Oil – A Cup of Coffee at $200

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Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Putin has isolated himself and Russia, but worst of all – the modern tenets – the internal plumbing of the entire Russian oil production ecosystem are facing meaningful decay. One of our planet’s largest oil and gas producers is facing a colossal impairment.  Oil exports from Russia are permanently challenged. Without foreign technology (the recently announced BP – Gazprom divorce). It´s a massive brain drain. Russian oil production will degrade over time. Even worse, we are told the all-important Turkish Straits are at risk of closure to certain vessels as Russian naval activity in the region has made transport of crude extremely expensive to insure. This would essentially land lock 1.3MBD out of Novorossiysk.  We are now in record industry draws – demand, even without the Ukraine invasion.

“A deal to limit Iran’s nuclear program would lead to sanctions on its oil sector being lifted but it could take several months for any more Iranian crude to flow, and even then it may only offer short-term respite to tight oil markets.” Reuters.

If Iran oil production comes back online, the problem is – right now Libya and Iraq have their own oil production issues. These challenges more than offset the return of daily Iranian production. The only way to curb demand is by price, a very high price. Assuming demand destruction is at $150, that implies a possible move to $200. Markets overshoot.

Oil Volatility Explosion

Oil was declared “uninvestable” by the Wall St. Research community in Q2 2020, and today they are jumping over the seats to try and get involved. Under Investment comes with a price – $2.2T has come out of the oil, gas, coal, and metals 2014-2020 investment trajectory (CAPEX) while the global population has grown by another 700m. In other words, the previous addiction to capital investment came crashing down in recent years as the ESG – Green revolution took hold. 

The Lessons from 2020

We must remember the negative price of oil in Q1 2020  – the lessons – the oil market is no exception and can overshoot. Rampant inflation is nigh. Will the Fed slam on the brakes? Maybe, but Powell isn’t Volcker and even Volcker didn’t slam on the brakes until he had hard data that unemployment was headed south. The last unemployment statistic of 3.8% means we aren’t at the point where the Fed will hike Fed Funds high enough to stop inflation. Even now, markets aren’t pricing in the odds of $200 oil. We see 77% implied volatility at the front end of the curve means that trading spot crude oil is difficult to do. The back end of oil is attractive given the amazing backwardation we are witnessing. The oil itself is the best hedge. The second-best hedge is oil service companies – we have been long OIH ETF names for clients for over a year. The third best hedge is oil producers.

Bear Traps Report from Jan 26, 2022

What if the Unthinkable Happens?

What if Russia invades Ukraine and Europe and the U.S. kick Russian banks off SWIFT and imposes other debilitating restrictions on the Russian banking system? This would severely restrict Russia from selling oil and other essential commodities in the international markets. Without an emergency supply response by OPEC, oil could surge beyond $150 per barrel. Other commodities are vulnerable too.

Russia is now by far the largest supplier of natural gas to Europe. It is also the world’s largest supplier of palladium and the 2 nd largest producer of cobalt (EVs). A surging oil price has caused almost every
recession in the US since 1945. Global growth could be reduced by 75% this year if oil jumps to $135 per

In this note, we will discuss this what-if scenario and recommend strategies to prepare for such an outcome. We don’t say this often, but we hope that we are wrong; that this scenario can be avoided, and that our strategies fail.

Where is the Trade?

Should Russia invade Ukraine we can expect oil to initially react strongly to the risk of supply shortages. Since the reaction is in the front of the curve, the USO ETF will be more reactive than stocks of oil producers. OPEC would likely respond quickly by maximizing its oil production to balance the market. Such a response may set a top in the price of oil, but it would still pose a serious risk to U.S. and global growth. Besides oil, we see natural gas and palladium as commodities with upside risk in such a scenario. Russia is responsible for 45% of EU imports of natural gas and Russia dominates palladium mining. In a worst-case scenario, the EU would face significant gas shortages and would rely on more U.S. LNG shipments. If Russia is restricted in the supply of palladium, South African palladium miners such as Anglo-American Platinum and Sibanye-Stillwater are poised to benefit.

***Bear Traps Report from Jan 26, 2022.

Oil and Conflicts

Authorities in the U.S. and Europe have warned for weeks about a large Russian troop buildup at the Ukrainian border near the
Donbass region. More recently policymakers have also signaled large Russian troop movements into Belarus to encircle the northern border of the Ukraine. The U.S. and Europe have threatened Russia that if it invades the Ukraine, they will respond with draconian measures. One of those could be to remove
Russia from SWIFT (Society for Worldwide Interbank Financial Telecommunication) and to put debilitating sanctions on its banks. SWIFT is like the central nervous system of international financial
transactions. Their platform facilitates the smooth flow of funds across borders. Kicking Russia off SWIFT and sanctioning dollar transactions by Russian banks may severely limited Russia’s ability to export its commodities into the global markets.

The U.S. kicked Iran off SWIFT in 2018 after Trump pulled the U.S. out of the Iran deal. By doing so, it prevented international oil shippers from being able to insure their oil cargos to and from Iran. It also made it nearly impossible for oil trading firms to deliver payment to any Iranian banks to buy its oil. As a result, Iran oil exports dropped from 2.4ml to 350K barrels per day in a matter of months. The U.S. offset this loss by increasing shale oil production by 3ml barrels p/d that year.

***Bear Traps Report from Jan 26, 2022.

Russia’s expanding grip on Ukraine

In 2014 Russia supported an armed rebellion of pro-Russian separatists who wanted to form two independent republics in the Donbass. These actions followed Russia’s annexation of Crimea in February of 2014. A war broke out in Ukraine in April of that year and fighting continued into 2015.

In February of 2015 a peace deal was struck between Russia and the Ukraine (Minsk accord) but despite this, the area remains a war zone, with dozens of soldiers and civilians killed each month. During the war the U.S. and Europe imposed sanctions on Russian individuals, organizations and businesses but didn’t go as far as sanctioning Russia’s ability to export commodities.

Early in 2021 Russia began a troop buildup again on the Ukrainian border. This to deter further NATO support for Ukraine. Several events during the summer and fall motivated Putin to further buildup troop levels around the Ukraine. Russia has now deployed approximately 32% of its military’s battalion tactical groups near Ukraine, a figure the U.S. intelligence community reportedly believes could rise to 60%.

Russian and Belarusian officials also announced that their forces will take part in a joint exercise that will last until February 20 including the deployment of a fighter squadrons and air defense battalions. In
short, Russia is setting the conditions where it could conduct a significant military escalation on short notice and with little warning.

