It was an eventful week for indications of the real economy’s (waning) soundness. At 15.2 million annualized, January vehicle sales were the weakest since October 2005 (that followed more than a year of very strong sales). A larger-than-expected increase in weekly initial unemployment claims (356k) pushed continuing unemployment claims rose to the highest level (2.785 million) since late 2005. The ABC/Washington Post weekly Consumer Comfort index sank a notable 6 points this week to negative 33, the lowest reading since the early nineties.
Importantly, this week’s Federal Reserve survey of senior bank-loan officers provided confirmation both that bankers have become much more cautious in lending and that borrowers have lost enthusiasm for taking on more debt. Moreover, any indication of general tightening of bank Credit takes on major significance today due to the seizing up and breakdown of Wall Street finance. Inarguably, what erupted last year in subprime has now evolved into a broad-based and severe Credit tightening. Notably, 80% of banks tightened Credit for commercial real estate lending and better than a third tightened commercial and industrial (C&I) Credit. It is worthwhile excerpting directly from the Fed’s survey:
“In the January survey, significant numbers of domestic respondents reported that they had tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the past three months; the remaining respondents noted that their lending standards had remained basically unchanged. About 55% of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40% in the October survey. Of the thirty-nine banks that originated nontraditional residential mortgage loans, about 85% reported a tightening of their lending standards… compared with about 60% in October…”
“About 60% of domestic respondents…indicated that demand for prime residential mortgages had weakened over the past three months, and 70% of respondents…noted weaker demand for nontraditional and subprime mortgage loans over the same period… About 60% of domestic respondents indicated that they had tightened their lending standards for approving applications for revolving home equity lines… Regarding demand, about 35% of domestic banks…reported that demand for revolving home equity lines of credit had weakened over the past three months.”
“About 10% of respondents -- up from about 5% in…October -- reported that they had tightened their lending standards on credit card loans… About 30% of respondents noted that they had reduced the extent to which such loans were granted to customers who did not meet credit-scoring thresholds… About 15% of domestic banks -- up from about 5% in…October -- indicated a diminished willingness to make consumer installment loans… About one-third of domestic banks -- up from about one fourth… -- reported that they had tightened their lending standards on consumer loans other than credit card loans… Regarding loan demand, about 35% of domestic institutions, on net, indicated that they had experienced weaker demand for consumer loans of all types…”
“About 80% of domestic banks reported tightening their lending standards on commercial real estate loans over the past three months, a notable increase from the October survey. The net fraction of domestic banks reporting tighter lending standards on these loans was the highest since this question was introduced in 1990…”
“In the January survey, one-third of domestic institutions…reported having tightened their lending standards on C&I loans to small as well as to large and middle-market firms over the past three months. Significant net fractions of respondents also noted that they had tightened price terms on C&I loans to all types of firms… Compared with domestic institutions, larger net fractions of U.S. branches and agencies of foreign banks reported having tightened lending standards and terms on C&I loans…”
With Wall Street’s securitization markets basically closed for business and even bank Credit Availability now tightening meaningfully, January’s collapse in the ISM Non-Manufacturing index should have been less of shock to the markets. After all, the services-based U.S. economy is primarily finance-driven, and our financial system is floundering.
The ISM Non-Manufacturing index unexpectedly sank 12.5 points to 41.9 (below 50 indicates contraction), the lowest level since October 2001. Expectations had the index slipping only a point or so to a still expansionary 53. Instead, New Orders dropped more than 10 points to 43.5, while the Prices component dipped ever so slightly to a disconcerting 70.7. Alarmingly, the Non-Manufacturing Employment index sank to 43.9, the lowest reading since the 43.9 registered in the month subsequent to the 9/11 terrorist attacks. This report corroborates the recent dismal jobs report, where “Service-Producing” job growth collapsed from December’s 143,000 (5-month average growth of 138,000) to January’s 34,000.
