Analyst in Full Capitulation in Tesla

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Lackluster demand and overseas Model 3 delivery problems will weigh on Tesla’s first-quarter earnings results when the company reports in April, RBC Capital Markets warned clients Monday. – CNBC noted.

The brokerage cut its first-quarter Model 3 delivery forecast to 52,500 from 57,000 and slashed its price target to $210 from $245, a 14 percent reduction that implies more than 20 percent downside over the next year.

“We see both 2019 and 2020 revenue as down vs. the 4Q18 run-rate and, given Tesla is priced for growth, believe the valuation will come in,” analyst Joseph Spak wrote in a note to clients. “Overall, for 2019 we now forecast about 261,000 Model 3 [deliveries], down from 268,000 prior. Our 2020 forecast of 347,500 remains unchanged.”

RBC in Full Tesla Capitulation
RBC Capital Markets lowers its 12-month price target on shares of Tesla amid softer demand expectations and a delivery snag in China – new target is a 14 percent reduction to his prior forecast and implies more than 20 percent downside over the next year from Friday’s close. “We see both 2019 and 2020 revenue as down vs. the 4Q18 run-rate and, given Tesla is priced for growth, believe the valuation will come in” – CNBC Reported.

RBC’s price target on Dec 20 was $340 raised that week – up from $325. So they hiked the target 2x in Q4, now in full capitulation with 3 reductions.

MUST READ: We have a full report on electric vehicles, lithium, and Tesla here.

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Mueller Report Finality and Market Impact

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Mueller Report Market Impact via CNBC

Wall Street is scrambling to figure out what the conclusions of special counsel Robert Mueller‘s long-awaited investigation means for the stock market.

Japan Equities Plunge Sunday Night Post the Mueller Report News
Japan led off this week where US equities closed out last, in the red. The 3% plunge is equivalent to 765 dow points.

Market were NOT Taking Impeachment Risk Seriously

While many investment and equity strategists told CNBC that Attorney General William Barr’s letter about Mueller’s report relieves a persistent concern, few had expected a disastrous outcome for President Donald Trump.

Others, like The Bear Traps Report founder Larry McDonald, were more optimistic and suggested the findings could be a boon to certain sectors.

“It frees him up to focus on infrastructure and housing reform,” McDonald said. “We will rally on this but everything that took us down last week will keep rearing it’s ugly head again.”

Here are the full comments from market investors, strategists and analysts via CNBC.

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Classic Signals – Fixed Income and Equities

“With a cross-asset view (emerging market currencies, eurodollar/Fed funds, gold, and silver); bets on a “one and done” Fed have dramatically outperformed U.S. equities in Q4 and are all pointing to early signs of a softer Fed policy path. Looking down the road ahead, the U.S. equity market will CRASH in 1987 style if the Fed plays tough guy (3/4 more rate hikes?!), it’s that simple. Similar to the March 2016 landscape, the market is about to embarrass the Fed yet again. As we have stressed over the last month, they will capitulate in our view.  Stay long emerging markets EEM, gold GLD and the gold miners GDX.”

Bear Traps Report, November 15, 2018

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Breaking: *AUSTRALIA’S 10-YEAR BOND YIELD DROPS TO ALL-TIME LOW – Bloomberg at 5:39ET, March 24, 2019

Using Equities to Confirm Signals coming from Fixed Income Markets

At the Bear Traps Report, we take a cross-asset view from 20,000 feet looking for important signals which can validate an investment thesis. Today, fixed income and equity markets are telling us something, and it’s time to listen.

March 2019: Ex-Fed Chair Yellen, Global Central Banks Do Not Have Adequate Crisis Tools

June 2017: Fed’s Yellen expects no new financial crisis in ‘our lifetimes’

Recent yield curve inversion has central bankers a bit uncomfortable.

Equities, Consumer Discretionary are Crushing Staples
In recent years, U.S. equities in the economically sensitive consumer discretionary XLY sector have substantially outperformed consumer staples XLP (82.6% vs. 47.9% over the last five years total return). Since June 2018, the world has changed – staples XLP have had their day in the sun (red channel above). During Friday’s 500 point swoon in the Dow Jones Industrial Average, the XLY was 2% lower – while defensive equities in the XLP were unchanged – a sign of things to come. What’s the connection here between what bonds and equities are telling us?

