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China Syndrome? Is Evergrande A Symptom Of Deeper Malaise

China Syndrome? Is Evergrande A Symptom Of Deeper Malaise

Authored by Bill Blain via,

“If that’s true, we are very…

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This article was originally published by Zero Hedge

China Syndrome? Is Evergrande A Symptom Of Deeper Malaise

Authored by Bill Blain via,

“If that’s true, we are very close to the China Syndrome ”

Evergrande’s imminent default is rocking markets – but few believe the collapse of a Chinese property developer could trigger a global financial crisis. What if Evergrande is just a symptom of a deeper malaise within the Chinese economy and its political/business structures? Maybe there is more at stake than we realise? What if Emperor Xi decides he needs a distraction?

Amid this week’s market turbulence, and the overnight headlines, Evergrande dominates thinking this morning. The early headlines say the risk is “easing”. Don’t be fooled. S&P are on the wires saying it’s on the brink of default and is unlikely to get govt support. It’s Asia’s largest junk-bond issuer. Anyone for the last few choc-ices then?

The market view on the coming Evergrande “event” is mixed. Some analysts are dismissing it as an internal “China event”, others reckon there may be some systemic risk but one Government can easily address. There is some speculation about “lessons” to be learnt… There are even China supporters who reckon its proof of robust China capitalism – the right to fail is a positive!

I’ve got a darker perspective.

The massive shifts we’ve seen in China’s political/business public persona over the past few years have been variously ascribed: a reaction to Trump’s protectionism, China taking its place as a leading nation, Xi flexing his military muscle, and now a clampdown on divisive wealthy businesses to promote common prosperity.

What if Evergrande is just a symptom of something much deeper?

That that last 30-years of runaway Chinese growth has resulted in a deepening internal crisis, one that we barely perceive in the west? What if the excesses that have spawned Evergrande and the illusion every Chinese can afford luxury flats and a western standard of living is about to implode? Crashing oriental minor chords!

The looming Chinese property debacle will be fascinating, but it many respects will be similar and yet very different to the multiple market unwinds we’ve seen in the west. How it plays out will have all kinds of implications for growth, speculation and how global investors perceive China in the future. Folk are variously describing it as China’s Lehman Brothers, or the next “Minsky Moment” when speculation ends with a sharp jab of reality to the kidneys.

I’m thinking back to a story I read a few years ago about the Shanghai Auto-fair pre-pandemic. Evergrande New Electric Vehicles had the largest stand and was showing off 11 different EVs. Not one of these were actually available to buy – they were all models of as-yet unproduced cars. The company was valued at billions and yet never sold a single vehicle. This morning, it’s just another worthless business Evergrande is trying to flog. (See this story on Bloomberg TV: China’s Zombie EV Makers.)

The market is asking itself a host of questions about Evergrande’s collapse: How bad will its tsunami of Chinese contagion deluge global markets? When it’s going to happen? What knock-on effects will cascade through markets?

Perhaps the most important question is: Who will be exposed “swimming naked” when the Evergrande tide goes out? Who will be left with the biggest losses? As the company is definitely bust, these losses rather depend on just how China’s authorities respond.

Step back and think about it a moment – try putting these in context:

  • Fundamentally all business is about identifying a consumer need and filling it.

  • Fundamentally, greedy businessmen tend to get carried away because the political-financial system enables them.

  • Fundamentally, it’s just another burst bubble and who cleans up the mess.

  • In Evergrande’s case a thousand flowers of capitalism with Chinese characteristics grew into an unsustainable business – fundamentally no different from debt-fuelled sub-prime mortgages, or CDOs cubed, in the West.

The big difference this time is its China! China has done things… differently. The path China pursued in its recovery and growth since 1980 has not been without… consequences.

Thus far we’ve praised China for its spectacular growth and the creation of valuable companies under the red banner of Chinese capitalism. It is going to be “interesting” to see how the subsequent mess is cleared out. Questions about Moral Hazard are going to be shockingly simple – Government has made it abundantly clear that any wrongdoing by company executives will be punished in the harshest possible way.

More importantly, Chinese politics and business works on a very different playing field to the west. Forget the rule of law or the T&C’s of Evergrande bonds. It easy to dismiss and characterise the way Chinese business works as institutionalised systemic corruption – but it’s a system Ancient Roman Emperors would recognise as a patron/client relationship. Emperor Xi’s clients and his princelings will continue to benefit from his patronage in return for their support at his court, and will be protected in a meltdown. The system Xi presides over will have little motivation to intervene to protect western investors who find themselves caught in the Evergrande fiasco.

