Market panic, gray swans, and a eulogy for the debt-driven Canadian consumer
SEPTEMBER 22, 2011
Market panic as Fed disappoints: Has the famed 'Bernanke put' finally been removed?
The US Fed made the widely expected announcement of 'Operation Twist' yesterday. Earlier, analysts like David Rosenberg warned that unless Bernanke 'shocked' the market with something wildly unexpected, the reaction would likely be very negative. Good call.
In this case, markets had largely anticipated the move, though the size of the announced operation was at the high end of what was expected. Operation Twist will essentially involve the Fed selling a portion of their short-term treasury holdings in order to buy long-term treasuries. In doing so, it will provide a bid for longer-term treasuries, causing their price to rise and their associated yields to fall. Long term interest rates, like the 30 year mortgage in the US, are determined by long bond yields.
In short, it is an attempt to drive interest rates lower, no doubt with the hopes that it will revive the still-ailing housing market in the US and spur consumer spending. The absurdity of this move should be evident when we look at US bond rates in a historical context. Here is the US 10 year, of which the Fed expects to purchase roughly $100 billion dollars worth:
We're already at ridiculously low levels. Consumers in the US have wisened up and are now well into the deleveraging stage. They were not willing or able to take on additional credit to buy crap when interest rates were already at ridiculous lows, but if we can just push them....a.....wee.....bit.....lower....
This is neoclassical economic thinking at its finest. It's absolute lunacy. You can tell from the market reaction just how impressed investors are at the proposed plan.
With the markets realizing that the Fed is looking pretty exhausted and running out of meaningful options, reality has set in. The risk trade is firmly off. The capital flight into the US dollar has pushed it back above parity with the loonie, while simultaneously smacking commodities and stocks.
The loonie is now hovering around 97 cents to the US dollar after diving as low as 95. Those who predicted ongoing strength in commodity prices and a stable global economy have been left eating crow while those who foresaw the commodity weakness on the back of a slowdown in China and an intensifying Eurozone debt crisis are not at all surprised at what's been going on. I stand by my prediction that the loonie will finish the year closer to 90 cents than to parity.
All eyes on Europe while another gray swan takes flight:
Investors continue to watch Europe, and for good reason. Sovereign credit default swaps point to rising mistrust in the ability of several nations, particularly Greece, to meet their ongoing debt obligations. Increasingly, these same swaps, together with inter-bank credit conditions, are suggesting very strongly that things are not well among some of the big European banks. While I also suggested in January that they would be a fantastic short, and they have been, I think that the greater 'gray swan' just took off from China, where there is increasing evidence of a significant slowdown and the unwinding of a credit bubble of epic proportions.
It's worth reminding my readers once again that should China's growth slow from 'outrageous' (10%) to 'robust' (5%), models suggest that this alone will crush commodities to the tune of 40%, kill business investment in central Canada and the east, knock 1-2% off global growth, and all but guarantee a full blown global recession that would be most disastrous in Canada and Australia. The ridiculous growth model in China is about as sustainable as their demand for our industrial commodities, the main reason I suggested that all industrial commodities would get spanked in 2011, with copper as the worst performer. What I have no idea about is how the China unwind will unfold. I'm increasingly fearful of that 'hard landing', which I maintain is of far more concern for Canadians at the moment than what is transpiring in Europe. Time to get out the binoculars and watch this bird in flight. For that, I suggest you have a look at this video featuring renowned China watcher, Jim Chanos.
End game for the Canadian consumer:
With consumer credit growth slowing to levels not seen in 20 years, it was only a matter of time before this began to show up in retail sales. With the new rules limiting home equity lines of credit, and with Canadian consumers so stuffed with debt that they're starting to dry heave, it's no shock that both the year-over-year percent change in consumer credit, and the 3 month annualized change in consumer credit are both running at shockingly low levels:
And of course we've seen the connection between consumer credit expansion and consumer expenditures:
So it should be no surprise that retail sales fell hard last month. I won't bore you with the specifics, but I will direct you to overviews of the data provided by TD, BMO, and CIBC.
It certainly increases the likelihood of an outright recession after Q3 GDP results are in. It's unlikely that manufacturers will be storing up inventory amid rapidly falling sales.
