The US Treasury market opened well bid in Asia and remains so. Major Asian equity markets all in the red. Trade balance data released in China over the weekend were weak but subject to a variety of distortions but nevertheless caused some angst for investors. GDP in Japan was revised lower,too. Dealers report yen funded buyers in the belly of the curve as well as central bank and Japanese sellers of the short end of the Treasury market.
The WSJ is carrying an article on the probability of more defaults similar to the default last week by the small solar energy company Chaori. The article contains a great analogy by an analyst at Sinolink Securities who states ” It is just like when you find a dead roach in your kitchen. You know there are more around”. There is a tension between instilling discipline in the market and the contagion which could develop if indeed the Chaori default was a seminal Bear Stearns type moment.
Via the WSJ:
Chinese Firm’s Bond Default May Not Be the Last
Some See It as Injecting Some Discipline Into a Swelling Debt Market
BEIJING—The first default in China’s corporate-bond market is unlikely to be the last.
The failure by a distressed Chinese solar-equipment maker to make a bond-interest payment on Friday signals Beijing’s willingness, however tentative, to let some weak companies fall—a move that analysts and investors said could inject some discipline into a swelling debt market long viewed as implicitly supported by the government.
At the same time, the default by Shanghai Chaori Solar Energy Science & Technology Co. also adds to worries over mounting risks in the country’s financial system.
“It’s just like when you find a dead roach in your kitchen. You would know there must be more to come,” said Huang Cendong, an analyst at Sinolink Securities Co., a Chinese brokerage firm.
Shanghai Chaori failed to pay 89.8 million yuan ($14.7 million) in interest on a one billion yuan bond sold two years ago. If relatively small, the amount is part of a mountain of hundreds of billions of dollars that businesses and local governments borrowed during a credit binge that started in late 2008 and falls due this year.
With China’s slowing economy testing a 15-year low in year-over-year growth, concerns about companies’ abilities to repay are rising. A director at the China Securities Regulatory Commission said the regulator “will keep an eye on potential regional and systemic risks” in the wake of Shanghai Chaori’s default.
Some analysts and investors welcomed the default, saying it is a sign that Chinese authorities are beginning to chasten companies and investors after years of bailouts and arranged fixes for financially unviable borrowers.
“It’s a good start,” said Zhang Zili, a managing director at Harvest Fund Management, a Chinese mutual-fund company that manages more than $35 billion. “Unlike a bank failure, which could really freeze up the market, this default is a small test case that could make investors more cautious when buying bonds,” Mr. Zhang said.
After Shanghai Chaori disclosed early last week that it wouldn’t make the interest payment, the yield on five-year AA-minus notes, China’s equivalent of junk bonds, rose 0.05 percentage point to 7.89% on Thursday, the highest level since late last month, according to the most recent information available on ChinaBond, a government website that tracks China’s bond market. Bond yields rise as prices fall.
“If China wants to develop its domestic financial system beyond a bank-dominated framework, then bond defaults have to be possible,” said Brian Coulton, an emerging-market strategist at London-based Legal & General Investment Management, which has more than $700 billion in assets under management. But “the change can cause some volatility and disruption in the near term.”
Borrowing by Chinese companies has risen faster than China’s economy has expanded over the past five years. J.P. Morgan Chase & Co. estimates that overall corporate debt jumped to 124% of China’s gross domestic product in 2012 from 92% in 2008. That exceeds the 81% for the U.S. and is far higher than the 40% to 70% of other emerging economies, according to J.P. Morgan Chase.
While banks remain the most important source of funding for companies and local governments, an increasing share of credit comes from the bond market and so-called shadow lenders—trust companies, leasing firms, pawnbrokers and other loosely regulated nonbank lenders.
Shanghai Chaori is a symbol of China’s growing debt troubles. The midsize maker of solar cells and panels has continued to borrow in recent years even as overcapacity swamped the industry and the company’s losses grew. It booked a loss of about 1.4 billion yuan in 2012, the year it sold the one billion yuan, five-year bond with a variable annual interest rate starting at 8.98%.
