With nothing much happening in the markets, this edition of the Daily Grail will have its net dispersed over a wider spectrum of events. I hope readers had an enjoyable Christmas. Don't worry about putting on a few pounds, the gym welcomes you on Monday so you start the new year fit as fab.
On a serious note, 2014 has been a relatively positive year for the markets, and events in general despite the slew of negativeness including the 2 downed Malaysian Airliners, the Ebola outbreak that did have the world panicking for a while, massive gains on almost all aspects for the terror group ISIS, and other shenanigans. Don't forget that we saw one of higher variances in central bank policies this year, I don't think we have felt the full brunt of those consequences to come. Maybe 2015 will draw up those curtains. You might not be very aware of this, but quite a number of records were set this year; market related and non-market related.
Regardless of those negatives, we have collectively seen more progress than regress, markets are generally placated and happy. Although I will not write a note on my expectations for 2015 and also a "year in review" for a very eventful 2014, I believe 2014 has sown the seeds for what might be a very interesting year ahead.
US Closes Friday At Record Highs, Sellers On Holiday
The S&P 500 index closed at a record high of 2083 at Friday's close, capping what has been an ebullient Christmas week where equities have historically enjoyed outsized returns relative to volatility. Indeed, the S&P 500 was joined by the Russell 2000 index of stocks and the DJIA (Dow Jones Industrial Average of 30 stocks) to close Friday at their respective record highs.
Trading volumes have been thin across the board, perhaps not so in China where people apparently are told not to celebrate the festivities of Christmas, as markets there remained opened for the entire week. Apart from American markets, the Shanghai Composite surged to a record high this past week. Reason? Mainstream media has been blaring more stimuli from the PBoC. If indeed true, that the PBoC is indeed gearing up for more stimulus come 2015, it would indeed be trying to balance a very tricky scale. Readers will recall that earlier in December, the PBoC reigned in on shadow banking by tightening collateral rules; and now wants to prop up asset prices by introducing more stimulus via other conduits? Seems like some central bankers over there are a little confused on what they actually wish to achieve with their Schrödinger policies.
Fast forward 3 weeks and the PBoC loosens policy yet again. The PBoC was reported to have lowered the non-bank deposit reserve rate to zero; this essentially means non banking financial institutions can create as much loans as they wish to without constraints on reserves. This, together with expectations of further loosening of policies, rammed the Shanghai Composite, for the second day in a row, 2.8% higher to close Friday at 3,158. The Chinese know their way around the lack of a Santa Rally in the West, don't they?
Equity markets aside, other measures of risk including HY credit and inversely the entire yield curve has not been as excited about ending 2014 with a bang. As the chart above illustrates, the real decoupling of HY credit and credit spreads happened late February possible due to a shift in the Fed's language pertaining to policies going forward, and of course the eventual end of a tapering QE program that has been fodder for risk assets since 2009. Credit has inevitably been more sensitive to monetary policy (Fed funds forward rate) than equities have been, but what remains peculiar is the bull flattening treasury curve. What does the long bond know that most other risk assets don't? We should leave that question open until the market fixes itself, hopefully next year.
What is certain however, is that 2014 will go down the books as one of the most consistent streaks of gains for US stocks and leaves 2015 hanging midair as they are set to end 2014 at record levels.
Japan Slips Deeper Into Recession As Prices Continue Their Plight
Across the Atlantic, the slow motion train wreck that is the "Land of The Setting Sun", continues to unfold in a grotesquely and cringe-worthy fashion. Without boring readers with the usually chicanery, here are the gruesome details that we were updated with on Boxing Day. Sheer carnage indeed.