***Bear Traps Report from Jan 26, 2022.

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Harder to avoid War

Russian officials have committed themselves to a strong response unless they receive concessions. If it does not achieve some of their stated goals, Moscow will suffer a cost to its credibility if it does not

Europe and the U.S. have repeatedly threatened to slap unprecedented sanctions on Russia if it were to invade Ukraine.  Biden last month warned Putin that if he were to attack Ukraine, the U.S. and its allies would impose sanctions on Russia – “like none he had ever seen.” Press Secretary Psaki last week said that “stopping Nord Stream 2 pipeline is a credible piece we hold over Russia” and that “No option is off the table with regard to removing Russia from SWIFT financial system”. This week the Wall Street Journal
reported that the Pentagon places hundreds of troops on standby for deployment to Eastern Europe.

So, both Russia and the U.S./Europe have placed themselves in a position whereby backtracking from threats would cause severe credibility risk. Putin is playing power politics with several neighboring countries (Turkey, Moldova, Georgia, Kazakhstan, China) and cannot afford to look weak. The U.S. after
the Afghanistan debacle can ill afford another international humiliation. That’s why the path of least resistance increasingly looks like Russia has no choice but to invade and the U.S. will be unable to back down from severe sanctions.

***Bear Traps Report from Jan 26, 2022.

Oil and Recessions

Oil has played a vital role in almost all major U.S. recessions since World War II, which is when oil became the prime source of energy for the U.S. and global economy. U.S. GDP declined by 3.2% from
1973 until 1975, following the 1973 oil crisis. The oil price quadrupled as OPEC threatened to stop supplying oil to the U.S. in retaliation for its support for Israel in the Yom Kippur war. This combination of surging prices of oil and a declining economy is now known as the period of stagflation. In 1979, the Shah of Iran was deposed in the Iranian revolution. Once again oil prices soared, and the U.S. entered a double-dip recession (1980 and 1981-1982) as the Federal Reserve raised the Fed funds rate to 20% to eradicate runaway inflation. In aggregate, the U.S. economy declined by 4.9% during this period. In 1990 oil prices briefly surged as Iraq invaded Kuwait and international forces, led by the U.S., started the Gulf War to remove Iraq from Kuwait. A brief recession followed, whereby the U.S. economy contracted 1.4%. The root cause of the great recession of 2008 was the debt-fueled housing boom. But a vital straw that broke the economy’s back was the surge in oil prices in H1 of 2008 when oil rallied from $95 in the beginning of that year to $147 a barrel by early July. The rally in oil (and other commodities) was partially related to Chinese buying ahead of the 2008 summer Olympics and the weakening of the US dollar driven by the divergence of Chinese and U.S. economic growth. Either way, the already fragile U.S. economy went into a deep recession shortly after, which reduced GDP by over 5%.

***Bear Traps Report from Jan 26, 2022.

If oil prices quickly surge to $135 in reaction to the inability of Russia to export its oil, global growth could see a 75% haircut this year from 4% to 0.9%. Given that oil is the single biggest driver of headline CPI inflation, the Fed may be forced to react late to such an abrupt slowdown. Headline inflation could double in a $150 p/b oil scenario. Of course, when enough economic data show the economy is sharply slowing down and financial conditions deteriorate enough, the Fed will likely reverse course, but history tells us that it can then take months for the economy to recover.

In February of 2011, a civil war caused Libyan oil production to collapse. The result was a shortfall of more than 1ml barrels of Libyan (primarily light, sweet) oil per day from February until May. A total of 59ml barrels of production were lost during that period. The Libya example is useful to gauge a market reaction in case of a sudden production shortfall in a tight market. During the Libyan civil war Brent rose from $100 to $125 per barrel. And the Brent curve backwardation blew out to $25 per barrel (=the spread between the front month and the 6 month future).

Where can oil go in case of a Ukrainian invasion?

When the U.S. revoked the Iran deal and slapped draconian restrictions on its banking system, the oil markets were adequately supplied. We know this because, despite the sanctions, the oil markets were oversupplied by about 1ml p/d all year. Most of the extra supply came from the surge in U.S. shale oil but Saudi Arabia also increased production by about 1ml bpd.

***Bear Traps Report from Jan 26, 2022.

Today the markets are tight, as demonstrated by the backwardation in the futures market, which means spot is trading at a premium to the futures. The market only does this if it wants to draw barrels out of inventory because the spot market needs those barrels now. In 2011 the market became extremely tight when production seized during the Libyan civil war. A total of 59 ml barrels of production were lost during that civil war. As a result, the spread between the front and the 6-month contract blew out to as much as $25 and oil went from $100 to $125 per barrel.

Since mid-December the curve has blown out by $4 and oil has increased by $12 per barrel. We like to assume that that is primarily due to the Ukraine risk. After hurricane Ida last summer, the WTI curve spread blew out $3 as the hurricane knocked a total of 24ml off production and oil rose $15 per barrel in subsequent weeks. There is no way to quantify the total amount of barrels lost in case of sanctions on Russian exports as they can go on indefinitely. OPEC (ex Iran) has about 4ml spare capacity but may only be able to quickly increase production by 2ml barrels p/d (as we saw in April of 2020). Any additional production may take longer to come on-line.

To what extent has the market priced in a Ukrainian invasion by Russia? If we assume a loss of about 60ml barrels (see below) over a 5-month period, then the market currently prices the odds of a Russian invasion around 30%.

How many Barrels can disappear from the Market?

If we assume a 5-month timeframe to offset the loss of remaining Russian barrels, that would imply a total loss of about 50 to 60ml barrels. The price action in the curve and WTI since mid-December
suggests that the market may already price-in a 22ml shortfall. If Russia does invade Ukraine and subsequent sanctions prohibit the export of most of its oil, it means at a minimum another $15 on the front month to $100 per barrel. In case of a 4.5ml barrel shortfall (little to no OPEC/US production increase/SPR releases to offset Russian export ban), oil could rise another $50 per barrel to $135 per barrel.

What about other Commodities?

Russia is responsible for more than 45% of the natural gas that the EU imports. The decision by the Netherlands in 2015 to gradually phase out their natural gas production has only increased EU’s
dependence on Russian natural gas. It’s possible that Germany finds a way to circumvent sanctions and to continue to assure Russian gas supplies. If Russia is no longer able to supply natural gas to the EU
market, a shortage of natural gas would be inevitable and electricity prices will become prohibitively expensive. More gas will probably be shipped from Qatar and the U.S. to offset Russian shortfalls.

Already the U.S. has become the largest exporter of LNG and exports to Europe reached 7ml tonnes in December, which is about 19% of EU demand. Provided the US has the capacity to expand LNG exports, domestic prices would likely increase as well. US.. LNG exports to Europe already represent 12% of total US dry natural gas production.