In addition to tapping the bond market, company founder Ni Kailu also turned to trust companies. From March 2011 to November 2012, company filings show that Mr. Ni and his daughter, who together owned 44% of the company’s shares, began pledging their shares to a number of trust companies in exchange for funds. The pair kept borrowing money from those companies to pay off existing loans, the filings show. By November 2012, they had pledged all their shares. The company later said it started to experience “serious liquidity problems” at the end of 2012.
Mr. Ni and his daughter couldn’t be reached for comment. Liu Tielong, the company’s board secretary, said Shanghai Chaori plans to pay just four million yuan in interest owed on the bond. “We’ll try our best to pay bondholders as soon as possible but the company also has other debts,” he said.
Zhang Kouzhen, a 73-year-old Shanghai resident, and her husband are among the investors who bought the Chaori bond in 2012, according to Ms. Zhang’s daughter, Shen Wenjie.
Ms. Shen said her parents used to invest in stocks but moved their money into bonds a few years ago because it was a better option for retirees. “The bond was rated AA. AA bonds are supposed to be relatively good, right?” Ms. Shen said. “There was definitely no risk.”
Penyuan Credit Rating Co. originally rated the Shanghai Chaori bond as AA but downgraded it to BBB+ last April. It declined to comment.
Shanghai Chaori avoided a default a year ago after a district government in Shanghai persuaded its bank to defer claims on overdue bank loans, according to the company’s filings. At the end of June, the last period for which such data are available, Shanghai Chaori had failed to pay 12 banks almost 1.5 billion yuan in loans on time.
Beyond Shanghai Chaori, a total of 2.7 trillion yuan worth of corporate bonds and 1.2 trillion yuan worth of high-interest loans extended through trust companies are scheduled to mature this year, according to analysts at Macquarie Capital Securities Ltd.
The FT carries an article in which Bank for International Settlements economists warn of the dangers of forward guidance. The economists believe that the policy can fuel dangerous risk taking behavior and might lead to panics of investors believe the guidance is about to change. The economists believe that central banker fear of such a panic might even lead them to leaves rates longer than necessary fueling even more dangerous behavior.
Via the FT:
Forward guidance threatens to ‘encourage excessive risk’
By Claire Jones in Frankfurt
Efforts by central banks to spur economic recovery by providing guidance on what will happen to interest rates could endanger the global financial system, economists at the Bank for International Settlements have warned.
Investors are being encouraged to load up on risk because they believe forward guidance will warn them well in advance about any rise in interest rates, according to research published by the Basel-based institution known as the central bankers’ bank.
The strategy could also result in rates remaining too low for too long because central banks fear the reaction of markets to any rate rise, fuelling even riskier behaviour.
The guidance, which all four of the leading central banks have undertaken, could raise the threat of “an unhealthy accumulation of financial imbalances”, economists Andrew Filardo, who heads the BIS monetary policy unit, and Boris Hofmann argue. It could also cause panic if investors believe the guidance had changed unexpectedly.
The findings raise questions over the Bank of England’s use of forward guidance.
Mark Carney, the BoE’s governor, made guidance his big idea to revive the British economy when he took over last year. In August, the bank pledged to keep the bank rate at its current record low of 0.5 per cent at least until unemployment fell to 7 per cent. Mr Carney has faced criticism after unemployment fell far more quickly than expected, raising the prospect of rate cuts more than a year ahead of the mid-2016 date implied by the Monetary Policy Committee’s original forecasts.
The US Federal Reserve began using guidance on interest rates in 2008, and the Bank of Japan and the European Central Bank followed suit in 2010 and mid-2013 respectively.
The BIS economists said the perception that the Fed had unexpectedly changed its guidance in mid-2013 was to blame for the turmoil in emerging markets that followed comments from Ben Bernanke, then the central bank’s chairman, that the $85bn monthly asset purchases programme could be reduced.
If markets became focused on certain aspects of guidance, a broader interpretation or suggestion of a change of policy could lead to panic, the economists said. They added: “The global market developments last May and June in response to the Federal Reserve’s tapering communication highlight such a risk.
“In that episode, financial markets fundamentally reassessed the path of future interest rates in the United States, and a global bond market sell-off ensued, along with a break in equity markets and a sharp depreciation of some emerging market exchange rates.”
The economists warned that a more worrying development would be if guidance made central banks so concerned about investor reactions to their communications that they delayed raising rates.