More importantly, it's symptomatic of a general weakness in consumer spending, which we know has grown to contribute disproportionately to our economic growth in Canada:
Weakness in consumer spending will only worsen as the housing market rolls over, wealth effect spending all but dies, and our made-in-Canada credit bubble meets its untimely end. It's a great time to be short leveraged, over-bought, and overvalued assets. Real estate in Canada's bubblier markets is high on that list.
-Ben
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30 Comments
Kaboom. Love the enthusiasm.
Political will is seriously lacking to deal with the current situation in the United States and in Europe. The white knight called China sure isn't coming to the rescue.
I always like Peter Schiff's take on things, he spells it out in layman terms
http://peterschiffblog.blogspot.com/2011/09/operation-twist-will-really-...
Looks like China just got another 5% discount on Canadian homes.
http://i56.tinypic.com/abqgax.png
Or... CAD asset sellers short USD just lowered their net take.
Consumers in the US have wizened up and are now well into the deleveraging stage.
Just the slightest of quibbles with this statement. (And it's not about "wizened".)
US consumers have barely started deleveraging, and to date the vast majority of it has been through defaults, not prudently paying off of debt.
The peak household credit liability was $13.92 trillion. It currently stands at $13.30 trillion, a reduction of a mere 4.6%.
This all came from home mortgages going ka-boom; $10.6 trillion to $9.9 trillion, a reduction of $700 billion. Total net reduction in liability was $620 billion; ex-mortgages consumer leverage has actually increased.
From Denninger: http://tinyurl.com/3gencrs Well worth a read in entirety.
Yes, I know Karl has been ranting like this for years, but I've yet to find a mistake in his math, or to find someone who can give a sensible fact-based explanation of how credit can continue growing faster than GDP without going boom at some point.
I'm pretty sure Ben won't argue with his basic premise.
Yeah, I've heard both sidez of that debate and I'm sure it'z a lot of both. As for 'wizened', that was juzt an awesome typo.
Test post, HTML is acting odd.
Starting a bold.
After a line break does bold continue? Close bold after this.
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There you go, Ben. A line break closes the tag. I thought I had done my preceding comment properly.
Makes it hard to properly format, but doesn't take away from the depth and value of your greatly appreciated analysis.
Here we gooo. Stephen Harper steps up to the plate before G20 meeting this weekend.
CANADIAN PRIME MINISTER STEPHEN HARPER AT A NEWS CONFERENCE IN OTTAWA ON GLOBAL MARKETS:
"The difficulty is this: that we're now at a stage where the uncertainty in global markets is getting to extremely dangerous levels and simply more steps is not what is going to solve the problem."
"In terms of the big question ... of debt and facing up in some countries to the very severe consequences of the measures to deal with that may have, look, what can you say other than 'The longer you wait, the worse the solution becomes'. That's a tough thing to say to people."
http://www.chicagotribune.com/business/sns-rt-us-g20-highlightstre78m002...
With Harper's majority government, Canada Action Plan 3.0 is already pre-approved.
You mention in your post Jim Chanos and the idea of a hard landing for China.
Cooincidentally I had just seen this video before I read your blog.
Stephen Roach on Global Recession, Fed, Europe
http://www.ritholtz.com/blog/2011/09/stephen-roach-on-global-recession-fed
Stephen Roach is Morgan Stanley Asia non-executive chairman
First video of the three:
9:12 he rips Chanos on China
"I don't think Jim has read a macro textbook on anything in his life so you gotta be careful about getting these micro stock guys on here to make a macro call about a big economy like China. Most of the framework that he's used to describe China is factually and analytically wrong."
10:27 "China's not gonna have a crash landing"
Perhaps Roach should talk with "macro guy" Michael Pettis who is forcecasting a hard landing in China. Not right now, mind, but he thinks their investment boom is impossible to unwind in an orderly way.
Every time I hear soft landing I'm disappointed.
China will manage itself much better then the US or Europe in any event. This is a communist government that has the means to impose any intervention or regulation it wishes to. There is no congress or bi-partisan negotiations, rather a few men sit a table and decide the fate of the country. Simple. Jim Chanos
And about those wealthy Asians...
If you understand communism, you will also understand why wealthy Chinese are going abroad to park their wealth out of the country. Chinese cannot own (outright) a home or land in China, it can only be leased for 75 years; they cannot hold money in foreign accounts, they do not have RRSPs or 401ks. These are just some of the laws and regulations Asians try to work around by any means necessary.