From the Recent Highs

Regional Banks $BKX -10.6%
Financials $XLF -6.9%
Russell $IWM -4.4%
Dow Transports -3.8%
Semiconductors $SMH -3.5%
Energy $XLE -2.9%
Dow -2.8% FANGs -2.6%
Cons Disc $XLY -2.0%
Oil -1.8%
Utilities $XLU +0.40%
Staples $XLP +1.1%

It’s far too early to draw major conclusions, but one thing is clear – economically sensitive sectors (banks, small caps) are leading the way lower for now.

Floating Rate Loans Take a Beating
When Fixed Income markets start to price in a cap on near term / intermediate term bond yields, floating rate securities begin to dramatically under-perform (bank loans BKLN).

Economic Risk Indicators

In October, Wall St.’s economists were looking for 3-4 more rate hikes. Here we are in March and they’ve thrown in the towel. Clearly, there are so many cross-currents to watch. Most are obsessed with the U.S. Treasury curve. Late this week she inverted for the first time since the start of the financial crisis, it’s the talk of the town.  Economists call this the first reliable market signal of an approaching recession and a rate-cutting cycle coming at us.

Financials Leading Stocks Lower
Since October, the 2-10s US Treasury curve has flattened from 34 to 11bps. Since March 18, the XLF Financials ETF has plunged nearly 7%, the KBW Nas­daq Bank In­dex of large lenders post­ing its big­gest one-week slide since 2016, off 10.6% since Tuesday – all with the staples XLP up 1%. Sure, we all know banks’ earnings power struggles with a flat curve and the follow on pressure on net interest margins. But, is this downdraft in the financials simply a product of a flattening yield curve? Or is something more ominous afoot?

US Corporate Bond Binge
Yields on U.S. investment-grade bonds have plunged to the lowest in more than a year.

3-Month vs. 10-Year Treasuries

After 9 rate hikes, the Fed has pushed its target rate or “upper bound” to 2.50%, this is holding up the front end of the yield curve. At the same time, global economic pressures have investors buying long-dated bonds, putting downward pressure on yields.

German Bond Yield Back to 2016 Levels
German 10-year bonds were up at 0.57% in October, they touched -0.01% this week – their lowest yield since 2016. The last time bond yields in Europe were this low the ECB was buying $60 to $80B a month of asset purchases vs. just $5 to $10B today.

Where’s the Trade?

Late this week, the spread between the three-month and 10-year U.S. Treasury yields evaporated, a rush of panic buying pushed 10’s yield to a near 15-month low of 2.40% – the 3-moth TBill yield is 2.40% as well.  In Treasuries, a three-month investment or ten years, the yield is the same. Everyone knows inversion is considered a reliable omen of a recession in the U.S., within roughly the next 12-18 months – but where’s the trade?

An Economist Worth Listening To
We have an economist (above – white line) that’s actually worth listening to. As you can see above – going back 30 years – well before U.S. recessions, consumer staples dramatically outperform consumer discretionary stocks.  When we take a close look at a recession-proof sector like the staples XLP ETF vs. a sector with a high degree of economic sensitivity, consumer discretionary XLY – we come up with eye-opening data. Notably, this ratio has historically rolled over before yield curve inversions as well. Historically, yield curve inversion only confirms what Stan’s economist is already telling us. For our full report, join us here.

Stan Druckenmiller’s Economist

We must introduce you to Druckenmiller’s Economist. Stan will tell you, looking at U.S. Treasury yield curve inversion – in isolation – relative to recession risk is a fool’s errand.

On our Real Vision platform, recently billionaire and legendary investor Stan Druckenmiller talked about clues he takes from the stock market and various economic indicators he uses to make an informed decision about where we are headed. Stan often refers to his “economist” in measuring the performance of different economically sensitive sectors. We agree, but let’s look at fixed income and equity signals together. How do the Staples XLP perform vs. the S&P 500 SPY once the Treasury curve inverts?

Fixed Income Signals in Equity Markets – Consumer Staples vs. the S&P 500
Since 1990, the 3 Month / 10 Year yield Curve has inverted twice. During 2000 to 2002 and from 2006 to 2008. Staples outperformance was substantial in these periods.

 **Notably, staples outperformance does not start immediately. For example, in the Financial Crisis, it takes over 12 months for the XLP to outperform the SPY after inversion. Though it took over a year, the relative performance accelerated quickly in 2008.

Stapes vs. S&P in a Post-Inversion Regime
Above, is the peak to which staples outperforms the S&P 500 post-inversion. If it was a fight, they’d stop it. In a late cycle, post “yield curve inversion” regime, investors want to be overweight consumer staples – and underweight the S&P 500. Bottom line, the key lessons from previous cycles must be listened to:

1) After “sustained” U.S. Treasury yield curve inversion, equity markets are unlikely to experience a meaningful recovery (price appreciation) from that point forward.

