Ben Hunt:
Brexit is a Bear Stearns moment, not a Lehman moment. That's not to diminish what's happening (markets felt like death in March, 2008), but this isn't the event to make you run for the hills. Why not? Because it doesn't directly crater the global currency system. It's not too big of a shock for the central banks to control. It's not a Humpty Dumpty event, where all the Fed's horses and all the Fed's men can't glue the eggshell back together. But it is an event that forces investors to wake up and prepare their portfolios for the very real systemic risks ahead.
There are two market risks associated with Brexit, just as there were two market risks associated with Bear Stearns.
In the short term, the risk is a liquidity shock, or what's more commonly called a Flash Crash. That could happen today, or it could happen next week if some hedge fund or shadow banking counterparty got totally wrong-footed on this trade and — like Bear Stearns — is taken out into the street and shot in the head.
In the long term, the risk is an acceleration of a Eurozone break-up, which is indeed a Lehman moment (literally, as banks like Deutsche Bank will become both insolvent and illiquid). There are two paths for this. Either you get a bad election/referendum in France (a 2017 event) or you get a currency float in China (an anytime event). Brexit just increased the likelihood of these Humpty Dumpty events by a non-trivial degree.
What's next? From a game theory perspective, the EU and ECB need to crush the UK. It's like the Greek debt negotiations ... it was never about Greece, it was always about sending a signal that dissent and departure will not be tolerated to the countries that matter to the survival of the Eurozone (France, Italy, maybe Spain). Now they (and by "they" I mean the status quo politicians throughout the EU, not just Germany) are going to send that same signal to the same countries by hurting the UK any way they can, creating a Narrative that it's economic death to leave the EU, much less the Eurozone. It's not spite. It's purely rational. It's the smart move.
What's next? Every central bank in the world will step up their direct market interventions, particularly in the FX market, where it's easiest for Plunge Protection Teams to get involved. Every central bank in the world will step up their jawboning and "communication policy" to support financial asset prices and squelch volatility. It wouldn't surprise me a bit if the Fed started talking about a neutral stance, moving away from their avowed tightening bias. As I write this, Fed funds futures are now pricing in a 17% chance of a rate CUT in September. Yow!
What's the result? I think it works for a while, just like it worked in the aftermath of Bear Stearns. By May 2008, credit and equity markets had retraced almost the entire Bear-driven decline. I remember vividly how the Narrative of the day was "systemic risk is off the table." Yeah, well ... we saw how that turned out. Now to be fair, history only rhymes, it doesn't repeat. Maybe this Bear Stearns event isn't followed by a Lehman event. But that's what we should be watching for. That's what we should be preparing our portfolios for.
Monday, June 27, 2016
Friday, June 24, 2016
Pre-Brexit
Earlier this week, the folks at Stratfor put together a piece on the implications of the British vote and exit. Their view was that the impact would be more in the realm of geopolitical than economic. Here are some of the highlights from that article:
“If Britain quits the European Union, though, it risks disrupting the base of power the bloc has come to rest on. Germany relies on Britain's backing when it comes to promoting free trade in the face of France's protectionist tendencies. France sees Britain as not only a key defense partner but also a potential counterweight to German influence. Removing Britain from the equation would shatter this tenuous arrangement at a particularly dangerous time for the deeply fragmented Europe, when neither Germany nor France is satisfied with the status quo.
Should the "leave" camp win the British referendum, tension would rise between the Continent's north and south. Countries in Southern Europe want to turn the European Union into a transfer union that redistributes wealth from the relatively rich north to the less developed south and shares risk equally among members. Northern Europe, by comparison, is eager to protect its affluence and would agree to share risk only if the bloc assumed greater control over the south's ability to borrow and spend. The regions also disagree on how the European Union should use its funds. Southern Europe advocates generous subsidies for agriculture and development, a view most Eastern European states share, but Northern Europe would prefer to freeze or even reduce the bloc's budget…
The north-south divide would not be the only gulf to widen on the Continent, either. Should Britain leave, the European Union would split between east and west, too. Countries in Central and Eastern Europe see Britain as the defender of non-eurozone members' interests, and many share London's views on the sovereignty of member states. Poland, Hungary and the Czech Republic, for instance, are generally supportive of the European Union but suspicious of Brussels' attempts to interfere with their domestic affairs. In particular, these countries have sympathized with British Prime Minister David Cameron's campaign to give national parliaments more power to block EU legislation. Poland and the Baltic states also see Britain as a critical partner on the issue of Russia, since London has fought for a tough European stance against Moscow in response to its annexation of Crimea. In the event that Britain leaves the Continental bloc, its Central and Eastern European allies may eventually become more isolated from Brussels…
No matter what British voters choose, the damage to Europe has already been done. If Britain leaves the European Union, it would throw the Continent into yet another political and economic crisis, giving Euroskeptic forces greater ammunition against the bloc and voters fewer reasons to defend it. But if Britain keeps its membership, it would have proved to other European governments that it is possible to demand concessions from Brussels while winning support at home. And so, regardless of what happens June 23, Britain has set a precedent that Brussels cannot stop other EU members from following.”
