How Low Can You Go Japan?

Fresh Record Lows

Japan’s 10 year bond touched -0.16%, a record low yield.

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Japan 10 Year

Asian stocks tumbled as anxiety over the ‘Brexit’ vote and forthcoming decisions from the U.S. and Japanese central banks stoked demand for haven assets. Crude oil also slid.

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Japanese shares fell to a one-month low, leading losses in Asia following the steepest slump in global equities since February. The yen climbed with gold, and 10-year Treasury yields fell for a fifth straight session, as traders favored safer assets ahead of a week where Chinese data on factory output and retail sales will be followed by meetings of the Federal Reserve and the Bank of Japan. The pound slid to its lowest level in almost two months after a poll showing a 10 percentage-point lead for Britain to leave the European Union sent it tumbling late on Friday. Oil retreated on an increase in U.S. drilling rigs.  – Bloomberg



The Fed has China Debt Bubble’s Blood on its Hands

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IMF officials warned this weekend, China must act quickly to address mounting corporate debt, a major source of worry about the world’s second-largest economy.

China’s surging debt load has profound implications for U.S. equity markets, it’s the subprime mortgage crisis all over again, just a different serpent, another beast.

David Lipton, first deputy managing director of the IMF, warned in a speech to a group of economists in the southern city of Shenzhen that companies’ indebtedness is a “key fault line in the Chinese economy.”


The U.S. Federal Reserve clearly has the China debt bubble’s blood on its hands.  As the Fed kept interest rates near zero for 8 years and expanded its balance sheet, Chinese companies used the easy money gravy train to LEVER up (see below).

China Debt 2

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“Company debt problems today can become systemic debt problems tomorrow. Systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both,”


China, whose economy grew in 2015 at its slowest pace in a quarter of a century, has been trying to deal with with rising debt levels and overcapacity.

People’s Bank of China warned in its mid-year work report that the government’s push to reduce debt levels and overcapacity could increase bond default risks and make it more difficult for companies to raise funds.

Corporate debt in China stands at about 145 percent of gross domestic product, a dangerously high ratio. State-owned enterprises, accounted for a staggering 55 percent of corporate debt but only 22 percent of economic output, according to IMF estimates.

China must deal with both creditors and debtors and to address governance problems in both the corporate and banking sectors.

 “The lesson that China needs to internalize if it is to avoid a repeating cycle of credit growth, indebtedness, and corporate restructuring, is to improve corporate governance.”


China leverage side effects continue to explode.  Pick up our latest trading ideas, click on this link:

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“Here’s Why Bonds are a Screaming Buy.” Bear Traps, March 2016

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“Here’s why bonds are a screaming buy, (1.97% on the U.S. 10 year).”

Our Larry McDonald; March 14, 2016 on CNBC (1.64% today)

While Wall St. economists and strategists  have been lecturing you to get out of bonds since 2014, we’ve maintained a bullish stance on bonds for the last 3 years.  Equities have trailed bonds by a long shot in 2016.

See our Bullish Bond call on CNBC here.

100 to 150

Just look at the German 30 year bond, crushing stocks since 2014.

German 10 Year

3.50% to 2.45% Since 2014

US 30 Year

Where do bonds go from here, get on our next Bear Traps report below:

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S&P 500 Earnings Fraud

If we told you the S&P 500 has made $118 for three years running with zero growth, would you believe us?

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On January 1st, Wall St. told us the S&P would make $124.25, but now they’ve come clean, they only expect $118, we’re at $113.

Earnings x Multiple = S&P Value

$118 x 19 = 2242

$118 x  18 = 2124

$118 x 17 = 2006

$118 x 16 = 1888

Ironically, it was the same story last year, $123.85 expected earnings, only to finish at $117.50.

$113 x 19 = 2147

$113 x 18 = 2034

$113 x 17 = 1921

$113 x 16 = 1808

S&P 500 EarningsIt’s a magic act, stocks can rise for years without earnings growth, presto!

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Janet Yellen’s Fire Hose

Join our Larry McDonald on CNBC’s Trading Nation, Wednesday June 8, at 2pm.

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This morning, copper and oil continue their great divergence.  Someone’s right on the global economy, we think it’s Dr. Copper.

The amount of metals and mining bonds trading at distressed levels is $26 billion after peaking at $86 billion in February and starting at $31 billion in October. With most commodity prices below last October’s levels, it appears these changes have been driven by the various measures that the companies have undertaken rather than an upturn in commodity prices. Additionally, companies with bonds continuing to trade at distressed levels may signal the market is expecting more drastic restructuring measures. – Bloomberg



Janet Yellen’s Fire Hose

A dovish turn yesterday from Chair Yellen put more goodies in the “risk on” bag.