2) Yield curve inversion signals are near meaningless in isolation. We need to see early confirmation from Stan’s economist; defensive sectors’ (staples) outperformance relative to cyclicals (consumer discretionary).

** Beware of fake-outs in yield curve inversion. The 3-Month / 10-Year yield curve inverted in 1998 but only for a FEW DAYS. However, the data seen above begins when the curve consistently inverts in July 2000. In 1998, the S&P 500 rallied viciously after inverted yield curve signal – some call this the Greenspan Put – Wall St. was forced to come together with the Fed to ‘save’ Long Term Capital. This false inversion signal would have caused one to miss out on the next leg of the equity rally.

 

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German Mega-Merger in a Desperate Need of Cash

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Deutsche Bank and Commerzbank Confirm Merger Talks

Wall St’s oldest secret, the merger of two of the world’s most over-levered financial institutions came out of the closet today. Deutsche Bank and Commerzbank faced concerns from workers unions, Chancellor Angela Merkel’s office and top shareholders on Monday after confirming merger talks. How much capital would the German taxpayers have to put up is the question on everyone’s mind?

The concerns underline the obstacles to combining the banks, which confirmed talks about a tie-up on Sunday following months of pressure from Berlin, which has pushed for a deal amid concerns about the health of Deutsche Bank, which has struggled to sustain profits since the 2008 financial crisis.

Combined Entity

Commerzbank

Debt: $54B
Equity: $10B
+

Deutsche Bank

Debt: $174B
Equity: $18B

=

Post Merger

Debt: $228B
Equity: $28B

German GDP: $3.6T

*Enterprise value of the combined entity is equal to 7.1% of the country’s GDP. This deal has been lingering around for months, for one reason, who’s going to come up with the $30B? With levered banks, you MUST look at “enterprise value” (Debt + Equity), NOT the meaningless stock price or equity market capitalization. See the data above.

Need for Equity

The deal has yet to go through due to the political pushback given the lack of equity relative to the massive amount of debt in the combined entity.  In our view, the merger needs to get to at least $50B in equity for regulators to accept it. This would mean a near $30B capital injection from the German Government. Keep in mind Germany is the one holding fellow EU members’ feet to the fire on fiscal spending, putting them in a further precarious position.

Leverage vs. US Banks

JP Morgan:
Debt: $230B

Equity: $350B
D/E: .66x

Morgan Stanley:
Debt: $160B
Equity: $74B
D/E: 2.16x

The New (Merged) Deutsche / Commerzbank:
Equity: $28B
Debt: $228B***
D/E: 8.14x

In Q4, Deutsche Bank’s common equity tier-one capital ratio (CET1), a key measure of financial strength, came in near 8% in the European Union-wide test of banking resilience. The bank’s CET1 ratio will compare to 7.8% in the previous round in 2016, per Reuters. In contrast,  Barclays’ CET1 ratio ended 2019 at 13.2% (December 2017: 13.3%).

Debt to Equity Ratios
The German government will probably (must) inject some state capital into the merged bank and retain an equity stake, but it would have to be substantial. We would assume the merged entity needs to at least double its equity capital. 

Employees

Deutsche Bank AG: 92k
Commerzbank AG: 50k

Another obstacle for the acceptance of a deal is the jobs it would need to destroy. The merger takes out 20-30k here, unfortunately. After a decade of downsizing, financials are still downsizing.

Global Bank CDS
Credit risk in Europe has tightened substantially since the beginning of the year. However, the CDS in Deutsche and Commerzbank remains well above the banks in the US. Pick up our latest report here

 

 

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Corporate Credit Signals

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Our Thought Leadership Series on Real Vision is Coming Soon – See our Latest – Debt Jubilee here.
Our Larry McDonald with hall of fame historian Niall Ferguson in Manhattan Friday. The Debt Jubilee, see our latest sit down on Real Vision here .

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Watch Financial Conditions NOT Economic Data
We often tell clients, “credit leads equities.” Even more important, tightening financial conditions (FCIs) drive Federal Reserve policy movements, NOT lagging economic data. Nearly every economist in the U.S. was calling for 2-3 rate hikes back in October / November – even as financial conditions were tightening at the fastest pace since 2015.  By focusing on FCIs, in late Q3 2018, we were able to position clients in a basket of “Fed Pause” trades (emerging markets, energy, gold) – this thesis has played out beautifully.