In 2021 the European natural gas market went parabolic in a perfect example of Murphy’s law; everything went wrong that could go wrong. Renewable energy dropped off due to a decline in wind power, French nuclear plants went offline due to maintenance, and Russia’s Nord Stream II pipeline, which should have come online last fall, was held up indefinitely (in part due to the situation in Ukraine). As a result, European gas prices went up as much as 800% in one year.

***Bear Traps Report from Jan 26, 2022.

U.S. natural gas prices did rally in the fall as more LNG shipments went to Europe, but a relatively mild winter has put a damper on U.S. gas since.

SBSW Sibanye Stillwater – A PGM Play

Sibanye Stillwater Limited provides metal mining services. The Company develops and extracts mineral properties. Sibanye Stillwater serves customers in the United States and South Africa. See client trade alert buys – full position.

Risk – Reward in Metals

Our focus is on SBSW Equity and palladium a market where Russia dominates global supplies. Russia is responsible for 41% of total palladium produced globally. In a worst-case scenario, Russia would be severely limited in exporting palladium and shortages would be the result. Non-Russian palladium miners could benefit as prices of palladium are likely to increase. If, and when, palladium becomes uneconomically expensive, producers could switch to platinum as well. While Russia mines platinum, South Africa is the world’s most dominant platinum miner. Once again Anglo-American Platinum is the dominant miner, followed by Impala Platinum.

Top ex-Russia Platinum Miners

Anglo platinum – 2ml oz per year
Impala platinum – 1.3ml oz
Sibanye-Stillwater – 1.08ml oz
Northam Platinum – 900K oz

Russia is by far the largest producer of palladium in the world, responsible for more than 40% of global supplies. The largest use of palladium is in catalytic converters. Secondary uses for palladium are in jewelry, ceramic capacitors, hydrogen production, and storage. The irony is that palladium demand has been floundering due to the inability of the car industry to produce at capacity due to the semiconductor shortage. If palladium supplies become limited, it could further limit automotive production, thereby further inflating prices of new and used cars even more.

***Bear Traps Report from Jan 26, 2022.

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.



Inflation´s Ugly Side Effects – Inventory Hoarding & Recessions

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Inflation´s Ugly Side Effects – Inventory Hoarding & Recessions

The Commerce Department´s first estimate of 4th quarter GDP growth came in at 6.9%. And yet all the polls show consumer pessimism and voters´ lack of trust in Biden´s handling of the economy. This seems like a contradiction, but it isn’t. The economy grew in large measure because of a COLOSSAL inventory build, which is a fancy term for businesses hoarding inventories, which in turn is caused by inflation. It is cheaper and safer to buy inventory now rather than later —- 4.9% of the 6.9% GDP growth was caused by panicked businesses hoarding inventories in a desperate attempt to front-run inflation and escape the worst of the nightmare supply chain. And it is that very same inflation that has made the American consumer, and voter, so pessimistic. The question begged is: if businesses are hoarding, are consumers hoarding as well? The answer? Of course, consumers are hoarding. This in turn implies that if businesses and consumers had not hoarded, then GDP would have been negative in the 4th quarter. This sums to a classic stagflationary economy.

GDP Regimes

In the 1960´s, 1970´s, and early 1980´s, before the widespread adoption of “Just-In-Time” inventory management and attendant advanced technologies, business cycles were more frequent, predictable, and violent (SEE the green oval above), even adjusting out for supply shocks.  The Lehman crisis and Covid crisis aside, we see the business cycle became much less volatile thereafter.  This cycle – with the Fed forced to hike rates into a recession – we think U.S. GDP prints -6% to -8% somewhere in 2022 – 2023.

This brings us to the old-fashioned reason for recessions. Once upon a time, recessions were caused by excess inventory build. Businesses would over-estimate unit demand, produce too much, then reduce production and compensate by lowering costs, by firing employees. Recession, and bear markets, ensued. As we have detailed in our note on how the supply chain has affected the chemical industry, hoarding by business is a logical individual response to supply chain snafus, while collectively being a response that only further aggravates supply chain woes with increased demand, spurring on more inflation, spurring on yet more hoarding. A vicious negative feedback loop if there ever was one. And so inventories build and build as businesses and consumers both hoard.

XLP Recession-Proof Stocks – OUTPERFORMING
Since late November, the XLP Consumer Discretionary ETF is dramatically outperforming the Nasdaq, +5% for the XLP vs. -14% for the QQQs. This is CLASSIC pre-recession price action – when the Coca-Colas and Proctor and Gambles are outperforming the Teslas and Microsofts – look out. What stops this inflationary spiral is ongoing negative real income. Eventually, consumers buy fewer things because they have less money in real terms. As unit sales fall below lower targeted inventory turns, the industry produces fewer goods. Fewer goods purchased and produced = recession.

We have not seen an old-fashioned excess inventory recession in a long time. We have become accustomed to crises like Lehman and Covid causing recessions, but, excess inventory recessions were once quite common. What made them less frequent was this: just-in-time delivery which in turn was made possible by advances in technology. By being able to more quickly adjust inventories to demand, by increasing inventory turn, in other words, businesses rarely found themselves with too much inventory. Inventory levels were “optimized” and so hiring levels were “optimized” in turn as well. This shift meant that the unemployment level that once caused inflation now gradually fell ever lower, from what economists once put at 6% to 3% or even lower in their revised estimation. The optimization of inventory levels optimized the entire supply chain. The result? No more excess inventory recessions.

But it turned out there was a risk to the optimized technology-driven just-in-time delivery supply chain. If a massive demand shift happened, the oh-so-delicately balanced and hyper-complex supply chain would clog up. And this clogging of the supply chain would metastasize into a crisis. This is what happened when people were given money to spend in lockdown. The goal of the stimulus checks was to avoid recession. The result is a delayed recession. This is the classic Cobra Effect: the government causing the very problem it attempts to solve.

Measuring Supply Chain Stress

We see above the New York Federal Reserve´s Global Supply Chain Index that was recently introduced, measuring a variety of metrics and blended into a weighted output designed to reflect how the supply chain is doing. Obviously, with the advent of Covid, the supply chain went haywire and is quite snarled, with no obvious relief in sight besides unsubstantiated assurances that never seem to pan out.  Businesses & consumers are hoarding in response, further exacerbating the problem.

We are not in a full-blown recession yet, but we are heading there. We know for a fact that inventories are building and inventory turns are deliberately slowing or set to slow soon via businesses hoarding. We know for a fact that real wages are in decline. The collision of the two will result in an old-fashioned excess inventory recession. It has not gotten so bad as to affect the demand for labor… yet. It is anybody´s guess, but ours is that it will take a few more quarters for labor in the manufacturing sector to feel layoff pain as that is more a trailing effect of inflationary excess inventory build than coincident. Only at that point will the Fed abandon its incrementalism and go full Paul Volcker on rates, money supply, and bank reserve requirements. But at that point, it will be too late. It already is: the Cobra´s fangs are in too deep.