It is worth noting that, despite the bursting of the technology Bubble, the Non-Manufacturing index remained above 50 (at 50.7) through February 2001. But as Credit problems engulfed the corporate debt market, the Employment component proceeded to drop 6.4 points in 11 months to fall to 44.3 by early 2002. Remarkably – and indicative of breadth and severity of the unfolding Credit Crises – the Non-Manufacturing Employment index sank 7.9 points just last month. Meanwhile, the ISM Manufacturing Employment index declined 4.7 points in two months to its lowest level since September 2003. The Bubble Economy is now clearly suffocating from insufficient Credit. In particular, the unfolding Corporate Credit Crisis has begun to impact jobs, incomes and the overall economy.
It was, as well, an eventful week for indications of the soundness of the U.S. and global financial systems. On the inflation front, major commodities indices (including the CRB and the UBS/Bloomberg Constant Maturity) surged to record highs. Platinum jumped 7% this week to a record on tight supplies and power shortages in South Africa. Lead gained 5%. Copper jumped 7.5% (biggest gain in almost a year), increasing y-t-d gains to almost 16%. Palladium rose to the highest price since 2002. Sugar rose 5% on Friday, and I’d be remiss not to note crude’s 4% one-day surge.
But when it comes to spectacular moves, wheat takes the cake. Prices surged to yet another record high (up 30% y-t-d), as forecasts have U.S. stockpiles falling to the lowest level since 1948. Global supplies are said to be the lowest since 1978. Alarmingly, wheat increased the 30 cent daily limit in Chicago trading for five straight sessions, with Bloomberg reporting this week’s 16% gain as the “biggest in history.” Prices are now up 140% y-o-y. Along for the ride, soybeans rose 4% this week to a near-record ( U.S. inventories at 4-yr low), increasing one-year gains to 80%. Corn prices gained 2% (having doubled in the past two years), also trading at record highs. Production and inventory concerns saw coffee prices rise 5.8% this week to the highest level since 1999. Cocoa gained 3.8% this week (37% 1-yr gain).
The question remains: How much will the Chinese, Indians, Russians, American consumers and others be willing to pay for wheat and other vital commodities? For energy? For stores of value such as gold, silver and the other (increasingly) precious metals in an age of unregulated, unrestrained, unanchored, electronic-based, securities-based, and market-driven global “money” and Credit. With trillions of dollar liquidity sloshing vagariously around the global financial “system”, there is clearly more than ample high-octane inflationary fuel to destabilize markets for myriad essential things of limited supply. And, increasingly, there is talk of problematic margin calls and derivative-related issues impacting commodities trading conditions. The talk is of trading dislocations and nervous “bankers” pulling away from the financing of hedging activities in various markets. Or, in short, we are witnessing a precarious ratcheting up of Monetary Disorder – in a multitude of key markets and on a global basis.
At the Heart of Monetary Disorder, we have a leveraged speculating community increasingly on the ropes. January was a tough month for the hedge fund community. In particular, it appears the (over-hyped) “long/short” (holding both long and short positions) and (over-hyped) “quant” funds had an especially tough go of it. To begin the New Year, last year’s favorite stocks (i.e. technology, emerging markets, energy, and utilities) were hammered, while the heavily shorted sectors have significantly outperformed (i.e. homebuilders, banks, retailers, “consumer discretionary,” and transports). The yen and Swiss franc (currencies traders had shorted to finance higher yielding “carry trades”) have rallied. Even the dollar has rallied somewhat. Many speculators have been (caught) short commodities, having expected negative ramifications from the bursting of the U.S. Credit Bubble. Others have been caught over-exposed to emerging equities and debt markets. And, increasingly, it appears various trades throughout the complex corporate Credit arena have run amuck.
Friday, various indices of corporate credit risk moved to record highs, including the previously stalwart “investment grade” sector. Leveraged loan prices fell to record lows late in the week, as talk of further bank and hedge fund liquidations captivated the marketplace. While the status of the (“monoline”) Credit insurers is now a central focus, behind the scenes there is increasing angst at the prospect for a disorderly unwind of various leveraged trading strategies in corporate Credits and Credit derivatives. “Synthetic” CDOs (collateralized debt obligations) – pools of Credit default swaps and other derivatives – are especially vulnerable and problematic for the system. In short, the Corporate Credit Crisis took a decided turn for the worse this week. There is, with the economy sinking rapidly and the leveraged speculating community faltering abruptly, little prospect at this point for stabilization. The downside of the Credit Cycle is attaining overwhelming momentum.