Inflation, down but NOT Dead

It’s interesting to note just how much financial conditions have eased since the Fed’s hall of fame cave. This speaks to creeping reflation risk, a rate hike probability revival. Gold has been singing this tune over the last week.

Hints of Reflation
The very latest reading of the core PCE index, rose 0.19%, its largest monthly gain since May. Prices for services, more sensitive than goods to domestic labor supply / wages, surged 0.29% – the largest jump in nearly 15 months. It’s also interesting to note how much bonds have rallied with sharply lower yields in U.S. Treasuries, while core PCE inflation is still up meaningfully over the last 18 months and NOT giving up any ground (see the white circle above).

Bonds are Taking a Beating in recent Days
Just when the Street gave up on reflation and the rate cut camp started to overflow – bonds put in the most significant sell-off since Q2 2018 in recent days. It’s looking more and more like China hit the panic button heading into the trade negotiations. They were dealing from a position of weakness with an economy reeling from the sharpest global slowdown in decades. The mountain of fiscal and monetary policy actions they’ve taken is nothing short of remarkable. RRR cuts, tax cuts, infrastructure spending splurge. Looks like an $800B boost to the German economy 🙂 – maybe global synchronized growth will appear on stage after all?

The China Panic Button
Economic boost: This will help Xi’s team sitting across the table from Uncle Bob (U.S. trade hawk) Lighthizer.

Financial Conditions vs. Credit Availability Surveys

We must track true credit conditions, credit availability – follow the leading indicators.

C&I Senior Loan Officer Survey
The CDX IG is the most followed measure of corporate credit conditions in the U.S., we’re looking at the credit spreads on large investment grade companies above.  As you can see, credit conditions tightened dramatically, and then the senior loan officer survey caught up with what the CDX IG was telling us weeks earlier.  The Fed pays close attention to the loan survey data above, unfortunately, it takes forever to compile the STALE data. The survey above is the most recently available, as of January 31, 2019, but the actual engagement with loans officers was compiled in Q4. The white line above is telling you current credit conditions are easing, and easing fast relative to the now “out of date” C&I loan survey data.

Working with our Associate Ed Casey

Our associate Ed Casey points out,  the first time in two years, banks were tightening standards for Commercial and Industrial (C&I) loans in Q4 despite facing increased competition from nonbank lenders.  Although loan growth continues to accelerate +10% YoY, it has tended to lag lending standards by 18 months. Corporate credit spreads typically lead bank lending standards, so we will all be closely monitoring their recovery and changes C&I balances. Fed chair Powell’s cave-athon – or dovish pivot – remains supportive of risk assets and financial conditions in the short run. Pick up our latest report here.

In the hole, December 2018, see our high conviction “get long equities” call here.

Charge-Offs

C&I delinquency and charge-off rates remain close to historical lows, indicating few signs of asset quality stress which is support for risk assets.

Levered Up Economy

Our Ed Casey notes, total US bank credit is equivalent to 70% of GDP, but below 60% as recently as 2014. At $2.3T commercial and industrial (C&I) loans outstanding have doubled since 2007, as their percentage of total bank credit, increased from 15% to 18%. Since mid-2017 smaller banks are increasing their lending at a faster pace than larger institutions.
We continue to monitor the lagged impact of slowing PMI indicators on loan growth and credit spreads. Pick up our latest report here.

 

 

 

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Fed Cave-athon Driving Stocks Higher for Now

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“The trade of 2018’s second half will come down to meticulously measuring the “tug of war” between the Federal Reserve and emerging market stress in global financial conditions. The Powell Fed has consistently claimed they’re U.S. data dependent. In obnoxious fashion with a splash of hubris, they’re “NOT concerned” with emerging market stress in financial conditions – we’re going to “stay in our lanes” has been the mantra. We wish we were back in the 80s listening to the Thompson Twins, but we’re NOT, there’s far too much GDP outside the U.S. today, over $60T. With a strong dollar and sky-high Q3-Q4 earnings expectations for the S&P 500, the trade for the next 6-12 months will be found in playing the (catch up) mean reversion between the U.S. and emerging market equities. Each month, as the Powell Fed has tried to stand their ground, day-by-day the beast inside the market is piling more and more pressure on them. Once again, this serpent will break the Fed. Get short (or underweight) U.S. equities and long emerging market equities. Once global credit risk invades America’s shores, pummelled emerging markets (Brazil $EWZ) will lead the way to higher ground.”