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NASDAQ Up Volume, the Epic ARKK, SPAC, Meme Top

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

NASDAQ Up Volume, Telling Signs
Up volume on the NASDAQ for most of the 1st quarter 2021 was spectacular. The Fed was pumping away at $120 billion a month as far as the eye could see, enticing speculators into an orgy of rampant excess. 

Trying to Break Out of the Bear´s Grip

Monday was the highest up volume day on the NASDAQ since then. Interestingly,  that up volume came after a real smash in many speculative names, a true bear market for over 50% of NASDAQ stocks. This was profit-taking by short-sellers, not the start of a new bull market.  It was short  – risk-off,  not long risk on. As well, it served to relieve an over-extended, over-sold decline.  That´s what bear markets do to set up another leg down. If we don´t get real follow-through upside soon, then this relief rally will prove a prelude to further pain.  Ultimately, the question facing traders: was the Monday up volume surge a prelude to a new extended bull run, or a prelude to a new bear decline? We side with the latter.





How did the Fed get Inflation so Wrong?

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

“By their fruits, you will know them. Do men gather grapes of thorns or figs of thistles?” —Jesus Christ, in his Sermon on the Mount as related in Matthew, a warning against false prophets.

Up More than 10% Year to Date, 33% from Omicron Fears on Dec1
A Large Tax on the middle class – energy prices. Goldman is now calling for $100 crude by August. Large implications on inflation looking forward.

The Shock

For the last available data week, money borrowed via reverse repo increased $66.4 billion while the Fed’s balance sheet increased another $22.6 billion. Back in Volcker’s day, that would have been considered a massive liquidity injection, and quite inflationary. You see, back in 1980, there was this thing called “the Volcker Shock” which involved increasing the Federal Funds Rate to the highest it has ever been. Such a dramatic move convinced everyone that he had the courage to kill inflation. He drained money from the system. He didn’t inject money into it! Volcker believed once inflation oozes into a million corners of the economy, it cannot be stopped with small – incremental rate hikes – you MUST go big to kill it. 

Killing Inflation Comes with a Price
Killing inflation comes with a high price, on a cumulative basis – Nasdaq’s new lows are epic.

Just as false prophets do not produce good fruits, so too do false inflation fighters fail to use a Volcker Shock. One should not judge prophets, and Central Banks, only by their words.

*Paul Adolph Volcker Jr. – He served two terms as the 12th Chair of the Federal Reserve from 1979 to 1987. He was nominated to position by President Jimmy Carter and renominated by President Ronald Reagan. He was widely credited with having ended the high levels of inflation seen in the United States during the 1970s and early 1980s. 

Markets Pricing Four Moves in 2022 – Now What?

The continued strong inflation has led to both a Fed pivot on inflation and markets now pricing in four 25bp moves this year, 160bp by December of 2023, and only 10bp more by December of 2024. With “transitory” officially retired at Powell’s September FOMC press conference, the main issue for investors is whether the Fed will meet the priced targets, undershoot or overshoot. In the 2015-2016 rate hiking cycle kickoff, they promised 8 moves to start and only delivered two over 24 months.

The Inflation Pivot

When we were on the trading floor at Lehman in Q4 2006. At that point, as the clock struck midnight on a frosty evening in December, we gathered the courage to pitch a colossal short on the US housing sector (Beazer, Countrywide, New Century – credit and equities). We pitched the trade into Mike Gelband (Global Head of Fixed Income) and Alex Kirk (COO of Fixed Income). Both approved the SIZE short – but said. “Make sure you run it by our economics team.” Before breakfast, the academic brain trusts – NONE of whom had EVER actually sat in a risk-taking seat – refused to endorse the trade. “Every model we believe in tells us housing will NOT decline on a national level with unemployment at these levels, it´s just NOT possible (historically, more people were working than ever before).” Gelband and Kirk approved the trade anyway, they said – “make sure you double it – 2x the size proposed.” Legends.

(This story is laid out in our New York Times Bestselling book – “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business reads in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.)

The Fiscal and Monetary Response

Covid Crisis

$2.2T CARES Act, Q2 2020
$0.9T Aid package, Q4 2020
$1.9T American Rescue Plan, Q1 2021
$1.0T Infrastructure, Q4 2021
$4.0T Fed asset purchases


Post Lehman´s Failure

$0.7T Tarp Relief
$1.1T Fed asset purchases


FAILED Fed Economic Models Come with a High Price – Even in the face of this fiscal and monetary response differential – this cycle vs. last, the Fed models saw NO RISK OF SUSTAINED inflation six months ago. Economic models were focused on premature deaths, reduced immigration, forgone capital investment, the economic costs of lockdowns on unemployment, pandemic induced exits from the labor force. The Fed was too focused on demand, NOT supply. For example, ESG’s impact on oil, coal, and gas exploration – a $1T + hit to capex –  has had a colossal impact on the cost of energy. 

Back To Powell´s Change of Heart

Whether it was the continued release of strong inflation data or the realization of his reappointment, Chairman Powell exhibited a definite shift towards controlling inflation following the November 22 reappointment announcement. In Congressional testimony on November 30, he said it is a “good time to retire the term transitory.” At the press conference following the December 15 meeting, he stated “There’s a real risk now, I believe, that inflation may be more persistent and…the risk of higher inflation becoming entrenched has increased” … “That’s part of the reason behind our move today, is to put ourselves in a position to be able to deal with that risk.” This past week he stated, “If we have to raise interest rates more over time, we will.” He also said, “we need to focus on inflation a little bit more at the moment than the maximum employment goal.” With the unemployment rate back under 4%, that seems a good bet. While the past two nonfarm employment figures have been less than expected, the Household survey, which feeds into the unemployment rate, showed increases of 651 thousand and 1.09 million respectively.

US 30 Year Treasury Bond Yield vs. the Data

Up from 167bps to 212bps since early December

ISM Man 58.7 vs 60.0 exp Jan 4 (miss)
ISM Svs 62.0 vs 67.0 exp Jan 6 (miss)
Jobs NFP 199k vs 450k exp Jan 7 (miss)
AHE 4.7% vs 4.2 YOY exp Jan 7**
CPI 0.5% vs 0.4% exp MoM on Jan 12**
Retail sales -1.9% vs -0.1% MoM exp on Jan 14 (misss)
Industrial Production -0.1% vs +0.2% MoM exp Jan 14 (miss)
UMich 68.8 vs 70.0 exp on Jan 14 (miss)

**hot wage – inflation data

Rates and Economic Data
Economic data in the USA is rolling over, meaningfully. Inflation is already hiking rates for the Fed – very aggressively – where is the trade?  Reach out to tatiana@thebeartrapsreport.com.