The Wall Street punditry seems to go out of its way to get things wrong. The latest talk is that the market will simply look over the “valley” and begin focusing on a recovery from what will be, at worst, a brief and mild recession. The relative strong performance of the banks, retailers, homebuilders, and transports is accepted as confirmation of the bullish view. I’ll instead take the view that the recent major squeeze in the heavily shorted stocks and sectors is only further destabilizing and indicative of dynamics troubling to the leveraged speculating community and the Credit system more generally. “Hedges” have stopped working, creating a backdrop of angst and forced liquidations.
Despite last year’s subprime collapse and mortgage turmoil, the leveraged speculating community overall chalked up another stellar year of performance. Actually, the “community” in total likely boosted returns with bets against subprime and mortgage Credit more generally. Certainly, the hedge funds profited nicely from shorts on the financial and consumer sectors. Ironically, the initial stage of the bursting of the Credit Bubble proved a favorable backdrop for many of the major players and the community in general. The deluge of industry inflows ran unabated through much of the year, a crucial dynamic that masked rapidly developing fragilities and vulnerabilities. These flows were surely critical in supporting speculative trading positions away from the mortgage bust.
In particular, I believe the general backdrop delayed a problematic unwind of leveraged and highly speculative positions in corporate Credits (securities, derivatives and other “structured products”). Shorting mortgage-related Credit last year provided a convenient mechanism for hedging corporate Credit and equity market risk. Meanwhile, the combination of profitable (mortgage bust-related) shorts and hedges – in concert with industry fund inflows – emboldened the speculators to press their (huge) bets on technology, energy, the emerging markets, global equities, and other speculative Bubbles. The relative resiliency of the U.S. corporate Credit market and global markets through 2007 played a critical role in delaying impending economic and stock market adjustment.
Well, I believe the dam broke in January. The leveraged players were hit with losses from all directions. Their long positions were immediately slammed with simultaneous bursting Bubbles round the globe. Meanwhile, a rush to unwind positions led to upward pressure on the heavily shorted sectors, only compounding the leverage speculating community’s predicament. Last year fostered an extraordinary dynamic of ballooning “crowded trades,” and January saw the bursting of this multifaceted Bubble.
The leveraged speculating community has suffered the occasional tough month – last August providing a recent case in point. Each time, however, performance quickly bounced back. In true Bubble fashion, each quick recovery from a setback emboldened all involved; industry fund inflows not only never missed a beat – they accelerated. Yet a strong case can be made today that this (historic) Bubble has now burst – that last year was the “last gasp” before succumbing to New Post-Credit Bubble Realities. I don’t expect performance to bounce back, while I do foresee a flight away from the leveraged speculating now beginning in earnest. With “crowded trades” unraveling virtually across the board, marketplace risk is now escalating significantly for leveraged strategies in general. Systemic liquidity issues and dislocated market conditions have created an environment where there is seemingly no place to hide.
Importantly, a leveraged speculating community “unraveling” would prove a death blow for myriad sophisticated trading strategies and risk models, with enormous ramifications for systemic stability. There are unmistakable “Ponzi Dynamics” involved here worthy of a few Bulletins.
Going forward, I expect a foundering leveraged speculating community to be At The Heart of Deepening Monetary Disorder. The initial victims appear the fragile global equities market Bubbles and the U.S. Corporate Credit market. Forced deleveraging of hedge fund corporate debt and derivatives is in the process of creating a massive overhang of securities to sell, in the process profoundly curtailing Credit Availability and Marketplace Liquidity throughout. The ramifications for our finance-based Bubble Economy are momentous. As an economic and financial analyst (as opposed to “fear-monger”), I feel it is imperative to highlight that it is more “technically” accurate to categorize the unfolding scenario in the historical context of an economic “depression” rather than “recession.” This is certainly not shaping up as a short-term inventory-led economic adjustment or “mid-cycle” slowdown. Instead, we have now entered the very initial stages of what will likely prove a deep, prolonged and arduous adjustment to the underlying structure of our Credit and economic systems.
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