Where Xi will have to take notice is outside the rich, wealthy princeling cadre which increasingly owns and runs China. There will be massive implications for wealth/inequality among the Chinese people from a property collapse. With a third of Chinese GDP dependent on the property sector, (and about 4 million jobs at Evergrande), the collapse of one of the biggest players, and the likelihood others will follow is much more than just a systemic risk.

Property is a key metric in the aspirations to wealth of the rising Chinese middle classes. The same smaller Chinese investors and savers will likely prove the largest losers from the property investment schemes they were sucked into. These real losses will rise if hidden bank exposures trigger a domestic banking crisis – which apparently isn’t likely (meaning it is..). There are reports of investor protests in key China cities – putting pressure on the govt to act to mitigate personal losses.

Xi’s clampdown on big tech is painted as the Party’s programme to engineer a more socially-equal economy. He has pinned the blame for rising inequality on “corrupt” business practices and has his cadre’s waving books on Xi thought, mouthing slogans about “common prosperity” and “frugality”. These are going to look increasingly hollow if the middle classes bear the coming Evergrande pain, and the Party Princelings continue to prosper.

The really big risk in China is not that Evergrande is going to default – it’s much bigger. If the Party is seen to fail in its promise to deliver wealth, jobs and prosperity for the masses – then that is very serious. China’s host of failed EV companies, an economy still reliant on exporting other nations tech, and a massively overvalued property sector (that the masses still equate with prosperity) all suggest a much less solid economy than the Party promotes.

If the illusion of a strong economy is unravelling – who knows what happens next, but in Ancient Rome the answer would be simple… Blame someone else, and invade..

This could get very “interesting…” and not in a good way.

Tyler Durden
Wed, 09/22/2021 – 08:45

Author: Tyler Durden

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3 Things The Fed Must Do To Normalize Bond Markets

3 Things The Fed Must Do To Normalize Bond Markets

Authored by Brendan Brown via The Mises Institute,

By late in the second decade of the…

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3 Things The Fed Must Do To Normalize Bond Markets

Authored by Brendan Brown via The Mises Institute,

By late in the second decade of the twenty-first century, we could say that the long-term US interest rate market had been dysfunctional for a long time. We could identify the starting point as being the immediate aftermath of the Nasdaq bust and recession of 2000/01. In signalling that the rise in the Fed funds rate would be slow and gradual over a prolonged period (described by central bank watchers as a pre-commitment to a given rate path), the Greenspan Fed put an unusual dampener on long-term interest rates at the time—in hindsight the start of manipulation under the 2% inflation standard and a powerful impetus to the asset price inflation which started to form during that period. Many contemporary market critics, including senior monetary officials, attributed the “artificially low” long-term rates not to their own manipulations in the short-term rate markets but to such factors as the “Asian savings surplus”. Indeed, Federal Reserve speakers stimulated that particular speculative narrative followed widely by carry traders (including prominently the “Asian savings surplus”!) in search of term risk premium to bolster the meagre returns available in the money markets. (It is also possible that the only contained rise of long-term rates at this time reflected widespread concern that present asset inflation would end with a bust and that indeed the long series of Fed rate rises could end in speculative over-kill).

Even so the corruption of signalling in the long-maturity interest rate markets in the early 2000s paled in comparison to what was to occur under the use of the non-conventional tool box in the second decade. And the central bankers added to the corruption by citing the low long-maturity interest rates as evidence that the so-called neutral level of interest rates had indeed fallen. Yes it was a puzzle why ostensibly low long-term rates were not sparking strong growth of capital spending. Central bankers, however, were not ready to embrace the obvious explanation that their monetary manipulations had created such huge uncertainty which discouraged long-run investment spending. In particular, if almost everyone and their dog realized that a wide range of asset prices—including, crucially, equities—had become hot due to the monetary manipulations and that they were likely to crash within a few years, this would surely restrain capital spending especially for long-gestation projects to well below levels which would pertain if the hot prices were for real.

And so the prevailing central bank doctrine became long-term rates were not very different if at all from neutral. Yes, it made sense for central banks to gradually shed their huge portfolios of long-maturity debt built up during the active years of [quantitative easing] QE, but they should be ultra-cautious not to set off a snowball process of rising long-term rates and falling asset prices. Gradual should be the order of the day—or, better yet, glacial. And to match, the rise in short-term rates strictly under the control of the authorities should proceed very cautiously.