“This could translate into an undue delay in the speed of monetary policy normalisation,” the economists said, adding that this could heighten the threat of asset bubbles.
“The mere perception of this possibility, over time, could encourage excessive risk-taking and thereby foster a build-up of financial vulnerabilities.”
Macroblog is the blog of the Federal Reserve Bank of Atlanta and it often posts cogent and insightful analysis of macroeconomic topics. The bank’s most recent post is an analysis of the state of the labor market which focuses on the broader U6 measure of unemployment. The article notes the those who move from that broader series into the work force still have a very difficult time finding work as only 10 percent of those who move into the labor force find a job within a month.
Something called Coupons.com went public with an IPO which raised $168 million. The shares surged post the offering and were up as much as 88 percent from the offering price which attached a $2.2 billion market cap to this firm which lost money last year and had sales of $168 million last year.
This is just another in a long list of stupid valuations. I hope this ends soon while I blog because I love the smell of napalm in the morning.
Via the WSJ:
Coupons.com Shares Nearly Double in Debut
The Coupon-Providing Website Valued at About $2.2 Billion
Steven Boal started Coupons.com Inc. COUP +87.50% in 1998 but didn’t take it public during the dot-com frenzy. Sixteen years later, amid the hottest market for IPOs since the dot-com days by some measures, the digital discount distributor is finally stepping out.
Coupons.com CEO Steven Boal on the trading floor of the New York Stock Exchange on Friday. Reuters
On its first day of trading Friday, the Mountain View, Calif.-based company’s shares jumped 88% to $30, nearly doubling their $16 initial price.
The IPO raised $168 million for the company, and after the first-day “pop,” Coupons.com has a stock-market value of about $2.2 billion.
Coupons.com is no longer just a dot-com. It has tapped into a surge in investor demand for “enterprise software” companies. Coupon.com’s software is sold to retailers and manufacturers of consumer goods, which use it to distribute coupons through the Web, mobile devices and social media.
Mr. Boal, who once worked in derivatives-trading technology at J.P. Morgan Chase & Co., co-founded Coupons.com with his wife and another business partner. Their first big expense was $1.3 million, plus some of the equity in the company, to buy the Coupons.com domain name.
“Blind ambition” stopped Coupons.com from going public in the late ’90s, Mr. Boal said Friday. The founders eschewed venture-capital money because it would come with pressure to expand quickly. Instead they funded the company with their own money and with investments from friends and family.
They wanted first to build a big enough platform to handle potentially billions of transactions. In the early days, the company’s website crashed after a local TV station featured it.
Once the dot-com IPO market dried up in 2000, it took Mr. Boal over a decade—”much longer than I expected”—to convince enough big packaged-goods makers to adopt an online platform on a large scale that would give Coupons.com the size needed to go public. The coupons distributor now counts Campbell Soup Co. CPB +0.43% and Procter & Gamble Co. PG +0.41% among its clients.
Mr. Boal, who serves as CEO, said that having an established customer base was the major difference between today’s IPO market and the dot-com era. “Today, you really have to have a foundation around your business,” he said. “You can’t make up for a bad business model with free shipping anymore.” Post-IPO, Mr. Boal has a 9% stake worth more than $200 million.
The U.S. IPO market has surged in 2014, with the 46 deals so far matching the pace set in 2007, which was the best start to a year since 2000, according to Dealogic. There were also 56 new IPO filings through February, the best pace since 2000, according to Renaissance Capital LLC, an IPO research and investment firm.
Other online discounters have had mixed success after going public. Daily-deals company Groupon Inc. GRPN +0.94% jumped 31% on its first day of trading in 2011, but its stock is now down 57%. RetailMeNot Inc., SALE +1.40% an online-shopping discounter, is up 108% since its IPO last July.
In 2013, Coupons.com recorded $168 million in sales, an increase of 50% from the prior year, on 1.3 billion revenue-generating transactions, up 43%. The company posted a loss last year, $11.2 million, though it was profitable in the fourth quarter, which Mr. Boal attributed to a pickup in the holiday season.
Analysts will look to see how well it retains big-brand customers over time. “Consumer-packaged goods brands tend to spend their budgets on a campaign basis, rather than on a recurring basis,” said Rett Wallace, founder of Triton Research LLC, a private-company data firm. “This makes the business hard to win, and hard to keep.”