Bear Traps Report, August 21, 2018

Fed Chair Powell and the S&P 500: “Not Concerned” to “Concerned”
Here’s a look at the S&P 500 and Fed Chair Powell’s posture on global financial conditions. With a splash of hubris, we’ve been lectured for nine months that the Fed is going to “stay in our lanes, the U.S. economy.” The latest shift from “Not Concerned” to “Concerned” has global equities moving higher. Since 2010, through all their denials, ultimately global financial conditions (FCIs) have been driving the Fed policy path NOT U.S. economic data, the Fed made a colossal shift this week.

Economic data in recent weeks is sending a message loud and clear. Regional Federal Reserve Bank Factory output readings and global PMIs are making the recent equity and credit market volatility look HIGHLY credible in forecasting future tangible economic weakness. As a result, with a fire hose in hand, Fed Chair Powell spoke this week alongside Janet Yellen and Ben Bernanke where we witnessed a further dovish shift from the Fed Chair.  Markets ripped higher in response to the Powell cave-in (capitulation from his Q4 2018 policy path stance). The re-pricing of Fed probabilities in the past four weeks has been on a historic run, from pricing 83% probability of a Fed “tightening” in 2019 to 30% probability of “an ease” has had a dramatic impact on Eurodollar spreads, stock and bond prices and of course interest rates. Let us review.

Regional Federal Reserve Bank Factory Gauges
The Richmond Fed manufacturing survey for December came in exceptionally weak; -8 vs +15 expected. This is the lowest level since June 2016. This is yet another data point showing economic momentum in the U.S. slowing down, which will eventually be helpful in pushing the Fed to back off on rate hikes. The Markit Manufacturing PMI print came in slightly below expectations on Wednesday, however, the ISM Manufacturing PMI  released Thursday morning was a massive miss. Working with our associates at Astor Ridge, we expected the ISM PMI to come in well below expectations and calculated it could be as low as 54.0. Regional PMIs had seen substantial misses in the past two weeks and though the market was pricing in a significant drop from 59.3 to 57.5, it seemed to be overlooking the surprisingly poor regional data prints. Above are listed the Dallas, Philadelphia, New York, Richmond, and Kansas City Factory gauges, the dotted line is too close for comfort, recession territory.

Recent Highs to Lows in ManufacturingPMIs around the World

China:  52.4 to 49.4
Germany: 63.3 to 51.5
Eurozone: 60.6 to 51.4
Canada: 57.1 to 53.6
United States: 61.3 to 54.1

U.S. Treasuries vs. Average Hourly Earnings in the USA
One thing driving the Federal Reserve and the bond market crazy is the whacky disconnect between U.S. wages (AHE in white above) and the global economy’s downward pressure on bond yields (see the U.S. 10 year yield in yellow above). Bonds are in rally mode with lower yields in part because of a large supply of workers, U.S. labor force slack. There are far too many young people NOT in the labor force to generate sustainable inflation. Friday, the unemployment rate rose to 3.9% from 3.7% because the labor force increased by 419k. That’s real size slack* coming back into the labor force. Per OECD data, the U.S. labor force of 25-54-year-olds is down one million (80m to 79m) workers over the last decade, but the U.S. population is 26m larger. A colossal impact on the bond market is baked inside this data. Pick up our latest report here.

“Particularly with the muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves.”

Fed Chair Powell told the American Economic Association in Atlanta this Week

*This does confirm a long-held belief that the U.S. economy during the 2008-2016 period of economic “secular stagnation” pushed far too many (young) eligible workers off to the sidelines. As such, the available (real world) labor “slack” remains much more plentiful than the headline unemployment rate reflects. (We believe Fed Chair Powell has commenced using this slack to justify a softer policy path). Note in December, the labor force participation rate rose above 63.1% for the first time since 2013! Bottom line, look at the whole picture, NOT the unemployment rate when trading gold, bonds, and interest rate sensitive equities.

The Great Powell Balance Sheet Cave In – The Words that Moved Markets – Nasdaq up 4.3% on Friday

Fed Chair Powell on their Current Balance Sheet Reduction at $50B a Month:

“I don’t see us changing that”

December 19, 2018, Fed Meeting

“We wouldn’t hesitate to change balance sheet policy if needed.”

January 4, 2019, Event with Yellen and Bernanke

Fed Capitulation Driving Stocks Higher

Powell’s cave-in comes after the another Regional Fed president capitulated Thursday morning in a Bloomberg Television interview.

“We should NOT take any further action on interest rates until these issues are resolved for better or for worse.”