There was an alternative to the phoney normalization programme, which in any case could readily implode along the way. This would have been to turn the clock back on interest payments on reserves (permanently zero again as before 2008) accompanied by immediate action to restore the monetary base to a normal proportion of the broader money supply. Yes, long-term rates could well jump under this programme, and there could be some decline in asset prices (from the sugar highs of peak asset price inflation). But the return of reliable signalling could also have gone along with a new robustness in spending, especially capital spending, given no longer the malaise of “artificial” capital prices which could break at any point.

Policy normalization – defined as closing down the non-conventional tool box and restoring a well-functioning price signalling mechanism to the bond market – is in fact multi-dimensional.

  • At the most fundamental level, it requires abandoning the 2% inflation standard – in particular its ignoring of the natural rhythm of prices over time.

  • The second dimension is to get the monetary base back to the pivot of the monetary system. This means no payment of interest on reserves and the supply of monetary base in line with demand as consistent with a non-inflationary path forward.

  • The third dimension is getting the share of long-maturity government debt in the total liabilities of the government sector (including the central bank) back to normal proportion. That can be accomplished over a period of many years.

Action in the second dimension can take place very quickly. The central bankers take their portfolio of long-maturity bonds to the Treasury and exchange them for short-maturity Treasury bills (T-bills). The central bank conducts open market operations in Treasury bills (short maturity) to shrink the monetary base to “normal”. Of course there is much ambiguity about where is normal, and so the process of normalization on this dimension could go along with some considerable monetary turbulence for some time. That is an inevitable consequence of the huge experiment.

The normalization in the third dimension starts from the situation where the Treasury department, looking at the consolidated balance sheet of the Treasury and central bank, admits that years of QE mean in effect that an abnormally large share of government bonds outstanding are in the form of floating rate short maturities. Traditionally such a high proportion of floating rate is seen as exposing the central bank to large political pressure not to raise the short-term rates under their control (because of direct funding cost implications in terms of budget deficit)—even when it suspects that monetary inflation has got under way.

If the central bank buckles under such pressure, then it becomes indeed an important source of tax collections for the government – in the form of inflation tax. One form is the suppression of interest rate income (to below what would be the case under sound money) on Treasury paper – the other is the capital tax (in real terms) on government bonds and monetary base enacted by inflation erosion.

*  *  *

This article is a selection from The Case Against 2 Per Cent Inflation: The Negative Rates to a 21st Century Gold Standard (Palgrave Macmillan, 2018).

Tyler Durden
Mon, 10/25/2021 – 15:40

Author: Tyler Durden

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3 Top Stock Trades for the Week

Editor’s Note: This article is updated weekly to bring you fresh trade ideas.

The risk-on rally is continuing in earnest on Monday. Headlines will…

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Editor’s Note: This article is updated weekly to bring you fresh trade ideas.

The risk-on rally is continuing in earnest on Monday. Headlines will point to the S&P 500 pushing to a new record high, but what traders should find most impressive is the breadth of participation. Buyers aren’t just coming after stocks. They’re scooping up commodities and crypto too. Given the tailwind, this week’s update to the top stock trades gallery features three bullish ideas.

In scouting for the best opportunities, I found a diversified list to give you plenty of options.

First up is a red-hot retailer that has made bank of the post-pandemic economic recovery. Next comes an exchange-traded fund (ETF) offering a path to play a potential year-end breakout in small caps. Finally, we’ll break down a steel company that’s ramping after passing a recent earnings test.

That said, here are the tickers:

  • Dick’s Sporting Goods (NYSE:DKS)
  • iShares Russell 2000 ETF (NYSEARCA:IWM)
  • Steel Dynamics (NASDAQ:STLD)

As always, we’ll do a quick rundown of each chart, followed by an options trade.

Top Stock Trades: Dick’s Sporting Goods (DKS)

Source: The thinkorswim® platform from TD Ameritrade

Earnings growth for Dick’s Sportings Goods has been explosive over the past 18 months. Its best quarter EPS in the year before the pandemic was $1.26. It just reported $5.08. Its share price has reflected the incredible recovery by rising more than 10-fold from last March’s low. Spectators loath to chase will be happy to learn that DKS stock just pulled back 23% from its highs, providing a compelling chance to get in at lower prices.

The daily chart just completed an inverted head and shoulders pattern, confirming buyers are returning. Additionally, today’s 1.5% rally is pushing prices back above the 50-day moving average and suggests now is a smart time to enter.

Implied volatility is high enough to make spreads a better choice than buying calls outright.

Top Stock Trades: Buy the December $130/$150 bull call spread for $5.50.