This is a rather lengthy article from private intelligence and analysis firm Stratfor. It delves into the process of imposing trade sanctions on Russia and what is necessary to make the action meaningful.
As the standoff between Russia and the West continues over Ukraine, the United States is considering enacting trade sanctions against Russia. However, there is little Washington can sanction that would affect Moscow significantly, unless the White House takes the drastic and unlikely step of banning U.S. firms from working with or in Russia.
Any sanctions regime would require Europe’s participation if it is to pose a meaningful threat to Russia, and enacting real trade sanctions against Moscow would hurt many Europeans as well. Washington will probably have to act on its own if it moves forward with sanctions.
What Can the United States Do?
The Possibility of Allied Sanctions
Russia’s Potential Response
The Wall Street Journal has a long story on the tired bull market in equities. The article notes that stocks are not cheap anymore and the future capital appreciation will need the support of growing corporate profits. The equity market needs to shift to a market supported by company fundamentals rather than by the raging torrent of QE liquidity.
Via the WSJ:
To Continue Gains, Stocks Are Liable to Rely More on the Economy Than Fed Support and Need Higher Corporate Profits
Hitting Bottom: Traders work on the floor of the New York Stock Exchange on March 9, 2009. Reuters
As the bull market turns five years old, stock investors have a lot to celebrate.
The Dow Jones Industrial Average has soared 151% since stocks bottomed March 9, 2009, following the financial crisis. That ranks it fifth in gains among the 32 bull markets since 1900.
It also is tied for fifth-longest-running, in trading days, with the one that ended in 2007, according to Ned Davis Research.
If the current stock advance lasts another 16 trading days, it will be the fourth-longest, surpassing the one that ended in 1987.
The Nasdaq Composite Index is up 242%, and the Russell 2000 small-stock index is up 251% in that time. A bull market is commonly defined as a gain of at least 20% from a market low.
But this bull market is showing its age. The Dow, which rose 30.83 points Friday to 16452.72 on stronger-than-expected job-creation news, is down 0.7% this year. The S&P 500 is up just 1.6% this year, although it closed Friday at a record 1878.04, up 1.01 points.
The question now is whether the still-soft economy can push stocks higher as the Federal Reserve slowly ends the multitrillion-dollar stimulus program that has supported stocks for so long.
The widespread expectation is the bull market isn’t over but will rely increasingly on improvements in the economy rather than Fed support. Many money managers believe the character of the market is changing. “The stock market doesn’t look like it is going to get year after year of double-digit growth as it has in recent years, but the bull market can continue as long as you get continued economic growth pushing stocks higher,” said Russ Koesterich, chief investment strategist at investment firm BlackRock Inc., BLK -0.10% which oversees $4.3 trillion.
But further gains are far from guaranteed, Mr. Koesterich added. Stocks no longer are cheap by historical standards. For them to keep rising, U.S. corporations must push profits higher at a time when profit growth has slowed. An economic glitch or a sudden upswing in interest rates could put an end to the stock gains.
The S&P 500 now trades at 16 times its component companies’ earnings for the past year, according to FactSet. That is double its level of five years ago and almost identical to the level at which stocks peaked and began their decline in October 2007.
A broader measure of stock prices developed by Nobel-prize-winning Yale economist Robert Shiller measures the S&P against a 10-year average of earnings. It puts the S&P at 25 times earnings, far above the historical average of 16.5 but not quite back to the 27.5 hit in 2007.
If you perfectly timed the market, and got in at the very bottom five years ago, how much would at 10K investment be worth now? WSJ’s Jason Bellini reports.
These measures show that stocks are riskier than before but don’t tell what stocks will do next. Stocks can remain expensive for years. Mr. Shiller’s measure, for example, was at its current level in 2003 and moved higher and lower for four years before the bull market ended in 2007.
The problem is that the market faces three big hurdles: expensive stocks, a slowing pace of earnings gains and profit margins so high they are having trouble rising, said Scott Clemons, chief investment strategist of Brown Brothers Harriman Private Banking.
“That means there is no margin of safety in any of those things,” said Mr. Clemons, whose firm oversees $28 billion. The volatility with which stocks began the year could continue. “I think we will have multiple 5% to 10% corrections in the next 12 to 18 months,” he said. He expects the S&P 500 to finish the year with a gain, but only by 6% to 8%, including dividends. That compares with a 32% rise last year, including dividends.
