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A Warning Knell From the Housing Market–Inciting a Riot

February 7, 2018

A WARNING KNELL FROM THE HOUSING MARKET – INCITING A RIOT?

  • Global residential real estate prices continue to rise but momentum is slowing
  • Prices in Russia continue to fall but Australian house prices look set to follow
  • After a decade of QE, real estate will be more sensitive to interest rate increases

As anyone who owns a house will tell you, all property markets are, ‘local.’ Location is key. Nonetheless, when looking for indicators of a change in sentiment with regard to asset prices in general, residential real estate lends support to equity bull markets. Whilst it usually follows the performance of the stock market, this time it may be a harbinger of austerity to come.

The most expensive real estate is to be found in areas of limited supply; as Mark Twain once quipped, when asked what asset one should invest in, he replied, ‘Buy land, they’re not making it anymore.’ Mega cities are a good example of this phenomenon. They are a sign of progress. As Ian Stewart of Deloittes put it in this week’s Monday Briefing – How distance survived the communication revolution:-

In 2014, for the first time, more of the world’s population, some 54%, lived in urban than rural areas. The UN forecasts this will rise to 66% by 2050. Businesses remain wedded to city locations. More of the UK’s top companies are headquartered in London than a generation ago. The lead that so-called mega cities, those with populations in excess of 10 million, such as Tokyo and Delhi, have over the rest of the country has increased.

Proximity matters, and for good reasons. Cities offer business a valuable shared pool of resources, particularly labour and infrastructure. Bringing large numbers of people and businesses together increase the chances of matching the right person with the right job. 

…click on the above link to read the rest of the article…

The Risk of a Correction in the Equity Bull Market

January 25, 2018

THE RISK OF A CORRECTION IN THE EQUITY BULL MARKET

  • Rising commodity prices, including oil, are feeding through to PPI
  • Unemployment data suggests wages may begin to rise faster
  • Federal Reserve tightening will continue, other Central Banks may follow
  • The bull market will be nine years old in March, the second longest in history

Since March 2009, the US stock market has been trending broadly higher. If we can continue to make new highs, or at least, not correct to the downside by more than 20%, until August of this year it will be the longest equity bull-market in US history.

The optimists continue to extrapolate from the unexpected strength of 2017 and predict another year of asset increases, but by many metrics the market is expensive and the risks of a significant correction are become more pronounced.

Equity volatility has been consistently low for the longest period in 60 years. Technical traders are, of course, long the market, but, due to the low level of the VIX, their stop-loss orders are unusually close the current market price. A small correction may trigger a violent flight to the safety of cash.

Meanwhile in Japan, after more than two decades of under-performance, the stock market has begun to play catch-up with its developed nation counterparts. Japanese stock valuation is not cheap, however, as the table below, which is sorted by the CAPE ratio, reveals:-

Star_Capital_-_Equity_Valuations_31-12-2017

Source: Star Capital

Global economic growth surprised on the upside last year. For the first time since the great financial crisis, it appears that the Central Bankers experiment in balance sheet expansion has spilt over into the real-economy.

An alternative explanation is provided in this article – Is Stimulus Responsible for the Recent Improved Trends in the U.S. and Japan? – by Dent Research – here are some selected highlights:-

…click on the above link to read the rest of the article…

China–Leading Indicator? Stocks, Credit Policy, Rebalancing and Money Supply

December 14, 2017

CHINA – LEADING INDICATOR? STOCKS, CREDIT POLICY, REBALANCING AND MONEY SUPPLY

Chinese 10yr bond yields have been rising steadily since October 2016. They never reached the low or negative levels of Japan or Germany. 1yr bonds bottomed earlier at 1.76% in June 2015 having tested 1% back in 2009.

The pattern and path of Chinese rates is quite different from that of US Treasuries. Last month rates increased to their highest since 2014 and the Shanghai Composite index finally appears to have taken notice. The divergence, however, between Shanghai stocks and those of the US is worth investigating more closely.

The chart below shows the yield on 10yr Chinese Government Bonds since 2007 (LHS) and the 3 month inter-bank deposit rate over the same period (RHS):-

china 10yr vs 3 m interbank - 10yr

Source: Trading Economics

From a recent peak in 2014, yields declined steadily until October 2016, since when they have begun to rise quite sharply.

