by Doug Noland
This week marked the one-year anniversary of a historic stock market rally. The S&P500 enjoys a one-year gain of 66.8%. The broader market has fared even better. The small cap Russell 2000 and S&P400 Mid-Caps sport 12-month gains of 90.6% and 87.4%. The past year also witnessed record junk debt issuance and an amazing turnabout in financial conditions. Housing markets may be stuck in the mud, but government-induced reflation has worked wonders for equities, corporate debt and global risk assets more generally.
Long-time readers may have noticed that awhile back I stopped the weekly presentation of bank Credit and asset data. For the record, bank Credit declined $470bn over the past year, or about 5%. I specifically have not emphasized this bank contraction, believing it had become a deceptive indicator of financial conditions. Also luring in those anticipating deflationary conditions, M2 "money supply" expanded just under 2% over the past year. There has been no reason to fret a substandard $200bn one-year expansion of narrow "money," with Treasury and agency securities inflating a couple Trillion and the Fed monetizing a Trillion of MBS.
One year ago, the Federal Reserve held $69bn of mortgage-backed securities. Their hoard now surpasses $1.027 TN. Over the past year, Treasury has run deficits of about $1.5 TN. Our government's "electronic printing press" has dispersed unprecedented purchasing power to households and businesses throughout the economy. The Fed's Trillion dollar monetization has unleashed unmatched liquidity throughout the financial markets.
March 5 - Bloomberg (Wes Goodman): "Investors plowed a record $2.6 billion into global bond funds in the week ended March 3, moving out of money markets to seek higher returns because of the threat of quickening inflation, EPFR Global said... U.S. bond funds drew in $2 billion, attracting cash for a 61st straight week... 'Flows into these funds remained incredibly robust in early March,' EPFR said. 'Cash continues to flee the safe havens of 2006-08.'"
Brazil's Bovespa has gained 84.2% in 12 months, Mexico's Bolsa 86.8%, and Argentina's Merval 140.8%. In Asia, China's Shanghai Composite gained 36.5%, Hong Kong's Hang Seng 70.2%, Taiwan's Taiex 65.3%, South Korea's Kospi 54.4%, Australia's S&P/ASX 200 49.5%, the Thai index 73.6%, the Jakarta Composite 100.2%, and the Ho Chi Minh index 108.1%. In Europe, the Prague stock index has gained 80.8%, Budapest 131.3%, and Russia's RTS index 170.1%. Emerging Market debt spreads (EMBI) were above 730 a year earlier yet closed this week below 300 bps. Mexican bond yields traded to a record low today (4.80%). Over the past year, the South African rand has gained 43%, the Australian dollar 42%, the New Zealand dollar 39.5%, the South Korean won 37.5%, the Brazilian real 34.5%, the Swedish krona 30.8%, and the Canadian dollar 25.6%. The price of crude oil has almost doubled in 12 months, and the CRB Commodities index has gained 35%.
Over the past six weeks of Greek and European debt consternation, emerging debt markets remained notably resilient. Brazil's 10-year dollar bond yields barely traded above 5.3%, while Mexico's yields stayed below 5.2%. Around the world, debt markets hardly flinched. It is also worth mentioning that Greece's bond offering yesterday was three times oversubscribed. They had to pay up somewhat (6.385%), but there was no shortage of bids.
At this point, global reflationary forces appear well entrenched. There is little indicating that the dollar's rally is forcing the unwind of the so-called "dollar carry trade." It is difficult to identify signs of deleveraging and fading liquidity. There are instead indicators pointing to unrelenting liquidity overabundance. If this were an environment with tight global financial conditions, Greece would likely be in a heap of trouble. In a backdrop of risk aversion and deleveraging, Greek contagion would likely be a serious global issue. In some ways, the Greece debt crisis is providing a litmus test for the global risk and liquidity backdrop. At least so far, there is ample confirmation of extraordinarily loose global financial conditions.
After the bursting of the technology Bubble, the Federal Reserve was content to live with mortgage excesses as it worked toward its objective of systemic reflation. The post-Bubble focus was to make sure the bad guys were punished (Enron, Worldcom, Arthur Anderson, etc.) and that accounting rules were significantly tightened up. The causes behind the system's proclivity toward dangerous financial excess - the root of the problem - were so easily disregarded. The Greenspan/Bernanke Fed's overriding objective was to ensure abundant cheap liquidity and foment reflationary forces. I am unsympathetic to Federal Reserve President Jeffrey Lacker's assertion this week that the Fed is "being made a scapegoat."
Today, the Fed's overriding objective - understood in the markets more clearly than ever - remains ensuring abundantly cheap liquidity. This period's bad guys - the bankers - are under the spotlight, as the focus for this round of reform turns to ensuring that the banks are not the instigators of future crises. And I expect the "Volcker rule" to be about as successful as the Sarbanes-Oxley Act when it comes to protecting the system from financial excess and devastating Bubbles.
March 4 - Bloomberg (Rebecca Christie and Phil Mattingly): "The Obama administration's legislative draft of the so-called Volcker Rule incorporated exemptions that may ease the impact on financial markets should it be enacted. President Barack Obama... sent Congress the five-page proposal to ban proprietary trading and block mergers that give banks more than a 10% market share... It also would bar banks from owning or investing in hedge funds and private equity firms. The rule, which is aimed at reducing the risk of another financial crisis, exempts mergers that exceed the market-share limit in cases when a firm acquires a failing bank with regulators' approval. Also left out are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac."
Throughout the post-tech Bubble reflationary period, mortgage Credit expansion was viewed as integral to the solution. Mortgage finance was basically off limits from a regulatory standpoint, with this dynamic providing major impetus for historic Credit and speculative excess. Rather than recognizing an unfolding mortgage finance Bubble as a systemic risk, policymakers were content to feed the excess and look the other way. Of course, a speculative marketplace figured this all out and took full advantage. The government's multifaceted (Fed, GSEs, Treasury, etc.) support of mortgage finance fanned speculative excess and directly fueled the Bubble.
These days, the Administration's watered-down "Volcker rule" - which will likely be diluted to water-like reform legislation in Congress - excludes the government debt markets from proprietary trading restrictions. Government finance is today's unfolding Bubble and, not surprisingly, this Bubble is off limits for regulatory reform. Government deficits are integral to the Bubble, and there will be no serious effort to rein them in. The Fed's balance sheet is a serious Bubble issue, but it also remains untouchable. Treasury, GSEs, and Federal Reserve Credit are viewed as the solution, and a historic Bubble is emboldened and builds momentum.
The markets' perception of "too big to fail" has for years been an integral facet of Bubble dynamics. And despite all the talk of trying to rid the marketplace of this notion, the markets remain more persuaded than ever: the unfolding global government finance Bubble is much too gigantic for policymakers to risk letting it come anywhere close to failing. Massive U.S. deficits and near-zero interest rates ensure a steady flow of finance (newly created as well as an ongoing exodus out of low-yielding instruments) to debt markets around the world. Confidence runs high that ultra-loose U.S. financial conditions will continue to underpin Credit expansions globally. Politicians may talk tough, and they do put on a good show. Meanwhile, markets function with reticent aplomb, knowing they've got policymakers right where they want them.
Doug Noland The Credit Bubble Bulletin PrudentBear.com
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