“It really depends on any crisis signal from stocks. A 25% one-day crash in US equities would halt the Fed in its tracks. A 25% decline of 2-ish percent a month over 12 months or so may not alter Fed behavior. Just because the Fed doesn’t like crashes doesn’t mean it can’t deal with slow grind declines. It is all about financial conditions” – Hedge Fund CIO in our Live Chat on Bloomberg.

Fed pricing reflects a steady tightening path in 2022 and 2023 with a terminal fed funds rate of around 1.75%. Note this is lower than the previous peak in fed funds of 2.50% in 2018/2019 and may prove to be low, indeed. By comparison, CPI was just 1.9% at the end of 2018 vs 7.0% today.

A number of Fed Presidents (Bullard, Mester, Harker, Bostic, Daly, George) have mentioned the possible need to raise rates in March and the possibility of four rate increases this year is also becoming more prevalent, matching market pricing. The surprise would be if the Fed tightens by 50bp or skips moving at a quarterly meeting. With Mester, George, and Bullard voting this year, the FOMC will have a more hawkish slant.

Balance sheet adjustment is also a discussion point, with some estimates it could come as early as June and certainly this year. A reduction in the balance sheet could potentially also be implemented in lieu of one tightening.

What Can Delay a Tightening?

At this point, with the Fed widely viewed as behind the curve, it will be difficult to delay the path. Two potential causes would be – 1. a continued uptick in Covid cases or a new, more deadly strain; and 2. a sharp correction in risk assets. With inflation gaining traction, the Fed is in a tricky spot, as they may have to continue tightening even though they don’t want to. As mentioned above, balance sheet reduction may help in this case.

Markets have had a dramatic move so far this year, and the GAMMA Alert (sent to clients) we had at the start of the year worked well. Green March Eurodollars are down 42bp and TYH is down almost three points the past two weeks. Special thanks to Arthur Bass, at Wedbush for his weekly insights.

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Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.



A Colossal Theft in Pain Sight

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Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.


What have we done with the $11 Trillion?

We have clients in 23 different countries, but most reside within the continental United States – in recent weeks, we keep hearing countless stories of self-proclaimed 24-hour turnaround testing centers to do a PCR test, then taking more than 80 hours to get the results back. Friends in New Jersey tell us not one pharmacy or walk-in clinic in a 100-mile radius has appointments available in the next week. Home testing has improved but for those traveling overseas – it is a PCR test that is needed.

The question that haunts us now is that, almost two years into this crisis and an $11 Trillion U.S. Fiscal and Monetary spending deluge, we still don’t have an adequate testing infrastructure? It blows us away –  we are still dealing with endless waiting lines, no availability of testing appointments, shortages of at-home tests and overwhelmed testing labs scrambling to process vials.  Where did all that money go?

State and Federal Debts Add Up

In the US, the corona crisis started on January 29, 2020, when the White House initiated its coronavirus task force. Since then, the US has gone from crisis to crisis and the media and our politicians have been obsessed with this epidemic and its consequences ever since. Amidst all the turmoil, the US government has left no stone unturned to throw money at this disaster. The Fed kicked off in early March by lowering interest rates to zero and shortly after began rolled out an alphabet soup of emergency programs. From buying high yield debt to bankrolling bailout checks (PPP loans), nothing was left on the table for our adroit stewards at the Fed. The byzantine maze of fiscal stimuli has left everyone confused. Nevertheless, the total amount of support the Fed has pumped into the economy is best measured by the expansion of its balance sheet. When the Fed finishes its asset tapering program in March of 2022, its balance sheet will have expanded by $5 Trillion. In less than two years the Fed deployed more money than during, and in the 10 years after, the great financial crisis ($3.5TR). This monetary support alone is also more than that of the entire GDP of Japan, the third-largest economy in the world.

Not to be outdone, the Federal government opened the floodgates by quickly passing spending bill after spending bill. After less than two years, the total amount of fiscal stimulus, as measured by the fiscal deficit spending, has reached a mind-blowing $6 Trillion. U.S. Federal debt has reached $29 Trillion and $32 Trillion if you add State and Local debt. At this point, US debt is a whopping 134% of GDP, giving the U.S. the dubious honor of being among top ten most indebted countries worldwide. This is a spot the erstwhile creditor to the world shares with the likes of Italy and Venezuela.
Where did all the money go?

And what did we, the American people, get for this colossal $11 Trillion in a monetary and fiscal deluge? As we find ourselves in the midst of yet another massive outbreak is case count, this seems like a valid question. You would think that the priority for these funds is to bolster essential healthcare needs to address this medical crisis. But even now, the US is still woefully ill-equipped with testing capabilities, almost two years into this crisis.  Our friends in Europe tell us testing is quickly done there. They live in urban areas such as Paris where testing is still readily available. France is also in the midst of another outbreak but seems to have no problem providing its citizens with ample testing facilities.

In hospitals, there has apparently been no improvement in available capacity in the critical ICUs, judged by the Johns Hopkins weekly hospitalization trends.


Incredulously, ICU beds-in-use compared to overall availability is almost higher now than it was a year ago.

So Where did the Money Go?

According to the Congressional Research Service, $25 Billion was appropriated for “selected domestic COVID-19 vaccine-related activities”. That sounds like a lot, but it’s a mere 0.5% of the federal emergency spending in the last two years. It turns out that the department of health and human services wasn’t even the biggest recipient of all the emergency spending. It was fourth on the list, which was topped by the Treasury Department, the small business administration, and the department of labor. Other major recipients were the department of education and the agriculture department. Why farmers needed a $160 Billion windfall during the pandemic is incomprehensible, especially since most crop commodities have been at record highs for a year now.

Reasonable people can agree that small businesses needed support during this crisis, especially during the lockdown. But the Fed’s Term Asset-Backed security Loan Facility (TALF), Primary and Secondary Market Corporate Credit Facilities ((P/S) MCCF), and Municipal Liquidity Facility (MLF) had absolutely nothing to do with small business assistance. These programs, together with the $5 Trillion purchases of Treasuries and agency debt, helped to foster an explosion in debt issuance by big business. Fueling stock buybacks – Investment-grade debt issued in this year and last year was a total of $3.1 Trillion, almost half the size of the total IG market. High yield issuance was even more baffling, setting issuance records two years in a row amidst a debilitating epidemic.