“If Britain quits the European Union, though, it risks disrupting the base of power the bloc has come to rest on. Germany relies on Britain's backing when it comes to promoting free trade in the face of France's protectionist tendencies. France sees Britain as not only a key defense partner but also a potential counterweight to German influence. Removing Britain from the equation would shatter this tenuous arrangement at a particularly dangerous time for the deeply fragmented Europe, when neither Germany nor France is satisfied with the status quo.
Should the "leave" camp win the British referendum, tension would rise between the Continent's north and south. Countries in Southern Europe want to turn the European Union into a transfer union that redistributes wealth from the relatively rich north to the less developed south and shares risk equally among members. Northern Europe, by comparison, is eager to protect its affluence and would agree to share risk only if the bloc assumed greater control over the south's ability to borrow and spend. The regions also disagree on how the European Union should use its funds. Southern Europe advocates generous subsidies for agriculture and development, a view most Eastern European states share, but Northern Europe would prefer to freeze or even reduce the bloc's budget…
The north-south divide would not be the only gulf to widen on the Continent, either. Should Britain leave, the European Union would split between east and west, too. Countries in Central and Eastern Europe see Britain as the defender of non-eurozone members' interests, and many share London's views on the sovereignty of member states. Poland, Hungary and the Czech Republic, for instance, are generally supportive of the European Union but suspicious of Brussels' attempts to interfere with their domestic affairs. In particular, these countries have sympathized with British Prime Minister David Cameron's campaign to give national parliaments more power to block EU legislation. Poland and the Baltic states also see Britain as a critical partner on the issue of Russia, since London has fought for a tough European stance against Moscow in response to its annexation of Crimea. In the event that Britain leaves the Continental bloc, its Central and Eastern European allies may eventually become more isolated from Brussels…
No matter what British voters choose, the damage to Europe has already been done. If Britain leaves the European Union, it would throw the Continent into yet another political and economic crisis, giving Euroskeptic forces greater ammunition against the bloc and voters fewer reasons to defend it. But if Britain keeps its membership, it would have proved to other European governments that it is possible to demand concessions from Brussels while winning support at home. And so, regardless of what happens June 23, Britain has set a precedent that Brussels cannot stop other EU members from following.”
Wednesday, June 22, 2016
Brexit
Courtesy of Stratfor & ETM Analytics:
After June 23, Britain will have a definitive answer to the question of whether it will stay in the union. But the outcome of the vote won't change the fact that the British economy is cyclically and structurally fragile. Nor will it solve, by itself, the problems created by a debt super-cycle, zero interest rate policy, regional stagnation and asset market bubble risk. Europe's banking system is frail, Brexit or not.
The vote does, however, affect perception. A Brexit could create sufficient uncertainty to spark panic in financial markets, even though it would be a mere catalyst rather than the ultimate cause. A victory for "remain," on the other hand, could calm the markets. The latter could offer opportunities to position for a bearish phase of the business cycle and for the negative structural consequences of EU entanglement, including having less flexibility to treat Europe's chronic illnesses.
A Brexit would be more difficult to exploit. Do markets panic, or do they wait patiently to watch how leaving the European Union will unfold? The initial reaction, most likely, will be some degree of panic. In one scenario, this panic persists only for a few days or weeks and then settles down as the slow, measured process of a Brexit begins. Politicians convince markets that it will be a gradual, amicable split. There may have to be a series of joint announcements with the European Union assuring that the transition will be slow, steady and tightly controlled. If panic persists for more than a few days or weeks, however, and if political assurances are unconvincing, then it could begin to expose British (and European) macro fragility rather quickly. The especially destabilizing factor to watch here is that as business cycle risk emerges, markets correct lower and growth slows, so a Brexit would be in line for receiving the bulk of the blame. That could spark further rounds of Brexit panic, causing something of a vicious cycle that precipitates a recession and credit crunch.