Dallas Fed President Robert Kaplan, January 3, 2019

Kaplan’s comments were especially important NOT because of the content, but because of his substantial shift in tone since just last October.

“Another two to three interest rate increases from the Federal Reserve will likely put U.S. borrowing costs in “neutral” territory where it is neither stimulating nor restricting economic growth”

Dallas Fed President Robert Kaplan, October 19, 2018.

The Tremor before the Quake and the Fed’s $450B Balance Sheet Reduction
The combination of rate hikes and balance sheet reductions from the Federal Reserve in 2018 sucked up global U.S. dollar liquidity and put emerging markets under immense pressure. Next, the collateral damage forged onto the global economy took U.S. stocks lower in Q4. In our view, so far the Fed’s $400B balance sheet reduction vacuumed $1T out of the banking system. Through 2018, foreign banks – size holders of excess reserves – have been forced to search for other funding sources. The unintended consequences here are all over the floor. Globally, borrowing costs for consumers have surged with short term money market yields. The economic destruction is far more than meets the eye, the Fed is clearly walking in the dark here and they can’t find the light switch.

Emerging Markets, the Global Economy – Both Federal Reserve Balance Sheet Victims in 2018
Emerging market equities were 20-30% lower from February through October, bonds (credit markets) didn’t fare much better (see above), next the S&P played catch up to the downside. This, combined with tariffs from the White House has placed global manufacturing in a significant slowdown that has begun to circle back into the United States. After all, over $60T of global GDP is OUTSIDE the USA.

What a Coincidence?
All-time highs in U.S. equities just so happen to be perfectly timed with global central bank candy (asset purchases) fleeting into negative territory.  Offshore dollar debts worldwide have ballooned to $12.8T (BIS data). Roughly $4T of contracts outside the US are priced off three-month Libor rates alone, which have doubled over the last year. Rate hikes matter, the Fed balance sheet reduction matters more, pure global economic impact.

Next, The Mester Cave

Loretta Mester is considered one of the most hawkish Fed governors. It’s very important to watch for shifts from the extreme wings inside the Fed. When a hawk shifts to a more dovish posture, it means far more than a Fed dove repeating a long-held view.

*Fed “hawks” favor less market/economy accommodation (further rate hikes, Fed balance sheet reduction). Fed “doves” favor more accommodation (fewer rate hikes, possible hold period or rate cuts; less Fed balance sheet runoff).

A Colossal Shift in just Eight Weeks from the Cleveland Fed President

 *MESTER SEES NO URGENCY TO RAISE RATES NOW GIVEN INFLATION
*MESTER: SHE’S OPEN TO SEEING WHERE ECONOMY GOES ON RATE MOVES
*MESTER: FED ALWAYS LEFT OPEN OPTION OF BALANCE-SHEET CHANGE

*FED POLICY ISN’T AIMED TO PUT PEOPLE OUT OF WORK

“We should take our time and assess. We may be where we need to be (need to stop hiking rates).”

Cleveland Federal Reserve Bank President Loretta Mester said in an interview with Reuters this week.

(Our Larry McDonald had dinner with Loretta Mester in October, spoke to her personally, “one-on-one” for 15 minutes, this is a far different perspective from her in our view, with a meaningful impact on markets).

Two Year Yields vs. Fed Funds Upper Bound
The market is giving the Fed the “Rodney Dangerfield, “No Respect.” The Fed’s ability to hike rates further in 2019 is in doubt above. Not only are U.S. 2 year yields BELOW the upper bound of the Fed Funds rate, but this week futures were pricing in a higher probability of a rate cut than a rate hike in 2019. 

GDX Gold Miners – Simple Way to Bet Against the Fed
There are a number of ways to bet against Fed rate hikes, most efficient is trading EuroDollar futures. One of our best trade ideas issued to clients in the fourth quarter of 2018 was buying Gold and Silver miners. In our view, precious metals are powerful tools to take advantage of a Fed that has been too hawkish. Since October 1st, the probability of ANY Federal Reserve hike has completely caved. Meanwhile, since August, the GDX gold miners ETF is up +23.1% while the SIL Silver Miners ETF is +15.2% higher with the S&P 500 off nearly 15%. Pick up our latest report here.

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One Sky High Junk Bond Maturity Wall

“With a cross-asset view (emerging market currencies, eurodollar/Fed funds, gold, and silver); bets on a “one and done” Fed have dramatically outperformed U.S. equities in Q4 and are all pointing to early signs of a softer Fed policy path. Looking down the road ahead, the U.S. equity market will CRASH in 1987 style if the Fed plays tough guy, it’s that simple. Similar to the March 2016 landscape, the market is about to embarrass the Fed yet again. As we have stressed over the last few months, they will capitulate in our view. As we stressed in September, stay long gold GLD and the gold miners GDX.”