The next chart shows the change in yield of Government bonds and AAA Corporate bonds across the entire yeild curve:-

China_Government_vs_Corp_AAA_Yield_Curve

Source: PBoC

The dates I chose were 29th September – the day before the People’s Bank of China (PBoC) announced their targeted lending plan. The 22nd November – the day before the Shanghai index reversed and 6th December – bringing the data set up to date.

The general observation is simply that yields have risen across the maturity spectrum, but the next chart, showing the change in the spread between government and corporate paper reveals some additional nuances:-

China_Government_vs_AAA_Corp_Spread

Source: PBoC

Spreads have generally widened as monetary conditions have tightened. The widening has been most pronounced in the 30yr maturity. The widening of credit spreads may be driven by the prospect of $1trln of corporate debt which is due to mature between now and 2019.

Another factor may be the change in policy announced by the PBoC on September 30th. Bloomberg – China’s Central Bank Unveils Targeted Lending Plan to Aid Growth provides an excellent overview:-

…click on the above link to read the rest of the article…

Is Chinese Growth About to Falter?

September 20, 2017

IS CHINESE GROWTH ABOUT TO FALTER? 

  • The IMF revised Chinese growth forecasts higher in July – were they premature?
  • Retail sales, industrial output and fixed investment have slowed
  • The Real Estate sector is still buoyant but home price increases are moderating
  • Narrow money supply growth has slowed, other parts of the economy will follow

China has long been the marginal driver of demand for a wide array of commodities. In an attempt to understand the recent rise in the price of industrial metals, the strength of Chinese demand is a key factor. The picture is mixed.

The chart and commentary below is taken from Sean Corrigan’s August newsletter – Cantillon Consulting – China: Is the tide turning?:-

China_Money_Supply_-_Cantillon_August_2017

Source: Cantillon Consulting

As Corrigan goes on to say:-

As the deceleration has progressed, the PMI has shown its expected downward response. In due course, company revenues – and ultimately profits – will follow if this is long maintained.

Greater recourse to receivables financing (funded partly by recourse to shadow finance) can delay full recognition of this awhile, but it cannot fail to impair either the magnitude or the quality of earnings as it works through the economy.

At the heart of the credit equation lies the Real Estate market:-

China_Real-Estate_and_M1_-_Cantillon_-_August_2017

Source: Cantillon Consulting

During 2016 property prices in China increased by 19%, new homes by 12.4%, the fastest since 2011, but the market has cooled of late due to government intervention to subdue its speculative excess. New-home prices, excluding government-subsidized housing, gained from the previous month in 56 of 70 cities in July, compared with 60 in June. New Home Sales for August were the weakest in three years at +3.8%, however, investment in Real Estate development increased 7.8% last month – this is hardly a collapse. House prices are still forecast to rise by 6.8% in 2017 with growth driven by continued increases in second and third tier cities:-

…click on the above link to read the rest of the article…

Does the Rising Price of Industrial Metals Herald the Beginning of the Next Commodity Super-Cycle?

September 15, 2017

DOES THE RISING PRICE OF INDUSTRIAL METALS HERALD THE BEGINNING OF THE NEXT COMMODITY SUPER-CYCLE? 

Super-cycle theory

In a 2012 paper for the United Nations/DESA – Super-cycles of commodity prices since the mid-nineteenth century – Bilge Erten and José Antonio Ocampo review the literature on the theory of Commodity Super-Cycles and go on to suggest that the current cycle began in 1999. Here is an extract from their concluding remarks:-

The decomposition of real commodity prices based on the BP filtering technique provides evidence of four past super-cycles ranging between 30 to 40 years. For the total real non-fuel commodities, these cycles have occurred (1) from 1894 to 1932, peaking in 1917, (2) from 1932 to 1971, peaking in 1951, (3) from 1971 to 1999, peaking in 1973, and (4) the post-2000 episode that is still ongoing. These long cycles, which possess large amplitudes varying between 20 to 40 percent higher or lower than the long-run trend, are also a characteristic of sub-indices. Among the agricultural indices, the tropical agriculture exhibits super-cycles with much larger amplitude relative to non-tropical agriculture. The amplitudes of super-cycle components of real metal and crude oil prices are comparable to those of agricultural products in earlier parts of the twentieth century, but they become much more pronounced and strong in the latter parts of the century. The presence of co-movement among non-fuel commodity indices is supported by the correlation analysis across the entire sample, and a marked co-movement between oil and non-oil indices is present for the second half of the twentieth century.