The stock market’s biggest driver so far has been the Fed’s determination to keep the economy out of a depression and heal the wounded financial system. The central bank cut overnight interest rates almost to zero in 2008. Then it pushed down longer-term market rates by buying bonds in the open market, spending more than $3 trillion since 2008.
Now the Fed is slowly trimming those bond purchases and is on track to end them entirely in the autumn. Its next step will be to gradually let short-term rates return to normal, ending years of exceptional intervention.
Because those who bet against the Fed have lost, few professionals now predict a bear market, meaning a sustained decline of 20% or more. If the economy and financial markets falter, many think the Fed will intervene again.
This optimism has boosted stock demand among former skeptics, both ordinary individuals and people at institutions with money to invest.
Ed Green, co-chief investment officer at Foster Group in West Des Moines, Iowa, has a new not-for-profit client whose money was in cash. Mr. Green began gradually moving half to stocks. Late last year, with stocks up strongly, the client asked to move new money into stocks faster, he says.
Individual investors, once the stock market’s backbone, also have begun returning.
Investors put more than $100 billion a year into U.S. stock funds for six consecutive years starting in 1995, according to Lipper Inc. But after the 2008 crisis, they withdrew more than they invested in 2009, 2011 and 2012. Now, some are returning.
Last year, U.S. stock funds received $172 billion, the highest annual net inflow on record. Flows to U.S. stock funds have continued this year, at a slower pace. Net flows to bond funds, widely perceived as safer but less lucrative, surged after the financial crisis but now have declined in size.
“We are returning to a more normal market, with more normal volatility,” says Mr. Koesterich of BlackRock.
Earlier today I wrote a piece entitled “Asset Allocators ” and described the demand for bonds which would flow from pension funds and insurance companies next week in the refunding process. Some of those end user clients have huge gains in their equity portfolio and on any back up in rates they sell some of their equities and buy bonds. In my earlier post I reported how several traders with whom I spoke today had seen evidence of that flow and expected it to continue next week.
Merrill Lynch research has just published a piece which is an excellent synopsis of that process and how they believe it will impact financial markets in 2014.
Via Merrill Lynch:
- Reverse rotation, redux. Our most important theme this year is that we will see an acceleration in pension money being re-allocated out of equities, into fixed income – i.e. a “reverse rotation” (see 2014 US High Grade Outlook and Retiring the pension deficits). This portfolio shift makes sense as the jumps in stocks and interest rates have significantly improved the funded levels of defined benefit plans, especially on the private side. Given the difficult experience of significantly underfunded pension plans during the post-crisis years, the regulatory requirements for private plans, and the fiduciary duty to diversify we expect that many plans will find it prudent to lock in improved funded levels, or at least de-risk I.e., out of equities, into bonds.
- Selling equities, buying bonds. The 4Q Federal Reserve Flow of Funds data shows that the reverse rotation was alive and well at the turn of the year, as in 3Q and 4Q 2013 US pension funds sold on average $39bn of equities and bought $25bn of bonds per quarter. We expect these numbers to accelerate in 2014, as plans increasingly become fully funded, for a reverse rotation worth at least $200bn, although given the size of the underlying pension portfolios any number is possible. However, the decline in interest rates in the beginning of 2014 represents a step back in terms of average funded levels – for example the average funded level for private defined benefit plans declined to roughly 92% at the end of February from about 95% at the turn of the year. (Page 7)
- Driving credit spreads tighter. As interest rates go back up and the reverse rotation accelerates in 2014, we expect pension demand to help drive credit spreads tighter, especially in the back end of the curve. (Page 8)
- Closing the gap between stocks and bonds. This week marked the first in a multiple week period it will take to close the gap between stocks and bonds, developed over the first two months of the year on US economic weakness and EM uncertainties. Today’s jobs report highlights how we close the gap – upside risk to data as the economy recovers from the cold spell. That drives convergence between rates and stocks as diminished expectations for monetary policy easing compounds the sell-off in Treasuries, while dampening the improvement in stocks and credit. In other words, we are looking for meaningfully higher interest rates and modestly tighter credit spreads