Bear Traps Report, November 15, 2018

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Spending nearly $1T on deficit overloading tax cuts, then lighting it on fire with 8 rate hikes (nine since December 2015) and an experimental $430B of Fed balance sheet reduction, will go down as one of the most destructive policy mistakes in the history of the Republic. From 2010-2016,  central bankers enabled run-away corporate borrowing, now credit markets are telling them they’re pulling away from the steroids far too quickly.

More Rate Hikes?
There have been far more rate hikes than meets the eye. As we can see above, financial conditions are already as tight as found during the 2015-2016 oil credit crisis / China currency devaluation equity market sell-off. Back then, the Fed went on (rate hike) hold for 12 months. Fed fund futures are now pricing in just under 10% probability of just one rate hike in 2019. The Fed and U.S. economists are saying 2-3, high yield (credit markets) market saying zero. Who do you believe?

Credit Risk Veto of the Fed Policy Path

Credit markets are freezing up, recently companies have NOT been able to raise capital through the $1.6T US high-yield bond market. The first full month since November 2008 (just after the failure of Lehman) that not a single junk bond has been able to price in December.

Redemption

Junk bond maturities will soar to $110B in 2019 from $36B  in 2018, according to Moody’s Investors Services. And we expect that number to double to near $200B in 2020. For highly-levered companies who must roll their bonds over when the principal payments come due, a sharp rise in borrowing costs will catch them grossly ill-prepared, it’s a death sentence. When Chair Powell tells you the Fed will hike 2-3 times in 2019, he’s being Pollyannish, to say the least. In the real world, credit market functionality runs Fed policy, NOT backward looking U.S. economic data.  If you give us a colossal debt maturity wall vs. a Fed chair, the wall wins EVERY time.

Junk Bond Maturity Wall

2018: $36B
2019: $108B
2020: $191B
2021: $293B
2022: $385B

*Moody’s data, combined leveraged loan and high yield bond maturities. Two to three more rate hikes? Who are they kidding???

Investment Grade Debt Maturity Wall also in the Ugly Category

“In the US, investment grade debt outstanding has grown from $2.3T in 2007 to $6.1T heading into 2019. In the next 3 years, a large load of $1.3T is coming due, which is 3.5x greater than what we faced in 2007. ” With our associate Ed Casey.

*U.S. LOAN FUNDS SEE RECORD $3.53B WEEKLY OUTFLOW: LIPPER

Mr. Powell, are you listening to Leveraged Loans?
Credit spread contagion on stage here, the beast inside the market keeps moving from one victim to the next. Price discovery in the loan market found religion last week. For most of Q4, while investment grade bonds (see LQD above) suffered a bloody nose, secured bank loans were seen as a safe haven – then prices collapsed after the Fed meeting. Leverage is a very dangerous beast, the larger it becomes the more perfection it demands in capital markets functionality (the ability of HIGHLY leveraged companies and countries to sell investors more bonds, debt obligations). Leveraged loan sales in November dropped to $21B, while there was just $5.1B of high-yield bond issuance. That’s the lowest combined volume of speculative-grade debt supply since February 2016, according to LCD, a unit of S&P Global Market Intelligence.  And that was BEFORE the Fed rate hike. December’s new issuance is close to zero, “the betting window is closed, Sir.”

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The True Cost of  Rate Hikes, a Fed Smoking in the Dynamite Shed

The global debt markets – especially US credit – have ballooned in size since the financial crisis. If you think of the reasons behind a rate hike (besides reloading the stimulus quiver), they basically boil down to the Fed’s ability to reprice assets and slow capital formation to stave off inflation. The repricing of assets is first felt in the debt markets. The fact that these markets are now substantially larger than they have ever been (having grown at a double-digit clip in corporate credit and even faster in government-issued bonds), makes the impact of even a modest hike exponentially more powerful than ever before! With this fact in mind, Why are U.S. economists sooooo focused on domestic economic data? Their eyes should be on credit risk. This is a major flaw in our view – in the post-Lehman era credit risk has been driving the Fed policy path bus.

It is not hard to calculate the amount of monetary value being repriced by a mere 25 basis point hike and see that it is far more powerful than ever before. The term duration refers to the percentage of gain or loss in bond prices for a given shift in interest rates, usually 100b basis points. So, for instance, a  pool of bonds with a duration of 2.5 would have about a 2.5% gain in value for a 100 basis point cut in rates and about a 2.5% loss in value for a 100 basis point hike in rates.