“When would it be appropriate to resume normalization of interest rates? What she really said today was: ‘I have no idea.” And it was the right answer,” said former Fed Governor Laurence Meyer, who now heads the Washington firm LH Meyer Inc. “Normalization is a concept. There is no time frame.”

In January, the Fed told use they would hike rates 4x this year, today the market is telling us they’re nearly done for 2016.  The poorly thought through four rate hike promise to markets was a horrendous risk management move by the Fed.  In a little over a month, the U.S. dollar ripped from 94 to 100.

Next, China, emerging markets and commodities were crushed by the Fed’s unwise management of global risks.  Today, Janet Yellen doesn’t have her hand of the wheel anymore, China does.  She’s still putting out the fire.

“Coming credit crisis will put Fed on hold for 2016.”

Bear Traps, December 11, 2015

Global credit and economic risks have VETOED the Fed policy path for 2016, something we stressed back in December.

File_004 (1)This green line is even LOWER after Friday’s Jobs Bomb.

The global economy is driving the U.S. rates bus.  Over the last year, what U.S. economists have been consistently getting wrong, is the fact that global conditions are overpowering the U.S.

Global GDP

Outside the USA: $61T

Inside the USA: $18T

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Big Blow to Puerto Rico Bailout Bill on Capitol Hill

Join our Larry McDonald on CNBC’s Trading Nation, Wednesday June 8, at 2pm.

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With $2B of debt maturities, much of which are General Obligation bonds due in July, all eyes are on Washington and their proposed bailout plans.
With our partner ACG Analytics
Puerto Rico’s next governor and congressional representative will be individuals who oppose the bill to address territorial fiscal issues passed by the U.S. House of Representatives Committee on Natural Resources May 25th, a primary election in the islands’ New Progressive Party (NPP) determined yesterday.
Support of the bill is believed to have been the deciding factor in the defeat of Pedro Pierluisi, the territory’s Resident Commissioner in the House, in the gubernatorial primary. The bill’s Federally-appointed board within the Government of Puerto Rico that would be able to overrule the Legislative Assembly and the governor on matters affecting finances became the major issue of the campaign after the Committee vote.
General Obligation Bonds, 8s due 2035
Primary victor Ricardo Rossello, son of the governor from 1993 until 2001, stepped up his opposition to H.R. 5278, which carries the acronym “PROMESA.” With 90.1% of polling stations reporting as of this morning, his margin of victory was 2.1%.
The primary for the nominee to replace Pierluisi in Congress was also won by a PROMESA critic, Puerto Rico House of Representatives Minority Leader and Republican Party Chair Jenniffer Gonzalez. She overwhelmed the only candidate on the ballot other than Pierluisi to have supported the bill drafted by the U.S. Treasury Department with Republican U.S. House leaders and acceptance by House Democratic leaders. Her victory with a whopping 70.6% of the vote over the PNP’s 2000 gubernatorial candidate who ran with Pierluisi, however, was due to a number of factors.
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Both candidates for the Popular Democratic Party (PDP) nomination for Congress opposed H.R. 5278. The nod was taken by former PDP President and House Minority leader Hector Ferrer, the party’s first noteworthy critic of Governor Alejandro Garcia Padilla (PDP). Ferrer was the favorite of the nationalist (“sovereigntist”) wing of the PDP, although he is not clearly a member of that faction. With 57.7% of the vote in 92.5% of polling paces, he bested Senator Angel Rosa, whose support came primarily from the “commonwealth” wing of the party.
PDP President David Bernier was unopposed for their party’s nomination. He, too, rejects H.R. 5278.
All four nominees said at the end of last week that they would travel to Washington, DC to lobby against the bill this week.
Bond Insurer MBIA