- November housing starts fell 14.3% YoY, more than 13.2% decline expected than worse than October's -12.3%;
- The Tokyo core CPI for November rose by less than expected at 2.3% YoY against the forecast 2.4% and is down 0.1% from October;
- The National core CPI for November fell to 2.7%, inline with expectations but 0.2% under October's print;
- The Tokyo CPI was unchanged at 2.1% YoY for November, while the National headline CPI fell to 2.4% YoY from 2.9% in October;
- The November unemployment rate held steady at 3.5%, matching estimates;
- Household spending decline by 2.5% YoY in November, leas than the 3.8% fall expected, an improvement from October's 4% decline. The sequential figure came in at 0.4%, better than the 0.2% foretasted but down from October's 0.9%. However, this still marked the 8th straight month that real consumer spending has dropped declined YoY since the consumption tax hike;
- Real consumer spending on housing continued to slump in November, down 20.3% from a year ago, marking the largest YoY decline in 3 months. Real consumer spending fell 1.4% YoY;
- Industrial production fell sequentially by a massive 0.6%, versus an estimated 1% increase and was another far cry from October's 0.4% gain;
- Manufacturer shipments were -1.4% lower than in October, marking the first contraction in three months. As a result, the inventory ratio rose 4.0% from October;
- Retail sales missed widely in November, up 0.4% YoY against expectations for a 1.1% increase and down massively from October's 1.4%;
- Real wages for November fell a stunning 4.3%, worse than October's 3% YoY decline. This makes it the largest decline in real wages since the 4.8% decline recorded in December of 1998;
- Average cash earnings fell by 1.5% YoY in November, missing widely on expectations of a 0.5% increase and down from October's 0.2% gain
The absolute stunner remains consumer wage growth, or in this case, wage contraction. Real wages remains the age old indicator for future consumer expenditures because wages less current consumer spending equals savings. If we have understood one thing from the countless prologues, it is that the Japanese are pretty darn good savers.
First of all, readers must understand that much of the consumer expenditure we saw earlier in the year was actually pushed forward due to the VAT hike. The controversial consumption tax hike was something that formed a fundamental part of Abebonics - PM Shinzo Abe's grand fiscal plan to evoke a supernatural recovery in the Japanese economy after decades in the doldrums.
As a result of knowing that goods and services will see higher prices once the tax hike started came about early 2014, Japanese consumers naturally drew from their savings and spent an abnormal sum of money on purchasing just about all they could before everything got more expensive. It is not inaccurate to say that the spike in consumer spending at the start of 2014 was essentially borrowed spending from the future. This was exactly what we saw. Whether this was part of the intended consequences stemming from Abenomics is not out concern.
The tax increase was a massive disrupted both to the Japanese economy and also to vital economics stats. As seen in the charts below, the tax hike had all kinds of effects on nominal and real wages, and of course consumer prices. It is therefore wise to factor in and ultimately exclude the effects arising from the tax hike from economic assessments.
Using prices as a prime example, November's National core CPI slowed to a mere 0.7% YoY when the tax hike effect was adjusted for, versus the 2.7% headline figure. Just by factoring out the BoJ's calculation of a 2% price boost from the consumption tax hike, we start to appreciate the scale of disinflationary pressures pressing on all sides of the Japanese economy. The same can be said for consumption and retail sales. All of these were merely brought forward because of the tax hike.
Shoving powder back and forth doesn't constitute an improvement in Japan's economy. It merely creates a façade of doggy improvements in the former stages of said policies. This also frankly why no one should have been shocked to find that Japan was once again mired in its fourth technical recession in 5 years when it's 3Q14 GDP declined. Output was merely borrowed (for lack of a better substitute), and not created.
Even if we talked about the organic economic situation, prices will continue to face headwinds, and one can bet big that the 2% central banking holy grail headline inflation figure will not be attained anytime soon in 2015. Japan is a major net energy importer, energy prices have crashed and will continue to stay low as I've painstakingly outlined here, here, and here.
In my opinion, prices are only an indication of more central planning idiocy to ensue in Japan as the country edges every deeper into its economic twilight zone. It seems that the the leaders that are so incompetent are leading the populace to a slow slaughter; because very soon Japan won't enjoy the status as the third largest economy of the world. We are seeing a slow motion train wreck as mentioned in the onset of this section.