Junk Bond Bonanza Fueling Stock Buybacks

The effect of all this government largesse has had a profound impact on the stock market. The total market value of all stocks has risen from $34 Trillion to $53 Trillion; a whopping $19 Trillion (50%) increase from pre-pandemic levels. The IPO market has been red hot this year, with 1000 deals for the first time in history. Rock bottom interest rates and epic multiple expansion have driven investors into IPOs, as they clamor for excess returns in the most unsavory deals. U.S. junk bonds, we see new supply to plunge as much as 30% in 2022 as refinancings, the driver for almost 60% of issuance this year, will shrink because companies already capitalized on low yields and lengthened maturities. Likewise, a Fed in a hiking cycle should tighten financial conditions – shrink issuance.

Buybacks Driving S&P and Nasdaq Higher – On Leverage

Congress wants to tax stock buybacks – the implications are sky-high as a colossal equity market bid comes from Fed-induced corporate bond sales- See above with @SamRo – he notes just 20 companies are responsible for half the stock buybacks – this is one enormous – central bank fueled – leveraged Ponzi is driving stock indexes (S&P 500 and Nasdaq) higher. Of course in Q1 – Q2 2020 when stocks were on sale – few companies were buying back stock. Per Fitch – U.S. dollar-denominated, investment-grade (IG), corporate bond volume, excluding financial institutions, supranationals, sovereigns, and agencies, tallied $705 billion through Dec. 16, 2021. We saw the second-highest issuance through the first 10 months of the year and are up 27% and 13%, from 2018’s and 2019’s respective levels. Volume is down 36% versus the record 2020 amount; though that gap could shrink by year’s end as the final two months of 2020’s issuance was well below 2021’s monthly average. The volume disparity between 2020 and 2021 relates to deal size. Last year, there were double the number of transactions done for $4 billion or more compared with this year (60 in 2020 versus 29 in 2021). Both years featured at least two $20 billion issuances, with AT&T Inc. and The Boeing Company driving 2020 while Verizon Communications Inc. and AT&T led 2021. Several prominent companies tapped the IG market in 2021, including Verizon, AT&T, Amazon.com Inc., Oracle Corp., Comcast Corp. and Apple Inc. These six issuers comprised 21% of the year’s total volume, with all completing bond transactions of $15 billion or more. In fact, the 10 largest issuers make up 29% of 2021’s volume, highlighting the market’s concentration.

The problem is – central banks are fueling unsustainable inequality.

Share of Total Net Worth held by the Top 1%

2021: 32.5%
2010s: 31.2%
2000s: 27.2%
1990s: 26.7%
1980s: 23.2%

*Since 2003, the Bottom 50% total net worth held has plunged from 39% to 30%. Federal Reserve data. For 20 years 1990-2010, the top 1% net worth held was range-bound 26-27% – since central bank aggression in balance sheet expansion in 2009, inequality has exploded higher. 

The Great Heist at the Taxpayers Expense

This is all great if you own stocks, or when you are a Fortune 500 company issuing debt to repurchase your own stock, but neither the deluge in debt nor the record number of buybacks (at a run-rate of $1 Trillion this year) have done anything to bolster our country’s medical care or Americans’ health. More troubling even is reports showing outright theft of funds earmarked for pandemic emergency spending. The Wall Street Journal quoted the U.S. Secret Service who said that “some $100 billion has potentially been stolen from Covid-19 relief programs designed to help individuals and businesses harmed by the pandemic.” The main culprits are worldwide organized crime networks, who defrauded primarily the pandemic unemployment insurance program. On top of that, as much as 15% of the PPP loans ($76 billion out of $800 billion total) may have been fraudulent, according to the New York Times.

The Middle Class is in Pain

After $11 Trillion of emergency spending and support, the US healthcare system is just as inadequate as it was before the crisis, violent crime is rampant, drug overdoses have never been higher and the economy is showing signs of stagflation, as illustrated by the record spread between Treasury breakevens and TIPS yields¹.  What these bond market metrics suggest is that the potential growth rate of the US economy has structurally declined since the pandemic (it already declined a lot since the “great financial crisis”) and that any growth future growth is coming from price increases. The bond market is telling us – a significant portion of future GDP growth is coming from price increases, but there is little real growth in the economy, which is why TIPS yields are -1.00%.

Consumers in Pain
Since August – we have had THREE sub-80 readings from the University of Michigan Consumer Economic Confidence Data.  Looking back over the last 30 years – it is HIGHLY unusual for the Fed to hike rates with consumers in this kind of pain. Inflation´s taxing powers over the consumer have already hiked rates 100bps for the Fed in our view – colossal demand destruction has taken place. These stagflationary conditions erode people’s real disposable income, making them worse off. Ultimately, most of the $11 Trillion ended up benefiting the top wealthiest Americans, by inflating the prices of assets such as bonds and stocks and lowering interest rates for borrowers with the highest credit rating. For the average citizen, this has been a very raw deal.

Loud Covid Narrative Hides Inconvenient Truths     

We must look at the big picture. There is a high price from lockdowns and Covid human suppression / OUTSIDE of cases. The number one killer of Americans aged 18 to 45 is now fentanyl overdoses, with nearly 79,000 victims in the age range dying to them between 2020 and 2021.

Inflation is a Regressive Tax on the Middle Class
TIPS: Treasury Inflation-Protected Securities: The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater. Breakeven yield is calculated by deducting TIPS yields from real yields. Breakeven rates derive the rate of inflation priced in by the bond market for applicable maturity (such as 10-year breakevens express the implied rate of inflation in the next 10 years).

Trillions of Fiscal and Monetary Support

What is so painful is that not only is there no discernable improvement in the healthcare infrastructure to deal with the corona crisis, but other facets of America’s healthcare are now even worse off. The CDC reported this week that fentanyl is now the leading cause of death among teenagers. These drugs have killed more people between the ages of 18 to 45 than corona, car accidents, and suicides. Data from Families Against Fentanyl suggests that now one person dies from an overdose every 8.5 minutes. The pandemic has pushed drug abuse into overdrive as “the stress of the pandemic has led more people to use these types of drugs, according to experts.”  The Census Bureau this week reported that America’s population grew at the lowest rate in history. In the year that ended July 1, the U.S. recorded only 148,000 more births than deaths, with the balance coming from net immigration. America’s life expectancy last year declined by an unprecedented 1.8 years to 77 years. Besides corona, increases in mortality from drug overdoses, heart disease, homicide and diabetes also decreased life expectancy. Violent crime especially has seen a dramatic increase in the last two years. CDC’s National Center for Health Statistics reported that homicide rates rose 30% between 2019 and 2020 and they continue to go up this year.  At least 12 major U.S. cities have broken annual homicide records in 2021 — and there’s still three weeks to go in the year.

US Annual Population Growth

2021: 0.1%
2011: 0.8%
2001: 1.0%
1991: 1.2%

*America is dying – and it’s NOT just a Covid narrative. From 1999–2019, nearly 500,000 people died from an overdose involving any opioid, including prescription and illicit opioids -CDC data. 

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Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – top 20 all-time at the CFA Institute.