You’re risking $5.50 for the chance to make $14.50 if DKS stock rises to $150 by expiration.

iShares Russell 2000 ETF (IWM)

iShares Russell 2000 ETF (IWM) with looming breakoutSource: The thinkorswim® platform from TD Ameritrade

If you’re hesitant to chase the S&P 500 at all-time highs, then consider shopping small-caps. The Russell 2000 Index has done nothing for the last 10 months. As a result, we have a long-term trading range that could lead to some serious upside once resistance gets breached. The silver lining of price pausing is it has allowed earnings to play catch-up and stretched valuations to become less so.

Although IWM has been unsuccessful in breaking out of its range, I think it’s just a matter of time. And, with the bullish seasonality of November and December looming, a year-end run could finally deliver what bulls have been waiting for.

Over the past two weeks, small caps have pushed toward the upper end of the range, placing us within striking distance of another resistance test.

I like using bull call spreads to profit from the expected move higher.

Top Stock Trades: Buy the December $230/$240 bull call spread for $4.

You’re risking $4 to make $6 if IWM rises above $240 by expiration.

Top Stock Trades: Steel Dynamics (STLD)

Steel Dynamics (STLD) stock chart with bullish breakoutSource: The thinkorswim® platform from TD Ameritrade

The basic materials sector benefits when inflation heats up. Nowhere has this been more apparent than in the steel industry. Consider the past four EPS quarterly numbers for Steel Dynamics: 97 cents, $2.10, $3.40, $4.96. Talk about an eye-popping profit surge! It’s no wonder STLD has doubled in price this year.

Though the stock didn’t move much after the latest report, prices are now breaking through resistance. We’re also back above all major moving averages, which clears out a lot of potential supply. Volume patterns have been heavily favoring bulls in the wake of last week’s report as well.

To capitalize on the follow-through from Monday’s breakout, consider the following idea.

Top Stock Trades: Buy the December $70/$75 bull call spread for$1.35.

You’re risking $1.35 to make $3.65 if STLD rises to $75 by expiration.

On the date of publication, Tyler Craig was long IWM. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

For a free trial to the best trading community on the planet and Tyler’s current home, click here!

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Author: Tyler Craig

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Precious Metals

Hedge Fund CIO: The Market Knows That The Fed’s Next Rescue Will Be The Biggest Ever

Hedge Fund CIO: The Market Knows That The Fed’s Next Rescue Will Be The Biggest Ever

By Eric Peters, CIO of One River Asset Management


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Hedge Fund CIO: The Market Knows That The Fed’s Next Rescue Will Be The Biggest Ever

By Eric Peters, CIO of One River Asset Management

“I do think it’s time to taper,” said Jay Powell, struggling to be heard above the whir of his magnificent money machine, wet Benjamins flying off the press. $120bln per month. “But I don’t think it’s time to raise rates,” added the Fed Chairman, cautious, haunted by Bernanke’s Taper Tantrum. Way back then, in the Spring of 2013, bearded Ben, the Princeton Professor with one too many PhDs, dropped the hint that maybe, just possibly, he might potentially slow the pace of printing.

Bond prices collapsed. 10yr yields jumped from 1.65% to 3.00% in a flash. That’s the kind of thing that only happens when markets are utterly surprised — a truly rare event. Markets almost always anticipate policy announcements, whether from central bankers or presidents.

Millions of global traders and investors – intellectually and philosophically diverse, intensely focused, triangulating, weighing, placing bets sized according to their conviction, their precious capital at risk, with the most talented deploying the largest sums, exerting the greatest influence – produce humanity’s only true artificial intelligence. A superorganism, as magnificent as it is heartless, vicious to those who oppose its verdict: the wisdom of crowds.

“We need to watch, and watch carefully, and see if the economy is evolving consistent with our expectations and adapt policy accordingly,” explained Powell, doing his best to play the highest stakes game of his career with the weakest hand of any central banker in living memory. You see, for decades, the mega macro-trends of expanding globalization, breathtaking technological advance and favorable demographics, combined to produce a global disinflationary environment.

This allowed central bankers to pursue increasingly aggressive monetary policies to moderate the economic cycle.

Now we find ourselves at a point where central bankers fear making a misstep that sparks a stock and bond market reversal which would force them to come to the rescue in even greater size. The market knows this. And sizing up a tentative Fed, the market in its infinite wisdom taunted the Fed, pushing the S&P 500 to an all-time high. Bitcoin too.