Doing the same thing over and over again and expecting a different outcome is the definition of insanity in its purest form. As long as Japan continues to chase its own tail, failing to address its fundamental shortcomings, and administering entirely inappropriate economic and financial medicine use to treat cyclical rather than structural maladies that are a legacy issue, continue to bet with the trend; that is to say continue to expect the usual stuff from a boring and soon to be incontinent country.
Abenomics, for all the pomp it has created, has done absolutely nothing to better the state of the real economy. What it has however done, is create multiple layers of faux prosperity through what is known in traditional economics as the Wealth Effect - consumers feeling better off because of higher asset (stocks) prices, and therefore behaving differently than they otherwise would have; spending more as they feel increasingly wealthy due to higher asset prices. We have clearly seen the potency of the wealth effect in America, but Japan isn't America; this positive feedback loop hasn't been triggered yet and will probably never be.
As we've seen, not only has Abenomics created heightened uncertainty and obfuscation amongst Japanese consumers and businesses, it has also led the country down a path of ruin. Readers only need to revert to the above set of charts to remind themselves how worse off Japan actually is than before the grand plan of nothingness was launched in 2012.
The sole beneficiary of all that Japanese madness, and the only thing that matters to traders, is most assuredly Japanese financial assets (namely stocks and bonds). A weak Yen be damned, in fact now that energy and most input prices are falling, the BoJ has all the leeway in the world to weaken the Yen by as much as it wishes, thereby stoking another match of global currency wars that saw much drama is 2010. As one would logically expect then, that Japanese stocks (Nikkei 225, Topix et al) and those infamous JGBs (Japanese Government Bonds) continue to see almost unlimited upside only capped by the level of insanity of the Japan's very own central planners.
The markets on the other side of well-intentioned economists, only wish for the continuity the Necromancer's marching to the anthem of Abenomics, the placebo of a large monetary bazooka. By the looks of it, there should not be an iota of a concern that any of this induced insanity would stop.
Of course, for readers who wish to see even more color in the graying canvas, here is more from Bloomberg and Reuters for your reading pleasure:
Russian Ruble Rebounds Sharply, Inflation Up To 10.4%, Deep Recession Ahead
The once roaring bear has quietened to a whimper as the economic and financial situation in world's largest country (by land mass) looks increasingly dismal following a rout in global oil and energy prices, and heavy financial and trade sanctions imposed on it by NATO nations after it was accused of being directly involved in the still ongoing war in neighboring Ukraine.
Readers will know from our extensive coverage on the developments in Russia (see here, here, here, and here), Russia has just seen the worst economic crisis since 1998 courtesy of a currency that has weakened 50% against the greenback in 2014 alone, isolation from the West, and hyperinflation on domestic soil. However, the Kremlin hardly curls into a ball even when it faces extreme stress from all fronts. Besides the back-and-forth vendetta between NATO and Russia, Moscow has also come out to declare the end of the crisis in the currency.
Recall that on the day USDRUB reached an all time high of around 80, we publicly said that we felt the lows in the ruble (and therefore the Russian stock market) had been carved in. So far, we have been proven right. A day after the worst selloff in the ruble, the CBR (central bank of Russia) accounted 7 drastic measures to stabilize the Russian banking system as well as halt the crash in the currency. Apart from raising its key interest rate to 17% from 10.5% a week earlier, the CBR had also been actively conducting intense rounds of FX interventions by selling foreign reserves (allegedly to have included Gold) that is had accumulated through decades worth of trade surpluses. Readers should not forget that Russia is still an energy giant in the oil and gas market, and especially so in Europe. Low energy prices have put inflicted huge dents in Moscow's position but it doesn't spell the end of its supremacy.