Garbage Floating to the Top

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Institutional investors can join our live chat on Bloomberg, a groundbreaking venue, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – top 20 all-time at the CFA Institute.

If the Fed’s gravy train had been this aggressive in 2008, Bernie Madoff would still be sipping mint juleps in the Hamptons. Lehman NEVER would’ve failed. Central bank largess is protecting Enron’s out there – as accommodation is withdrawn – garbage will float to the top. The toxicity is off the charts this cycle – Dozens of Madoffs and Enrons – it is sickening.

All you need to know is one important fact – there is $30T more debt on earth today sub 2% in yield – than there was in the last two hiking cycles. The below 2% part is important because it speaks to colossal convexity in today´s bond market.  Everyone knows – with interest rates UP, bond prices go DOWN.  The problem is – with trillions more debt on earth BELOW 2% – just ONE little 25bps rate hike carries the destructive forces of 4 hikes 15 years ago!!! The bond market is telling us this, screaming at us. The U.S. 30 year bond yield is 1.87% – while the 20-year is yielding 1.91%. Eurodollar futures have recently started to price in rate cuts in 2024-2026, NOT hikes.  The last two rate-hiking syles were FOUR years-long – NOT this time.

Rate Hiking Cycles
The bond market is telling us, the Fed´s ability to pull back accommodation over an extended period of time is HIGHLY limited. Nearly 71% of the U.S. Federal budget is interest spending and entitlement spending vs. 30% thirty years ago.  Close to 14% of Americans are on Food Stamps today vs. near 3% in 2000.  There are bills to pay, the Fed´s hands are tied.

The Secret

The dirtiest secret in economics is that it provides no coherent, provable, and universally accepted theory of recession. The reality is, economists, don’t actually know what causes recessions. The reality is, there may be no single cause. It’s even hard to wrap your brain around how you are supposed to approach the data. For example, if you look at rate hikes and when recessions occur, it’s not clear that rate hikes cause recessions. Certainly, about 75% of the time quick rate hike sequences were followed by recessions. But then, 25% of the time they weren’t.

Well, a cause is something that works 100% of the time. Certain predictable chemical reactions work 100%. Entire industries and thus economies are built on these industries and their 100% certain causalities. They wouldn’t exist if the criterion for a cause = 75%. As traders, we are delighted if we find something that works 75% of the time and so too readily falls into the trap of confounding probability with causality.

So, we can accept that rate hikes are probably followed by recessions. We think the explanation, perhaps, is that a withdrawal of lending by banks causes recessions. And they stop making loans when they feel, sometimes rationally, sometimes irrationally, that if they make loans they will lose money. Sometimes this feeling happens when interest rates rise. Sometimes it doesn’t. 75% of the time in a rising interest rate environment, banks get the feeling making loans isn’t a grand idea.

Well, why does that happen? There are lots of reasons unique to each cycle, unfortunately, which is why there is no grand unified theory of recession. But clearly, if interest rate hikes go too far, somehow the lending proposition becomes less viable. Again, how do we know when the hikes are too far? We don’t, until after the fact. However, we can say that if a bank’s model is to create money by borrowing short term and lending long term, a negative sloping yield curve will kill loan creation. And what causes a yield curve to invert?

The belief that the demand for money will steadily decline i.e. the belief that there will be a recession. So it’s circular, far from rational. Or it could simply be that a yield curve inverts because traders think inflation will be lower later, causing the curve to invert, thereby causing banks to restrain lending, thereby, in turn, causing a recession. In which case traders’ opinions about distant inflation trigger recessions, which seems a tad bizarre but the world is a crazy place so perhaps it’s true. But yield curves aren’t perfect predictors either. And they change. We do know that if growth is greater than the cost of capital that is less likely to cause a recession than if growth is less than the cost of capital. That does seem logical. So if rates rise less quickly than growth, it seems reasonable that there will be no recession. But growth rates can be a moving target, so a rate hike that is appropriate now may be inappropriate two months later. So we don’t know. But we have the odds: 75% of the time rate hike sequences lead to recessions.

We would only add that when rate hikes are accompanied by an increase in bank reserves then recessions happen for sure. This is why we are so impressed by China’s recent lowering of reserve requirements for its banks. To us, that is a buy signal. Certainly in the US when bank reserve requirements are lowered, equity bull markets follow.

Value vs. Growth – Late Stage
Value vs. Growth the Epic Final Days of this Battle – TSLA is Through key support – 20% off sale – Tesla TSLA is going through the recent lows pre-market – observation of the week – the 25-30x sales LARGE caps (NVDA – TSLA) – are playing CATCH UP with the COUNTLESS 40-100x sales garbage that is now trading 10-20x (ARKK names). So we have a washout in the Nasdaq with 300+ companies moving from 40-100x sales to 10-20x sales and NVDA still sits unched at 30x sales?? – Large-cap stretched names are playing catch up this week.

Value vs. Growth – Early Stage
Close to 20% off their highs – hot software names are in pain. The Nasdaq Composite Index is up roughly 15% year-to-date. However, when removing the 5 largest equities, the index is down close to -20% on the year! This shows how large the tail-risk to US equity markets is if the largest names are to see a significant pullback. This is one of the most top-heavy markets in history.  As we stressed in January on Real Vision and CNBC – the net present value of FUTURE cash flows is worth A LOT MORE with certain deflation and worth ALOT LESS with certain sustainable inflation. 

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The Week that Changed the World – 13 Years, Just Wow

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“‘China’s Lehman Brothers moment’: Evergrande crisis rattles economy” – The Guardian

“The crisis engulfing Evergrande, China’s second-biggest property company, is the greatest test yet of President Xi Jinping’s effort to reform the debt-ridden behemoths of the Chinese economy. As angry protesters occupied the headquarters of the troubled property developer in recent weeks, some analysts have described the Evergrande crisis as “China’s Lehman Brothers moment”. Only this time it’s a credit-fuelled housebuilder that suddenly can’t pay its $300bn debts, rather than a blue-chip (Lehman) investment bank that many assumed was too big to fail but was instead thrown to the wolves 13 years ago.” They took Lehman´s head underwater and they watched for the bubbles – but why?