Such a recession would be the inevitable cyclical outcome hastened by a Brexit, rather than a fundamental consequence of it. The strategic opportunity here is a long-term one. There is a significant chance that Britain Inc. gets oversold. If the country can move toward sensible economic and financial sector reforms and retain an open, smart immigration policy, it could present attractive re-entry opportunities for investors, especially as a relative play to the medium- and long-term dysfunction expected to prevail in the European Union and eurozone.
Despite the narrative in the mainstream media, a Brexit may not fundamentally hurt the British economy. On the contrary, it offers a medium- to long-term call option on greater economic dynamism and a more efficient and autonomous crisis response mechanism. Also lost in the Brexit noise are the macroeconomic problems Britain faces regardless of the referendum.
After June 23, Britain will have a definitive answer to the question of whether it will stay in the union. But the outcome of the vote won't change the fact that the British economy is cyclically and structurally fragile. Nor will it solve, by itself, the problems created by a debt super-cycle, zero interest rate policy, regional stagnation and asset market bubble risk. Europe's banking system is frail, Brexit or not.
The vote does, however, affect perception. A Brexit could create sufficient uncertainty to spark panic in financial markets, even though it would be a mere catalyst rather than the ultimate cause. A victory for "remain," on the other hand, could calm the markets. The latter could offer opportunities to position for a bearish phase of the business cycle and for the negative structural consequences of EU entanglement, including having less flexibility to treat Europe's chronic illnesses.
A Brexit would be more difficult to exploit. Do markets panic, or do they wait patiently to watch how leaving the European Union will unfold? The initial reaction, most likely, will be some degree of panic. In one scenario, this panic persists only for a few days or weeks and then settles down as the slow, measured process of a Brexit begins. Politicians convince markets that it will be a gradual, amicable split. There may have to be a series of joint announcements with the European Union assuring that the transition will be slow, steady and tightly controlled. If panic persists for more than a few days or weeks, however, and if political assurances are unconvincing, then it could begin to expose British (and European) macro fragility rather quickly. The especially destabilizing factor to watch here is that as business cycle risk emerges, markets correct lower and growth slows, so a Brexit would be in line for receiving the bulk of the blame. That could spark further rounds of Brexit panic, causing something of a vicious cycle that precipitates a recession and credit crunch.
Such a recession would be the inevitable cyclical outcome hastened by a Brexit, rather than a fundamental consequence of it. The strategic opportunity here is a long-term one. There is a significant chance that Britain Inc. gets oversold. If the country can move toward sensible economic and financial sector reforms and retain an open, smart immigration policy, it could present attractive re-entry opportunities for investors, especially as a relative play to the medium- and long-term dysfunction expected to prevail in the European Union and eurozone.
Despite the narrative in the mainstream media, a Brexit may not fundamentally hurt the British economy. On the contrary, it offers a medium- to long-term call option on greater economic dynamism and a more efficient and autonomous crisis response mechanism. Also lost in the Brexit noise are the macroeconomic problems Britain faces regardless of the referendum.
Wednesday, June 15, 2016
Housing
Mark Hanson on the housing market:
”The only difference between leverage in finance and cheap and easy credit and liquidity in bubble 1.0 and 2.0 is that Wall St investors and banks quietly pushed effective rates to the 2’s back then and the Fed took over the job, overtly, this time around.”
and
“If 2006 was a known bubble with housing prices at “X”, affordability never better, easy availability of credit, unemployment in the 4%’s, total workforce at record highs, and growing wages, then what do you call today with house prices at X+ 5% to 20%, worse affordability and credit, higher unemployment, weakening total workforce, and shrinking wages? Whatever you call it, it’s a greater thing than “X”.”
”The only difference between leverage in finance and cheap and easy credit and liquidity in bubble 1.0 and 2.0 is that Wall St investors and banks quietly pushed effective rates to the 2’s back then and the Fed took over the job, overtly, this time around.”
and
“If 2006 was a known bubble with housing prices at “X”, affordability never better, easy availability of credit, unemployment in the 4%’s, total workforce at record highs, and growing wages, then what do you call today with house prices at X+ 5% to 20%, worse affordability and credit, higher unemployment, weakening total workforce, and shrinking wages? Whatever you call it, it’s a greater thing than “X”.”