Back to the issue at hand, as a result of its constant FX interventions, Russia's foreign reserves have slumped to below $400bn for the first time since 2009 (adjusted for currency disparities). As bold as Finance Minister Anton Siluanov was when he declared the end of his nation's currency crisis, he also prepared Russians for more economic pain to come. Specifically, he mentioned that the official inflation rate had risen to 10.4% and could reach 11% just before the turn of the year. Actual inflation (prices on the street) is unquestionably higher than the official figure, and is already in hyperinflationary territory.
Besides prices, economic growth is set to worsen further as the full burden of its victimization by NATO and the new low oil price paradigm have yet to be borne. Credit rating agency Moody's said that it expected Russia's output to shrink by 5.5% in 2015. Various rating agencies have threatened to downgrade Russia's credit rating to below investment grade or even to junk status. Russia is reported to be in closed end talks with these rating companies in order to avert said downgrades.
One fact that is not widely mentioned, is that despite the allegations of direct involvements in the violence and ongoing war in Eastern Ukraine, despite the global controversy and condemnation of it's annexation of Crimea, and despite the current economic turmoil, President Vladimir Putin's approval ratings are still at one of the highest they have been. Unfortunately, affairs in Russian politics are always layered with grime, making it difficult to peer much deeper than the surface. Nevertheless, we will continue to cover critical developments concerning Russia.
US Natural Gas Prices Under $3, First In Almost 3 Years
When we say global energy prices are slumping together with crude oil we quite mean it. Sure enough, natural gas (America produces quite alot of it) prices have fallen under $3/mBTU (per million British Thermal Units) during Friday's trading session. Natural gas prices have historically been much more volatile than that of crude oil, and unlike the crude oil market, the gas market isn't globally priced but remains fragmented. For example, prices for the same quantity of gas in America will differ vastly from that of gas in China. This is mainly the result of the difficulties and costs arising from compressing the fuel from a naturally occurring gaseous state to a much denser liquid state; as such gas produced in a continent hardly gets shipped around across oceans. What this essentially means is that there is no one global natural gas market; prices of gas in Europe and Asia have always been higher than in the US.
The main reasons cited for the low prices are over supply, and winter demand that has been over priced into the market. The market had expected normal winter, but forecasts have emerged that this winter would be a milder one, just like we say last December. Whether it not America faces another polar vortex come January 2015 is anyone's guess. Meanwhile, we await the surge in consumer spending by US consumers now that less of their disposable income gets channeled to utilities, on top of the already cheapened prices at the pump.
US Oil Production Estimated To Increase In 2015 Despite Low Prices
Without further beating a partially dead horse, the surprise story to those who have been following the markets, is that US oil production is estimated to surpass that of 2014, according to EIA estimates. This comes on the back of declining oil rig counts amid a new paradigm in the global crude oil market.
American producers are expected to boost production by 300,000bbl/day in 2015, up to a yearly average of about 9.3 million barrels per day. It is easy to forget that the US is the world's largest oil producer, albeit also the largest importer in part due to its gas guzzling culture. The number of oil and gas rigs in operation is already beginning to drop as highlighted by the chart below. For week before Christmas total rig count dropped 18 to 1,875 from 1,893 a week earlier, indicating that exploration companies are starting to reduce investments in prospecting for new fields.
Extrapolating this thesis one step further, we are able to logically correlate oil prices, US rig counts, and the future trajectory of the crude oil market. If the main goal of OPEC is to crowd out US producers (those with higher breakeven costs), then until enough producers have dropped out of production, oil prices should remain low around the region of $50-60 all else equal. Although current prices are a result of both supply and demand, it is apparently clear to us that there is a pathological and objective based strategy at work here. There are veteran analysts in the energy space who also agree that the key to projecting the future performance of oil prices is to watch the rig count figure closely.
The troubles don't stop at producers and explorers themselves. As reported by oilprice.com, offshore and onshore rig producers have been hit has hard if not harder than front line energy firms have been. This again relates directly to capex (capital expenditures) of producers and explorers who are increasingly facing cost pressures and thinking margins.
All still pandering to disinflation...