Credit Leads Equities – Our 21 Lehman Systemic Risk Indicators

My name is Larry McDonald, that’s our UK book cover above. In the years before the failure of Lehman Brothers, I ran a successful distressed credit business at what was the 4th largest investment bank in the U.S. – becoming one of the most consistently profitable traders in the fixed income division. In late 2008, early 2009 – with Patrick Robinson, we penned “A Colossal Failure of Common Sense” – the Lehman Brothers inside story. At least once a month, I tell my wife while wearing a hopeful smile —“if we sell a million books — we´ll break even on our Lehman stock.” On September 15, 2008 – it all came crashing down in the largest bankruptcy in U.S. history. Known as, “the week that changed the world,” a very painful experience indeed. I was down on the mat looking up at the referee as he delivered the count. It was one of those fateful moments most of us face. Staring into the abyss, drenched in blood-curdling uncertainty, there are times in life when we must get up. Even when it looks like all is lost in a valley of no hope.  Ultimately, the lucky ones learn there are valuable lessons in re-invention. The last 13 years have been a breath of fresh air. Our New York Times bestseller has been published in 12 different languages, the “page-turner” is in the CFA Institute’s top 20 all-time (finance books), and was featured in the Academy Award-winning movie with actor Matt Damon, “Inside Job.” It’s an absolute must-read filled with countless lessons, especially for someone under 35 years of age. Over the last decade, I have been told more than a thousand times – it´s one of the most readable books in finance, ever written. Anyone can enjoy it.

Today – we run one of the largest institutional client chat rooms across the Bloomberg terminal. Since 2010, more than 600 buy-side investors participate, now from 23 different countries. Please reach out to tatiana@thebeartrapsreport.com for more details.

Life´s Lessons

One of the important lessons in our book comes down to – how to use leading credit risk indicators? In the 2007-2010 period, the global credit risk epicenter was obviously inside the US.  In the 2011-2013 period, Europe´s banks were the focus during the Grexit panic. In recent years, Asia has become far more interesting, a new epicenter has been formed.

Credit Risk, the US Epicenter 2007-2010

As far back as the spring of 2007, U.S. banks began to underperform financial institutions in Asia. By now, everyone knows most of the subprime mortgage credit risk was inside the USA with domestic banks more exposed than other banks around the world. Notice above, Goldman Sachs (green above) 5 year CDS (the cost of default protection on the bank), began to meaningfully divergence from Standard Chartered. Standard Chartered PLC is an international banking group operating principally in Asia, Africa, and the Middle East. The company has far more credit risk exposure to China – Asia than U.S. banks. It is clear above, more than 12 months prior to Lehman´s failure, banks in the USA were dramatically underperforming from a credit risk perspective. In other words, in 2007 – the cost of purchasing credit default protection on Goldman Sachs was far more expensive than the bank´s Asian peers. Indeed, elephants leave footprints – when large hedge funds see credit risk – they start placing bets months if NOT years before a credit event. The credit market sniffed out Lehman´s demise months BEFORE equity investors got the joke.

CNH China Currency Volatility
During the 2015-2016 China currency devaluation crisis, CNH volatility was a solid leading indicator while China was hemorrhaging foreign currency reserves. In recent weeks, all has been calm, but in recent days a lot has changed. If an asset manager wants to buy some cheap protection against a credit event in China, one can place a bet against the CNH – Yuan. As capital flows into these kinds of wagers, the cost of currency hedging surges. Hence, CNH vol is on the rise. If there is truly a credit crisis in China, the currency should be a lot lower and the cost of CNH vol should be MUCH higher.

Lessons of 2015-2016

Now, let us think of Asia in the summer of 2015.  The Fed was attempting “liftoff” – their first rate hike since 2004. Finally, in December of 2015, the Fed hiked rates 25bps for the first time in eleven years. In the process, as the central bank prepared the world for the now-infamous rate hike. In just six months the dollar ripped from 80 (July 2014) to 100 (March 2015). Emerging markets were in flames, the Fed had triggered a global dollar crisis. More than $1T left China (the country´s fx reserves were on the run). The world was in a real currency devaluation panic, with Asia wearing the epicenter title this time around.

Credit Risk, the Asia Epicenter 2015-2021

During 2015, the China currency devaluation crisis picked up steam in September and came to risk climax in Q3. But months before, the cost of default protection on Asia´s Standard Chartered began to sharply diverge (blue above) from Goldman Sachs in the U.S. Once again, credit risk was screaming “there is a problem” in May 2015, by September the S&P 500 lost 16%. In 2007, Goldman’s credit risk was so telling. Then, eight years later – banks in Asia would wear the credit risk epicenter title. Fast forward to 2021, Evergrande headlines are all the media rage, especially with the Lehman, the lucky 13th anniversary this week. But, what are credit markets telling us this time? As you can see above – far right. Credit risk is calm on Asia banks with exposure to China, no difference to speak of. Central bank liquidity is so abundant, there is NO way Lehman would have failed today. Free markets no more. Adam Smith has one (invisible) hand tied behind his back. We have unintended consequences as far as the eye can see with Uncle Sam’s fingerprints on every street corner.

The Trillion Dollar a Day Gravy Train

The flood of cash in U.S. interest-rate markets pushed the amount of money that investors are parking at a major central bank facility to yet another all-time high – every day a new high indeed. In recent weeks, EVERY DAY more than Eighty participants have been lining up for nearly $1.2 trillion at the Federal Reserve’s overnight reverse repurchase agreement facility. Large counterparties like money-market funds can place cash with the central bank. This easy money gravy train is hiding the next Lehman Brothers, all embraced in deception. In terms of bond yields, let’s look around the planet. In the U.S., close to 90% of the junk bond market is trading below CPI inflation of 5.3% (highest since the early 90s). Over the last 50 years, the highest this number ever reached was 7%. China’s high yield credit market is just 8-10% away from its March 2020 lows in bond prices – highs in yields. All of which begs the question – How can the U.S.-centric JNK Junk Bond ETF yield 4.4% while China´s junk bonds are offering 10-12% cash flows?! Always with an important lens – our friend, Jens Nordvig reminds us – “foreign involvement is small in China. It is true that the high-yield bond market has a sizable USD component (mostly foreign). But relative to the US, where subprime exposure was sold around the world, it is a much more local (controllable) system.” It has been clear for months, there is Evergrande credit contagion – it’s just inside China at the moment.

An Unsustainable Reach for Yield Comes with a Price – It is NOT FREE

Each year that goes by while central banks force investors to reach for yield – any paltry plus return on capital will do these days – complacency builds over time to an extreme – dangerous level.  Mark my words – there were dozens of Bernie Madoffs, Al Dunlaps, and Jeff Skillings sipping mint juleps in the Hamptons and the beaches of the south of France this summer. Central bankers are these guys’ best friends, that is the reality no one wants to admit. As long as central banks do NOT allow the cleansing process of the business cycle to function over longer and longer periods of time – credit risk will continue to build under the surface. Each month, week, and year we allow this charade to move forth – the corners capital flows into are deeper and deeper soaked with moral hazard toxicity. Today´s players on the field make “Dick Fuld” – former Lehman CEO –  look like a choir boy walking out of Sunday mass. The coming event will dwarf what was – “A Colossal Failure of Common Sense.”



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