So if you wonder why they bid like crazy on Canadian homes, it's because they don't care about the price and even losing 25% of its value. It's an insurance policy for their wealth.
BTW, Jim Chanos just lost about 40% of his value in Galaxy Entertainment.
I have to say, I'm not a fan of Chanos' views on China. I prefer Rogers.
Less than 8% growth in China is effectively a recession. They need that much growth to keep unemployment down.
China is an ancient country. It will do what it has to do to survive and it will throw the rest of the world under the train if need be.
" It will do what it has to do to survive and it will throw the rest of the world under the train if need be"
I think there will be lots of "under the train throwing" going on. The answer China knows all too well is if it takes its marbles and goes home, it's booking a guaranteed recession and the developed world will carry on.
I'm sensing a whole lot of protectionism mantra coming out of the US recently, in part because of foreign monetary policy creating huge current account flows and distorting trade terms. Protectionism is not good news for export countries; the US is grasping at anything it can to get unemployment down. That's some serious "throwing" going on.
Hi Colin
A couple points to consider:
Chanos is advocating an outright crash in China, which I'm not sure I entirely believe. Nevertheless, many economists are concerned of a slow down in China, which would very likely crush commodity prices.
China is a massively complex and opaque economy. Nevertheless, we do know that fixed investment drives their economic growth. How that's sustainable when it's being used to encourage speculation in the housing market and to build empty cities is a huge, huge question that even the best macro folks are wrestling with.
All in all, I'm firmly of the belief that the China growth story is very over-rated, and I'm very concerned with the implication of a slowing China on commodity producing nations like Canada.
Talking about predictions, here are the ones from GEAB (I talked about them a few weeks ago on this blog). These guys have been right 80% of the time.
(...)
The politico-financial « perfect storm » of November 2011
So, in November 2011 the United States will brace itself for a politico-financial "perfect storm" that will make the summer problems look like a slight sea breeze. The six elements of the future crisis have already come together (32):
. the "super committee" (33) responsible for deciding budget cuts on which there was no agreement this summer will prove incapable of resolving the tensions between the two parties (34)
. the automatic budget cuts required to be made in the absence of agreement will result in a major political crisis in Washington and increasing tensions, especially with the military and the recipients of social benefits. At the same time, this "automatic function" (a real abdication of decision-making authority by Congress and the United States Presidency) will generate major disturbances in the functioning of the state system.
. the other major rating agencies will join S&P in downgrading the US credit rating and diversification out of US Treasury Bonds will accelerate, in the knowledge that the United States now depends primarily on short-term financing (35).
. the inability of the Fed to do anything but talk and manipulate stock markets or gasoline prices in the United States (36), now makes any last-minute "rescue" impossible.
. over the next three months the US public deficit will increase dramatically as tax revenues are now already in the process of collapsing under the impact of the relapse into recession (37). In other words the increased debt ceiling voted in a few weeks ago will be reached well before the November 2012 elections (38)... and this is information that will spread like wildfire in the fourth quarter of 2011 ... reinforcing all investors’ fears to see the United States follow Euroland’s example over Greece and force its creditors to take heavy losses.
. Barack Obama’s new plan in the fight against unemployment will have no significant effect. On the one hand, it’s not up to the challenge and, for this reason, can’t rally the country’s energies; and on the other, it will be cut to pieces by the Republicans who will only keep the tax cuts... The only result of which will be to increase the country's debt even more (39).
So for LEAP/E2020, it's a combination of all these elements at the end of 2011 that will trigger this major financial shock ... a kind of final shock thrusting the planet out of the world before the crisis for good. But the world after is still to be built because many futures are possible, beginning 2012. As Franck Biancheri anticipated in his book, the period 2012-2016 forms an historical crossroads. One must try not to mistake the path (40)!
the full article can be found here:
http://www.leap2020.eu/GEAB-N-57-is-available-Global-systemic-crisis-Fou...
The Americans have hardened their position. Low interest rates are here to stay.
Uncle Sam has decided to go full-blown "Terry Shiavo" on the economy - in other words, the comatose patient will be kept on life-support indefinitely, period, full stop.
The reality is that mortgage interest rates in the U.S are still high in comparison with Canadian variable-rate mortgages - almost double in fact. Four percent; and it's all 30-year money!