Tuesday, June 14, 2016
Russia's Dilemma
From Stratfor:
Gorbachev began to see the deep cracks in the system. He publicly denounced his predecessor, dubbing Brezhnev's rule the "Era of Stagnation." Many Soviet citizens considered Brezhnev's administration a time of prosperity and military might that put the Soviet Union on equal footing with the United States. Nonetheless, Brezhnev had set up a structure that could not be sustained in the absence of enormously high oil prices. As a result, the Soviet government was forced to start running a budget deficit and to borrow on international markets — unheard of in previous Soviet eras. In short, the Soviet Union was going bankrupt. Meanwhile, between the brutal and fruitless war in Afghanistan, the Soviet military's downing of a civilian Korean Air Lines flight and the Chernobyl nuclear disaster, the rest of the world was beginning to see the cracks as well…
Putin has fallen into the same trap that lured Brezhnev, then left Gorbachev to pick up the pieces. The Russian system is vulnerable to shocks, both internal and external. It will be able to muddle along for many years to come — much as the ailing Soviet system did in the late 1970s and early 1980s — thanks to Putin's enduring popularity and his cronies' resistance to reform. Still, it is becoming more obvious that, facing problems at home and pressures abroad, Russians in and out of government are starting to consider the country's next stage. Today's decisions will affect the country for decades. The problem is deciding what will take priority…
Though Russia could pull out of its economic slump in a few years, the dearth of foreign investment today will delay large projects, particularly in the oil sector, in the future. Eventually, this will impair oil production. Proponents of liberal reform therefore advocate scaling back foreign military campaigns and conceding on Syria and Ukraine to mend ties with the West and reinvigorate investment in Russia. On the other hand, as NATO builds up on Russia's borderlands, Moscow needs to project a strong military presence, not only to deter further encroachment but also to maintain domestic support. This gives rise to another pressing issue. Russia's military is in desperate need of modernization, and if the Kremlin does not invest now, then the military will fall behind in the long term relative to its peers. But how will the Kremlin finance the makeover — with money taken from its already lean social spending budget or by putting off energy investment?
Gorbachev began to see the deep cracks in the system. He publicly denounced his predecessor, dubbing Brezhnev's rule the "Era of Stagnation." Many Soviet citizens considered Brezhnev's administration a time of prosperity and military might that put the Soviet Union on equal footing with the United States. Nonetheless, Brezhnev had set up a structure that could not be sustained in the absence of enormously high oil prices. As a result, the Soviet government was forced to start running a budget deficit and to borrow on international markets — unheard of in previous Soviet eras. In short, the Soviet Union was going bankrupt. Meanwhile, between the brutal and fruitless war in Afghanistan, the Soviet military's downing of a civilian Korean Air Lines flight and the Chernobyl nuclear disaster, the rest of the world was beginning to see the cracks as well…
Putin has fallen into the same trap that lured Brezhnev, then left Gorbachev to pick up the pieces. The Russian system is vulnerable to shocks, both internal and external. It will be able to muddle along for many years to come — much as the ailing Soviet system did in the late 1970s and early 1980s — thanks to Putin's enduring popularity and his cronies' resistance to reform. Still, it is becoming more obvious that, facing problems at home and pressures abroad, Russians in and out of government are starting to consider the country's next stage. Today's decisions will affect the country for decades. The problem is deciding what will take priority…
Though Russia could pull out of its economic slump in a few years, the dearth of foreign investment today will delay large projects, particularly in the oil sector, in the future. Eventually, this will impair oil production. Proponents of liberal reform therefore advocate scaling back foreign military campaigns and conceding on Syria and Ukraine to mend ties with the West and reinvigorate investment in Russia. On the other hand, as NATO builds up on Russia's borderlands, Moscow needs to project a strong military presence, not only to deter further encroachment but also to maintain domestic support. This gives rise to another pressing issue. Russia's military is in desperate need of modernization, and if the Kremlin does not invest now, then the military will fall behind in the long term relative to its peers. But how will the Kremlin finance the makeover — with money taken from its already lean social spending budget or by putting off energy investment?
Monday, June 13, 2016
Saturday, June 4, 2016
The Greatest
"Impossible is just a word thrown around by small men who find it easier to live in the world they've been given than to explore the power they have to change it. Impossible is not a fact. It's an opinion. Impossible is potential. Impossible is temporary. Impossible is nothing."
-Muhammad Ali
-Muhammad Ali
Friday, June 3, 2016
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