Colossal Losses, Impact of Fed Rate Hike in the Market

One of the most popular bond indices, the Barclay’s U.S. Aggregate, has a market value of $20.9 trillion today. This compares to a market value of $8.3 trillion at the time of the last rate hiking cycle kick-off on June 29, 2006. A look around the world is an eye opener; the Barclay’s Global Aggregate has a market value of $46.2 trillion versus $21.9 trillion on June 29, 2006. Some of this is already priced in of course, but the quick and dirty calculation tells you that for the U.S. Agg, a 25bps hike has 2.53x the impact of a 2006 era move and for the Global Agg, the impact is around 2.36x a 2006 era move in terms of the value of immediately repriced assets. This gives the adage “interest rates up, bond prices down” profound new meaning.

Put another way, the amount of losses by global bond investors in percentage terms for a given hike in rates is around 2.5x as powerful as it was the last time the Fed hiked rates over nine years ago. So might 25bps act a bit more like 62.5bps? Over the last few months, credit markets have been screaming this fact, are you listening?

Economic Data Still Strong?We must keep in mind, there are public and private economists who actively try and sell investors on economic modeling and follow-on equity market impact. Well, this crowd has been embarrassed in recent months. In November, ISM Manufacturing PMI came in with a healthy 59 handle. During the 2015-2016 equity market sell-off, she printed down at 48. There was NO warning for U.S. equities here. Bottom line, listen to credit markets, not economists.

Recession in 2019 or Does that Even Matter?

A 2019 recession will be more than an inconvenience for companies who rely on an easy money gravy train, or access to capital markets to stay afloat. Rolling over the debt during an economic downturn is no fun, especially when rates for high-yield paper shoot up, only adding to the pain of keeping debt on their already stretched balance sheets. “What blows my mind are the U.S. economists who are so focused on backward-looking economic data. With leverage this high, you need perfectly functioning capital markets period. Credit markets ALWAYS trump economic forecasting” said Larry McDonald, founder of the Bear Traps Report. Think of it this way, the St. Louis Fed and Goldman Sachs are both calling for 2.5-2.6% Q4 GDP growth, but does that even matter while companies cannot roll-over sky-high piles of debt?

Interest Coverage Ratio High Yield Junk Bonds

2018: 3.20x
2017: 3.50x
2016: 3.80x
2015: 4.50x
2014: 4.70x
2013: 4.75x

Bloomberg data, with leverage like this, there’s little room for error.

Colossal Losses, Impact of Fed Rate Hike in the Market

One of the most popular bond indices, the Barclay’s U.S. Aggregate, has a market value of $20.9 trillion today. This compares to a market value of $8.3 trillion at the time of the Fed rate hiked rates during the last credit cycle on June 29, 2006. A look around the world is an eye opener; the Barclay’s Global Aggregate has a market value of $49.2 trillion versus $21.9 trillion on June 29, 2006. Some of this is already priced in of course, but the quick and dirty calculation tells you that for the U.S. Agg, a 25bps hike has 2.53x the impact of a 2006 era move and for the Global Agg, the impact is around 2.36x a 2006 era move in terms of the value of immediately repriced assets. This gives the adage “interest rates up, bond prices down” profound new meaning.

Put another way, the amount of losses by global bond investors in percentage terms for a given hike in rates is around 2.5x as powerful as it was the last time the Fed hiked rates over nine years ago. So might 25bps act a bit more like 62.5bps? Recent price action in the stock and corporate bond markets are screaming this fact at us today.

Credit Leads Equities
From late October to late November, U.S. equities were flat, but junk bond credit spreads over U.S. Treasuries were nearly 50bps wider, or higher in yield. Credit was telling you, there’s more pain ahead for U.S. equities. Goldman Sachs just shaved its growth forecast for the first half of next year, from 2.50% to 2.00%, once again credit markets have been two steps ahead here. Listen to credit risk, NOT economists.

Unintended Consequences

Junk bond companies trying to refinance their hefty debt load, also have to deal with the tax bill passed through Congress and signed by President Trump a year ago. The new legislation raised the cap on how much an issuer could deduct in interest payments from their profits. As a result, highly levered companies, who no longer qualify for the tax loophole, will have less cash to pay back the interest on their bonds. “Diminished ability of highly leveraged companies to service high-interest costs would worsen their refinancing opportunities,” warned analysts at Moody’s Investors Service.

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