our Bear Traps report on February 9th. Rich contango (front month trading cheap to the outer months) comes as a sell signal. The recent high in the S&P coincided with the steepest VIX futures curve in the last year. Think of a car moving from 30 to 90mph, the speed of the curves flattening process, the stronger the equity sell signal.

As most know, China lost $800B last year in capital outflows.  As the dollar weakened in March, capital outflows in China took a well needed breather.  The Chinese yuan is pegged to the US dollar, thus a strong US currency makes China’s goods sold around the world much more expensive.  After the dollar’s pull back (March – April), China posted their two best export months in the last year.

If you’re a billionaire in China and you know your currency is dramatically over-valued, you’re going to do everything you can to get cash out of the country and into dollars.  This explains the record amount of US acquisitions by companies in China, it’s the great cash run out of the country.

In January, the Fed wanted to hike rates four times this year, they misjudged the negative impact a strong dollar has on the global economy.  Hence, after they woke up and brought their rate hike forecast to 2, global markets stabilized.

Here we sit, halfway through the month of May and the Federal Reserve has promised to hike rates two more times in the next 6 months.

Much Smaller Part of the Global Economy

Global GDP Outside the USA: $61T


There are only two ways out for China, a substantial currency or credit devaluation.  We think they’ll choose the former.  With NPLs (non-performing loans) at 17% of outstanding credit vs what the PBOC tells us (less than 2%), it’s a mess.  Bad loans are  8x to 10x than the bogus official numbers lead us to believe.  Ultimately, we believe there are likely $700B to $1T of losses.

Transports are Flashing Sell Signals

Dow Jones vs Transports
Classic market top price action is found in the divergence between the Dow Jones Industrial Average (heading north) and the Dow Jones Transports (heading south).

In the post Lehman era, central banks either huddled together or off on their own, have carried a heavy policy cross with the goal of giving their underlying governments time to heal from the financial crisis.
It’s a game of central bankers using monetary policy in an effort to take time off the clock. Their ultimate hope? A prayer that the burned out engines of fiscal policy would finally ignite to save the day. That day has never come, so far central banks have only become the great enabler.

Today, global leverage is found in chains wrapped around the feet of former powerhouse economies. Total debt (corporate, household, government), laying in advanced economies is now 259% of GDP vs 175% in emerging markets, and 246% in the US and China.

The year 2016 will mark a turning point. The serpent inside global markets has been contained by central bankers, but this beast is about to have his revenge. We witnessed opening acts last September and again in January, but the show has just begun.

Over the last 10 years central banks have thrown a lot of firepower, trying to contain Mr. Market’s natural laws. The experimental drugs are wearing off, the patient now needs stronger and more intense doses to achieve the same desired effect.

This fight is so long in the tooth, we must prepare for what’s next. When common sense becomes harder and harder to find, you’re far closer to the end than the beginning. The last act will not end in laughs, there won’t be a dry seat left in the house.




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