With American banks reluctant to lend, 20% down-payment requirements floating around and 4% mortgages - it's no wonder the U.S housing market is moribund.
Canadian real estate on the other hand, looks to be in the sweet-spot for a few more years, at least.
I love my investment properties. With the latest inflation figures at 3.1%, my variable rate mortgages with RBC are currently 95 basis points below inflation. Free money! who da thunk-it?
The problem with watching a slow motion train wreck is it is so slow. It is like watching grass grow.
Just the same, it is still a wreck.
Appraiser - Quite possibly the most ridiculous one-sided comment you've made so far. Do you even read Ben's articles?
Do I read Ben's articles? Yes. And when it comes to real estate they're all wrong. That is a verifiable fact.
What's that loud clunking noise I hear?
It's the sound of stock market investors having their asses handed to them!
*facepalm
Keep on trying, junior
"The reality is that mortgage interest rates in the U.S are still high in comparison with Canadian variable-rate mortgages - almost double in fact. Four percent; and it's all 30-year money!"
I agree with Petr, the quote above is possibly more ridiculous than any comment I have read on this blog. On a similar level, the average summer temperature in Canada is still very high relative to variable rates in the States, therefore real estate will crash.
While you losers sit around chewing your nails waiting for a real estate crash to happen - those who have walked the "final 30 steps" understand the situation perfectly.
You may be right Appraiser, and if you're right, it's not for the reason you proclaim. That's what makes you a moron. And if you're wrong, you're the type that will come on here stating that you sold your home before the crash and made a profit. That's why nobody cares about your comments on this blog. It's irrelevant to our analysis.
Investing in a market with 70% home ownership rate puts you in the same investment skill level as the average person. Hardly impressive.
And lastly, if you knew how to measure in real terms, you would have figured out that the purchasing power of your home is losing value and will continue to lose value against real inflation.
"interest rates in the U.S are still high in comparison with Canadian variable-rate mortgages"
I loled at this one. But come on, Canada's economy is just dying for shrewd investors like Appraiser to pull out the old Smith Manoeuvre and retire early. The market is begging him, pleading him, to arbitrage shrewd investments.
Just know what the risks are, is my free and useless advice.
Appraiser has a nominal-head that doesn't know 30yr bonds at 2.68 yield, and CPI running at 3.1 is a real negative rate of -0.3%. If measured with real CPI (probably at 4-6%) then real rates would be negative 2-3% on a 30yr bond!
Look at the US yield curve in nominal vs real over 2 years (CPI 2.1) http://i51.tinypic.com/1zmknth.png
Absolutely ridiculous. The G20 better come out with some huge numbers (in the trillions) to convince the markets that the ponzi scheme will continue for another year or two, otherwise it's game over in the coming months.
I'm still quite dumbfounded by some claiming that interest rates/environment is not acommodative enough.
Houses need to drop down in price considerably before people will be able to afford them. Once an average person needs more then 5y of cash savings to OWN (not mortgage or other gimmick, but to own) a dwelling, I'd consider this unaffordable. I bet if houses would cost 1/2 what they are now, there will be no shortage of investors willing to rent them out for a nice cash flow. Till that time I'll patiently wait.
" those who have walked the "final 30 steps" understand the situation perfectly."
I hope so. I bet the realizations are awful.
Yesterday, a spokesperson for Alberta Treasury Branches said that 'consumer fatique' had hit Alberta. Is the definition of consumer fatigue "becoming tired of spending money that one does not have?" More likely it has to do with exhausting all available credit.
Consumer fatigue may mean credit exhaustion for many, but I think a lot of people do see the light at some point and realize they have too many demands on their pay cheque and decide it might be a good idea to pay a few things off.
OT, but I bet Garth is going to have a good time at the expense of the precious metals crowd tonight. In particular, anyone who listened to little bunnies saying The JPMorgue could be brought down by buying silver on margin is going to be nursing wounds tonight. Ouch!
Anyone buying the dip? Hmmm?
Of course their buying the dip and ironically today is the beginning of Indian wedding season, and I'm sure Indians will appreciate the lower spot price. I'm not sure how much you follow the gold/silver trade but what we're seeing is a mass liquidation of short positions, not longs. This is what happens when you have an over-leveraged paper market (another ponzi scheme) dictating physical supply.Today's COT report confirms commercial (banks/hedge funds) short positions scrambling to cover.