1987: The stock market crashed on Oct 19, 1987. Almost everyone knows this. Ask people to explain why it happened, they’ll tell you portfolio insurance combined with program trading created a structural weakness in market structure so that lower prices produced more selling. Some might blame comments on the preceding Sunday night from Treasury Secretary Baker. They’re probably right. But what most people will forget to mention is that the S&P 500 printed its all-time high on Aug 25, and in its infinite wisdom had fallen 16% before the crash.  

Gulf War I: Saddam invaded Kuwait on Aug 2, 1990. Oil prices soared. Coalition forces from 35 nations assembled forces in the region. On Jan 16, 1991, they struck. The CNN video images remain seared in our memories. Oil futures soared that night, briefly. Then collapsed. Prices closed the day down an unprecedented $10.56, settling at $21.44 which was 10 cents below the August 1, 1990 close (the day before the invasion). As a young trader, I watched in awe as the market destroyed those who over-leveraged themselves to an all but certain outcome.

1994 Bond Crash: Greenspan held rates at 3.00% for 17mths which was plenty of time for financial engineers to construct highly leveraged negatively-convex products to boost returns for those who needed higher yields. The Fed shocked markets in Feb 1994 with a rate hike. Bond prices crashed, with yields surging from 5.85% to 8% in Nov 1994. But despite the cries of surprise, markets had started moving well before the Fed hiked. 10yr yields had already sniffed out the policy shift, sending a quiet signal, jumping from 25yr lows of 5.20% in Oct 1993.

9-11: Only very rarely do terrible things happen when markets are in strong bull trends. When stocks reverse abruptly after a historic rise, it is usually for no apparent reason. Somehow, in some way, the wisdom of the crowd tends to sense approaching doom and prices start falling before something bad happens. Stocks were down 30% from the highs and 1.5yrs into a bear market when the planes hit. And stocks were 23% off the highs and 11mths into a bear market when Lehman went bust. If China invades Taiwan, it is unlikely it’ll happen near all-time highs.

Covid-19: The S&P 500 hit record highs on Feb 19, 2020. A month later, it closed 42% lower. Unlike so many tragedies, the pandemic hit with stocks right near their apex. Even so, the market had been sending signals that something wasn’t quite right. The S&P 500 rallied strongly in January 2020, yet implied volatility failed to decline. In fact, it moved slightly higher. For those who have suffered enough to learn to really listen, such signals are whispers to “watch out.” The market, in its infinite wisdom, is an imperfect crystal ball, but it’s the best one we have.

IPOs: Coinbase went public April 14th. The excitement was extraordinary. Bitcoin hit a record high that day at $64,899. And for so many young traders who have yet to learn how terrifyingly efficient the market is at separating speculators from their money, the immediate decline in Bitcoin prices was terrifying. Three months later, after an avalanche of negative headlines and a move by China to ban crypto mining/trading, Bitcoin traded 55% lower. It made record highs this week as new ETFs went live. And once burned by a reversal from these levels, the market psychology and trading setup is quite different this time around. A new lesson to be learned.

Anecdote: The market is never wrong. The price it produces reflects the collective wisdom of humanity, weighted toward those with the most capital at risk. And because money generally flows to those with the greatest aptitude, the collective judgement resulting from their aggregate bets – reflected in the market clearing price – does a better job than any other forecasting algorithm ever developed. But just because such a system is superior to all others does not mean there are no opportunities to profit. Most make the mistake of taking the market head on, trying to out-forecast it. They find their periodic successes heroic, thrilling. But in time, the odds destroy them. Survivors make money by studying market movements for decades, listening, watching, learning. Reacting to familiar setups. The most fundamental truth in the game is that for every buyer there is a seller. And vice versa.

Before you go short, understand who will sell to you at a lower price in the future. The most reliable future seller is someone who owns something that fails to move higher even though the fundamental news suggests it should rise. When such longs get stubborn and angry that the market starts sliding, the odds rise dramatically that they will eventually puke at much lower prices. The gold market is a candidate for that kind of setup. People bought too much of it in a panic, to protect themselves from inflation after the 2008 QE money printing. They hoped their children would eventually buy it from them at much higher prices.

But inflation finally arrived, and yet gold stopped going up. Now their kids are buying digital assets – they’ll never buy gold. And this also leads to a bullish digital setup. The most reliable future buyers of innovative assets are those who are stubbornly resistant to change even as it manifests, stuck in investments that are underperforming and in companies that are being unseated.

So naturally, they will be the future buyers of digital assets and the infrastructure that they represent.  

Tyler Durden
Mon, 10/25/2021 – 14:35

Author: Tyler Durden

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