Another important finding of the paper is that, for non-oil commodities, the mean of each supercycle has a tendency to be lower than that of the previous cycle, suggesting a step-wise deterioration over the entire period in support of the Prebisch-Singer hypothesis*. This finding applies especially to tropical and non-tropical agricultural prices, as well as metals in previous cycles. 

…click on the above link to read the rest of the article…

A History of Fractional Reserve Banking–Or Why Interest Rates Are the Most Important Influence on Stock Market Valuations? Part 1

October 16, 2016

A HISTORY OF FRACTIONAL RESERVE BANKING – OR WHY INTEREST RATES ARE THE MOST IMPORTANT INFLUENCE ON STOCK MARKET VALUATIONS? PART 1

William Hogarth – The South Sea Bubble

The South Sea Company was founded in 1711. The company was part of the treaty during the War of Spanish Succession, which was traded in return for the company’s assumption of debt run up by England during the war. The South Sea Company collapsed in 1720.

  • Central banks appear more powerful than at any time in their history – has something changed?
  • Not really – because of their role in government debt management and fractional reserve banking, central banks have always possessed this power

The main driver of stock market performance, since the 1980’s, has been interest rates. It will continue for the foreseeable future. Its influence has increased inexorably over the past thirty years but the mispricing of the market rate of interest has been a distorting and destabilising factor for much longer, in fact, since the invention of the central bank.

In the first part of this article I will look at the development of central banking with specific reference to the Bank of England. In part 2, I go on to suggest that the long run effect of government borrowing, at lower rates than corporate borrowers, increases pro-cyclicality, crowds out more economically productive private investment and, even as it reduces absolute interest rates for all borrowers, drives rates further below the “natural rate” leading to malinvestment.

Part 1, however, is predominantly an attempt to learn from history. You may detect the occasional “inverse déjà vu” – the unconventional monetary policies of the last few years have even more egregious precedents.

A brief history of central banking

Medieval Banking

The Bardi, Peruzzi and Acciaiuoli companies of Florence were the first true banks of the modern era.

…click on the above link to read the rest of the article…

 

Will Japan Be the First to Test the Limits of Quantitative Easing?

June 25, 2016

WILL JAPAN BE THE FIRST TO TEST THE LIMITS OF QUANTITATIVE EASING?

The Japanese stock market peaked in December 1989, marking the end of a period of economic expansion which briefly saw Japan eclipse the USA to become the world’s largest economy. Since its zenith, Japan has struggled. I wrote about this topic, in relation to the economic reform package dubbed Abenomics, in my first Macro Letter – Japan: the coming rise back in December 2013:-

As the US withdrew from Japan the political landscape became dominated by the LDP who were elected in 1955 and remained in power until 1993; they remain the incumbent and most powerful party in the Diet to this day. Under the LDP a virtuous triangle emerged between the Kieretsu (big business) the bureaucracy and the LDP. Brian Reading (Lombard Street Research) wrote an excellent, and impeccably timed, book entitled Japan: The Coming Collapse in 1989. By this time the virtuous triangle had become, what he coined the “Iron Triangle”.

Nearly twenty five years after the publication of Brian’s book, the” Iron Triangle” is weaker but alas unbroken. However, the election of Shinzo Abe, with his plan for competitive devaluation, fiscal stimulus and structural reform has given the electorate hope. 

In the last two years Abenomics has delivered some transitory benefits but, as this Japan Forum on International Relations – No. 101: Has Abenomics Lost Its Initial Objective?describes, it may have lost its way:-

The key objective of Abenomics is a departure from 20 year deflation. For this purpose, the Bank of Japan supplied a huge amount of base money to cause inflation, and carried out quantitative and qualitative monetary easing so that consumers and businesses have inflationary mindsets. 

…click on the above link to read the rest of the article…

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