In addition to rejecting the authority of the bill’s board, they also want Puerto Rico to place a greater emphasis on consensual debt restructuring with creditors than on forced reduction in the nominal value of bonds. They also hope that Federal legislation to address Puerto Rico’s fiscal problems will provide greater equality for the territory in Federal programs and include other measures that would ease strains on the insular budget and boost the islands’ economy.
Rossello has, additionally, stressed that he would bring about substantial economies in government spending, minimizing the need for debt restructuring.
U.S. House Republican leaders have planned for the full House to consider PROMESA Thursday and/or Friday. Rules Committee Chairman Pete Sessions (R-TX) has notified House Members returning to session tomorrow that proposed amendments must be filed by 10:00 a.m. Tuesday.
How House leaders of both parties and representatives of States of Puerto Rican origin will react to the rejection of PROMESA in the results of the primaries is unclear. Representative Nydia Velazquez (D-NY), who played a key role in enlisting House Minority Leader Nancy Pelosi (D-CA) to be an aggressive advocate for Puerto Rico debt reduction legislation, wavered in her support for the bill recently because of insular opposition but reportedly left a meeting between the Treasury Department’s lead official on the legislation, Antonio Weiss, and New York elected officials of Puerto Rican origin Friday afternoon recommitted to the legislation.
It is also unclear whether Pierluisi will continue to support the bill in light of its rejection in the primary. His support has been seen as critical to the measure, particularly because Gov. Garcia Padilla says that he cannot support it because of its fiscal control board. Last night, Pierluisi closed ranks behind Rossello but said that he would continue to fight for Federal legislation to address Puerto Rico’s fiscal situation. A key advisor, however, said that this might not include urging the House to pass H.R. 5278.
Even if the House passes PROMESA, it faces an uncertain future in the Senate, with several senators of both parties harboring reservations or expressing opposition before the primaries. Democratic presidential candidate Bernie Sanders (D-VT) has pledged to block passage and sponsor an alternative.
With 69.25% of polling places reporting as of this morning, Sanders had received 37.5% of the vote in the Puerto Rico Democratic presidential primary with Hillary Clinton having 59.4%. The bill was also the major issue in their contest with Clinton expressing concerns about the power of the control board and provisions concerning pensions, retirement accounts of individual bondholders, and pay of workers in Puerto Rico. Clinton won 68.5% of the vote in Puerto Rico against a much stronger campaign by fellow Senator Barack Obama in 2008.
Puerto Rico Economy Continues to Weaken
Puerto Rico’s economy was 1.9% smaller in April than it was a year before, according to the territorial Government Development Bank’s Economic Activity Index. The measure, which has a high correlation with the islands’ Gross National Product, edged down 0.1% from March to April. The slide since last July’s beginning of the territory’s fiscal year was 1.3%.
Cement sales were the major drag on the economy, falling 13.3% over the year. Cement is used is most construction in the islands. Gasoline consumption was the only economic indicator that registered an increase. It grew 2.9% during the year.
Leading economist Joaquin Villamil also pointed out this weekend that the manufacturing Purchasing Managers Index fell 5% during the first quarter of this year from the same period the year before, while government revenue increased 5.4% because of greater taxation.
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Off Balance Sheet Hell

Join our Larry McDonald on CNBC’s Trading Nation, Wednesday June 8, at 2pm.

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The explosion of off balance sheet financing in China is creating Lehman like risk across Asia’s financial system.

U.S. equity investors must keep an eye on China.  The last two elevator shaft drops in the S&P 500, 12% last August – September and 14% in January – February, both had there genesis in China.

“The regions face high levels of contingent liabilities.” Moody’s

“Off balance sheet financing increases uncertainties.” S&P

Year-to-date, there have already been 71 downgrades by S&P Global Ratings and 150 by Moody’s.

China Off Balance Sheet Financing*

Q22016: $300B

Q12016:  $160B

Q42015: $230B

Q32015: $230B

Q22015: $140B

Q12015: $0

*local government bond issuance surges to a fresh record high

Shadow Banking 2.0

An Evil Thirst for Yield

Lets not forget, from December 2001 through November 2004, the Federal Reserve kept rates between 1% and 1.75%, down from 6.5% in 2000.

Fed Funds

The net result?  Trillions of dollars flowed into shadow banks in the USA as investors sought higher yields.

The same thing is playing out today in China.

Cost of Default Protection on China

China CDS

Direct sales of local government bonds have surged to a record 2 trillion yuan ($304 billion) since March 31, up from 906 billion yuan in the first quarter, fueled by a program to swap expensive debt for cheaper municipal securities. Moody’s Investors Service and S&P Global Ratings say that while municipal notes are a more transparent way of raising money than the previous practice of using private financing vehicles, the concern is that authorities are still resorting to off-balance-sheet funding methods.


The Global Epicenter of Risk

2015-16: China / Asia

2010-12: Europe

2006-8: USA

One of our classic systemic risk indicators is found in global banks positioned near the epicenter of risk.  Standard Chartered is a leveraged bank with a high concentration of risk focused on Asia.

Stan Chart

“Our negative outlook on the Chinese sovereign ratings reflect both slow economic rebalancing and growing financial risks,”

“Non-government debt is still growing relatively quickly and off-balance-sheet financing increases uncertainties in the financial system that could worsen the impact of any potential economic or financial shock on China,” 

S&P Global Ratings

Cost of Default Protection on Indonesia and Malaysia

Malaysia Indonesia

Our trade ideas focused here include….

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